On 12 February the IMF published a paper by Olivier Blanchard (the IMF Chief Economist from MIT), Giovanni Dell’Ariccia and Paolo Mauro, on “Rethinking Macroeconomic Policy.” The paper re-examines the traditional macroeconomic and financial policy framework in the wake of the recent devastating crisis. It reviews the main elements of the pre-crisis consensus about macroeconomic policy, evaluates what was wrong and what still holds of that consensus and makes a first attempt at re-drawing the contours of a new macroeconomic policy framework. It makes compulsory and compelling reading. Among other points the authors note how, traditionally, central banks have adopted low inflation rates of around 2 percent (like the ECB, just to name names); they argue that such a target should be raised. Interviewed by the IMF Survey Online, on this point Olivier Blanchard explains:
“The crisis has shown that interest rates can actually hit the zero level, and when this happens it is a severe constraint on monetary policy that ties your hands during times of trouble.
As a matter of logic, higher average inflation and thus higher average nominal interest rates before the crisis would have given more room for monetary policy to be eased during the crisis and would have resulted in less deterioration of fiscal positions. What we need to think about now is whether this could justify setting a higher inflation target in the future.”
Such an enlightened argument is not universally accepted. Frankfurt Rundschau reported that a Bundesbank internal paper, on the strength of this policy recommendation by Blanchard et al., launched a devastating attack on the IMF and referred to it as the Inflation Maximising Fund (Eurointelligence.com of 9 April).
The Wall Street Journal of 9 April reports:
Trichet: Some Euro Zone Countries May Need to Accept Deflation (by Brian Blackstone)
“European Central Bank President Jean-Claude Trichet says some countries in the euro zone might have to accept a period of deflation to restore long-term economic growth prospects.
“Some countries, to regain competitiveness, will have to keep inflation below the EU average,” Mr. Trichet told the Italian paper Il Sole 24 in an interview published Friday.
Asked by the paper whether this means “even accepting a period of deflation, with all the possible social consequences this might have?” Mr. Trichet replied: “Yes.”
“It is normal that some regions, after growing above the EMU average for some time, and after having accumulated high national inflation, experience a correction and therefore a period of negative inflation, as it is currently happening in Ireland,” Mr. Trichet said.
The ECB contends that it has avoided deflation for the euro zone as a whole, which is supported by recent data showing annual inflation in the region at about 1.5% in March, though that was probably pushed higher by energy and food prices.”
Let us rejoice that Monsieur Jean-Claude Trichet has not demanded that all the Euro-zone countries should have a rate of inflation lower than the average …
Subscribe to:
Post Comments (Atom)
Posts
12 comments:
It is "enlightenment" that caused the problems to begin with. It was inflation that caused the crisis (not consumer price inflation!), but the remedy according to the IMF is more inflation. Crazy and immoral proposals such as these can only come from those who don't understand how the crises came about to begin with, how money and production work, or how to prevent the next crisis.
Kel Kelly
I agree with your proposition that it was not consumer price inflation that caused the crisis - if you mean that it all started with the asset price inflation associated with Greenspan's monetary expansion and low interest rates.
But once the asset bubble burst, the ensuing credit contraction transmitted the crisis to domestic and foreign trade, to investment and consumption, i.e. to the real sector. Any attempt to contract monetary expansion and cut public expenditure and public deficits can only worsen the recession.
This is why monetary and fiscal stimuli were launched and co-ordinated on a large scale throughout the global economy. And this is what avoided the kind of global depression that took place in 1929-32. We can argue about the exit strategy from such stimuli, but you will find opposition to their introduction very hard to substantiate.
The IMF, or rather Blanchard & Co., recommend that Central Banks might raise inflation targets in order to make monetary and fiscal policy more effective. Have you forgotten Japan, and can you not see and touch liquidity preference today?
Yes, it all started with Greenspan's monetary expansion. (But you said the quantity of money is irrelevant, so I'm not sure why you would agree with this)
A collapse of credit, or merely a reduction in the volume of spending and thus an increase in the demand for holding money ALWAYS causes a credit contraction that affects the rest of the economy--it has for three hundred years. Credit creation through a fractional reserve banking system always creates an artificially heightened level of spending and malinvestments in the real economy, in the areas of the economy that require large-scale capital investments and/or that are interest rate sensitive (since the interest rate is artificially pushed below the market rate). In this round of credit expansion, the money flowed disproportionately into the housing industry. Now, the economy is trying to correct itself, and move capital and labor back to other locations where they would naturally be in absence of manipulation of credit.
But, the public expenditures and deficits that you seem to believe could somehow help, along with yet more monetary inflation, are preventing the needed correction of the imbalances and setting us up for the next crisis (the seeds of this one came from the money being pumped in to stop the 2001/2 crisis.
To argue that another 10+ year Great Depression could come about from a credit expansion and subsequent implosion is to misunderstand what the Great Depression was. The stock market bust of 1929 was in no way related to the ensuing depression, except to the extent that the government stepped in to "help" and caused what would have been a typically sharp, quick recession (as in 1921)to become a depression. The main way it did this was by keeping wage rates artificially high, and preventing them from falling. "Sticky wages" means government-supported/endorsed/created price floors for wages. Prices fell 25%, wages only 15%, therefore, they rose in real terms. That's why there was 25% unemployment (same as our other conversation about unions causing unemployment from demanding too high of a wage). The wage market cleared only when the government put in put in wage ceilings but not price ceilings in WWII. Unemployment was still 17% in 1939. This "help" from the government will have the same effects today. Saying that government spending could somehow help is preposterous (the multiplier is as fallacious as Santa Claus).
Japan today is the result of a monetary boom and bust just like the one we have now (but theirs was derived mainly from U.S. money supply transmitted through our trade deficit). The stagnation is because they did not clear bad investments off the books. Still, they are doing quite well. To understand this you must look at real production, not a superficial indicator called GDPl, which measures nothing but monetary inflation (deflators don't deflate). Pumpoing money into an economy does not help it in the least--it harms it in numerous ways, the most obvious is the creation of booms and busts, which academics, the IMF and the like argue are the means with which to fix it. They say that adding more of the cause of the problem is the solution. They will never learn. Liquidity preference is also a myth—in fact the whole liquidity preference argument is completely opposite to reality.
Now that I think about it, there was not much of a credit crisis, at least in the U.S.: http://www.minneapolisfed.org/research/WP/WP666.pdf
The inflation thing still boggles my mind. What is your argument for what caused high rates of inflation in Italy and the devaluation of the Lira for many years? I assure you that you will find an increase in the money supply. Similarly, during the same time period in West Germany I assure you you will find a less rapidly increasing money supply. Take a look at Iceland's base money growth through the 2000s--that's a boom and bust!
Many thanks for your comments. It is very useful to have such a lucid and full illustration of a strictly monetarist version of economic crises.
Italy had to devalue over and over again precisely in order compensate for its loss of international competitiveness due to its labour costs exceeding those of its competitors. If Greece could devalue, like the UK has done on a grand scale, it would not be in trouble today.
Clearly you are a strict monetarist and I am a Keynesian. Nobody is perfect. Let's agree to disagree.
I forgot to add:
I never said that monetary policy is irrelevant, only that the quantity of money is determined also by the behaviour of the public, and that the relationship between money and prices is two-way and variable.
To say that inflation is a monetary phenomenon is like saying that fever is a thermic phenomenon. It says nothing at all about causes and cures.
It is a common opinion that the financial crisis was caused by the asset inflation brought about by Greenspan's easy monetary policy. I do not agree. The puncturing of inflationary asset bubbles, such as has happened often in the past, has caused usually recessions, not a financial and real economy crisis of the present dimensions. The crucial factors were the extent of the financial deregulation without supervision and constraints and the ensuing incentive perversity in the working of banks and financial institutions. After all it is the mountain of toxic assets that has been the ultimate cause of the credit crunch and of the crisis. The fact that sellers of mortgage loans could immediately cash in the fees, and the banks contracting them did not have a particular interest in the actual solvency of the debtors, because the loans were immediately resold to repackaging intermediaries that would resell them as part of mortgage guaranteed securities to some unknowing far away customers has been of paramount importance. The same applies to the conflict of interest, and incompetence, of rating agencies. It has been a fundamental failure not of only of the financial institutions (and their managers), which were stupid and incompetent to the point of keeping the toxic assets in their own portfolios, but especially of the supervisory role of the government and of the legislation, due to ideology, myopic interests and sheer incompetence.
As to the easy money policy, the judgment must for the moment be suspended. It is true that it has conjured the asset bubble, but it has also brought about a long period of high growth and prosperity for the American and the world economy, without the cost of inflation (as far as the consumer price index was concerned), thanks to the cheap imports from China. Until now, notwithstanding the crisis, probably the results in terms of long run growth accounting have been positive. It is left for the future to see whether, as is probably the case, the long run drag of the resulting high public debt on American and world growth will more than compensate the past good times of easy money.
As to the eurozone, since the exchange rate is irrevocably fixed at one (the currency is the same) the only way to adjust the real exchange rate is through prices and wages. If the wage level in one country or region (no major country in Europe after all is an optimal currency area) renders its real exchange rate uncompetitive, its prices and wages should be allowed to fall in relation to those of its partners. It is doubtful whether a higher inflation could be of much help, unless unexpected: when the inflationary expectations come to be incorporated in wage contracts and price setting, higher inflation ceases to be of much use. In the end, real wages may have to fall in some country (such as Greece or probably Italy) where they have grown too much. And the way is either trough social consensus (say, the German way), income policies conjured, as in the past Italian experience, by dramatic circumstances, or through deflation. The latter in an inflationary context consists in provoking a reduction of inflation and may be eased by money illusion, so long as agents are prone to be illuded, but in a non-inflationary context could require an actual reduction of money wages, with analogous consequence on real wages. The other solution is to change the institutions in order to conjure higher productivity (increasing for instance labour mobility and greater flexibility in the labour market, attacking the wastes in the public sector, and rent-seeking of organized interests), but this requires probably more time and consensus than sheer deflationary policies.
As to the Italian experience of having higher growth of money wages and prices than elsewhere with periodic devaluations, I don't see the merits. Apparently the German way of price stability and lower inflation has produced much better results in terms of employment, real wages and economic growth (not to speak of the public debt).
Regarding Chilosi's comment #1:
Toxic assets do not become toxic on their own, in a vacuum. They became toxic because the underlying assets declined in value. They declined in value because mortgages were suddenly not being paid. Mortgages were not being paid because interest rates rose (i.e., less money was created), making payments too expensive. Also, when the flow of credit was reduced, there was less money available to purchase houses, and most importantly, to push up prices higher.
Housing prices—not to mention asset prices—could not have risen without massive amounts of new money being created. Similarly, new money created the credit to both purchase and finance derivatives—there could not have been the growth in derivatives without new money being created. And created it was—more than $2 trillion in the US in the mid 2000s.
In short, there is no way the housing boom, derivatives implosion, credit crisis, asset collapses, or recession could have happened without credit creation.
Saying that toxic assets is the cause of the crisis is like saying recessions begin due to a lack of spending. You have to ask why there was a lack of spending, what lack of spending actually means, and what exactly would have transpired to bring such a thing about. Merely assigning blame to something in a vacuum does not explain very much.
Further, it is absurd to argue that inflation somehow brought prosperity at any time. Printing paper bills or extending credit does not create real goods and services. Adding fake money to real savings does not help produce more capital goods. Pumping up a meaningless calculation called GDP with inflation and partially deflating it with a bogus deflator does not mean that there has been real economic growth. Real prosperity takes place in the form of falling, not rising prices (which is in no way related to deflation).
Regarding Chilosi’s comment #2
You start off right about wages needing to adjust. But then you go into all sorts of possible manipulation of the economy and government intervention to bring this about. All that’s needed is to let market forces work. The only reason wages would not fall—when too high—is if they were actively being held artificially high by government price floors or by government-enforced union price floors. There is no need for all the academic mumbo jumbo ideas of manipulating economies—that has been tried over and over for 100 years and it hasn’t worked yet—especially in Italy. Markets will work if you will simply allow them. Do deny this is to fail to understand how markets function.
Kel (Klusplatz): the kind of fundamentalist monetarism and hyper-liberalism that you represent is getting rare and rarer in the aftermath of the global crisis of 2008-2009 (and 2010). Conversions to keynesian economics, like that of Richard Posner, are much more frequent instead.
I strongly disagree with your propositions, but I welcome them on my blog not just out of tolerance but precisely because of their rarity value, and above all the total unshakable certainty with which you hold your views. Dubito, ergo humanus sum. But you never entertain any doubt. Are you sure you are not a robot? [no offence meant].
D. Nuti: No offense taken, and none intended with my following response – I’m just stating facts.
Tolerance is appreciated, especially since tolerance of other economic views is shut out by Keynesians in most other aspects (government textbooks, for example). But of course, if you fully believe in your theories and can defend them, you should not feel threatened at all. In fact, I would invite you to prove my certainty-backed hyper-liberalism wrong, and your government-manipulation economics correct, but I fear that neither of us has such time on our hands (but I really wish we did).
Once again, what I speak is not monetarism, but of free markets. There is indeed a world outside of Keynesianism and (the smaller world of) monetarism. In actual fact, those interested in learning how free markets actually work—something not known to Keynesians—has increased dramatically, not decreased. Yes, there have been conversions to Keynesianism from those confused about what happened (http://mises.org/daily/3929 ), even though it is also a school that didn’t foresee the recent events and still can’t explain what happened (not to mention that Keynesians don’t understand how their own policies created the mess that they blame free markets on). We, on the other hand, predicted this throughout the 2000s, and can explain in gory detail exactly what took place and why (I’ve sent you this proof previously).
Indeed, Keynesians have done a great job of stepping up to claim credit for saving us from the abyss, even though the actions that took place have nothing to do with Keynesianism. Having confused central bankers desperately decide to write checks and swap good assets for bad, hoping and praying along the way that it “works” can be found nowhere in the Keynesian playbook. These desperate actions which benefit the bankers at the expense of the citizens came before the “stimulus” packages, which themselves of course could never be shown to have any effect except a very detrimental one to the real economy (regardless of what it does to a meaningless GDP calculation). Even in terms of our superficial economic indicators, the “Keynesian” policies have failed: unemployment, housing, etc. But that does not matter, as I’ll explain below, as Keynesian policies have never succeeded anywhere – especially during the great depression and during the 1970s, which is why Keynesianism constantly changes and re-invents itself, and splits into different sects.
It’s not as though Keynesianism is a real economic theory of how an economy works. It is only a theory that explains how something can’t work, and only during recessions. In fact it states that recessions are as good as things can get! Keynesianism, with its myriad contradictions, double-talk, completely backwards theories of cause and effect, cannot stand up to any real scrutiny. We free marketers have put it to shame by dissecting every aspect of it and proving it to be incoherent, illogical, and mindless from top to bottom in numerous books (and there is not a book written that refutes, in detail, the works of Mises, Menger, Bohm-Bawerk, Hayek, Rothbard et al – Keynes claims to have refuted Say, but didn’t even understand what Say had said). Why has this fact had no impact? Because Keynesianism is successful only because it promotes government management of the economy and socialism (since most academics are socialist) and, not because it’s right. You don’t have to be the right to be successful.
Those moving to Keynesianism (from other forms of government-manipulation economics) represents the blind being led by the blind.
I’ll stick with my small, but correct, school. Yes, I have unshakeable faith, because 1) we’re always proven right, 2) we have solid, unchanging and accurate theories that never fail. I would rather be correct and unrecognized than incorrect but popular.
Post a Comment