It’s getting to the point that you almost feel sorry for economists. Kenneth Rogoff has an opinion piece in the Financial Times in which he seems to be groping for the next magic bullet to fire at economies.
Indeed, the question of whether the largest advanced economy regions are going to experience a double-dip recession is almost moot. For all intents and purposes, most European and US economies have never fully exited the downturn, with output per capita still below its pre-crisis peak.
Everyone agrees that bold action is required, but what kind of bold action? It is far from clear that any huge temporary fiscal stimulus will rev up the engine enough to achieve self-sustaining growth. Higher government debt adds an overhang of higher expected future taxes on top of pre-existing private debt overhang. True, in the classic analysis of a zero interest rate liquidity trap, the ideal policy is a money-financed temporary surge in government spending. But the canonical model completely ignores debt overhang.
The most direct remedy, of course, would be to find expeditious approaches to cleaning up balance sheets whilst maintaining the integrity of the financial system. In the case of Europe, this involves very large debt writedowns in the smaller periphery countries, combined with a German guarantee of central government debt in the rest. In return, Germany will have to receive a disproportionate share of fiscal power in a more deeply integrated union, for at least as long as it is making substantial transfers. In the case of the US, policymakers need to offer schemes to write down underwater mortgages, perhaps in return for other concessions such as giving the lender a share of any future home price appreciation.
If direct approaches to debt reduction are ruled out by political obstacles, there is still the option of trying to achieve some modest deleveraging through moderate inflation of, say, 4 to 6 per cent for several years. Any inflation above 2 per cent may seem anathema to those who still remember the anti-inflation wars of the 1970s and 1980s, but a once-in-75-year crisis calls for outside-the-box measures. Ideally, both the ECB and the Fed would engage in expansionary policy, as otherwise there could be profound exchange rate consequences. Of course, simply trying to stabilise exchange rates without overall monetary expansion – as the G7 seems to have proposed – is far less helpful.
Last but not least, monetary and financial solutions must be buttressed by structural reforms, including to unsustainable old-age pension and healthcare funds.
I guess we should at least give him some props for admitting that the Keynesian solution of juicing the economy with government spending fails to account for existing government debt. As for just a little dose of inflation, let me offer this from Foseti:
Arnold Kling also wants inflation – he thinks it’s easy. All the Fed needs to do is “buy stuff.” But what’s left to buy? Corporate bonds are at record highs, treasuries yields are negative, mortgage yields are at historic lows, and commodity prices are setting records. Can we really solve crises brought on by too much debt by printing money to make it cheap to issue debt? There’s not much left to buy. Does he really want the Fed to start nationalizing firms by buying equity? Should the Fed start buying consumer goods? Should it start buying personal loans from banks? Should it start buying foreign currencies in a way that would (somehow) not start a currency crisis?
Matthew Yglesias (is there a better representative of official thinking?) seems to agree with Cowen and Kling. Yglesias thinks inflation will cause households that are “flush with cash” to spend money.
My household is just such a household. I think an anecdote about how loose monetary and fiscal policy has affected my household will serve to demonstrate why this official wisdom is wrong.
We’ve spent a lot of money since the start of the crisis in the sense that we started the crisis with lots of cash and we now have only a small amount of cash (i.e. US dollars).
Most of the money we had at the beginning of the crisis is now in commodities (agricultural generally), Swiss Francs and gold. All of these assets have “inflated.”
I want to save. Cowen and Yglesias want me to spend. In the past, they could make me spend. This is not the past.
The idea that we need inflation to solve our problems may have been a good idea in the ’30s, when people had no choice but to hold dollars or gold and FDR could steal their gold. This isn’t the ’30s anymore. For under $10, you can now convert your dollars into just about anything. The Cowens and Yglesiases of the world can create all the inflation they want, they just can’t control what assets inflate. In other words, they can’t give it to responsible citizens in the ass anymore – at least not in this particular way. I’m sure this is very troubling . .
Looking at it from a different angle, a little bit of inflation isn’t going to hurt the really rich very much. They will continue to spend regardless of the price level. The “Obama rich” are scared witless and pretty much emulating Foseti. Buying protection anywhere they can find it. So, that dose of inflation is going to most likely hit those who can’t very much tolerate it and likely do little or no good. All that assumes of course that these Svengalis can indeed let the genie out of the bottle and put him back in at will.
Rogoff is right to suggest that the debt overhang has to be eliminated. But then again, how many times have we heard this from economists and politicians only to see them evade the painful solution in favor of hope and kick the can schemes.
I can’t shake the feeling that we are simply moving towards the final accounting in this whole crisis. From Bernanke’s pronouncement that subprime was easily containable to Lehman, to TARP, to supposed recovery and then flat lining growth, to Europe imploding and debt downgrades, the whole thing has a feeling of one incredible train wreck. Economists are pretty clearly out of ideas, governments are running out of money and the Foseti’s of the world are running for cover. The final chapter of this saga might be pretty grim.