Monday, May 18, 2009

Understanding Recent Economic History

The Economist magazine has an article on what it sees as the beginning of a new global economic order. In the article, the history of international monetary systems up through the present economic crisis is reviewed. Here is an excerpt from this history that I particularly liked:
The post-Bretton Woods system worked well, engendering the long period of low inflation and steady growth known as the Great Moderation. But one of the reasons for its apparent success—the growth of India and China—may have sparked its demise. The addition of these two great nations to the international financial system was a supply shock that put downward pressure on inflation rates.

As Stephen King, an economist at HSBC, has pointed out, the result might have been a benign deflation that boosted Western living standards. But central banks struggled to avoid a deflationary outcome; the result was a loose monetary policy that encouraged asset bubbles. Those bubbles lasted longer than expected because the flood of savings from developing markets held down the risk-free rate.
This is spot-on analysis by The Economist. I make a similar argument in this recent article in the Cato Journal.

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