Paul Krugman writes about a two-speed global economy where the emerging economies are experiencing rapid economic growth and rising inflation while the advanced economies remain in a slump. A key point he makes is that the countries still in a slump should focus on their own economic problems, not those of other countries. This especially applies to concerns about the Fed's monetary policy being exported across the globe:
What about complaints from other countries that they’re suffering inflation because we’re printing too much money? (Vladimir Putin has gone so far as to accuse America of “hooliganism.”) The flip answer is, Not our problem, fellas. The more serious answer is that Russia, Brazil and China don’t have to have inflation if they don’t want it, since they always have the option of letting their currencies rise against the dollar. True, that would hurt their export interests — but economics is about hard choices, and America is under no obligation to strangle its own fragile recovery to help other nations avoid making such choices.
He makes a fair point here in that the reason the Fed's policies are being felt overseas is because those affected countries have chosen to link their currency to the dollar. By linking to the dollar these emerging economies have made a decision to allow their monetary policy to be set in Washington, D.C. That is a choice outside the Fed's control.
Here is where I wish Krugman would go with his argument. Because these dollar block countries--all those emerging economies that either explicitly or implicitly peg to the dollar--are a significant share of the global economy, the BoJ and the ECB have to be mindful of what the Fed does too. If the BoJ and the ECB try to ignore the Fed's easing of monetary policy in the United States and in the dollar block countries, then they risk having their currency appreciate too much against a large portion of the global economy. That is why, as I noted earlier, the ECB could not possibly maintain its plans to steadily raise its targeted policy interest rate throughout the rest of the year. For better or for worse, then, the Fed is a monetary superpower.
Now if you buy this reasoning so far, think about this question: could the Fed's monetary superpower status have played a role in the global credit and housing boom in the early-to-mid 2000s? I say yes and explain why in this working paper.
Interesting argument.
ReplyDeleteBut, should we blame the bartender if patrons get drunk on their investments? No one is forced to buy a house, dot.com stock or commodity at high prices.
Having enough money in the system to propel growth should be a goal of the Fed. Should not investors take responsibility for how they invest?
Another question; If we run the Fed to never finance a bubble, do we do a Japan? No bubbles there.
I contend the housing bubble had to do with poor underwriting and a global capital glut (and craven ratings agencies). It was particularly damaging due to leverage (unlike the dot.com bubble, in which mostly capital was consumed). Banks got hurt in the housing -real estate bubble.
The global capital glut may is a function of global savings rates, and will get bigger in the future.
I wonder what is the policy response to such a situation?
Benjamin:
ReplyDeleteI agree that there were a lot of moving parts to the boom, some of which cannot be laid at the feet of the Fed. And I am certainly not asking the Fed now to tighten up because of the potential problems its policy is causing in emerging economies. All I want is for folks to grapple with the possibility that the Fed may have had an important role in the global economic boom in the early part of the 2000s.
Typically, what keeps investors from 'getting drunk on their investments' ? Interest rates and prices do. Interest rates help allocate resources over time, reflecting the tradeoff between consuming now vs later. They are a function of our time preferences and impact capital structure. Just like any price, they reflect tradeoffs and capture the knowledge and preferences of millions(billions?) of individuals. As such, the Federal Reserve's manipulation of the money supply undermines this very informative feedback loop, loosening the restraints imposed on excessive risk takers, and disrupting the spontaneous order of capital structure. Sure people go to the bar and get drunk, and in any market people's investments wash out, but a better question would ask, do you blame the bar tender when he's slipping patrons free drinks or mixing them extra strong?
ReplyDeleteVery good, very clear. I buy it.
ReplyDeleteSome questions:
DO you see some pararel lines with Rajan "Fault Lines"?
In any case, the growing external deficit could not again be disdained by monetary policy.
When in 200-2005 I used to work on US economy, I never understood why the huge external deficit was not in the focus of the discussion.
David, with your permission, I take three graph of figure 1 to my blog. Thanks
ReplyDeleteMatt-
ReplyDeleteWhenever people blame the Fed for a bubble, it does remind me or bar patrons who sue the bartender for getting them drunk and letting them drive home.
The Fed does not spike drinks, or give them away free. There might be a "happy hour."
And there is a nagging policy issue: Can we stomp out every bubble before it happens without doing a japan? And who knows when something is a bubble?
The NGDP policy strikes me as sound, as it is growth oriented.
It may be within a few years that chronic weak growth and deflation become the problems we face, along with zero bound. See Japan.
We need to think about policies to promote growth and mild inflation.
No problem Luis.
ReplyDelete