Time to Take Our Medicine - Financially Speaking

The following is from Kenneth Rogoff, Financial Times. I agree with his premise, once we solve the credit crisis; but until then our medicine dosage needed to correct our problem(s) needs careful oversight, for without oversight we will face a dramatic negative impact. His solution would be effective if we were faced with a traditional supply side recession alone, but when you add our current credit crisis, the solution follows short.


The world cannot grow its way out of this slowdown, by Kenneth Rogoff, Financial Times: As the global economic crisis hits its one year anniversary, it is time to re-examine not just the strategies for dealing with it, but also the diagnosis underlying those strategies. Is it not now clear that the main macroeconomic challenges facing the world today are an excess demand for commodities and an excess supply of financial services? If so, then it is time to stop pump-priming aggregate demand while blocking consolidation and restructuring of the financial system.

The huge spike in global commodity price inflation is prima facie evidence that the global economy is still growing too fast. ...

Absent a significant global recession..., it will probably take a couple years of sub-trend growth to rebalance commodity supply and demand at trend price levels (perhaps $75 per barrel in the case of oil...) In the meantime, if all regions attempt to maintain high growth through macro­economic stimulus, the main result is going to be higher commodity prices and ultimately a bigger crash in the not-too-distant future.

In the light of the experience of the 1970s, it is surprising how many leading policymakers and economic pundits believe that policy should aim to keep pushing demand up. In the US, the growth imperative has rationalised aggressive tax rebates, steep interest rate cuts and an ever-widening bail-out net for financial institutions. The Chinese leadership, after having briefly flirted with prioritising inflation..., has resumed putting growth as the clear number one priority. Most other emerging markets have followed a broadly similar approach. ... Of the major regions, only ... the European Central Bank has resisted joining the stimulus party... But even the ECB is coming under increasing ... pressure as Europe’s growth decelerates.

Individual countries may see some short-term growth benefit to US-style macroeconomic stimulus... But if all regions try expanding demand, even the short-term benefit will be minimal. Commodity constraints will limit the real output response globally, and most of the excess demand will spill over into higher inflation.

Some central bankers argue that there is nothing to worry about as long as wage growth remains tame. ... But as goods prices rise, wage pressures will eventually follow. ...

What of the ever deepening financial crisis as a rationale for expansionary global macroeconomic policy? ... Inflation stabilisation cannot be indefinitely compromised to support bail-out activities. However convenient it may be to ... bail out homeowners and financial institutions, the gain has to be weighed against the long-run cost of re-anchoring inflation expectations later on. Nor is it obvious that the taxpayer should absorb continually rising contingent liabilities...

For a myriad reasons, both technical and political, financial market regulation is never going to be stringent enough in booms. That is why it is important to be tougher in busts, so that investors and company executives have cause to pay serious attention to risks. If poorly run financial institutions are not allowed to close their doors during recessions, when exactly are they going to be allowed to fail? ...

The need to introduce more banking discipline is yet another reason why the policymakers must refrain from excessively expansionary macroeconomic policy ... and accept the slowdown... For most central banks, this means significantly raising interest rates to combat inflation. For Treasuries, this means maintaining fiscal discipline rather than giving in to the temptation of tax rebates and fuel subsidies. In policymaker’s zealous attempts to avoid a plain vanilla supply shock recession, they are taking excessive risks with inflation and budget discipline that may ultimately lead to a much greater and more protracted downturn.