Alan Blinder has an op-ed piece in the New York Times warning of the dangers of reversing course in economic policy in the near term. Meanwhile Liam Halligan writing in the Telegraph asks where’s deflation.
Blinder recounts the familiar story of the policy errors that the Fed and administration made in 1936 and 1937 that led to the recession within a depression of 1937-1938. Reducing the money supply, reducing spending and increasing taxes all conspired to put the economy back into a tail spin. The purpose of his short history lesson is to warn against incipient pressures he sees building up for the same course of action in the near future.
The moral of the story should be clear: Prematurely changing fiscal and monetary policies — from stepping hard on the accelerator to slamming on the brake — can be hazardous to the economy’s health.
Wow, we’ve learned a lot since the ’30s, right? Well, maybe not. For the echoes of 1936 are being heard right now, even before the current recession hits bottom.
If you’ve been paying attention, you know that a number of critics of the Fed are sounding alarms over the huge stockpile of excess reserves it has created — more than $775 billion at last count. What these critics are fretting about now is exactly what goaded the Fed into action in 1936: that the vast pool of loose money will ultimately be inflationary. The clear inference is that some of it should be withdrawn before it’s too late.
On the fiscal side, many of President Obama’s critics are complaining vociferously about the huge federal budget deficits. Try to ignore, if you can, the sheer hypocrisy of many Congressional Republicans who, having never uttered a peep about the huge deficits underGeorge W. Bush, are suddenly models of budget probity. But whatever the motives, the worries of today’s deficit hawks sound eerily reminiscent of Roosevelt in 1936 and 1937.
FORTUNATELY, Mr. Bernanke is a keen student of the Great Depression who will not allow the Fed to repeat the errors of 1936-37. But his critics, both inside and outside the Fed, are already branding his policies as dangerously inflationary, and no Fed chairman wants to be called an inflationist.
Similarly, I hope and believe that President Obama will not transform himself from the spendthrift Roosevelt of 1933 to the deficit-hawk Roosevelt of 1936 — at least not until the economy is back on solid ground. That said, a growing flock of budget hawks are already showing their talons. They will have their day — but please, not yet.
To avoid a replay of the policy disasters of 1936-37, both the Fed and our elected officials must stay the course. Mark Twain once explained that, while history does not repeat itself, it often rhymes. We don’t want any rhymes just now.
Halligan is an inflation hawk and he sees it coming. He asks where is the deflation that the Bank of England advertised as being right around the corner, the mere prospect of which was reason enough to engage in all manner of fiscal stimulus and monetary shenanigans. Instead of deflation, he sees slow growth and inflation coming down the road.
That’s why the Bank has done a handbrake turn. Three months ago, the Inflation Report forecast that economic slowdown meant CPI inflation would fall to 0.6pc by the end of 2010 – still not in negative deflationary territory, but close. Last week, the Bank raised that forecast sharply, predicting a CPI close to 1.5pc at the end of next year.
At the same time, the Bank now sees the downturn getting deeper. The economy will shrink 3.8pc this year, it says, before growing 1.1pc in 2010. Just three months ago, a 2.3pc growth rate was pencilled in for next year.
So the Bank has raised it inflation forecast, but slashed its future growth rate. Less growth would normally mean less inflation, not more. But in this case, our efforts to avoid the inevitable fallout from “sub-prime” – the money-printing and all the extra borrowing – have stoked up future price pressures. In the coming months, these policy excesses will weigh on sterling, raising import prices further. Next year’s VAT cut reversal will add to inflation too.
Both men have valid arguments and both men are so committed to certain policies as to be blind to the need for flexibility as economies either do or do not mend.
Blinder’s recounting of history is correct but history isn’t a road map, it merely suggests that under certain circumstances similar results might occur. Depressions and recessions are unique and no two are exactly susceptible to the same cures. In arguing that we have no choice but to forge on, Blinder ignores the need to mind that we do not solve our current problems by creating something worse. He throws up bogeymen in order to ward off responsible policy shifts.
Halligan can see nothing but inflation and views that as the monster that cannot at any cost be let lose. He is probably right in his assertion that much of monetary policy is designed to continue the bailout of financial institutions. To the extent that is true and stakeholders are being given a free ride at the expense of society paying for it via inflation then a thorough reexamination is warranted. His intimation that we are proceeding towards stagflation deserves a hearing as well for we know all to well from experience the pain that comes from conquering that circumstance. In the end though, his arguments turn so narrowly on the inflation threat as to be less than persuasive.
We are approaching points at which flexibility is going to be an important virtue. The last thing we need is to be so overly committed to courses of action that we are incapable of shifting course when evidence suggests that would be the proper response. Unfortunately, the signs are going to be subtle so some deftness is definitely going to be in order. Perhaps it will require tweaks and gradual shifts rather than wholesale changes of direction, more probably that’s exactly how it will play out.
One thing is certain. If our approach is as dogmatic as these two suggest then we will most likely end up on the wrong path for awhile.
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