"If money isn't loosened up, this sucker could go down" - George W. Bush warned in September 2008

Tuesday, September 14, 2010

Really good links - Global imbalances - Tim Duy - Inflation targeting

Lorenzo Bini Smaghi - Member of the Executive Board of the ECB - Global imbalances - "The negative correlation recorded during the crisis between the current account and the fiscal balances has been largely in line with expectations. In the long run, however, current account deficits could well increase again globally if the fiscal expansion which has taken place in recent years is not reined in. In fact, the available evidence suggests that the adjustment of current account imbalances has so far been largely cyclical. The reduction in trade imbalances following the crisis has slowed and, in several cases, has started to reverse. In both the United States and China we are already close to pre-Lehman levels in absolute terms.
         The sheer asymmetry in size and composition of the fiscal stimulus in advanced countries compared with any measures taken in emerging economies is likely to magnify the expected resurgence of current account imbalances. Similarly to the pre-crisis situation, advanced economies’ indebtedness would be financed with capital flows from emerging economies. This implies not only a massive misallocation of global capital, but also undermines the credibility of any initiative to rebalance savings and investments both within and across the main regions of the global economy. As a result, it risks creating - once again I should say - delusional expectations in financial markets about the sustainability of imbalanced financial and trade flows. <..>
        It seems to me that we need better economic analysis in order to address this issue. First, we need to understand whether a given level of world growth, if achieved through unsustainable imbalances, is in itself sustainable. In 2003-07 the world economy grew at an unprecedented pace, also owing to the large imbalances financed through the recycling of large capital flows. If these imbalances were not sustainable, the underlying rate of growth of the world economy, and of some of its components - in particular the deficit countries -was probably in itself not sustainable. Accordingly, asking who will provide the demand of last resort if the deficit countries save more might not be the right question to ask, because it is based on the presumption that the unsustainable pre-crisis growth rate represents the post-crisis objective.
        We certainly need a better understanding about the potential growth of the various economies and its structure, taking due account of how comparative advantages have changed, also as a result of the crisis. My intuition is that such an analysis would suggest that potential growth in the United States is substantially lower than the average growth it experienced over the past decade and requires a shift of resources from the non-tradable to the tradable sector. Given that such a shift in resources cannot occur instantaneously, it should not be surprising if the US economy experienced a period of temporary higher unemployment. In that case, trying to stimulate growth and reduce unemployment to achieve the pre-crisis equilibrium through macroeconomic policies, as some are suggesting, might only delay the adjustment and lead again to an unbalanced path. On the other hand, some surplus countries, such as Germany, might be able to achieve higher growth than in the past decade, because of the increased potential resulting from their better positioning in international trade specialisation achieved over the years and if they are able to employ resources more efficiently in the non-tradable sector."

Tim Duy - Fed Watch - "Bottom Line: Although the Federal Reserve is poised for another round of quantitative easing, it is important to recognize their ultimate objective. It is not to pursue an a rapid return to potential output in order to rapidly alleviate unemployment. It is simply to maintain policy expectations in the context of a return to potential growth. Thus, one should expect the actual easing to be commensurate with such a policy. In other words, pay attention to what Bullard is saying - "measured" policy action. This, in my opinion, will be too little too late, as I am more concerned with an aggressive assault on unemployment and believe that using potential growth as a policy reference effectively locks the US into a suboptimal equilibrium."

Nick Rowe - Inflation targeting - "Inflation targeting wasn't something dreamed up in academic seminars. It came out of the central banks themselves, and their interactions with governments. But it turned out to fit right in with the rules vs discretion debate. Twenty years ago the new Prime Minister of New Zealand was going around all the government departments insisting they announce some sort of target they would be held accountable for meeting. When asked for his target, the Governor of the Reserve Bank of New Zealand said "Ummm, inflation?". The Bank of Canada had been quietly working on implementing an inflation target at the same time. It announced its target with the government's backing."

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