While it's 'full marks' to both Krugman and Roach for having focused all our attention on the complex problems attendant on the collapse of the internet boom and the bursting of the stock market bubble, I still can't convince myself that the analysis isn't missing something. Both of them have, correctly in my view, stressed heavily the point that bubble-unwinding takes us into territory which is outside the pattern of the 'normal' business cycle as we have come to know it since the 1970's. In particular this is a result of the negative credit dynamics which follow the unwinding, a dynamic process which makes investment much more expensive for the corporate sector and hence, as a consequence, growth much slower. It is this 'sluggish' growth which brings the danger of deflation nearer as rapid productivity improvement puts downward pressure on prices. Hence our economies as they say 'are subject to downside risks'.
The latest piece of evidence Roach cites to back his thesis are the just-released minutes of the early-November Federal Open Markets Committee meeting. For him there is little question about what the Fed is really up to: they are preparing the fire brigade ready for action. In the Fed's own words : "…a faltering economic performance would increase the odds of a cumulatively weakening economy and possibly even attendant deflation. An effort to offset such a development, should it appear to be materializing, would present difficult policy implementation problems."
However I cannot help feeling that there is something missing in this story. As I have said before, it is rather like staging Hamlet without the Prince. In the present case offering a projection of our current problems and future prospects absent the principal actor: the demographic transition.
I’ve been bearish for so long, they’ve removed the "plus key" from my laptop. I am still of the view that the risks to this US-centric global economy remain decidedly on the downside of consensus expectations. I also believe that there’s more to come on the deflation watch. But this once heretical view has now caught the attention of policy makers around the world. They have jumped on the anti-deflation bandwagon as never before.
America’s Federal Reserve has led the way. The Fed has clearly gotten religion on the deflation watch. The first inklings of this conversion were evident in the form of a seemingly obscure staff research paper published by the Federal Reserve Board last June (see A. Ahearne, et. al., "Preventing Deflation: Lessons from Japan’s Experience in the 1990s," International Finance Discussion Papers, No. 729, June 2002).
I have long felt that the Fed was laying the groundwork at the time for an anti-deflationary assault in the United States (see my 15 July 2002 dispatch, "Asymmetrical Risks" in the Global Economic Forum). And that’s exactly what has happened. The Fed threw down the gauntlet, with its larger than expected 50-basis-point monetary easing on 6 November. The ink was barely dry on the policy statement of that action, when Chairman Alan Greenspan went public on the deflation debate in front of the US Congress. That was followed by a seminal speech by newly installed Governor Ben Bernanke, which dispelled any lingering doubts over the Fed’s concerns over deflation (see his 21 November remarks before the National Economists Club, "Deflation: Make Sure ‘It’ Doesn’t Happen Here").
Source: Morgan Stanley Golbal Economic Forum
The problem is that as we empty all our conventional armoury of ammunition - interest rates steadily draw nearer to zero, and fiscal policy looks increasingly problematic as outstanding obligations to ageing populations make debt-related spending a non-starter for any protracted period - the only remedy which seems to be left is exchange rate policy (unless your're in the Euro zone that is, because there even that is a non-starter). But even a mathematical non-genius can see that if we all try to come down at once it won't work. And, hey, doesn't this smell awfully like those 1930's style competitive devaluations which seemed to do so much harm, and which all the post 1945 financial and monetary architecture was supposed to stop. Well guess what, we're back in the land of Keynes, a land where looming indebtedness seems to be about to throw an enormous brake switch on our collective growth capacity, and we haven't even realised it's happening, yet. Well Keynes was always unorthodox, so I've got one 'New Keynesian' proposal which might help start the ball rolling. How about an international 'Bretton Woods' style conference on population and international migration?