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Friday, May 16, 2003

(N)either the Fiscal Side (N)or the Monetary Side Sould Be Effective.

I grew up on Xmas re-runs of a film called 'the longest day', I have a feeling that as this year's solstice approaches this title may ring through my head on more than one occassion. This week has been a worrying one for Brad . It started on Wednesday after a hard day at the chalk-face struggling with thinking about liquidity traps . As he reflects

Paul Krugman has just made me much more pessimistic about the likely success of "unconventional monetary policy" measures to fight deflation and liquidity traps. It's not that I hadn't heard the argument before--this is the third time I've read Paul's stuff on liquidity traps, after all. But when you are teaching something, you focus on it in a way that you almost never do otherwise...

Then yesterday he started reading the economist and noted:

Economists vary in their beliefs about what needs to be done to fight deflation: large devaluations followed by pegged exchange rates, inflation targeting, or the two-handed approach of large government deficits financed by printing money: either the fiscal side or the monetary side should be effective (even if we are not sure which).

Things, however are not so simple. Firstly, the problem with large devaluations, as we're seeing with the dollar now, is that one man's meat is another's poison. Solving the US problem by sending Germany to a dark and horrible place is no solution, and this needs to be said clearly. In this sense this weekend's G7 finance meeting is critically important. It's here that the whole Bush strategic vision needs to be reversed, in a global world there is no go-it-alone solution available. But here also is the danger: my fear is that the very shock which Stephen Roach so fears could come from a realisation that money has no safe haven, that a frantic chase from dollar to euro to yen and back again serves no known purpose. In a world swimming in money, this could be very grave indeed. Inflation targeting: this is all about 'expectations', and convincing people you can do it, I mean, I'm not convinced and I fear there may be others. Looking at Japan, what we may well be in is a 'credibility trap'. On the deficit, this is back to Gauti Eggerston, and 'commiting to being irresponsible'. Isn't that just what the Bush set are doing. Is this convincing people? Not if I read Brad's column aright it isn't. Pumping up the deficit as Japan and Europe already know, and the US is discovering, only pushes you closer up against the hard rock of the underlying demographic reality. Bottom line: things are more complicated than 'most economists' tends to assume, and for starters we need to take a view which looks well beyond short run business cycle dynamics.

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