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Monday, June 09, 2003

Whither Goes the 'Coalition of the Willing?

Just in case you were thinking that Bonobo was getting a bit low on economics content today, here's a really interesting piece from Stephen Roach:

On the surface, the policy bet isn't hard to understand. The world's major central banks are now taking dead aim at that once "nonexistent" risk - deflation.......American investors are taught, “Don’t fight the Fed.” Does anyone dare to confront the collective firepower of this international “coalition of the willing”?

Yet in the end, the policy bet may well be the weakest link in this daisy chain. History tells us that macro policy has had a truly terrible track record in dealing with deflation. That’s been the case since the 19th century but has been especially evident in so-called modern times. The worldwide deflation of the 1930s, to say nothing of the more recent Japanese experience, are grim reminders of stunning policy failures in dealing with this most corrosive of all macro diseases. Yet this time, we’re all being asked to believe it’s different -- that policy makers have learned the lessons of history and will never allow deflation to occur again. None other than Fed Governor Ben Bernanke -- the intellectual force behind America’s anti-deflation battle -- has said this in no uncertain terms. Recently, at Milton Friedman’s 90th birthday celebration, he honored the world’s most well-known monetarist by thanking him for showing us all the way. The “way” is Bernanke’s belief in the power of the printing press as the central bank’s antidote to deflation. It is at the core of the Fed’s purported last line of defense against deflation. It’s also as pure a monetarist prescription as you could ask for. Fed Chairman Alan Greenspan has echoed this confidence, boasting repeatedly of the Fed’s possession of the unlimited ammunition of monetary creation as the means by which the anti-deflationary battle ultimately will be won. It’s the ultimate compliment of a Friedmanesque view the world -- that fluctuations in the aggregate price level are first, and foremost, a monetary phenomenon.

The markets are up, and many an economic forecaster is joining the celebration. But a new note of caution is now in order: The same intellectual deception that was in vogue in the 1980s has returned with a vengeance. This is not the time to embrace the seductive promises of failed theories. Policy traction in a post-bubble and increasingly deflationary climate is not about the quick fix. That’s the lesson from history that keeps me awake at night. And yet that’s the very possibility that ever-bullish markets are now ignoring.
Source: Morgan Stanley Global Economic Forum

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