In this blog, Bob says let’s not blame all today’s problems on the US Fed (although some find that tempting). We are in a complex, idiosyncratic, interlinked world. This supports Bob’s view that we have to look at the pieces. Of course, China is a big one.—Jack Rivkin
Not Quite Impotent, but a World Away from Omnipotent by Bob Barbera
Suppose the world’s economic policy makers ceded authority to a central entity, in recognition of the fact that national economic prospects, increasingly, are largely influenced by global developments. What would a Keynesian benevolent despot do, if she had control of all nations’ economic policy levers?
She would embrace the notion that the world suffered from an insufficiency of demand. She would acknowledge that three striking imbalances are in place, one international, one financial and one within most nations. She would impose policy changes meant to resuscitate global demand and unwind global imbalances.
She would acknowledge the obvious and point out that in the aftermath of the Great Recession, global recovery has been strikingly sluggish. Only China and the United States registered meaningful recoveries. China embarked upon a state government financed real estate boom, which temporarily lifted its economy and other emerging economies. When this stimulus ended, so did recovery for China and the rest of the developing world. The USA embraced fiscal stimulus, early on, but reversed course soon. Aggressive monetary policy stimulus, did deliver modest expansion through 2015. Europe has failed to deliver any meaningful recovery.
Equally obvious, she would note, China and Germany run large and destabilizing trade surpluses. The USA and Europe are saddled with large and still deteriorating trade deficits. So, too, is it obvious that monetary policy, alone has limited ability to right the global ship, in a world where the most common short term interest rate is ZERO. Financial system excesses are a genuine risk, when central banks are forced to deliver ever more liquidity into asset markets, in their attempts to lift real economic activity.
Finally, she would lament the violent shift toward income inequality, noting that the super-wealthy spend very little of their income, worsening demand deficiency, even if one ignores any notion of equitable outcomes.
She would declare, therefore, that policies would need to do the following:
- Jump start global demand.
- Reduce global trade imbalances.
- Relieve pressures on central banks.
- Reverse income inequality pressures.
She would declare China and Germany as the new places to look for demand stimulus. Major tax cuts would be enacted in both nations. Tax cuts would be super progressive.
Large tax adjustments would be made globally, so as to shift after tax incomes toward low and middle income earners. She would slowly remove developed world monetary policy stimulus. This would occur, however, only after clear evidence of strong global growth and a return to inflation rates above 2% in developed world economies.
Alas, our savior is a fiction. Nations have no intention of ceding control of their policy levers. Any one nation, therefore, pursues a policy that is focused solely on its nation, while accounting for global influences on its nation, arriving in part a consequence of policy moves taken by other nations.
Worse still, policy makers in many nations are likely operating with many self-imposed constraints. Fiscal stimulus? Tax changes to modify income inequality? In most nations the only game in town is monetary policy. That is, of course, excluding European nations. European nations don’t even have an empowered central bank that they can alone control.
It is in this spirit that one has to feel genuine empathy for Janet Yellen. Monetary policy in the USA has delivered modest recovery. And after over seven years of zero interest rates, USA central bankers, recalling the financial bubbles that precipitated the last several recessions, decided they might try to slowly wean markets away from full throttle liquidity provision. But increasingly it appears that China’s efforts to create a new growth engine have failed and the rest of the developing world is contracting as a consequence. In Europe, Germany steadfastly refuses to pursue any sort of pro-growth policies. As a consequence, the U.S. dollar has resumed its ascent. Thus the USA faces both faltering rest-of-world demand and rising dollar rising [sic]. As a consequence the mismatch between USA spending gains and output gains is destined to worsen. Likewise, despite low U.S. unemployment, inflation looks set to fall in the quarters ahead, not rise.
Should Yellen reverse course, end the plans to tighten and hint at a potential reversal for short rates? That may be in cards. But is it the issue of the hour? More to the point, did a 25 basis point move up for short rates in the USA doom China’s economy? Did a promise of perhaps four tightening moves in the USA over the next year shut down European growth? In sum, is the Fed the precipitator of emerging evidence of a global reversal of fortunes? If Chair Yellen were our global Keynesian benevolent despot, and global barometers were heading south, we could confidently say yes. Given her complete inability to adjust the many policy levers around the globe that are wrongly positioned, how can you lay today’s madness at her feet?