Wednesday, 23 January 2008

Bernanke - you are on your own, mate

A day after the big fed cut, and the message from other central banks has been as clear as crystal - Bernanke is on his own.

No other central bank is likely to follow with a headline hitting uber-cut. While other banks might be contemplating a rate reduction, moderation will be the order of the day. Inflation may be only a marginal issue for the Fed, but other central banks continue to be concerned about rising price pressures.

Here in the UK, King went to Bristol where he gave his own account of recent developments. The speech is well worth a read. Although it has a rather dubious sea-faring theme running through it, the message is stark; "this year we (i.e. the UK) are probably facing a period of above-target inflation and a marked slowing in growth”. No talk of avoiding recessions for the Bank of England.

In contrast to Bernanke, King does not claim to have any Harry Potter-like magic potion hiding up his cape. "We (the Bank of England) have little control over the strength of the economic winds buffeting our economy. We cannot avoid some volatility in the short run and it is important that everyone understands the limits to the ability of central banks to smooth the economy."

Over at the ECB, one finds a similar realism about the limits of central banks. Earlier this week, J├╝rgen Stark, a member of the Executive Board of the ECB provided a straight talking assessment about how far central banks can influence economic growth. His assessment is worth quoting at length.

"Any attempt by central banks to systematically stimulate output and employment is ultimately doomed to failure, the only certain outcome being inflation. The perceived trade-off between inflation and growth will, sooner or later, reveal its true nature. Although it is tempting to believe that such a trade-off exists, it is in fact a mirage.

New empirical evidence and new insights in monetary theory have shown that even moderate levels of inflation have considerable negative repercussions for long-term economic performance, and maintaining price stability is therefore the best contribution that monetary policy can make to economic welfare, growth and employment."

Unfortunately, Bernanke and his fellow inflationist friends on the FOMC believe that a dramatic gesture and easy money will somehow save the day. However, the US macroeconomic imbalances are simply large. A further round of easy money will not reduce the burgeoning current account deficit, it will only exacerbate inflation, and it will not improve bank lending standards.

Although the Bank of England and the ECB have in the past made some terrible mistakes, neither central bank are quite so stupid as to believe that the answer to today's problem is a massive interest rate cut. Nor do they believe that the answer to a credit-induced asset bubble is yet more easy credit.


Anonymous said...

I agree with critics about the faultering Anglo-Saxon way of "borrow your way to prosperity". But sometimes I believe you don't understand just how right you are.

We are facing an extreme deflationary environment in the wake of a massive collapse in credit and housing bubbles.

If you, the BoE and the ECB wish to ignore this reality and go the way of Japan, so be it. But I credit Ben Bernake with a least trying to avoid this possibility.

The fact that the dollar has barely moved after a 75 bp cut (and talk of another 50 bp just next week!!!), should tell you that even currency speculators are a bit freaked out by recent developments and rethinking their assumptions.

You may be right and all of the Feds' actions may do nothing, but I don't envy Britain (or Spain, Greece, Ireland, etc.) which will be squeezed trying to prevent a little extra inflation in the short run and much deflation in the long run.

But hey, time will tell.

Anonymous said...

One more thing...

I do agree that Bernanke has allowed himself to be bullied by the markets and should not be cutting as fast and deep as he is. If that was your only point, I could agree.

But the idea that we should allow for no cushion in the economy and let unemployment go throught the roof is ridiculous in my opinion.

Noboby is trying to reinflate the housing market. Everybody in the USA knows homes are overpriced. Heck, even real esate agents on television are now calling this a "healthy correction". Translation: "I can't keep lying, so let's put a good face on it"

But why should people like myself -- who avoided the insanity of the housing and credit bubble -- have to pay the price with job insecurity. In fact, I remember way back in 2004 telling a coworker that I was holding off on buying a house because prices were crazy and would come down.

No, I'm more than happy to risk a little inflation than pay the price of other peoples' irresponsiblity with my job.

No matter what Bernanke does, home prices will not come back. That will mean HELOCs and other ways of borrowing massive amounts of money will be near impossible for all but the most responsible of borrowers. This means consumption will take a huge hit, even with large interest rate cuts.

Hello deflation!

As for the argument that inflation will make this different from the disinflationary recession of 2001, I refer you to Stephen Roache. He is an economist who has been a voice in the wilderness for years pointing out the unsustainabilty of the US/UK way of borrow and spend. How they have kept him on Wall Street for so long, I'll never know.

But he has pointed out that the cumulative trade deficits of the western world have provided a huge stimulus to the world economy. Take that stimulus away -- which is inevitable at this point -- and you have a large drop in global demand for everything.

Markbaldy said...

The problem in the UK seems to be that when the BOE cuts rates, people go crazy spending more money they don't have and whatever the price of that house, they will buy it at that price - thus forcing house prices up even more.
Then the retailers have a bad day and cry "recession", the BOE reduces rates further and so the cycle continues.
The most responsible thing is for the BOE to increase rates - it won't be pleasant for a lot of people but it is time for reality instead of "mirage".