My column for MINT today did not provide the links to four professors from the US and one from Europe whose recommendations I had directly and indirectly critiqued. You can find Rogoff’s piece here; Simon Johnson’s piece here; Shiller’s piece here; Krguman’s piece here and Daniel Gros’ piece here.
As noted in my MINT article, Rogoff suggests 4% to 6% inflation as the solution. Simon Johnson frets that the success of the Tea Party makes counter-cyclical fiscal and monetary policies impossible; Shiller thinks that debt-GDP ratios do not matter. Krugman argues for loose fiscal and monetary policies and housing debt forgiveness. Daniel Gros thinks that the European Central Bank should massively buy debts of Italy and Spain, etc.
Now, these people are accomplished, experienced and have done wonderful work. All four of them – I do not know much about Daniel Gros – anticipated the crisis of 2008 in their own ways and some of them have continued to do great work, esp. Simon Johnson. Rogoff and Reinhart’s work on the history of sovereign debt will be cited for years. They anticipated the problems in the US with deleveraging and the sluggish growth that has materialised. So, I do not think that they are incapable of sound advice.
Their suggestions on this occasion fall short of the high standards one expects of them. They have failed to acknowledge the limitations of their and our knowledge given the unprecedented situation – a global credit boom now giving way to global de-leveraging – especially in the face of resource availability, supply exacerbated by climate change related impacts.Their suggestions could have far-reaching repercussions and the costs globally could exceed the local benefits. In that case, there has to be compensations from some one to some one. They fail to consider these issues. To that extent, their opinion pieces are incomplete, inadequate and disappointing.
Raghuram Rajan has indirectly responded to Rogoff’s piece in today’s FT. He analyses the costs of Rogoff’s recommendations – something that Prof. Ken Rogoff should have done himself.
Furthermore, like Raghuram Rajan, John Hussman does a clinical job of dissecting the ‘success’ of Quantitative Easing II (QE II) in his latest weekly piece. It is easily one of his best. It is not as though either Raghuram Rajan or John Hussman stops with criticisms. They make some suggestions. There is an overlap between the suggestions of both of them.
First, on QE II from John Hussman:
Without question, one of the notions buoying Wall Street optimism here is the hope that the Fed will pull another rabbit out of its hat by initiating QE3. That’s a nice sentiment, but it does overlook one minor detail. QE2 didn’t work.
Actually, that’s not quite fair. The Federal Reserve was indeed successful at provoking a speculative frenzy in the financial markets, which has now been completely wiped out. The Fed was also successful in leveraging its balance sheet by more than 55-to-1 (more than Bear Stearns, Lehman, Fannie Mae, Freddie Mac, or even Long-Term Capital Management ever achieved), and driving the monetary base to more than 18 cents for every dollar of GDP – a level that requires short-term interest rates to remain below about 3 basis points in order to maintain price stability ( see Charles Plosser and the 50% Contraction in the Fed’s Balance Sheet ). The Fed was indeed successful in provoking a wave of commodity hoarding that affected global supplies and injured the poorest of the poor – particularly in developing countries. The Fed was successful in setting off a very predictable decline in the value of the U.S. dollar. The Fed was successful in punishing savers and the risk averse, and driving investors to reach for yield in risky investments that they would normally avoid were it not for the absence of yield. The Fed was successful in provoking those with strong balance sheets to pay down existing higher interest-rate debt, and in creating an incentive for those with weak balance sheets to issue more of it at low rates, resulting in a simultaneous deterioration of credit quality and compensation for risk in the financial system. The Fed was successful at boosting the trading profits of the banks that serve as primary dealers, by announcing precisely which securities it would be buying prior to Treasury auctions, and buying them on the open market a few days later from the dealers that acquired them. The Fed was successful in creating a portfolio of low yielding securities that will be almost impossible to disgorge without capital losses unless the Fed holds them to maturity. On proper reflection, the list of the Fed’s successes from QE2 is nothing short of stunning.
It is beyond comprehension why anyone would wish for more of this recklessness.
His policy suggestions:
Many “standard” elements of economic policy can be crafted toward these ends, including infrastructure spending, R&D credits, unemployment compensation, funding of NIH and other basic research, and so on. Restructuring mortgage debt by using Treasury to administer, but not subsidize, property appreciation rights would also be helpful (see the second portion of Handicapping QE3 ). By contrast, it is disastrously misguided to defend holders of bad debt, to distort financial markets, and to obstruct rather than facilitate the restructuring of excessive debt burdens.
John Hussman cites extensively from Joseph Schumpeter’s works. The full comment is well worth a read.
As for the failures of QE II, check out this exhaustive post too at www.pragcap.com