Understanding the Second Great Contraction: An interview with Kenneth Rogoff

[Napodano]

Interesting interview at https://www.mckinseyquarterly.com/Economic_Studies/Productivity_Performance/Understanding_the_Second_Great_Contraction_An_interview_with_Kenneth_Rogoff_2871

"The Quarterly: You’ve advocated allowing inflation to increase as one kind of remedy. Can you explain?

Kenneth Rogoff: There are no quick fixes. But I do think that this is a period when we shouldn’t be worried about raising inflation slightly. Indeed, moderate inflation, I would say, is exactly the prescription for a Great Depression–type scenario or a Japan-type scenario. It lowers real interest rates, helps facilitate housing price adjustment (the real price still needs to come down in many places), and modestly shortens the typical long post-crisis deleveraging period. I’ve pushed the idea, for some time, that we’re in a Great Contraction, not in a typical recession, and one has to analyze the problem differently. Unfortunately, there is still a risk that this thing could get much, much worse. The biggest problem is the global overhang of debt. After publishing our book, Carmen Reinhart and I did a study that looked at the impact of public debt on growth. When debt gets over a certain level—a good marker is 90 percent of GDP—it is linked to lower growth.

If elevated inflation—I’ve suggested 4 to 6 percent for a few years—somewhat reduces real debt levels, that would be welcome. Of course, I do get a knee-jerk reaction from many people saying that even slightly elevated inflation is anathema; we’d be going back to the bad old days of the ’70s. And my answer is that this could still be much worse than the ’70s. I’ve worked my whole career on designing central banks and promoting tools and institutions for containing inflation. But right now, given a once-in-80-years downturn, you have to balance the risks."

Check also this link https://www.mckinseyquarterly.com/Economic_Studies

[petagny]

This seems to be what's happening in the UK. Real value of debt and incomes is being eroded by inflation in the 4-5% range. Within certain bounds, inflation can be a useful adjustment tool.

Roger Bootle reckons inflation will fall steeply next year though (in line with Bank of England forecasts):

http://www.telegraph.co.uk/finance/financevideo/yourmoneytheirhands/7706556/Roger-Bootle-the-Euro-UK-rates-and-inflation.html

Is the euro-zone hampered by the ECB's asymmetric inflation target of 'less than 2%'?

[harnett]

The issue is growth and its relationship with inflation.  The question should therefore be couched as "What is the best rate of inflation for maximum growth?"  If it happens to be the 2% thumbsuck of the ECB (and Bank of England), then fine.  However in these times of crisis it seems an opportune time to provide a different answer to the question!  Just make sure only one economist is asked, as the answer could well be as varied as the number of economists consulted.

The view of the ECB, however, appears not to understand what the question should be.  It implicitly thinks that low inflation is the primary objective, with growth and employment secondary:

"To maintain price stability is the primary objective of the Eurosystem and of the single monetary policy for which it is responsible. This is laid down in the Treaty on the Functioning of the European Union, Article 127 (1).

Without prejudice to the objective of price stability", the Eurosystem shall also "support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union". These include inter alia "full employment" and "balanced economic growth". http://www.ecb.europa.eu/mopo/intro/objective/html/index.en.html

Similarly the Bank of England:

"The Bank’s monetary policy objective is to deliver price stability – low inflation – and, subject to that, to support the Government’s economic objectives including those for growth and employment."  http://www.bankofengland.co.uk/monetarypolicy/framework.htm

[petagny]

Whereas the US Federal Reserve has the dual goals of promoting "maximum" sustainable output and employment and promoting "stable" prices through monetary policy (1977 Amendment to the Federal Reserve Act).

The BofE is less hamstrung than the ECB because its inflation target is 2% and not '2% or less'. In reality, the BofE seems to be taking a much more flexible approach to monetary policy, which is closer to the Fed than the ECB.

[harnett]

Granted - but for how long can the ECB maintain its position?  Given the news of Berlusconi's move to step down and the Italian bond yields hitting 7.5%, surely it can only be a matter of time before the ECB is involved in a massive rescue operation with a radical change in its position.  The Germans may not like to swallow this but the alternatives are getting worse by the day it appears.  The ECB is apparently already intervening and buying Italian sovereign debt even though it cannot buy "vast quantities" whatever that is defined to mean!!!!  And despite this, the yields have not decreased.  Crazy times.

[harnett]

Just to back you up, Petagny - the bank of England's inflation report is now out - here is the view of Paul Krugman who praises the BoE for its courage

http://krugman.blogs.nytimes.com/2011/11/16/the-very-brave-boe/

[harnett]

And on the subject of the ECB....  Paul Krugman directs us to Ed Harrison's nightmare scenario should the ECB not back Italy. http://krugman.blogs.nytimes.com/2011/11/16/decline-and-fall/

"Ed Harrison has a good essay on how the euro ends if the ECB doesn’t step in on a massive scale. I don’t agree with everything — I think he’s wrong to attribute the commodity spike of 2010-2011 to monetary policy — but he’s basically right about how the thing unravels. I might place greater emphasis on the immediate channel through which falling sovereign bond prices force bank deleveraging, but we’re picking nits here.

And this is totally right:

    If the ECB writes the check, the economic and market outcomes are vastly different than if they do not. Your personal outlook as an investor, business person or worker will change dramatically for decades to come based upon this one policy choice and how well-prepared for it you are.

Crunch time. If prejudice and false notions of prudence prevail, the world is about to take a major change for the worse."

Ed Harrison's article is here: http://www.nakedcapitalism.com/2011/11/italian-default-scenarios.html

[petagny]

'...false notions of prudence...' this is why we are now at the brink of catastrophe and I fear that there may be no going back. The Germans, the Dutch and the Finns ought to read Ed Harrison's article and, hopefully, understand that if things go bad, they will go bad for everyone - the prudent will not be spared.