[OPE] What if deflation doesn't work? What if there is no traction?

From: Jurriaan Bendien <adsl675281@tiscali.nl>
Date: Sun Nov 02 2008 - 10:51:13 EST

In his blog, Harvard Professor of international political economy Dani Rodrik (sharp guy, this) quotes Mr Bernanke's description of the lurch into depression at the beginning of the 1930s:

"A particularly destabilizing aspect [during the crisis] was the tendency of fears about the soundness of banks and expectations of exchange-rate devaluations to reinforce each other... An element that the two type of crises had in common was the so-called "hot money," short-term deposits held by foreigners in domestic banks. On one hand, expectations of devaluation induced outflows of the hot-money deposits (as well as flight by domestic depositors), which threatened to trigger general bank runs. On the other hand, a fall in confidence in a domestic banking system (arising, for example, from the failure of a major bank) of ten led to flight of short-term capital from the country, draining reserves .... Other than abandoning the parity altogether, central banks could do little in the face of banking and exchange-rate crises, as the former seemed to demand easy money policies while the latter required monetary tightening." http://rodrik.typepad.com/

Prof. Rodrik comments on this:

"Include corporates along with domestic banks among the affected entities, change the language to take into account that what is at stake is not a draining of reserves but uncontrolled currency depreciation, and you have a pretty good description of the dilemma faced by most EMs at the moment." http://rodrik.typepad.com/

For its part, Morgan Stanley judges that:

"The recalibration of monetary policy is still in full swing, so further rate cuts by virtually all major central banks look likely in the next few days, weeks and months. This, together with the unlimited provision of liquidity and the many measures taken by governments to stabilise the financial sector, should imply that monetary policy eventually gets traction, even though the timing is highly uncertain. And if the policies used so far don't work, we believe that central banks and government won't shy away from even more unorthodox measures. A global recession looks unavoidable, but the multi-year deflationary outcome that markets now price in looks unlikely to us in the light of massive monetary and fiscal policy intervention. (...) Naturally, investors worry deeply whether these measures will be sufficient to stabilise the financial sector and prevent an economic depression. We think so, but would be the first to admit that the degree of uncertainty is very high. However, we feel sure that the authorities will keep using all available means to address the problems if things don't stabilise in the coming weeks and months. What could this entail? Here's a highly subjective and patchy list of possible actions that might still be taken if the measures enacted so far don't help:

. If needed, there is no reason why official interest rates could not be cut all the way down to zero.
. Central banks such as the Fed and the ECB already provide unlimited liquidity against collateral. If this is not sufficient, they could engage in unsecured lending to banks.
. Central banks could start to buy private sector assets such as equities or corporate bonds directly, in order to stabilise prices.
. Also, central banks could start to make loans to the private sector directly in order to alleviate the credit crunch.
. Governments could 'persuade' banks, especially those that receive a capital injection and/or a liability guarantee from them, to keep lending to the private sector.
. Or, governments could simply nationalise a large part of the banking sector and instruct banks to lend.

To be clear, we are neither saying that such steps are desirable, nor that they are particularly likely. Also, there are several legal and technical hurdles that would have to be overcome. However, we do believe that, if needed, central banks and governments would be willing and able to take even highly unconventional measures such as these or others in order to prevent the great unraveling. In the Great Depression, policymakers stood by watching most of the time. In Japan in the 1990s, policymakers waited for several years into the stagnation and deflation phase before contemplating and then enacting some of the measures that have already been put in place in the current turmoil. This time, the message from policymakers appears to be that it will not be allowed to happen again." http://www.morganstanley.com/views/gef/index.html

In an impeccably argued article, Martin Wolf ("What the British Authorities should try now", FT October 30 2008) writes:

"How long and how deep? The answer depends on what the authorities do. This is the moment at which David Blanchflower, an external member of the monetary policy committee and professor of economics at Dartmouth College in the US, is entitled to say "I told you so". Prof Blanchflower has voted for a cut on every occasion since October 2007. In retrospect, he was right to push strongly in this direction, usually against majority opinion on the MPC." http://ricardo.ecn.wfu.edu/~cottrell/OPE/archive/0805/0005.html

Mr Wolf's argument implies that really additional inflation would hurt ordinary folks more than it would hurt capitalists, the latter whom can always invest their money somewhere above the rate of inflation. But he has nothing to say about the unemployed population, which was Keynes's prime concern. And he is talking only shortterm about Britain, not the world economy (where Prof. Rogoff's inflationary pressures are lurking; notice that even Morgan Stanley doesn't believe deflation can be sustained long term). Mr Wolf's "watered-down" Keynesianism consists mainly of the state supplying more cheap money to the financial institutions. Question is, what are they going to do with it?

As Dr Geert Reuten (senator in the Dutch upper house of parliament) admonished me on Friday, "you should go back to Keynes's General Theory (the last chapter) to see exactly what Keynes himself argued":

"...we have shown that the extent of effective saving is necessarily determined by the scale of investment and that the scale of investment is promoted by a low rate of interest, provided that we do not attempt to stimulate it in this way beyond the point which corresponds to full employment. Thus it is to our best advantage to reduce the rate of interest to that point relatively to the schedule of the marginal efficiency of capital at which there is full employment. There can be no doubt that this criterion will lead to a much lower rate of interest than has ruled hitherto; and, so far as one can guess at the schedules of the marginal efficiency of capital corresponding to increasing amounts of capital, the rate of interest is likely to fall steadily, if it should be practicable to maintain conditions of more or less continuous full employment unless, indeed, there is an excessive change in the aggregate propensity to consume (including the State). (...) Now, though this state of affairs would be quite compatible with some measure of individualism, yet it would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital. Interest today rewards no genuine sacrifice, any more than does the rent of land. The owner of capital can obtain interest because capital is scarce, just as the owner of land can obtain rent because land is scarce. But whilst there may be intrinsic reasons for the scarcity of land, there are no intrinsic reasons for the scarcity of capital. An intrinsic reason for such scarcity, in the sense of a genuine sacrifice which could only be called forth by the offer of a reward in the shape of interest, would not exist, in the long run, except in the event of the individual propensity to consume proving to be of such a character that net saving in conditions of full employment comes to an end before capital has become sufficiently abundant. But even so, it will still be possible for communal saving through the agency of the State to be maintained at a level which will allow the growth of capital up to the point where it ceases to be scarce. I see, therefore, the rentier aspect of capitalism as a transitional phase which will disappear when it has done its work. And with the disappearance of its rentier aspect much else in it besides will suffer a sea-change. It will be, moreover, a great advantage of the order of events which I am advocating, that the euthanasia of the rentier, of the functionless investor, will be nothing sudden, merely a gradual but prolonged continuance of what we have seen recently in Great Britain, and will need no revolution. http://www.marxists.org/reference/subject/economics/keynes/general-theory/ch24.htm

What Mr Keynes was really talking about was the "euthanasia of the rentier" to forestall revolution. Mr Wolf's "euthan" has dropped off, and he's left with the "Asia of the rentier". In a post-Keynesian world, the bail-outs so far are the victory of the rentier.


There's a choice we're making
We're saving our own lives
It's true we'll make a better day
Just you and me


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Received on Sun Nov 2 10:54:08 2008

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