Tag Archives: Keynesianism

The IMF’s Policy Shift

IMF Board

IMF Managing Board

Last Friday, the International Monetary Fund released a staff position note  (basically, a working paper) entitled “Rethinking Macroeconomic Policy.” The impetus for the paper, writing in a surprisingly clear and jargon-free tone, seemed clear enough. In the introduction, the authors argue that macroeconomists and policymakers had been lulled into a false sense of complacency about how to conduct macroeconomic policy. The onset of the global economic crisis—or perhaps more accurately, the inability of our macroeconomic policy toolkit to address the crisis—challenged that complacency, creating the need to rethink our policies.

But the surprising part doesn’t come from the paper’s assertion that we need to think about what our post-crisis macroeconomic policy might look like. Rather, the surprising part—and the part that has generated considerable discussion in the blogosphere—are the recommendations themselves. The report recommends that central banks and the International Monetary Fund make several key changes in their policy outlook:

  1. Increasing the inflation target from 2 to 4 percent.
  2. Automatic lump sum payments should be introduced for poorer families if unemployment crosses a pre-determined threshold.
  3. Exchange rate intervention should be permitted for developing countries heavily dependent on international trade.
  4. Central banks should be granted greater regulatory authority and capacity.

These proposals represent a dramatic departure from the Washington Consensus [glossary] that dominated international economic policy since the early 1980s. Indeed, the Financial Times noted that, “The suggestion that inflation targets should be raised to 4 per cent will cause many central bankers to choke on their breakfasts, since they have spent their whole careers gaining and preserving the creditability of keeping inflation at levels close to 2 percent.”

Needless to say, the proposal has sparked considerable coverage. While Ben Bernanke still seems to be committed to keeping inflation under the 2 per cent target, Paul Krugman and James Vreeland have both already chimed in the on discussion, offering some important contributions. (Krugman importantly notes that the current financial crisis facing Greece and the other PIIGS countries has its roots in this low-inflation policy). And Joseph Stiglitz has written several books critiquing the Consensus. But the new position note comes from within the IMF, suggesting a more dramatic policy shift may be on the horizon.

So why the move? The argument presented in the position note concludes that because the inflation targets were set so low, there was no room for central banks to maneuver once the global economic downturn hit. Central banks quickly lowered interest rates, attempting to stimulate the economy. But when this did not work, monetary policy provided few good options for addressing eh economic crisis.

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Fixing the Economic Stimulus

On Monday, two heavy hitters in economics weighed in on the economic crisis facing the United States (and the global economy more generally).  In an opinion piece published in the New York Times, Nobel Prize-winning economist Paul Krugman offered a powerful argument in favor of a Keynesian-style stimulus package.  In particular, he contends that because the Federal Funds rate is effectively at zero, the only real policy option remaining for the U.S. government is a fiscal stimulus package.  In an article writing for CNN, Nobel Prize-winning economist Joseph Stiglitz offers an equally powerful critique of the current discourse surrounding the economic stimulus packageBoth make powerful points in addressing the current crisis.  Hopefully, Geithner is listening.

 

The Return of Keynesianism, Redux

A couple of weeks ago, I wrote about the return of Keynesianism in the face of the exhaustion of monetarist policy options in the United States.  On Tuesday, the Financial Times carried a similar story.  In an editorial entitled “The Undeniable Shift to Keynes,” the FT argues that Keynes’s ideas are more relevant today than ever.  The story provides a great overview of the current policy options on the table in the United States, Germany, France, the United Kingdom and the European Union, nearly all of which have embraced Keynesian policy solutions to the economic crisis.  It’s well worth a read.

The Return of Keynesianism?

On Monday, the Federal Reserve’s Board of Governors took the dramatic move of lowering the federal funds rate—the interest rate the Fed charges banks on short term loans—by 50 basis points.  A half point cut would normally be noteworthy by itself.  But this cut was particularly newsworthy because it lowered the federal funds rate to 0.25 percent—one quarter of one percent—its lowest rate ever.

The Fed hopes that the move will provide the market a clear signal of the Fed’s willingness to take sweeping action to address the current financial crisis.  And indeed, U.S. markets briefly reacted positively to the announcement, with equities increasingly slightly before falling by day’s end.

However, the move also raises some concerns.  First, with the U.S. funds rate so much lower than the rate of other major central banks (especially in European Union), the move may put downward pressure on the dollar.  This could help the U.S.’s balance of trade, but it may also make investors more hesitant to hold dollar-denominated assets, particularly U.S. Treasury Bills, due to their historically low yields.  Some groups within the Chinese government, the single-largest holder of U.S. t-bills, have already raised such concerns and have been pushing the Chinese government to diversify its holdings.  Were this to happen, the U.S. government could find it increasingly difficult to finance its operations, not to mention its $10 trillion debt.

More generally, however, the current low federal funds rate raises some important questions regarding the relative influence of (Neo)Keynesian and Monetarist policy in the United States.  Since the early 1980s, monetarism has been the prime approach to managing the nation’s economy, and the most important tool in the monetarist policy kit is arguably the federal funds rate.  By increasing the rate, the Fed can slow down the economy and bring inflation under control.  Conversely, by lowering the rate, the Fed can inject liquidity into the system, stimulating the economy and encouraging expansion.  Until recently, this system worked relatively well, keeping recessions (such as the one that occurred in 1990-1991) relatively short and shallow.

But with the federal funds rate now near zero percent (and potentially negative in real terms), the most important tool in the monetarist economic policy kit is no longer available.  If this move does not work—and there is good reason to think that it may not—the Fed will be forced to come up with new ways to stimulate the economy.

The current situation may therefore call for a return to Keynesian policies of this post-Great Depression era.  By focusing on the maintenance and expansion of aggregate demand, Keynesian policies may provide an additional tool for the U.S. government to address the current crisis.  Although Keynesianism may have fallen out of favor in the 1980s, in truth Keynesian policies never fully disappeared from the scene.  Since the 1980s, the U.S. government has been much less willing to use Keynesian tools than it historically had been.  But now that monetarism’s most important tool has been exhausted, perhaps we are all, to paraphrase Richard Nixon, Keynesians again.

If you’re interested in learning more, Paul Krugman has written extensively on the topic.  There’s a great ongoing discussion of his book, Return of Depression Economics, at Taking Points Memo.  And Krugman’s blog always makes for an interesting read!

Five Stories You Might Have Missed

It’s been a bad week for economic news.  Both the United States and Canada posted record job losses, home foreclosures continue to rise, and Congress is at an impasse on how to (or if to) bail out the U.S. auto industry.   Here’s five stories you might have missed amid all the bad economic news coming out this week.

1. Massive riots rocked the Greek capital of Athens on Sunday, as young Greeks took to the streets to protest the killing of teenager by police.  The center-right Greek government has been under pressure amid the spread of the financial crisis to Greece.  It currently holds a narrow two-seat majority in the country’s parliament, but the protests—the largest in Greece since World War II—may force some concessions on the part of the government.

2.  Amid news that the global economic crisis is taking a severe toll in Asia, both China and India are seeking to limit the spread of the crisis by instituting Keynesian-style economic stimulus packages.  India has announced a $4 billion package while China is seeking to boost domestic consumption.  Both plans have been criticized for being too small in the face of the current crisis.

3.  The Israeli closure of the Gaza Strip continues.  According to Palestinian officials, the impact of the closure is so severe that the Gaza’s financial institutions have run out of money.  The lack of cash has affected nearly all aspects of daily life in Gaza, as families lack the cash to purchase basic supplies and relief agencies have been forced to suspend their work.  Israel maintains the closure is necessary to prevent the Hamas government in Gaza from attacking Israeli settlements near Gaza. 

4.  Elections are being held in Ghana, one of Africa’s most longstanding and stable democracies.  Sunday’s presidential election is projected to be very close, potentially triggering a run-off election later this month.  Many are looking to Ghana to illustrate the potential of peaceful political transitions to countries like Kenya, Zimbabwe, and Nigeria, which experienced violence surrounding recent elections.

5.  Regional economists are raising concerns that Latin American governments may be crowded out of international credit markets due to barrowing by the United States and other developed countries.  The Latin American Shadow Financial Regulatory Committee, comprised of former finance ministers and central bank governors from the region, are warning that the loss of access to credit could have severe consequences in the region, potentially forcing countries to undertake painful fiscal adjustments or detrimental import restrictions and capital controls.

Five Stories You Might Have Missed

The global economic summit of the G20 countries concluded yesterday.  The meeting, intended to address the global financial crisis, concluded with a promise to take “whatever further actions are necessary” to address the crisis, but offered few concrete steps forward.  The summit was an opportunity to reconsider the international financial architecture, often referred to as the Bretton Woods system.  I’ll have a more detailed assessment of the summit tomorrow.  In the meantime, here are five other studies you might have missed:

1. Remember the timeline for withdrawal from Iraq that would have handed a victory to the terrorists?  Well, now we have one.  The Bush administration concluded a status of forces agreement with the Iraqi government that requires the complete withdrawal of U.S. forces by 2011.  The UN Security Council resolution which authorized the U.S. military presence in Iraq is due to expire in December, and without either a new Security Council authorization or an agreement with the Iraqi government, the status of American troops in Iraq would have been uncertain at best (and illegal at worst).  The timeline for withdrawal was a sticking point for approval of the Iraqi legislature. 

2.  The ceasefire between Israel and Gaza militants continued to come under strain last week.  An Israeli attack early last week resulted in the death of six Hamas militants.  Palestinian militants responded by increasing rocket and mortar attacks against Israeli towns near the Gaza Strip.  The Israeli government then closed Gaza’s borders, shutting down the flow of supplies.  The European Union on Friday called on Israel to permit the importation of food, fuel, and basic humanitarian supplies, but so far, the Israeli government has declined.

3.  The Eurozone has officially entered its first recession ever.  Established in 1999 and comprised of all European Union members which have adopted the Euro as their official currency, the 15-member Eurozone has now experienced two consecutive quarters of declining gross domestic product.  According to an FT editorial, the recession represents the first real challenge for European economic unity.  Already the European Central Bank has taken steps to address the economic downturn, cutting interest rates and increasing liquidity.  The effectiveness of these policies—and the difficulty of managing fifteen national economies through a single monetary policy—remains to be seen.

4.  Faced with oil prices declining below $55 per barrel and the lowest level of growth in demand for oil since 1985, the Organization of Petroleum Exporting Countries (OPEC) scheduled an emergency meeting for the end of the month.  Most forecasters believe OPEC will try to trim global output in an attempt to increase world oil prices.

5.  The fighting in eastern portions of the Democratic Republic of the Congo, which has resulted in the displacement of as many as 250,000 people, continued last week despite UN pressure to establish a ceasefire.  The United Nations is attempting to address the humanitarian crisis, but has so far been unsuccessful. But according to sources within the UN mission in the Congo, known as MONUC, rebel forces are attempting to force the withdrawal of UN peacekeepers from the region.

And a bonus story for this week:

6.  The Mexican Congress passed its annual budget for 2009.  In an environment characterized by the global economic downturn and tight finances, the Mexican government will increase spending by 13.1 percent in real terms in 2009.  The budget—the first in six years in which the government will run a deficit—increases spending on infrastructure, security, and social development. The new budget represents a return to Keynesian-style counter-cyclical spending which the Mexican government hopes will permit the country to avoid the worst of the global economic crisis.

The New Face of Capitalism: Are We All Socialists Now?

Less than a month ago—in what now seems like a lifetime ago and another world—I was engaged in a discussion with a colleague from the economics department down the hall.  He was arguing that—at least in policy circles—the neoclassical paradigm was the only model really under consideration.  We had reached the “end of history” as Fukuyama would have it. “There is [was] no alternative,” to quote Margaret Thatcher.

Less than a month later, we now seem to be living in a different world.  With world credit markets seizing up, financial markets in meltdown, and the Dow Jones in apparent freefall, governments are increasingly intervening in an attempt to prevent the expansion of the global financial crisis.  The U.S. Congress passed a $700 billion rescue package.  The British government took an even more dramatic step, partially nationalizing several major banks on Wednesday.  The U.S. government is now considering a similar measure.  The Federal Reserve has described the new policy as a “regime change,” stressing that the current economic environment is such that radical policy changes may be necessary, even going so far as to suspend traditional neoclassical principles of noninterference in the free market.  This represents a dramatic shift from March 2007, when, during a visit to Shanghai to meet with Chinese officials, U.S. Treasury Secretary Henry Paulson argued that “an open, competitive, and liberalized financial market can effectively allocate scarce resources in a manner that promotes stability and prosperity far better than governmental intervention.”

The policy reversal has led the conservative Daily Telegraph to conclude that “we’re all socialists now.” Perhaps a bit of dramatic license.  But it does highlight the dramatic changes taking place in the world today.  Communism it is not.  But perhaps return to the Keynesian system of regulated domestic and international markets.  Time will tell.