Citing concerns over China and other emerging market economies, volatility in global markets, and an uncertain global economic outlook led the US Federal Reserve Chair, Janet Yellen, to announce that the Federal Reserve would not increase interest rates following its current Board meeting. Interestingly, the Board noted that it could increase interest rates given the current global economic outlook, but noted that it was “waiting further evidence “ and “an improvement in the labor market” before increasing interest rates.
The announcement came as a bit of surprise, as global markets had been bracing for an increase in rates. By not increasing rates, the Federal Reserve will help to keep the value of the US dollar low, making US exports more competitive on global markets. But also limits the ability of the Fed to use monetary policy to stimulate the US economy should the economy continue to exhibit an ongoing pattern of slow growth.
What do you think? Did the Federal Reserve make the right decision in keeping interest rates near zero? What would you have advised the Fed to do?
The challenge for Greece is that the plan is highly unpopular, and the country has been rocked by several rounds of widespread protest. The Greek economy has collapsed, contracting by 20 percent over the last year alone. Yet absent external relief from the IMF and EU, Greece faces the prospect of bankruptcy and potential expulsion from the eurozone. And outside of Greece, observers in Spain, Portugal, and other troubled eurozone economies are watching developments closely.
The current conundrum in Greece illustrates some of the economic challenges of the common European currency. In normal times, a common currency presents clear benefits. It facilitates closer and more efficient management of the economy, reduces transaction barriers and cost of trade between countries sharing the currency, and can help to reduce economic uncertainty. Indeed, when the euro was adopted as the exclusive currency in the eurozone in 2002, it was highly popular, and many eurozone members enthusiastically embraced the new currency.
At the same time, though, the common currency presents a key challenge, particularly during economic downturns. Traditionally, governments have two economic toolkits available to them. Fiscal policy, advocated most famously by John Maynard Keynes, focuses on the use of government revenue (taxation) and expenditures (spending) to influence economic activity in the country. Keynes argued that in good times, governments should run a budget surplus so that during poor economic times, it would have ample revenue to spend, including running a deficit, and prevent a deep recession or depression.
Monetary policy, on the other hand, focuses on manipulation of the money supply, often through interest rates, to promote economic growth and stability. Monetary policy, which was most famously promoted by Milton Friedman, provides that governments should lower interest rates to promote economic growth, but should engage in contractionary policies (including raising interest rates) to prevent the economy from overheating. Above all, monetary policy focuses on maintaining a stable money supply and money value, and keeping inflation as close to zero as possible.
In practice, governments regularly use a combination of both monetary and fiscal policy to manage economic growth and stability. However, the eurozone encompasses a wide range of countries and economies, ranging from the economic powerhouse of Germany to the crisis-ridden economies of Greece, Spain, and Portugal, to a large number of smaller economies somewhere in the middle. The question of how to balance competing demands across all eurozone economies presents a challenge. The monetary policies that would maintain economic stability and growth in Germany are different from the monetary policies that might be used to prevent economic collapse in Greece. Consequently, the European Central Bank faces the challenge of finding a fine line to walk between the two.
The other challenge, of course, is that because Greece is a member of the eurozone, it effectively has cut off one of the two primary economic policies governments might use to address the economic crisis. While the Greek government can continue to use fiscal policy, its ability to use monetary policy to address the crisis is sharply limited by the fact that the Greek government does not control the Greek currency.
Not that leaving the eurozone would make things better for Greece. For now, it appears the Greek government is committed to remaining in the seventeen nation eurozone, and the German government is committed to helping Greece remain there. But if Greece is unable to reach agreement with the troika, exiting the eurozone, either on its own terms or aftering being forced out by the other members, may be Greece’s only option.
What do you think? Do the benefits of eurozone membership outweigh the costs for the Greek government? Should Greece make the sharp spending cuts demanded by the international community to remain part of the eurozone? How would Greece leaving the eurozone affect future economic developments in other troubled European economies, like Spain and Portugal? Let us know what you think by leaving a comment or answering the poll question below.
Street cleaner sweeps worthless German Marks into the gutter.
Apart from the U.S. elections, the news last week was heavily focused on the decision of the U.S. Federal Reserve to inject some $600 billion into the economy by purchasing treasury bills. The policy, referred to as quantitative easing, is a tool of monetary policy [glossary] intended to address the ongoing economic malaise in the United States. Because interest rates are already near zero, the traditional monetary policy of reducing interest rates is not viable.
The move has provoked considerable discussion, not least because it risks stimulating inflation, as Alex Evans at the Global Dashboard notes. The policy will certainly cause a decline in the value of the U.S. dollar, promoting U.S. exports and encouraging greater investment. The broader challenge, as Robert Reich observes, is that a dual economy system is emerging in the United States. On the one hand, the financial economy is doing well. The Dow has had its ups and downs, but the sharp declines of 2008 appear to be in the rear view mirror. On the other hand, the economy of American workers continues to be in the doldrums. Unemployment appears to be stuck at just under 10 percent, real wages are frozen, and workers continue to be skittish about future employment prospects. Will Bernanke’s efforts to stimulate the economy work? It depends on who you are. Financial markets may worry about the inflationary effects of quantitative easing, but the policy of keeping interest rates near zero has certainly been positive. For workers, however, monetary policy may not be as effective as fiscal policy [glossary]. Sustaining unemployment benefits, for example, may be more effective as an economic stimulus. But such a policy is politically untenable, particularly after the mid-term elections. However imperfect, quantitative easing may be the only policy tool left to address the ongoing economic crisis in the United States.