Archive for December 3rd, 2008

Let inflation shoot to manage the crisis

December 3, 2008

Simon Johnson and Ken Rogoff, both ex- IMF Chief Economists, point there is a need to let inflation shoot to manage the crisis. Rogoff article is here and Johnson’s is here. They talk about inflation in developed economies.

How much inflation? Johnson says:

We need to have significant inflation: 2% is not enough to improve solvency significantly, and we may experience 5-10% for a year or two. Inflation has major drawbacks and creates its own risks, but compared to the alternatives, it would be a relief.

Rogoff says:

Moderate inflation in the short run – say, 6% for two years – would not clear the books. But it would significantly ameliorate the problems, making other steps less costly and more effective.

True, once the inflation genie is let out of the bottle, it could take several years to put it back in. No one wants to relive the anti-inflation fights of the 1980s and 1990s. But right now, the global economy is teetering on the precipice of disaster. We already have a full-blown global recession. Unless governments get ahead of the problem, we risk a severe worldwide downturn unlike anything we have seen since the 1930s.

This is a very complex world we are living in. In order to avoid a 1929 situation (the severity of the crisis seems to have surpassed all previous crisis except 1929), both advocate high inflation scenario. Say, we save 1929 situation by huge pumping of money and fiscal stimulus. If inflation is managed fine. If not, then we have 1970’s inflation scenario which interestingly was controlled by Volcker by forcing another recession.

How do things end? It looks like a real vicious circle right now.

Back to Socialism?

December 3, 2008

Despite the complexity and uncertainty in current events, the search for basics continues. On reading the various speeches and policy prescriptions, one always sees the basics. It is like reading the introductory economics text-book.

On reading this speech by Lorenzo Bin Smaghi, one goes back to economic systems and the age-old debate- capitalism vs socialism.

There are two ways to escape this crisis. The first is to replace the market economy with a different system for the allocation of resources, in which the state has a predominant role – some new form of socialism (although there might not be many left who really remember how a socialist economy functions). The risk is that the remaining confidence in public authorities may be lost. The second solution is to rebuild a functioning market economy, which possibly functions better than it did previously. The state has a fundamental role in rebuilding agents’ confidence in the market. If confidence is not restored, policy actions may be in vain. And the crisis may get worse.

The experiences with socialism have not been productive and hence he stresses on the second path.

To escape from the crisis we therefore need intervention from the state, in order to recreate a functioning market economy. However, if we have just get more state and less market we would be worse off. In the following I will try to develop this reasoning.

He then looks at policy options and says bank recapitalisation with enough conviction is needed.

Interesting speech.

Assorted Links

December 3, 2008

1. MR points to next crisis

2. Krugman on wages and employment in 1930s

3. WSJ Blog points to Plosser speech. I am increasingly seeing people saying growth not likely to pick up till 2009

4. CMB on depression and scare tactics

5. Mankiw on TIPS puzzle

6. CTB on temptation of capital controls

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