The Great Debate

“Act and learn” versus “debate and wait”

Mohamed El-Erian

Nov 14, 2011 10:02 EST

By Mohamed El-Erian and Michael Spence The opinions expressed are their own.

In formulating policy, the process and the mindset can have a significant impact on the success or failure of outcomes. How you do it can be as or more important than what you do.

In today’s western economies, this observation may go a long way in explaining why policy outcomes have consistently fallen short of what policymakers themselves have expected, let alone what is needed to address important and growing economic challenges.

Signs of disappointing policy outcomes are, unfortunately, all around us. Over the last two years, American policymakers have failed miserably to lower persistently high unemployment despite a series of stimulus measures, fiscal and monetary, conventional and unconventional. In Europe, the debt crisis has spread despite numerous summits, declarations, policy actions and political changes.

In both cases, policymakers identified and sometimes mis-identified the problems and took highly publicized steps to solve them. Considerable financial resources and political capital were deployed. The credibility of policymakers (and policymaking itself) was placed on the line. Yet to no avail. The identified problems not only persisted, they deepened. When one compares policymaking episodes around the world – successful and less so – it seems clear that there is more at play than the content of policies. The mindset of policymakers and the process of policymaking seem to also have a lot to do with the disappointing outcomes. Indeed, one often hears policymakers point to political dysfunctionality as being the major hindrance to good outcomes.

In the US, it is the highly polarized nature of the political discourse and the associated lack of a “center.” In Europe, it is the need to get universal approval from the seventeen members of the Eurozone in what is often a cumbersome process that pits European necessities and realities against national interests and individual political party posturing. As valid as the political constraints may be, we believe that there is something even more fundamental at play. It is not just about politics. In the last few years, the policy mindset has been unhelpful and, as a result, the sequencing outmoded.

Western policymakers have been hostage for too long to a cyclical mindset. Their economies have been going through structural and secular changes brought about by major re-alignments at the national, regional and global level. Repeatedly, the extent and duration of the ongoing economic changes were not sufficiently understood and embraced. As a result, economies have suffered rather than evolved.

The great global rebalancing and its implications

Manoj Pradhan, left, a global EM economist, is an executive director at Morgan Stanley. Alan M. Taylor, right, a senior advisor at Morgan Stanley, is a professor of economics at the University of California, Davis. The opinions expressed are their own.

Policymakers have fretted about global imbalances for nearly a decade, but little consensus or clarity has emerged. Some saw problems created by surplus countries, others deficit countries. Many feared a fiscal-cum-balance of payments crisis in the U.S., but the crisis we got reflected private/financial failures. G20 proposals for collective action remain a work in progress. Uncoordinated policy actions triggered talk of currency wars.

As these debates drone on, there may be less cause for concern about global imbalances. Emerging market-developed market (EM-DM) relationships may revert to a more typical historical pattern. We highlight key areas of global adjustment in this scenario: shifts in capital flows, exchange rates and real interest rates.

The peculiar global macro configuration of the last 15 years was unprecedented. Capital flowed “uphill” from poor to rich countries — EMs saved more than they invested, the excess showing up as current account surpluses (net exports of EM goods) and financial outflows (net acquisition of DM assets). But digging deeper exposed a crucial fact: private capital still flowed “downhill” to EM economies in line with intuition, but offset by even larger “uphill” official flows, the reserves bought by EM central banks and sovereign wealth funds.

Despite allegations of strategic undervaluation, mercantilism, and the like, EMs had good reason to accumulate reserves as a precautionary measure. They had learned painful lessons from past crises. A loss of capital market access or sudden stop, or a bank/currency run or sudden flight, could trigger a vicious risk spiral linking currency crashes, banking panics and default.

In the 1997 Asian crisis, IMF help was seen as slow, limited, expensive and laden with unpleasant policy conditionality; economies, and their political leaders, suffered heavy damage. Reserve war chests were a “self insurance” response, obviating the need to rely on the kindness of strangers.

Fed is banking on phony wealth effect

J Saft

Oct 7, 2010 07:19 EDT

The Federal Reserve is committed to enticing Americans into doing once again what worked out so badly in the last decade: spending the phony paper gains engineered by overly loose monetary policy.

That, at least, is the very strong impression given by a speech by Brian Sack, the markets chief of the New York Federal Reserve, a man whose job it will be to implement the second round of large-scale quantitative easing coming after the elections in November.

A round of speeches from key Fed officials has given the clear view that, faced with deteriorating conditions and trapped by the lower bound of zero in its monetary policy, the Fed is preparing to once again buy up large amounts of Treasuries, perhaps even more than the government is issuing on an ongoing basis, in an attempt to drive down market interest rates and stimulate the economy.

Will that do any good, given that people generally do not want to borrow and the banking system is impaired?

“Balance sheet policy can still lower longer-term borrowing costs for many households and businesses, and it adds to household wealth by keeping asset prices higher than they otherwise would be,” Sack said in a speech in Newport Beach, California on Monday.

“It seems highly unlikely that the economy is completely insensitive to borrowing costs and wealth, or to other changes in broad financial conditions.”

So, there you have it: pump up asset prices and hope that people spend some of the ephemeral gains. The idea that people will spend more if their houses and other assets rise in value is called the wealth effect, but this policy creates only pretend wealth.

Looking for Keynes’ angels

James Saft

Sep 14, 2010 07:40 EDT

Keynesian stimulus works perfectly, but only if you can find politicians who don’t care about re-election and central bankers who aren’t interested in being liked.

The Obama administration, confronted with staggeringly high unemployment and a struggling economy, has proposed another round of, well, stimulus, this time in the form of tax cuts and investment incentives, but such is the toxicity of the word in current debate they can barely bring themselves to utter the “S” word.

As envisioned by economist John Maynard Keynes, in order to successfully run an economy based on counter-cyclical spending during downturns, you need to also have a policy of counter-cyclical savings during fat times. Budget surpluses must be built up so that they can be run down during recessions

It is brilliant advice, but really should begin with “first elect angels,” because the natural tendency is usually for the election cycle to dominate the thinking of those whose survival depends on it, with concerns about the economic cycle downgraded to a secondary issue mostly important because it might one day influence elections and careers.

This isn’t so much a criticism of current U.S. policy. The stimulus should never have been launched from a fiscal position as weak as it was.

The ratio of government debt to gross domestic product grew almost continuously throughout the last decade. After reaching a low of 56.4 percent in 2001 it climbed steadily and was at 64.4 percent in 2007. Compare that to the figures in the 30 percent range that prevailed during most of the 1970s, or if you dare, to the 100.8 percent that the Congressional Budget Office is forecasting for 2012, the highest such figures since the U.S. was working down debt taken on in World War II.

Whatever you think about the current stimulus, it is fair to say that the return on investment will be a good bit lower than saving the world.

Market should prepare for autumn rate “exit”

John Kemp

Apr 13, 2010 11:41 EDT

Could the first increases in  short-term U.S. interest rates come much earlier than most forecasters expect, perhaps as soon as September or November 2010?

Past experience suggests rates begin to rise about 30-35  months after the trough in the manufacturing cycle (as measured by capacity utilisation rates).

In the last four expansions, before this one, rates started rising 27 months, 48 months, 33 months and 31 months after  capacity utilization had hit its low point.

Three of these observations lie in a narrow range of 27-33 months. Rates rose after an average lag of 30 months. The  fourth reflected the unusually sluggish recovery after the last deep downturn ended in January 1983. Rates did not start to rise until four years later in January 1987.

Including this very deep recession pushes up the average to 35 months.  If the Fed’s behaviour follows past practice, policymakers  will not begin to boost the federal funds target until the end  of 2011 or even the first half of 2012. That would be around  30-35 months after the recent cyclical turning point in July  2009. It would give the economy plenty of time to reabsorb the slack created by the recession and for the expansion to prove  itself self-sustaining.

But another way to look at the problem is to ask how much  of the slack created by recession is re-absorbed before the  central bank begins to tighten.  In the last four recessions, capacity utilisation fell by  16.8 percentage points, 18.2 points, 8.2 points and 13.6 points  respectively (an average of 14.2 percentage points).

The Fed announced its first rate increase when utilisation  had climbed back by 11.7, 11.0, 4.0 and 4.8 percentage points  respectively (for an average of 7.9 percentage points). The  first rise came when about 55-60 percent of the slack created during the preceding recession had been reabsorbed.

There’s no way to hedge politics

James Saft

Jan 26, 2010 13:22 EST

Ben Bernanke in peril and the Volcker crackdown on proprietary trading by banks show two truths of the current dispensation: there is no effective hedge against politics and the reflation trade rests on fragile foundations.

Neither of these realities is particularly good for financial markets and neither is going away any time soon.

Both, too, are utterly related not just to each other, but to the Senate election in Massachusetts which installed a Republican into what had been a Kennedy seat, in the process terrifying Democrats who fear they will be sunk by association with a set of policies perceived to be favoring Wall Street.

In the aftermath, President Obama unveiled a policy authored by former Fed chief Paul Volcker, which is intended to make financial firms get out of the business of using government insurance to underwrite speculative bets; well, er, not all speculative bets, but the bad kind.

At the same time the confirmation of Bernanke is under threat, and he and the institution he works for had to endure the humiliation of seeing Senator Harry Reid issue a statement endorsing him but implying that he’d extracted some sort of undertaking from the central banker to “redouble” his efforts to help those struggling in the recovery.

Whether all of this is good or bad, or even if it has much of an impact, the fact is that both are the result of a financially struggling electorate which is going to strive to control things that they’ve previously been convinced to more or less let alone.

That’s quite a change from a few years ago, when most of us sat around stroking our chins and praising Alan Greenspan, banks and market forces as if they were one and the same. Everyone still agrees that you need banks, a market and a Federal Reserve Chairman, but there is a lot less agreement about how much freedom the three should be given.

Obama bank plan is good policy, good politics

John Kemp

Jan 22, 2010 08:17 EST

– John Kemp is a Reuters columnist. The views expressed are his own –

President Barack Obama’s proposed curbs on bank size and proprietary risk-taking will be criticised for being vague, hard to implement, and focusing on issues that were only part of the cause of the recent crisis.

But the president should ignore self-interested counsels of perfection from the industry that aim to preserve the status quo. The plan is good politics, and good policy. On the political front, the plan is a belated attempt to reposition the administration and congressional Democrats. It aims to channel the popular revolt that washed away Democrats in New Jersey and Virginia last autumn and now in Massachusetts.

For much of the year, the administration and its allies have seemed obsessed by issues which are low on the list of voters’ concerns (healthcare, climate change) or reward special interests (bank bailouts) while appearing impotent to do anything about the rising tide of unemployment and punish those responsible for causing the crisis.

The president was radical where the electorate is cautious (healthcare and climate) but appeared to advocate the status quo where voters wanted change (banking, jobs and incomes). While each of these policies can be justified, the combination made the administration appear dangerously out of touch. The bank plan is an attempt to reconnect with the voters.

COVERING FIRE The bank plan is crucial to the administration’s course correction. It has been apparent for months that the rising tide of anti-incumbent sentiment would force the administration and congressional Democrats to change priorities or risk heavy defeat in November’s mid-term congressional elections.

Massachusetts, by giving Senate Republicans the 41st vote needed to filibuster controversial legislation, has made a shift inevitable as well as desirable. In the next few weeks, the administration will disappoint many of its supporters on the left by abandoning ambitious elements of its healthcare and climate programme, as well as card-check.

from India Insight:

U.S. on Israel — double standards or a double-edged sword?

Madhu Soman

Dec 30, 2008 03:22 EST

December 24 - Palestinian militants in the Gaza Strip ratchet up rocket fire towards Israel after Hamas ended a six-month ceasefire.

December 27 - Israel launches air strikes on Gaza in response killing more than 200 people in Gaza, the highest one-day death toll in 60 years of Israeli-Palestinian conflict.

December 27 - The United States blames Hamas for breaking the ceasefire and provoking Israeli air strikes.

Secretary of State Condoleezza Rice expressed concern about the escalating violence and called for immediate restoration of the ceasefire.

"We strongly condemn the repeated rocket and mortar attacks against Israel and hold Hamas responsible for breaking the ceasefire and for the renewal of violence there," she said in a statement.

December 28/29 - Israel steps up air strikes. The death toll is now close to 350.

In another part of the world, there are now murmurs. Some sections of Indian media have raised eyebrows over what they call a clear case of double standards on the part of Washington.