Friday, November 19, 2010


Ben Bernanke delivered a superb speech this morning at the ECB.? He was eloquent, non-partisan and displayed an unusual understanding of the problems the global economy confronts.? The speech is an absolute must read as it provides an excellent overview of our current malaise.

The theme of the speech was the two speed recovery – the stagnant growth in developed economies vs the high growth in emerging markets – and how imbalances have been created that require differing policy responses.? He says:

“International policy cooperation is especially difficult now because of the two-speed nature of the global recovery… These differences are partially attributable to longer-term differences in growth potential between the two groups of countries, but to a significant extent they also reflect the relatively weak pace of recovery thus far in the advanced economies.”

The Chairman appears to have backed off his monetarist tendencies in favor of a non-partisan approach.? At one point he even admits that the recovery was largely due to fiscal stimulus:

“In the United States, the recession officially ended in mid-2009, and–as shown in figure 3–real GDP growth was reasonably strong in the fourth quarter of 2009 and the first quarter of this year. However, much of that growth appears to have stemmed from transitory factors, including inventory adjustments and fiscal stimulus.”

He goes on to appropriately describe the disinflationary environment that currently rules the day and why this environment is likely to persist:

“Low rates of resource utilization in the United States are creating disinflationary pressures. As shown in figure 5, various measures of underlying inflation have been trending downward and are currently around 1?percent, which is below the rate of 2?percent or a bit less that most Federal Open Market Committee (FOMC) participants judge as being most consistent with the Federal Reserve’s policy objectives in the long run.1 With inflation expectations stable, and with levels of resource slack expected to remain high, inflation trends are expected to be quite subdued for some time.”

Mr. Bernanke acknowledges that he has failed in his mandate of creating full employment, but makes vitally important comments regarding fiscal policy.? He seems to have made an about face in recent months and now understands that monetary policy is indeed a blunt instrument.? In addition to monetary policy Mr. Bernanke is directly calling for fiscal stimulus.? This is a crucial change in his stance as it shows an openness to the possibility that we are in a balance sheet recession and monetary policy simply won’t cut it:

“In sum, on its current economic trajectory the United States runs the risk of seeing millions of workers unemployed or underemployed for many years. As a society, we should find that outcome unacceptable. Monetary policy is working in support of both economic recovery and price stability, but there are limits to what can be achieved by the central bank alone. The Federal Reserve is nonpartisan and does not make recommendations regarding specific tax and spending programs. However, in general terms, a fiscal program that combines near-term measures to enhance growth with strong, confidence-inducing steps to reduce longer-term structural deficits would be an important complement to the policies of the Federal Reserve.”

He points out that, because the recovery has two differing speeds, it requires two differing responses.? In one region more support is required.? In the emerging markets it is likely that tightening phases are beginning.? This unevenness in the recovery is not a good sign and creates an imbalance that could pose a future threat:

“The two-speed nature of the global recovery implies that different policy stances are appropriate for different groups of countries. As I have noted, advanced economies generally need accommodative policies to sustain economic growth. In the emerging market economies, by contrast, strong growth and incipient concerns about inflation have led to somewhat tighter policies.”

Without naming names, Mr. Bernanke shows how a fully free floating exchange system would improve the global economy.? These are important comments in my opinion as the Chairman is emphasizing the fact that countries should not run persistent and large trade surpluses as these policies ultimately discourage domestic consumers from experiencing the benefits of what they sow:

“It is instructive to contrast this situation with what would happen in an international system in which exchange rates were allowed to fully reflect market fundamentals. In the current context, advanced economies would pursue accommodative monetary policies as needed to foster recovery and to guard against unwanted disinflation. At the same time, emerging market economies would tighten their own monetary policies to the degree needed to prevent overheating and inflation. The resulting increase in emerging market interest rates relative to those in the advanced economies would naturally lead to increased capital flows from advanced to emerging economies and, consequently, to currency appreciation in emerging market economies. This currency appreciation would in turn tend to reduce net exports and current account surpluses in the emerging markets, thus helping cool these rapidly growing economies while adding to demand in the advanced economies. Moreover, currency appreciation would help shift a greater proportion of domestic output toward satisfying domestic needs in emerging markets. The net result would be more balanced and sustainable global economic growth.”

These currency pegs also create internal costs that have never proven sustainable.?? Again, the Chairman notes that government should endorse monetary and fiscal policy which best supports higher living standards at home:

“Third, countries that maintain undervalued currencies may themselves face important costs at the national level, including a reduced ability to use independent monetary policies to stabilize their economies and the risks associated with excessive or volatile capital inflows. The latter can be managed to some extent with a variety of tools, including various forms of capital controls, but such approaches can be difficult to implement or lead to microeconomic distortions. The high levels of reserves associated with currency undervaluation may also imply significant fiscal costs if the liabilities issued to sterilize reserves bear interest rates that exceed those on the reserve assets themselves. Perhaps most important, the ultimate purpose of economic growth is to deliver higher living standards at home; thus, eventually, the benefits of shifting productive resources to satisfying domestic needs must outweigh the development benefits of continued reliance on export-led growth.”

Mr. Bernanke concludes with a comparison to the Great Depression.? Although he emphasizes that this is certainly not a depression he shows how there are similar problems.? Interestingly, he uses an example involving the gold standard and how such a policy can in fact have recessionary tendencies.? I can’t be certain that this is a subtle jab at the recent nonsense regarding the revival of the gold standard, but it looks that way to me:

“As currently constituted, the international monetary system has a structural flaw: It lacks a mechanism, market based or otherwise, to induce needed adjustments by surplus countries, which can result in persistent imbalances. This problem is not new. For example, in the somewhat different context of the gold standard in the period prior to the Great Depression, the United States and France ran large current account surpluses, accompanied by large inflows of gold. However, in defiance of the so-called rules of the game of the international gold standard, neither country allowed the higher gold reserves to feed through to their domestic money supplies and price levels, with the result that the real exchange rate in each country remained persistently undervalued. These policies created deflationary pressures in deficit countries that were losing gold, which helped bring on the Great Depression.3 The gold standard was meant to ensure economic and financial stability, but failures of international coordination undermined these very goals.”

All in all, this is some of Mr. Bernanke’s finest work.? It appears to me as though he is displaying a more flexible and open opinion with regards to monetary and fiscal policy.? That’s a nice change and a positive development. In addition, he exhibits an unusual understanding for what is occurring on Main Street instead of his persistent focus on Wall Street.? Let’s hope he will use his influence to follow thru and rather than consistently helping bankers, help Main Street for once.


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