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Reason for decline in inflation in last 40 years: Monetary policy or Asia joining world economy production?

Summary:
William White (Former BIS chief economist and DG of Bank of Canada) says we need to ask five questions on world economy: Fostering a sustainable recovery, in spite of such preconditions, requires answering five questions. First, what public policies have led us to the current unsustainable state of affairs – what I call ‘policy preconditions’ – and should be avoided in the future? Second, what future shocks threaten sustainable growth? Third, what would a more sustainable global economy look like? Fourth, what policies are required to get ‘there from here’? Fifth, how do we – to use John Kenneth Galbraith’s phrase – choose between the ‘unpalatable’ and the ‘disastrous’? My analysis emphasises the importance of monetary and fiscal policies in both shaping the recent path, and

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William White (Former BIS chief economist and DG of Bank of Canada) says we need to ask five questions on world economy:

Fostering a sustainable recovery, in spite of such preconditions, requires answering five questions. First, what public policies have led us to the current unsustainable state of affairs – what I call ‘policy preconditions’ – and should be avoided in the future? Second, what future shocks threaten sustainable growth? Third, what would a more sustainable global economy look like? Fourth, what policies are required to get ‘there from here’? Fifth, how do we – to use John Kenneth Galbraith’s phrase – choose between the ‘unpalatable’ and the ‘disastrous’?

My analysis emphasises the importance of monetary and fiscal policies in both shaping the recent path, and conditioning the future. However, interactions over time between the global economic system and the surrounding political and environmental framework are also crucially important. These interactions imply the need for policies with a much longer-term focus than hitherto. As well, it requires global political leaders able to rise to the challenge of choosing the ‘unpalatable’ over the ‘disastrous’.

Lord Meghnad Desai responds to the piece:

My view on the last 40 years differs from White’s. The great moderation arose out of the stagflation of the 1970s and the monetarist counter attack on Keynesian policies. Lowering inflation became the goal of monetary policy. However, when prices started to come down, it was not due to policy. It was because after the decade’s oil shocks, capital moved away from the North Atlantic shores to Asia. Manufacturing prices, on which Keynesians once blamed inflation (wage rigidity, high mark-ups, monopoly capital, among others) dropped as production moved to China.

White shows that monetary easing was the principal anti-recession tool. When QE was introduced, low interest rates, along with central bank asset purchases, took over.

Despite large amounts of money in circulation, inflation did not rise. The Asian labour force carried on supplying manufactured goods at a flat rate. QE put more wealth in the hands of the asset-rich and exacerbated already rising income inequality. Fiscal policy was still tethered to lowering the debt-to-income ratio in the UK and European Union generally. The consequence was excess savings by the asset-rich. This has now led to negative interest rates. It is as if financial markets are no longer alarmed by debt to income ratios. They are in search of good yields, which are hard to find.

In the meantime, the technological revolution has almost eliminated the threat of inflation. Central banks are desperate to raise inflation rates back up to their target levels. In the days of hard monetarism, the idea of a central banker hoping for higher inflation was beyond the realms of fantasy. The world’s five largest publicly listed companies deal in data – not steel, cars or oil. It is a Schumpetarian process of creative destruction. While the old economy is in severe recession, data companies are making large profits.

The first question that arises is whether the burden of debt will hinder economic recovery, or whether the modern ‘magic money tree’ really exists. Economists wait to see if and when interest rates turn positive, especially real interest rates. The real economy will change as global supply chains are redesigned to mitigate the risk of future disruption and adjust to US-China decoupling.

Amol Agrawal
I am currently pursuing my PhD in economics. I have work-ex of nearly 10 years with most of those years spent figuring economic research in Mumbai’s financial sector.

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