Central banks make an historic turn

When the economic history of the 21st century is written, September 2012 is likely to be recorded as a defining moment, almost as important as September 2008. This month’s historic events, Ben Bernanke’s promise to buy bonds without limit until U.S. returns to something approaching full employment, Angela Merkel’s support for ECB bond purchase plans and the Bank of Japan’s decision to accelerate greatly its easing program, may not seem earth-shattering in the same way as the near-collapse of every major bank in US and Europe. Yet the upheavals now happening in central banking represent a tectonic shift that could transform the economic landscape as dramatically as the financial earthquake four years ago. (source: by Anatole Kaletsky – Reuters – 19/09/2012)

To see why, we must go back in history 40 years, to the early 1970s. Maintaining full employment was at that time regarded as the main objective of all economic policy, and this had been the case for roughly 40 years, since the Great Depression. But by the early 1970s, voters had enjoyed decades of more or less full employment and were starting to focus on inflation rather than depression as main threat to their prosperity. Economists and politicians were responding to this shift. Milton Friedman led a monetarist “counterrevolution” against Keynesian obsession with unemployment, designing new economic models to challenge Keynesian view that market economies were naturally prone to long-term stagnation. By restoring the pre-Keynesian assumption that market economies were automatically self-stabilizing, monetarist models produced two powerful policy prescriptions directly opposed to the Keynesian views.

First, the monetarists insisted that price stability, rather than full employment, was the only legitimate target for monetary policy and government macroeconomic management more generally. Second, they argued that central bankers should not accept any direct responsibility for unemployment, since sustainable job creation depended solely on private enterprise, full employment would be achieved automatically if inflation were conquered, market forces, were allowed to operate freely, with minimum of government interference or union constraints. Few years later, Thatcher and Reagan turned Friedman’s intellectual revolution into practical politics. On top of its economic impact, monetarism had huge ideological effects by absolving the government macroeconomic management of any direct responsibility for the jobs, and instead attributing unemployment to regulations, unions, welfare policies, other market distortions. The historic significance of this month’s central bank decisions should now be clear. The Fed has promised to keep printing money until full employment is restored, and it has committed itself to even bolder measures if those announced last week prove inadequate. The ECB has undertaken to “do whatever it takes” to preserve euro and specifically to buy Spanish and Italian government bonds with newly created euros in unlimited amounts. In making these announcements, the Fed and the ECB were not just demoting their previously inviolable inflation targets to near-irrelevance. They were breaking intellectual and political taboos had dominated central banking for 4 decades. This iconoclasm has prompted extreme reaction from the one remaining bastion of traditional monetarism in central banking, Germany’s Bundesbank. On Tuesday, the Bundesbank’s president, Jens Weidmann, described new central banking quite literally as work of the devil; Mephistopheles, he recalled, had used just such policies to create chaos and hyperinflation in Goethe’s Faust. And indeed, attempts to use monetary policy to restore full employment will need to overcome 2 main objections presented by monetarist theory and repeated this week by Bundesbank. Will printing more money produce intolerable inflation? What happens if businesses fail to respond to monetary expansion by creating more jobs, won’t lead to ever more desperate and risky efforts to artificially stimulate employment?

Most of the admonitions against using monetary policies to achieve full employment focus on the risk of unleashing inflation. On this score, the Fed and the ECB have a very credible response, offered most recently from Bernanke and Draghi last week: As long as unemployment and industrial excess capacity remain anywhere near present levels, generalized inflation is unlikely. Even if some commodities, such as oil or food, experience inflation, this will be offset by others goods and services whose prices fall. The more insidious danger is that the Fed will simply fail in its efforts to stimulate job creation and accelerate economic growth. Disappointment was, after all, the outcome of the last two rounds of QE. So why should this one be any different, even if Fed keeps increasing the amount of new money printed? This is the troubling question that Ben Bernanke has so far failed to answer or even seriously confront. It may turn out that just injecting money into banks and bond funds is not sufficient, regardless of amounts. A genuine economic stimulus may require newly created money to be distributed directly to businesses or households as suggested here in the past. Imagine, for example, the extra $40 billion the Fed will pump every month into bond market were spent instead on a $130 monthly payment to every U.S. citizen, repeated until the economy returned to full employment. With taboo against central banks accepting responsibility for unemployment now completely broken, such truly radical monetary policies may just be a matter of time.

Acerca de ignaciocovelo
Consultor Internacional


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