Global Inflation

I went to an event at New America yesterday where Tom Gallagher, Senior Managing Director at the International Strategy and Investment Group, put forward an idea I hadn't heard before regarding the current debate over whether or not the Fed is making a mistake by setting interest rates too low and setting off inflation. Gallagher's take on this is that loose monetary policy is appropriate given the current state of the U.S. economy, but that the problem is that developing countries, especially China, are loathe to let their currencies appreciate too much against the dollar. Consequently, they wind up "importing" a good deal of American monetary policy even though they're not in slowdown conditions. And the upshot is inflation over there which then, via the global commodities markets, becomes exported to the United States.

The ideal response to this, he said, would be for Bernanke to keep our monetary policy loose but for other countries to tighten. But if that doesn't happen, we may be forced into a situation where we need to tighten our monetary policy in order to halt inflation even though really it would be better to keep things loose. Long story short, some financial diplomacy is badly needed in order to help us avoid an unfortunate macroeconomic policy conundrum.

Comments

Matt, you should really read the FT's op-ed page (and obviously the rest of it too). Seriously, if you were reading Martin Wolf, for example, you would have heard that--and if you were reading other people on the page you would have read lots of interesting ideas on how to address it.

Posted by David | June 26, 2008 11:32 AM

Not interesting, just one more demonstration that hedge funds are full of smooth talking dimwits. If all of our trading partners had floating exchange rates, then when we loosened money, our currency would depreciate and import prices would increase more rapidly than if currency rates were fixed and we had to wait for foreign inflation to accelerate.

As a policy maker, Bernanke has no problems at all. He spent the last 15 years of his academic career advocating price stability as the the only important goal of monetary policy. The problem is that he wants to bail out all the investment banks because they are the people that will invite he and Tim Geithner for $50,000 speeches and $2mil/year hedge fund jobs after they retire. The fixed income retirees that will get screwed by inflation arent in a position to make him a Master of the Universe if he takes their needs into account, so guess who gets the shaft.

Posted by AldenP | June 26, 2008 11:43 AM

David, Good suggestion on the FT. Matt, maybe even The Economist would work to get some good exposure to financial markets and such. Plus, being weekly it is a fairly concise way to do so.

AldenP, if Ben Bernake wants to get a job on Wall Street he will, and always would have made, a lot more than $2 million a year.

Posted by bjh | June 26, 2008 11:56 AM

The real answer is relatively simple to identify, even if a bit hard to enact. Free (ish) trade requires the participants to allow currencies to adjust in the market, otherwise there is not much free about the trade in the first place.

Posted by George | June 26, 2008 11:56 AM

i'm just going to join in the direction that David has already suggested: if this is a new thought to matthew, it's just proof that he needs to get out more. if there is an academic discipline that has taken more to blogging than economics, i'd like to know what it is.

a professional blogger who has nothing to do all day but read and write and who is interested in current affairs really has no excuse not to keep up better with current thinking.

AldenP, sometimes a cigar is just a cigar: bernanke is not trying to bail out all investment banks so that he can get large speaking fees. he felt (hardly uniquely) that allowing bear stearns to go under was to expose the entire economy to a total freeze-up and that brokering a deal was the better option.

Posted by howard | June 26, 2008 12:06 PM

The Fed is not really a national central bank. It's a private bank, owned by the largest NY banks. It has never been audited. So when confronted with the choice of bailing out its owners or maintaining the integrity of the nation's currency it's not hard to figure out which it will choose, notwithstanding the lip service it pays to fighting inflation.

The Fed has acquired many critics in the last 10 years, including Paul Volcker, Greenspan's predecessor. The Fed's loose money policies over the last decade have been the subject of much justifiable criticism, and "Easy Al" Greenspan has lost the "Maestro" aura he once had.

Posted by kafka | June 26, 2008 12:15 PM

b.j. h -- When you're right, your right. My remarks about the scale of corruption at the Fed were really penny ante. Tim G. and Ben B. are looking at $10-$20 mil a year pay days if they come through for the boys. Forget my mention of $2mil a year, that is, as you suggest, an insult by their standards.

The fact is that Ben and Tim have traded $400 billion of US treasuries for whatever crappy MBS that money center banks, investment banks, and securities dealers want to dump off on them. At a 300 basis point spread between MBS and treasuries, the best case scenario is this is a $12 billion gift (per year) to the very banks that got us in this mess. b.j. h is right to scoff at $2million. They deserve o much bigger cut of the pie than that.

The next to worse case scenario is that you and I get stuck with a $400 billion bill. The worst case scenario, is that the Fed inflates the monetary base by $400 million, ignites inflation, and destroys US monetary credibility for decades.

Posted by AldenP | June 26, 2008 12:19 PM

kafka:

As far as I know Volcker is a critic of some of Greenspan's policies but not the Fed as an institution; notably his keeping the interest rate so low for so long. If I am wrong I would appreciate a link.

Posted by David | June 26, 2008 12:21 PM

Kafka:
Monetary policy has been loose for as long as Commander Codpiece has been in office. Why do you think The Fed did away with the M3 report? Hell, loose monetary policy is part of the reason we are in the housing mess we are in right now.

Posted by Joe Klein's conscience | June 26, 2008 12:30 PM

You lost me at "diplomacy." Pussy.

Posted by aleks | June 26, 2008 12:34 PM

If all of our trading partners had floating exchange rates, then when we loosened money, our currency would depreciate and import prices would increase more rapidly than if currency rates were fixed and we had to wait for foreign inflation to accelerate.

And China wants fixed rates so this doesn't happen and so our domestic exporters won't become more competitive?

Posted by Peter K. | June 26, 2008 2:00 PM

There's been some pretty interesting things written by Brad Setser and Economist's View on this recently. China and the US are at something of a stand off right now over monetary policy. China's currency peg is becoming nearly untenable as speculators flood the country with foreign currency that the state has to buy up at inflated values to keep the exchange rate pegged. Right is caught because they're afraid of the economic problems rapid currency appreciation would create for the export sector.

We're in a tight spot right now, but they may be in a worse one. Fun stuff.

Posted by Joel | June 26, 2008 2:18 PM

Long story short, some financial diplomacy is badly needed in order to help us avoid an unfortunate macroeconomic policy conundrum.

It took a great economic depression and two world wars to get the christian caucasian western nations to trust each other enough to co-ordinate macroeconomic policy.
Asia will not change without similar cataclysms changing their perspective of the consequences of their independent actions first.
Call it human nature.

Posted by Northern Observer | June 26, 2008 2:45 PM

Man, there's some real economic ignorance in this thread. The MBS securities were taken at a haircut; there's no way the Fed loses money on them. Afaik, the Fed has never had a default on a short-term loan. Now, how the Fed regulates investment banks is an interesting question -see recent comments from a speech by Jeff Lacker - but this belief that the Fed is a crony institution run by the NY banks is complete balderdash.

And as for Bernanke - if he cared about the millions, he could've made it long ago by going to Wall Street. He's a fairly nerdy academic whose lifelong specialty involves how we stop liquidity crises from becoming Great Depressions. I trust he knows what he's doing.

Posted by cure | June 26, 2008 3:54 PM

Since the point of loose monetary policy is to encourage extension of credit to promote activities that boost economic activity ...

... why not start focusing on the direct extension of credit on activities that are, intrinsically, difficult to outsource in their entirety, so that we can be confident that a substantial share of the activity will occur in the US?

Even better if the medium and long term impact of the activity is to reduce the present "century flood" in trade deficits ...

... which is to say, why not directly extend cheap credit to installation of sustainable, renewable energy production as well as energy-saving investments in home and industry?

Given that the cost of financing activity is such a big part of the hurdle for a wide range of activity from new utility grade wind turbines to insulating home and replacing drafty windows, direct provision of low credit in these areas would have the short term effect of a loose monetary policy and the long term effect of countering the impact of the neo-mercantalist exchange rate policies and China, most ASEAN nations, and a wide range of others.

Posted by BruceMcF | June 26, 2008 7:25 PM

Cure,

I work as a statistician with micro development economists, and know much too little finance and macro theory to make an educated point in the debate of the economics going on here. But I've worked with a lot of economists, and saying someone who has the ambition to have become Fed chair under W is a fairly nerdy academic economists is basically the same as agreeing with the qualitative analysis, at least, of the most conspiracy minded commenters here.

Given, any beliefs horribly against the interests of all but the moneyed class would never be defended in the way those folks are accused of thinking by liberals, but I've literally never met a macroeconomist or academic finance type in the sort of specialty Bernanke spent his career who wasn't a... well, asshole is the only one that comes to mind. Not necessarily in an interpersonal way. Just in that he's so far removed from even understanding what could possibly motivate someone to believe that reducing inequality below gilded age levels could be anything but immoral and shockingly stupid and unjust if it reduced the GDP growth rate by 0.001% that he can't even really take seriously a conversation with someone who believes that resisting descent into plutocracy might be a worthwhile goal.

What this means in terms the debate here, I couldn't say. But insofar as men of Bernanke's ilk essentially equate the balance sheets of the high powered finance, hedge-fund, and banker types he knows with the prosperity of the country as a whole, I don't think you need to descend to conspiracy theorism to believe Bernanke doesn't have the interests of the average American anywhere in his equation, except in that the masses need to be compensated just above the minimum required to dodge the risk of civil unrest. Allowing of course his job is made much easier with the regulatory corruption and government hostility to the working and middle class of the conservative era.

Posted by Matt | June 26, 2008 8:07 PM

cure:
Now, how the Fed regulates investment banks is an interesting question -see recent comments from a speech by Jeff Lacker - but this belief that the Fed is a crony institution run by the NY banks is complete balderdash.

The Federal Reserve Banks are each owned by the banks in their Federal Reserve Districts that are their account holders ... this was, after all, the gimmick used to get a central reserve bank back in place after the tradition of opposition to central banking in the form of the First and Second Banks of the US.

However, confusing this gimmickry with a crude, direct cronyism is, indeed, wrong. The capture of "respectable views" on how the economy works is far more important to the co-option of the Fed by the interests of the financial institutions (that it ought to be regulating) than any crass mercenary activity by the members of the Federal Open Market Committee.

There is no reason to doubt that they genuinely believe that they are doing the right thing, and genuinely think that the minutia on which they disagree represents taking a range of views into account ... and, indeed, outsiders ascribing base motives and shady conspiracies to their actions is itself convenient, because then the debate can be on the credibility of the conspiracy theory rather than on the degree to which their model of the operation of the economy rests upon unscientific assumptions, unachored in observation of human behavior in the real world.

Posted by BruceMcF | June 27, 2008 12:21 AM

Note a fundamental premise to the argument set forward by Gallagher, which is that the appropriate monetary policy to cope with imported cost-push inflation is identical to the appropriate monetary policy to cope with demand-driven inflation.

However, it does not follow. If the economy is starting to run up against its limits of productive capacity, then raising the cost of credit makes all the sense in the world.

It is not automatic, however, that if the economy has spare capacity but is experiencing imported cost-push inflation, that going even further from full capacity is in the public interest. This is especially the case when technologies for reducing dependence on oil often have a higher cost to buy combined with a lower cost to own, and a simple-minded monetary policy response to the imported cost-push inflation can interfere with efforts to adopt these technologies.

Posted by BruceMcF | June 27, 2008 12:40 AM

Smart minds like Matt have been all over the place to point out the ‘entitlement attitude’ of Clintons all along. Then where are these smart minds in pointing the ‘entitlement’ view of vast American Economic Establishment?

People like Tom Gallagher are so into America’s privileged position that for every ill of America they want to point fingers at others – in this case how China is not appreciating its currency. Oh so arrogant! Oil is not traded in Chinese currency. It is traded in dollars. If for the reckless policies of Greenspan and ideologically driven FED, SEC and Bush Administration, we get housing bubble and if to address that interest rates have to go so low; it is not the problem of foreigners if they trash dollars. Collapsed dollar is one significant reason of sky high oil prices and consequent inflation.

What is more is not only America’s myopic policies are bringing misery to Americans; those are responsible in substantial measure troubles in China, India and many other countries because all of these countries have to buy high price oil. If those countries appreciate their currencies their export market will vanish, deepening recession over there. And don’t even get started for selfish and Iowa driven Ethanol policy and Agricultural subsidies. That is literally starving many countries as well as poor Americans. In which world rest of the world should not worry about their own financial well being but benefits of already supersized, energy obese American way of life? It is like robbing poor to sustain an already bloated lazy pig.

So Americans must stop blaming others and make substantive changes in their life style as well as policies to get their house in order. But that seems to be a tall order when Congress is paralyzed (one Senator holds Housing Bill at ransom), Bush is still salvaging his legacy in Iraq and rest of American Media / Blogs are all enthralled about spicy, but frivolous, details of Obama show (look for the media coverage for Obama Clinton summit as if it is the summit of two super powers and agreement between two of those will bring solutions to all of America’s problems).

American Media failed to connect the dots and we got 911 and reckless Iraq war. American Media and Blogs are failing once again while the financial Armageddon is unfolding in front of everyone. Matt should go and check how much coverage his blog gives to the true issues important to common Americans – gas prices, inflation and collapsing economy.

Posted by Umesh Patil | June 27, 2008 12:44 AM

if matt (and many of the rest of you) would just follow barry ritholtz's big picture blog, for one, he'd get a crash (!) course. there's a link on atrios.

Posted by annie | June 27, 2008 2:25 AM

When trade increases between previously separate markets, prices tend to converge in real terms. In the US, globalization kept prices (and salaries) steady. In emerging markets, globalization raised prices and salaries. Over the long term, this will bring the global income equality that so many people say they want. It will also mean future US economic growth will depend more on production improvements than customer captivity. Viewed in this light, moderate inflation in emerging markets is a good sign as long as salaries are also keeping up and the pace does not get too fast.

Posted by Joseph | June 27, 2008 11:49 AM