Stephen Roach: QE represents ‘what got us into the mess’
I am on-board with Roach’s sentiments. This is certainly what I take away from the U.S. policy mix.
Now, a lot of economists of the Keynesian variety are telling us that the problems in the US are cyclical i.e. an aggregate demand (AD) problem. Certainly, this is true if you are using a flow model that disregards the effect of a particular industrial organization on debt accumulation. We could gin up some more AD and be back to the future.
However, flow models are cyclical in nature; they have no real understanding of the secular trends that devotees of Minsky or the Austrian School talk about. The secular problems in the US are mostly structural: overly large financial sector, excess consumption, low savings rate, hollowed out manufacturing sector, declining relative education scores, increasingly unequal income distribution, crumbling infrastructure. The policy mix now in place in the US is not geared to move the US away from this unsustainable mix. This inevitably means that when the next recession comes, with debt levels still high and interest rates still low, all of the structural problems will magically re-appear and the talking heads will say "whocouldanode." Then we will try the same policy mix: low rates, fiscal stimulus, buying up financial assets with printed money – only more aggressively.
And when you look at this regarding Germany or China, this is significant. Marshall recently posted on the incongruence between Germany’s G-20 rhetoric and the imbalances they have created intra-Eurozone. I have made similar arguments in the past. See here, for example. Nevertheless, I would couch it differently than Marshall. My view on Germany’s rhetoric is that the U.S. should first concentrate on increasing its savings rate and decreasing excess consumption and that once it has begun to do so, it can then start talking about the responsibility of others. This is true as much regarding China as it is regarding Germany.
I think the point many Germans make is that German wage prices, while not significantly higher than a decade ago are still very high – and given the overvaluation of the Euro you would expect this to be a headwind. Yet the Germans have a large current account surplus because they are competitive in the areas where they export. I think this is the right approach. Certainly, Germany must increase domestic consumption demand but not in the reckless and unsustainable way that we have seen in the US or the UK. And QE is part of the problem here, not part of the solution.
Update 10 Nov 2010: I am not quoting Roach here. I made these comments myself in a previous post. Nor I am claiming "Keynesians" are unaware of the need to do something about the overly large financial sector. Certainly, MMT folks who take a Keynesian view on fiscal policy like Marshall Auerback, Warren Mosler, and Randy Wray talk about this ad nauseam. See here and here, for example. Even ‘Keynesians’ like Paul Krugman have talked about the overly large financial sector.
The U.S. has a problem of excess consumption, with consumption rates well above 70% of GDP and savings rates that had dropped to negative before the bubble collapsed. Federal Reserve monetary policy of zero rates and quantitative easing is geared at preventing the deleveraging and increased private sector savings that must occur in order to deal with high private sector debt levels. This is not going to solve the structural problems that I pointed to. Nor will it work. Monetary policy is pushing on a string. In my view, fiscal policy is much better here. Randy Wray points this out here.
As I have said numerous times on this site using the financial sector balances approach, an increase in private sector savings necessarily means an increase in non-private sector dissaving. The natural outgrowth of the desire of the private sector to save and rebuild balance sheets is an increase in government deficits.
Given the framework above, it should be clear that when the private sector has a net surplus, the government and foreign sectors must have a combined net deficit.
So what happens when the economy lapses into recession because of a financial crisis caused in large part by excessive leverage and debt?
The answer is credit revulsion, also known as deleveraging. And this is what we have just seen in the U.S. economy. Credit revulsion means that the private sector (businesses and households) reduce or are forced to reduce their debt burdens. This change in behavior induces a net surplus in the private sector; the private sector increases savings.
I’m sure you know where this is going. If the private sector moves to a net surplus, the combined government/foreign sectors must axiomatically move to a deficit.
What should happen is that government should allow the increased saving and deleveraging to occur by promoting a sustainable industrial mix that includes shrinking the financial sector, but also includes initiatives toward better education and infrastructure investment. Clearly, the policy of the Fed and the Obama administration is geared toward actively promoting private sector dissaving. That’s not what Lord Keynes would have suggested, by the way. And it’s certainly not what anyone in the Austrian or Minksy Schools would advocate either.
Update 2 (from Marshall Auerback):
"My view on Germany’s rhetoric is that the U.S. should first concentrate on increasing its savings rate and decreasing excess consumption and that once it has begun to do so, it can then start talking about the responsibility of others".
- My criticism of Schaeuble should by no means be read as a defence of US policy. Heaven knows, I’ve criticised US policy enough times to make that clear. But I will say that "excess consumption" must have context. If you mean relative to private debt then that takes you to fiscal. Which brings me to my second point:
- If the objective is to increase the US savings rate, then it can either be done via increased fiscal deficits, reduced trade deficits, or some combination thereof. Fiscal Austerians in the US (particularly in the new Congress) make the fiscal lever virtually impossible to deploy and countries like Germany and China make the trade imbalances tough to eliminate.
Now, you might say that we need to stop "malinvestment" and that we need to shrink the FIRE segment of our economy, but how do you do that? It seems to me that the Austrian prescriptions don’t get you there at all. I have seen a number of comments from readers that they "have problems" with MMT. That’s fine. But I’m simply laying out the accounting logic. Double bookkeeping entries are more than 700 years old. This is not evil high Keynesian theory.
If your readers have any other ideas, I’m all ears.