By Steven K. Beckner
But the Reinharts also warn against the “policy error” of providing
too little stimulus.
“Many past policy mistakes across the globe and over time can be
traced to not recognizing in a timely basis that such changes have taken
place,” they write. Weak growth and high unemployment “could materialize
as a consequence of the failure of policy makers to provide sufficient
stimulus after a wrenching event in an economy where rigidities give
ample scope to demand management.”
“An important role for credit in supporting spending might imply
that an associated collapse in financial intermediation lengthens and
deepens the downturn,” they continue. “In such circumstances, slow
growth might be a self-fulfilling prophecy produced by timid authorities
who neither supported spending nor dealt with the capital-adequacy
problems of key financial institutions.”
An incorrect policy response can lead to prolonged stagnation, they
warn.
“Economic contraction and slow recovery might also feed back on the
prospects for aggregate supply. A sustained stretch of below-trend
investment and depreciation of human capital prompted by elevated and
lengthy spells of unemployment could hit the level and growth rate of
potential output. The unemployment rate stays high because it has been
high.”
The Reinharts caution, however, that “political leaders sometimes
grasp for quick fixes that impair, not improve, the situation.” As
examples of “unfortunate interventions,” they cite restrictions on trade
(both domestically and internationally), work rules and pay practices,
and the flow of credit.”
“The output effects of crises might be persistent because we make
them so,” they write, citing research that shows how this occurred
during the Great Depression.
The authors argue for not holding the inflation rate too low before
a crisis so as to leave the central bank room to operate when the crisis
leads to disinflation.
“For whatever the initiating change, the real interest rate
consistent with full employment of resources presumably falls as a
consequence of slower economic growth,” they write. “The logic is that
households need less inducement to defer consumption when future
consumption prospects are bleaker.”
“In addition to the fallout of a lower real interest rate on asset
prices, monetary policy makers need to reconsider the benefits of an
inflation buffer to protect from the zero lower bound to nominal
interest rates,” they add.
They also have advice for fiscal policymakers: “If real GDP growth
has permanently tilted down as a consequence of a severe economic
dislocation, or at least has done so in a time frame measured by
decades, fiscal authorities face lower prospects for revenue and higher
pressure on outlays. Similarly, the apportioning of the current budget
stance into its cyclical and structural components will shift with
changes in the level and rate of growth of potential output.”
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** Market News International **
[TOPICS: M$$CR$,M$U$$$,MMUFE$,MGU$$$,MFU$$$,M$$BR$]
