Friday, August 5, 2011

Great Recession or Great Contraction?

Kenneth Rogoff claims in Project Syndicate that governments pursue the wrong policy recipe in trying to revive economic growth by fiscal policy or massive bailouts, which usually terminate recessions within a year, returning the economy to its long-run trend.

The current problem “is that the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation.” It is a typical deep financial crisis, not a typical deep recession. In the former, it typically takes an economy more than four years just to reach the same per capita income level that it had attained at its pre-crisis peak.

“Many commentators have argued that fiscal stimulus has largely failed not because it was misguided, but because it was not large enough to fight a “Great Recession”. But, in a “Great Contraction,” problem number one is too much debt. If governments that retained strong credit ratings are to spend scarce resources effectively, the most effective approach is to catalyze debt workouts and reductions. (…) the only practical way to shorten  the coming period of painful deleveraging and slow growth would be a sustained burst of moderate inflation, say, 4-6 % for several years.”

My comment: I think Rogoff is completely right. But in the case of Southern European members of the euro zone the amount of cumulated debt and the deterioration of competitiveness are such that at least partial defaults and a return to flexible exchange rates are required. And anyway, an independent monetary and exchange rate policy would be necessary to increase inflation from 2% to the 4-6 % range, given the price trend and inflation aversion of Germany.

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