Tuesday, February 26, 2013

Easy-Money-and-Easy-Fiscal Policy Mix

In a remarkable new article John Makin, an acute observer and analyst of macroeconomic trends and problems, explains how “currency wars” (the “quantitative easing” policies adopted by most large economies, with the exception of the Eurozone) combined with restrictive (conservative) fiscal tightening, amount to a negative sum game: by definition not all large economies can depreciate their currencies at the same time, and the combined “austerity” policies depress the aggregate level of activity worldwide.

A solution could be found in the new Japanese economic policy of EMEF (easy-money-easy-fiscal policy) combining easy money now and temporarily easier fiscal policy, leaving the balancing of the budget task to future, more prosperous times.    


“The easy-money-tighter-fiscal policy (EMTF) mix being pursued globally in 2012–13 with increasing intensity is the classic policy mix for a weaker currency. Easy money pushes down interest rates and spills cash abroad in search of higher returns, pushing down the value of the easy-money currency. Tighter fiscal policy reduces growth and weakens demand, including demand for imports, and so the demand for foreign currency is reduced and the easier-money currency weakens. Easier money—in the United States, for example—increases the supply of dollars in global financial markets, while tighter fiscal policy reduces the US demand for foreign currency in global financial markets. This is a clear recipe for a weaker dollar.”

In this context, as the author notes, the governments that still pursue tighter fiscal policy while refusing to weaken their currency are doubly penalized and that is the case of all the Eurozone economies but Germany.

“Governments under the political strain of enacting meaningful tax increases and spending cuts often find their efforts unrewarded because almost all countries are pursuing EMTF, leaving almost no room for government efforts to succeed in sustaining growth while fiscal consolidation is underway. It becomes very tempting for a country like Spain to protest any weakening of the dollar or yen, which by definition strengthens the euro. France has been pushed into a recession by the austerity imposed by deficit reduction and trapped inside the euro system of fixed exchange rates that mandates an overvalued currency for all but Germany. For these reasons, France is among the loudest objectors to Japan’s recent aggressive and successful efforts to push down its currency.”

“France’s dilemma is being felt even more intensely in Spain and Italy, where political backlash is building. The outcome of Italy’s February 24–25 elections may include a thumbs down on the austerity programs Italy has been forced to follow. Greece, meanwhile, has become the poster child for the “pain and political backlash” club of countries trapped inside the eurozone with a politically and economically toxic combination of an overvalued currency, higher taxes, and reduced government spending. The eurozone entered a recession in the fourth quarter of 2012, its “reward” for pursuing deficit reduction with a still-overvalued currency for most of its members.”

“Japan’s new government—under Prime Minister Shinzo Abe, who was elected in December 2012—is pursuing a modified EMTF formula that is essentially an easy-money-easy-fiscal policy (EMEF). “Abenomics” is a two-pronged approach to getting Japan out of deflation, which is a currency-strengthening disaster in a world of widespread EMTF. If every country’s currency but Japan’s is weakening, then the yen becomes very overvalued.”

“… policymakers need to remember and recognize that the aftermath of a global financial crisis like the one that occurred in 2007–08 is never easy. Wealth losses and resulting consolidation and debt reduction by the private sector make for weak recoveries and stubborn unemployment.
EMEF provides temporary relief, but it ultimately must turn into EMTF as budget deficits and debt quantities get too high. Added to this is the complication surrounding the fact that the world’s third-largest economy, Japan, has entered the EMEF stage late, complicating efforts in the rest of the world to transition to the EMTF phase. With patience and a clear understanding of the fact that the world economy still faces a difficult period of recovery from the global financial crisis, it should be possible to reach a sustainable path to global recovery by 2015. 
The trick is not to let the challenges underway result in counterproductive measures that delay progress toward that sustainable recovery.”

The whole paper is a must read here.

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