Central Bankers Favoring Foolishness Over Facts
Tuesday 19 October 2010
by: Paul Krugman, Krugman & Co. | Op-Ed
The view from the roof of the Savoy hotel, London. In Britain, inflation is more than one percentage point above the Bank of England’s annual target of two percent. (Photo: Andrew Testa / The New York Times)
These days there seem to be two types of thinkers in the world of central banking.
On one side there are the serious people, who believe that central banks should raise interest rates in the face of high unemployment and falling inflation, because, well, that is what serious people believe.
On the other side there are the unserious people, who believe that central banks should fight deflation as well as inflation, and try to prevent the economic slump from turning into a quasi-permanent state of depression. But say this to serious people and they wonder: How ridiculous can you get?
In Sweden, Lars Svensson — formerly my colleague at Princeton University and now deputy governor at the Riksbank — is concerned about the recent efforts of his colleagues, who are eager to raise interest rates in the face of inflation that is far below target and in an economy that has not entirely recovered.
On Sept. 2, when Sweden’s central bank voted to raise a benchmark credit rate, Mr. Svensson’s was the lone dissenting voice on the board.
“The policy rate is an ineffective instrument for influencing financial stability,” Mr. Svensson said in a speech delivered in Tokyo on Sept. 16, according to Bloomberg News.
But what does he know? He is only one of the world’s leading monetary economists, having spent a great deal of time studying the problems of monetary policy at the zero lower bound.
In Britain, Adam Posen, an economist who serves on the Monetary Policy Committee of the Bank of England, is urging central banks to act. In a speech on Sept. 28, Mr. Posen noted that central banks will know whether they have implemented enough stimulus measures only when solid indicators such as wages, output and employment are going in the right direction at a sustained pace.
“[It] is not enough for a central bank to say, ‘look, we expanded our balance sheet more than any time in history,’ or ‘we did things we never did before,’ and argue that, therefore, we must have done a lot, if not too much (not that the Bank of England has done so),” Mr. Posen said. “In my opinion, that is backwards logic. It would be like saying ‘that fire must be out, because we’ve already pumped more water than for any previous fire we’ve fought.’”
But what does he know? He’s only a leading expert on Japan’s lost decade following the bursting of its real estate bubble in 1991 — a period during which deflation and slow growth haunted the nation.
Mr. Posen also points out that mainstream macroeconomics — which suggests that struggling countries need a lot more stimulus, both monetary and fiscal — has actually held up very well in this crisis. It has, above all, made the right predictions about inflation and interest rates.
And the serious people hold that benefits can only come from suffering. But they have gotten it all wrong. Yet “serious” policy makers are rejecting theories that work in favor of those that don’t.
Backstory: Sweden and Britain, Both Trapped
While some European countries have seen the prices of goods and services drop over the last two years, they have been climbing in Britain. Recent data shows that consumer prices have increased a troubling 3.1 percent since 2009, putting inflation more than one percentage point above the Bank of England’s annual target of 2 percent.
Economists explain that this rise in inflation is partly due to the British pound’s falling 26 percent against the dollar in 2008. Then oil prices jumped 80 percent in 2009, and this year the government reinstated a hefty sales tax. As these forces pushed consumer prices higher, the Bank of England kept interest rates low, supporting the expectation that high inflation would linger. Workers demand wage increases and companies charge more for goods and services when they believe the purchasing power of the pound is likely to keep diminishing.
The usual monetary policy solution for high inflation — raising interest rates — isn’t a feasible option for the Bank of England. With widespread unemployment and cuts to public-sector jobs and welfare looming, bank officials are unlikely to apply policies that would further slow the economy.
Britain isn’t the only country caught in this sort of trap. Through August of this year, housing prices in Sweden jumped at an annualized rate of 6 percent, in what appears to be a property bubble in the making. To quash it, Sweden’s central bank, the Riksbank, raised interest rates in September and seems likely to raise them again this month and in December.
This has some economists worried. At the end of last year, Sweden’s economy successfully pulled out of eight months of deflation — raising interest rates too quickly in a low-inflation environment could lead the economy to shrink again.
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Paul Krugman joined The New York Times in 1999 as a columnist on the Op-Ed page and continues as a professor of economics and international affairs at Princeton University. He was awarded the Nobel in economic science in 2008.
Mr Krugman is the author or editor of 20 books and more than 200 papers in professional journals and edited volumes, including "The Return of Depression Economics" (2008) and "The Conscience of a Liberal" (2007).
Copyright 2010 The New York Times Company.
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