HEINZ REPORT HEINZ LIVE RADIO HEINZ IRC CHAT 2001® - webcast news















The HEINZREPORT
Delivering tomorrow news today online-Entregamiento mañana noticias hoy en línea




Édition Internationale. Now Life Radio Broadcasting
Site Updated: Januar 2, 2002 23:26










Fighting the wrong battle
Jan 2nd 2002
K. Heinz, IAC SocietyFor economic policymakers across the globe, the coming year will present unusually difficult challenges. The world economy is in the middle of the worst slowdown for nearly 30 years. Finding the right policy prescription involves learning the lessons of history—but not the wrong ones




IT IS less than two years since the peak of the dotcom boom. Yet already those days seem far away: it is hard to believe quite how carried away otherwise level-headed people became by the extravagant promises made for the New Economy. The collapse in global economic confidence since then has been startling. Economic weakness has spread across the globe—from America to Europe, Asia and Latin America. This is now widely reckoned to be the worst global slowdown for nearly 30 years, since the massive oil-price shocks of the early 1970s brought the post-war boom to an abrupt halt.



Of course, the so-called “golden age” of the 1950s and 1960s was largely confined to the big industrial countries. But even today the relative size of the rich economies means that their performance has a large, and direct impact on the poor countries, where the vast majority of the world’s population lives. The level of demand in industrial countries feeds through directly to export opportunities in the developing world. And the economic-policy consensus is also enormously influential in determining the policies adopted in many emerging-market economies. There is a real risk that as the world’s economies struggle out of the recession many of them now face they will mistakenly focus on the wrong aspects of policy, which could postpone rather than hasten recovery.


Counter-inflationary policy could be the hardest thing to get right. Those who recall the after-effects of the 1970s oil-price shock recoil from the memories of stagflation—that unpleasant combination of inflation and sluggish, near-zero growth. The failure of many industrial countries to respond firmly and quickly to the inflationary impact of the quadrupling of the oil price over a few months saddled many countries with an inflationary legacy which took many years to overcome.





The experience of the 1970s and beyond has coloured the thinking of a whole generation of economic policymakers. Counter-inflationary policy is at the heart of the economic strategy of every industrial country. This is partly because conventional wisdom now accepts that price stability is a pre-condition for sustainable economic growth. Many countries target inflation directly. This is true, for example, of all 12 euro-area countries, whose monetary policy is run by the European Central Bank (ECB) as well as of Britain, whose policy is managed by the independent Bank of England. America’s Federal Reserve does not have a specific inflation target, but it does attach great importance to inflationary pressures when making its judgments about interest rates. The Bank of Japan has also recently begun to target inflation in its monetary policy.



But the Japanese case is rather different, and highlights why some economists have become concerned at the emphasis on fighting inflation. The Bank of Japan’s aim is to move back to the point at which prices start rising again. The world’s second-biggest economy is currently in the grip of deflation, a phenomenon not seen in the industrial economies since the Depression of the 1930s. The price level is falling, the economy is slumping and, notwithstanding the central bank’s policy adjustments, Japan has so far failed to get to grips with its problems. Indeed, in the summer of 2000, the Bank of Japan raised interest rates at a time when most economists thought that doing this would be a mistake, so ingrained has the need to fight inflation become.

The recession in America has brought fears among a gloomy minority of a Japanese-style decade-long slump accompanied by deflation. And yet these fears may be overdone. Inflation is clearly subdued in America. But unlike the Bank of Japan, the Fed has been quick to respond to the slowdown, cutting interest rates 11 times last year, from 6% to 1.75%. In addition, the federal government has been using fiscal policy (ie, government spending and tax cuts) to stimulate demand. America may, indeed, be headed for a painful recession, rather than the short and relatively painless one so many optimists have talked themselves into believing (there have been only muted signs of a pick-up and many sectors of the economy remain flat or in decline). And yet extreme pessimism is probably unwarranted as well. America has responded much better to the bursting of its investment bubble than did Japan, and its economy and political system is far more resilient.



In Europe, though, the policy imbalance is more clear-cut. The Bank of England has an inflation target set by the government: it has to deliver inflation of 2% plus or minus one percentage-point. Undershooting that target range carries the same opprobrium as overshooting. Monetary policy as determined by the Bank must also be supportive of the government’s wider objectives of promoting growth. By contrast, the ECB is, by law, bound to focus only on price stability—though it is free to define what that means. The ECB’s chosen definition is revealing. It defines it as 2% inflation or less. It is, in other words, an asymmetrical target: by their own standards, Europe’s central bankers score better if they undershoot their target than overshoot. The emphasis on keeping inflation low reflects, at last in part, the long German pre-occupation with inflation which goes back to the hyper-inflation of the 1920s but also to the inflationary surge of the 1970s.



Europe’s problems are compounded by the so-called “growth and stability pact” which was a crucial part of the agreement which led to monetary union, or the creation of the euro, Europe’s new single currency. Under the pact, governments within the euro area have limited scope for fiscal relaxation at a time of slowdown. The limits on government borrowing were intended primarily to prevent fiscal irresponsibility, particularly by habitual over-borrowers such as Italy. In practice, these constraints have hit Germany hardest, restricting its freedom of manoeuvre at a time when the euro area’s largest economy is in recession. The ECB, which some economists think is overly obsessed by the fear of inflation, has been slow to cut rates.

The path of inflation since the second world war suggests that the 1970s and 1980s were a spike, an exceptional period rather than one which revealed a chronic weakness. Yet there is increasing evidence that the fear of inflation, which dominates the ECB’s thinking, is overdone. It is low across the industrial world. And the path of inflation since the second world war suggests that the 1970s and 1980s were a spike, an exceptional period rather than one which revealed a chronic weakness. Before those decades, prices, except in war time, had remained remarkably stable for long stretches of time, even during periods of rapid economic growth. This is not to say that inflation can be safely ignored altogether, simply that it needs to be seen in perspective, alongside other economic objectives. One danger facing policymakers today may be that they settle for growth levels too low in the mistaken belief that this is necessary to deliver price stability.



The industrial countries are not alone. Most developing countries are heavily influenced by the rich world’s policy consensus. David Lubin, an economist at HSBC, a large international bank, points out that many emerging-market countries now have inflation targets. He argues that this means there is a risk of too much emphasis on fighting inflation and not enough on delivering sustainable growth. Countries in Latin America, Central Europe and elsewhere also often have asymmetrical inflation targets, similar to the ECB’s, and this encourages policymakers to undershoot their targets.



Not all economists subscribe to the notion that inflation is dead. Too many of them are keenly aware of the damage runaway inflation can inflict, often on the most vulnerable members of society. And there are obviously fewer survivors of the 1930s Depression, the decade of devastating price deflation, to counter their influence. And yet both periods of history may carry lessons for a world in the grip of a global slowdown.