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Gerald Epstein
Part of a Triple Crisis series leading up to the Nov. 11-12 G-20 meetings.

A strange thing happened on the way to the G-20 meetings: world elite opinion has turned against the Federal Reserve’s “quantitative easing” (QE) program, the only significant “Keynesian” macroeconomic policy being implemented anywhere in the face of massive unemployment in much of the developed world; and this criticism is garnering some support from strange places, including among some progressive economists.  With all the hub-bub, the mercantilist policies of Germany and China and the pre-Keynesian Gold Standard-like stance of the European Central Bank (ECB), are getting a virtual free ride. Meanwhile, the true villain is escaping scrutiny all together: the elite consensus that there is too much sovereign debt in the world and so there cannot be any more fiscal expansion.

Matias Vernengo’s excellent post calling for a global Keynesian response to the global crisis is right on the mark. Vernengo reminds us of the failed global meetings in the 1930s that were needed to bring about a coordinated expansionary response to the depression which, instead, led to squabbling about currency issues. We are witnessing a repeat.

The Obama administration is correct to defend Quantitative Easing (QE) by the Federal Reserve, but it should be pushing for more global fiscal expansion. Of course, Obama has undermined his own case at home by failing to press for a second stimulus package and by his self-destructive decision to name a fiscal deficit commission destined to undermine future arguments for fiscal expansion. Meanwhile, Germany calls for belt tightening as it pursues its mercantilist policies, and China just wants the old order to remain as is it always was, so it can continue to pursue its model of export led growth, rather than take on more responsibility for helping to steer the global economy out of the crisis.

Some progressive critics of the Fed’s policies have correctly pointed to the problems excessive capital flows are creating for “emerging market” countries such as Brazil, Colombia, South Korea and South Africa. This has led to the adoption of capital controls by some of these countries to defend themselves from the inflows, and even the IMF has endorsed these controls as useful temporary measures.

It is true that this flood of short term capital creates problems for these countries but it is also having a positive side benefit: it is leading many countries to reconstruct the institutional mechanisms,  such as capital management regimes,  they need to help create the policy space they have been asking for, and creates arguments–even sanctioned by the IMF– against neo-liberal forces inside and outside their countries to be much more pro-active about building up national institutions to manage and help allocate credit flows. So while these inflows are creating short term problems, they are contributing to longer run policy investments. And in the meantime, these countries may even learn how to use incredibly cheap capital flows to help finance greatly needed domestic investments.

One of the innovations that should be talked about more as a result of this failure to develop a truly coordinated response to the global crisis is the need for more regional solutions of financial cooperation and investment. As Columbia’s Jose Antonio Ocampo has argued, regional funds could make use of the cheap credit created at the center, and re-cycle it in ways to make it available on regional bases for productive investment.

Of course, the Fed’s policy is not likely to have large enough impacts in the U.S. without some substantial reforms and restructuring of the U.S. financial system: these include a system of creative credit allocation mechanisms to direct credit to more employment generating initiatives, as described, for example, by my colleague Robert Pollin; a massive Federal program of writing down mortgages on the edge of foreclosure, along the lines of the Home Ownership Loan Corporation of the 1930’s;  and forcing banks, who, apparently, often do not have legal title to the mortgages, to take a very significant haircut along the way.

But, for the time being, the Fed’s QE is the only game in town– indeed, in the world. So what is it that the Fed bashers at the G-20 are calling for? I hope it is not for the Fed to turn into the ECB. I hope it is not for a return to a gold standard. I hope it is not for the dollar to try to return to an over-valued rate, just as the British tried to return to the pre-war Gold Standard in the 1930’s. Focusing on the Fed’s QE is the wrong enemy. The true problem is the return of neo-liberal thought and policy that is dominating debate, and the financial and political elites that are using this return to push their own destructive agendas.

15 Responses to “Spotlight G-20: Fed Bashing at the G-20: A Return to the Gold Standard Anyone?”

  1. There is a serious error in quantitative stimuli qualify as part of the Keynesian doctrine. Quantitative stimuli respond to the idea of Milton Friedman’s “throwing money by helicopter”, which is what Ben Bernanke has made.
    Keynes never thought that “quantitative injections” resolved the crisis. In his “General Theory of Employment, Interest and Money,” says the need to generate mecanismos to cushion the economic cycle. That is, mechanisms that are expansive in times of crisis and in which the private sector experiences a sharp drop (eg, lower taxes, increase spending on job creation). In turn, for periods of boom, the Keynesian proposal requires contractionary mechanisms (eg, increased taxes, reduced public spending). As seen, It is a counter-cyclical policies. But, was done increased taxes in boom times? was done savings for times of crisis?. On the contrary, taxes were cut, and allowed excessive private debt. The imbalances are large and much higher than the crisis of the 30′s. Can not blame Keynes when their proposals were completely dismantled in the 80′s with up privatization and tax reduction.

  2. Marco Antonio that’s not right. QE implies that interest rates on long term government bonds remain low (during the 30s Eccles, chairman of the Fed, guaranteed an interest rate of no more than 2.5%). This in un turn allows fiscal expansion on a sustainable basis because the interest burden remains low, and growth leads to decreasing debt-to-GDP ratios, even with large deficits. That was in fact the Fed’s rationale for QE in the 30s. Monetarists like Meltzer think that QE was not important for the recovery in the 30s, and that unsterilized gold flows did the trick.

  3. Lyuba Zarsky says:

    Unlike Gerry Epstein, I’m no expert… but I did find Robert Reich’s critique of QE persuasive. He argues that it won’t do zilch to stimulate job growth in the US economy for three reasons: 1) interest rates are already low; 2) people don’t have the wage income to spend to buy things, so there is little incentive for business to invest; and 3) the monies will flow out of the US in search of higher interest rates. I could imagine the strategy making sense if it was done in concert at least with the EU and Japan. But unilateral US action just seems like more of the Bush approach–shoot first, then see who is willing to go along.
    It seems that the troops are not only unwilling, but starting to look for other leaders.

  4. Kevin P. Gallagher says:

    As a progressive economist and a critic of QE2 let me say that I couldn’t agree more with the spirit of Epstein’s piece. The US has fewer options by the day. The election crippled the ability of the US to do fiscal policy (which has now been reinforced by pro-cyclical support from Cameron, Merkel and beyond) and short term interest rates were already close to zero. So Bernanke is the brave last believer in expansionary policy that has any power. I hope it works for the US, with positive spillovers for the rest of the world. Problem is, in a world of globalized finance, the possibility of negative spillovers is also very real. Jerry notes that this gives developing countries the opportunity to innovate new policies for capital management. I also agree. But they will have to be very quick learners given the scale of capital flows now entering their economies. India and China have a long history of using controls and have the institutional capacity to stem them—having built that capacity over time. Other countries have shunned capital controls and are just now “flicking the switch” given the new legitimacy of controls. Those nations, and the nations too timid to change, will still be in danger.

    A truly progressive approach is for the US to deploy QE2 and tell the world to use coordinated capital controls. Even better would be for the us to deploy QE2 and put in place capital controls on outflows of US capital in order to wedge the carry trade.

  5. History here would help. QE was used in the 1930s as part of an agreement that would allow fiscal expansion without increasing interest rates. Usually the Fed only manages the short term interest rates. QE guarantees that long term rates will remain low too. Hence, as Eccles argued in the 30s, they are a necessary complement of expansionary fiscal policy. Even if we do not pursue additional fiscal expansion, which would be a mistake, QE allows the large deficits and the accumulation of debt on a sustainable basis, and for that reason only it should be maintained and pursued for a few years. I actually think it’s a very good thing that Bernanke took a page from Eccles’ book.

  6. Gerald Epstein says:

    Kevin Gallagher’s point about the need for capital controls on outflows by the United States is an excellent one and should be emphasized as a key component of a successful QE policy.

  7. [...] particular, Gerald Epstein is right: A strange thing happened on the way to the G-20 meetings: world elite opinion has turned [...]

  8. P.E. Bird says:

    The fact that QE2 is going forward without capital controls (the Fed and Treasury still have some discretionary regulatory powers) is indicative to me of more of a “save the banks” mechanism than a stimulus function.

    The stimulus comments made by Bernanke seem like a cover story – without capital controls this is a hot money flow to emerging countries to locations that were burned once before (Asian crisis). I am sure that if presented with some controls the G20 would have been less critical. The leadership displayed by the US (both by Congress as well as the Executive branches) is embarrassing. Expecting the ROW to institute controls that US fails to do is wishful thinking, IMHO. I hope I am wrong.

    Perhaps this is an attempt to pressure China to revalue or loosen the peg. I doubt it will result in much stimulus to the US. It is indirect and the results are subject to the responses of those outside the US. Is this really the best we can do?

  9. Tom says:

    I have a genuine question: How is Germany being mercantilist?

  10. How is the stance of the ECB pre-Keynesian Gold Standard-like?

    The ECB has published an explicit inflation target more than ten years ago. What I’m hearing from Keynesian economist bloggers is calls for the Fed to do the same (although they usually advocate a higher target than what the ECB uses).

    The ECB has been offering unlimited liquidity (subject only to the requirement of adequate collateral) at the ECB policy rate to the banks for some time now. That’s very un-gold standard-like if you ask me.

  11. sean says:

    Right. The \”elite\” finally get what economic science has known for, well, at least the early 1970′s, when Robert Barro wrote his brilliant piece showing no \”Keynesian multipliers\” and \”We are all Keynesians now\” Nixon and Carter nearly destroyed the world with Keynesian \”stimulus\”.
    What did everyone learn?
    That Keynesian policies do not work.
    Maybe this is why the “elite” are rejectingthem? Just sayn’.

  12. The evidence for Barro’s brilliant argument on Ricardian Equivalence is nil. Something you should take into consideration.

  13. Rick Rowden says:

    Just word on the importance on capital controls on outflows, too…
    While I like Kevin Gallagher’s proposal that the US ought to impose controls on outflows in the context QE2, I am hoping emerging market economies and other developing countries will be able to fully use these as needed. Much of the recent emphasis has been understandably placed on the IMF’s remarkable turn around on the efficacy of controls on inflows in the face of mounting evidence. That is the good news. But I am not so sure the IMF has yet seen the light on the efficacy of controls on outflows. Ilene Grabel has cited the cases of Argentina, Venezuela, Indonesia, Russia and Ukraine adopting controls on outflows without any apparent negative response by IMF so far. And I understand many types of new controls adopted recently include reserve requirements and other forms of controls on outflows. Yet, the IMF has so far said very little about controls on outflows. Indeed, in their much-cited February 2010 IMF Staff Position Note by Ostry et al., there is only one brief paragraph on Page 10 that deals with outflows, which seems to suggest their continued belief in the sanctity of the ability of capital to flee whenever it wants:

    “Second, though the discussion here is confined to controls on inflows, relaxing controls on outflows may also have an impact on aggregate net inflows, and hence on the exchange rate and other macroeconomic variables. But the direction of that impact is unclear. On the one hand,
    liberalizing capital outflows can reduce net inflows as some of the inflows are offset by outflows. On the other hand, greater assurance that capital can be repatriated may make the country an even more attractive destination for foreign investors.”

    While I support the call of the South Centre and others for the establishment of global financial regulatory arrangements on capital flows, and innovative approaches for regional developments as well, in the mean time emerging markets may at any time need to be “allowed” to try to deploy controls on outflows. As Martin Khor reminds us, “sudden capital inflows can also turn into equally sudden capital outflows when global conditions change” or as soon as investors get spooked and start a stampede. I hope advocates will continue to pressure to IMF to clarify its position on this side of the controls issue as well.

  14. Ilene Grabel says:

    Thanks Rick. I agree that it is critically important to expand the discussion and the requisite policy space to make clear that controls on capital outflows can be a ‘legitimate part of the policy toolkit,” to use the now customary language of the Fund when it comes to controls on inflows. That the IMF staff involved in the Icelandic rescue recognized the necessity of controls on outflows (by validating the controls put in place before the SBA) and also discussed outflows controls in some other countries in matter of fact (though terse) language as part of strategies to “stop the bleeding” (IMF 2009, Annual report on exchange rate arrangements and exchange restrictions) is very notable, especially in comparison to the hysterical discussion of controls on outflows that followed Malaysia’s adoption of them during the East Asian crisis. But certainly advocates of increased policy space for both inflow and outflow controls should recognize that there is more work to be done to legitimize outflow controls in manner that has so clearly happened with controls on inflows. If the existing inflow controls adopted by many rapidly developing countries do not end up achieving their principal aims, then we may well see the same countries putting outflow controls in place. And perhaps this will continue the process of legitimation that is going on right now, and we will again see further evidence that views of IMF staff on capital controls is catching up to those long held by sensible people.

  15. Great article and great debate!
    In the (political) absence of an expansive policy that will prevail the next two years QE2 only can work, if the banks are forced to lend out money e.g.by taxing their liquid reserves and allowing other countries a kind of coordinated capital control.
    Unfortunately the article has a kind of China and Germany bashing, that is presently popular but absolute misleading. There is a currency problem with China, no doubt. But its effects are widely overstated. There are other reasons why the US is strong in Import and weak in exports. And: China still is a underdeveloped country that is seeking a way out of its underdevelopment. The means are not necessarily fair nor appropriate, but the free traders weren’t fair in the past either. So negotiating instead of bashing would be an appropriate approach.
    To equal China with Germany, simply because both are having an export surplus, lacks any analysis. Germany is a high wage, high energy price country virtually without any natural resources. It is a welfare state with free market access: otherwise it could not be explained why Chinese solar companies overtook German producers. The “analysis” mercantilist, may refer to another country, but not the Germany in Europe.

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