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Thursday, February 07, 2008

Kenneth Rogoff: America Needs Foreign Advice on its Ailing Economy

Ken Rogoff says it's time for the U.S. to stop giving financial advice and to begin to listen to countries who have successfully negotiated financial troubles similar to the ones we are now facing:

America needs foreign advice on its ailing economy, by Kenneth Rogoff, Commentary, Project Syndicate: As the United States' epic financial crisis continues to unfold, one can only wish that US policymakers were half as good at listening to advice from developing countries as they are at giving it. Americans don't seem to realize that their subprime mortgage meltdown has much in common with many previous post-1945 banking crises throughout the world.

The silver lining is that there are many highly distinguished current and former policymakers out there, particularly from emerging market countries, who have seen this movie before. If US policymakers would only listen, they might get an idea or two about how to deal with financial crises from experts who have come out safely on the other side.

Unfortunately, the parallel between today's US crisis and previous financial crises is not mere hyperbole. The qualitative parallels are obvious: banks using off-balance loans to finance highly risky ventures, exotic new financial instruments, and excessive exuberance over the promise of new markets.

But there are strong quantitative parallels as well. ... Across virtually all the major indicators - including equity and housing price runs-ups, trade balance deficits, surges in government and household indebtedness, and pre-crisis growth trajectories - red lights are blinking for the US. Simply put, surging capital flows into the US artificially held down interest rates and inflated asset prices, leading to laxity in banking and regulatory standards and, ultimately, to a meltdown.

When Asia and Latin America had their financial meltdowns in the 1990s and early 2000s, they took advice not only from the International Monetary Fund, but also from a number of small panels composed of eminent people representing diverse backgrounds and experiences. ...

Admittedly, the ... panel would have to look past America's current hypocrisy. The US Treasury strongly encouraged Asia to tighten fiscal policy during its 1990s crisis. But today the US Congress and president are tripping over themselves to adopt an ill-advised giant fiscal stimulus package, whose main effects will be to tie the hands of the next president in simplifying the US tax code and closing the budget deficit.

Americans firmly told Japan that the only way to clean up its economy was to purge insolvent banks and regenerate the financial system through Schumpeterian "creative destruction." Today, US authorities appear willing to contemplate any measure, no matter how inflationary, to insure that none of its major banks and investment houses fails.

For years, foreign governments complained about American hedge funds, arguing that their non-transparent behavior posed unacceptable risks to stability. Now, many US politicians are complaining about the transparency of sovereign wealth funds..., which are taking shares in trophy American assets such as Citibank and Merrill Lynch.

In fact, having countries like Russia and China more vested in the well-being of the US economy would not be a bad thing. Yes, the IMF ought to develop a voluntary code of conduct for sovereign wealth funds, but it should not be used as a weapon to enforce financial protectionism.

For years, I, along with many others, have complained that emerging markets need greater representation in global financial governance. Today, the issue goes far beyond symbolism. The US economy is in trouble, and the problems it spins off are unlikely to stop at the US border. Experts from emerging markets and elsewhere have much to say about dealing with financial crises. America should start to listen before it is too late.

How, exactly, does a stimulus package make it harder to simplify the tax code? Not sure I see that connection. In any case, I disagree on the stimulus package, I think it can help.

More generally, we don't want to penalize those who had no hand in creating the crisis, and if the economy suddenly begins a downward spiral because we failed to solve problems in financial markets, then many innocent people could be hurt. The goal of monetary and fiscal policy is not to prop up markets or to save financial institutions from facing the consequences of their choices, it's an attempt to keep all of us from getting caught in the turmoil brought about by the choices of others and by conditions outside of our control. If policymakers do nothing in response to a crisis and only those who caused the problems face the consequences then sure, policymakers should step aside. But that's not what happens. When credit markets begin to malfunction the problems can spread far beyond the sources of the problems causing a general drying up of credit and the start of a downward movement in the economy that feeds on itself and makes things even worse. Why risk a severe downturn because you are afraid that the deficit might blip upward or that you won't be able to implement tax simplification?

We should certainly do all we can to maximize the effectiveness of policy, and creating the correct set of incentives going forward is one of the considerations in the formulation of a response. But worst case outcomes need to be avoided and I am not willing to risk a severe downturn because we are uncertain about whether policy will work, it might work and choosing to do nothing when policy would have fixed the problem is a big mistake, or because we are afraid that a policy response might somehow fail to teach lessons that financial market participants need to learn. If these firms are only profitable in bubble conditions, then they will go out of business soon enough anyway, particularly if there are effective regulatory responses that prevent the excesses we have seen recently and cause the source of their profits to dry up.

    Posted by on Thursday, February 7, 2008 at 12:15 AM in Economics, Financial System, Fiscal Policy, Monetary Policy, Regulation | Permalink  TrackBack (0)  Comments (30)


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