Tuesday, June 7, 2011
British lessons in monetary failure
The IMF in its latestreport gives thumbs upfor further doses of QEshould the economicrecovery weaken further.Yet they (IMF) offer nocritical assessment of howthe UK version of Bernanke-ism – QE plusaggressive currencydepreciation – hasactually fared.
In fact the experience of UK monetary andeconomic outcomesduring the past decadeprovides a basket case of what is wrong withBernanke-ism!
This publication should not beviewed as a ‘personalrecommendation’ as defined by therules of The Financial ServicesAuthority.
Contact: Brendan BrownTel: +44 20 7577 2712Economic ResearchMitsubishi UFJ SecuritiesInternational plc
DEVALUATION AND QE PRODUCE STARKLY NEGATIVE RESULTS
In many respects the UK is a basket case as to what is wrong with Bernanke-ism. All the elements – inflation targeting, repudiation of automatic monetarycontrol mechanisms which would have the central bank targeting monetary basewhilst leaving interest rates market-determined, non-comprehension of wideraspects of monetary stability than just goods and services inflation, deflationphobia, principle of central bank infallibility, and legitimization of currency war(competitive devaluations) - had all come together in the conduct of UK monetaryaffairs even before President Bush invited Professor Bernanke to pack up his bagsand move from the Princeton Economics Department to the Federal Reserve.And what is the visible consequence of Bernanke-ism as applied in the UK?Well, first there was the bubble economy of the last decade, featuring a giganticcredit bubble alongside a consumer boom and commercial/residential real estatemarket boom and bust (except for the special case of London prime residential).And so deep was the mal-investment during the bubble years that even now thelevel of output in the UK economy remains some 3% below its 2007 peak. Thatshortfall is all the more remarkable given the aggressive policies of QE andcurrency devaluation (the two are opposite sides of the same coin) which weremeant to powerfully stimulate a UK recovery.Instead, the main recovery story in the UK has been the return of inflation,expected to peak this year at above 5%, and then sink back towards 2% p.a. bylate 2012 or into 2013. At least, you might think, if there were going to be such agigantesque bubble and bust the UK could at least extract the benefit of long-runprice level stability from its woes. But no, the QE policies and aggressivedevaluation (under-written by the QE) have left the UK economy with an inbuiltinflation momentum significantly higher than in other medium-sized advancedeconomies around the globe.And yet despite this fairly self-evident catalogue of failure the UK monetarypolicy makers can take pride in the fact they are still getting good marks from theIMF! In its latest survey of the UK economy (published yesterday) the IMF laudsthe conduct of policy by the UK monetary authorities and – wait for it! – exhortsthem to turn to a further dose of QE should the present recovery continue tostutter. Well, the UK may be a bigger case of what University of ChicagoProfessor Robert Aliber recently observed in connection with Iceland. He raisesthe question “How did the IMF and OECD completely miss the implications of themassive imbalances in Iceland (even as late as early 2008): staff from bothinstitutions visited Iceland once or twice a year”. And Professor Aliber continues,“one of my economist banker friends commented – Darwin had to visit theGalapagos to see phenomena that he might have observed in his backyard inEngland if they had not been obscured by a lot of clutter. And you had to go toIceland in your hunt for a bubble and to identify its origin”.The IMF scores such big misses in part because it purveys the same monetarydoctrines as the flawed ones practised in the countries it visits. A journalistrecently questioned whether Adam Smith or von Hayek would get a job today in aUS university given the dominance of econometrics and mathematics (tools whichthey did not espouse). Well in similar vein, it is certain that a leading economistpreaching a story of monetary stability and the role of monetary disequilibrium in