Summary:
Kenneth Rogoff says the global commodity price inflation is not surprising, given that we've experienced the most remarkable growth boom in modern history. Global economy is still growing too fast, and a global recession is necessary to rebalance commodity supply and demand at trend price levels. Efforts to maintain high growth through macroeconomic stimulus, will only result in even higher commodity prices and ultimately a bigger crash in the not-too-distant future. Bail-out activities in response to the ever-deepening financial crisis are compromising inflation stabilisation effort. Gains from this have to be weighed against the long-run cost of re-anchoring inflation expectations later on. Poorly run financial firms need to be allowed to go out of business, and the industry needs to shrink commensurate with the sharp fall in key lines of business related to mortgage securitisation and derivatives. Central banks need to raise interest to combat inflation, and Treasuries maintain fiscal discipline rather than giving in to the temptation of tax rebates and fuel subsidies. (Published: 29/07/08)
Notes:
- huge spike in global commodity price inflation is evidence that the global economy is still growing too fast
- not surprising: world has just experienced perhaps the most remarkable growth boom in modern history
- huge cumulative rise in global growth during the 2000s
- little wonder that commodity suppliers have found it increasingly difficult to keep up, even with sharply rising prices
- for many commodities, particularly energy and metals, new supply requires long lead times of five to 10 years
- although demand response is more nimble, it has been greatly dulled by a wide variety of subsidies and distortions in fast-growing emerging markets
- without significant global recession it will probably take a couple of years of sub-trend growth to rebalance commodity supply and demand at trend price levels
- if all regions attempt to maintain high growth through macroeconomic stimulus, main result is going to be higher commodity prices and ultimately a bigger crash in the not-too-distant future
- surprising how many leading policymakers and economic pundits believe that policy should aim to keep pushing demand up
- US: aggressive tax rebates, steep interest rate cuts and an ever-widening bail-out net for financial institutions
- China: briefly flirted with prioritising inflation, now resumed putting growth as the clear number one priority
- Dollar bloc countries: have slavishly mimicked expansionary US monetary policy
- rapid growth is putting huge upward pressure on inflation
- Europe: ECB coming under increasing domestic and international political pressure as Europe's growth decelerates
- if all regions try expanding demand, even the short-term benefit will be minimal
- commodity constraints will limit the real output response globally
- most of the excess demand will spill over into higher inflation
- central bankers mainly looking at wage growth
- argue that there is nothing to worry about as long as wage growth remains tame
- globalisation continues to shrink unskilled labour's share of global income.
- but: as goods prices rise, wage pressures will eventually follow
- ever deepening financial crisis as a rationale for expansionary global macroeconomic policy
- bail-out activities compromising inflation stabilisation effort
- may be convenient to have several years of elevated inflation to help bail out homeowners and financial institutions
- but: the gain has to be weighed against the long-run cost of re-anchoring inflation expectations later on
- also: not obvious that the taxpayer should absorb continually rising contingent liabilities
- financial firms need to be allowed to go out of business
- financial industry needs to shrink commensurate with the sharp fall in key lines of business related to mortgage securitisation and derivatives
- airline industry often goes through periods of excess capacity
- giant companies going out of business or merging
- we have grown accustomed to these traumas and learned to live with them, as in many other industries
- banking industry holding nations hostage each time they experience consolidation
- As major central banks extend their discount windows to complex investment banks whose business lines are evolving and churning constantly, "crises" of consolidation are surely going to become more frequent.
- financial market regulation is never going to be stringent enough in booms
- that is why it is important to be tougher in busts
- so that investors and company executives have cause to pay serious attention to risks
- "if poorly run financial institutions are not allowed to close their doors during recessions, when exactly are they going to be allowed to fail?"
- need to introduce more banking discipline
- policymakers must refrain from excessively expansionary macroeconomic policy at this juncture and accept the slowdown that must inevitably come at the end of such an incredible boom
- for most central banks, this means significantly raising interest rates to combat inflation
- for Treasuries, this means maintaining fiscal discipline rather than giving in to the temptation of tax rebates and fuel subsidies
- "In policymaker's zealous attempts to avoid a plain vanilla supply shock recession, they are taking excessive risks with inflation and budget discipline that may ultimately lead to a much greater and more protracted downturn."
