Summary:
Barry Eichengreen argues that Asia needs tight money, appreciated exchange rates, and fiscal stimulus. Despite the growth of inter-Asia trade, Asian economies are not decoupled from the West, as latter is buyer of final product. As growth in Europe and US is coming to standstill, will have impact on Asia. Nor is Asia being spared from turbulence in credit markets. In addition, Asia has imported inflation from the US by following the Fed's rate cuts. Asian economies need demand restraint but got demand stimulus instead. Inflation rates at 10 year highs. Now negative real interest rates in many Asian economies: unhealthy subsidy for borrowing by households and firms, artificial stimulus to consumptioin. Caused Asian crisis 10 years ago. Central banks need to increase interest rates. Alternative will be even more painful increases later. Will push up exchange rate and slow down economy. Asia can sustain demand under these circumstances by means of fiscal policy: tax cuts and increases in public spending on locally-produced goods. (Published: 19/06/2008)
Notes:
- Asian developing economies not decoupled from rest of the world
- despite growth of inter-Asia trade, West ultimately needs to buy their final product
- but: growth in US and Europe slowing to standstill
- Asia also negatively affected by turbulence in credit markets
- spreads greatly increased between August 2007 and Feb 2008
- Philippines: 200 base points
- Indonesia: 131
- Korea: 93
- China: 70
- declined after Bear-Stearns rescue
- growth will not stop, but slowdown is likely
- new development, in addition to slowdown: acceleration of inflation
- April headline inflation for Asia ex Japan: 7.5% (core: 4.5%)
- 10 year high
- origin of Asian inflation
- came from US: sharp rate cuts by Fed in response to subprime crisis
- Asian countries followed in order to prevent appreciation of their currencies
- cuts were not appropriate for Asia
- last thing needed in Asia is lower interest rates
- Asian economies need demand restraint but got demand stimulus instead
- causes inflationary pressure
- additional factors are geopolitical uncertainty, oil-market speculation, bad weather and ethanol programs
- affect headline inflation
- failure of Asian central banks to tighten more aggressively in turn tends to re-export inflation back to the West
- what Asian economies should do
- should raise rates
- higher interest rates will push up the exchange rate and damp down inflation
- have been half-hearted efforts in this direction, but they have not done the job
- negative real interest rates!
- Indonesia: central bank rate is 8.5%, inflation rate above 10%
- Philippines: central bank rate is 5.25%, but inflation rate is 10%.
- Vietnam: central bank rate is 14%, but its inflation rate is 25%.
- negative real interest rates make no sense in Asia
- because they are growing at or near capacity
- negative real rates are an unhealthy subsidy for borrowing by households and firms
- they encouraged inefficient investment and excessive leverage in Asia in the first half of the 1990s
- was followed by Asian crisis
- negative interest rates and their artificial stimulus to consumption and investment are also reason why we haven’t seen more of a slowdown in Asia
- reason why we haven’t seen more recoupling.
- but: now that Asian central banks are being forced to tighten, we will see more evidence of their economies slowing down
- Asian currencies will appreciate against both the dollar and the euro
- Although the Fed and the ECB may raise rates as well, both inflation and growth are weaker than in Asia, so they will have reason to respond more moderately
- alternative to painful interest rate increases now will be even more painful increases later
- Asia can sustain demand under these circumstances by means of fiscal policy
- tax cuts and increases in public spending on locally-produced goods will limit the contraction of aggregate demand
- will push up the exchange rate still further
- as they stimulate the demand for locally-produced goods
- will moderate the rise in import prices and further contain inflationary pressure
- should be calibrated to US and global slowdown
- should be explicitly temporary
- apart from case of China perhaps
- conclusion: Asia needs tight money, higher exchange rates, and fiscal stimulus
- has been Argued by Bush administration for last three years
- but: now need for a change in the Asian policy mix is more urgent than ever
