Saturday, July 05, 2014

Krugman and Wolf bash the BIS for its Hoover/Brüning austerity obsession

The Bank of International Settlements (BIS) has issued their annual report, which I quoted earlier on the state of European banks. I quoted from it a few days ago on the state of European banks.

But the report also advocates austerity politics. Which has provoked some pushback from macroeconomists. Paul Krugman among others takes them to task for their dogmatic recommendations for fiscal and monetary austerity policies in Stability or Sadomonetarism? 07/01/2014. Krugman clearly thinks it's the latter:

... it's more or less insane to argue that the economy must be kept persistently depressed for fear that investors will be too exuberant — and at the same time to argue against fiscal expansion or anything else that might offset rising rates. What he doesn’t note, however, is that while the BIS has argued for raising interest rates at least since 2010, it keeps changing its reasoning.
That's a technical economics/finance term, "more or less insane." He concludes, "What all this suggests is that the BIS basically just wants to raise rates, and is always looking for a reason. It’s about sadomonetarism, not stability."

Martin Wolf calls their austericide formula Bad advice from Basel’s Jeremiah Financial Times 07/01/2014. Wolf likes the part of the report on the onset of the financial crisis which began in 2007, which he describes as follows:

One can divide the BIS analysis into three parts: what caused the crisis; where we are now on the way out of it; and what we should do. On the first, the perspective is that of the "financial cycle". This analysis goes back to the work of the great Swedish economist Knut Wicksell at the turn of the 20th century. The core idea is that if the rate of interest is too low, a boom driven by expanding credit and rising asset prices may ensue. One of the crucial (and correct) implications is that credit and money are endogenous: they are created by the economy. When the financial cycle turns from boom to bust, crises erupt. Then follow the "balance sheet recessions" described by Richard Koo of the Nomura Research Institute – painful deleveraging and extended periods of feeble growth. Such cycles, argues the BIS, "tend to play out over 15 to 20 years on average". To give credit where it is due, the BIS gave such warnings well before the crisis hit the high-income countries from 2007.
But he does criticize their analysis of the crisis for ignoring "the impact of adverse shifts in the distribution of income and in business behaviour on propensities to save and invest." It's nice to see maldistribution of income getting more prominence in discussion of the crisis.

This is a memorable jab at the kind of Herbert Hoover/Heinrich Brüning austerity economics the BIS is recommending: There is no doubt that most crises end up with huge long-term losses. But, by the 1950s, the US had recovered fully from the gigantic losses relative to the pre-1929 trend in GDP per head caused by the biggest crisis of all: the Great Depression ... Is this not because, unlike in the pusillanimous present, the US subsequently experienced the biggest fiscal stimulus ever – the second world war? I can imagine how the BIS would have warned against such fiscal irresponsibility. [my emphasis]
And he describes the level of its foolishness this way:

... the notion that the best way to handle a crisis triggered by overleveraged balance sheets is to withdraw support for demand and even embrace outright deflation seems grotesque. The result, inevitably, would be even faster rises in real indebtedness and so yet bigger waves of bankruptcy that would lead to weaker economies and so to further increases in indebtedness. The reasons for abandoning the pre-Keynesian consensus were powerful, whatever the BIS (and many others) may think.

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