One of the themes of Globaloney 2.0 is the idea that globalization needs to be rethought and restructured if it is to be both economically feasible and politically sustainable. This isn’t a message that policy makers seem to want to hear. Most of the ideas in the air today boil down to a simple “reset and replay” strategy. Reset the economy (at a lower level) and start playing the same old game again.
Honestly, it’s enough to make you want to scream like my friend Homer shown here.
The good news is that some important people are taking the need to rethink and reform seriously. The International Monetary Fund, for example, has released a couple of policy papers that challenge the conventional wisdom about economic policy. They suggest that (1) maybe we need to rethink inflation-targeting goals and (2) maybe we need to rethink global capital market regulation.
Both these ideas challenge contemporary economic dogma. Both are worth considering. (Read this article in today’s New York Times to learn more about the IMF’s proposals.)
The Conventional Wisdom about Inflation
The conventional wisdom is for central banks to aim for zero inflation. The IMF papers ask if maybe low but predictable 4% inflation might not be better. Why? Well, the Times article gives one argument, but my opinion is this. When global financial crises hit, central banks sometimes need extreme tools to use to combat the effects. Sometimes (as we saw in Japan in the 1990s and around the world in recent years), pushing interest rates down to zero is not enough. In extreme emergencies you need to actually make interest rates negative (in real inflation-adjusted terms).
If inflation is zero, then the lowest that real interest rates can go is zero in a practical sense. And, as I’ve said, when the big crisis hits, that may not be enough. A 4% inflation rate would give central banks room to lower real interests as low as -4%. The fact that the IMF wants to consider this option suggest that they take seriously the possibility of another major crisis.
(BTW I think this is the reason the Federal Reserve increased the discount rate last week. Raise it now so that there is more room to lower it later if that is necessary.)
The Conventional Wisdom about Capital Flows
The conventional wisdom holds that nations grow fastest when they have open access to global capital flows. The conventional wisdom, however, seems to ignore the fact that higher returns come with higher risks associated with these flows and there are good arguments to be made for imposing sensible capital controls to reduce risk. The IMF acknowledges this trade-off and proposes some models of sensible capital controls.
Hopefully we can all appreciate today that maximizing return by maximizing risk is not maximizing common sense. Time to rethink the conventional wisdom.
I am not sure that many countries will embrace the IMF’s new ideas, but I think this is a good place to start. Ideas come first, after all. The necessary policy changes can only build upon them.