Thursday, March 4, 2010

Rhyming echoes

I have a follow up to this one about how our problem is we have nothing to devalue against any more.

It turns out the William White had a piece in the FT yesterday about how to devalue without devalueing.

If the repeated asymmetric use of macro policies has rendered them ineffective, what other policies might help deal with the debt problem?

One possibility would be to try to make existing debt levels more sustainable. Encouraging an orderly deleveraging of balance sheets, both household and financial, is one route. But as saving rates rise, multiplier and accelerator effects might interact to produce a much less orderly outcome than anticipated. Another way to raise debt service capacities would be to increase potential growth through structural reforms. Since a crisis commonly acts as a catalyst for such reforms, they should now be pursued vigorously. At best, however, both routes would seem likely to produce many years of very slow growth.

A second, faster, but initially much more painful way to make debt levels more sustainable is to reduce them. This could be done either through bankruptcies or negotiated workouts, with productive resources being freed for other uses. It might also require restructuring and recapitalisation of lending institutions. Again, there are many impediments, particularly in countries (such as the US) where the debt problem affects millions of households. In addition, justifiable concerns would be raised about the short-term costs of higher unemployment, moral hazard and property rights. Many countries also lack the legal framework to facilitate such measures, particularly for financial institutions. Policymakers should try much harder than they currently are to remove unnecessary impediments to an orderly writing down of debt.

Economics is often about hard choices. If the headwinds of debt have overwhelmed the capacity of macro policies to stimulate real growth, then other, more structural, measures must be turned to. Failing to muster the political will to do so would increase the likelihood of an inflationary solution to the debt problem. There are many historical examples to prove this can be done, though few that stopped short of hyperinflation. Why take this very dangerous path when there are other less dangerous paths to follow?

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