Over the past decade, Joe Stiglitz, Jeffrey Sachs, and others have heavily critiqued IMF advice to countries in crisis to raise real interest rates and establish budget surpluses as likely to have counterproductive and perverse consequences. Now comes Olivier Blanchard to argue that these critiques are half right in the case of Brazil in 2002-2003: tighter monetary policy would have worsened the situation (but tighter fiscal policy would have--and did--help matters.)
Posted by DeLong at April 6, 2004 11:22 AM | TrackBack | | Other weblogs commenting on this postFiscal Dominance and Inflation Targeting: Lessons from Brazil, by Olivier Blanchard. NBER Working Paper No. w10389. Issued in March 2004
Abstract: A standard proposition in open-economy macroeconomics is that a central-bank-engineered increase in the real interest rate makes domestic government debt more attractive and leads to a real appreciation. If, however, the increase in the real interest rate also increases the probability of default on the debt, the effect may be instead to make domestic government debt less attractive, and to lead to a real depreciation. That outcome is more likely the higher the initial level of debt, the higher the proportion of foreign-currency-denominated debt, and the higher the price of risk. Under that outcome, inflation targeting can clearly have perverse effects: An increase in the real interest in response to higher inflation leads to a real depreciation. The real depreciation leads in turn to a further increase in inflation. In this case, fiscal policy, not monetary policy, is the right instrument to decrease inflation. This paper argues that this is the situation the Brazilian economy found itself in in 2002 and 2003. It presents a model of the interaction between the interest rate, the exchange rate, and the probability of default, in a high-debt high-risk-aversion economy such as Brazil during that period. It then estimates the model, using Brazilian data. It concludes that, in 2002, the level and the composition of public debt in Brazil, and the general level of risk aversion in world financial markets, were indeed such as to imply perverse effects of the interest rate on the exchange rate and on inflation.
I haven't read the paper but I don't see how OJ deals with dollar denominated debt ($dd). I could tell a (maybe false) story in which ($dd) is held by foreigners so the interest rate is unaffected by the Brazilian central bank. Then it seems that high real Real interest rates are just another factor that affects the budget deficit.
By the way the currency is the real spelled just like not nominal right ? They got to do something about that.
Posted by: Robert Waldmann on April 6, 2004 08:42 PMTo be perfectly frank about it calmo, I'm not sure I get YOUR point: I suppose my Greenspanish isn't as good as it could be. Speaking of interest rates, far-out places, missing the point and haystacks though, YOU might find the "point" you're looking for here:
(Good Luck ;-)
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Remarks by Chairman Alan Greenspan: The Reagan Legacy
At the Ronald Reagan Library, Simi Valley, California
April 9, 2003
http://www.federalreserve.gov/BoardDocs/speeches/2003/200304092/default.htm
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It just occured to ME that OTHERS, others who may or may not be as "fluent" in Greenspanish as Brad, Stiglitz, Sachs and/or calmo, would PROBABLY be better off if THEY started THEIR search for the "point" HERE:
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Welcome to 50 Years is Enough
US Network for Global Economic Justice
http://www.50years.org/index.html
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The World Bank and the International Monetary Fund (IMF)
QUESTIONS AND ANSWERS
http://www.50years.org/updates/questions.html
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Or here:
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The Divine Right of Capital: Dethroning the Corporate Aristocracy
http://www.divinerightofcapital.com/
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Feudalism with a Digital Face?
http://www.divinerightofcapital.com/newpage15.htm
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If the previous comment seems "context-free', that's because stuff disappears around here.
Here's the scoop:
After complimenting me with the appelative adjective "enclclopedic", a correspondent whose comment has since disappeared too and whose handle happened to be calmo noted that my now TWICE disappeared comment on Brad's comment on Joe Stiglitz and Jeffery Sach's "heavy critiques" of the IMF wasn't Brazil centric and then went on wonder aloud about what my point might be.
What follows is a faithful copy of the message calmo was responding to: a message which, as it happens, was the second version of MY original comment...
I posted this earlier: it must have disappeared into some memory hole or other, I guess. A perverse little glitch in the system maybe? Who knows? Good thing I left the window open. Here's a faithful copy of the original, for anybody who might have missed it...
Speaking of "peverse" economic "advice" (Abstractly)
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Greenspan!
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Ronald Reagan and the Commitment of the Mentally Ill: Capital, Interest Groups, and the Eclipse of Social Policy
Alexandar R Thomas
Department of Sociology and Anthropology
Northeastern University
Introduction
Almost ten years after Ronald Reagan left office as president, the legacy of his administration continues to be studied. What is almost indisputable is that the changes in public policy that were implemented during the 1980s were sweeping and marked a turning point in American domestic policy. Faced with increasing competition from overseas, American business found it necessary to alter the social contract. This would require a realignment of the political economy so as to weaken labor unions and the social safety net. In Reagan, the Right found a spokesman capable of aligning conservatives, centrists, and working class whites. With this coalition, Reagan was able to bring about a number of reactionary changes in public policy (Alford, 1988)...
The Economy
In the aftermath of World War II, the United States experienced a period of dramatic economic growth. The industrial economies of Western Europe and Japan were by and large devastated by the war. As a result, American firms found little competition abr oad in an expanding world market. The implementation of the Marshall Plan under President Truman provided American goods and services on credit to the war ravaged economies. During this period of economic hegemony, American companies were able to make con cessions to labor in regard to wages and fringe benefits. Thus, the postwar political economy of the United States was characterized by relative peace between management and labor. With record corporate profits and rising standards of living, the United States government passed a series of liberal reforms throug hout the period. Among these reforms was the passage of the Civil Rights Act, various social welfare programs, the construction of the interstate highway system, and the deinstitutionalization of the mentally ill.
During the late 1960s and early 1970s, the rebuilt economies of Europe and Japan began to give American companies stiff competition in the world marketplace. The growth experienced by American firms during the previous two decades began to slow, and profit margins were deemed to be too low (Barlett and Steele, 1996; Gruchy, 1985). In order to increase profits, many American firms attempted to become more comp etitive by trimming labor costs through layoffs and the relocation of factories (Bluestone, 1990; Bluestone and Harrison, 1982; Gruchy, 1985; Harrison and Bluestone, 1988; Moriarty, 1991; Perrucci et al, 1988; Sassen, 1991; Wallerstein, 1979). In addition , the reduction of corporate taxes was pursued with a renewed vigor (Barlett and Steele, 1994).
In order to reduce corporate taxes, it was necessary to reduce the size of the welfare state. This objective was carried out by the Reagan administration (Abramovitz, 1992). After taking office in 1981, the administration set out on a course to alter t he (relatively) labor sensitive political economy to be more business friendly. Reagan appointed anti-union officials to the National Labor Relations Board, "implicitly [granting] employers permission to revive long shunned anti-union practices: decertify ing unions, outsourcing production, and hiring permanent replacements for striking workers" (102). Reagan himself pursued such a policy when he fired eleven thousand striking air traffic controllers in 1981. Regulations designed to protect the environment , worker safety, and consumer rights were summarily decried as unnecessary government meddling in the marketplace (Abramovitz, 1992; Barlett and Steele, 1996). Programs designed to help the poor were also characterized as "big government," and the people who utilized such programs were often stigmatized as lazy or even criminal. With the help of both political parties, the administration drastically cut social welfare spending and the budgets of many regulatory agencies.
The new emphasis was on "supply side" economics, which essentially "blamed the nation's ills on 'big government' and called for lower taxes, reduced federal spending (military exempted), fewer government regulations, and more private sector initiatives " (Abramovitz, 1992, 101). Thus, to effect a change in the political economy, Reagan was able to win major concessions regarding social policy that continue today. By taking away the safety net, the working class was effectively neutralized: workers no lo nger had the freedom to strike against their employers or depend upon the social welfare system as a means of living until finding employment. Business was thus free to lower wages, benefits, and the length of contracts. The overall result was that the av erage income for the average American dropped even as the average number of hours at work increased (Barlett and Steele, 1996; Schor, 1992)...
http://www.sociology.org/content/vol003.004/thomas.html
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Alan Greenspan!
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Interim Report: Notes on the
U.S. Trade and Balance of Payments Deficits
1999
Wynne Godley
Summary
1. The United States has a balance of payments deficit worth nearly 4 percent of GDP and negative net foreign assets (or foreign debt) worth nearly 20 percent of GDP. If U.S. growth is sustained in the medium term, it is quite likely that the balance of trade in goods and services will not improve. The United States is the only major country, or country "bloc," to have a substantial trade deficit and this is proving of great advantage to the rest of the world.
2. If the balance of trade does not improve, there is a danger that over a period of time the United States will find itself in a "debt trap," with an accelerating deterioration both in its net foreign asset position and in its overall current balance of payments (as net income paid abroad starts to explode)...
http://www.levy.org/docs/stratan/stratan.html
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Chairman Alan Greenspan!
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April 11, 2002
US dollar hegemony has got to go
By Henry C K Liu
There is an economics-textbook myth that foreign-exchange rates are determined by supply and demand based on market fundamentals. Economics tends to dismiss socio-political factors that shape market fundamentals that affect supply and demand.
The current international finance architecture is based on the US dollar as the dominant reserve currency...
http://www.atimes.com/global-econ/DD11Dj01.html
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Urgent call for Alan Greenspan!
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U.S. Budget Deficit Threatens World Economy, IMF Warns
Thursday, January 8, 2004
A rising U.S. budget deficit and trade imbalance may create such a burden of foreign debt that it could cause financial instability in the United States and the rest of the world, a report released yesterday by the International Monetary Fund says....
http://www.unwire.org/UNWire/20040108/449_11858.asp
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It's your legacy, sir...
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BUSH'S DEEP REASONS FOR WAR ON IRAQ: OIL, PETRODOLLARS, AND THE OPEC EURO QUESTION
(Updated 5/27/03)
As the United States made preparations for war with Iraq, White House Press Secretary Ari Fleischer, on 2/6/03, again denied to US journalists that the projected war had "anything to do with oil." He echoed Defense Minister Donald Rumsfeld, who on 11/14/02 told CBS News that "It has nothing to do with oil, literally nothing to do with oil."
Speaking to British MPs, Prime Minister Tony Blair was just as explicit: "Let me deal with the conspiracy theory idea that this is somehow to do with oil. There is no way whatever if oil were the issue that it would not be infinitely simpler to cut a deal with Saddam...." (London Times 1/15/03).
Nor did Bush's State of the Union Message, or Colin Powell's address to the United Nations Security Council, once mention the word "oil." Instead the talk was (in the president's words) of "Iraq's illegal weapons programs, its attempts to hide those weapons from inspectors, and its links to terrorist groups."
However our leaders are not being candid with us. Oil has been a major US concern about Iraq in internal and unpublicized documents, since the start of this Administration, and indeed earlier. As Michael Renner has written in Foreign Policy in Focus, February 14, 2003, "Washington's War on Iraq is the Lynchpin to Controlling Persian Gulf Oil."
But the need to dominate oil from Iraq is also deeply intertwined with the defense of the dollar. Its current strength is supported by OPEC's requirement (secured by a secret agreement between the US and Saudi Arabia) that all OPEC oil sales be denominated in dollars. This requirement is currently threatened by the desire of some OPEC countries to allow OPEC oil sales to be paid in euros....
http://ist-socrates.berkeley.edu/~pdscott/iraq.html
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...She sounds UGLY.
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April 6, 2004
Asia's Stockpiles of Dollars Pose U.S. Economic Risks
By Tyler Marshall, Times Staff Writer
HONG KONG — A massive buildup of U.S. dollars held by Japan, China and other Asian countries is fueling increasing unease among analysts and policymakers, who fear it poses risks to the fragile American economic recovery and global financial stability.
Collectively, Asian countries hold foreign exchange reserves — mostly in dollars — valued at more than $2 trillion, nearly triple that of just seven years ago, according to the Asian Development Bank. Those dollar holdings continue to grow rapidly, with the Japanese and Chinese governments particularly heavy buyers.
Asian governments buy dollars because it helps boost their export-led economies. Snapping them up keeps the greenback's value high and the value of regional currencies low, giving Asian countries a vital competitive edge in foreign markets.
Though this strategy makes a Chinese-made toy or a Japanese TV set cheaper for Americans and other global consumers, it has serious side effects. The dollars that Asian countries rake in as payments for those exports further boost their already bloated reserves while the record U.S. trade deficit grows even larger.
But that's not all. Asia's dollar purchases also effectively finance the huge and growing U.S. budget deficit as central bankers in the region invest most of their dollars in U.S. Treasury bonds and other securities. They have done this with such gusto that Uncle Sam doesn't even have to offer higher rates to move the average $1.5 billion of Treasury securities it must sell each day to sustain the current year's deficit.
Without that demand, the United States would have to offer higher interest rates to lure buyers — a move that would drive up rates on mortgages, business loans and more...
...Asia's "dollar habit" also poses other risks to Americans, experts say. By allowing the U.S. to pile up record deficits without having to pay the usual price of higher interest rates, Asia has effectively encouraged Congress and the Bush administration to amass even more debt...
...At some point, economists are convinced, the U.S. will be forced to take corrective action to rein in its deficits. But these experts also believe the political costs are probably too high for the administration to act on its own prior to the November election.
Still, they stress that developing a plan that can steer the world economy through an orderly adjustment must be among the first tasks for whoever resides in the White House next year. A delay well into the year could easily undermine confidence in the greenback, spook central banks in the region and possibly start a wave of uncontrolled dollar selling, the experts say.
"Eventually, the United States will have to address the deficits..."
http://www.latimes.com/business/la-fi-dollar6apr06,1,6876656.story?coll=la-home-headlines
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