The Economist talks about the Federal Reserve's deliberate decision to stay "behind the curve" during the current business cycle:
Economist.com | The world economy: In the 1980s and 1990s, the Fed pursued a hawkish doctrine of pre-emptive strikes against any inflation-related activities it could espy, even if they did not yet show up in headline consumer prices. If you waited until you could see inflation, so the doctrine went, it was already too late. Now, some are asking whether the Fed has fallen “behind the curve”. In fact, the Fed has advertised its behind-the-curveness at every opportunity, telling the markets that rates would stay low for a “considerable period” and that it could be “patient” before raising them. Last year, the Fed felt that deflation was a remote but disturbing possibility; a little inflation would provide a welcome cushion against falling prices. It therefore made a strategic decision to stay behind the curve, making sure that modest inflation had returned before it tightened monetary policy.
By contrast, the Bank of China does not seem sure what it is trying to do:
Posted by DeLong at May 15, 2004 08:52 AM | TrackBack | | Other weblogs commenting on this postEconomist.com | The world economy: China’s monetary authorities... have pulled on one lever after another in an attempt to stop the overlending and overinvestment that threaten to destabilise the economy. Reserve requirements for banks have been raised three times since last summer, to no avail: banks still managed to lend 21% more in the first quarter than a year ago. On Friday, the Chinese authorities ordered financial institutions to “immediately stop fresh credit” to projects in a long list of sectors that are growing too fast for comfort, including light industry, construction and textiles.
The Chinese authorities are attempting to restrain and redirect the flow of credit by fiat, because they are reluctant to raise its price. Some media reports had suggested that they might raise interest rates for the first time in nine years as soon as the Golden Week holiday ended last week. But raising rates could break China’s brittle state enterprises and lure in more speculative capital from abroad, exacerbating the overheating problem. China’s monetary policy must also be guided by the need to maintain the yuan’s peg to the dollar. Until Mr Greenspan raises interest rates, China’s monetary authorities will find it difficult to do so. His stately calm, then, is one reason for their frantic hyperactivity.
Is this a sign that the peg might go bust soon?
Posted by: Chris on May 15, 2004 09:52 AMThe Chinese monetary authority is called the People's Bank of China, not Bank of China, which is a (state-owned) commercial bank.
Posted by: joe on May 15, 2004 10:12 AMWell the fundamental things being juggled are inflation, GDP growth, current accounts balances, debt, interest rates, and market stability.
In the simplest scenario, you get the Fed going too slow, China picking it's peg, and the Chinese economy has a hard landing, inflation grows, and the dollar corrects somewhat. This is a mixed market but pure central bank strategy.
A pure market strategy would be to let the currenct and current accounts balance correct to sustainable levels, and see gold and oil jump about 25% each. A pure banking strategy would be for the Fed to raise faster, retain lower inflation and the currency peg, but at the cost of a twin recession - Chinese and American. However in either pure scenario there is a chance of a market crisis.
There really is no happy ending here, just a choice of preference of poisons. I think the Fed is going to go slow and the chinese pick their currency peg, and so pick a kind of worst of all worlds scenario where we have some inflation, some debt market crises, some currency devaluation, and some part of an economic recession.
Who knows, maybe they're even right to make this choice.
Posted by: Oldman on May 15, 2004 11:06 PMComment should have read: this is a mixed market and central bank strategy", not mixed market and pure central bank strategy.
Obvious a pure market or a pure banking strategy wouldn't be mixed. So the contrast should be two extremes versus middle.
Oh and joe is right, the central bank of China is the People's Bank of China and not something sensible like Bank of China, etc. which is a commercial venture.
Posted by: Oldman on May 15, 2004 11:13 PM"By contrast"? The Chinese have nine years of experience in the business of trying to avoid raising rates prematurely. In comparison, the Fed looks like an untrained greenhorn thatīs unsure of its steps.
Ned Davis Research predicted it would take the Fed four years of playing the expectations game before actually making the next move. Maybe they got it wrong, and the Fed hasnīt yet figured out how to toe the line.
The primary options the Chinese have are tax increases and getting tough with the state enterprises (more privatization). What exactly is an interest rate hike supposed to achieve in a country of dedicated savers and investors? Create yet more savings? Or fuel a consumption boom that propels energy prices through the roof?
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