Plain English: Some Thoughts On Bernanke’s LSE Speech

2013.03.26.Bernanke Plain English-helicopter benBernanke gave a speech at the London School of Economics yesterday which is grabbing a lot of attention. Those who have heard or read some of his other non-Fed public lectures over the past few years will recognize that he spent about half of it reviewing some of his favorite historical lessons, mostly sourced from his pre-Fed academic work. But there were some new statements to add to this mix. My interpretation of some of the key themes:

  • The current financial crisis is in fact a classic panic: a systemwide run of “hot money” away from assets whose values suddenly became uncertain.
  • That said, there were some different bells and whistles this time, notably the introduction of new financial instruments, more varied actors beyond just banks and (in my opinion) most vitally, a scale and complexity altogether new.
  • Currency war, which Bernanke chooses to refer to as, “competitive depreciation of exchange rates”, is similarly not new.
  • The accommodative monetary policies central banks around the world have been implementing (read: zero interest rate policy) to support growth do not constitute competitive devaluations, currency wars or whatever term you prefer. The primary reason for this is that domestic demand counts for a lot more than exchange rate meddling and in any event when competitive economies both devalue their currencies, whatever effects result from these devaluations effectively cancel each other out.

  • Emerging market economies face a more complicated situation than developed economies. The long and short of this has to do with the fact that domestic demand in emerging economies is not so developed, leaving them perennially subject to export-led growth strategies, which in turn leaves them more vulnerable to external shocks.

 

“Regarding the effects of monetary easing on exchange rates and exports, I would note that trade-weighted real exchange rates of emerging market economies, with some exceptions, have not changed much from their values shortly before the intensification of the financial crisis in late 2008. Moreover, even if the expansionary policies of the advanced economies were to lead to significant currency appreciation in emerging markets, the resulting drag on their competitiveness would have to be balanced against the positive effects of stronger advanced-economy demand. Which of these two effects would be greater is an empirical matter. Simulations of the Federal Reserve Board’s econometric models of the global economy suggest that the effects are roughly offsetting, so that accommodative monetary policies in the advanced economies do not appear, on net, to have adverse consequences for output and exports in the emerging market economies.”

So basically, two steps forward, followed by two steps backward.

“Regarding capital flows: It is true that interest rate differentials associated with differences in national monetary policies can promote cross-border capital flows as investors seek higher returns. But my reading of recent research makes me skeptical that these policy differences are the dominant force behind capital flows to emerging market economies; differences in growth prospects across countries and swings in investor risk sentiment seem to have played a larger role. Moreover, the fact that some emerging market economies have policies that depress the values of their currencies may create an expectation of future appreciation that in and of itself induces speculative inflows.”

This excerpt above is Bernanke’s take on the carry trade. He does recognize that it exists, but does not believe it to be as decisive a factor in financial stability for emerging markets as foreign interpretation and analysis of macroeconomic fundamentals.

“[Emerging Markets] Policymakers have also experimented with various forms of capital controls. Such controls raise concerns about effectiveness, cost of implementation, and possible microeconomic distortions. Nevertheless, the International Monetary Fund has suggested that, in carefully circumscribed circumstances, capital controls may be a useful tool.”

Everyone at these levels of the global elite always stops just short of coming right out and admitting the IMF got it wrong, so allow me: THE IMF GOT IT WRONG.

Finally, to close:

“In sum, the advanced industrial economies are currently pursuing appropriately expansionary policies to help support recovery and price stability in their own countries. As the modern literature on the Great Depression demonstrates, these policies confer net benefits on the world economy as a whole and should not be confused with zero- or negative-sum policies of trade diversion. In fact, the simultaneous use by several countries of accommodative policy can be mutually reinforcing to the benefit of all.”

This is Bernanke basically talking up his book, in a manner of speaking. And who can blame him? No central banker at that level can afford to come off as wishy-washy.

Nevertheless, every time Bernanke steps out to address the public in a non-Fed setting, the screaming and shouting the man inspires from all sides of the political economy spectrum is quite striking. My sense is that a lot of this ire is misdirected frustration at moral hazard risks wrought from bailing out more financial institutions than I care to count, plus the fact that the US Government still has yet to really prosecute anyone of consequence in connection with the massive systemic fraud whose time came up over 2008-09.

The thing is, that’s not in the job description of the Chairman of the US Federal Reserve and it never has been. The Fed Chairman’s job is for the most part predicated on two duties: keep inflation low and keep unemployment low–that’s it. So far, Bernanke seems to have whipped the first one; his next challenge is to get the second one into line. And he sure as hell isn’t going to get there by raising interest rates any time soon. Sure, something else is needed besides the interest rate lever, but that’s not entirely under his realm of influence. But that’s a topic for another day.

Full speech text here.

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