Wednesday, 30 July 2008

Rogoff Misdiagnoses the Problem

In his FT article of July 30, ‘The World Cannot Grow Its Way Out of This Slowdown’, Kenneth Rogoff makes some curious arguments. In particular, he identifies excessive demand for commodities and the excessive supply of financial services as the two main problems facing the global economy. And in response he advocates more restrictive fiscal and monetary policies and a greater willingness to allow financial services firms to fail.

Rogoff cites the large increase in commodity prices as prima facie evidence that the global economy is still growing too quickly and hence that commodity demand is excessive. However, one need only consider the oil price increases from 1974-1980 and the price of gold in 1980 to see that commodity price increases do not constitute prima facie evidence of even trend growth.

Rogoff chides central bankers in dollar bloc countries for having “slavishly mimicked expansionary US monetary policy.” While the Bank of Canada has lowered its lending rate in recent months, the Reserve Bank of Australia and the Reserve Bank of New Zealand have significantly tightened policy over this period. Perhaps Rogoff is also referring to Asian countries with managed currencies, such as China? If so, this characterization still appears misleading, as China has been increasing its rediscount rate and has significantly increased its required reserve ratio in recent years. The overall impression is that policy is relatively stimulative in markets operating below capacity and relatively restrictive in markets that appear to be operating above capacity, just as one would expect in a world still dominated by the Phillips curve paradigm.

Rogoff also chides regulators for preventing the failure of firms in the financial services sector, apparently ignoring the considerable consolidation occurring in the sector. The recent acquisitions of Bear Stearns and Countrywide serve as examples of ongoing consolidation, as does the recent acquisition of ABN AMRO, the largest such transaction to date. Regulators may be subject to criticism for failing to provide adequate regulation in certain instances but not for failing to allow consolidation and removal of capacity in the sector.

In short, I believe Rogoff has misdiagnosed the problem. The demand for commodities and the supply of financial services are the consequences of the profound changes that have taken place across the globe. They are not the causes of the current turmoil, and his prescriptions are unlikely to help ease the turmoil or set the stage for a more supportive environment in the future.