April 3, 2002
According to the latest forecasts by the International Monetary Fund (IMF), world economic activity may grow less than 1.5 percent in 2002. Unlike individual countries, where a recession requires a decline in economic activity, most economists believe that a world recession occurs when economic activity is expanding by less than the growth in world population.
World population is growing about 2 percent, although population growth appears to be slowing in virtually all countries except those garnering migration from other parts of the world. Thus, the IMF forecast is one of global recession.
Of course, economists are aware of the speculative excesses that led to consumers spending more rapidly than they were earning and corporations investing more aggressively than they could use the equipment they were acquiring. Some of this excess was worldwide, especially in communications.
(Actually, I believe the IMF forecasts are too pessimistic and that world growth will be closer to 2.2 percent, but this does not alter my criticism of world monetary activity).
I already have criticized two policy flaws in our own monetary activity that have not yet been eliminated. First, our Federal Reserve appears to begin a change in monetary policy with timidity and then become bolder. Thus, the most aggressive policy usually is at the end of a policy shift, when policy overshoots the target.
Second, our Federal Reserve does not re-establish normality
in the credit markets after a policy shift is completed.
The interest rate cuts that protected the
These clearly are areas that require improvement if non-inflationary sustainable growth at high levels of resource utilization are to be sustained. Nevertheless, our Federal Reserve has attacked problems and generally repelled the worst outcomes that those problems could create.
Kudos also are deserving for the central bank in
The British pound has made their task more difficult.
Instead of being rewarded with a strong currency for preserving growth,
the pound has been acting as if it is tied to the euro.
As a result, currency related inflation has created an added challenge
Of course, the European central bank has been fighting an
inflation that was caused by rising oil prices and a falling currency while
unemployment rose on the continent. The
recessions that spread throughout most of
The fallacy that restrictive monetary policy will support currency values also is restraining the Japanese central bank from aggressively fighting the deflation that continues to threaten the lending capacity of its banks.
This fallacy arises because our basic economic textbooks teach that tight monetary policies raise interest rates while restricting inflation domestically. As a result, world savings flow to this happy state of higher inflation adjusted returns. This increased demand for domestic assets raises the value of the currency a rewards astute international investors.
What is missing from this reasoning is what such a monetary policy is doing to the earning capacity of assets in the domestic economy. Who wants to buy equities in a country where earnings are falling? How much can interest rates rise when no capital is needed?
What the textbooks do not emphasize is the separate impact
that earnings from capital creates in attracting international savings.
In fact, the no growth policies in euro-land and in
Hopefully, these central bankers will learn from past misdeeds and stop waiting for external forces to support their economies. If not, more frequent world recessions are likely in the years ahead.