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Unwinding the Unnecessary: QE and the Periphery


In today’s Wall Street Journal an editorial examines the impact of Fed Policy on the developing world (Ben Bernanke’s Global Adventure : The markets show unwinding QE is not so easy). The emphasis is, as it maybe should be for now, on the difficulty facing not only the U.S, but the world economy if and when the Fed begins to unwind QE infinity:

This week’s turmoil nonetheless shows that it’s a rocky road from here to there, and the market tribulations should be on American policy makers’ minds. Monetary optimists have argued that, when the time comes, the Fed will be able to taper its easy money relatively smoothly. Perhaps, but a global repricing of risk in line with changing rates in America will also unsettle the very economies to which American companies increasingly turn for revenue growth.

However, attention should be paid to the world wide monetary misdirections of production created by the Fed’s misguided attempts to bolster the U.S. economy with Mondustrial Policy and other new tools of monetary central planning. As in many cases Austrian-based analysis is ahead of much of the main stream.

As examples see:

Nicolas Cachanosky’s (Metropolitan State University of Denver) “U. S. Monetary Policy’s Impact on Latin America’s Structure of Production (1960-2010)” which extends ABCT and capital-based macroeconomics in the international arena, especially as it applies to the ‘periphery’.

The abstract:

I study the effects of U.S. monetary policy on Latin America’s structure of production prior to two recent economic crises. I find that changes in the Federal Funds rate produced uneven effects across economic sectors. Those industries that are more capital intensive and relative long-term projects are more sensitive to changes in the Federal Funds rate than projects that are less capital intensive and relative short-term in duration. Therefore, periods of loose monetary policy resulted in a misallocation of resources that has been costly to correct during the bust. This result finds a particular pattern of economic distortion during an unsustainable boom.

Also see Andreas Hoffman’s “Zero Interest Rate Policy and the Unintended Consequences on Emerging Markets.

The abstract:

In response to the subprime crisis and Great Recession central banks in advanced economies have cut interest rates towards zero and increased monetary accommodation to step-up domestic growth. In this paper I attempt to describe the unintended consequences of the low interest rate policies in emerging markets. I argue based on the Mises-Hayek business cycle theory that the current low interest rate policy in advanced economies may have planted the seeds for new bubbles and gave rise to interventionist cycles in emerging markets. I show that capital flows to high-yielding emerging markets translate into monetary expansion in emerging markets. In the face of buoyant capital inflows fear of floating forces emerging markets to follow the interest rate policy of advanced economies. The monetary expansion triggers mal-investment and over-borrowing. To stem against arising inflationary pressure and kill-off speculative capital inflows empirical evidence suggests that emerging market governments increasingly repress financial markets. International financial markets disintegrate. I conclude that the monetary policy of the large advanced economies is incompatible with financial integration and globalization

Currency wars and a race to the bottom by major central banks have major demonstrated negative unintended consequences around the world.

Guillermo Calvo in his paper “Puzzling Over the Anatomy of Crises: Liquidity and the Veil of Finance” has made similar points in a paper that draws significantly on insights from Mises and Hayek.

Peter Boettke and Tyler Cowen have commented on this paper and I will say more in a future post.

See Boettke on “ABCT Providing the Missing Gap.”

It is, therefore, with great excitement that I read papers by leading figures in the profession that seem to recognize the power of the ABCT as developed by Mises and Hayek. Guillermo Calvo has just produced such a paper, and it should move to the top of your reading list. Calvo sees as one of the great strengths of ABCT that it is able to explain the financial disturbances without recourse to irrationality. The source instead lies in the manipulation of money and credit which distorts the guiding and weeding functions of the price system for the time being, but the market eventually pierces that distortionary fog and a process of recalculation ensues. It is again the very basic price theoretic explanation of the boom and bust cycle that Calvo believes can provide the missing gap in modern macroeconomics.”

Cowen’s commentary is here: Guillermo Calvo on Austrian business cycle theory

John P. Cochran (1949-2015) was emeritus dean of the Business School and emeritus professor of economics at Metropolitan State University of Denver and coauthor with Fred R. Glahe of The Hayek-Keynes Debate: Lessons for Current Business Cycle Research. He was also a senior fellow of the Mises Institute and served on the editorial board of the Quarterly Journal of Austrian Economics.

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