Comments from Dr.Nouriel Roubini highlighted on theglobeandmail, Desperately seeking an exit strategy
- ...... So the key issue for policy-makers is to decide when to mop up the excess liquidity and normalize policy rates – and when to raise taxes and cut government spending, and in which combination.
The biggest policy risk is that the exit strategy from monetary and fiscal easing is somehow botched, because policy-makers are damned if they do and damned if they don't. If they have built up large, monetized fiscal deficits, they should raise taxes, reduce spending and mop up excess liquidity sooner rather than later.
The problem is that most economies are now barely bottoming out, so reversing the fiscal and monetary stimulus too soon – before private demand has recovered more robustly – could tip these economies back into deflation and recession. Japan made that mistake between 1998 and 2000, just as the United States did between 1937 and 1939.
But if governments maintain large budget deficits and continue to monetize them as they have been doing, at some point – after the current deflationary forces become more subdued – bond markets will revolt. When that happens, inflationary expectations will mount, long-term government bond yields will rise, mortgage rates and private market rates will increase, and one would end up with stagflation (inflation and recession).
- Getting the exit strategy right is crucial: Serious policy mistakes would significantly heighten the threat of a double-dip recession. Moreover, the risk of such a mistake is high, because the political economy of countries such as the United States may lead officials to postpone tough choices about unsustainable fiscal deficits.
In particular, the temptation for governments to use inflation to reduce the real value of public and private debts may become overwhelming. In countries where asking a legislature for tax increases and spending cuts is politically difficult, monetization of deficits and eventual inflation may become the path of least resistance.
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http://www.bloomberg.com/apps/news?...id=a9FIT6a2gei4
By Peter J. Brennan, Christine Harper and Scott Lanman
Sept. 16 (Bloomberg) -- Paul Volcker, the former Federal Reserve chairman who’s an economic adviser to President Barack Obama, said there’s a “long way to go” before the economy returns to pre-recession levels.
“It will be a long slog -- a matter of years -- with the risk of some relapses along the way,” Volcker said today at a financial conference in Beverly Hills, California. While Volcker said he sees signs that the economy is in the “early stages of recovery,” he also warned that “it is way too soon to resume business as usual.”
He echoed Fed Chairman Ben S. Bernanke’s assessment yesterday that while the recession is probably over, “it’s still going to feel like a very weak economy for some time.” Volcker, who pushed the federal funds rate as high as 20 percent to throttle inflation in 1980, also renewed his call to restrict the activities of banks so large that their collapse would threaten the financial system.
“We have a long way to go to get back the point of fully utilizing our economic resources and restoring something approximating full employment,” Volcker, 82, said at a conference hosted by the Association for Corporate Growth, a group for executives who deal with mergers and acquisitions.
At the same time, the economy is seeing “some bounce” from the lows of the downturn, Volcker said.
Banking Limits
In his speech, Volcker urged limits on the activities of banks that are considered “too big to fail,” going beyond what other officials in the Obama administration have advocated.
“I do not think it reasonable that public money --taxpayer money -- be indirectly available to support risk-prone capital market activities simply because they are housed within a commercial banking organization,” Volcker said.
Since January, Volcker has advocated that regulators should prohibit financial companies whose collapse would pose a risk to the economy -- those considered “too big to fail” -- from engaging in certain types of trading and investing activities. The administration wants stricter oversight for such companies and tighter capital and liquidity requirements.
“Extensive participation in the impersonal, transaction- oriented capital market does not seem to me an intrinsic part of commercial banking,” Volcker said. “Substantial involvement in heavily leveraged finance and heavy proprietary trading almost inevitably entails risks.”
“I want to question any presumption that the federal safety net, and financial support, will be extended beyond the traditional commercial banking community,” he said.
Job Losses
Keith Hembre, a former Fed researcher who’s now chief economist at U.S. Bancorp’s FAF Advisors Inc. in Minneapolis, said he agreed with Volcker’s economic outlook, given the jobless rate declined by less than 1 percent a year after past recessions.
“It’s multiple years before you get back to a point where you’re anywhere close to where anyone would view full employment,” Hembre said.
Bernanke, 55, who was nominated for a second term by President Barack Obama, told Congress in July that projected declines in the jobless rate over the next two years “would still leave unemployment well above” what Fed policy makers prefer in the long run.
Warren Buffett, the billionaire investor who runs Berkshire Hathaway Inc., said separately in an interview shown today on CNBC that the U.S. economy has “hit a plateau at bottom.”
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