Legitimate Complaint

Professor Deepak Lal’s piece in ‘Business Standard’ on April 16th has the following blurb: ‘A more open financial sector is necessary for global financial recovery’. Unfortunately, history has provided ample evidence to the contrary and the Professor himself does not offer any evidence in support of his blurb. 

He thinks that the world has no reason to complain about the US’ QE2:

With a free floating exchange rate and an independent monetary policy, the import of US-generated inflation could be tamed by tightening money and allowing currency appreciation, as Australia has successfully done during the mineral boom and the yen-Australian dollar carry trade.

This blogger disagrees with the Professor.  We need to be careful with judgements on economic policies and developments made in real time. History might compel us to revise our stance later (more on this topic in the next post). Australia might have allowed its currency to appreciate because booming global economy and the relatively essential nature of its exports (commodities like iron ore and coal) offset the drawbacks of an appreciating currency. Further, China might have kept buying these two items from Australia because it was able to offset the rising cost of these two import items through domestic productivity gains. China’s productivity growth might slow in coming years; its export price index is rising at an accelerated rate. Further, China might wish to produce less and consume more in the years ahead. It would be interesting to see how Australia copes then with a strong currency, with its dismal household savings rate and a housing bubble.

Even if these risks turn out to be minor for Australia, Australia is not a valid comparison for other emerging nations who are forced to cope with appreciating currencies, capital inflows and rising cost of living – all at the same time. In the first half of the last decade, interest rates in the developed world were low but not this low. Capital inflows into emerging economies are now turning into a deluge.

Developing countries would experience faster growth; the rates of return (interest rates) in growing economies must rise and hence their currencies must also appreciate. All this can happen over time. But, the developed world’s low interest rate policy – led by the US – is leaving them with very little time to adjust. That is politically difficult for governments – elected or unelected.

Second, Professor Deepak Lal gives a clean chit to the Fed monetary policy, from the American perspective. Perhaps, he should read Raghuram Rajan’s piece covered in this blog post at TGS.


This post originally appeared at The Gold Standard and is reproduced here with permission.