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Dean Baker

Dean Baker is co-director of the Center for Economic and Policy Research

March 16th, 2011 6:23 PM

Guess which policy your central bank will pursue

An IMF conference exposes a clear choice: who pays for this crisis – workers by unemployment or banks through inflation?

The International Monetary Fund (IMF) held a conference last week devoted to re-examining macroeconomics in the wake of the economic crisis. This conference was evidence of a glasnost that would have been unimaginable a decade ago. One of the organisers and speakers was Nobel Laureate Joe Stiglitz, a man who had previously been persona non grata at the IMF after he had trashed the institution in a piece in the New Republic back in 2000.

In addition to Stiglitz, the conference included several speakers who were quite critical of the economic policies pushed by the IMF in recent years. Given the format and the large number of speakers, there was limited opportunity for back and forth in these sessions. But at least the important questions were being asked.

In spite of the increased openness of the discussion at the IMF, it is not clear that its policies have undergone a similar adjustment. In particular, it openly touts the route of "internal devaluation" for countries that have fixed the value of their currency to other currencies or don't have their own currency.

This is an incredibly painful process. The idea is that a country that has high unit labour costs relative to its trading partners will get its costs in line by lowering wages. The way they lower their wages is to force workers to take pay cuts under the pressure of high rates of unemployment. Latvia is currently the poster child for internal devaluation. Its unemployment rate was still 16.9% in the final quarter of 2010, falling from 18% the quarter before. The IMF path would have other countries with serious competitiveness problems such as Ireland, Greece, Spain and Portugal go the same path.

The alternative would be to promote a somewhat higher rate of inflation in the surplus countries – most importantly, Germany. Higher inflation in the surplus countries would allow the deficit countries to regain competitiveness simply by having their wages rise less rapidly than the inflation rate in the surplus countries. This could be accomplished without the double-digit unemployment rates that the latter countries are not enduring.

This route is consistent with the path suggested by Olivier Blanchard, the IMF's chief economist, in a paper he wrote last year. A higher inflation rate would also have the benefit of eroding the real value of the debt for both heavily indebted countries and heavily indebted homeowners. This would allow these economies to get back on a normal growth path more quickly.

Remarkably, IMF policy still doesn't seem to allow for the possibility that somewhat higher rates of inflation might actually be the best path under some circumstances. Many of the speakers seemed still to believe that the policy of inflation targeting, in which central banks target a 2.0% inflation to the exclusion of all other concerns, is the best route to pursue. This certainly seems to be the practice at the European Central Bank, as well as at many other central banks around the world.

This should have populations everywhere rising up with their pitchforks. Inflation targeting has led to an enormous economic and human disaster, likely costing the world more than $10tn in lost output and leaving tens of millions of people unemployed. If this experience is not enough to discredit a policy, it is difficult to imagine any possible set of events in the world that could lead the inflation targeters to change their minds.

In this respect, the arguments set out in the IMF conference should be useful for political purposes – even if they have little immediate effect on the conduct of central banks or the policy prescriptions of the IMF. The fact that many of the world's most prominent economists, including even the chief economist at the IMF itself, can make policy prescriptions that are essentially ignored by those conducting policy, provides more evidence that policy is not being guided by neutral individuals seeking the best outcome.

This is yet more evidence that the central bankers and others directing policy place the interests of the financial sector at the centre of their concerns. For the financial industry, a modest rise in the inflation rate would genuinely be bad news, reducing the value of their assets and the real value of their interest income. In order to ensure that the major banks of the world do not have to deal with this situation, the central banks are prepared to force tens of millions of people to remain out of work.

If we had real democracies, the central bankers who couldn't do their job would be the ones out of work right now.

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