Paul Krugman on currency independence, circa 1999

If there's one macroeconomic observation that has gone from obscure to remarkably mainstream in recent years, it's that a nation that has given up its currency independence is at a big disadvantage relative to nations with independent, sovereign currencies, especially when it comes to options for addressing economic downturns and overcoming the aftermath of financial crises.

Paul Krugman has been a main proponent of this view. And he's been at it for a while.

Here's an excerpt from a classic piece by Krugman from 1999 on the ills faced by Argentina after it experimented with dollarization in the 90s:

The problem, you see, is that the same rules that prevent Argentina from printing money for bad reasons--to pay for populist schemes or foolish wars--also prevent it from printing money for good reasons such as fighting recessions or rescuing the financial system. [...] 

Now, these problems with a rigidly fixed exchange rate are not news. But for a while, currency-board enthusiasts managed to convince themselves that they weren't significant. They argued that as long as governments themselves followed stable policies--and as long as the economy was sufficiently 'flexible' (the all-purpose answer to economic difficulties)--there would be few serious recessions. 

But it turns out that history does not stop just because the currency is stable. And faced with a politically inconvenient recession, the Peronists find that there is nothing they can do. They cannot print money. They cannot even borrow money for some employment-generating public spending, because fiscal indiscipline would undermine the peso's hard-won credibility.

Read the entire column here.

Reference 

Krugman, P., Don't laugh at me Argentina, Slate, July 20, 1999

Inequality in the recent business cycle

This is a good speech by Governor Sarah Bloom Raskin of the Federal Reserve (also available in audio here). It was given during the Hyman Minsky Conference held at the Levy Institute earlier this week.

The speech focuses on the obstacles to recovery associated with household debt deleveraging and the decline in wealth for low-income households since the financial crisis. That low- and middle-income households held a disproportionate share of wealth in housing prior to the crisis meant they were highly exposed by the decline in house prices.

Raskin notes:

...[W]hile total household net worth fell 15 percent in real terms between 2007 and 2010, median net worth fell almost 40 percent. This difference reflects the amplified effect that housing had on wealth changes in the middle of the wealth distribution. The unexpected drop in house prices on its own reduced both households' wealth and their access to credit, likely leading them to pull back their spending. In particular, underwater borrowers and heavily indebted households were left with little collateral, which limited their access to additional credit and their ability to refinance at lower interest rates. Indeed, some studies have shown that spending has declined more for indebted households

Although later in the speech Governor Raskin discusses the Fed's strategy to address these issues (mainly by the use of unconventional monetary policies aimed at lowering long-term interest and mortgage rates), there is unfortunately no mention of the possible role of the Fed's current quantitative easing (QE) strategy in amplifying wealth inequality via the use of unconventional policies.

Since the start of the Fed's asset purchases programs (i.e., QE), we have seen stock indexes recover their losses while the decline in house prices has stayed flat (see charts below - Note: Increases in the monetary base is a good indicator of the magnitude of QE). In a context where the Fed is also hoping QE to sustain economic activity through the "wealth effect" channel (whereby a rise in asset prices causes investors to feel more secure about their wealth and, consequently, spend more), it's only normal to question whether current strategy is contributing (albeit unintentionally) to the wealth gap.

Source: Federal Reserve

Source: Federal Reserve