Saturday, June 07, 2003

For all those who still stubbornly believe that deflation is primarily a monetary phenomenon and aggressive interest rate policies combined with massive deficit spending will solve all our problems (this includes the Fed and the ECB), take a look at Stephen Roach's commentary this Friday.
Consider the case of the United States: Decades of business cycle experience have taught us that there are three sectors of the real economy that are always most sensitive to policy stimulus: consumer durables, residential constructions, and, with a lag, business capital spending. Recessions typically crush demand in the first two sectors � cars and housing, for short. Policy stimulus then unleashes pent-up demand and the recovery typically springs to life. In the current cycle, cars and housing never fell and actually rose to records in the early stages of an anemic recovery. In short, there is no pent-up demand in the United States that will now get traction in an era of policy stimulus. That leaves business capital spending as the only real hope. But with companies lacking in pricing leverage and therefore awash in excess supply, I am hard-pressed to believe that this sector will draw support from reflationary policy efforts � even from the temporary tax incentives that the Bush Administration has just enacted. In an era of global capacity bloat, cost-of-capital considerations � the means by which policies can influence the investment decision � just don�t matter that much at all. In a post-bubble era, the policy responsiveness of the US economy bears little or no resemblance to that of the more traditional cyclical climate.

The story in Germany is different but ends up at basically the same point, leaving us with good reasons to question the likelihood of policy traction. With record-high and still rising unemployment, the German consumer is all but dead in the water. Will lower interest rates really make a difference?
Roach really hits the nail on the head when he observes that "Macro policies are very blunt instruments." The world is bearing the fruit of transnational neoliberalism. Only massive political change can solve these problems.

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