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Stanley Fischer for Fed Chair?

Saturday, 16 February 2013 08:58

Dylan Matthews has an interesting column discussing former M.I.T. professor Stanley Fischer's career in the context of the possibility of him replacing Ben Bernanke as Fed chair in the fall. There are a couple of important items that are not mentioned in this discussion.

First, Matthews notes the central role that Fischer played in the I.M.F.'s resolution of the East Asian financial crisis. While this discussion might lead readers to believe the resolution was a success, this crisis actually marked a turning point that led to the major imbalances of the next decade.

Prior to the crisis there were substantial capital flows from rich countries to poor countries, as textbook economics would predict. However as an outcome of the crisis developing countries began to accumulate massive amounts of foreign exchanges reserves, presumably to avoid ever having to be in the same situation as the East Asian countries were placed when they had to deal with the I.M.F. in the crisis.

This led to a huge rise in the value of the dollar and large trade deficits. The gap in demand created by the trade deficit with developing countries was filled in the United States by the housing bubble. The predictable outcome of this situation was the collapse in 2007-09, which is likely to cost the country close to $10 trillion in lost output before the economy fully recovers.

This raises the more general point that Fischer is one of the pillars of the school of thought that central banks should target 2.0 percent inflation and otherwise do nothing. If it is in principle possible for an economic theory to be refuted by evidence, this view of the optimal monetary policy has been decisively discredited. 

These items may affect how people would view Stanley Fischer's qualifications as a candidate for Fed chair.

The piece also gets one other important item wrong. It contrasts the ability of Israel (where Fischer now runs the central bank) as a small country to devalue its currency with the United States, as the holder of the world's reserve currency.

"If Bernanke halved the value of the dollar relative to, say, the Chinese yuan, that would dramatically increase U.S. exports and probably economic growth, too, but it would also wreak havoc with the global financial system. Every dollar-denominated asset in the world, including all manner of bonds, would plummet in value."

Actually this is very far from being the case. Most holders of dollar denominated assets are not hugely interested in the value of their assets measured in yuan. (Quick, how many yuan is your 401(k) worth?) While the repercussions of a large fall in the value of the dollar against one or more major currencies are certainly greater than the fall of the Israeli shekel, it is certainly not obvious that a major reduction in its value would have disastrous consequences. In fact, over time it is virtually inevitable.   

Comments (2)Add Comment
Hasn't Fischer evolved?
written by Kosta, February 16, 2013 11:51
It's great that you're pointing out how Fischer's adherence to orthodox policies have created, rather than solved, problems in the past. However, it is important to note how Fischer's views have evolved over time. His stint as the head of the Israeli Central Bank was marked by rather unorthodox policies which helped Israel weather the 2008 downturn better than the vast majority of Western economies. It is unfair to claim that Fischer is wedded to the 2% inflation target given the policy mix he chose for Israel.
the value of the dollar
written by watermelonpunch, February 16, 2013 1:25
Most holders of dollar denominated assets are not hugely interested in the value of their assets measured in yuan. (Quick, how many yuan is your 401(k) worth?)

Does this mean, for practical purposes, (moderate) changes in the value of the dollar (either way) do not necessarily cause significant effects to ordinary people's amount of money (buying power), here in the U.S., nor around the world?

Or what should I take from this?

In fact, over time it is virtually inevitable.

What's inevitable? A major reduction of the value of the dollar is virtually inevitable?

I think some assumptions of some ordinary people, about this issue, would go a little something like this:

If the value of the dollar were to be diminished, we, as a society, would turn into a 3rd world country scenario. That somehow the diminishing of the dollar's value would mean that our ipads and smartphones would have to be handed over, and we would all wind up living with sewage contaminated drinking water.
The way it is for average people in countries with "low value currency".

If this is not true, (and I don't think it is), explaining this issue to ordinary people in a way we can understand, has to include explaining why a diminished value of our currency would not lead us to be the ones with our children featured on charity television spots in China, asking the relatively affluent citizen in Bejing to provide $5 a month so children in Philadelphia living in tin shacks with thatched roofs, have clean water to drink.

This might seem silly & not worth bothering about for economists. But I assure you it's a real misunderstanding out here in the real world of average people!
I know that if the value of the dollar falls a bit I'm not going to have to give up my internet or my cell service, buy a cow for my back yard, and revert to an agrarian existence.
But I have NO IDEA how to explain WHY that won't happen to other people.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.