I was reminded this past weekend of how loathe the central banks in Europe are to lower interest rates. Many Europeans have some memory of World War II or at least have a connection to someone who remembers that time. And as the baton has been passed from one central banker to another, the last word on the way out has been – “keep inflation in check”. Inflation, in the minds of many of Europe’s banks, is the prime catalyst for chaos which leads to political instability and ultimately, conflict. And so, the fact that the ECB and Bank of England have made an aggressive, pre-emptive move to relax monetary policy in an effort to cut off deflationary trends should be noted – and, indeed, applauded. Compare that with our own Fed, which claims that inflation is its primary enemy, but in reality, sees a falling stock market as the real thing to avoid… In any case, central banks seem to be somewhat coordinated in their effort to shore up the world economy. China is even pushing hard to coordinate with this monetary policy. That, too, is a good sign. All of this is clearly a recognition of an ever-more connected world economy. Coordinated monetary policy will be a key to stabilizing, and ultimately healing, the sick patient.
The key issue in the US over the next 12-18 months will be our government’s use of fiscal policy to build more demand in the economy. Can the new administration and Congress put an end to a growing unemployment number and shore up asset prices? President-elect Obama, yesterday on Meet the Press, seemed to indicate that the deficit will take a back seat to the need for government to provide a proxy for market demand – this underscores the prediction that large public works projects will get underway fairly soon after the inauguration (look out for a big fight about environmental impact issues related to some of these projects). He also test drove an idea to provide foreclosure relief – when pressed by Brokaw on the potential moral hazards associated with this (why should I pay my mortgage if Bob across the street is getting bailed out?), his response was classic law school language – if your neighbor’s house is burning, don’t you have a vested interest in making sure that the fire is put out before it spreads and consumes your house?
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