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Barry Eichengreen on Asian Macro Policy

From <>:

Asian macro policy is out of kilter: The new development... is the acceleration of inflation [in Asia]. In April headline inflation in Asia ex Japan was 7.5%, a 10 year high.... As for where this inflation came from, it came mainly from the United States. Starting last summer, in response to the subprime crisis, the Fed cut interest rates sharply.... The Asian economy was growing full out in 2007. The last thing it needed was lower interest rates. But that’s what it got, given the habit of limiting the fluctuation of Asian currencies against the dollar. Allowing Asian interest rates to rise more sharply against US rates would have caused Asian currencies to appreciate against the dollar more strongly... not something that Asian governments and central banks were prepared to countenance.

As a result, Asian economies that needed demand restraint got demand stimulus instead....

What should Asian central banks do now? They should raise rates.... It makes no sense when most Asian countries are growing at or near capacity that they should have negative real interest rates. Negative real rates are an unhealthy subsidy for borrowing by households and firms. They encouraged inefficient investment and excessive leverage in Asia in the first half of the 1990s, and we all know what followed....

Critics of inflation targeting will say that central banks have a dual mandate not just to fight inflation but also to foster growth and that Asian central banks have no business raising rates in a deteriorating growth environment. But the fact of the matter is that they now face a very serious test of their credibility.... The alternative to painful interest rate increases now will be even more painful increases later.... Higher interest rates will push up the exchange rate and damp down inflation. Tax cuts and increases in public spending on locally-produced goods will limit the contraction of aggregate demand....

I am aware that what I am arguing Asia needs now – monetary tightening, currency appreciation and fiscal stimulus – is the same thing that the Bush Administration has been arguing for three years. But the fact that the advice is old hat and that it comes with unwelcome associations should not lead to its rejection...

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