Scott Sumner: evaluation

Transcript context

…Why don’t the Chinese just give up the exchange rate target? On your account, it sounds like a big mistake. You’re saying they’re stupid in a sense, right? They don’t import that much, so it’s not going to be a problem there. It would help their exporters marginally. It certainly wouldn’t hurt them. Why not just push the button and do what Scott Sumner says? I’ll give you an example. I hope I get the facts right on this. In the early 2000s, there was a lot of criticism from American economists like, “Why don’t the Japanese just devalue the yen if they want to create inflation? They can get out of the liquidity trap.” At the very time the economists were making this suggestion to the Japanese, Treasury officials were putting a lot of pressure on Japan not to depreciate the Japanese yen, with the implied threat of protectionist response if they did. You can argue that essentially, to the extent that the US is able to influence Japanese policymakers, we may have pressured Japan into a long period of deflation by discouraging them from devaluing the yen in a way that would have been required to get Japan out of deflation in the ’90s and early 2000s. I can only speculate, but maybe part of the reason is fear of the way the US would respond with protectionist measures if there was a sharp fall in the yuan. Now, I’m not certain that’s the case, and I’m not certain that China is making the right decision. On balance, I think they’d be better off allowing a little more weakness in their currency. I’m not exactly certain all of the reasons why. It could reflect different interest groups within China, some of which benefit from a strong currency, some from a weak currency. I don’t know enough about the Chinese situation, but if you’re asking me, does China have the ability to get out of deflation with a weaker currency? Yes, they do. They have that ability. I don’t think there’s even any question. One economist, Lars Svensson, called currency depreciation a foolproof way of escaping a liquidity trap. You can always weaken a currency and create inflation under a fiat money system if you’re determined to do so. If you haven’t done so, there is some sort of political barrier to taking the steps that would be required. Or there’s simply a cognitive error like you’re not thinking about the problem in the right way, which has also been an enormous problem in monetary economics because of confusion about what low interest rates mean and other things about monetary policy that confuse even policymakers, often, into thinking their policy stance is different from what it actually is. Let me give you an alternative hypothesis, and tell me what you think of it. This is for China. Their banking system is radically undercapitalized. They keep on shoveling money into it. A lot of their credit channels are broken. They believe a more activist monetary policy won’t work through credit channels. They do in fact know they could get higher price inflation by doing something like printing up currency, but they don’t feel they can control that process because they don’t have a good theory of how their own monetary base relates to their own price level. And they’re afraid to do that, somewhat justifiably, and that’s why they keep on suffering under deflation.…

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