The pace and severity of financial crises has taken an ominous turn for the worse. Over the past 30 years, a crisis has occurred, on average, every three years. Yet, now, only 18 months after the meltdown of late 2008, Europe’s sovereign debt crisis has hit with full force. With one crisis seemingly begetting another, and the fuse between crises now getting shorter and shorter, the world economy is on a very treacherous course.Around 1990, several years after the Japanese central bank in effect bailed out the United States after the stock market crash of 1987, economist David Hale wrote that the global economy, managed now by enlightened (as he saw them) central banks, had entered a phase in which economic progress and regress would take the form of a (manageable) succession of financial bubbles moving from one country or region to another with boom growth and burst bubbles driving movement from one area to the next.
But Hale did not anticipate what Stephen Roach, in retrospect, sees as the Achilles heal of the Hale's prediction of a succession of bubbles: the alarming fact of the acceleration of bubbles: the alarming frequency of their occurrence because central banks, in managing one bubble, are unwisely sowing the seeds for the next.
Breaking the "daisy chain" of accelerating bubbles "won't be easy," Roach says. But history will help us, he says, and he looks back to the late 1970's and suggests that a second "Volcker moment" is what the world needs now. He sets guidelines for a new approach and illustrates it:
As an example of how this approach might work, consider the task of the Federal Reserve.
Step One: Announce a target of restoring the real federal funds rate back to its long-term average of 2 per cent.
Step Two: Lay out a three-year macro forecast of the US economy. For the sake of argument, plug in average real GDP growth and inflation of 2.5 per cent and an unemployment rate that falls back to 6 per cent by the end of 2013.
Step Three: Conditional on that forecast coming to pass, announce a normalisation plan of nine moves of 50 basis points in the federal funds rate – spread out over 18 months and commencing as soon as the dust settles on the euro crisis.
I'd love to hear David Hale's take on them.