Thursday, March 10, 2011

The Real Economic Effects Of Monetary Policy Distortions

At the Thinkmarkets blog, Professor Andreas Hoffmann and Gunther Schnabl explains lucidly the real economic effects of monetary policy distortions.

Mr Hoffmann and Schnabl write, (all bold highlights mine.)

Speculative capital inflows and accelerating reserve accumulation in emerging markets are counteracted with sterilization measures and capital controls. In Brazil capital controls prevent a free allocation of capital to the best uses. In China non-market based sterilization and credit rationing is used to further stimulate the already overinvested export sector. While sterilization keeps credit generally tight (for instance for consumers), the export industries and state owned enterprises enjoy low-cost credit to keep the capital stock growing. As sterilization operations also hold inflation low, the real exchange is kept undervalued what helps to clear the overproduction on international markets.

Even worse: In countries with large raw material sectors, the global liquidity driven raw material price inflation causes huge public surpluses, which are distributed by mostly autocratic governments ad libitum. Rising public expenditure and/or thriving stabilization funds replace “competition as a discovery procedure” by guided structural change and state funded economic development. Dubai loves to invest in a palm shape island and Babylon towers. Russian bureaucrats see potential in pharmaceutical and military industries. Venezuela and Algeria pump money into social security systems to create political stability. The Saudi Arabian General Investment Authority sets up glamorous new cities that shall create more jobs in the name of the King.

While all these policies may be well intended, they distort markets, as public investment in subsidized industries misguides private investment decisions. Investment in industries, which are picked by the government, is risky. Once the golden rain stops, the readjustment will set in. This may happen, once the advanced economies exit from easy money policies as growth prospects lighten up or inflation accelerates. Only then, it will be obvious which of the many economic miracles which we currently observe is real and which is an illusion.

My comment

Notice the distributional effects?

The sectors that benefit from these policies are primarily those connected with the government or the government itself, as I also explain here and here.

And it is why policies of monetary authorities have systemic (externality costs) impact and can’t be ignored or dismissed by free market advocates.

The welfare-based political structure, crony capitalism and central banking have all been intertwined or all interconnected.

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