2 Prescriptions to Help Resolve the Global Crisis

One thing that experts know, andthat non-experts do not, is that they know less than non-experts think they do. This much was evident atthe just-completed Spring Meetings ofthe International Monetary Fund andthe World Bank Group. They were three intense days oftalks that brought together finance ministers, central bankers andother policymakers.

Our economic expertise is limited infundamental ways. Consider monetary andfiscal policies. Despite decades ofcareful data collection andmathematical andstatistical research, onmany large questions we have little more than rules ofthumb. Forexample, we know that we should lower interest rates andinject liquidity tofight stagnation andthat we should raise policy rates andbanks' cash-reserve ratios tostifle inflation. Sometimes we rely onour judgment incombining interest rate action with open-market operations. But thefact remains that our understanding ofthese policies' mechanics is rudimentary.

These rules ofthumb work as aresult ofevolution. Over time, thewrong moves are penalized, andtheir users either learn bywatching others or disappear. We get our monetary andfiscal policies right thesame way that birds build their nests right.

As with all behaviors shaped byevolution, when theenvironment changes, there is arisk that existing adaptations become dysfunctional. This has been thefate ofsome ofour standard macroeconomic policies. Theformation ofthe eurozone anda half-century ofrelentless globalization have altered theglobal economic landscape, rendering once-proven policies ineffective.

When Sweden's Riksbank was founded in1668, followed bythe Bank ofEngland in1694, themotivation was that asingle economy should have asingle central bank. Over thenext three centuries, as thebenefits ofinstituting amonopoly over money creation became more widely recognized, aslew ofcentral banks were established, one foreach politically bounded economy.

What was not anticipated was that globalization would erode these boundaries. As aresult, we have returned toa past fromwhich we tried toescape: asingle economy with multiple money-creating authorities.

This is clearly maladaptive, andit explains why themassive injections ofliquidity byadvanced-country central banks are failing tojump-start economies andcreate more jobs. After all, ina globalized economy, much ofthis liquidity spills across political boundaries, giving rise toinflationary pressures indistant lands andprecipitating therisk ofcurrency wars, while unemployment athome remains dangerously high, threatening toerode workers' skills. Thelong-run damage could be devastating.

What was evident atthe World Bank andIMF Spring Meetings was that virtually all policymakers are distressed, andno one has acomplete answer. Neither do I. But here are two simple ideas that could help tomitigate thecrisis.

First, inthe absence ofa single global central-banking authority, amodicum ofmonetary-policy coordination among major economies is required. We need agroup ofthe major economies call it "G Major" that announces monetary policies ina coordinated fashion.

Tosee why, consider thecase ofJapan. Japanese policymakers have good reason totry topromote some inflation andeven correct some ofthe yen's secular appreciation over thelast six or seven years. But intoday's unilateral world, other central banks would soon respond byinjecting liquidity, prompting theBank ofJapan toact again. These actions are usually justified as policies forboosting domestic demand, but they end up fueling asurrogate, low-grade currency war.

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2 Prescriptions to Help Resolve the Global Crisis