It is a question provoked by reading the latest annual report of the Bank for International Settlements (BIS). The BIS, founded in 1930 and based in Basel, Switzerland, is the world’s oldest international financial organization. The BIS, often referred to as the central bankers’ central bank, besides promoting cooperation among central banks, including the Central Bank of the Republic of Turkey, and providing financial services to central bank customers, carries out first-rate research on global economic and financial issues. Its 244-page 77th annual report, issued on June 24, surveys the global economic and financial developments between April 2006 and March 2007 (http://www.bis.org/publ/arpdf/ar-2007e.pdf). The report is worth reading for its excellent description and analysis of these developments in terms of: (1) global economic conditions; (2) changes in emerging market economies (EMEs); (3) monetary policies in developed countries; (4) basic trends in foreign exchange markets; (5) major events in global equity and credit markets; and (6) trends in the financial sectors of developed countries.
The report’s coverage of the developments in the Turkish economy can be summarized as follows: (1) Turkey was among the EMEs, such as India and South Africa, with rapidly rising current account deficits; (2) the May-June 2006 financial market volatility caused a sharp depreciation of the YTL that increased interest rates significantly as well as the actual inflation rate and the inflation forecasts for both 2006 and 2007; (3) Turkey was among the EMEs, such as Venezuela and Russia, with rapid real private credit growth, reflecting easy monetary conditions; (4) the gross public (domestic and external) debt/gross domestic product (GDP) ratio fell significantly in Turkey as it did in all EMEs during 2003-2006; and (5) Turkey, which in September 2006 launched a 10-year global bond in exchange for short-dated higher coupons and cash, was among the EMEs that completed debt management operations in order to improve financing terms, extend maturities, reduce currency mismatches and increase the use of domestic relative to international capital markets. The share of Turkish external or foreign currency-linked debt, net of reserves, fell from nearly 56 percent of the GDP in 2002 to less than 36 percent in 2006.
The report is of particular interest, however, because it raises subtly but persistently an intriguing and disturbing question: Whether the recent extraordinary period, our golden age of high economic growth, coupled with low inflation and long-term real interest rates as well as small risk premiums for EMEs that we have experienced throughout much of the globe during the last four years might end in a major economic crisis. Arguing that history matters, it draws parallels with the decades prior to World War I and the economic boom of the 1920s, characterized by: (1) major technological innovations; (2) a rising wave of globalization; (3) rapidly increasing productivity; (4) accelerating credit growth; (5) strong fixed investment, creating widespread excess capacity; and (6) feverish and highly leveraged speculative activity, leading to asset bubbles in real estate and financial markets, all of which ended in the Great Depression of the 1930s.
The intellectual foundation of this question was developed in a recent BIS working paper (see William R. White, “Is Price Stability Enough?” Monetary and Economic Department, BIS Working Paper, No. 205, April 2006 at http://www.bis.org/-publ/work205.pdf), first noted elsewhere (http://-blogs.wsj.com/economics/). That paper contrasted the Keynesian framework -- which became the dominant way of thinking after World War II about macroeconomic issues, such as unemployment and inflation, from an aggregate, static, and short-term view -- with the Austrian school of economics, which focused, in the interwar period, on the same set of issues from an intersectoral, dynamic and long-term view. The paper emphasized the inadequacy of the Keynesian approach in identifying emerging macroeconomic crises, such as a major depression, and highlighted the strength of the Austrian approach that focused on the effect of changes in relative prices causing serious resource misallocations and subsequent economic crises. The Austrian school “… treated economic developments as part of dynamic processes in which past events had an influence on the future. The long run was not just a series of short runs.” The fact that the good times prior to the Great Depression were characterized by relative price stability, similar to the current globally tamed inflation, is offered as evidence that price stability is not enough to ensure high and sustained growth and that major economic downturns do not necessarily follow periods of high and unstable inflation.
The BIS annual report cautions against the short and medium-term risks of: (1) the possible resurgence of global inflation; (2) a sudden and significant slowdown in the US economy; and (3) a worsening of the persistent and substantial global current account imbalances, leading to increasing instability in foreign exchange rates and to crises in global financial markets. It draws from the earlier BIS working paper in arguing against the smug conventional wisdom that our understanding of economic processes, based on cumulative research and experience, has improved so much that we can predict and deal with major global economic crises. It warns that “... virtually no one foresaw the Great Depression of the 1930s ... preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a ‘new era’ had arrived.” Coming from such a mainstream and prestigious international financial organization, this sober warning, articulated on the basis of the intellectual legacy of the great Austrian economists such as Ludwig von Mises, Joseph Schumpeter and Friedrich Hayek, made me think the Keynesian orthodoxy could blind economic policy-makers and business leaders to critical risks facing us in the global economy. Let us hope that does not happen.
