Eswar S Prasad is a professor at Cornell University and a Senior Fellow at the Brookings Institution. His latest book, The Dollar Trap, published by Princeton University Press, explores the global monetary system, and the dominant role played in it by the dollar.
Prasad explains that the dollar cannot for now escape its role as the global reserve currency, “due to weaknesses in the rest of the world and deep problems in the structure of the global monetary system.” There are substantial consequences of this, for the US, other western nations and the developing world.
He spoke to the Prospector about this and other subjects, the full results of which will be published here over the coming days.
Jay Elwes: We’ve been talking to a lot of economists and reading with great interest the thoughts of, for example, Larry Summers and Robert Gordon—who I spoke to last week—and Thomas Piketty, all of whom are gloomy and worry that economic growth will necessarily return to levels enjoyed in the past. Are you optimistic for growth in developed economies, or do you share their gloom?
Eswar Prasad: The US in particular is a fundamentally very resilient and dynamic economy, so I think the US will pull it together. But what causes a lot of concern really is the lack of political will in many of the advanced economies in particular to undertake the hard reforms that are needed. There is this reliance on monetary policy as a simple and easy tool for getting away from doing what really needs to be done.
So if you take the US for instance, there are good grounds for pessimism because on fiscal policy for instance, ideally fiscal policy should support the economic recovery for now and we should be dealing with the longer-term fiscal problems. But the US is getting it backward, pulling back on fiscal policy and not dealing with the longer-term fiscal problems, and the pulling back in the short term is having a very negative effect on expenditures like education, infrastructure and so forth that are very important for long-term productivity. And if you don’t have productivity growth that is certainly going to be difficult.
Now it’s been argued that there are regulatory burdens and so on that are holding back US growth. But my sense is that while those uncertainties are important the government plays an enabling role and given how much of a paring back there has been in government expenditures on these productive areas, my sense is that the government is not playing that enabling a role anymore. But again, I remain reasonably confident that the US can return to reasonable growth rates of at least 2.5 to 3 per cent. If nothing else to catch up for what has been lost over the last few years.
The labour market is very troubling, the fact that despite where we are in the economic cycle the labour market continues to perform very poorly certainly gives grounds for the secular stagnation story that Larry Summers has been talking about both in the economy and in the labour market in particular.
As I look around the rest of the advanced economic world, the UK is doing quite well. But in countries like Japan I don’t see the political will to put in place the tough reforms that are needed, so it’s still only one of Prime Minister Abe’s three arrows that is really being fired, and keeps continually being fired, the other two are not working well at all.
The eurozone has begun the process of repairs, and some progress has been made and some significant progress has been made on some of the periphery economies. But I don’t think that’s enough to ensure the competitiveness of those countries in the eurozone so I think this part of the advanced economic world will remain under serious tensions for a while and across all these economies the common theme again, is the excessive reliance on monetary policy without other policies pitching in.
JE: Do you worry about deflation as a global economic phenomenon?
EP: I think that, given how aggressively central banks are moving towards ensuring that that outcome is avoided and given how much fiat money they have actually provided, one has the sense of optimism that that will be avoided. But unless aggregate demand picks up in these economies, unless consumers and investors show some degree of confidence, that isn’t going to translate into a boost in aggregate demand which in turn could lead to deflationary pressures continuing.
In the emerging markets I think we are beginning to see a significant slowdown in growth and that adds to these concerns because the emerging markets have accounted for the bulk of growth since the financial crisis and if those economies start slowing down and if they too start relying on external demand then we could be back to the old scenario before the financial crisis where much of the world was riding on the US coat tails, and to some extent on the Chinese coat tails.
And if those two economies are not able to pull their weight then they could drag everybody down with them. So I think it is an ever-present concern but my sense is that in the advanced economies, at least in the US and the UK in particular, will be able to avoid these risks. Japan I worry about a lot more as the policies in place are certainly not credible in generating more aggregate demand. The eurozone again remains a concern because they seem to have gotten out of the hole they were in, but other than Germany it is hard to see significant strength in the other economies. In those economies not contracting already seems to be a victory every time so it’s not a good position to be in.
JE: You mention the problem of demand—do you make the link between weakness of demand and inequality? Because that’s one of the big political and economic questions here and certainly in the United States.
EP: That’s not something I have done any research on myself, but it’s certainly a plausible argument that the rise in inequality has contributed to the weak demand because it is certainly true that those at the lower end of the economic distributions tend to have a higher propensity to consume. And if you shift a lot of income away from there towards the upper parts of the income distribution where saving rates are typically higher, that alone mathematically would lead to a reduction in aggregate demand. But this is again not an area I have looked at closely myself. I find it to be a plausible connection. But I don’t have a good sense of quantitatively how important it is.
JE: Is it an idea that you think has political traction in the United States?
EP: I think the concerns about inequality and especially what they imply for the labour market are certainly very much part of the political dialogue in the United States. There is of course enormous dissension about what the policy implications of that are—whether the government should actually step in, with policies like raising the minimum wage, and providing other sort of protection to workers, what the re-distributive role of the government should be. And there I think we are not going to see significant progress simply because the political dissensions are too great and all these programs to have the government play a role in reducing inequality require money and the money is not there.
Prasad explains that the dollar cannot for now escape its role as the global reserve currency, “due to weaknesses in the rest of the world and deep problems in the structure of the global monetary system.” There are substantial consequences of this, for the US, other western nations and the developing world.
He spoke to the Prospector about this and other subjects, the full results of which will be published here over the coming days.
Jay Elwes: We’ve been talking to a lot of economists and reading with great interest the thoughts of, for example, Larry Summers and Robert Gordon—who I spoke to last week—and Thomas Piketty, all of whom are gloomy and worry that economic growth will necessarily return to levels enjoyed in the past. Are you optimistic for growth in developed economies, or do you share their gloom?
Eswar Prasad: The US in particular is a fundamentally very resilient and dynamic economy, so I think the US will pull it together. But what causes a lot of concern really is the lack of political will in many of the advanced economies in particular to undertake the hard reforms that are needed. There is this reliance on monetary policy as a simple and easy tool for getting away from doing what really needs to be done.
So if you take the US for instance, there are good grounds for pessimism because on fiscal policy for instance, ideally fiscal policy should support the economic recovery for now and we should be dealing with the longer-term fiscal problems. But the US is getting it backward, pulling back on fiscal policy and not dealing with the longer-term fiscal problems, and the pulling back in the short term is having a very negative effect on expenditures like education, infrastructure and so forth that are very important for long-term productivity. And if you don’t have productivity growth that is certainly going to be difficult.
Now it’s been argued that there are regulatory burdens and so on that are holding back US growth. But my sense is that while those uncertainties are important the government plays an enabling role and given how much of a paring back there has been in government expenditures on these productive areas, my sense is that the government is not playing that enabling a role anymore. But again, I remain reasonably confident that the US can return to reasonable growth rates of at least 2.5 to 3 per cent. If nothing else to catch up for what has been lost over the last few years.
The labour market is very troubling, the fact that despite where we are in the economic cycle the labour market continues to perform very poorly certainly gives grounds for the secular stagnation story that Larry Summers has been talking about both in the economy and in the labour market in particular.
As I look around the rest of the advanced economic world, the UK is doing quite well. But in countries like Japan I don’t see the political will to put in place the tough reforms that are needed, so it’s still only one of Prime Minister Abe’s three arrows that is really being fired, and keeps continually being fired, the other two are not working well at all.
The eurozone has begun the process of repairs, and some progress has been made and some significant progress has been made on some of the periphery economies. But I don’t think that’s enough to ensure the competitiveness of those countries in the eurozone so I think this part of the advanced economic world will remain under serious tensions for a while and across all these economies the common theme again, is the excessive reliance on monetary policy without other policies pitching in.
JE: Do you worry about deflation as a global economic phenomenon?
EP: I think that, given how aggressively central banks are moving towards ensuring that that outcome is avoided and given how much fiat money they have actually provided, one has the sense of optimism that that will be avoided. But unless aggregate demand picks up in these economies, unless consumers and investors show some degree of confidence, that isn’t going to translate into a boost in aggregate demand which in turn could lead to deflationary pressures continuing.
In the emerging markets I think we are beginning to see a significant slowdown in growth and that adds to these concerns because the emerging markets have accounted for the bulk of growth since the financial crisis and if those economies start slowing down and if they too start relying on external demand then we could be back to the old scenario before the financial crisis where much of the world was riding on the US coat tails, and to some extent on the Chinese coat tails.
And if those two economies are not able to pull their weight then they could drag everybody down with them. So I think it is an ever-present concern but my sense is that in the advanced economies, at least in the US and the UK in particular, will be able to avoid these risks. Japan I worry about a lot more as the policies in place are certainly not credible in generating more aggregate demand. The eurozone again remains a concern because they seem to have gotten out of the hole they were in, but other than Germany it is hard to see significant strength in the other economies. In those economies not contracting already seems to be a victory every time so it’s not a good position to be in.
JE: You mention the problem of demand—do you make the link between weakness of demand and inequality? Because that’s one of the big political and economic questions here and certainly in the United States.
EP: That’s not something I have done any research on myself, but it’s certainly a plausible argument that the rise in inequality has contributed to the weak demand because it is certainly true that those at the lower end of the economic distributions tend to have a higher propensity to consume. And if you shift a lot of income away from there towards the upper parts of the income distribution where saving rates are typically higher, that alone mathematically would lead to a reduction in aggregate demand. But this is again not an area I have looked at closely myself. I find it to be a plausible connection. But I don’t have a good sense of quantitatively how important it is.
JE: Is it an idea that you think has political traction in the United States?
EP: I think the concerns about inequality and especially what they imply for the labour market are certainly very much part of the political dialogue in the United States. There is of course enormous dissension about what the policy implications of that are—whether the government should actually step in, with policies like raising the minimum wage, and providing other sort of protection to workers, what the re-distributive role of the government should be. And there I think we are not going to see significant progress simply because the political dissensions are too great and all these programs to have the government play a role in reducing inequality require money and the money is not there.
