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Can Monetary Policy Alone Guarantee Prosperity?

There is no substitute for hard work

Based on experience in largest advanced economies, many have suggested that emerging economies should „print money“ to grow out of the stagnation/crisis. Life would be easy if this was the right answer. So, before doing so, I would strongly urge emerging central banks to consider the three lessons below:

1. „There is no substitute for hard work“. T.A. Edison. When I was working in the region (Bosnia in particular) there was a lot of discussion on the exchange rate regime and competitiveness. Like what is the “exit policy” for a currency board or fx risk in the region (in relation to foreign exchange lending at the time)? In most cases the answer was: We need to enter the EU and EMU as soon as possible. Once we have the euro (officially, not unilaterally like Montenegro and Kosovo today) our problems will be “over”. Greece, Portugal and some other Euro economies has taught us an important lesson: there is no substitute for structural reforms, sound macroeconomic policies and competitive companies capable of exporting to globalized markets. When the euro was introduced some claimed that by definition there is only “one inflation in the eurozone” or that the balance of payments (more specifically, current account deficits) does not make sense in the eurozone (only on an aggregate level) because the state of Montana in the US does not have a BoP either, etc. Today we know better. What is clear is that the euro is not a substitute for sound economic policies. I would even argue provocatively that entering the euro zone prematurely can aggravate the problems for a country. The euro created an illusion that there was no “exchange rate risk”, creditors were willing to lend much more and at lower rates due to the euro. But the main economic lessons still apply.

2. For my second lesson I would like to paraphrase a famous saying from Bill Clinton’s 1992 presidential campaign: It’s the politics, stupid. Politics is much more important in economic policy making than I had anticipated. And until we economists start addressing it explicitly when discussing measures and actions, I doubt we will ever end up with successful economic reforms. Let me explain: Good economics should lead to an increase in welfare for the society (otherwise it would not make sense). But we all know that people do not like change (the tyranny of the status quo), have very high discount rates (i.e. want it all now), will fight hard for their acquired “rights” and benefits etc. Every measure of economic policy redistributes income (if it does not, it is useless). So, someone will always be against any measure. And in democratic societies the only real power comes from elections. Even central bank governors with all their independence are elected by parliaments, i.e. political institutions par excellence, and are ultimately accountable to voters. Of course, some professional skills are necessary, no doubt. But, for tough reforms of your economies you need to build support for them. Again, in democratic societies power comes from elections. So, ultimately you need a mandate for tough reforms. And you can implement reforms only by explaining this regularly. So, the lesson that I have drawn from this is that while a necessary precondition for good policy making is, of course, “technical excellence”, to implement it you need political support. I am arguing that there are a lot of information asymmetries regarding what I would call sound economic policies and their benefits for societies in the long run. No doubt that these are fundamental questions of political economy .

3. My lesson number three is: One can “defy” economic laws as much as those in physics. The main economic forces that shaped the economic landscape in the past will continue to do so both on the micro and macro levels. Let me point out just two of these forces. First, globalization is to a large degree driven by scale economies. The more of something you produce the cheaper it is. In our individual countries we tended to produce steel. How can we, from our small economies, compete with Korea or China in steel production today? The answer is, we cannot. And scale economies will continue to exist regardless of the degree of state intervention. Second, the laws of supply and demand are still the best allocators of resources. This does not mean that we are not aware of market failures, but my point here is: Do not throw out the baby with the bath water. Market economies work. Economic agents still make decisions based on relative prices. Private sector driven economy is still the best “development engine that we know”. Of course we should be aware of market limitations and not believe blindly in market efficiency, but state failures are less discussed, but can be much more damaging than market ones.

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