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Daily Archives: August 12, 2008

Feldstein: A tale of two monetary policies

Marty analyzes on FT why ECB and the Fed take two different approaches in their monetary policies.  There are three major differences.
First, as frequently mentioned elsewhere:
The contrast between the ECB’s mandate to achieve price stability and the Fed’s “dual mandate” to balance the goals of price stability and employment is not just an accident of legislative history but a reflection of fundamental differences between the two economies. Those differences make it more difficult to tame inflation expectations in Europe and therefore require the ECB’s tougher policy.
Second, the more powerful trade union and its wage setting role in Europe: 

The role of trade unions is the most important difference. Only 7.5 per cent of US private sector employees are union members and they are concentrated in automotive, airline, construction and other depressed industries. In contrast, more than 25 per cent of employees in the European Union are members of trade unions and in some EU countries the wages set in union contracts are automatically extended to other companies in the same industry.

Because of this union power, the ECB must persuade union members and their leaders that it is determined to bring inflation down to its target level of less than 2 per cent. The ECB’s tough stance and exclusive emphasis on price stability is crucial to shifting inflation expectations and persuading unions to accept the rise in food and energy prices without pressing for offsetting wage gains.

In contrast, the Fed does not have to worry in the same way about union power and collective bargaining. Wage setting is decentralised and wage contracts do not have the formal links of wages to inflation that intensified the wage-price spiral of the 1970s.

Third, ECB is quite a young institution and central bankers there need to earn their reputation as a tough inflation fighter: 

Finally, the ECB recognises that it is still a very young institution that must prove to the European public that it will follow the successful anti-inflation tradition of the German Bundesbank. But a decade of relatively good performance is not a reliable guide to the future. The ECB is only now facing its first challenge of imported high inflation and the expanding membership of the European monetary union is bringing new voting representatives to the ECB whose views are yet to be tested.

China’s Success: Anything But Collectivism

David Brooks wrote on NY Times that China’s economic success story was a result of collectivism and it provided an alternative to Western individualism in development model. He can’t be more wrong about his judgement.

…What happens if collectivist societies, especially those in Asia, rise economically and come to rival the West? A new sort of global conversation develops. The opening ceremony in Beijing was a statement in that conversation. It was part of China’s assertion that development doesn’t come only through Western, liberal means, but also through Eastern and collective ones.

Since the reform 30 years ago, China’s economic takeoff has been anything but collectivism. The most famed and much researched agricultural reform, the so-called Individual Contract and Responsibility System, like many more reforms followed, has a distinct feature of letting people take more individual responsibilities and providing them with more incentives, which was a great breakaway from former collective farming and state-planned economy.

As Wu Jinlian, a prominent economist in China, famously said, “Wherever you see more private businesses, you see more prosperity”. Several Nobel winners in economics also called China probably “the most capitalist” country in the world. Astonishing comments to many observers, initially.

Make no mistake that China still remains not free, and the government also plays a relatively big role in the economy. But if you look back at China’s development in the past 30 years: it’s less and less government control and more and more free-market. Most people simply compares China’s level of government control with theirs, and reached the conclusion that it’s China’s government who made the real difference. This can’t be more wrong.

I suggest they look at China’s development dynamics, and do not compare statics. This is an easy mistake by confusing superficial correlations with fundamental causes.

Indeed, during the Olympic opening ceremony, 2008 drummers playing like one easily left people with easy impression that Chinese society values collectivism over individualism. But don’t be fooled.