As a follow-up to yesterday's post here are more details of the remarks by Kenneth Rogoff at the Tokyo forum. According to Bloomberg, Rogoff said after the speech that the U.S. is likely to tighten monetary policy before cutting government spending, sending “shockwaves” through financial markets.
He does not see the U.S. as coming to grips with its budget deficit immediately. “The U.S. is in a state of paralysis in its fiscal policy,” he said. The IMF has forecast that by 2011 gross borrowings will amount to the equivalent of 99.5 percent of annual economic output for the U.S., 94.1 percent for the U.K., and 204.3 percent for Japan.
Rogoff said that investors around the world will eventually demand higher interest rates to lend to countries that have heavy debt loads, including the U.S. In his scenario, the U.S. government will delay any efforts to contain the deficit until Treasury yields reach around 6 percent to 7 percent. Fiscal discipline won't be imposed until soaring bond yields trigger “very painful” tax increases and spending cuts, he said.
“When they start tightening monetary policy even a little bit, it’s going to send shockwaves through the system.”
“Clearly the dollar is going to go down against the emerging markets -- there’s going to be concern about inflation and the debt.” He said that currently the dollar is being propped up by concerns about the euro zone's ability to withstand the deteriorating finances of member nations like Greece.
Oddly, in the audio of his remarks, Rogoff argued that the "main event" is over and that the situation is "not that bad" now, despite a deep recession and long recovery. His data indicate that stock prices recover remarkably well following a deep financial crisis and return to their former peak within two or three years. Rogoff did hedge this view, however, saying that government debt will be a huge problem, and it will be challenging to extricate from stimulation.
In Europe, he expects Greece will eventually be bailed out by the IMF rather than the European Union. Although he expects the EU to provide a bridge loan, he believes that it won't be enough in the long run. “The more they suck in Greece, the lower the euro goes, because it’s not a viable plan.”
As mentioned yesterday, Rogoff is co-author with Carmen M. Reinhart of the book This Time Is Different, a study of eight centuries of financial crises.
