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From world's central banks, lessons for America's

By David R. FrancisStaff writer of The Christian Science Monitor / November 18, 2002



Central banks have an influence on geopolitics, and on their nations' standards of living.

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And worldwide, the pecking order is changing.

The Federal Reserve, with its relatively successful monetary policy, has promoted the economic might of the US.

With an overly tight squeeze on credit, the Bank of Japan has shrunk Japan's role in the world by causing a decade of stagnation. By now, China's 1.2 billion people have more combined purchasing power than Japan's far more prosperous 126 million. China's central bank has supplied its economy with enough money to grow at rapid rates - running about 10 percent a year.

Britain's standard of living, encouraged by a generous Bank of England, has been rapidly catching up with that of Germany.

"Over the past 20 years, Britain has improved its economic performance remarkably," notes Richard Reid, an economist in London with the brokerage house Schroder Salomon Smith Barney.

At the moment, unemployment stands at a 40-year low of 3.1 percent in Britain, half that in the United States and way below that in Germany.

Inflation in Britain is running about 2 percent and wages are growing at a handsome 3.8 percent rate.

The latest comparison by the Organization for Economic Cooperation and Development in Paris shows that, in terms of purchasing power, Britain in 2001 had a per-capita gross domestic product of 102 percent of the average of the 30 well-to-do countries in the OECD; Germany had 109 percent, and the US 148 percent.

Since 1995, however, Britain's economy has grown almost twice as fast as that of Germany. It is closing in on Germany's high standard of living. It already beats by a little that of France.

Federal Reserve chairman Alan Greenspan told Congress last Wednesday, in effect, that the US central bank won't make the awful mistake of the Bank of Japan and allow deflation - prices falling on average - to trouble the US economy.

This month, Fed policymakers cut short-term interest rates half a percentage point, to 1.25 percent, leading some economists to worry that the Fed might be "running out of ammunition" soon, particularly if the economy worsens.

It couldn't push short-term rates below zero, essentially the prevailing rate in Japan.

"We are not close to a deflationary cliff," Mr. Greenspan assured Rep. James Saxton (R) of New Jersey. That's because, he explained, the Fed is not limited to purchasing the investments that affect its target interest rate, the federal funds rate that commercial banks charge one another on overnight loans. Under its charter, the Fed can also buy middle-term or long-term government notes or bonds and drive down their interest rates as well.

In this process, the Fed would send checks to the former owners of these assets. Those owners would have more money in their pockets and presumably go out and spend some of it.

The economy would then revive, and deflation disappear.

During World War II and for several years afterward, the Fed actually did accumulate huge amounts of Uncle Sam's long-term debt to hold down the interest rate and cost of the debt to the US Treasury.

Eventually, however, such a policy could cause severe inflation. So in 1951, the Fed and the Treasury reached an "accord" that abandoned "pegging" of long-term interest rates.

Faced with the problem of short-term interest rates of zero, the Bank of Japan this year started to buy Japanese government bonds to stimulate its economy. On Oct. 30, the bank announced it would increase these purchases by 20 percent to about $10 billion a month.

Many economists are skeptical that this monetary stimulus will work, arguing that reforms to reduce huge losses on commercial-bank investments are essential.

But David Malpass, an economist at Bear Stearns, an investment bank based in New York, holds that an even more aggressive Bank of Japan monetary policy would be the best remedy for Japan's problem.

The latest numbers hint that the stimulus may already be working. Japan's gross domestic product rose at an annual rate of 3 percent in the third quarter, and, according to revised numbers, 4.2 percent in the second quarter.

Germany's big problem is that the European Central Bank has stubbornly kept its benchmark interest rate steady at 3.25 percent. That level, according to Mr. Reid, may be appropriate for most of the 12 nations in the European Currency Union (ECU) with its euro. But it is twice as high as the sluggish German economy can support.

"If there are risks [of deflation], they are probably highest in Germany," says Reid.

Of course, monetary policy isn't the only factor driving a nation's economic path.

For example, Japan suffered a huge bubble in stock and real estate prices in the 1980s that burst in the early 1990s.

Germany's problems hang partly on unification with East Germany. Also, Germany joined the ECU at a currency rate that left it hampered competitively.

With that problem and market rigidities, Reid sees a "pretty crummy growth rate" ahead for Germany.

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