There’s an old joke that Jacob Frenkel, formerly of Chicago and then the Bank of Israel, used to tell to illustrate the fallacy of thinking that you always have to do the opposite of what caused the initial problem. A driver runs over a pedestrian; he looks back, realizes what he’s done. “I’m so sorry,” he says. “Let me fix the damage.” So he backs up, running over the pedestrian a second time.
What we have now is a spending slump. It’s the consequence of easy credit that led to reckless spending in the past — but the problem now is how to sustain spending; trying to encourage austerity at this point will just make things even worse. Keep cutting, Ben!
Frenkel of AIG Says U.S. Housing Market `Will Adjust Itself' (Bloomberg Podcast)
NBER Working Papers by Jacob Frenkel
Interview with Jacob Frenkel;
Region: Donning your University of Chicago hat for a moment, the Federal Reserve System has aimed its policy at the stabilization of prices. What are your thoughts on the Fed's efforts?
Frenkel: Well, I cannot remove all my hats at the same time, so therefore, I will not comment specifically on the performance of the Fed, except to say that I have no doubt that the primary responsibility of the monetary authority should be the attainment of price stability. The greatest contribution that monetary policy can make to growth, the standard of living, employment and the like, is by ensuring that there is an environment in which stability prevails and inflation is as low as possible...
Region: I would like your views on the various exchange rate regimes. Our bank has expressed a considerable interest in fixed exchange rates.
Frenkel: Well, I think that the debate about the choice of the exchange rate regime has been with us for many, many years and it will continue to be with us for many, many years. The real issue is not so much the choice of the exchange rate regime, but the choice of the policies that are capable of sustaining whatever regime one chooses to adopt. My gut feeling is that we will continue to have a relative degree of flexibility of exchange rates between the three major poles, namely the U.S. dollar, the European currencies, call it the Deutsche mark, and the Japanese yen. The other smaller countries will probably find it useful to hook themselves to one of these blocks.
So, within Europe we saw the exchange rate mechanism design, but we also saw how it has faced significant difficulties during the past few months. These difficulties have taught us an important lesson, which is exchange rate intervention in and of itself cannot be a substitute for fundamental conversions of economic performance and economic policies. It makes no sense to try to peg the wrong exchange rates because in the present as we have huge capital markets and very well integrated capital markets, there is no way the authorities through foreign exchange intervention can overcome the flows that are determined in the marketplace. Therefore, what we are probably going to see is the European exchange rate mechanism learning some lessons concerning the need to have conversions on the inflation front before they solidify again their exchange rate into a more rigid formula.
I think that the real issue is what exchange rate mechanism is capable of generating the inflation path that each country wishes to have. There is no way that a country that does not have its own house in order can in a sustainable way import this stability through the exchange rate. The exchange rate is a manifestation of policies rather than the policies themselves.
Region: Milton Friedman reportedly discouraged you from leaving the University of Chicago to join the IMF, arguing that you could make more of an impact through research. Any regrets for having left?
Frenkel: Well, I obviously miss the academic career that I had at the University of Chicago. It was one of the most stimulating places that I could imagine. And, I owe practically all of my human capital, as far as understanding economic theory and developing my economic philosophy, to my colleagues and the atmosphere at the University of Chicago.
As for myself, I found the move from the University of Chicago to the International Monetary Fund a natural progression in the development of my own human capital. Having been involved many years in teaching and research, primarily in the field of international economics and international economic policy, it was very challenging and indeed natural to try to apply these concepts within the context of the International Monetary Fund, where I was asked to not only head its research department but also to be very directly involved in the policy coordination efforts of the G7 countries. I have found this experience rewarding. I have learned a lot about how economic theories feed into economic policy advice. I definitely do not regret having made this particular move. Needless to say, one always misses his good colleagues and the atmosphere at the University of Chicago, but I guess that is the way life goes on.