Over the past week there has been a fundamental recalibration in understanding about the current economic crises afflicting Europe, the USA, Japan, the UK and some other countries. The IMF analysis of the likely magnitudes of budget multipliers (see “World Economic Outlook,” October 2012) has raised the stakes dramatically in the debate about the relative merits of fiscal austerity versus fiscal stimulus.
Take a periphery country, or the UK. Currently, foreign demand cannot be relied upon to create economic recovery. Current monetary policies — with their excessive emphasis on interest rates and increasing unproductive banks’ reserve accounts, rather than on ensuring an effective money supply — have run their course. New money creation is not reaching consumers. At the same time, austerity policies are contributing to lower economic growth, or deeper contractions, and bond financed budget deficits are adding to higher interest rates and debt burdens. There is talk of centralizing banking and fiscal policies in the Eurozone, but that ambitious undertaking may take years to agree, let alone implement.
Samuel Brittan (‘The harmful myth of the balanced budget’, Financial Times, October 11) proposes a new way to consider fiscal policy architecture. Yes, ‘excessive fiscal austerity’ is bad policy, as it adds to public debt and weakens the economy. Yes, longer-term fiscal consolidation is desirable as public expenditures relative to GDP and public debt burdens are both excessive. But, in the midst of the current crisis, should mere ‘austerity’ continue to be supported: answer, No! The IMF may be saying this when it states (in Chapter 1 of the World Economic Outlook, October 2012) that ‘fiscal policy…should be a stabilizing factor against short-term downturns…’. Brittan’s proposal is worthy of consideration.
In his most courageous Mansion House speech, Lord Adair Turner suggested that consideration be given to employing still more innovative and unconventional policies. The Financial Times editorial (‘UK needs to talk about helicopters’, 12 October) subsequently recognized the need for the UK government to consider alternative monetary and fiscal policy strategies. If that might be so for the UK, it applies with equal force to the Eurozone periphery countries, and to some other countries as well.
Dennis Snower, President of the Kiel Institute for the world economy (‘A grand bargain that could reconcile the Eurozone’,Financial Times, 16 October) bravely proposes a counter-cyclical fiscal policy rule: ‘the greater the fiscal stimulus permitted in recessions, the greater the fiscal contractions in booms’.
At some point very soon, policy will be required to urgently, and simultaneously, lift aggregate domestic demand and decisively contain, and then lower, public debt burdens. The relatively high ‘fiscal multipliers’ identified by the IMF could play a pivotal role in lifting demand, assuming that they are symmetrical: that is, that they apply equally to both contraction and expansion phases. Lifting demand and growth will be critical if debt burdens are to be lowered and unemployment is to be reduced.
Some at the IMF believe that some countries could possibly aim, in the short-term, to pull-off a ‘hat trick’: re-establish competitiveness, re-establish fiscal balance and maintain growth. However, it would seem highly implausible that this combination of objectives could be achieved in the short-run with current policies. On current policies, GDP is predicted by the IMF itself to actually contract in the short-run, not only in Spain and Italy, but also in Greece, Cyprus, Slovenia, Portugal and the UK. And, as is acknowledged by the IMF, fiscal consolidation is unquestionably weighing on demand. Progress on increasing competitiveness will be slow on current policies in austerity-exhausted countries.
Given the latest IMF modelling results, there is now a clearer mandate for misplaced orthodoxies to be challenged. Austerity — by lowering tax revenues without cutting tax rates — creates ‘unhealthy’ budget deficits, and raises the debt burden, and cannot, therefore, be the way to contain rising public debt. Further quantitative easing is not the only way, or the best way, to inject new money into the economy to lift growth. Austerity and massive unemployment are not the only ways to reduce prices and improve international competitiveness. New bond financing is not the only way, or the best way, to finance on-going budget deficits in debt-ridden countries, as it raises interest rates and further increases public debt.
A new macroeconomic strategy is likely to be required soon to address the unfolding short-term crisis. Article 123 of a now out-dated treaty may need to be adjusted. Greater coordination between monetary and fiscal policy will be essential. Using new money creation to finance on-going budget deficits would rapidly work toward containing the rise in public debt, and sterilisation (if required) would ensure there would be no increase in inflation (for analysis and details see R. Wood, Centre for Economic Policy Research, Policy Insight Paper No. 32, ‘The economic crisis: How to stimulate economies without increasing public debt’, 31 August 2012) . This policy combination would stop interest rates periodically surging upward, reduce uncertainty, avoid a financial crisis, and provide a basis for an effective monetary policy and economic stimulus. The strategy applies whether countries stay inside the Eurozone, or leave it. Budget deficits do not increase public debt: bond financing does.
It is simplistic to conclude that monetisation of public deficits generated hyperinflation in central Europe. In his book (1969), former German Reichsbank President (H. Schacht) makes it clear that it was the private Reichsbank at the time that allowed private banks to issue massive amounts of currency, and it was the private Reichsbank that enabled speculators to short-sell the currency. The ECB is not private and, consequently, the problems of the 1920s need not necessarily arise today. Martin Wolf (‘Lessons of history on public debt’, Financial Times, October 10) is quite right to favour Keynes over Hayek.
A new approach to improving international competitiveness will be required as austerity is abandoned. Appropriately constructed prices and wages policies and competition policies could potentially be effective in some periphery countries — even in the short-run — without creating widespread poverty.
Should public debt burdens continue to mount — as seems certain due to on-going budget deficits if new bond financing is retained as the means of their financing — debt rescheduling may be necessary to provide more time to turn economies around.
With all the constraints upon it, the IMF has done well to adjust its views. However, an on-going macroeconomic policy challenge remains: to be prepared to act and think beyond current orthodoxies; to recognize the dramatically changed nature of the urgent economic problems confronting particular countries; and, to prepare new country-specific policy frameworks to turn them around. When economic circumstances become so fundamentally disparate across countries and regions then uniform centralized macroeconomic policies become increasingly questionable, and large scale capital flight likely from the weakest regions.
Richard has published papers on wages policy, the taxation of financial arrangements and macroeconomic issues in Pacific Island countries. Views expressed in these articles are his own and may not be shared by his employing agency.