Monday 23 Jul 2018 | 04:37 | SYDNEY
Monday 23 Jul 2018 | 04:37 | SYDNEY

Economists' ideas deficit


Stephen Grenville

26 September 2011 12:33

Few would dispute that the politicians' handling of the world economy has been seriously deficient. Perhaps the lack of political consensus on what to do is not too surprising: the issues often trespass on vested interests and deeply-held views. Less understandable and less forgivable, however, is the inability of economists to offer clear policy guidance, relevant to a world which threatens to fall back into recession.

The international agencies should be the most reliable source of objective policy advice. At the IMF, the new Managing Director is saying sensible things on fiscal policy and bank recapitalisation. But the just-released IMF Global Financial Stability Report is worried that low interest rates will trigger a 'search for yield' and cause rapid growth in credit.

Of course low interest rates present vexed issues for pension funds, encourage excessive flows to emerging economies and send a price signal which cannot be maintained in the longer run. But given the parlous state of economic activity in the advanced economies, 'search for yield' seems the least pressing problem. Risk aversion is driving investors into US government bonds which offer the lowest return for fifty years. Not much sign of 'search for yield' here.

As recently as end-June, the Bank for International Settlements (the central bankers' 'club' in Basel) still foresaw such a strong recovery that they began their Annual Report by saying: 'Pessimism has become tiresome, so optimism is gaining a foothold.' Their policy prescription was for tighter monetary settings together with 'swift and credible action to bring debt levels down to sustainable levels'. Pervasive market pessimism has overtaken this misreading of the mood but no revised policy prescription has been forthcoming.

The OECD, having trimmed its forecast markedly over the past six months, noted that in the OECD area 'activity has come close to trade is imbalances persist...improvements in labour markets are fading...confidence has weakened...and risk perceptions have changed, with multiple sources of risk'. Despite this bleak outlook, their advice was that monetary policy 'should be kept on hold'.

On fiscal policy, the OECD warned that 'countries with limited fiscal space have restricted scope for fiscal easing and some have to tighten amid cyclical weakness.' No signs of the OECD's traditional Keynesian orientation here.

Academic economists seem hopelessly divided. On fiscal policy, the idea of an 'expansionary contraction' (where the market is so impressed by government's belt-tightening that private expenditure increases more than the contraction in public spending) still retains adherents, despite Paul Krugman's disparaging references to the 'Confidence Fairy'.

Others see the US 2009 stimulus as a failure, whereas its main deficiency was that it was too small to do the job. Too many economists have branded the current conjuncture as a 'balance sheet' recession with the implication that only time will correct it. More excuses for inaction.

Among the economic policy-makers, the US Fed seems to be the most active and inventive. But the US Fed's latest innovation, while technically sensible, has back-fired. 'Operation Twist', designed to lower the long-term interest rate, was interpreted by financial markets as a sign that the Fed, spooked by the economic prospects, was resorting to desperate measures. Thus confidence took another hit. This kind of Catch 22 market reaction reinforces policy inaction.

The 'do-nothing' view was endorsed by the much-revered former Fed Chairman Paul Volcker. His message was balanced and nuanced, but nevertheless his concern was exclusively about inflation rather than 9% US unemployment.

The European Central Bank, preoccupied with the debt problems in Greece and other southern euro countries, seems to have forgotten that it increased interest rates as recently as July because its inflation zealots were more worried about price stability than anything else.

US Treasury Secretary Tim Geithner has offered sensible advice on European fiscal policy. More recently (and urgently) he has argued that: 'The threat of cascading default, bank runs, and catastrophic risk must be taken off the table, as otherwise it will undermine all other efforts'. His call-to-action is, however, muffled by European mutterings about his inability to get his own house in order.

It's regrettable but understandable that politicians should have trouble finding a workable consensus on economic policy. There is no excuse for the current dearth of positive policy ideas among economists.

Photo by Flickr user skye underwater.