Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
I am increasingly reading analysis from the mainstream economists that attempts to reconstruct the current crisis as a fiscal crisis. The claim is that the crisis is about lax fiscal policy and that the solution to the on-going sluggish (if not continued negative) growth is to quickly withdraw all fiscal stimulus. The conservatives are thus in total denial as to the real causes of the crisis and the role that fiscal policy interventions have played in attenuating the damage invoked by the crisis. For a time they were silent because it was clear that the neo-liberal macroeconomics paradigm that is forced down the throats of students around the world was incapable of providing any coherent explanation for the crisis. But they are now re-appearing, larger than life itself, and have resumed their arrogant hectoring of the policy makers and the electorate. They are once again trying to impose the same policies on governments that led to the crisis in the first place. They are doing this by reconstructing history and relying on our lack of memory recall and incomplete comprehension of things economic.
This is one the worst articles I have read so far in 2010 – G20’S Keynesian group think bungled GFC. It was published today (June 24, 2010) in the News Limited daily (our only national newspaper) The Australian by one Tony Makin, who is a professor of economics at an Australian university. He is an ex-Treasury official and aligned with the right-wing think tank, the Institute of Public Affairs. The fact that he has been able to get a professorial appointment is one of those anomalies in our educational system. These anomalies are common in economics though given the dominance of the mainstream paradigm.
Makin claims that in the early days of the gloabl financial crisis the world leaders (G-20), influenced by the IMF, reverted back to “Keynesian group think on a grand scale” which has worsened the problem.
However, in fighting the GFC, the fiscal element of the response promoted by the IMF and endorsed by the G20 contributed to the second, European-centred, crisis. Europe’s economic problems are nothing more than the culmination of past fiscal folly, including budget laxity in the wake of the GFC.
So this article in among the growing number that are attempting to reconstruct the crisis and the fact that it is dragging on and threatening to double-dip as a fiscal crisis of the state. This strategy is an essential plank of the conservative attempt to regain the dominant intellectual position which it had lost as the full implications of the crisis and its causes came to attention in late 2007.
It is clear that the crisis was caused by a complex interplay of factors which were all manifestations of the two or more decades of financial and labour market deregulation, privatisations and outsourcing, attacks on welfare systems, and the erroneous belief that the private markets could effectively self-regulate. Please read my blog – The origins of the economic crisis – for more discussion on how this crisis emerged.
If you studied macroeconomics at a university over the last 20 years or more and used the standard mainstream textbooks you would be unable to understand anything about the reasons the crisis emerged. The mainstream profession, of which Makin is part of, does not have the analytical capacity which would have enabled them to see the crisis coming or provide an effective solution.
For them the increased financialisation of the economy was fine because they extolled the alleged virtues of self-regulated markets operating under their defunct efficient markets theorems and blind faith in free markets.
They also believed that allowing a huge gap to emerge between real wages growth and productivity growth was desirable because it transferred more real income to the profit sector and they believed that would be invested. It was “invested” but not in real productive capacity. Instead, it provided the largesse for the unproductive financial markets to develop unfathomable products (in terms of risk) in pursuit of even more profit.
All of this resulted in the collapse of the banking sector and the subsequent withdrawal of private spending which ensured that the financial crisis became a crisis that has beleagured the real economy.
So if you understand the true nature of the crisis and the fact that it was the culmination of a few decades of neo-liberal policy changes then you will realise that trying to reconstruct it as a fiscal crisis of the state is ludicrous.
Further, the current crisis in Europe is not a fiscal crisis. I have written extensively about the problems that confound Europe at present. Please read these blogs – Euro zone’s self-imposed meltdown – A Greek tragedy … – Exiting the Euro? – as representative of the analysis.
The focus on the fiscal state of several EMU nations is a typical smokescreen that the conservatives use to avoid confronting the real problem which is the structural design of the Eurozone monetary system and the rules that were imposed on the member states by the Stability and Growth Pact.
The design of the EMU system meant that the member states could never adequately respond to an aggregate demand failure of the magnitude that the world economy has had to absorb in the last three years. The automatic stabilisers were always going to drive the budget outcomes beyond the SGP thresholds.
That only tells you that those thresholds were not meaningful in any real sense. Further, it was to be expected that the member states would also expand their discretionary fiscal components to try to minimise the real damage that the demand failure was inflicting on their economies, particularly the rise in unemployment.
The long-term costs of not acting would have been huge. Now those costs are likely to be significant because the Euro bureaucrats have forced nations to introduce pro-cyclical fiscal policy as a re-assertion of the mindless SGP rules.
So the real problem of Europe is nothing to do with the capacity of fiscal policy to improve real outcomes in an economy. It has all to do with the lack of vision among Euro planners and their penchant for imposing mindless neo-liberal constraints on their economies.
Further, the fact that a banking crisis in Europe is still likely to emerge is indicative of the poor design of the monetary system. The member states have largely guaranteed their banks but do not have the monetary capacity to follow up on those undertakings should a bank run begin. Ultimately, the ECB will have to intervene and violate all the Lisbon rules. In other words, the ECB intervention already and that which will come later has already shown the design of the overall monetary system to be unworkable.
But for the conservatives it is very convenient to re-cosntruct the crisis as a fiscal crisis given their hatred for government fiscal interventions.
Makin argues that:
Applying fiscal stimulus in southern European economies became untenable when international lenders refused to finance ever larger budget deficits without exacting a much higher interest risk premium.
This is factually correct but misses the point. Makin is trying to argue that it is the fiscal stimulus that is the problem. But the responsible and correct thing for any government that was facing rising unemployment and stagnant (if not falling) private spending was to further expand fiscal policy. The design of that fiscal injection is open to debate but from my perspective should be employment-rich and ensure that the most disadvantaged citizens are saved from the ravages of recession.
So the real problem relates to the restrictions that bond markets place on governments pursuing their legitimate responsibilities. The power of the bond markets is only realisable because of the voluntary arrangements that governments have imposed on themselves. These voluntary constraints are more binding in the EMU because of the member states gave up their currency sovereignty.
The way forward is to redesign the operations associated with fiscal policy so that governments can pursue responsible policy choices and be judged on their performances at the appropriate democratic forum – the national election.
Allowing the amorphous bond markets to be the judge and jury is a gross violation of the democratic rights of all citizens.
Makin then argues that:
Faced with a fiscally generated crisis similar to crises experienced in numerous countries over recent decades, the IMF has reverted to norm and is once again prescribing fiscal austerity for the ailing southern European economies.
It has been little noticed that this position is a reversal of the rationale underpinning the G20 response to the GFC from late 2008 onwards, heavily influenced as it was by Keynesian-oriented economists in the IMF and the US administration.
Yes, the IMF doesn’t know where it is on policy. Its blind adherence to its neo-liberal ideology promoted policies that created the crisis in the first place. Once the crisis hit it was obvious the IMF had no clues at all. They even starting hedging their bets and issuing quallified apologies. Please read my blog – We are sorry – for more discussion on this point.
Now the dust is settling, the IMF are just like all the other conservatives, trying to reassert their neo-liberal ideology. They are coming in from behind a media and think-tank vanguard that has spread lies and misinformation with the aim of obscuring the neo-liberal role in undermining income and wealth generation around the world.
They assume that memories are short and comprehension limited. Accordingly, they are unashamedly imposing the types of policies that caused the crisis. It is an absurd scenario when you think about.
Makin then tries to run his favourite argument – the crowding out attack on fiscal policy:
… fiscal stimulus in the form of extra government spending has used up funds at the expense of the private sector.
The availability of funds is central to sustaining economic activity. Yet, it is remarkable how its importance has been neglected in interpretations of the worldwide fiscal response that followed the GFC.
Given the unprecedented global fiscal stimulus of recent years, it is therefore no surprise that funds for business ventures are in shorter supply than previously, globally and domestically.
Much blame is directed at banks in Australia for the unavailability of funds for financing investment, especially for small business, but fiscal largesse both at home and abroad must ultimately bear some responsibility.
First, you will note he just asserts that fiscal policy “must ultimately bear some responsibility”. Why should it? How does the fiscal interventions undermine the private capacity to access credit. It is a nonsensical claim reflecting blind ideology.
Second, the available of credit to fund working capital is an important part of expanding a business. Banks are not reserve constrained so can extend loans to any credit worthy customer. The fact is that apart from a few weeks early in the crisis, there has not been a shortage of liquidity in the banking system.
The banks can always lend. The problem is that they have reacted to the grave prospects of economic collapse and have increased the requirements they impose on borrowers seeking to establish their credit worthiness. Minsky covered these changes in banking standards across the stages of the financial cycle in great detail.
The reality is that a fiscal deficit adds exactly the same volume of bank reserves ($-for-$) that are subsequently drained by public bond issues. This is what I have called a “wash”. And as I demonstrated yesterday in this blog – Market participants need public debt – the debt issuance provides profit-making opportunities for the private buyers as well as a storage of saving for millions of workers (via pension funds).
If you put those two facts together – banks can always lend if there are creditworthy borrowers and fiscal deficits add the same volume of reserves that the bond issues drain – then the crowding out hypothesis that Makin is advancing is nonsensical.
Makin’s preferred policy strategy to the crisis was to rely on monetary policy:
The Asian financial crisis of 1997-98 was in retrospect the first major regional financial crisis of the modern globalised era and comparable to the GFC, surely now more aptly named the North Atlantic financial crisis. However, pre-G20, the international macroeconomic policy response was very different. There were no calls for an internationally co-ordinated fiscal action, yet we managed to survive it quite well. Instead, the international response relied on monetary easing by independent central banks in economies distanced from the epicentre of the crisis.
The Asian financial crisis was an exchange rate crisis driven by excessive holdings of foreign currency-denominated debt in some of the Asian nations. The developing nations had up until the mid-1990s soaked in huge volumes of financial flows in search of profit, much of it uncommitted to actually expanding the productive capacity of the host nations.
Interest rate rises under Greenspan in the US in the mid-1990s (under a misguided (informal) inflation targetting strategy) attracted a significant amount of the financial flows away from the developing nations.
This impacted severely on SE Asian nations which the IMF had bullied into pegging their currencies to the US dollar. The rising value of the latter reduced US export competitiveness and the other IMF strategy imposed on the developing nations – export-led growth – faltered badly.
So this crisis was the result of unregulated financial markets combined with the lack of exchange rate flexibility that the nations imposed on themselves via the dollar pegs. Further, the reliance on export-led growth strategies, which was the centrepiece of the misguided IMF development strategies proved to be the undoing of the Asian nations.
Fiscal policy should have been used to attenuate the domestic damage that the crisis caused. But the IMF had such a dominant position in the policy sphere and had the developing nations subjugated to their free market ideology that it was impossible for individual governments (other than the defiant Malaysia) to buck the IMFs iron grip.
The current crisis bears very little similarity with the Asian crisis. The current crisis was sourced in the banking system and spread to the real economy as private spending collapsed. It was not originated as an exchange rate crisis.
Further, the current crisis has been a truly international crisis affecting the banking systems and the production systems in all the advanced nations.
And, we should not underestimate the massive fiscal intervention of the Chinese government which has protected a number of economies, including Australia, from the worst of the recession. Makin completely overlooks the role of the Chinese fiscal intervention. It has had a very significant effect in the region.
Warren Mosler on Fox News
I don’t recommend anyone watches Fox Channels anywhere but overnight my good friend Warren Mosler appeared. Here is the link.
I just love the way the interviewers are so impartial and are such reflective listeners.
That is enough for today!
You are now reading this blog courtesy of a new server which has taken on the name of bilbo. We switched the systems over and sychronised at 9.45 Sydney time. The transfer was seamless.