I read a brief report from the US Tax Policy Center – The Debate over Expiring Tax Cuts: What about the Deficit? – last week which raises broader questions than those it was addressing. I also note that Paul Krugman references them in his current New York Times column (published August 22, 2010) – Now That’s Rich. The point of my interest in these narratives is that I have been researching the distributional impacts of recession for a book I am writing. The issue also bears on the design of fiscal policy and how to maximise the benefits of a stimulus package.

The Australian federal election campaign is in full swing and last night the federal opposition in Australia staged their policy launch for the federal election to be held on August 21, 2010. This is a campaign where both sides of politics are running on their respective claims to be better at implementing fiscal austerity measures. It has become a matter of who is promising the biggest budget cuts the earliest. It has made the parties barely distinguishable in terms of their overall policy appeal and has rendered both unfit to govern this country. It used to be said that procyclical fiscal policy was destabilising. This was typically in the context of neo-liberals claiming that expansionary policy always came too late and added to private spending that was already on the rebound and thus increased the inflation risk. But the reverse doesn’t appear to apply for the mainstreamers. Cutting public spending when private spending is weak is being held out as virtuous and the only way to engender growth. This inconsistency exposes the ideological nature of the austerity measures, which reflect as one UK commentator said recently – a desire to complete the neo-liberal demolition of the welfare state started 30 years ago but still incomplete or a reflection that the deficit hawks are total lunatics.

It is interesting how the big neo-liberal economic organisations like the IMF and the OECD are trying to re-assert their intellectual authority on the policy debate again after being unable to provide any meaningful insights into the cause of the global crisis or its immediate remedies. They were relatively quiet in the early days of the crisis and the IMF even issued an apology, albeit a conditional one. It is clear that the policies the OECD and the IMF have promoted over the last decades have not helped those in poorer nations solve poverty and have also maintained persistently high levels of labour underutilisation across most advanced economies. It is also clear that the economic policies these agencies have been promoting for years were instrumental in creating the conditions that ultimately led to the collapse in 2007. Now they are emerging, unashamed, and touting even more destructive policy frameworks.

At the end of 2008 and into 2009, as the real sectors in our economies were starting to experience the aggregate demand collapses instigated by the banking crisis, most governments took steps to stop the meltdown from becoming the next Depression. At times, the unwinding private spending looked to be pushing the world to those depths. So after years of eschewing active fiscal policies, governments suddenly rediscovered the fiscal keyboard key and in varying magnitudes pushed fairly large expenditure injections into their economies. Most of the mainstream economists who had been teaching their students for years that this would be futile were silent because they had to hide out in shame given their textbook models could neither explain how we got into the mess nor how to get out of it. But there were some notable exceptions from Harvard and Chicago who came out attacking governments for being profligate. They claimed their models would demonstrate that the fiscal interventions would come to nothing (Barro, Becker, Taylor all were leading this charge). Lesser lights, then emboldened, joined the throng screaming that proponents of the stimulus strategy should provide evidence. Well the evidence has been mounting and the conservatives should just lock their office doors and go home to their families in shame.

Australia’s central bank governor is now appearing in the world press as something of a hero for putting interest rates up recently in defiance of world trends. Today he is featured in many finance home pages for his statement that the RBA cannot afford to be timid in putting rates up in the current months. This has raised expectations that we are in a race to get the target rate up towards their so-called neutral rate sometime soon. So almost rock star status for our central bank governor. Pity, the whole paradigm he is representing is destructive and helped get us into this mess in the first place. This blog explains why inflation targeting per se is not the issue. The problem is that fiscal policy becomes subjugated to the monetary policy dominance. This passivity manifests as the obsessive pursuit of budget surpluses which allegedly support the inflation-first stance. But this policy strategy is extremely damaging in real terms and will provoke another debt-bust cycle sometime in the future.

Today I read an interview with Richard Koo from the Nomura Research Institute in Japan who is the touring the world promoting his views of why the fiscal stimulus packages are so important. His views are drawn from his extensive experience of the Japanese malaise that began in the 1990s. The interview was published in the September 11 edition of welling@weeden which is a private bi-weekly emanating from the US. I cannot link to it because you have to pay to read. Anyway, much of what he says reinforces the fundamental principles of modern monetary (MMT) and is quite antagonistic to mainstream economic thinking. It is the latter which is now mounting political pressure to cut the stimulus packages. Koo thinks this would be madness, a view I concur with.

There were two related stories this week from either side of the Pacific Ocean. From the east coast came – Rollout of jobs scheme ‘a sham’ and from the west coast – Stimulus Is Bankrupt Antidote to Failed Stimulus. While the US-based article is a polemic from the right-wing American Enterprise Institute and the second is a journalist’s reporting on Australian political trivia, they both raise interesting issues regarding the way fiscal policy is conducted. The issues raised provide further justification for employment guarantee schemes as a sophisticated addition to the automatic stabilisation capacity that is inherent in fiscal policy and makes it superior to monetary policy.