Treasury Must Look Past Interest Rates To Boost Economy

As the participants prepare for the “jobs summit” this week, they will be hoping for a strong lead from Treasury and the Reserve Bank as to the way ahead. But, on the evidence so far, our policy-makers are floundering. After trying and failing to use monetary policy to grapple with our own home-grown recession throughout 2008, they now have to meet the new challenge of a world that has changed dramatically and to do so with a monetary policy instrument that now seems even less relevant.

What, after all, is now the goal of monetary policy? For decades, we have been told that inflation is all that matters and monetary policy all that is needed to deal with it. Now that inflation is the least of our worries, and the limitations of monetary policy are evident, a significant change in mindset and a new range of policy instruments are surely needed.

We should in any case temper any sympathy we might feel for our policy-makers with the thought that it is their mistakes that created many of our problems in the first place. Our 2008 recession – well-entrenched by the beginning of 2008 – was the end result of decades of ideologically-driven policy errors that had eventually run us into the buffers. Those mistakes had seen the average New Zealand family end up $80,000 a year worse off than their Australian counterparts, and even that disastrous performance was achieved at the expense of massive overseas borrowings, a huge trade deficit, and the fire sale of many of our national assets.

It is from this unfortunate starting-point that we now have to face the threat of world recession. The measures put in place just to deal with our own recession were hardly adequate for the task, but they certainly need reinforcing now if we are to ward off the worst effects of the global downturn as well.

That is not to say that the steps that have been taken are not welcome, as far as they go. The cuts in interest rates may be far too late but are better late than never. Tax cuts will also help but fall far short of what is needed and, according to most observers, are less effective than public spending in stimulating economic activity. The promise of a rolling programme of public investment in infrastructure is certainly welcome, though it seems to be proceeding on a somewhat leisurely, drip-feed timetable and to be just tracking along in the wake of a crisis that is relentlessly gathering pace.

Worryingly, there seems to be more concern in some quarters about allowing the government deficit to grow than with the increased and substantial fiscal stimulus the economy now needs. But that is to put ideology ahead of practicality. The whole point of the last decade of reducing government debt was surely to equip us to use public spending to stimulate the economy when it proved necessary. The prudence of past governments has meant that, in that respect, we are better placed than most to use government spending to help counteract recession – and that, rather than the size of the government’s deficit, is surely our top current priority.

We are of course constantly assured by Treasury that the size of the fiscal stimulus already delivered to the economy is very large by international standards. But that assertion was made last year, before the crisis truly hit and before other countries had made responses that dwarf ours by comparison. The stimulus so far provided (including tax cuts and spending yet to materialise) is estimated to equate to 2.8% of GDP. But in the US and the UK (where huge sums have also been spent on bailing out the banks), packages the equivalent of several multiples of our own have been put in place, and our response is of course also much smaller than the fiscal stimulus announced by the Rudd government in Australia. These countries have, in other words, done much more than we have, from a starting-point that was much less difficult; they were not already in recession, as we were, when the global downturn struck.

It is time to forsake ideological purity (for whatever that is worth) and focus on what pragmatically needs to be done. On top of our domestic woes, we now need to address a desperate international situation that is unprecedented in most people’s lifetimes. If jobs and businesses are to be saved, we will need more than occasional, case-by-case interventions. We must recognise that, if bank lending and credit creation are falling back, the case for the government to fill the gap with programmed credit for investment is overwhelming.

The Prime Minister, at least, seems aware that more needs to be done, and that spending on infrastructure is the way to go. We must hope that this week’s summit – and his own advisers – will agree with him.

Bryan Gould

19 February 2009
This updated version of an earlier article was published in the NZ Herald on 26 February