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
When The Facts Change
“When the facts change, I change my mind. What do you do, sir?” Such was John Maynard Keynes’ famous riposte to a critic who accused him of changing his mind about monetary policy during the Great Depression.
A similar response might be made today to those, like Don Brash, who maintain that they have been right all along, when the facts say otherwise. And there must be a suspicion that the Treasury are similarly afflicted – more concerned to maintain ideological purity than to do what the situation requires.
If we were feeling generous, we might feel a twinge of sympathy for our policy-makers. 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 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.
Any sympathy we might feel should in any case be tempered by the thought that it is those same policy-makers who created many of our problems in the first place. Our 2008 recession – well-entrenched by the beginning of the year – was the end result of decades of ideologically-driven policy mistakes which 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 calamitous starting-point that we now 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 those measures 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 timetable and needs to be decided and implemented soon if it is not to be too late.
On the other hand, some Ministers seem more worried about allowing the government deficit to grow than with the increased fiscal stimulus the economy now needs. But this 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. In that respect, the prudence of past governments has meant that 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. As Keynes insisted, deficits should in any case be measured and evaluated over a period, not in the short term.
We are of course constantly assured by Treasury that there is no need to worry because the size of the fiscal stimulus already delivered to the economy is very large by international standards. But that assertion needs to be carefully examined. The stimulus so far provided (including tax cuts and spending yet to materialise) is estimated to equate to 2.8% of GDP. This may have seemed adequate when planned last year as a response to our own recession, but as a counteraction to the global crisis it provides only half the stimulus delivered in the US and the UK (where huge sums have also been spent on bailing out the banks), and of course falls well short of the package 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 than ours; they were not already in recession, as we were, when the global downturn struck.
What we must recognise, in other words, is that – on top of our domestic woes – we now need to address a desperate international situation that is unprecedented in most people’s lifetimes. Much now depends on the “summit” arranged for 27 February. The Prime Minister seems at least to be aware that more needs to be done, and that spending on infrastructure is the way to go. We must hope that the summit – and his own advisers – agree with him.
Bryan Gould
6 February 2009
An Ideological Straitjacket
With inflation falling, a full percentage point cut in interest rates at the end of the month now looks like a done deal. But while a relaxation of monetary policy is both welcome and overdue, it does not remotely measure up to what is now required if we are to ward off what could be the most serious recession in most people’s lifetimes.
That isn’t to say that home owners should not see some small reduction in their mortgage interest payments. Businesses – at least those still willing to borrow – should get marginally better deals from those lenders still willing and able to lend. And lower rates should mean that overseas speculators are less likely to push up the value of our dollar by chasing the interest rate premium we have insisted on offering them over recent years.
Even so, the impact of the Reserve Bank governor’s expected decision will be pretty marginal. Any slight easing in the cost and availability of credit at home will be offset by the higher cost and greater difficulty our banks will encounter in borrowing overseas. And even if credit is a little cheaper and easier, that may not be of much use if fears of a recession mean that people are no longer willing to borrow and spend. Relying on monetary policy in these circumstances is a bit like pushing on a piece of string.
When Treasury advised the government a week or two ago that the economic situation had worsened over the three weeks of the Christmas break, they revealed themselves as the only observers who failed to see – from some months back – that a further and rapid deterioration was inevitable. The suspicion must be that they are still fighting the last war, still fondly hoping that the measures that were too late to deal with last year’s home-grown recession – already well entrenched long before the global meltdown – will now serve to deal with the world crisis. Following along in the wake of events, relying on tax cuts planned last year and a belated cut in interest rates, will simply not cut the mustard now that the world economy is in free fall.
It is of course true that we have not so far had to grapple with the financial crisis that has engulfed much of the world’s banking system. Our (largely Australian) banks have so far avoided those problems, though they may find the going gets tougher over coming months. But what we haven’t seemed to have grasped is that the shattering loss of confidence in the world’s banks is now spilling over in to the real world economy – the one where people actually live and work and spend and try to make a living.
As recession gathers pace overseas, we have yet to feel the full impact of export markets that are going backwards, of commodity prices that are falling, of import prices that are rising, of credit from overseas sources (on which – as proportionately the world’s second most indebted nation – we are dangerously dependent) becoming more difficult and expensive to arrange.
Nor have we understood the impact on our domestic economy of falling house prices, rising unemployment, tighter government spending levels and more bankruptcies, closures and bad debts. As people feel less wealthy – as the perceived value of their assets falls, and doubts grow over their future income levels and job security – they become less likely to spend and invest, compounding the recessionary impact of the meltdown overseas.
This is not to say that there is an easy consensus about what does need to be done. But what is clear is that most overseas governments, with varying degrees of reluctance, have accepted that simply cutting the cost of credit when people may not wish or be able to borrow is not the answer. What is now needed, as Keynes recognised 75 years ago, is a fiscal stimulus that will raise the actual level of spending in the economy. That means government investment in infrastructure and services that will benefit the economy, and possibly putting money into the pockets of people – like the poor and the retired – who will spend it, even if this means temporarily rising government deficits.
While others have accepted that difficult times require special measures, we seem locked into an ideological straitjacket which is obsessed with monetary policy and seems more frightened of a burgeoning government deficit than of national bankruptcy. Yet there is no reason why we should be less courageous than others in making our response to recession. The one bright spot in our economic situation, after all, is that the government’s finances are, by comparison with other countries, reasonably healthy. We must hope that our new government will have the courage to recognise this, to understand what they must now do, and to do it before it is too late.
Bryan Gould
21 January 2009
This article was published in the Sunday Star-Times on 25 January.
Fiscal Stimulus? Not Quite
The decision by the US Federal Reserve to cut interest rates to virtually zero, and the similar steps taken by other central banks, show how desperate are the world’s monetary authorities to avert a deep and entrenched global recession. This is, in effect, their last throw. There is nowhere else to go. If anything were needed to expose the limitations of monetary policy, it is the fact that even zero interest rates are – in a world where there is increasing reluctance to spend, lend alone borrow – as ineffectual as pushing on a piece of string.
That is not to say that the interest rate cuts overseas will have no effect. We in New Zealand have discovered that sooner than most. The Fed’s unprecedented action has meant that our own meagre cut in interest rates has left the interest rate differential pretty much where it has been all along – offering a standing invitation to speculators to take the New Zealand taxpayer for a ride. The rise in recent days in the Kiwi dollar’s value on the back of a renewed inflow of hot money now threatens to snuff out one of the few bright spots in an otherwise dismal New Zealand outlook.
Our caution in responding to the growing global downturn is part of a wider failure on our part to grasp the true dimensions of what is unfolding worldwide. We assume that the steps we have taken to counter our own home-grown recession (which was well entrenched long before the global crisis struck) will be enough to see us through the impact of the global downturn when it hits us. We don’t seem to recognise that we have yet to feel the full impact of declining export markets, falling commodity prices, more expensive credit, and higher import prices, to say nothing of the deflationary effect in the domestic economy of a foundering housing market, higher unemployment, lower wage growth, more bankruptcies, closures and bad debts, and tighter limits on public spending.
Most importantly, we appear to take no account of what Paul Samuelson calls the “wealth effect” – the impact on consumer confidence and therefore spending of a perceived decline in people’s wealth as house prices fall and unemployment threatens. The result? We are still looking to the early end of a recession that has barely begun.
This picture seems much clearer to policy-makers in other economies. But, in view of the ineffectual nature of monetary policy, little wonder that many overseas governments are now looking more and more to fiscal policy for salvation. Keynes, “thou shouldst be living at this hour!”
Not everyone of course is persuaded of the need for fiscal stimulus. For many conservatives, this use of fiscal policy (or deficit financing or printing money as it is often pejoratively labelled) is absolute anathema. Indeed, the British government’s readiness to create and live with a rapidly growing deficit has provoked a bitter row with German Ministers who would, apparently, prefer to see the recession take its course rather than use Keynesian measures to forestall it.
Yet the accuracy of Keynes’ prescriptions for dealing with recession has brought about what has been in many cases an overnight conversion to Keynesian economics. Our own policy-makers however – like the Germans – seem reluctant to recognise that, if recession is not to become endemic, exceptional measures have to be taken.
Their excessive caution in bringing down interest rates to a level which is still well above world rates has been matched by a similar reluctance to take effective action on the fiscal front. We have been assured that our economy is already benefiting from a large fiscal stimulus but it is difficult to see anything in the current policy stance that is likely to impact greatly on the real economy in the immediate future. True, we had some tax cuts a month or two ago and there are – marginally – more to come in April, and there are proposals (yet to be implemented) for an accelerated public spending programme in infrastructure. But what seems to be offered as the main element of our so-called “fiscal stimulus” is a growing government deficit as a consequence of falling tax returns and writing down the value of government assets.
It is certainly true that the government’s books look a lot less healthy than they did a year ago, (though it is also true that they are in better shape than in most countries). But declining tax revenues are simply the inevitable consequence of recession – not a stimulus to economic activity – while falling values for government funds are accounting provisions which have no immediate impact on the real economy. Neither is a substitute for a real boost to spending power, which – as Keynes explained – is the only factor that will really counteract a threatened recession. Without it, we are in for a long hard road.
True to form, our policy-makers are sticking to the obsessive orthodoxy that has handicapped our economic performance over more than two decades, even when that orthodoxy has been identified as responsible for a recessionary crisis and has therefore been abandoned on a global scale. It will be a real test for the new government to see whether it has the courage to seek different and better advice.
Bryan Gould
19 December 2008
This article was published in the New Zealand Herald on 22 December.
Open Letter to Our New Prime Minister
Dear John,
As you form your new government, there will be many who, for the sake of the country, will wish you well and who will hope that you have the wit and will to overcome the economic crisis that now afflicts us. This may be the moment to put to one side your experience as a merchant banker and to concentrate instead on the needs of the real economy in which most people live and work.
Your challenge is in fact twofold. You will first have to confront, with other world leaders, the global crisis that now threatens us, but at the same time you will have to look forward to the steps that will be needed if we are to improve our own endemically disappointing economic performance. The world’s big economies have been, after all, like great ocean liners which have done very well while sailing the global ocean, until they suddenly sprang a leak and started to sink. We, on the other hand, from the moment we launched our own tiny and vulnerable craft on global waters in 1984, have been waterlogged for 25 years.
The decisions you will have to take in response to the global crisis are, in a curious sense, relatively straightforward. There is a wide-ranging consensus as to what needs to be done, embracing right (George Bush) and left (Gordon Brown and Kevin Rudd), which you should have no difficulty in joining.
The steps taken so far in New Zealand are in line with that consensus. The cut in the OCR, the Bank Deposit Guarantee Scheme, the measures to improve bank liquidity, will all help to avert disaster. Even so, it is almost certainly the case that we have not yet seen the full dimensions of the crisis. As our export markets close down and our tourist numbers decline, we will feel – in addition to our own home-grown recession – the full brunt of the international recession. And, while our banks look reasonably well placed for the time being, the higher cost and greater difficulty of borrowing overseas will have their impact sooner or later.
The difficult issues, however, will arise in tackling our own deep-seated and endemic national problems. It is here that your real test will come. If your government is to slow down, or even stop or reverse, the migration across the Tasman (which has attracted so much attention from politicians over recent years), it will have to deal with the fact that if we had matched the Australian performance over the past 25 years, every New Zealand family would be $80,000 per year better off. It beggars belief that this disparity is unrelated to the policy prescriptions we have chosen to put in place over that time.
Just as the global crisis has compelled a freeing up of the debate about international economic and financial arrangements, so it should be seen as an equally strong reason for undertaking a re-appraisal of our own national policy stance. Both the global crisis and our own shortfall in economic performance, after all, have a common origin – the belief that there is no alternative to the current orthodoxy of unregulated markets and of economic decisions being the preserve of bankers rather than elected governments.
It is that simple-minded belief that must now be subjected to review. Your actions and statements so far suggest that you understand this (though you may have your work cut out to persuade your deputy and Minister of Finance that it is not “too hard” to make a change).
In case you need to buttress your resolve in this respect, you should take courage from the increasing chorus of influential voices – from Joseph Stiglitz at the United Nations, to Robert Skidelsky and Vijay Joshi in the pages of The Guardian – who are now calling for new thinking and new measures.
Nor is there any shortage of reputable New Zealand economists – Brian Easton, Ganesh Nana, Kel Sanderson, Anthony Byett – who believe that the time is long overdue for reconsidering the wisdom of relying on a single policy instrument – interest rates – to control inflation. There are many others who will concede in private that new thinking is needed. Even your predecessor as National Party leader, Don Brash, has recognised the need for additional instruments in his advocacy of a variable rate of excise duty on petrol. And the new Labour finance spokesperson, David Cunliffe, seems ready to break the shackles of current orthodoxy.
The country will hope that you might go further, and put your weight behind the growing international demand for a “new Bretton Woods”, which would put a new international framework in place – as Henry Paulson puts it – to redress imbalances and restrain excessive capital movements. No country has more to gain than we have from such a development. If we are to improve our economic performance, both at home and internationally, we must be ready to apply the lessons that both our own and the global experience should teach us.
Bryan Gould
13 November 2008