• 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.