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