I have just read the open letter by 21 prominent Australian economists on the AFR, 3 June 2009.
Those economists are prominent and reputable. There is no question about that. I personally respect them very much.
But with respect, I beg to disagree with some of the opinions in their letter.
For some reason, I did not follow the AFR recently and missed this important letter from these economists.
The title of the letter shown on the AFR is "debt no problem, for now".
The title itself is correct and not wrong, although it could be a little misleading.
The letter and the title is correct in saying that debt itself is not necessarily a problem. Very few would strongly question that.
But the letter missed the point of the debate. The debate has not been about having debt or not per se. It is really about what kind of debt and how much of debt and whether some of the debt is necessary.
The letter starts with quotes of Paul Krugman and Olivier Blanchard as follows, to quote:
In Paul Krugman’s words, right now, “knowledge is our only defence against catastrophe”. A natural reaction would be to retreat to timidity. But that would repeat mistakes that exacerbated the Great Depression by giving in to our fears and phobias. International Monetary Fund chief economist Olivier Blanchard has a similar blunt message: “Above all, adopt clear policies and act decisively. Do too much rather than do too little.”
Paul Krugman is a well known American economist, the 2008 Nobel laureate in economics for his contributions to the theories of international trade. Olivier Blanchard is well known France/American macroeconomist, with many publications on macroeconomics, including two famous textbooks on macroeconomics.
Their opinions are important and have many followers, presumably. That was probably why the 21 prominent Australian economists start their letter with those quotes to set the scene for their arguments.
Let’s look at the quotes of those two famous international economists.
First, Krugman’s “knowledge is our only defence against catastrophe”. Is that correct? I doubt it. Why? Let me explain.
Yes, it is obviously true that knowledge is important for all things. It is especially important at present when the world is in a great recession. I don’t doubt it a bit. But one would realise that it is at least equally if not more important that it not just the knowledge we have but also how we use our knowledge that matters.
Further all current knowledge is not necessarily always enough to enable us to solve all the current urgent problems. We may need to consider how to use our knowledge and to develop new “knowledge” that will be useful in our current and future endeavour. This is why I only half agree with Krugman’s point.
The knowledge of the 1930’s great depression and the experience with Keynesian macro policies including both fiscal and monetary tools is useful in combating the current great recession. Indeed, it was the collective government policy actions of most world large economies that prevented this great recession became another great depression. Credit to whoever when credit is due. Let’s acknowledge it.
The sentence following the quote of Krugman in the letter says that “A natural reaction would be to retreat to timidity. To be frank, I don’t know how one can draw that conclusion or make that statement. It sounds much like what the prime minister and the treasurer have said again and again. The point is confusing or ambiguous at best and deadly wrong more broadly, because that is not the only other options available and not a natural reaction. It may be natural to some, maybe well including these economists, but that is not necessarily natural to many others.
The point is not action or not, not a question of boldness or timidity. In a word, it has never been a black and white two extreme world. It is not a binary choice. It is a spectrum with many feasible options available. Some options or actions are better than others. More on this point later on.
Is out current knowledge enough or good enough for us to deal with the current financial and economic challenges? Probably not. Just ask the question why the Federal Reserve in the US has been using so called non-conventional methods in their monetary policy approach to the current financial and economic problems. It is not too difficult to understand that our conventional economic theories are insufficient and provide no effective policy prescriptions to the current problems, so policy makers have to resort to new methods.
Yes, one can argue that is also based on current knowledge. I agree with that, but only just. It is based on our knowledge that the current knowledge is not good enough for a ready solution to the current problems.
We need to apply our existing knowledge wisely. We need new knowledge. We need new economic theories that are more targeted to the current economic woes.
Second, let’s talk about the quote from Blanchard. There are two parts of that and I will deal with each of them. One is about “adopt clear policies and act decisively”. Is that necessarily correct? No, it is not in this case, unfortunately.
Are clear policies necessarily the correct ones? One has to wonder. Think about the IMF’s policies towards some of the East Asian countries during the 1997/8 Asia financial crisis. They were, or must have been clear by those important IMF officials, or in their minds. They also acted decisively in forcing those countries that were receiving IMF assistance at that time. Were they correct or right? No, they were not. Most economists and even IMF realised that point sometime later on. Some economists recognised that at the time.
This example from IMF, the one Blanchard is its chief economist now, experience states the obvious that clear policies and decisive actions, irrespective what they are, are not necessarily correct actions to take. They may be necessary, but not sufficient. It is not good enough for policy advisors of economists just say to governments that they adopts clear policies and act decisively. They need to say what those clear policies are. And they must get those clear policies the right policies to suit the occasion.
Another point of Blanchard’s quote is about whether governments should do too much or too little, that is, biased on the upside or down side. Again, is it good enough for policy advisors to give green light so blindly to governments’ spending their way out of recession? No, it is irresponsible! Some government if not many of them, tend to over spend and spend on unproductive projects. So it is important to know how much governments should spend and what they should be focused on.
Fiscal policy is never to be as simple as the symbol of G in the GDP equation in economics textbooks; when G is higher, GDP will be higher. Fiscal policy is much more than that. It is about both the total amount of G as well as its composition. The latter is more important than the former in most if not all circumstances for any good governance.
The proposition of biasing towards too much than too little appears to suggest that they only focus on the total amount rather the composition and quality of G. That is not good enough and any good government should be able to do better than that.
I will elaborate on the main points of that letter in another blog article, so to make this article not too much - to practise the point I argue in this article. To be frank, it is already too long.