Are we in for another period of stagnation?

Comments on Wolfgang Münchau’s commentary “No exit”, on Financial Times, see http://www.businessspectator.com.au/bs.nsf/Article/No-exit-pd20090727-UBS7F?OpenDocument&src=sph 27/07/2009

After a severe financial and economic crisis as the world has just experienced or is still experiencing, there will be many painful adjustments to realign the elements in the system.

While the concerted efforts by governments and central banking authorities have averted the total collapse of the international banking and financial system (and it is good indeed), we are just at the beginning of the long process of adjusting and realignment.

The first oil shock may have marked an important milestone as the beginning of the so called stagnation period that ran for many years. Stagnation was an adjustment process, a painful price to pay for that oil shock from the supply side. That lesson may be relevant for the current predicament we are having.

There were no effective policies, and for that matter, economic theories, that could solve that stagnation back then. We seem to be no different now from then, lack of effective policy tools to deal with this kind of so called balance sheet recessions.

There are some scenarios the matter would play out. The first one is that the world, especially the advanced countries, just wear the consequences of the recession and its aftermath of long and painful adjustment and realignment process, and sooner or later they will emerge from that process as the 1970 and early 1980s indicated, and return to a new and normal growth path afterwards.

The second scenario is that the governments and central banking authorities accidentally discover a magic cure in terms of policies and led the world out of that painful process. As a result, the total economic losses could be minimised. But the likelihood of that happening is fairly low.

The third scenario is that economists, academic or otherwise, develop new theories that can be used effectively to deal with these new economic challenges and minimise the total economic losses in that process. It is possible for this to happen, but main stream economists have to work hard and be innovative not dogmatic about it.

Let’s hope that either scenario 3 or 2 occurs and occurs as early as possible. This is trillions and trillions involved public work. We have got to accomplish it. Otherwise, stagnation may be here with us for a long period to come.