Thursday, June 11, 2015

Further musings on the GFC and the lessons for economic policy

Discussion on That Australian life - the Killing Season, Mr Rudd and the GFC, has focused on the extent to which Australia did better in economic terms during the Global Financial Crisis than other developed countries and, if so, to what extent Government policy contributed.

As suggested by this Reserve Bank of New Zealand graph, I don't think that there can be much doubt that Australia did do better. The question then becomes why.

One of the difficulties in answering this question lies in the need to avoid lumping all the Government measures into a bucket simply called stimulus measures and then to evaluate the total package. This doesn't work very well, for the GFC went through stages as did Government responses. A government measure or measures that were appropriate at one point may be inappropriate at another. This brings in the problem of lags, especially with capital spending. 

Yesterday (10 June 2015), Australian Reserve Bank delivered a useful and reflective speech on the global and domestic economies, trying to give some sense of what we have learned over the past couple of years. The speech if worth reading in full. It's not complicated, just informative. Here I want to make a few short observations. 

First, incomes in Europe as a whole have still to return to their pre GFC levels. If you think about it, that's a very large aggregate loss that cannot be recovered. Australia avoided that outcome.

Secondly, monetary policy has really done what it can. I think it true that its impact has weakened in all countries. Further, and this is something that I have written about, the wash of global liquidity has created its own problems, including the sheer difficulty in knowing how to unwind that liquidity without creating consequent problems. 

One of the difficulties that riddles the debate between the Keynesians and those who oppose them lies in conflicting time horizons.  I no longer pretend to have the technical skills or current professional knowledge or, for that matter, the time to define and understand the conflicting threads in the discussion. Keeping things very simple, Keynesian economics deals with shorter term macro-economic fluctuations, but is not especially good at dealing with longer term issues. 

In his gentle way, the Governor points to the need for fiscal action to supplement monetary policy. However, he also points to problems including the need for longer term structural reform, as well as lag problems with stepped-up infrastructure spend and the need to actually have an infrastructure pipeline. This, too, is something that I have written about.

In the case of the GFC, Governments around the world looked to increasing infrastructure spend as a way out. I couldn't see it because the shovel ready projects just weren't there. I got one thing very wrong. Given the lags involved in capital spend with a vacant pipeline, I expected the stepped up infrastructure spend to actually create economic over-reach, coming into full flood as the global economy was already recovering. I overestimated the likely recovery by a very considerable margin.

However, in Australia where (I think) the combined policy initial reactions were quick and reasonably well targeted, it did happen. We would have been better off scaling back some of the economic stimulus measures rather than treating them as targets that must be met. There  was waste. I don't think that anybody can deny that.

I leave it to you to read the Governor's speech. I would be interested in your reactions.        .       


2 tanners said...


There was always going to be waste, because of lags in information. Then the targets wee made political, so it was harder to back off without various newspapers and commentators lining up to announce "another Rudd backflip". 'Twas ever thus.

Winton Bates said...

The speech by Glenn Stevens is very good I think. My initial reaction to the idea of relying on fiscal policy to boost demand was highly negative, as usual.
However, the question at issue is the return on investment. If it is possible to take advantage of low world interest rates to undertake investments that will yield a high return, then we should not be too concerned that this will raise the fiscal deficit in the short term. But that is a big"If".

2 tanners said...

The banks, individually and collectively, are not always right. However they are pretty good forecasters of interest rates. It is my recollection (and I stand to be corrected) that for much of this period fixed interest rates were lower than variable implying a view that the already low interest rates were likely to drop further.

Jim Belshaw said...

Winton, as a first general comment (an using the investment model) i the effect of a fiscal splash is to keep GPP higher than it would have been, you can total the higher GPD and compare it to the costs of the cash splash to get a rate of return. We learned that at UNE in development economics. Now on your second point, with accrual accounting I don't think that borrowing for investment actually affects the fiscal deficit.

2t,interesting point that I cannot correct!

Winton Bates said...

Regarding fiscal stimulus, I think we would agree about the need to balance any initial benefit against the cost of servicing increased debt.

Regarding budget accounting I am sure that investment spending by government is included in total government spending and therefore raises the fiscal deficit. See Budget Paper 1, Statement 9, Table 1 and Table 7:

Jim Belshaw said...

e are in agreement on paragraph one, Winton, although we may well disagree on the definition of benefits! On the second, I think that you are right. You used the term fiscal deficit, while I was thinking of budget deficit. I will have to look at the tables in detail.