Wednesday, December 31, 2008
The Depression Chronicles – 6: A plea from the IMF
Remember "supply-side economics"? Essentially it's the notion that if the wealthy pay less in taxes, they will transform that additional capital into productive enterprise—a sort of Reaganite transmogrification of the famous saying of Chairman Mao: Let a thousand capitalists bloom! It was argued that the rest of the populace would eventually smell the flowers—not that it mattered all that much.
Well, our capitalists have bloomed and are now turning to seed—though not seed capital. They're in a panic and don't know where to turn. The harvests of 2005 and 2006 had been so bountiful! Now they're willing to listen to almost anyone—anyone, that is, who will not raise their taxes or tell them what to do.
Practically speaking this means a return to John Maynard Keynes, whose ideas enjoyed their ascendancy during the Great Depression. But the economists surrounding Ronald Reagan decided that Keynesianism was putting a drag on money-making, so that by the end of the 80s mention of Keynes might invoke the same eye-rolling in financial circles as if you'd mentioned Marx. What was so disagreeable about him was the notion that governments have a role to play in their economies, most notably in smoothing out the ups and downs of economic activity. But no government can do what a free market in private hands can do, they said.
By contrast with supply-side economics, the Church of Keynes believes in demand-side economics. A Simply Appalling interpretation of the model goes like this: In times of a recession keep the little buggers buying through judicious government spending and with any luck that will keep them off the streets and you can still get rich. The other nice feature of Keynes' prescription for a downturn is that he did not recommend raising taxes. Deficit-spending is the order of the day.
In Keynes' day the globalization of capitalism had not achieved the lofty pinnacle that looms over us today, so his prescriptions were intended more for national consumption. Today the Keynesian solution must be viewed in a global context.
In the commentary that passes as news, we continue to hear happy talk about the economy for 2009. I hate it when they try to delude us. But a week ago the French newspaper Le Monde published an interview with Olivier Blanchard, chief economist of the International Monetary Fund (IMF). A few key phrases were duly noted in the financial press—just enough to say they had covered the event—and there was no mention of it at all in the news for general consumption.
I decided to translate it since Monsieur Blanchard did not mince words about the severity of the crisis ahead. He is one of the few economists willing to contemplate in public the possibility of another Great Depression.
Blanchard offers prescriptions for both the financial system and the economy. Concerning the banks, he hints at temporary nationalization, which is if anything too weak a recommendation. But for the economy he offers the standard Keynesian remedies. For that malady Barack Obama appears eager to take M. Blanchard's medicine. We may hope it will act as a restorative—but it's certainly not curative.
Economist Joseph Stiglitz is among the few willing even to mention the more fundamental problems that underlie this crisis—
America, and the world, is also facing a major structural problem, not unlike that at the beginning of the last century, when productivity increases in agriculture meant that a rapidly declining share of the population could find work there. Nowadays, increases in manufacturing productivity are even more impressive than they were for agriculture a century ago; but that means the adjustments that must be made are all the greater.
Here's the full text of the interview with Olivier Blanchard—
Dominique Strauss-Kahn, the Managing Director of the International Monetary Fund (IMF), is pushing governments to increase their fiscal expenditures to sustain growth. Yet the IMF was a great enemy of deficits. Why this turnaround?
There is no turnaround. For different circumstances, different remedies. We have a crisis of exceptional amplitude whose main component is a collapse in demand. The indices of consumer and business confidence have never fallen to this extent since these measurements began. Unheard of! Beginning in October a paralysis in plans for spending came about suddenly and globally.
The coming months are going to be very bad. It is imperative to stem this loss of confidence, to restart and, if necessary, replace private demand, if we wish to prevent the recession from becoming the Great Depression. Of course, in normal times we would have recommended that Europe reduce its deficits. But these are not normal times.
And are there other measures that can be taken?
At this stage, two types of measures are necessary. First the measures of which I've just spoken—to restore confidence and stimulate demand. That involves using monetary and fiscal tools. But also, some measures designed to repair the financial system [are needed]. Banks continue to reduce credit to individuals as well as to businesses and emerging countries. There will be no resumption of growth unless this problem is resolved.
What should be done in terms of finance?
Financial institutions must recognize their losses and clear their balance sheets. They are certainly doing so, but too slowly, which introduces uncertainty and continues to worry investors. Governments should help the process by encouraging or forcing the banks to dispose of their dubious assets. When this has been accomplished, many of these institutions will clearly be undercapitalized. It will be necessary to inject fresh money. If private investors don't, governments must do it—not by giveaways but by participating through share ownership.
If repairing the private credit market takes too much time, governments must be ready to replace, at least partially and temporarily, private credit—for example, by buying back commercial paper as the American Federal Reserve is doing.
It's hard to see the effects. Why?
The principle behind these measures has, in fact, been accepted by all countries since the meeting of the G20 in Washington and the European summit in the Elysée Palace that took place in mid-October. Unfortunately they are being implemented too slowly. The behavior of the American authorities has lacked coherence and clarity. In Europe, the balance sheets of banks are still partially fictitious and the repurchase of assets has been in negligible amounts.
The result is that banks continue to liquidate their positions. Not only at home, but also abroad. They are repatriating in considerable amounts the capital they had invested abroad. It is estimated that their outstanding debt in emerging countries reached 4 trillion dollars [2,872 billion euros]. It's reported that a trillion dollars has left these countries in recent months.
The IMF has spoken of the necessity of dedicating 2% of the gross world product to these plans. Will this be enough?
The governments and central banks must show clearly that they are ready to do everything to prevent another Great Depression. For the moment a fiscal expansion of 2% appears to be enough. But if circumstances demand it, governments must be ready to do more—3% or more if necessary. We must think about it starting now, because it isn't easy to spend such quantities of money efficiently!
What forms should this fiscal reflation take?
It's better for the reflation to cut in through an increase in public expenditures than by the reduction of public receipts. To put it another way, construction of bridges and the renovation of schools stands to have more effect on demand than the reduction of taxes, which households are tempted to convert into precautionary savings.
Whether you reduce taxes or increase transfers, it's better to target the populations that are victims of unemployment or drowning in debt. They have greater need of it, and they will spend it as well, contributing to the resumption of economic activity. The temporary reduction in the value-added tax (VAT), a measure adopted in Great Britain, doesn't seem to me a good idea; 2% less isn't viewed by consumers as a real incentive to spend. On the other hand, the subsidy to the auto industry in France creates strong incentives and seems to me a good idea.
Despite the transience of its effects?
The important thing is to sustain activity and to revive confidence now. The six months ahead are key. If Germany doesn't participate sufficiently in this reflation, many other countries will also hesitate to do it, and that would be disastrous for Europe.
Should the emerging countries do likewise?
In view of the decline of their exports, it's in their best interest. China has announced a plan the details of which are poorly understood, but one may suppose they will do more if necessary. India, which has less room for fiscal maneuvers, is setting itself to the task also.
Many emerging countries face the additional danger that the retreat of foreign capital will lead to an exchange rate crisis and a general capital flight. In many countries, the potential size of such a capital flight may represent half of the gross domestic product.... This is a lot of money. Multiplied by the number of countries potentially exposed, we're speaking of trillions of dollars—an amount considerably greater than the IMF can advance. It is urgent to consider and to develop ways to mobilize the necessary liquidity, if it's needed.
[a Simply Appalling translation]
Admonition of the Day (4/14/08)
Global Effect of the Day: The new world order (6/05/08)
Announcement of the Day: It's a recession! (12/02/08)
"First" of the Day: Fall of the CPI (12/19/08)
Quote of the Day: On the power of defunct economists (12/22/08)