March 15, 2020 14:49:19
You can never be sure if the policies you choose to fix an economic crisis will work.
Why? Because an economy is like an organism that’s constantly evolving (due to technological and political change), so economic “laws” that once seemed immutable can lose their coherence over time.
That’s what seems to have happened to the Phillips Curve.
Since the late 1950s, the Phillips Curve suggested there was an inverse relationship between unemployment and inflation — if you let unemployment fall too low, wages grow too quickly and inflation starts growing uncontrollably, and if you want inflation lower you have to accept a slightly higher level of unemployment.
But in 2017, former US treasury secretary Larry Summers warned that America’s union movement had become so weak that the Phillips Curve had broken down.
He said the bargaining power of employers had become too strong and their ability to hold wages down was having a negative effect on the economy.
Society had changed so much that a useful predictive tool of monetary policy had begun to lose its power.
What will the coronavirus do?
The coronavirus pandemic is having its own huge impact on economists’ forecasting abilities.
The coordinated shut-down of schools, sporting contests, offices and factories across multiple countries, and the grounding of planes and tightening of borders, is unlike anything the world has seen in peacetime.
The crisis is evolving so rapidly that economic opinions that sounded reasonable last week now seem woefully out of date.
Indeed, the recent devastation on Australia’s stock market has made it impossible for companies to even raise cash.
On Thursday evening, NAB had to abandon its plans to raise about $2 billion on the stock market with a note issue, because the market had become too volatile. On Friday, Macquarie had to abandon a $500 million note issue of its own.
Who could have predicted that a few months ago?
It’s obvious that we don’t know what problems we will be confronting in coming weeks. Time will tell if coronavirus makes a lasting impact on global supply chains or the composition of economies.
But the Morrison Government may have to be prepared to scale up and expand its $17 billion stimulus package in a matter of months — because the economic dislocation that’s occurring globally may quickly overwhelm its ability to support the economy.
And in that regard, what problems would an expanded package hope to solve?
It’s an awful predicament for Treasury to find itself in. Economic phenomena are evolving so rapidly there’s a risk we’re not capable of understanding the nature of the problem yet.
In these circumstances, a rushed stimulus package could make the economy worse.
What should the next package look like?
Economic history is filled with booms and crises.
And if we remember a crisis at all, we often find it hard to recall the names of the key players involved, especially as time passes.
Older Australians remember the early 1990s recession, for example, but there would be millions of younger Australians who have never heard of Bob Hawke, Paul Keating or Bill Kelty.
That’s the way it goes — the further back in history we look, the more academic the past feels for everyone.
There would be few Australians these days who have heard of Douglas Copland or Lyndhurst Giblin, even though both men were internationally-renowned economists in the 1930s.
They were part of a small group of economists who provided the intellectual framework for Australia’s policy response to the Great Depression, known as the “Premiers’ Plan”.
Their plan, adopted in 1931, was designed to run for a few years with the full agreement of state premiers and the federal government.
Their policy prescriptions were deflationary (because their advice was tailored to match the political atmosphere of the day) with an overriding goal of fiscal consolidation.
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They recommended returning state and federal budgets to balance by cutting government spending dramatically, reducing real wages by 10 per cent, reducing real government wages and salaries expenditure by 10 per cent, increasing taxes to raise revenue, and depreciating the currency.
They also wanted the pain of economic adjustment to be shared equally among Australians (so bond holders, pensioners and public servants all took a hit).
Initially, their plan was hailed as a success.
In 1932, the British economist John Maynard Keynes observed, “I am sure the Premiers’ Plan last year saved the economic structure of Australia.”
But history hasn’t been so kind to it.
By the 1950s, the economist Colin Clark was scathing of the plan, saying its recommendation to balance federal and state budgets had been “harmful”.
“This action prolonged the depression and made unemployment very much worse than it would otherwise have been,” he wrote.
In 2009, Treasury economist David Gruen (who’s now heading the Bureau of Statistics) agreed that Australia’s fiscal response to the Great Depression had exacerbated the downturn.
“When viewed from a modern perspective, knowing how important it is to support aggregate demand when private sector spending is in retreat, Australia’s policy responses to the Great Depression appear counterproductive, and certainly not supportive of recovery,” he said.
Of course, extenuating circumstances prevented Copland and Giblin from pursuing other policies.
They faced a recalcitrant Commonwealth Bank that refused to lend more money to state and federal governments with budget deficits, and public opinion was strongly against the logic of expansionary fiscal policies.
But the economists had fought for their plan to be adopted ahead of alternative proposals, such as the proposal from Labor’s Ted Theodore who thought Australia ought to pursue a £20 million public works programme, expand bank credit, expand unemployment relief, lower interest rates, and reduce the salaries of high income earners only.
The so-called “battle of the plans” has been recorded in volumes of Australian economic history.
But the economic plan that won the battle? It’s become infamous.
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March 15, 2020 14:22:48