Economics: It’s up to the wonks

J Bradford DeLong, professor of economics at the University of California at Berkeley, posed good question recently: Is economics discipline? His answer was that among Chicago School economists, at least, it is definitely not science. “Moreover, it is not even discipline.”
Back in 1830, DeLong argued, economists like Frederic Bastiat, Jean-Baptiste Say and John Stuart Mill knew lot about the origins of aggregate demand shortfalls and the usefulness of expansionary fiscal policy in downturn. This was stuff “that modern Chicago never bothered to read, never bothered to learn, or have long forgotten”.
Nobel economics laureate Paul Krugman kicked things along in his New York Times column, drawing attention to DeLong’s several references and quotes “from freshwater economists who were shocked… at the idea that anyone imagined that fiscal expansion might be expansionary”. DeLong had stressed these economists’ ignorance of intellectual tradition. “But they were and still are amazingly ignorant of what contemporary economists who don’t happen to be part of their hermetic world have been doing.”
In short, closed minds hadn’t noticed the revival of Keynesianism in recent years.
Krugman cited the work of Maurice Obstfeld and Kenneth Rogoff, whose work had given rise to whole genre of New Open Economy Macroeconomics. They had shown that when there are unemployed resources, the expansion of government spending need not come at the expense of private spending, but instead comes from putting additional resources to work.
He was dismayed, therefore, as the fiscal debate unfolded in the US, that “we had all these Chicago types sneeringly asserting that ‘nobody’, except possibly people at ‘third-tier’ departments, has believed for decades that fiscal expansion can actually expand demand. Obstfeld and Rogoff are pretty prominent nobodies.”
This was heady stuff and Krugman cautioned that his column was “very wonkish”.
But wonks are influential in shaping public policy and our Treasury wonks have been advising the Government on this year’s Budget at time when the economy is sluggish and the Christchurch earthquakes are making massive demands on the public purse. We can’t be sure what they advised. We can be sure the Budget will be austere.
Finance Minister Bill English told the public sector the Government no longer can afford to fund “nice-to-have” policies that soak up money needed elsewhere. The overall size of the Government had to reduce as proportion of the economy.
Prime Minister John Key warned it was likely the Government would not spend any new money in the Budget. The Government had planned to spend $800 million more, but – because of the demands heaped on public finances by the Christchurch earthquake – we can forget about it.
The fiscal situation has worsened since then: the net cost to the taxpayer for its obligations to South Canterbury Finance investors increased early in April from $900 million to $1.2 billion because the company’s loan book was worse than expected. Then came the rescue package for AMI, with the potential to require taxpayers to cough up anything from not one cracker to $1 billion or so. The snag is that AMI did not know the magnitude of the earthquake claims it would have to meet in city where it covered many more properties than its rivals.
There are plenty of good reasons for austerity. Those spending demands (some real, some potential) were being at time when the Budget deficit was growing and tax income flows were slowing because of the economic downturn. And don’t forget the need to keep the credit rating agencies happy.
On the other hand, here’s hoping the policy wonks are up with the play on what fiscal policy can and can’t do to stimulate sluggish economy. As BERL economists cautioned, over-zealous spending cuts by the newly elected National government in 1990 and 1991 had adverse short-term effects: economic activity fell. The pick-up from there was strong, however, helped by an export surge on the back of lower exchange rate. M

Bob Edlin is leading economic commentator and NZ Management’s regular economics columnist.

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