Wednesday, July 17, 2013

Should the GFC be viewed as a 'balance sheet' recession of the kind Irving Fisher wrote about in the 1930s?

I have been feeling a strong urge to write about the economic policies of the former government of our resurrected prime minister, Kevin Rudd. Whenever I begin to write on this topic, however, what comes to mind is my grandmother’s advice that if you haven’t got anything nice to say, perhaps you shouldn’t say anything. It might be churlish of me to attempt to remind people that Kevin – whom so many people seem to revere as much now as in 2007 – has a record of achievement that is somewhat less than perfect.

Fortunately, not everyone has such qualms and some excellent articles about the economic policies of the Rudd government have appeared in the media over the last week or so. The best newspaper article I have read so far is one by Henry Ergas, entitled ‘Rudd’s Real Record’, published in The Australian last Saturday (July 13, 2013). Ergas reminds us, among other things, that in 2009 Rudd mounted a massive scare campaign about the severity of the GFC in an attempt to justify a splurge of poor quality government spending.

I recall how Janet Albrechtsen suggested in The Australian at the time that the GFC provided Rudd and his treasurer, Wayne Swan, with an opportunity that they were only too eager to grasp:
The Rudd Government finds itself at a very fortunate juncture. As Rudd’s treatise in the present edition of The Monthly reveals, he can blame capitalism for the coming government extravagance funded by taxpayers. Prepare for Rudd’s hubris-filled pitch on how he “saved” capitalism and why you had to pay for it.’

Whether we are prepared or not, we are now hearing Rudd’s hubris-filled pitch:
‘As you know, here in Australia, we deployed a national economic stimulus strategy, timely targeted and temporary, which helped keep Australia out of recession, kept the economy growing, and kept unemployment with a five in front of it – one of the lowest levels in the world.’

The hollowness of the claim by Rudd and Swan that the fiscal stimulus pulled Australia though the GFC has been demonstrated many times. For example, in an article entitled ‘Wayne Swan’s legacy of unrivalled incompetence’ in yesterday’s Financial Review (July 16, 2013), John Stone, former secretary to the Treasury, points out that the hubris of Rudd and Swan overlooks the strength of Australia’s fiscal position prior to the GFC, the role played by monetary policy, the underlying strength of Australia’s banks and the growth in China’s demand for our minerals.

John Stone’s article also raised the question I am intending to address here about balance sheet recessions. Stone suggests that the Australian Treasury had erred in seeing 2008-09 as another cyclical recession like that of 1991-92, rather than as a ‘balance sheet recession’ of the kind that Irving Fisher wrote about in an Econometrica article in 1933.

In my efforts to overcome my ignorance about the characteristics of a balance sheet recession I have managed to find an ungated copy of Irving Fisher’s article. Fisher suggested that in ‘great booms and depressions’ … ‘the big bad actors are debt disturbances and price level disturbances’, with other factors playing a subordinate role.
Fisher argued that it is the combination of over-indebtedness and price deflation that causes the depression:
‘When over-indebtedness stands alone, that is, does not lead to a fall of prices, in other words, when its tendency to do so is counteracted by inflationary forces (whether by accident or design), the resulting "cycle" will be far milder and far more regular.
Likewise, when a deflation occurs from other than debt causes and without any great volume of debt, the resulting evils are much less. It is the combination of both—the debt disease coming first, then precipitating the dollar disease—which works the greatest havoc.’

Fisher suggested:
 ‘it is always economically possible to stop or prevent such a depression simply by reflating the price level up to the average level at which outstanding debts were contracted by existing debtors and assumed by existing creditors, and then maintaining that level unchanged’.

That seems to me to be similar to the rationale for the quantitative easing policies adopted by central banks in recent years, following the failure of fiscal stimulus efforts. Lars Christensen, a market monetarist, has written more extensively about this similarity on his blog.

John Greenwood’s analysis, conducted in the spirit of Irving Fisher, suggests that some balance sheet repair has occurred in recent years in the countries most affected by the GFC, with greater progress having been made in the US than in the UK and least progress having occurred in the eurozone. 

An article by Max Walsh in today’s Financial Review (July 18, 2013), entitled ‘Rudd’s demands could exceed all expectations’, is another excellent article about the implications of the economic policies of the first Rudd government. Walsh refers to Rudd’s essay in The Monthly (February 2009) in which he sought to differentiate the economic ideology of the two major political parties in Australia. As might be expected, Rudd sought to portray his political opponents as extreme proponents of free market ideology, but he also portrayed the Labor party as being wedded to interventionism.

Kevin Rudd wrote: ‘Labor, in the international tradition of social democracy, consistently argues for a central role for government in the regulation of markets and the provision of public goods’. Max Walsh comments: ‘That’s a view that looks to be at odds with the deregulation and privatisation initiatives of the Hawke-Keating years’.

Viewed in that context, it seems to me that the most likely outcome of Kevin Rudd’s recent promise to pursue microeconomic reform ‘with new urgency’ will be further restriction of economic freedom and lower productivity growth. 


Anonymous said...

Hello Winton

I enjoy reading the likes of John Stone and Janet A. And also Bob Ellis, Mike Carlton, and Andrew Bolt - to name a few others from both sides of the political debate. In past days I particularly enjoyed Alan Ramsey, mainly for the irascible spittle.

But while it is very interesting to engage with their facility with the language, I suspect that I am not alone in 'reading through' that facility, and deciding it is merely facile.

Kevin Rudd certainly is a 'failure' - we agree on that basic point, but possibly from differing definitions of his role? My take would be that he failed to get re-elected - nothing more. That was his primary role, impetus, whatever, and he was rolled by his own party before any chance at achieving that very basic proof of 'success'.

But anyway, back to the GFC: is there any commentary from any 'expert' you can suggest who is able to a) provide a detailed explanation as to the 'why's' of the GFC, and b) provide a supportable proof as to the almost certain success of significant alternative options which were available at short notice, at the time, in response to the GFC?

Because I've yet to find such person or commentary.


Anonymous said...

On the 'whys':

I keep coming back to the elimination of the clear distinction between the pirates and the ordinary people - as was attempted by the Glass-Steagall legislation.

I'm all in favour of commercial pirates - so long as they play with their own money. But when they are allowed to play with my money as well, it removes what Jim Belshaw might term 'elasticity of response'.

In other words it may possibly have been a little easier to watch some (or even all) of their boats sink if the rest of we poor souls weren't unwitting, unwilling passengers.


Winton Bates said...

Hello kvd

Kevin Rudd may well turn out to be highly successful again in terms of getting himself elected. He did it in 2007 by giving the impression that in all important respects his policies were the same as those of his opponents. He should not be allowed to get away with doing the same thing again.

Regarding the GFC, which should probably be called the great recession, I think Scott Sumner comes close to meeting both a) and b) in his article in the latest issue of 'Policy. I say only that he comes close because I think he claims too much when he implies that the banking crisis played no role. I will try to explain more in a subsequent post.

Unfortunately, Scott's article is gated, but his views are also availableon his blog.

I like the distinction you make between the pirates and the ordinary people. We have previously had a discussion about bankers. Similar considerations apply with respect to politicians. I feel very ordinary (ornery?) and an unwitting and unwilling passenger when it comes to judging the performance of the previous Rudd government. It was not until after Kevin wrote his infamous essay for the Monthly that I knew where he was leading us.

Winton Bates said...

kvd: By the way, if you decide to buy the Winter edition of 'Policy' you will get the bonus of being able to read my article entitled: 'Is Progress History?'

Anonymous said...

Thanks for the pointer to CIS Winton; I'll ring them after 9 to see if it is possible to get a copy of that edition because the topic does interest me. I will also wait with interest for any follow up post you might publish.

And I very much agree with your application of the pirates theory to politics!