As I’ve mentioned before, the drama of the financial crisis has tended to distract attention from the bigger long-term problem of climate change. But is there more than that? How will the crisis affect the economics of a response to climate change? I’ve been asked by GetUp to do a guest post on this.
Category: Economic policy
Quick take on fiscal stimulus package
I’ve been responding to quite a few media questions about the government’s fiscal stimulus package and I haven’t had time to formulate more than a dot-point response. So here goes
* The size of the package is about right and it makes sense to announce it now
* The help for pensioners and low-income households is well-targeted to meet both policy objectives and the need to bolster demand
* I’m less impressed by the increase in the First Homeowners grant. In the long run, this scheme has been part of the problem of high housing costs, not part of the solution. Maybe the government has information suggesting the possibility of a rapid collapse in the housing sector, in which case some sort of emergency stimulus might be necessary. But the medium term direction of house prices has to be down
I don’t think that differs much from the par response from economists, but I’d be interested in readers’ thoughts
Update 19/10More on this from Tristan Ewins
Krugman wins Economics Nobel
Paul Krugman has been awarded the 2008 Nobel prize for economics[1]. The rules of the prize, honoured more in the breach than in the observance in economics, say that it is supposed to be given for a specific discovery, and Krugman is cited for his groundbreaking work in the economics of location done from the late 1970s to the early 1990s.
The reality, though, is that economics prizes are awarded for careers. Krugman’s early work put him on the list of likely Nobelists, but his career took an unusual turn around the time of the 2000 election campaign. While he has still been active in academic research, Krugman’s career for the last eight years or more has been dominated by his struggle (initially a very lonely one) against the lies of the Bush Administration, its supporters and enablers. Undoubtedly, the award of the prize in this of all years, reflects an appreciation of this work on behalf of truth in economics and politics more generally.[2]
The crew at Crooked Timber, of which I’m part, have a more parochial reason for cheering this outcome. Paul has generously agreed to take a part in a CT seminar on the work of Charles Stross, which should be published in the next month or so. Without giving too much away, there are some Nobel-related insights in his contribution.
fn1. Strictly speaking, the Bank of Sweden prize in Economic Sciences in honour of Alfred Nobel, or something like that.
fn2. Doubtless, Republicans will complain about being implicitly identified, yet again, as enemies of science and of truth. But they’ve made their bed and must lie in it (in both senses of the word).
The fiscal policy response to the crisis
With the effective nationalisation of the banking system now accepted as necessary (Australia’s comprehensive guarantees amount to public assumption of the risks of ownership, and hopefully the fees to be paid by the banks will reflect this) attention has turned to the role of fiscal policy.
Getting fiscal policy right involves a delicate balancing act. On the one hand, there is the short-term need for stimulus. On the other hand, the combination of a large stimulus and a bailout/nationalisation package imply big deficits, which will have to be recouped in the future.
In the Australian context, the Opposition is calling for an immediate pension increase and the bringing forward of the next stage of tax cuts. That’s a plausible line, although other opportunities for stimulus through public expenditure need to be explored. But the obvious, though unstated, quid pro quo is that the ‘aspirational’ tax cuts proposed for the next Parliament should be taken off the table. It will take a long time to restore the budget balance after the kind of stimulus that is needed here.
Now we're getting somewhere
The British government has abandoned proposals for non-voting preference shares and is moving towards full-scale nationalisation of the banking sector. According to the London Times(h/t Felix Salmon) the latest proposals would leave the government owning 70 per cent of Royal Bank of Scotland and 50 per cent of Halifax. The London stockmarket is likely to be closed, and it seems unlikely that many banks will remain private by the time it reopens. Presumably, with Morgan Stanley and Goldman Sachs in deep strife, the US can’t be far behind, though Paulson is still talking nonsense about non-voting shares. Still, it’s only three weeks ago that he was opposing any kind of public equity, and only six weeks ago that he was claiming that there were no real problems.
As the Times says, no-one knows how much toxic sludge will turn up when the government finally gets access to the books, but it seems unlikely that most governments will be overwhelmed in the way that Iceland has been. The capacity of developed-country governments to raise additional revenue is huge, easily enough to cover trillions in bad debt over a few years. So, once the sector is nationalised it should be possible to get lending flowing again. And, the prospects for an orderly shutdown of the massively overgrown markets for derivatives like credit default swaps suddenly seem a lot better.
All that is solid melts into air
My piece in Thursday’s Fin caused a modest stir by quoting Karl Marx, offset to some extent by an allusion to Schumpeter. It’s mainly about how to finance infrastructure investment, given that the PPP model looks to be off the table for some years to come.
A bit more on deposit guarantees
I worked a bit more on deposit guarantees and the resulting note is over the fold.
There’s also more from Joshua Gans, Peter Martin and Armagnac’d.
A bad move
The Rudd government has made its first big mistake in handling the financial crisis. The just-announced proposal to guarantee bank accounts up to $20 000 is worse than useless. Given that lots of people hold more than $20 000 in individual bank accounts, they have an obvious incentive to diversify, which means large scale withdrawals. The possibility of this turning into a run is far from remote. Turnbull’s suggestion of $100 000 is better, but the only serious option is an unlimited guarantee.
Update Some good news on this. Once we have a guarantee of $100K or more in place, the extra liability associated with an unlimited guarantee will be modest, while the gain in simplicity will be substantial, and the argument for exercising direct control over bank lending will be unanswerable. Of course, as a colleague pointed out in the course of email discussions on this point, the real problem is the banks’ reliance on overseas borrowing. I’ll be discussing some proposals on this before too long I hope.
State capitalism on the instalment plan
With the financial meltdown accelerating in the wake of the US bailout, and the recognition that many more failing banks will have to be nationalized, the British government is moving to get ahead of the game by offering equity injections across the board. But already this seems inadequate. Now that the taboo on nationalization has been broken, wouldn’t it make better sense to for the UK (and others) to nationalize the whole sector? With full control, governments could then ensure the resumption of interbank lending at least among their own banks. This would provide a feasible basis for co-operative moves to re-establish international markets.
For this week at least, such an idea is beyond the range of political acceptability. But it’s striking to look back a month and realise that in that period the US government has become the main mortgage lender, the guarantor of the short term money market, the effective owner of the world’s largest insurance company, the potential future owner of much of the banking sector and now the purchaser of last resort for commercial paper. Since the reluctance of banks to buy commercial paper must reflect a significant probability of default, it seems inevitable that some of this commercial paper will end up being converted into claims on the assets of defaulting issuers, extending the scope of nationalisation beyond the finance sector and into business in general.
This kind of instalment-plan nationalisation seems to offer the worst of all worlds. At some point, a more systematic approach will have to be adopted, and given the rate at which markets are plummeting, the sooner that point comes the better. This isn’t the return of socialism, but it certainly looks like the end of the kind of financial capitalism that has prevailed for the last few decades.
The decline of the dollar
So many bizarre things are happening in global financial markets that it’s impossible even to keep up with the critical events (today for example, more European countries guarantee deposits, 1 per cent cut in interest rates, US Fed starts buying commercial paper), so I’ll focus on one thing that has struck me. A few months ago, the Australian dollar was close to parity with the US. Since then it’s become apparent that the US financial sector is essentially insolvent, and that the US government is relying on the printing press to meet its obligations, while, by any reasonable standard of comparison, the Australian economy looks remarkably sound. So, in their infinite wisdom the financial markets have sold off the Australian dollar (as of today, it’s worth about $US0.72).
In the current environment, a big devaluation is probably beneficial for the Australian economy. It more than offsets the decline in ($US-denominated) commodity prices we’ve seen so far.
Still, on any reasonable assessment, the movement in the market exchange rate is plain crazy. At this point, the claim (essential to the efficienct markets hypothesis) that market-determined asset prices represent the best available estimate of future values, and therefore that capital markets are the best available method of allocating scarce resources for investment can only be sustained on the basis of the kind of dogmatic belief that asserts that humans and dinosaurs shared the earth 6000 years ago.
John Quiggin 