Be Prudent in Good Economy; Be Daring in Bad Economy?
November 20th, 2008 by ALVIN SOONG
THE economics news may be getting worse. However, it is not expected of another Great Depression. In fact, we probably won’t see the unemployment rate match its post-Depression peak of 10.7 per cent, reached in 1982 according to economist Paul Krugman
Depression economics. like that of the 1930s in which the usual tools of economic policy - above all, the Federal Reserve’s ability to pump up the economy by cutting interest rates have lost their full effects. When depression economics prevails, the usual rules of economic policy no longer apply: Virtue becomes vice, caution is risky and prudence is folly.
In earlier occasions a cut in the federal funds and interest rate is thought to boost back the economy. This may no longer holds truth. With no possibility of further interest rate cuts, there’s nothing to stop the economy’s downward momentum. Rising unemployment will lead to further cuts in consumer spending. Weak consumer spending will lead to cutbacks in business investment plans. And the weakening economy will lead to more job cuts, provoking a further cycle of contraction.
To pull us out of this downward spiral, the federal government will have to provide economic stimulus in the form of higher spending and greater aid to those in distress.
In normal times, it’s good to worry about the budget deficit - and fiscal responsibility is a virtue Americans will need to relearn as soon as this crisis is past. When depression economics prevails, however, this virtue becomes a vice. Franklin D. Roosevelt’s premature attempt to balance the budget in 1937 almost destroyed the New Deal.
Another prejudice is the belief that policy should move cautiously. In normal times, this makes sense: You shouldn’t make big changes in policy until it’s clear they’re needed. Under current conditions, however, caution is risky, because big changes for the worse are already happening, and any delay in acting raises the chance of a deeper economic disaster. The policy response should be as well-crafted as possible, but time is of the essence.
Finally, in normal times modesty and prudence in policy goals are good things. Under current conditions, however, it’s much better to err on the side of doing too much than on the side of doing too little. The risk is overheated economy, leading to inflation - but the Federal Reserve can always head off that threat by raising interest rates. On the other hand, if the stimulus plan is too small there’s nothing the Fed can do to make up for the shortfall.
Indeed, Goldman Sachs predicts that the unemployment rate, currently at 6.5 per cent, will reach 8.5 per cent by the end of next year. The new Obama administration will offer a major stimulus package. The question according to the economist Paul is would the Obama Administration dare to propose something daring.
Summarised from Economics Column in Sat Straits Times 15th Nov
