Auusterity or Keynesian Stimulus? Or …?

Australia’s GDP figures for the March quarter show an increase of 2.3% seasonally adjusted over the past year, a slightly lower rate than the budget forecasts for this and next financial years. It also continues to be lower than the so-called long term trend rate of just over 3% pa. Although exports (up 8%) saved the day, any lift in the current GDP rate of growth will seemingly require policy changes that lift the confidence of businesses and consumers.

The same applies to almost all western countries, which continue to experience sluggish growth.  The recession in OECD countries brought a fall in GDP of 3.4% in 2009 (Australia’s rose by 1.6%) and was followed by an increase of 3.0% ie taking those two years together there was still negative growth in OECD countries.

Further, the pre-recession sluggishness in growth then returned, with growth averaging 1.9% from 2009-15(est) compared to 2.2%  from 2000-08. This occurred despite the major reduction in official interest rates and the return to budget deficits (using “underlying balances” as published by the OECD)  at levels similar to those which occurred prior to the recession. The budget deficits averaged around 3% of GDP in the three years to 2015 est, similar to those in the three years to 2007.

What went wrong?

Last Friday The Australian published a front page lead reporting an address at a World Business Forum in Sydney by former chair of the US Federal Reserve, Ben Bernanke, defending the extent of the lowering of official interest rates by the Fed. Bernanke claimed that interest rates would have been higher, but with the same economic growth, if the major economic countries had adopted a more expansionary fiscal policy. On 29 May the Financial Review also published an exchange between Professors Niall Ferguson and Robert Skidelsky (who has written a 3 volume biography on Keynes) on whether the deficit reduction policies adopted in the UK since 2009 have increased or reduced economic growth. You can read both these article here.

Strangely, there has been no subsequent substantive public comment on this pro and anti Keynesianism. Yet it is surprising that a former US Federal Reserve chairman thinks even higher budget deficits would have been appropriate in the period since the 2009 recession. These deficits were very large in the 2009-2012 period (6-7 per cent of GDP) and, as noted above, they have recently been similar (relative to GDP) to what they were prior to 2009.

In Keynesian thinking fiscal policy would doubtless be regarded as “very contractionary” if one simply compares the most recent period with the 2009-12 one. But the failure of that “stimulus” to lift OECD growth even to pre-recession rates in the period from 2009 to the present suggests such thinking was not appropriate.

It is regrettable also that a senior ex-central banker appears to have overlooked that government debt levels, from earlier attempted “stimulus” policies, were already high. If major countries go further down the debt track (they are already at more than 100 per cent of GDP) the chances of another recession increase. The solution is to reduce the role of government and increase the opportunities for private enterprises.

My letter below, published in today’s AFR, focuses on the two entirely different explanations offered by Ferguson and Skidelsky of growth in the UK. My conclusion is that Skidelsky does not justify his support for larger budget deficits in the UK since 2009 (in fact they remained high, with the 2015 estimate at 4.9% of GDP). And the same applies to Bernanke’s support for higher deficits more generally (is he looking for an explanation of the failure of monetary policy?). As I suggest in my letter, the “solution” to sluggish growth may be reduced government intervention – such as workplace relations, environmental regulations and budgetary expenditure itself.