Monday, February 2, 2009

Limits of macroeconomic policy making?

In the ongoing Blanchard Roundtable debate in Free Exchange on what is to be done to get out of the deepening crisis, the IMF Chief Economist Olivier Blanchard has little to enlighten us about the way ahead, beyond the much discussed and by now obvious. It appears more a pamphlet of hope than an actionable policy advise about the way ahead, by the professionally competent head of one of the premier institutions that ought to be showing us the way out of this deep crisis.

Unfortunate as it sounds, after reading reams of analysis of the ongoing financial and economic crisis, I cannot but get a distinct sense of helplessness, even hopelessness, about our present predicament. The fundamental challenge of minimizing uncertainty and dispelling fears, so as to get investors, consumers, and businesses resume their normal economic activities, appears unsurmountable for objective policy making. The prescriptions have ranged from conventional "fiscal and monetary responses", "contingent" and "co-ordinated" policies, to abstract psychology involving "animal spirits" and "confidence multipliers", to the vain and forlorn hope of "placebo stimulus", and finally to the confused and wishful thinking of a "portfolio of policies". It almost seems clear that there cannot be any certainty associated with specific policies nor prioritization among them.

My arguement is not a case against implementing the commonly cited fiscal, monetary and financial measures, some or all of which will ultimately have to play the critical roles, for hindsight to discover, in the final resolution of the crisis. Nor is it a criticism of each or all of these fiscal or monetary policy responses. It is only a prima facie acknowledgement of the apparent helplessness of macroeconomic policy making at this point of time. Consider these.

How do we turn zombie banks to real banks, so as to resume lending activity with some semblance of normalcy? Everybody realizes that fundamental to this is addressing the issue of "distressed assets". But this poses clearly unsurmountable challenges - which are these assets, what is their total value, and how do we value them? Valuing them at the fair market prices, virtually worthless and in some cases zero, will only exacerbate the crisis, by wiping out these banks. Valuing them at their book values will only be handing over largesse to shareholders at tax payers expense. There is nothing settled or certain about the success of any of the standard monetary policy and "quantitative easing" prescriptions in vogue - lowering rates, recapitalization, dilution of collateral standard requirements, deposit insurance, comprehensive insurance backstop, purchases of troubled assets, ring-fencing into "bad banks" etc.

How do we get consumers to start spending and businesses to continue/start investing? All the debate about the respective merits of fiscal expansion and monetary easing, and tax cuts and government spending, have yielded little by way of concrete and certain prescriptions, and ironically enough may have left consumers and businesses even more confused and uncertain. Tax cuts may end up being saved or used to pay off debts, whereas government spending may take time to become operational, and both carry equal risks of pork and waste. And if government borrows beyond sustainable limits (and what is that?), the "Ricardian equivalence" could kick-in, forcing consumers and businesses to pull back.

With no certainty about whether specific policies will have any impact, leave alone consensus about them or larger policy plans, economists are left prescribing throwing everything available at the problem and then hoping that some miracle happens to get us out of this mess! Distinguished economists are left advocating universal truths like "too much rather than too little", "better early than late", "forget the future, think about the present", and "removing tail risks", all in the vain hope that something or the other will strike and help us out.

As Mark Thoma writes, the "uncertainty about the sources of the problems, and about which remedies will be effective, means we should do the equivalent of throwing a full spectrum antibiotic at the problems and hope this somehow manages to work", but also hope that this in turn does not trigger off any self-fulfilling policy pessimism that entraps all economic agents. A case of confusion leading to more confusion and uncertainty, further exacerbating a perilous situation and pushing us even deeper into the crisis and and further down the recovery slope!

The punchline comes from a post by Paul Krugman about the Obama administration's apparent policy on bank rescues - buy up only the written down troubled assets and offer a guarantee protecting the banks against large losses on the remaining (Geithner put!)

"This might — might — work out OK, just as the FDIC put of the early 90s did (with the S&L crisis). But let’s be clear what this is: it is lemon socialism, pure and simple: socialized losses, privatized profits. Is this really the best we can do?"

Yes, unfortunately, it appears so! A humbling experience indeed!

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