Monday, 22 June 2009

The seven principles of good economic management

There is an old adage that no one seriously argues whether two plus two equals four. In contrast, the more dubious the argument, the more violent the discussion.

For many years, economics had a solid repository of reasonably uncontentious claims. In terms of macroeconomic management, these claims could be summarized in seven straightforward principles:

1. We cannot inflate our way out of a recession.

2. Faster monetary growth leads to higher inflation.

3. Large fiscal deficits mean higher government borrowing, which pushes up interest rates, and discourages private sector investment.

4. A large public sector debt stock imposes huge interest rate costs on the taxpayer, and limits socially important public expenditure such as health and education.

5. Banks will always sacrifice liquidity for higher profitability and therefore must be closely regulated.

6. Negative interest rates discourage savings, reduce investment, and constrain long-term economic growth.

7. State guarantees on loans encourage banks to take excessive risks and generates moral hazard.

Although these principles didn't quite have the reliability of arithmetic, they did a decent job at ensuring economic staiblity. Before the crisis, economists did not debate the validity of these principles. Nor, for that matter, did the government or the Bank of England.

From the moment Gordon Brown became Chancellor he talked about fiscal prudence and the need to limit large government deficits. Countless speeches from members of the monetary policy committee warned against the dangers of allowing inflation to run out of control and how sound monetary policy was the key to a stable economy.

Today, the UK government and the Bank of England have abandoned sound macroeconomic management. Instead of following these seven tried and tested principles, Brown, Darling and King have a new guide for policy. Simply stated, credit is the lifeblood of the economy and it must be sustained at all costs.

However, credit is just another word for debt, which has to be repaid. If the solution is more indebtedness today, then we must expect more misery in the future.

It is time to return to what works; it is time to rein in the deficit, limit the growth of the money supply, and ensure that interest rates are positive. It is time to stop state intervention in the financial system, and cut out the guarantees and implicit subsidies.

It is time to return to orthodoxy and put an end to experimentation.


RF said...

At last, the truth is spelt out.

Anonymous said...

AC: "Simply stated, credit is the lifeblood of the economy and it must be sustained at all costs."

Yes, but are they succeeding? I think not. Which is why I agree with Mish, deflation is a very real possibility.

Mitch said...

Its time to kick these failed lectures and useless lawyers out and start fixing the UK.
None of them understand wealth and money because they have never really created any.

Mark Wadsworth said...

That's a good set of ground rules.

gaspachio said...

You can inflate your way out of a recession, as long as you are prepared to spend devalued money afterward. This is how every recession was fixed last century, and why fifty years ago you could buy candy bars for 2p

DBC Reed said...

How does quantitative easing create debt?It looks like the government creation of money out of thin air(what the banks do) but minus the requirement to pay interest.Maybe wrong .

Inchirieri apartamente said...

A very good article.Like it!

boiling frog said...

Excellent! You must stand for Parliament any party you like, against almost any venal incumbent you will do well.

DBC Reed said...

The question remains (unanawered) : How does quantitative easing create debt?