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'There are no magic bullets or simple formulae for dealing with financial
panics." So concludes Liaquat Ahamed in Lords of Finance, his recently
published analysis of the financial panic and economic collapse that
characterized the Great Depression. It's advice our own parliamentarians
might well heed as they meet next week to consider the federal budget and
stimulus package.
Many of our politicians, economists and editorialists are also in the grip of a
widely accepted conviction - the idea that "stimulative deficits" incurred by
governments are the magic bullets to slay the recessionary dragon. Public
opinion also supports this view, since no other alternatives are talked about
or offered.
In the 1920s and 1930s, it was John Maynard Keynes - the "premier gadfly of
economic orthodoxy," as Mr. Ahamed describes him - who challenged the old
gold standard orthodoxy. Keynes called for a new paradigm: the idea that
governments should run deficits when the economy is slow and surpluses
when times are good.
Politicians loved the first part of this thesis (while ignoring the second part)
because it provided an intellectual justification for doing what they liked best
- spending other people's money, much of it borrowed, in vast amounts. It
thus became the new conventional wisdom, leading to a vast increase in
government activity, public debt and taxes until eventually challenged by
new economic gadflies - such as Milton Friedman, who argued that excessive
government growth and spending should be constrained, that taxes should
be lowered, that we should look more to markets than governments for
economic growth and stability. Until very recently, this conservative
orthodoxy prevailed over much of the Western world. But with faith badly
shaken by the recent financial meltdown, we are now back to - guess what? -
a revival of faith in stimulative spending as the best answer to our economic
woes.
Do we not need a new and better paradigm for dealing with our economic
downturn? One that moves beyond either/or choices and toward both/and
solutions? Both governments and markets have enormously important roles
to play. In responding to this downturn, shouldn't the great imperative be to
find the right relationships and balance between them?
A year from now, when the limits to what can be achieved through deficit
spending have become more apparent, the search will begin in earnest for a
new, better paradigm. How much better would it be if we were to begin that
search now?