Download Chapters in Economic Policy Lesson 1 Economic policy making

Chapters in Economic Policy
Lesson 1 Economic policy making: motives
and driving forces in practice. Discussion …
“Economics is haunted by more fallacies
than any other study known to man.”
Henry Hazlitt, Economics in One Lesson
Frédéric Bastiat
• “Everyone wants to live at the expense of the state. They forget that the
state lives at the expense of everyone.”
• "In the department of economy, an act, a habit, an institution, a law,
gives birth not only to an effect, but to a series of effects. Of these
effects, the first only is immediate; it manifests itself simultaneously with
its cause - it is seen. The others unfold in succession - they are not
seen: it is well for us, if they are foreseen.
Between a good and a bad economist this constitutes the whole
difference: the one takes account only of the visible effect; the other
takes account of both the effects which are seen and those which it is
necessary to foresee.
Now this difference is enormous, for it almost always happens that
when the immediate consequence is favourable, the ultimate
consequences are fatal, and the converse.
Hence it follows that the bad economist pursues a small present good,
which will be followed by a great evil to come, while the true economist
pursues a great good to come, at the risk of a small present evil"
Purpose of economic policies
• macroeconomic intervention: anti-cyclical, stabilisation
framework
• implementing government structural priorities
• geo-political priorities
• correcting market failures
• promoting political priorities (social welfare etc)
• combining, arbitrating or fine-tuning intervention
instruments, held by various stakeholders (government,
central bank, employers, trade-unions etc)
• protect market environment (as perceived by political
representation)
Conventional wisdom
• governments are there to intervene to stabilize
the economy
• governments are there to implement political
priorities
• governments are there to promote economic
growth
• governments are there to correct market failures
Assumptions
• As opposed to laissez-faire, economic policy is
by definition about interventionism
• There is a great number of variants of the scope
of intervention …
• … resulting in a more or less defensive or
proactive approach to exercising the policies
(intervention power)
Hazlitt: “Economics is haunted by more
fallacies than any other study known to
man… This is no accident…“
„ …The inherent difficulties of the subject would be great
enough in any case, but they are multiplied a thousand
fold by a factor that is insignificant in, say, physics,
mathematics or medicine - the special pleading of selfish
interests.“
↓
Whether we like it or not, economic policy decision making
is no different …
Framing the subject of economic
policies …
Of course, the face value of stated intentions matters … and yet:
• Economic policy is all about politics …
• No one is owner of the only and full truth (truth is a very subjective
and very political category)
• „There ain't no such thing as a free lunch“ (who said that?)
• There are no anonymous resources
• There are no magic boxes …
Framing the subject of economic
policies … ctd
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The world almost always behaves differently to wishes of politicians (and
expectations of analysts …)
The most important piece of information is available either late, or is often
overlooked or misinterpreted
Usually, traders will note the crucial information earlier than analysts,
analysts earlier than managers and managers earlier than politicians …
For some reason, misjudgements get to be particularly resilient …
Views evolve substantially over time …
Memories are surprisingly short …
Policy mistakes are often reproduced (past lessons are often ignored –
example: fiscal impulse to revitalize an economy is always paid hard by
future generation, yet, governments keep having recourse to it …)
The textbooks are right in stressing that the leading motive for policy
makers is to get re-elected …
Always do expect surprises …
The risks of wishful thinking are not to be ignored … ctd
Example: the Euro – hopes and reality
Yves Thibault de Silgy: „The Euro will provide a stable and sound
macroeconomic framework“
… and the euro was expected to provide a growth impulse, promote further
convergence inside the zone and to have a disciplining effect on economic
policies
Events since the euro introduction:
- Speculative bubble on IT and CT markets 1999-2000
- Economic recession (stagnation) 2001-2004, implying …
- An extreme loosening of ECB monetary policies …
- Followed by a real estate bubble and excess credit supply …
- Followed by a global financial and economic shock, implying ..
- Series of conventional and unconventional actions of ECB monetary
policies
- Followed by a debt crisis, threatening the very foundations of the Eurozone
- The convergence has taken place only to a limited extent (or not at all…)
Example: the Euro – hopes and reality …
questions
Questions:
- What were the benefits of the Eurozone creation, how were they distributed
over time and over countries and are they still there? What were the costs
and how were they distributed?
- How much of the past and current trouble was actually imported and how
much was fuelled by systemic (institutional) deficiencies of the Eurozone
itself?
- Has the Eurozone served as a protective shield or, rather, has it exposed
further the structural weaknesses of its members?
- Why is it that further convergence has not taken place?
- Can the Eurozone ever survive without a European fiscal union?
Framing further the subject of
economic policies …
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Economic policy decisions have no measurable alternatives: it is not
possible to measure something that has not taken place … examples
(following the euro case):
– what would be the economic performance in the EU of the Euro was not
introduced???
– What would happen to economies in 2008-2009 if fiscal stimulus was not
provided by governments?
– What would be our own situation in this country if we adopted the Euro in
2009(as expected at one stage…)
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While it might be (and, actually, it is) possible to measure the benefit of a
given decision to groups, sectors or interested parties, on the other hand it
is not possible to conclude that a benefit has been provided to all
Actually, speaking about the words „benefit to all“, it is not even clear what
„benefit“ truly means (ex: is GDP the right indicator?)
Framing further the subject of
economic policies …
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It would be illusory to believe that a „win win“ solution to all can always be
designed … in reality, it is more likely that the benefit of some will imply a
loss (cost) to others (from the temporal or sectoral point of view, or both)
„There ain't no such thing as a free lunch“
If „there ain´t no such thing as an objective truth“ then no solution/decision
in economic policy can objectively be the best …
… which is primarily about politics (classical example: left wing parties will
promote that the budget deficit is covered by increased taxes, while right
wing parties would rather prefer cutting budget expenditures
Experiments rarely work, or their results are misinterpreted
Miracle solutions happen only in fairy tales
Models are a very useful tool helping to frame and discipline thinking,
however, if overestimated, they may imply serious mistakes in economic
policy decision making …
Framing further the subject of
economic policies …
• the issue of different time horizons (government, central banks,
financial institutions, shareholders, consumers etc …)
• carrying over costs … (has been dealt with already earlier today)
• carrying over risks (let’s talk about the crisis and it’s underlying
factors…)
• the issue of information asymmetry (and uneven distribution and
delays in delivery)
• the issues of emotions vs. rationality
• rent seeking
• the power of expectations in economic life, their role in economic
policies
• the phenomenon of vested interests and hidden motives
• the phenomenon of a “drop in the sea”
Examples of policy tricks
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Claiming de facto the anonymous feature of the budget resources („this is
so important that is simply has to be paid by the state budget“) …
… or the public debt („our current public debt to GDP ratio is 43 %, so we
can afford to increase it since the Maastricht criterion is 60%“)
Pushing the problems away (example: the debate about European bonds)
Playing the game of inter-sectoral or inter-temporal distribution of costs of
policy decisions (higher taxes or lower expenditure or higher deficit)
Having recourse to old (and failed) solutions (printing money etc)
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Recent examples:
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– Taxing more financial institutions or distribution networks
– Increasing the deposit insurance coverage will cost nothing to taxpayers …
Possible implications of all that …
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Unintended and unexpected distortions to markets (solar energy …)
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Solving the current problems today we create new problems tomorrow (the
financial – economic – debt crisis …)
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Feeding corruption, erode credibility etc …
So far, we have described quite a pesimistic vision of
economic policies. However …
A balancing comment about the subject of
economic policies …
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Despite all the previous (and the fact that no government has ever found the
solution to all deficiencies of a market economy) …
… a market economy has no viable alternative, denying the market is not an
option … we know something about it in our country
Similarly, it is not a solution to take economic policies out of the hand of
politicians (a propos: to whom would it be given? Technocrats tend to be no
better …)
Examples for consideration 1
Scrappage schemes:
• Purpose: increase demand for new cars: provide growth incentive to
car industry
• Assumption: segment of economy with lots of multiplication effects,
large employer, get consumers go against the investment cycle
(induced by crisis)
• Description of scheme: subsidy from state budget paid on new car
purchases
• Who benefited: not only domestic, but also foreign car producers
• Who suffered the costs: all taxpayers
• Side effects: distortion to competitive environment, market signals
Question for discussion: was that a useful scheme? Discuss the
immediate effects, compared to systemic implications (costs).
Examples for consideration 2
Investment incentives:
• Purpose: promote investment, mostly (but not only) FDI, create jobs,
instrument of „industrial“ policy (may also be calibrated regionally,
sectorally …)
• Assumption: important to actively promote competitivity of economy,
use a lot by all countries
• Description of scheme: various incentives provided to investor over
a certain financial limit (tax holidays, subsidy to jobs created,
providing all necessary infrastructure such as road, railway
connection, water and electricity lines etc)
• Who benefits: all investors eligible by financial criterion
• Who suffers the costs: all taxpayers, non-eligible companies who
are at clear market disadvantage, incidentally mostly domestic.
• Side effects: to some extent it is a scheme killer of small domestic
enterprises, in addition it distorts the structural balance in economies
(Slovakia and Czechs excessively dependent on highly cyclical car
industry)
Question for discussion: is that a useful scheme? Discuss the
immediate effects, compared to systemic implications (costs).
Examples for consideration 3
Fiscal stimuli
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Purpose: compensate for output losses in crisis time
Assumption: governments should actively play the anticyclical card of fiscal
policies
Description of scheme: implemented either through automatic fiscal
stabilizers (what is that?) or discretionary fiscal policies, most often both, in
many ways quite similar to the previous two (actually both could be seen as
part of it)
Who benefits: may have short-term cascade effects on many segments of
economy
Who suffers the costs: all taxpayers (current – via deficit - and future – via
debt), private sector (crowding-out and cost effect of public deficit/debt on
private investment)
Side effects: over time loss of credibility of fiscal policy, implied increased
cost of borrowing and, most of all, future pro-cyclical feature of fiscal policy
= fiscal consolidation in times of stagnation/recession (as seen currently)
Question for discussion: is that a viable policy instrument? Discuss the
short-term effects as opposed to the medium and long term ones ….
Examples for consideration 4
School fees for university education
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Purpose: decrease the cost of university education to the state budget, other
(but disputed) arguments: provide incentives to school and students
Assumption (as officially stated): create a new financing stream to cover the
needs and to improve the quality of education, create increased cost pressure
on this segment of the educational system with the aim of increasing the
quality, distribute more evenly the costs of getting university grades (“those
who directly benefit should pay more”) – currently presumably distributed very
unfairly
Description of scheme: fees paid by students to cover a certain part (not all) of
the costs of the education, technically various options exist …
Who benefits: in the short run immediately taxpayers, in the longer run
(perhaps) the entire society and economy (= benefits of better skilled
population)
Who suffers the costs: students
Side effects: if not designed properly, may lead to various discriminatory
distortions in access to education
Question: what is your view of that? Do you find it fair to introduce school fees
or do you stick to the assumption that education should be kept “free” (knowing
however that “ there ain´t no such thing as a free lunch”
Examples for consideration 5
Deposit insurance schemes
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Purpose: protect the savings of depositors (currently up to 100 k euros equivalent) in
case of bankruptcy of financial institutions
Assumption: costs of bankruptcy should be primarily covered by shareholders,
depositors should get better treatment because of information asymmetry
Description of scheme: covers most of the deposit instruments as offered by banks and
other financial institutions
Who benefits: depositors
Who suffers the costs: all depositors of all institutions (contribution of institutions to the
Deposit Insurance Fund, calculated as proportion of the deposits they administer): cost
transferred to the depositors themselves via increased fees
Side effects: moral hazard: depositors less vigilant to the institutional risk, the chose
their institution solely by conditions on deposits it offers, also counterproductive on the
institution´s side (aggressive market practices in search of new deposit client, in limit
approaching the prudential principles)
Question: what is your view of that? Is it correct that institutions (governments or
Deposit Insurance Schemes) take away from customers/consumers (individuals) an
ever increasing share of market risk? Why should consumers not be allowed to assume
their part of risk?
Choice of issues for discussion
– Forex interventions by the central bank: when are they justified?
– Should monetary policies consider asset price development and how?
– How much (if at all) fiscal policy power should be taken away from governments
in case of fiscal trouble?
– Is a higher economic growth (higher GDP increase) a viable option to eliminate
the accumulated fiscal debt?
– How can a government support economic growth in a situation when the fiscal
instrument is no more available (as it was so far)?
– And, actually, should governments exercise growth policies at all? If not, what
functions for governments do we see in the future?
– When is a deficit of public budgets excessive, what are the criteria to evaluate it?
Actually, is a deficit of public budgets an acceptable notion at all?
– What needs to be done further to the pension systems (beyond what has been
introduced already) to make them sustainable in the long run?
– Optimal mix of fiscal reform elements (expenditure vs revenue)
– Is a fiscal union a solution to the Eurozone trouble?
– Is an early membership in the Eurozone still an option for us, given the structural
weaknesses of our economy? Are there still benefits to be in? How do they
compare to the benefits of remaining out?
– Co-ordination of fiscal policies was embodied in the SGP – why has it failed? And
is the current fiscal pact sufficient to keep deficits and debts under control
Putting things into historical perspective
• The world before Keynes
– Fluctuations of the economic cycle are an “ct of Providence”
– Government intervention is needed solely to ensure the basic state
functions (yet, state budget were often in deficit)
– There is no anti-cyclical fiscal policy
– Generally, lower government intervention in economy allows for
(significantly according to current standards) lower fiscal redistribution
(lower expenditure and less taxes – but higher custom fees because of
protectionist attitudes)
– Money supply linked to gold, prices are remarkably stable over the long
run
– Forex rates are derived from gold, there are no exchange rate
fluctuations, changes are decided administratively
– Interest rates reflect the true content of there are – price of money, they
are solely determined by the market as a result of demand and supply
for/of credit
– Central banks (as understood today) did not exist
Putting things into historical perspective
ctd
• The world according to Keynes …
– The government’s primary role is to ensure that
economic growth is stable. The government has the
right and the obligation to make use, for that
purpose, of both the fiscal and monetary policies
– In case of economic decline, the government can and
is supposed to increase spending (and run budget
deficits) to stimulate the economy …
– However, in case of the growth phase of the
economic cycle, governments must run a budget
surplus and repay debts, accumulated in the crisis
time
– The stability of domestic prices should get the priority
to the stability of foreign exchange rate
Putting things into historical perspective
ctd
- you may actually run a budget deficit almost
indefinitely, there are almost not limits to
government indebtedness
– the public debt can be eroded by higher
inflation (implying the need to have
government influence – explicit or hidden –
over central banks)
– loss of credibility of both fiscal and monetary
policies
Purpose of economic policies
• macroeconomic intervention: anti-cyclical, stabilisation
framework
• implementing of government structural priorities
• geo-political priorities
• correcting market failures
• promoting political priorities (social welfare etc)
• combining, arbitrating or fine-tuning intervention
instruments, held by various stakeholders (government,
central bank, employers, trade-unions etc)
• protect market environment (as perceived by political
representation)