So what does the end of the Washington Consensus mean for economic policy?
Firstly, borne out of the Great recession, there are no certainties – including whether the recession is yet over or, as increasing numbers of pundits from Krugman and Stiglitz on down are warning, we are in for a further deflationary spiral.
Assuming no immediate major further meltdowns, we can probably draw some interim conclusions.
First, stable inflation will continue to matter, but should not be the only policy target. It follows that monetary policy cannot rest on one tool, the OCR. The number of tools should always exceed the number of targets.
The OCR is a poor tool to target excess risk taking or asset bubbles. IMF Chief Economist Blanchard recommends combining monetary and regulatory policy, such as countercyclical liquidity and prudential ratios, and directly targeting problem sectors such as housing.
If this sounds familiar, no wonder. The Governor of our own Reserve Bank has been quietly moving towards this in line with the other G20 central banks. Isn’t it ironic that in New Zealand the only institution really defending the old status quo is the Beehive.
Second, realistic stable exchange rates are crucial to small, open, trading economies. This is what our export sector has been saying for years. Now the IMF recommends central banks use reserve accumulation and sterilised intervention to do just that. Labour has pledged to investigate reasonable means to help reduce the volatility of the NZ dollar, one of the most outrageously over-traded currencies on the planet.
Third, when investors desert key markets, the case for publicly supplied finance (liquidity provision) can be compelling. However that implies that there is monetary and/or fiscal headroom available to offset a major recession (not necessarily true of some of the major western economies, worryingly).
It also implies that once recovery is firmly in place stimulus can be eased off in a way that is scially and economically sustainable. Arguably Cameron’s Tory Budget violates that principle with slash and burn polices that could tip the UK back into recession, and even deflation.
Finally, Blanchard recommends counter-cyclical fiscal policy, augmented where appropriate by automatic fiscal stabilisers such as cyclical investment tax credits or enhanced transfers to low-income households.
Counter-cyclical fiscal settings are not new to us and were used successfully under the last Labour Government (which reduced net debt to zero alongside full employment). But automating that process would require careful thought. One option used in other small open economies like Singapore is a countercyclical savings policy.
This is all food for thought. It is high time for our government started thinking. But increasingly New Zealanders are looking for fresh ideas in the absence of a Beehive that seems capable of new thinking.
In Part 3 I will point to some of the areas, post Budget 2010, where Labour believes a new emphasis is needed.