Chief investment officer of SBI Funds Management Navneet Munot crowned John Maynard Keynes the man of the year for 2009. Professor and columnist Arvind Subramanian wrote in the Financial Times (FT) that the discipline of economics had vindicated itself by the way it had helped policymakers avoid an economic depression in 2009 and that it was atonement for its failure to anticipate the crisis of 2008. He pointed to the massive monetary and fiscal stimuli, avoidance of beggar-thy-neighbour trade policies and competitive devaluations, and so on. To a large extent, the stimulus packages were based on Keynesian teachings. So, Munot gets indirect support from him for his choice.
However, it is possible that Subramanian spoke too early. After all, only one year has passed since the crisis and we do not know the relevant time frame that needs to elapse before one can declare the patient cured and the doctor praised. To be fair, Subramanian acknowledges these risks.
Further, if one examined carefully, both the monetary and the fiscal stimulus measures were clearly based on the determination to avoid the “errors” of the 1930s. It has been judged that the errors of the 1930s were inadequate monetary and fiscal stimuli and/or their premature withdrawal.
Therefore, in a sense, policymakers have set policy for the 1929-32 depression by avoiding the “errors” committed then. I deliberately put “errors” within inverted commas because we still do not know if they were errors and how such a judgement could be arrived at. For example, we do not know if the boom of 1945-65 would have been possible but for the relative austerity of the 1930s. We do not know the consequences that a large stimulus could have unleashed then and could still be unleashed now.
In other words, without running counterfactual scenarios, how can one be sure? That is why the field is polemical. At the same time, that is why the subject calls for a lot of humility from its practitioners. But it is not clear that the crisis has instilled humility. To that extent, it is too early to suggest that the field of economics is vindicated or that economists be exonerated.
It appears that professionals and policymakers are set to repeat the behaviour of the recent past that caused the crisis. Not that they are willing offenders, but they are prisoners of their intellectual training, past experience and the fear of consequences of unshackling themselves from both. John Cassidy writes in FT that Ben Bernanke’s remarks at the American Economic Association conference showed no inkling of admission (let alone remorse) of the Fed’s role in inflating bubbles. He is calling upon the Fed to abandon its commitment to exceptionally low rates for an extended period. There is little chance that it would happen.
One thing that stood out in the December non-farm payroll report for the US was the speed with which the number of long-term unemployed (27 weeks and over) had shot up from five million to six million in the space of the last four months. Second, a recent entry in Macro Man blog has a chart of the difference between the federal funds rate and the nominal gross domestic product (GDP) growth rate and the one-year ahead inflation rate (actually, the deviation of the inflation rate from the trend). Whenever the nominal federal funds rate has been higher than the nominal GDP growth rate, as is the case now, the inflation rate has fallen below trend in the?following 12 months.
So, the federal funds rate would stay on hold for an extended period and one of the risks for global financial markets routinely mentioned by economists is the risk of premature tightening. I remember hearing the same refrain back in 2003. We all know what happened subsequently.
In the recent monetary policy meeting of the Bank of Korea, a representative of the ministry of finance sat in and ensured that the interest rate was not increased from the current 2%. It might be the right decision but the manner in which it was arrived at does not inspire confidence. Policymakers in Asia, too—even while being critical of the West—might be about to assign a higher weight to short-term and narrow considerations in setting monetary policy while ignoring the systemic considerations of nascent bubbles.
Investment recommendations have, consequently, become harder to make although it is normal to expect one at the beginning of the year. Many have fallen back on the worn-out thesis of calling for differentiated preferences for specific countries, sectors, stocks and bonds. In truth, they are easily identified ex post rather than ex ante. Furthermore, in today’s world of correlated risky assets, such an investment strategy recommendation smacks more of intellectual convenience than intellectual honesty.
Most economists and strategists concede that the year would be challenging but less dramatic than the last two. That is one forecast we could verify in January 2011.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at firstname.lastname@example.org