Economic policy is based on a collection of half-truths. The nature of these half-truths changes occasionally. Economics as a scholarly discipline consists in periodic rediscovery and refinement of old half-truths. Little progress has been made in the past century or so in understanding how economic policy, rules, legislation and regulation influence economic fluctuations, financial stability, growth, poverty or inequality. We know that a few extreme approaches that have been tried yielding lousy results—central planning, self-regulating financial markets—but we don’t know much that is constructive beyond that.

The main uses of economics as a scholarly discipline are, therefore, negative or destructive—pointing out that certain things don’t make sense and won’t deliver the promised results (source:, 5 January 2009).

Just last week, he had written a note (“What more can central banks do to stimulate the economy", 9 May) making the case for central banks in the US and in the UK to engage in much bolder quantitative easing, taking a leaf out of the book of the European Central Bank (ECB). He had asked them to consider dropping money from the helicopter, as it were.

The immediate provocation for this piece of advice is not clear. After all, the economies of the US, the UK and the euro zone are not suffering from any imminent threat of deflation. Nonetheless, it is clear that he thinks that his advice is exempt from the injunctions he had raised on the usefulness of economics. He and his co-author assert that “a modern central bank can deliver price stability with any size balance sheet." Brave and deterministic words—something that an economist should guard against. Evidently, Buiter has dropped his guard.

The urge for policy interventions to restore economic growth is based on the following premises: (a) Economic growth is paramount for any economy—mature, aging and developing; (b) that most Western economies currently operate below their potential and, hence, there is scope to boost economic output without triggering inflation; and (c) policy intervention can bring (b) about. In turn (c) is based on the belief that humans have an answer to all the problems and that it is both their right and obligation to find their own answers, instead of letting natural forces do their repair work, keeping their intervention to the minimum.

Any estimate of potential output is imprecise. It is at best a moving target and at worst, it is misleading and incorrect. Estimates of potential output in the West fail to take into account the state of their economies and the current availability of resources such as water, air and energy. Therefore, the extent of economic slack available is often overestimated, rendering policy interventions ineffective as to growth and too successful as to inflation.

Over the weekend, The Wall Street Journal, reckoned that the economy in Hong Kong faces the risk of stagflation. Much the same can be said of the two large economies in Asia—China and India. Stagflation is not strictly economic contraction. We are referring to a substantial slowdown in growth accompanies by persistently high (actual) inflation. In the West, the outcome is more in conformity with textbook definition of stagflation: very low economic growth or contraction accompanied by inflation outcomes that are well above the comfort levels of policymakers.

Revelations of losses at JPMorgan on some hedging strategies they adopted are further proof, if they were ever needed, that hubris and complacency eventually and invariably end in disasters. Yet, our faith in our ability to solve economic problems is touchingly enduring.

There are rumours that Germany is prepared to tolerate higher inflation as a price to pay for preserving the single currency and broader European unity. If so, the green signal from Germany would prompt ECB to drop its policy rate to zero and engage in more aggressive long-term refinancing operations. In these circumstances, if the Federal Reserve and the Bank of England oblige Buiter on quantitative easing, they will cement stagflation globally.

That some asset managers are even willing to consider the German abandonment of adherence to low inflation as a bullish sign for asset prices suggests that delusions have become global and that the global financial industry is beyond the pale of reason. Only a wholesale destruction of the status quo can pave the way for lasting financial and economic stability. One good thing is that Buiter’s recommendations and hubris-laced losses would deliver precisely that outcome.

V. Anantha Nageswaran is a senior economist with Asianomics. These are his personal views. Comments are welcome at

Also Read |V. Anantha Nageswaran’s earlier columns

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