Listener 19 December 1999.

Keywords: Macroeconomics & Money;

There will be frequent reference next year, to repeating the “fin de siecle”, a movement of decadence at the end of the nineteenth century. However the economic end of an era may be this year. If so, it will be identified with the Russian financial crisis of August 1998. This is not because of the size of the economy, but rather numerous financial institutions were heavily exposed to Russian debt. Some were highly “leveraged”, with a high debt to equity ratio, and are very vulnerable. One hedge fund had a liquidity crisis, others have taken a terrible financial pounding.

Interesting, the conventional wisdom (outside the region) is that the East Asian financial crisis which began in 1997 could be quarantined from the rest of the world economy. That may not be the judgement of hindsight. However the more recent difficulties have focused thinking upon the decadence of the speculative financial markets.

In his Auckland University lectures, Paul Krugman observed that when things were going well, economists had no special claims to insight. Anyone can project a continuation of the current situation. It is when the turn around occurs that economists come into their own, although Krugman modestly remarked that their analysis can prove helpful even if it was probably wrong. We seem to be at one of those turning points. The unsayable – even the unthinkable – can now be said. Increasingly people, who the conventional wisdom respected, are wondering out loud whether it is in the best interests of the world economy for the international financial sector to be uncontrolled. (The harder question is how to control it.) Economic analyses, previously unmentionable in the financial pages, are now appearing. Even “Keynes” is there, sometimes followed by the explanation that monetarism applied to inflation: keynesianism to depression. The implication is the world economy is in a long run depression phase.

This misrepresents economics. Among professionals Keynesianism never went out of fashion, with an enormous effort put into making its foundations more rigorous. The Reserve Bank was monetarist in the rigorous sense for less than 12 months if at all, and had ventured down that path after it had been abandoned by most of the world’s major reserve banks. Instead they used a bastard version of Keynesian, which the public called “monetarism”.

All very confusing. My point is that what was (and is) going on among serious economists is frequently misrepresented by media pundits who, with financial analysts, latched onto monetarism because it was so easy to expound, rather than because it was right.

So any apparent Keynesian revival is a media event, rather than an academic turning point. But it reflects a growing lack of confidence in the financial sector. This is where New Zealand ought to have led the world, for the world financial crisis has strong parallel with the mess we got ourselves into in 1987. (Except that the world does not have a bigger economy to coddle it through.) We even had “dragon slaying”, a Chinese expression for technically brilliant skills which had have little practical use. It was easy to claim usefulness for the high powered mathematics that some financial institutions sold to investors when things were going well. Back in 1987 a well known then (now long forgotten) firm offered investment advice based on sophisticated mathematical models, and obtained consultancy contracts as a tie-in (much to the chagrin of its competitors). The firm crashed with the rest of them. Its investment advice was not much help to itself.

We have claimed to lead the world, but too frequently New Zealand has been behind the fashion. Which is why it is so important to scrutinize worldly fashions: they will soon be here too. As the world lost confidence in the economic nostrums of the last twenty years, we follow and suddenly there is the realisation – evident to the dispassionate observer for a decade – that the local economy has been doing dreadfully. Now even the conventional wisdom is beginning to say it. That represents an end of an era