The Wizards of Oz

For months I have been arguing that if only the Fed had pumped enough money into the economy to keep expected NGDP growth at around 5%, then we would be back where we were in mid-2008. As you may recall, in mid-2008 we had already had nearly 2 years of orderly contraction of the housing industry. Because growth in other sectors took up the slack, unemployment remained in the mid-5% range, only slightly above the normal rate. So we weren’t doing that bad. Then the Fed adopted a highly contractionary monetary policy (see Hetzel’s discussion of what they did wrong) and NGDP starting falling fast. And now we have 9.4% unemployment, and a mind-bogglingly large fiscal deficit as the government futilely tries to stop the recession with deficit spending.

Little did I know that there was a country that followed a policy similar to the one I advocated. No, not Britain, which was a model cited by Krugman in recent post. Britain has done a bit better than the eurozone, but they are still doing poorly in an absolute sense. No, I’m thinking of a much more successful country.

Imagine a continental-sized country populated by English-speaking people, with a highly diversified economy of manufacturing, services, mining, and agriculture. Imagine a country full of recent immigrants from all over the world. Imagine a country that typically runs “unsustainable” current account deficits of about 5% of GDP, year after year, decade after decade. Imagine a democratic political system and a free market economy where the government’s share of GDP is about the same as in the US. In fact, a country as similar to the US as you are likely to find anywhere in the world.

And while we are channeling John Lennon;

Imagine there’s no business cycle,

It’s easy if you try . . .

A commenter named Lorenzo sent me some data from the Australian Bureau of Statistics. He said that since 1992 the year over year NGDP growth rate has never fallen below 4%. If I am not mistaken, the most recent figures (ending March 2009) show 4.4% NGDP growth. Given that Australia relies heavily on commodity exports, and given that commodity prices collapsed late last year, it is no surprise that Australia has not completely escaped fallout from the worldwide slump. Unemployment edged up to 5.8% in June (wouldn’t we love to have that rate) and real growth has slowed. But the current view is that they will fall just short of a technical recession, getting by with a modest slowdown. Not bad for the worst worldwide economic crisis since the 1930s.

Yes, I know that Australia is called “the lucky country.” But ask yourself this; if it was just luck how did they also sail through the 2001-02 recession almost unscathed? My answer is that they kept NGDP growing at a fairly steady rate in 2001 and 2002.

Sometimes when I debate Austrian commenters they tell me that if we merely tried to paper over our problems by printing enough money to keep NGDP growing about 5% per year, then we would just create an even bigger bubble and a bigger future collapse. If so, by now the Aussies must be due for a Great Depression. But somehow I think they’ll continue to do better than us.

Earlier I said Australia is very similar to the US. The main difference is that the wizards who run monetary policy in Australia don’t listen to Puritans who insist we must suffer high unemployment for our sins. They are a pragmatic lot; the sort of people who realize that if you borrowed too much and spent too much the solution is not to force millions of workers to take long “involuntary vacations” but rather to buckle down and work even harder.

PS. In early 1991 I had the good fortune to teach in a university named after a convicted felon on the Gold Coast of Australia. Imagine Florida but with a better climate, less crime, lower prices, prettier scenery, nicer people and casino gambling. Lucky country? Yeah I’d say so. Then I traveled all over the country. I stayed with a very nice rancher near Goondawindi, and later drove by myself from Darwin to Perth. More than 3000 miles and in places the connecting “highway” was one lane (not each way, one lane total.) Once I found myself 50 miles off the highway in the desert of northwest Australia and bouncing over boulders on a dry creek bed in my rented Toyota 2 wheel drive minivan. I suddenly realized “this is really stupid” and headed back to the highway. So I have a lot of fondness for Australia. I was able to visit all the states except South Australia and Tasmania. In April 1991 I presented a paper on forward-looking monetary policy at RMIT in Melbourne. Australia hasn’t had another recession since 1991. Coincidence? I don’t believe in coincidences. (Unless they are being used to disprove the EMH.)

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