The Gold Standard | What they do not teach you at Princeton

Of course, that is a rather pompous title and meant to provoke. Seriously, this blogger does not think that he could teach all that they do not teach at Princeton. The title came in handy because two of the big interventionists today in the US – the Fed Chairman and Nobel Prize Winner Paul Krugman – taught or teach at Princeton.

On reading my article, ‘Mastering inactivity’ in MINT, a good friend sent me the following email:

very well written and insightful op-ed today.

have been thinking along similar lines after reading a few of your blog posts, but have not been able to square the logic on many directions.

but it poses some interesting challenges. assuming the danger of a world awash with liquidity spawning an inflationary non-growth phase, i have a couple of questions

1. in the ideal world, what would be the set of policy prescriptions to address this.
2. in the real world, given the political constraints and the need to be seen to be doing something, what would be the policy prescriptions.

In simple terms, i have held the view that given the adversity of economic forces, the obvious need to prop up aggregate demand, and the inability of private sector, government driven expansionary policies are necessary to get developed economies out of their slump. but expansionary policies in turn create several dangers (some of the crowding out arguments can be easily dismissed), the more critical of which are the inflation dangers and financial market distortions/instabilities, not only for these economies but also across the world, it poses. the danger is more obvious from the perspective of emerging economies. but from the perspective of policy makers in developed economies, what is the choice available?

given the limited conclusions that can be drawn with any degree of certainty from standard macroeconomic theories and models, is it ultimately not a case of trying out all available options, with some discretion, to get their economies out of the deep slump?

would be nice if you could blog on these

I sent the following response and I thought I would put it up on the blog. The reply has been slightly modified:

My answers to your questions below are that there are no ideal prescriptions. (1) can straightaway be scratched out. In Economics, you and I know that there are no costless solutions (Ideal world).

Stimulate now – you create debt, future taxes and inflation.

Embrace austerity now – you create the risk of deepening near-term pain, unemployment, popular anger, etc.

So, in time-tested fashion, you need to have a mix of the two and more importantly, dollops of luck.  I think England tried that – post Cameron. Fiscal tightening, currency weakness and monetary stimulus. It has not worked. Not yet.

Elected governments in democracies are biased to act. They have to appear to act. Hence, they do with little thought for efficacy or consequences or context.

My preference is for governments to do as little as possible, to allow natural healing processes to work and to use the opportunity (why waste a crisis?) to de-regulate, to unshackle, etc. It should definitely extend fiscal support to the most needy, the old, the widows, the infirm and the orphans among poor. Perhaps, definitions of poverty too can be relaxed in these times to help more people. But, all with a definite sunset clause.

Any other segment of the society has to engage in behaviour modifications in accepting the cards that the crisis has dealt them. If they do ask for and receive assistance, there should be mechanisms in place for payback before such government help is rendered. But, better to resist and refuse such assistance to those who can actually help themselves with a bit of belt-tightening.

Above all, there has to be accountability, fairness and integrity. Personal leadership examples are part of the integral part of austerity programmes. Else, they lose their inspirational and demonstrational effect. Thereby, they lose their economic effect. Such ‘leading by example’ has to come not just from political leadership, but from leadership in general, in the society. Then, ‘expansionary austerity’ will have meaning.

General principles of economics has to be respected and given scope to play themselves out:

(a) Economic growth comes through savings and investment, for the most part. Spending one’s way to prosperity is not possible.

(b) Beyond a certain point, low interest rates aid speculation and not investment because interest rates have to incentivise not just investment but savings too.

(c) Like it is with human beings, bingeing has to be followed by fasting. Bingeing is not cured by bingeing more.

(d) Excess capacity has to be destroyed or has to be allowed to self-destruct before new capacity generation or rebuilding can start.

(e) Capitalism has to have minimum morality to succeed. Since it is based on legal contracts between strangers, trust is not an important ingredient but it is not zero.

TGS has cited Emanuel Derman who correctly notes that economics cannot be values-free. See this blog post of Emanuel Derman on some principles of capitalism.

(f) Risk-taking means consequences of it have to be borne by the risk-taker both ways.

(g) There is no capitalism or for that matter, governance without accountability.

From the perspective of developed economies – as you ask below – what they need to do is to take cognizance of the above, accept, at least for the short-term, a decline in living standards (I think it will only be a relative decline), set about repairing the economy by going back to basics (see the list above) and hoping for the best.

I have written many times about the need for humility. We need to see an acknowledgement that the model was flawed. De-regulation and competition do not work in the financial sector in the same manner as they do in the real economy. I have not seen that acknowledged by a US Fed Chairman or the Treasury Secretary – past or present.

We are in a resource-starved (or, resource-tighter) world now than in the 1980s or 1990s. Non-inflationary growth is much tougher to attain or achieve than it seemed to be feasible in those two decades. Those were special circumstances. One-off factors helped. But, most policymakers and academics have assigned credit to themselves for that period of non-inflationary growth. So, they are trying hard to bring it back – growth thinking that inflation would be quiescent as it was then. It is not going to be. Accepting their limitations would be a great place to start, for the developed world.

Then, we need leadership to keep hammering this away even if it means losing the next election. That is the only way (success not guaranteed, of course) to achieve political consensus and get people to acknowledge the challenges, let alone accept and adapt. For ‘leadership to hammer away’ at sacrifices and economic growth limitations, it needs to be a spiritually, ethically and morally strong and unquestionable leadership.

You ask:

“ is it ultimately not a case of trying out all available options, with some discretion, to get their economies out of the deep slump?

I hope I have answered this question above. I do not think so. ‘Doing nothing’ or ‘doing as little as possible’ should be one of the options on the table because you simply do not know the consequences. What created the post-World War II prosperity? Let us face it. It was the enormous destruction of capacity during the War. Policymakers or Bretton Woods or Marshall Plans were ‘icings on the cake’.

As you can see above, in crisis times, restoring (as much as possible) good economic conditions has very little to do with economics as it is with other things.

Tangentially, this discussion set me thinking about the so-called government-corporations nexus. It is not as though governments become beholden to corporations. Politicians – individual human  beings – do.

Why do they seek favours from corporations and bind their future behaviour to narrow rather than larger public interests?

Answer: They want to be elected.

Why do they want to get elected to Office of Power?

Answer: If it is to serve the people and the nation, then they should know that dependence on fewer individuals and institutions to get there is self-defeating. So, this cannot be a goal.

Then, the answer has to be that they enjoy the trappings of power – material and psychological.

If that is the case, any public welfare improvement under present-day democratic governments is largely a matter of accident and unintended consequence than design.

How much of philosophical, spiritual, ethical and moral foundations are required before some can ascend the throne or attain office?

Is that possible to achieve or impart or acquire such a foundation today?


I hope, in some ways, I  have provided my answers. I do not  claim that they are THE ANSWERS. I know that you were not expecting that either.

DISCLAIMER: This is an archived post from the Indian National Interest blogroll. Views expressed are those of the blogger's and do not represent The Takshashila Institution’s view.