Friday, August 20, 2010

No Stimulus Measures This Time

So the PM says:

PM: Strengthening economic fundamentals better than stimulus packages

PUTRAJAYA: It is better for the government to strengthen economic fundamentals rather than introduce stimulus packages frequently to overcome the economic slowdown, the Prime Minister said.

Datuk Seri Najib Tun Razak said the country needed to avoid introducing stimulus packages too frequently because it would increase the government's deficit.

However, Najib said that stimulus measures, especially for local investors to increase investment, needed to continue.

"If we do this and projects with big multiplier effect on the economy are implemented, then even with a slight drop in foreign demand, we can still achieve our 6% target," he said…

I’m wondering just how many local economists have realised that because the policy structure of the economy has changed, so has the fiscal multiplier.

In July 2005, BNM unpegged the Ringgit from the USD and started something unprecedented in Malaysian history – the currency (apart from a couple of episodes of intervention in 2008) was allowed to float freely. Previously the Ringgit was either on a hard peg (pre-1972, 1998-2005), or soft peg to some other currency (GBP, basket of currencies, USD respectively).

Fiscal multipliers are high and effective when a country has low exposure to trade, an accommodating central bank (i.e. not responding to price pressures arising from government borrowing), and a fixed currency regime. Loosen any of those conditions, and the impact of government spending on output starts falling. If you have the opposite of those conditions, the multiplier falls to zero, and possibly negative (see this post for details).

So here’s Malaysia, with its huge exposure to trade, a sometimes accommodating central bank and fully floating exchange rate. That suggests at the very least a multiplier less than one, and probably closer to zero. In other words, stimulus measures shouldn’t be under discussion at all.

If we continue to want to have some government spe2nding support during downturns, then we should really be busy designing automatic stabilisers that come into play without the need for discretionary government action – unemployment benefits for instance.

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