Saturday, March 28, 2009

Blinkered? Thinking out loud about orthodox beliefs ...

Paul Krugman has been reading Eichengreen and Temin, "The Gold Standard and the Great Depression," and wondering if our sober and serious thinkers and policymakers are suffering, perhaps, from a blindness akin to that which derived from the ideology of the gold standard in the 1920s and 30s. He thinks that today's equivalent of the gold standard may well be the "mystique of finance," which he believes has not been expunged from the Geithner plan.

But let me play devil's advocate for a moment--always a useful role in an emergency, when urgency hardens choices prematurely and tends to shut out doubt and experimentation. I'm not as sure as Krugman that the mystique of finance continues to flourish, since it suckled on the milk of optimism, which has now evaporated. The ruling ideologies of the moment, derived from the lessons of the last Depression, are, I think, 1) that output gaps must be filled with unstinting government expenditure and 2) that trade openness must be maintained lest neighbors be beggared. About open capital flows there is less agreement, indeed a growing sense that these need to be regulated and perhaps taxed, but free trade in goods remains largely intact and untouchable.

I tend to believe these orthodoxies myself, to the point where I find dissent from either of them, such as that expressed by Angela Merkel on stimulus spending (h/t Eloi), shocking, just as the first attempts to throw off the "golden fetters" were found shocking in the 30s. But what if we orthodox believers are overlooking something?

Is there any reason to believe we might be? Well, take this column by Epifani and Gancia. They aren't directly concerned with the current crisis and are perhaps less likely, therefore, to be influenced by their emergency commitments. Although they are concerned with explaining the effect of trade openness on government size, the mechanism they discuss--the effect of government spending on terms of trade--is one that needs to be more thoroughly explored. For what Eichengreen and Temin remind us of is the way in which local instabilities were transmitted and magnified via adherence to the gold standard. We no longer have that to worry about, but we do have new mechanisms for the transmission and amplification of instability around the globe. How these mechanisms will interact with stimulus packages, especially when those stimuli are uncoordinated, is a matter about which history has little to teach us and theory--pace Mundell and Fleming--is underdeveloped.

I'm not saying that anxiety on this score should undermine belief in our orthodoxies. Just that all doubt shouldn't be thrown overboard to lighten ship in the storm. It just might turn out to be a life preserver. I see no reason to forget that, like our forebears, we, too, are likely to hold that the beliefs to which we cling in troubled times are the very embodiment of wisdom and virtue. That's certainly the way Paul Krugman feels about his beliefs.