Best to ditch the economic rules

This blog post was first published on Fundweb today.

This of course is the opposite of the mainstream view. The conventional argument is that there has been too much politics, particularly of the democratic sort, and too little expertise. It would be far better, according to this line of thinking, if more decisions were left to the grey-suited experts such as that nice Mr King at the Bank of England.

But it is not hard to find examples to call mainstream thinking into question. Britain had a well-regarded framework of monetary and fiscal rules before the crisis but it did not stop trouble emerging. Nowadays hardly anyone mentions Labour’s “golden rule” and “sustainable investment rule” but they were designed to protect the country against fiscal over-reach. The monetary framework, with inflation pegged around a clear target, was also crafted to ensure stability.

Defenders of the framework often argue that the crisis emerged in Britain as a result of an external shock rather than domestic weakness. But the eurozone too had an elaborate monetary and fiscal framework but this did not prevent turmoil there either. The crisis is rooted in the atrophy of the real economy rather than a lack of rules or the inability of politicians to follow them.

I was reminded of this discussion when listening to John Taylor, a professor of economics at Stanford university in California, interviewed on the latest Econtalk programme (regular readers will know I am a fan of the show even though I often disagree with the views expressed). He described how in his new book he outlines five keys to prosperity:

· Predictable policies.

· An emphasis on the rule of law.

· An emphasis on markets.

· The importance of incentives.

· A limited role for government.

Let us assume for a moment that these principles are all desirable (although the first one is arguably more of a policy guideline than a principle). Does it necessarily follow that they can be guaranteed by rules?

However well drafted or intentioned any set of rules it is likely they will be breached in times of trouble. Indeed it is desirable that politicians should have the discretion to react to unforeseen circumstances.

What Taylor is really concerned about is politics and particularly popular pressure. He does not like the idea that the public could react to particular problems in such a way that they go against free market principles. In other words he wants to insulate technocrats, such as central bank governors, from the popular will.

If Taylor is confident of his ideas he should be willing to argue the case for them among the public. That is the only way he can be sure of them being pursued consistently. If the public makes the wrong choices it should also have to face the consequences. Detailed rules of the sort Taylor advocates are not only undesirable, for they are undemocratic, they also tend not to work when they are most needed.

In contrast, principles are vital as they help provide a vision of people’s aspirations. As long as politicians stay loyal to the broad principles on which they are elected they should have the discretion to adapt to changing circumstances.