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    Adding fuel to the flames

    Fatih Özatay, PhD06 July 2009 - Okunma Sayısı: 1093

     

    For the last two articles I have been mentioning how being stuck with economic policies offered in the first chapters of economics textbooks direct Turkey to mistaken policies. In fact, this is a familiar theme for those regularly watching this column. The story always comes back to this issue.

    First chapters of macroeconomics text books propose that if the economy is growing at a rate highly below the potential growth rate of the economy or if the economy is contracting, expansionary policies must be implemented. Rise in public expenditures, reduction of tax rates along with a consistent loose monetary policy (keeping interest rates at low levels) will eventually push up private sector consumption and investment. Therefore, pace of growth will go up and unemployment will go down.

    A baby does not start to walk overnight. It first has to crawl; then it will stop; take the first step in fits and starts; then walk and then run. This is also what textbooks are like. They approximate the models they analyze to the real world step by step. The authors of those textbooks sure know that the confidence about the economy deeply affects consumption and investment expenditures. They are aware that the expectations regarding the sustainability of current policies in the future have an impact on the current spending schemes. Moreover, they also know that under different initial conditions same policies can give different results. However, they address in detail that issue in the 'following' chapters.

    A significant proportion of many countries' GDP is composed of private sector consumption and investment; share of public spending is usually small. For instance, in 2008 share of private sector consumption is 70 percent, private investment is 16 percent, public investment is 4 percent and public consumption is 12 percent (Total is above 100 percent because of negative net exports and inventory variation).

    In that case, if the economic policy you implemented to stimulate domestic demand does not scale up private consumption and investment, there is nothing much you can do for growth: in the first quarter of 2009, public investment and public consumption have increased by 24.6 and 5.7 percent respectively as compared to the same period last year. On the other hand, private sector investment and consumption have decreased by 35.6 and 9.2 percent respectively. This is why private investment, share of which in national income is quite lower than private consumption,  is nearly of equal importance with private consumption in terms of growth: because, investments fluctuate within a larger interval than consumption.

    If a consumer is afraid that she can lose her job tomorrow, she defers spending beyond necessity even if you cut down taxes. Why would a firm which notices that sales are rapidly falling down and credit opportunities are tightening make investments given that there is no sign of change?  Therefore, it is of importance that the fiscal and monetary policies to be implemented improve confidence.

    If the budget deficit is rising and you do not provide a strong guarantee that it will be controlled in the medium term and push up public spending to stimulate the demand, consumers and investors will be more reluctant to spend. Doubts like 'What is going on? Budget deteriorates continuously. Are old days coming back?' surround the air. This is why initial conditions (budget deficit) are also important.

    If, thinking about the elections ahead, you do not define a long term anchor and wait for the uncertainty in your head about the possibility of early elections to disappear; it means that things are not good. Because, it means that you are hoping to limit unemployment even slightly with the spending you will make before the elections. If you had made the correct decisions until now, this belief might have been valid to a certain extent. But given that the only thing we have done against the tsunami that hit out shores was to close our eyes tightly; it cannot be concluded that we have done the right things. Thus, such policy will only add fuel to the flames.

     

    This commentary was published in Radikal daily on 06.07.2009

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