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Fiscal stimulus alone cannot heal economy


PROFESSOR Paul Krugman of the Massachusetts Institute of Technology yesterday advised Thailand and other ailing Asian economies to avoid the Japanese-style syndrome of assuming a drastically accommodative monetary-policy stance to relieve the unsustainable burden of fiscal stimulus.

Speaking at the ''Inaugural Chin Sophonpanich Memorial Lecture'' at Bangkok Bank headquarters, Krugman welcomed the Bank of Thailand's plan to introduce inflation targeting as a means to achieve macroeconomic stability and enhance its independence in the conduct of monetary policy.

He suggested that the central bank should take management of macroeconomic policy away from the Finance Ministry.

With the Thai economic recovery relying on exports and fiscal deficit spending, Krugman warned that fiscal stimulus was not a long-term solution to driving economic growth.

In the medium term, monetary policy would have to become more accommodative to absorb the rising burden of public-sector spending because Thailand was not as rich as Japan.

Over the past year or so, Thailand had gone from a budget-surplus country to a budget-deficit country due to the need to counter the economic contraction and to absorb the cost of financial restructuring.

Still, Thailand must avoid fiscal consolidation in a premature way. Japan made another policy blunder during the Hashimoto government, which raised taxes in 1997-98 that further exacerbated the recession.

Following a five-day visit to Japan, Krugman said he was not very encouraged by what was happening there.

Over the past eight years, Japan had been running into a deep recession, with an annual average growth rate of 1 per cent, kept alive by government spending.

It was a classic economic story of how a rich, highly technologically advanced country could go wrong.

Even though interest rates in Japan had gone down to zero per cent, there was still room for a more expansionary monetary policy, Krugman said.

This, he suggested, could be done in the unorthodox way of further stimulating the economy through inflation targeting and by the Bank of Japan buying back government bonds to push money back into the system.

''I would consider inflation targeting of 3 per cent as a good number,'' he said.

Higher inflation would induce Japanese consumers to spend more instead of putting their money idly in bank deposits, which would turn out to be a net negative yield.

Although the Ministry of Finance had been calling for the Bank of Japan to come to its rescue because of the increasing fiscal burden, the latter had remained cautious about expanding its monetary policy.

Apart from inflation targeting, Krugman suggested that Thailand and the rest of Asia would have to sit down and take a look at micro management at company level. Simply tackling the banking sector would not solve the economic problems, he warned.

Even if the bad debts could be taken out of the banks' balance sheets, it did not mean that the firms or private enterprises, which drive the economy, could be restored to normal health, Krugman said.

Since the entrepreneurs of Thailand had been ''decapitated'' by the financial crisis, it would take time for them to bounce back.

Krugman said the Thai and Asian recovery had been possible without structural or banking reform because once the crisis reached a certain level, the domestic economy could recuperate on its own power.

For this reason, neither the International Monetary Fund nor Dr Mahathir Mohamad, the Malaysian prime minister who put in place capital controls, could claim credit for restoring growth because all countries experienced a cyclical recovery.

Yet this did not mean that Thailand and other Asian countries did not need to institute reforms, Krugman said, adding that these were crucial to prevent a similar crisis from happening again and to ensure long-term growth in the future.





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