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In 1919, John Maynard Keynes hypothesized that the free-market economy was fundamentally unstable—that rises in unemployment and drops in aggregate demand would not tend to self correct, but rather to self-magnify.  In 1936, in The General Theory of Employment, Interest, and Money, Mr. Keynes outlined how a government’s central bank could stabilize the economy, thereby avoiding the damaging boom-bust cycles of the late 19th and early 20th centuries.

Sixty-six years later American economist and Nobel-laureate, Joseph Stiglitz, attacked then chief-economist at the International Monetary Fund (IMF), Kenneth Rogoff, for participating in the economics of President Hoover—insisting that developing countries maintain balanced budgets, and therefore high overnight interest rates, in the face of recession.  Mr. Rogoff argued that while lowering national interest rates in emerging economies during economic depressions would stimulate demand, it would also drive deficit spending, which could easily cause investors to lose confidence in the immature currencies leading to unabated inflation.  Mr. Stiglitz, like Mr. Keynes before him, maintained that counter-cyclical monetary policies—namely lowering interest rates during periods of recession and raising them during periods growth—were necessary to protect economies from the downward spiral of depression.

For seven decades the Federal Reserve has pursued Keynesian strategies, loosening money when the economy contracts and tightening it when the economy expands, which has meant large budget deficits during recessions and smaller ones during surpluses.  Yet while Mr. Rogoff did agree with Mr. Stiglitz, that it makes sense governments should create consumer demand when it drops—through the power of easy credit—and recall borrowed money when aggregate demand grows, developing countries have previously been unable to afford such counter-cyclicalism.

Suddenly, emerging economies in Asia and South America are facing massive declines in expansion.  And where their governments have previously been reluctant to accumulate national debts and feared loss of confidence in their currencies over long economic recessions, they are experiencing a change in conviction.  In Thailand, where federal interest rates peaked at 23% in 1997, rates were lowered by one percent this month in order to ease credit and stimulate consumer demand.  Russia, India, Malaysia, South Korea, Indonesia, and now China have too pursued a counter-cyclical agenda, bringing interest rate cuts and stimulus packages over the past two months through deficit spending, a shift unprecedented in magnitude in emerging economies.

However Asian countries ought still to fear hyperinflation.  Even though Russia, India, Malaysia, Thailand, and China are now able to find funding to drastically cut interest rates, lower taxes, and potentially spend themselves into major deficits, perceived instability can cause withdrawals; investors, like customers, can walk with their feet.

If developing countries manage to consistently thwart recession through looser monetary policy, global Gross Domestic Product (GDP) may surpass 5% in coming years.  That Asian governments are willing to attempt to apply Mr. Keynes monetary theories could signal a renewed confidence in Keynesian economics.  Then again, it could merely be the result of them now being able to afford Mr. Keynes’ proposed policies, which is in turn a testament to their development over the past two decades.  Either way, looser credit may mean more subprime mortgages are on the horizon.

-David Lamb

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