The Policy Maker as Fire Warden

By TAN Kee Wee

(MediaCorp 938LIVE’s Money Talks, Thursday, 4 September 2008, 7.50 am and 7.20 pm)

When there’s a fire in a building, a good fire warden would calmly announce to everyone the steps to take, and then march them to safety. It’s not necessary to frighten everyone with details of the fire.

On the other hand, with an untrained fire warden, the situation could turn disastrous. A stampede could ensue and lives could be lost unnecessarily.

Managing an economy also requires the skill of a good fire warden. Last Saturday, Alistair Darling, the British Chancellor of the Exchequer, must have forgotten this.

That was when he alarmed everyone by saying that the British economy was going through its worst downturn in 60 years. He even warned that things would get worse. After realising his mistake, he said the following day that he was actually referring to the global economy.

But that follow-up remark fell on deaf ears. Sterling pound and stocks in London fell hard when markets opened on Monday.

In comparison, US Fed Chairman Ben Bernanke looks like a better fire warden. When the current subprime crisis began more than a year ago, he told us not to worry and that it would be contained.

Although things have gotten worse, Bernanke’s earlier optimism, some say lies, had good intentions. He just wanted to make consumers feel good so that they would continue to spend.

In economics, we learn of a term call the “multiplier effect”. This refers to the situation whereby an initial spending rise leads to an even greater increase in total spending.

Let me explain. A company spends $1 million to build a factory. The money goes to pay the builders’ wages and the suppliers. The builders and suppliers will, in turn, spend on food and clothing. This chain of events will continue. Ultimately, a multiple of the initial $1 million will be spent.

This “multiplier effect” is very important when combined with consumer sentiment.

The latest research suggests that in recent years this multiplier effect has grown larger. One possible reason is because we are using less cash today, which takes the pain out of spending, and makes the multiplier effect larger.

This stands to reason. Using cash is usually more painful than using a credit card, which is more painful than using “Nets”. Indeed using “Nets” stops being painful if you don’t look at your bank statements. Then it’s almost as if everything is free.

This may explain why the global economy and financial markets have become more volatile in recent years. It also means that policy makers must be more careful of their roles as fire wardens.

After Alistair Darling’s pessimistic view, the fear now is that British consumers could spend even less from this week, dragging the UK into a deeper recession.

Fortunately for Singapore policy makers, the challenges are not the same. This is because the Singapore economy is more heavily dependent on the external sector, rather than on domestic consumer spending.

So it’s alright to paint a gloomy economic picture for Singaporeans. In fact, there could be two benefits of being gloomy.

Firstly, it could better prepare Singaporeans to face the external threat, just like a good coach prepares his team players for the competition. Secondly, bad news could redirect some of the $4 billion Singaporeans spent, on shopping overseas last year, back home.

How does former US Fed Chairman Alan Greenspan rate as a fire warden? Well, we know he is famous for saying a lot of things and yet for saying nothing. Perhaps, that was his strategy.

By confusing investors, Greenspan would create a number of pessimists who want to sell, which is equal to the number of optimists who want to buy. As a result, the market does not move up or down. It moves sideways and remains calm. That looks like a fire warden at his best.