ANALYSIS:It is refreshing to see a body like the BIS take an undogmatic stance, writes DAN O'BRIEN, Economics Editor

“A LOT of theory is being made up as we go along by people who believe what they want to believe.” Speaking recently at a think tank in London on fiscal stimulus, these were the words of William White, the Canadian central banker who ran the economics department of the Bank for International Settlements (BIS) for 15 years until 2008.

As the debate about the risks and efficacy of fiscal stimulus rages, White’s words and those of the BIS are worth listening to, not least because few individuals or organisations can lay greater claim to having warned of the fragility of the world economy before the crisis began in 2007.

Although White retired after completing the bank’s 2008 annual report, his replacement, American academic economist Stephen Cecchetti, was similarly questioning of conventional wisdom during the boom years, arguing, for instance, that central banks need to consider not only inflation when setting interest rates, but asset prices too.

The bank’s annual report, which was published yesterday, highlights the unprecedented nature of the challenges for policy-makers. Echoing White’s recent words, it makes no bones about the absence of precedent which could guide policy-makers on the long march back to growth and stability. At a time when many in the economics business – on both sides of the stimulus-versus-austerity debate – take trenchant positions it is refreshing to see an authoritative source say so plainly that finding the way out of the crisis will involve much groping in the dark.

While the BIS comes down in favour of moving to scale back fiscal stimulus measures, it is not dogmatic. It recognises the costs of retrenchment. It does not advocate a one-size-fits-all approach, saying that some (unspecified) countries retain the capacity to stimulate. And it rejects out of hand the argument made by some fiscal hawks that inflation is a threat unless tightening begins immediately, saying that there is no evidence to support the view that inflation expectations have been unanchored.

That said, the BIS expresses cautious optimism that the net effects of front-loaded fiscal tightening will be positive, citing evidence from industrialised countries in the 1980s and 1990s (including in Ireland) where large budget adjustments succeeded.

Of particular relevance for Ireland, it goes on to say that there is little in the way of an evidence base to predict the effects on economic growth of radical fiscal tightening in the absence of big off-setting exchange rate and interest rate adjustments, as has already happened here.

It could have added that the experiences of Ireland and the Baltic states over the past year give reason for guarded optimism. These countries are all well down the path of unprecedented austerity, none has had the benefit of big exchange rate depreciation, but none appears to be locked into a deflationary spiral, as some feared. Indeed, Ireland, Estonia and Latvia all show tentative signs of a return to economic growth.

For good measure, the report highlights how it is not only with regards to fiscal stance that macroeconomic policy-makers are flying blind. On the effects of unconventional central bank interventions, such as quantitative easing, the BIS laments that “history offers little guidance on the economic significance of the side effects”.

If the BIS’s views on macroeconomic policy are solid and sensible, its stance on the regulatory reform of the financial system seems less radical than its own analysis would deem proportionate. “How could this happen? No one thought the financial system could collapse.” This was the opening line of the BIS report last year. System collapse is a serious matter. It is more than serious when it creates the sort of chaos that has come to pass, including the loss of tens of millions of jobs worldwide. It is more serious still when it creates the risks that the bank itself identifies, most of which have their roots in the extreme fragility of the financial system.

Yet despite this, it takes a curiously conservative view on the measures that might be adopted to prevent future crises, opposing both the prohibition of practices and financial products that contributed to the crisis and the use by developing countries of measures which could slow the movement of destabilising capital flows. If the risks that it highlights come to pass, by this time next year the bank may have cause to reconsider.