Posts Tagged ‘keynesian’

Look, you have to be patient. It takes time to repay debt, but once it is repaid, well…yippee. That is one argument.

Others go further, and say things such as: “If it isn’t hurting, it isn’t working.”

Those who support austerity don’t deny it will be painful – except that is for a few nutters in the US Tea Party that seem to think there is an automatic and immediate positive relationship between austerity and growth.  No, the sane austerians are simply saying that it is worth it in the long run: pain today, wealth tomorrow.

And, of course, for most individuals such an attitude is right. Some businesses may argue that the way to deal with debt is to expand, but on the whole, most agree that times of peril mean cuts.

The snag is that when we are talking about the whole economy, things can get very nasty if we all start behaving in the same way. If all those with debts make cutbacks, and as a result there is less demand, and those with savings see the fall in demand, so start saving even more, then the economy will start contracting faster. And supposing that as a result of these cuts, demand shrinks, our income falls, and as a result our debts actually increase. In such circumstances, the more we cut back, the worse our debts.

The National Institute of Economic and Social Research (NIESR) reckons this is precisely what’s happening.

In a report published this morning it said: “As a result of the fiscal consolidation plans currently in train, debt ratios will be higher in 2013 in the EU as a whole rather than lower.”

Its argument continued: “under normal circumstances a tightening in fiscal policy would also lead to a relaxation in monetary policy. However, with interest rates already at exceptionally low levels, this is unlikely or unfeasible.” To put it another way, when interest rates are near zero, the argument that you need to make cuts so that the central bank can then make interest rate cuts doesn’t hold up. Right now, we are in what’s called a liquidity trap. Rates can’t fall much further, but when the economy is struggling like it is, the normal solution is to cut interest rates. Quantitative easing is not proving very effective because people don’t want to borrow more. The Bank of England hopes, by the way, that QE will push up the price of government bonds, meaning other assets will look cheap in comparison and push their prices up, which will make us feel richer, so that we will spend more.

Returning to the NIESR report it stated: “During a downturn, when unemployment is high and job security low, a greater percentage of households and firms are likely to find themselves liquidity constrained.”

NIESR added – and this is the key bit – “With all countries consolidating simultaneously, output in each country is reduced not just by fiscal consolidation domestically, but by that in other countries, because of trade. In the EU, such spill-over effects are likely to be large.”

Now it is only right to point out at this stage that the NIESR director, Jonathon Portes, is very much a supporter of the idea of stimulus. He bats for the same side as Paul Krugman – an out an out supporter of Keynesianism. So given this, perhaps the conclusions of the NIESR report are not surprising.

But then again  austerity can work when applied by individual countries which can simultaneously grow via exports. But when austerity becomes a global thing, it becomes very dangerous.

On the other hand…

The big snag with fiscal stimulus is that sometimes economies need to adjust. There is a danger that a fiscal stimulus can take away the need for change.

Take Japan, as an example. In Japan failure is not popular. In fact, it is seen as something that needs to be avoided at all costs. But as a result, maybe Japan is too slow to change. This morning both Sharp and Panasonic warned of heavy losses in their current financial year.  Truth is, Japanese electronics companies are getting a drubbing.  Being thrashed by Apple, and Samsung and Google and Amazon is bad enough, but now even Microsoft with its Surface tablet is making the once seemingly invincible Japanese giants look like dinosaurs.

Maybe Keynesian is partly to blame. There’s not enough creative destruction in Japan.

So returning to the NIESR, it is right. Austerity is causing damage, and may even be making debt worse, but that does not mean we don’t need creative destruction.

The debate has become polarised. Either you are an Austerian or a Keynesian. Why can’t you be both?

Anyway to finish on a more cheerful note, here is piece by yours truly on some promising news out of China today.

©2012 Investment and Business News.

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As the earthquakes became worse, the ancient Minoans demanded blood. Clearly the gods weren’t happy, so it was time to make more human sacrifices. Of course, there were occasions when a blood sacrifice was followed by less seismic activity, which was cited as proof positive that the policy worked.

Except of course, from our enlightened position in the 21st century we get causation. Any fall in natural disasters following a religious ritual was a coincidence. There may have been a time when a leader of a country was also a priest, charged with appeasing angry gods, and such people were held responsible when the gods wreaked havoc, but these days we are a touch more sophisticated.

Perhaps you could, at a pinch, blame hurricane Sandy on manmade global warming, but it would be stretching credibility to blame any individual for the storms hitting the US East Coast. Some people across the pond are very anti-Barack Obama, but it seems not even they blame him for hurricane Sandy.  Although Obama they say can do his election prospects some good by looking presidential.

Yet the logic that says Obama was responsible for the poor US economic performance of the last few years is not much different from blaming a Pharaoh for lack of rain.

Two economists who have led the charges against Obama are Professor John Taylor and Glen Hubbard.

The argument runs like this. In the past the US has seen much more rapid recovery from a recession. This time recovery has been slower, ergo, Obama is to blame. Some go further, and say ergo Obama is the Devil, meaning maybe he was responsible for hurricane Sandy after all.

Martin Wolf, the ‘FT’s’ economic guru, has been crossing swords with Professor Taylor. The prof says that even in the 1930s, the US saw sharper recovery than it is now. ‘Duh’, replies Wolf, ‘that was because after 1929, when US authorities messed up, failed to support banks, and made cutbacks, the resulting contraction in the economy was enormous. Of course growth was higher in the aftermath because it had further to grow from’. See: You can’t measure an economy’s performance on recovery alone

Professor Taylor then compared the US performance today with its recovery in the late 1800s. Wolf countered with the argument that surely it is more realistic to compare the US today with other economies across the world, such as Japan, the UK, the Eurozone, or even China.

It takes an extraordinary level of arrogance about the superiority of your country to think the fact that the rest of the world is suffering a very severe economic shock bears little or no relevance to your country.

Over at the ‘New York Times’, it’s been a case of daggers at dawn between Nobel Laureate Paul Krugman and Glen Hubbard.  According to Hubbard, the US recovery should have been V shaped.  In the UK – where the debate is over whether the economy will be W, An elongated L, or even a letter than hasn’t been invented yet – the idea of a V shaped recovery feels like a pipe dream. Krugman says the Romney team is ‘waving’ little things like facts away, because it is politically convenient to do so. See: More Financial Crisis Denialism

The fact is, of course, that the US economy has been posting figures that we in the UK envy. It may well be that the US recovery has been stronger because it has had less austerity. It is certainly absurd to say that if Obama had been Austerian in his approach, the US recovery would have been stronger.

But where both Krugman and Wolf may have it wrong is not conceding that there is any benefit to creative destruction at all. Recession can correct bad habits, remove poor practice, and ensure only the very fittest companies with truly strong business models can survive.

The snag is that right now the debate between economists is black and white. Either we need to let the economy correct via allowing failure, or we have a really massive Keynesian push. There seems to be no middle group. Maybe what we really need is both, and economists are so blind to their adversaries’ opinions that they are forcing us to make a choice, when what we really need is the best of both worlds.

©2012 Investment and Business News.

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Suppose you gave me a fiver (yes please – ed). I would be five pounds better off, and you would be five pounds poorer. But the greater economy which is you and me would be no different.

Suppose the government gave me $500 billion (err, yes please– ed), you would be $500 billion worse off, because the government would have to take that money from you. At least it would if you and I were the only people in the world.

Economists like to assume there are only two people in the world. That famous economist from the music scene Dean Martin, applied that way of thinking to romance, and he created a model based on the assumptions that ‘you were the only girl,’ and he ‘the only boy’.

Martin’s conclusion was much the same as that drawn by many economists. Martin sang: “We would go on lovin’ in the same old way.” Economists say things would be no different for the economy either.

Take Robert Barro. One assumes he is a bright spark because he is an economics professor at Harvard. He says that if a government spends more, the rest of us must spend less. So if a government goes out and spends in an attempt to stimulate the economy, the effect will be round, fat and look this: 0. Yes that’s right, nothing.

Economists talk about it in terms of a multiplier. They ask: what effect government spending will have on the economy?  Barro says this multiplier effect is zero.

Some, on the somewhat extreme end of the economic thought spectrum, go a tad further. They say we have perfect expectations, and we know that if the government is going to spend more, we will realise that taxes will have to rise, so in preparation for that sad day, we start to save more.  Some go even further and say ergo Barack Obama caused the finance crisis of 2008, even though he wasn’t president at the time. The thinking goes like this: US households realised he would win, guessed he would implement economic policies of extreme irresponsibility, so they changed behaviour and thus we had the credit meltdown. Others says that those who hold that particular set of views about Obama are not so much letting their biases influence their behaviour, as setting up some pretty convincing credentials for suggesting they are mad.

But there is another point of view. This says that government spending does have a multiplier. They say that right now companies and households (especially companies) are sitting on cash. Normally, the interest rate moves up and down to assure that this cash is lent out and invested. But right now, real interest rates (that’s after taking into account inflation) are negative. And despite this, companies and households (especially companies) are saving, but investment is not rising. They call it a liquidity trap: rates are zero, or near zero, but still savings are too high and borrowing too low. Some economists – for example Nobel Laureate Paul Krugman, and Richard Koo, the top economist at Nomura in Japan – say that in such circumstances governments need to spend more.

They say that at the moment not only is this multiplier effect above zero, it is actually quite high.

Last week, the IMF seemed to side with Krugman and Koo. It had previously said this multiplier effect is 0.5. Now it is saying it is somewhere between 0.9 and 1.7.

So what does that mean? It means that if a government spends, say $1 billion, GDP will be boosted by between $900 million and $1.7 billion. It means that if a government imposes austerity, GDP will shrink too. (Thanks for that information say the Greeks and Portuguese.)

But that is all very well. But then what? Critics say governments can’t stimulate indefinitely. They say that sooner or later they will need to re-pay debt, and the more they try to boost the economy via spending, the worse it will be. Krugman and Koo have an answer. They say that for as long as savings are too high, interest rates will remain low and governments will have no problem borrowing money. They will only need to worry about repaying debt when savings start to fall, at which point the fall in savings will mean more demand, meaning more growth, and less need for governments to spend.

This is what Koo has to say on the matter: “In a democracy, however, where most people see only the trees and not the forest, even those few political leaders who understand the need for stimulus end up arguing endlessly about which projects the money should be spent on. In the meantime, the economy continues to shrink… Only during wartime, when it is obvious where the money should be spent, can democracies implement and sustain the kind of fiscal stimulus needed to overcome a balance sheet recession in the shortest possible time.” The world in balance sheet recession: causes, cure, and politics Richard C. Koo (Nomura Research Institute, Tokyo)

Frank Sinatra may have had a better idea. He sang: “I did it my way.” Right now the austerians are determined to do their way, and the Keynesians theirs.

©2012 Investment and Business News.

Investment and Business News is a succinct, sometimes amusing often thought provoking and always informative email newsletter. Our readers say they look forward to receiving it, and so will you. Sign-up here