Wednesday, June 9, 2010

Time to Plan for a Post-Keynesian Era

Jeffrey Sachs from the Earth Institute at Columbia University recently had a comment published in the FT at entitled "Time to Plan for a Post-Keynesian Era".

Here is my response in the form of a letter to the editor.

Dear Sir,

Jeffrey Sachs’s erudite dismissal of Keynesianism, although intellectually stimulating, flies in the face of much of what Keynes might have thought about the role of governments when confronted by the stylized fact of the business cycle.
Keynes would not have advocated a short-run fiscal boost to counter a major downturn, and nor would he likely have been comfortable about high levels of public debt. I doubt very much that Keynes would have advocated temporary tax cuts or car scrappage schemes, given what we know about the advice he metered out to governments during the Great Depression. On the other hand Keynes would have likely been in complete agreement with Sachs’s analysis of the broken politics which surrounds the US economic situation. US taxes are too low, given what is expected of the public sector, and spending programs are too entrenched to allow the flexibility to be enterprising in terms of public investment. Keynesianism is not dead, and many economists believe it still to be the best solution in the face of an unprecedented downturn in the global economy. And after all, Keynes’s original advocacy of public investment in the 1930s is also one of the hallmarks of the current administration’s emphasis on both stimulus and investment.

The myth that does need to be broken, however, is that there exists “the threat of bubbles if we pursue economic illusions”. This misguided thinking implies that the bubbles which likely cause business cycles can be avoided and are not “hard-wired” into human behavior. Certainly given the regularity of the business cycle, the empirical evidence provides extremely strong evidence to the contrary.

Monday, June 7, 2010

The Heightened Risk of a Double Dip? The euro and the US labor market

We certainly live in interesting times.  Who would have thought that 2010 would see a crisis in the euro area because of one of it's smaller members - Greece, an oil spill that has very uncertain economic consequences, a political crisis on the Korean peninsula, and a coalition government which will likely result in proportional representation in the UK.  And we're not even half way through the year yet!

And in the economics sphere, while I have made the case that the euro area crisis is overdone, it doesn't stop what I call "emotional contagion" taking over in the markets.  There is utterly no logic in thinking that a small country like Greece should precipitate a financial market crisis in Europe or elsewhere, and yet that's exactly what has happened, despite the best efforts of EU policymakers.  I hear on the news that even though Spain's and Portugal's bond yields have increased, reflecting speculation that these countries will default on the sovereign debt, the focus has now moved to Hungary, as fears mount that the sovereign debt crisis could spread further afield.  Last Friday the forex markets used this as a reason to push the euro to under $1.19, a level that really boosts the prospects for euro area export-led growth, particularly in the euro area core. 

This whole situation is fast becoming a bit of a farce as far as the euro area is concerned, as Hungary isn't even in the euro area and doesn't qualify to join it any time soon according to the Maastricht criteria.  I suspect that some forex traders have rather a lot at stake here, and need the euro to depreciate so have begun to grasp at straws.  But with the euro at current levels it does have ramifications for the US, where this type of "overshooting" becomes yet another reason to add to the growing list of the reasons as to why the US economy is edging towards a "double dip" recession. 

Which brings me to the US unemployment figures from last Friday.  While the census workers dominating the figures is old news, what was telling to me is that the sector that added most jobs was the manufacturing sector - a sector that is heavily reliant on export markets ( - think planes, machinery and equipment, etc etc).  So if the euro stays at these levels or moves lower even the current net new jobs we are seeing might slow leaving very little new net job creation.

Watching TV on Friday I then saw several economists talking about the probability of a double-dip recession now at about levels of 50% - this is not good either as I think that it might encourage consumers to become fearful (as the stockmarket has appeared to have done) and baton down the hatches again.  We all know that market psychology is important - but consumer psychology transmitted by the media is also an important transmission mechanism that is really unexplored.  I guess that is probably one of the biggest unknowns now going forward.

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