"Double-dips" on each side of the Atlantic?

It's rare in macroeconomics that we get a chance to experiment with economies, but at the moment we have the prospects of exactly that happening over the next 12 months.  And the results of this experiment will, no doubt, be picked over by economists for decades to come. 

In the US there is no sign of tightening on either the fiscal or monetary fronts, and it transpired that this is justified by the miserable jobs data for July which appeared last Friday with 131,000 jobs lost and the unemployment rate stubbornly stuck at 9.5%.  Even stripping out the temporary census worker layoffs, the private sector only managed to add an anemic 71,000 jobs, hardly the post-recession "bounce" that economists would like to have seen (see http://www.bls.gov/news.release/empsit.nr0.htm).  This was also underlined by the fact that the change for June was also revised from a loss of 125,000 to a loss of 221,000 jobs.  Despite the fact that public debt levels in the US are headed towards 80% of GDP there is no suggestion that expenditure cuts or tax increases should be foisted upon the general public, until the economic is truly underway.  Of course once this does occur as Clive Crook of the FT pointed out recently (http://www.ft.com/cms/s/0/1b4c44d8-a32e-11df-8cf4-00144feabdc0.html) fiscal tightening is inevitable.

In the UK, the new Conservative/Lib Dem coalition government has taken exactly the opposite position.  Underscored by an apparent "bounce" in the economy in the last quarter (GDP grew by 1.1% in Q2 alone), and up until recently a resumption in house price inflation, the government has already increased the sales tax (or VAT as it's called in Europe) from 15% to 20% and looks to embark upon draconian cuts in public spending (£6.2bn immediately, to be followed by much more swingeing cuts from the fall/autumn onwards) to try to balance the budget from it's current £156bn deficit or in a matter of just a few years (see http://news.bbc.co.uk/1/hi/uk_politics/8700342.stm and http://www.ft.com/cms/s/0/bdf7380a-7e0d-11df-8478-00144feabdc0,dwp_uuid=716ef204-6808-11df-af6c-00144feab49a.html)

As readers of the FT will no doubt know, the contrast between these two positions prompted Martin Wolf's "austerity vs stimulus" debate (see http://www.ft.com/cms/s/0/f3eb2596-9296-11df-9142-00144feab49a.html) which really caused a stir in the economics world, but of course no real conclusion as economists are largely divided on the issue. 

The main points that I would like to make though regarding this comparison (and apparent "transatlantic divide" in macroeconomic policy) are as follows:

i) the global recession started in the US, so any recovery has to address the underlying problem that caused the downturn in the first place. Despite some attempts from Congress, this is really not happening, with no withdrawal of the government from the housing market and an excess of housing.  New building now is cheaper in many parts of the US than is buying a "second hand" house.  So excess supply and falling prices look to continue now for an extended period of time.

ii) although both countries possess similar levels of labor mobility, the UK and US housing markets couldn't be more different.  The UK tends to have interest-sensitive mortgages while the US tends to have interest-insensitive mortgages.  That means that for the UK cutting public expenditure will tend to keep interest rates lower than they would otherwise have been (the opposite of "crowding out") which will tend to boost the housing market.  Now the other factor with housing is that in the US there is an abundant supply of land, whereas in the UK there is not.  This means that the UK housing market should recover well ahead of the US housing market.  It also means in the longer term the UK economy should also grow ahead of the US economy as well.

iii) the Conservative/Lib Dem coaltion government in the UK is completely dependent on Lib Dem support for the public expenditure cuts, and it is clear that below the surface the Lib Dems are extremely uncomfortable with what is going on right now.  I would predict that once the Electoral reform referendum is done next May, the current government may collapse in which case some of the public sector cuts might not actually be implemented.  Certainly with spending cuts of up to 25% of government services likely, the employment consequences are likely to be quite severe and the effect on consumer sentiment marked. 

So pulling this all together, a "double dip" recession in the US is now pretty remote in my view.  A mini deep "double dip" in the UK is now a real possibility, depending on how quickly the proposed public expenditure cuts are implemented and whether the Lib Dems withdraw support from the coalition government half way through the fiscal year.  So likely the UK will go into reverse from October through to the middle of 2011, but then another "bounce back" in economic growth will occur, pushing it ahead of the US once again. I'm sure Keynes would favour the US approach, but for this economist, at least, this is going to be a fascinating experiment to watch!

Comments in the FT's Austerity vs Stimulus Debate

First, I want to thank the FT for allowing this online "debate" to happen.

I believe though that this can no longer be a "debate" - it is the abject failure of a discipline, and a fundamental crisis for the subject area, with little "credibility" now being given to those in the elite economist "mafioso", as they really don't seem to be providing any intellectual guidance. The Queen's reasonable question of economists ('it's awful - why did nobody see it coming?') points the finger at the "closed shop" that academic macroeconomics has become, and suggests to me that external pressure needs to be applied so that the subject should no longer continue to be highjacked by a narrow group of academics, given their clear failure to predict or provide guidance in the face of a downturn. We hear the same tired voices from the Ivy League schools in the same dialectic debates with no new philosophical approaches. They hire the types of Ph.D.s who follow their thinking and we get stuck in an intellectual quagmire. So in this light the comments of Niall Ferguson are rather interesting - why should Behavioural Finance be the biggest winner so far from this intellectual meltdown in macroeconomics? I don't disagree with him, but shouldn't some new ideas in macro emerge and then save the day? After all that's how Keynesianism first came about, and most schools of thought in economics since that time ( - with the obvious exception of the Austrian school and the Post-Keynesians). My fear is that the way the economics discipline is now so institutionally structured, that is unlikely to occur this time around.

One new direction might be to think about the business cycle more seriously. The business cycle was basically downplayed and dismissed in some quarters during the 80s and 90s ( - the "great moderation"), and now looking back, this was clearly a mistake. Business cycles appear to be "hard-wired" into macroeconomic behaviour, and yet they don't appear explicitly in any of our models, let alone in our academic thinking - they are just treated as a "stylized fact". To date this phenomenon has been explained as the result of "shocks", and although "shocks" can cause recessions (think of the 70s oil price shocks), if we don't have exogenous shocks we now know (after our current downturn) that we can still get recessions. If you take this approach then obviously studying these cycles ( - as I am using frequency domain techniques) might give us a different perspective on these downturns. OK, this is only one approach, but at least it might offer some new direction to the subject, and I'm sure there are others with new and interesting ideas.

The main point here is that academic macroeconomics needs to be more open to ideas that come from both inside and outside the discipline. Most outsiders would be shocked to see how parochial the discipline has become. Hopefully if outside pressure is brought to bear on the discipline this will change, and academics long held back by the "mafioso" will get a chance to present their ideas and make an impact!