Listen to this episode
With head-snapping speed, the echo chamber abandoned recovery last week. Yes, the much-ballyhooed recovery engineered by the three amigos Baffled Ben Bernanke, Gofer Tim Geithner, and Tiny, Timid and Temporary Larry Summers, with their trillions in support to the banking sector and not one dime to households. That recovery. What? Didn’t happen. In the area roped off for recovery deniers, Demand Side has been lonely. Now there are plenty of people around. The echo chamber is ringing with recovery deniers, and frankly it’s uncomfortable. We used to have a nice little table here, Keen, Stiglitz, Roubini, Shiller. Now you have to stand in line for the bathroom. Of course, they’re not looking at us. No. But they’re sitting on the couch and checking out the fridge.
After Q2, the forecasters began moonwalking back their predictions of 4%. Now it’s a scramble, no grace to it. An incredible pile of bull has been simply abandoned, ignored, forgotten. Actually, there’s a little bit clinging to their shoes and messing up our carpet.
You will remember, Demand Side was the outlier, a minority of not one, but not more than a dozen, for our baseline forecast of bouncing along the bottom, with downside risks and negative growth in the second half. Aggregate demand is the driver of the economy and aggregate demand is fading – from cuts to states and municipalities, growing real debt burdens on households, and the paralysis of government to invest. This scheme is still not the mainline, by any stretch. The current mainstream is kind of a cross between the Fed’s favorite, “It was worse than we thought,” and the ever-popular “flock of black swans.” There is no absence of interest in flogging the whipping boy of government, either.
Rather than debate, today, we’re going to take some prerogative from being right and restate the position. Then we’re going to look at other canards from the echo chamber. Simple facts of conventional wisdom that will sooner or later be rescinded without a backward glance.
The consumer economy is dead. It is buried under a mountain of private debt. The only way out is to socialize investment, as Keynes said, putting people back to work doing things that need to be done. Essential, not optional, are writing down this private debt (either directly or by inflation) and reconstituting public goods and services that are currently the object of a thousand cuts. That is government – teachers, police, firefighters, and a new millennium of infrastructure. We have an incredible challenge to meet in climate change and we have the spare capacity available to put to work.
This is not going to happen, we are afraid, because the current economic institutional framework is basically that the corporate control regime runs the governments, central banks, and dominates business economics with its market fundamentalism. Three years ago, when a complete collapse of the economy was prevented only by massive government intervention, it was difficult to imagine how the financial sector and corporate elite could survive. Now the institutions which created the last bust are back in charge: ratings agencies, central banks, IMF, and the fundamentally insolvent financial sector. It is difficult to imagine how they are going to be dislodged before a new and deeper collapse occurs.
So, our listeners are likely members of the choir on this and we won’t go into detail here. The principle lesson from this new validation by the echo chamber is that your analysis should ignore them. That view has absolutely no correlation with eventual outcomes. Most of their effort goes into explaining why what they said would happen did not happen because of a new extraneous factor and anyway if you look at it more closely, actually they didn’t really say what we thought they said. Besides which nobody else saw it coming either.
So. What else is reverberating in the echo chamber that is worth rejecting?
Ah. The S&P downgrade of U.S. debt is a big deal. Not so. As you will see tomorrow with the rush into U.S. debt. The ratings agencies are like Inspector Clouseau who was repeatedly baffled and caught off guard and could only get the drop on Cato by sucker punching him. The real red flag here is that the same ignorant voices that were in charge during the last financial debacle – S&P here – still get a hearing.
Another favorite which gets reverberation on the Left side of the echo chamber is that an expansion of the payroll tax reduction will create jobs. This has history. Tax cuts in the Bush stimulus of 2008 and the Obama stimulus of 2009 and the 2% reduction currently in place all ended up in paying down debt, not increasing employment. Increase employment by hiring people. The multiplier out of new jobs will be three times that out of another $50 in the average monthly paycheck. What is two percent of annual payroll taxes? A minimum, I would guess, of $100 billion. You could hire three million Americans at decent wages for that. And they would immediately start paying payroll taxes. That’s two percent off the unemployment rate. You are not going to get two percent off the unemployment rate by beating around the bush.
What else? Here’s one. Tax increases will kill jobs. Here again the confusion derives from the sound bouncing off both political walls. Not all tax increases are jobs-killers. Just as not all tax cuts increase jobs. A carbon tax, for example, would do much less damage to the pump price than has oil price speculation. The price quoted on one web site said gasoline went from $2.10 to $3.40 in just the past year. Tax revenues could produce funding for jobs, not rents to resource extractors. Tax increases on the rich don’t cut spending because the rich spend out of accumulated wealth, not income. A Tobin tax on financial transactions only captures some of the losses inherent in speculation. Eliminating the cap on payroll taxes creates a flat tax instead of a patently regressive tax and at the same time gives people confidence in their social security, so they will not hoard against uncertainty. Capping the mortgage interest deduction at $500,000 and one home will push money into productive uses, not in indulgences for the already opulent.
What else?
Our favorite call and response was that the crash in the markets had nothing really to do with the debt ceiling circus and the outcome extorted by the Tea Party. That was just a distraction. To be fair, we said something similar, that the public was fascinated by a schoolyard shouting match and was ignoring the oncoming bus. But to say that the austerity extracted in the debt ceiling debate had no effect is not very convincing. After all, the markets crashed the very next day.
In fact, some of those losses may have come from investors who share our view, that millions of jobs will be lost as a result of no balanced approach. Cutting off government investment as a means of cutting the deficit works only hypothetically, only on a spreadsheet constrained by bad assumptions. Investment by government is the road out. Cutting it is blowing the road up. Since we are kicking the can down this very road, that really doesn’t make any sense in anybody’s metaphor.
We are going to have deficits. They will happen either because we restart the economy with much-needed public investment or because we crash the economy by the madness of austerity.
Next year, we’re going to look like Greece. Remember, the Greek people swallowed Austerity One. When it didn’t produce stability, but rather a major downturn in their economy, they protested that probably more of the same would produce more of the same.
So, echo chamber says, Austerity is good, but the markets are looking elsewhere. Survey of reality says, Austerity is throwing gasoline on the fire. There is no possible way that austerity will lead to debt reduction. We need to earn our way out, not starve our way out.
The only way out is, reducing private debt, creating jobs with a full spectrum demand profile, and bringing some market discipline back to the banking sector. We can try all the austerity, all the market fundamentalism, all the shoving money at the banks we want. It is not going to work, because it cannot work. The economy operates from the demand side.
Subscribe to:
Post Comments (Atom)
Posts
I like you have thought that this would be an L shaped recovery for the last four years. I have yet to be disproved. The reason being private debts. that cannot be reduced overnight. It will take a decade or more to clear that debt. It might take two decades. The issue will be how long can countries cope with large numbers of unemployed. With the sorry state of the US safety net they have much less scope than Europe. In a couple of years no one will have any benefits left and there will still be no more jobs.
ReplyDeleteI also think that Hayek has a lot to offer in terms of solutions. In the Depression much of the bad investment had already been written down by the time Keynes persuaded FDR to go with stimulus. Now with so much bad investment still standing it has absorbed all the efforts of QE. Hence the pathetic impact on the economy. Unlike some I do not see a dispute between Hayek and Keynes. The issue is the timing. Hayek applies to clearing the excess. Yet both are relevant when it comes to avoiding getting into that state again. Hayek calls for hair shirts when times are good, and Keynes for counter cyclical taxes and spending. Both are similar.
i am much more in favour of a period of tough conditions to clear out all those bad investments and then have some stimulus. Though I suspect that the US is so fixated on slashing government that it now needs to suffer the horrors of small government unable to support the economy before it abandons its neoclassical zeal for austerity, and balanced budgets. So those bad investments will fail just not now. It could take a decade before asset prices are back at a level that have real fundamental backing for them. Though with a greatly reduced debt burden it might revitalise the nation. Though the wealth of the country will be significantly reduced.
As for the stock markets they are overvalued and will probably hit levels considered apocalyptic by fund managers before they stabilise. So I foresee more than a decade of stagnation and even more so called wealth disintegrate through mismanagement.
Like Hayek said, the only way to avoid the pain is to not have the bubble beforehand. That is what is needed now. Yet with supply side economics dominating that will not happen. So the US will have its depression because it knows no other way.
I am not good with Hayek. Meaning I have dismissed him out of hand and not really engaged. The clearing, I can see in a general sense, but the market seems to mindlessly produce whatever the entrenched capitalists want, and that is often just another dead end.
ReplyDeleteOne of the under-appreciated pieces of the post-war recovery is that housing investment was consciously nurtured by the U.S. government, largely at the instigation of Leon Keyserling. Later, of course, this sector became entrenched and eventually exploited. But this was directed investment that paid off big, creating wealth for households, high-paid jobs, and a healthy and stable middle class.
Now it would be nice if government directed the same thing. To let the private markets determine what the next investment phase is going to be is to throw darts at the future. Particularly with the potential of catastrophic climate change, I don't see how we can do that. The next investments have to be public goods -- infrastructure and rehabilitation of the Commons. As I understand Hayek, the choice after clearing might well be a new generation of consumer gizmos, so we can have virtual paradise right up until the planet dies.
Hayek is the darling of the free markets because as an anti communist he spoke against the evils of a controlling government. Though later he did speak out against corporate domination. That element seems to be ignored. Until I found out about the other treatise on excessive corporate power I wrote him off as well.
ReplyDeleteHere is the link to a page from the BBC about Hayek and Keynes. There is also a podcast.
http://www.bbc.co.uk/news/business-14366054
I do agree with Hayek and Minsky that markets can get unbalanced and that excess needs to be cleared from the system. In the 30's this happened, then as Keynesian stimulus was applied it boosted the economy. It worked because there was no bad investments still standing. The only thing that stopped it was concern about deficits in 1937.
So my acceptance of Hayek is limited to the need to clear bad investments and for governments to do nothing apart from provide unemployment benefit till the bad investments are gone. Then use Keynesian stimulus to boost the economy. Though once the economy is going the second element of Hayek seem similar to Keynes. Hayek called for hair shirts to stop government spending getting out of control and Keynes for counter cyclical policies to curtail the excesses. Both have the same end result. The Hayek hair shirt could be taxes or cut spending just as Keynes would recommend. Hayek was against the excesses building up. If Hayek had been followed properly it would have led to no bubbles as policy makers would have had to intervene to avoid the boom itself. Though Policymakers always want a boom because they think that is what the public want. It is hard to resist.
I do know about the Federal Housing plans. These were instigated for two prime reasons. First to create employment and homes for those that lost their home. It was also to stop the build up of communist influence within the country. The US was paranoid that the masses unemployed with no stake in society would rise up and over throw the government. By giving them homes and a stake in society they were less likely to revolt. They did not feel the same about minorities and hence the red lines for credit acceptability. That was what stabilised the country for decades.
So my take on the recent crisis was that the policy makers learnt the wring lessons from the depression. I would have allowed the banks to collapse. It would have brought house prices down to the floor very quickly. That would have brought all the loans on to the FDIC balance sheet. Then started rewriting the mortgages in a way that meant they were repayable, and few needing to lose their homes. Then with lower debts the consumer would be in a far better state now. Then while millions would have lost jobs the extension to unemployment would have allowed bad investments to fold and clear the markets for new entrants. Then had a totally jobs centric stimulus package along the lines of a green economy. As you say allow the market find solutions with government direction. You can either clear the decks of bad investments quickly like the US in the thirties or slowly like Japan in the 90's. Personally I think a quick deep recession would also eliminate the cronyism with banks. None of the biggest nineteen banks would have survived without government support.
Hayek might be misunderstood but recessions happen for a reason and to intervene only creates problems. That is why the Fed should not have control over the economy but just inflation. Without recessions asset bubbles appear to be permanent and many failed to realise that assets bubbles burst eventually.
This comment is from David Lazarus. For reasons unknown to me, blogger refused to display it in its original form.
ReplyDeleteDavid Lazarus said:
Hayek is the darling of the free markets because as an anti communist he spoke against the evils of a controlling government. Though later he did speak out against corporate domination. That element seems to be ignored. Until I found out about the other treatise on excessive corporate power I wrote him off as well.
Here is the link to a page from the BBC about Hayek and Keynes. There is also a podcast.
http://www.bbc.co.uk/news/business-14366054
I do agree with Hayek and Minsky that markets can get unbalanced and that excess needs to be cleared from the system. In the 30's this happened, then as Keynesian stimulus was applied it boosted the economy. It worked because there was no bad investments still standing. The only thing that stopped it was concern about deficits in 1937.
So my acceptance of Hayek is limited to the need to clear bad investments and for governments to do nothing apart from provide unemployment benefit till the bad investments are gone. Then use Keynesian stimulus to boost the economy. Though once the economy is going the second element of Hayek seem similar to Keynes. Hayek called for hair shirts to stop government spending getting out of control and Keynes for counter cyclical policies to curtail the excesses. Both have the same end result. The Hayek hair shirt could be taxes or cut spending just as Keynes would recommend. Hayek was against the excesses building up. If Hayek had been followed properly it would have led to no bubbles as policy makers would have had to intervene to avoid the boom itself. Though Policymakers always want a boom because they think that is what the public want. It is hard to resist.
I do know about the Federal Housing plans. These were instigated for two prime reasons. First to create employment and homes for those that lost their home. It was also to stop the build up of communist influence within the country. The US was paranoid that the masses unemployed with no stake in society would rise up and over throw the government. By giving them homes and a stake in society they were less likely to revolt. They did not feel the same about minorities and hence the red lines for credit acceptability. That was what stabilised the country for decades.
So my take on the recent crisis was that the policy makers learnt the wring lessons from the depression. I would have allowed the banks to collapse. It would have brought house prices down to the floor very quickly. That would have brought all the loans on to the FDIC balance sheet. Then started rewriting the mortgages in a way that meant they were repayable, and few needing to lose their homes. Then with lower debts the consumer would be in a far better state now. Then while millions would have lost jobs the extension to unemployment would have allowed bad investments to fold and clear the markets for new entrants. Then had a totally jobs centric stimulus package along the lines of a green economy. As you say allow the market find solutions with government direction. You can either clear the decks of bad investments quickly like the US in the thirties or slowly like Japan in the 90's. Personally I think a quick deep recession would also eliminate the cronyism with banks. None of the biggest nineteen banks would have survived without government support.
Hayek might be misunderstood but recessions happen for a reason and to intervene only creates problems. That is why the Fed should not have control over the economy but just inflation. Without recessions asset bubbles appear to be permanent and many failed to realise that assets bubbles burst eventually.
I reproduce a view from a provacative article by Derryl Hermanutz http://econintersect.com/b2evolution/blog2.php/2011/08/09/solve-debt-problems-with-non-debt-money
ReplyDeleteWhat the system needs now, according to the Austrian School, is a good hard depression to bankrupt all the weak debtors and take down all the insolvent banks who lent unpayable sums to debtors: the Andrew Mellon solution. However, unless we also embrace social Darwinism and let all the losers die off in unemployed poverty, a depression will only further reduce GDP and government tax revenues and further increase automatic stabilizers and other welfare payments, making the deficit much worse than it is already. So Austrians: are you advocating social Darwinism or a massive expansion of the welfare state? Are you advocating creative destruction of the human losers, or a massive increase in national debt? I’ve never received a coherent answer to this question and I’m not expecting one now.
I would not consider myself an Austrian. They are too rigid about balancing the government books. I am for a massive clear out of bad debts and then followed by stimulus, but with permanent unemployment benefits till they are all working again. The aim should be full employment and nothing else.
ReplyDeleteThis crisis will not be solved by austrian policy. We still have too much debt and unless that debt is written off, and restoring moral hazard at the same time we will end up with the worst of all outcomes. Stimulus so small, and ineffective that all it does is discredit Keynes. I would want very specific jobs program that was very high in labour content to minimise leakage. No tax cuts and even big tax increases on Capital and capital gains. Tobin taxes on commodities and currencies. Even capital controls. Elimination of a lot of tax loop holes and a massive simplification of taxes. This would raise substantial revenues but initially it would all be used for unemployment benefits and then as jobs programs came along for those. As unemployment falls the surplus could be used to eliminate the deficit. As long as there is a credible plan for reducing the deficit the markets will be happy. Taking responsibility from the Fed for the economy and restricting it solely to inflation would increase its success there.
To ensure that it is supported make sure that if a politician votes against it that no federal stimulus or earmarks are allowed in that constituency. If both senators from a state vote against it the entire state will lose any additional funds. This way voters will see the impacts of their politicians votes. At the moment they can grandstand without any consequences. Add consequences to their votes and you will see politicians voting for the people not the lobbyist's causes.
I agree entirely with the thrust of reducing the debt by letting the bad debt die and the creditors absorb the risk they were paid for. The Austrians, Keynes and you all foresee the decentralized markets finding the appropriate investment for the future. Keynes and you see the enforcement of income equality as leading to both more efficient capitalism and better social outcomes. I agree with the latter. But I do not accept that the markets are going to find the way to productive uses of capital because to this point it has been most rewarded by consumer goods, and that is where it will look again.
ReplyDeleteIt is necessary for government to present capitalists with a demand that when it is filled creates a stable and prosperous outcome. Step back, the Internet was not developed as the result of market demand for the wonderful new thing we have today. People did not know it was possible, so there was no effective consumer demand. Active "creative destruction" is necessary to make global warming technology antiquated and reconstruction of the society profitable. We are nibbling around the edges, and there is really no reason to.
The point being, that the market will continue to hoard and sink into its liquidity trap because there is no profitable investment. Government can make profitable investment by creating markets for public goods. I believe we live now in a post-consumer society and we need to decide whether that means a starvation and decay society or an integrated, planned society.
From Keynes biographer Robert Skidelsky:
ReplyDelete2011-08-19
The Keynes-Hayek Rematch
LONDON – The Austrian economist Friedrich von Hayek, who died in 1992 at the age of 93, once remarked that to have the last word requires only outliving your opponents. His great good fortune was to outlive Keynes by almost 50 years, and thus to claim a posthumous victory over a rival who had savaged him intellectually while he was alive.
Hayek’s apotheosis came in the 1980’s, when British Prime Minister Margaret Thatcher took to quoting from The Road to Serfdom (1944), his classic attack on central planning. But in economics there are never any final verdicts. While Hayek’s defense of the market system against the gross inefficiency of central planning won increasing assent, Keynes’s view that market systems require continuous stabilization lingered on in finance ministries and central banks.
Both traditions, though, were eclipsed by the Chicago school of “rational expectations,” which has dominated mainstream economics for the last twenty-five years. With economic agents supposedly possessing perfect information about all possible contingencies, systemic crises could never happen except as a result of accidents and surprises beyond the reach of economic theory.
The global economic collapse of 2007-2008 discredited “rational expectations” economics (though its high priests have yet to recognize this) and brought both Keynes and Hayek back into posthumous contention. The issues have not changed much since their argument began in the Great Depression of the 1930’s. What causes market economies to collapse? What is the right response to a collapse? What is the best way to prevent future collapses?
For Hayek in the early 1930’s, and for Hayek’s followers today, the “crisis” results from over-investment relative to the supply of savings, made possible by excessive credit expansion. Banks lend at lower interest rates than genuine savers would have demanded, making all kinds of investment projects temporarily profitable.
But, because these investments do not reflect the real preferences of agents for future over current consumption, the savings necessary to complete them are not available. They can be kept going for a time by monetary injections from the central bank. But market participants eventually realize that there are not enough savings to complete all the investment projects. At that point, boom turns to bust.
Every artificial boom thus carries the seeds of its own destruction. Recovery consists of liquidating the misallocations, reducing consumption, and increasing saving.
Part 2:
ReplyDeleteKeynes (and Keynesians today) would think of the crisis as resulting from the opposite cause: under-investment relative to the supply of saving – that is, too little consumption or aggregate demand to maintain a full-employment level of investment – which is bound to lead to a collapse of profit expectations.
Again, the situation can be kept going for a time by resorting to consumer-debt finance, but eventually consumers become over-leveraged and curtail their purchases. Indeed, the Keynesian and Hayekian explanations of the origins of the crisis are actually not very different, with over-indebtedness playing the key role in both accounts. But the conclusions to which the two theories point are very different.
Whereas for Hayek recovery requires the liquidation of excessive investments and an increase in consumer saving, for Keynes it consists in reducing the propensity to save and increasing consumption in order to sustain companies’ profit expectations. Hayek demands more austerity, Keynes more spending.
We have here a clue as to why Hayek lost his great battle with Keynes in the 1930’s. It was not just that the policy of liquidating excesses was politically catastrophic: in Germany, it brought Hitler to power. As Keynes pointed out, if everyone – households, firms, and governments – all started trying to increase their saving simultaneously, there would be no way to stop the economy from running down until people became too poor to save.
It was this flaw in Hayek’s reasoning that caused most economists to desert the Hayekian camp and embrace Keynesian “stimulus” policies. As the economist Lionel Robbins recalled: “Confronted with the freezing deflation of those days, the idea that the prime essential was the writing down of mistaken investments and…fostering the disposition to save was…as unsuitable as denying blankets and stimulus to a drunk who has fallen into an icy pond, on the ground that his original trouble was overheating.”
Except to Hayekian fanatics, it seems obvious that the coordinated global stimulus of 2009 stopped the slide into another Great Depression. To be sure, the cost to many governments of rescuing their banks and keeping their economies afloat in the face of business collapse damaged or destroyed their creditworthiness. But it is increasingly recognized that public-sector austerity at a time of weak private-sector spending guarantees years of stagnation, if not further collapse.
So policy will have to change. Little can be hoped for in Europe; the real question is whether President Barack Obama has it in him to don the mantle of President Franklin Roosevelt.
To prevent further crises of equal severity in the future, Keynesians would argue for strengthening the tools of macroeconomic management. Hayekians have nothing sensible to contribute. It is far too late for one of their favorite remedies – abolition of central banks, supposedly the source of excessive credit creation. Even an economy without central banks will be subject to errors of optimism and pessimism. And an attitude of indifference to the fallout of these mistakes is bad politics and bad morals.
So, for all his distinction as a philosopher of freedom, Hayek deserved to lose his battle with Keynes in the 1930’s. He deserves to lose today’s rematch as well.
Robert Skidelsky, a member of the British House of Lords, is Professor Emeritus of Political Economy at Warwick University.
Copyright: Project Syndicate, 2011.
www.project-syndicate.org