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Keynesian US?

by afew Wed Sep 3rd, 2008 at 09:49:30 AM EST

More thinking on Europe's economic difficulties in this month's number of French economics monthly Alternatives Economiques, where chief ed Guillaume Duval does a transatlantic comparison.

Politiques budgétaires : Etats-Unis 1, Europe 0 par Guillaume Duval - Septembre 2008 Budgetary policies: USA 1, Europe 0 by Guillaume Duval - September 2008
... L'éclatement de la bulle de l'immobilier américain à l'été 2007, combiné à la hausse des prix du pétrole et des produits alimentaires, faisait redouter le pire. Et cela d'abord pour l'économie américaine. Pourtant, un an plus tard, c'est en Europe que les conséquences de ce krach sont les plus sévères.... The bursting of the US real estate bubble in summer 2007, combined with rising oil prices and food, gave rise to fears of the worst -- for the U.S. economy first and foremost. Yet, one year later, the consequences of the crash are most severe in Europe.
L'activité économique européenne (et française) a reculé au second trimestre 2008, tandis que l'économie américaine continuait à croître au rythme de 1,9 % l'an. Une situation analogue s'était déjà produite après l'éclatement de la bulle de la high-tech en 2001: combinée aux affaires Enron et autres, ainsi qu'aux attentats du 11 septembre, elle avait déclenché un sévère coup de frein sur l'économie mondiale. D'où vient ce paradoxe ? Essentiellement de la différence de réactions des autorités monétaires et budgétaires de part et d'autre de l'Atlantique. La gouvernance économique de l'Europe ne lui permet pas en effet de répondre de façon adéquate aux chocs conjoncturels.European (and French) economic activity declined in the second quarter of 2008, while the U.S. economy continued to grow at an annual rate of 1.9%. A similar situation already occurred after the bursting of the high-tech bubble in 2001: combined with Enron and other affairs, along with 9/11, it triggered a severe slowdown of the global economy. Why this paradox? It comes essentially from the differing reactions of monetary and fiscal authorities on either side of the Atlantic. The economic governance of Europe does not allow it, in fact, to respond adequately to economic shocks.
Les contraintes statutaires qui pèsent sur la Banque centrale européenne et l'absence de politique de change de l'euro ont pesé lourd dans les difficultés du Vieux Continent ces derniers mois. Mais la rigidité des politiques budgétaires du fait des règles fixées par le pacte de stabilité et de croissance joue aussi un rôle majeur dans les mauvais résultats économiques actuels de l'Europe...The statutory constraints on the European Central Bank and the absence of a euro exchange rate policy, have weighed heavily in the difficulties of the Old Continent in recent months. But the rigidity of budgetary policies due to the rules of the Stability and Growth Pact also plays a major role in Europe's current poor economic performance...

Duval shows this graph of budgetary impulses on either side of the pond:

explaining that this shows money (in % of GDP) injected into the economy to support economic activity, in the form of deficit-funded public spending. Twice as much in the US than in Europe after the 2001 crisis; and


Rebelote en pire en 2007 et 2008: les pouvoirs publics européens devraient même avoir, selon les chiffres de la Commission européenne, une action budgétaire globale restrictive sur l'économie de la zone euro à hauteur de - 0,3 point de PIB, alors que les Etats-Unis auront injectés dans leur économie 2,5 points de PIB supplémentaires. Un montant probablement sous-estimé d'ailleurs, car de nouvelles mesures ont été décidées outre-Atlantique depuis que ces chiffres ont été établis. Pas étonnant, dans ces conditions, que les crises financières venues des Etats Unis aient des effets moins sensibles outre-Atlantique que chez nous...Same again, but worse, in 2007 and 2008: European governments are even likely to have, according to figures from the European Commission, a restrictive budgetary effect on the eurozone economy to the tune of - 0.3 percentage points of GDP, while it is reckoned the USA will have injected 2.5 percentage points of GDP into their economy. An amount probably underestimated by the way, since new measures were decided across the Atlantic since these figures have been established. It's not surprising, in these conditions, that financial crises originating in the United States have less palpable effects across the Atlantic than on our side...

One could complain about this view in a number of ways, not least among them that comparisons of GDP growth are hazardous, particularly when considering the US. Duval also gives the impression he thinks the US did well in getting out of the post-2001 downturn, forgetting the Greenspanian monetary impulse towards a new bubble, the one that burst last year. But essentially what he's saying is that Europe (read rather: the eurozone) lacks economic governance. And that, if it had economic governance, Keynesian policies could usefully have been applied. In the absence of it, we simply have a central bank making monetary (in this case hard monetary) choices.

Yet, in a following article, Jacques Adda says this:

Le grand écart des politiques monétaires par Jacques Adda - Septembre 2008 Monetary policies wide apart by Jacques Adda - Alternatives Economiques September 2008
Au début des années 50, l'économiste néerlandais Jan Tinbergen énonçait une règle qui allait devenir fameuse: pour pouvoir atteindre ses buts, une politique économique doit disposer d'autant d'instruments qu'elle a d'objectifs. Ce qui est vrai de la politique économique dans son ensemble l'est aussi de la politique monétaire en particulier. La chose ne poserait pas de problème si, comme c'est le cas traditionnellement, la politique monétaire était uniquement investie de la préservation de la stabilité des prix, la politique budgétaire assumant par ailleurs la régulation de l'activité. Cette simple division des tâches n'est cependant plus de mise dans nombre de pays, où le niveau élevé de la dette publique et le vieillissement des populations ont imposé une orientation structurellement restrictive aux politiques budgétaires. A quoi s'ajoute le fait que les délais importants d'élaboration et d'impact du budget de l'Etat ont fini par discréditer la fonction conjoncturelle de cette politique.In the early 50's, Dutch economist Jan Tinbergen set out a rule which would become famous: In order to achieve its goals, an economic policy must have as many instruments it has aims. What is true of economic policy as a whole is also of monetary policy in particular. This would be no problem if, as is the case traditionally, monetary policy was only concerned with the preservation of price stability, while fiscal policy looked after the regulation of economic activity. This simple division of labour, however, no longer applies in many countries, where the high level of public debt and the ageing of the population have imposed a structurally restrictive orientation on budgetary policies. Added to this is the fact that a considerable time lag in the development and impact of government budgets ended up by discrediting the economic function of this policy.
Du coup, l'essentiel du pilotage à court terme de l'activité et des prix incombe dans la plupart des pays aux banques centrales.As a result, most short-term steering of activity and prices falls, in most countries, within the purview of the central banks.

He goes on to argue that the ECB has paid too much attention to inflation and has throttled activity, but I'm more interested in this: how far is it true that the US has much greater freedom to manoeuvre, as a wealthy and relatively powerful nation state, than the eurozone, as a wealthy and relatively powerless... central bank plus collection of bridled nation states?

Display:
... the US built the institutional freedom to maneuver, of course, in two world wars and a Great Depression, so it is perhaps not surprising that a large amount of that Keynesian stimulus is in the form of funding reckless military adventures abroad.

The big flaw with a collaborative policy negotiated under terms informed by the conventional wisdom is that the conventional wisdom is wrong, so rather than mandating sound economic policy, for much of the business cycle the negotiated terms forbid sound economic policy.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Sep 3rd, 2008 at 10:48:34 AM EST
Yup, the question of what the deficit-funded spending was on was subjacent to the one I asked. It wasn't on any Tennessee Valley stuff, fo' sho'.

Point taken on paragraph two. What elements of the CW are wrong (with ref to the ECB and Stability Pact), and how to right them?

by afew (afew(a in a circle)eurotrib_dot_com) on Wed Sep 3rd, 2008 at 11:09:32 AM EST
[ Parent ]
Let's look at the actual CW policy versus a kind of generic Post Keynesian macro policy advice. I'm not really in shape in the middle of the week to get into nitty gritty, so I'll keep it generic.

(1) The interest rate should be low and stable.

(2) There should be active automatic stabilizers that kick in when the economy slows substantially.

(3) The economy should be allowed to move toward full employment ... running the economy at a perpetual idle reduces incentive to invest in plant and equipment which reduces productive capacity which increases the level of unemployment at which demand-pull inflation kicks in.

(4) The response to supply-side inflation is medium and long term investment in complementary infrastructure and development that increases productivity growth rates.

CW:

(1) Set the inflation benchmark absurdly low ... 0%-3% ... and use variable interest rates as the primary policy tool.

(2) Target a balanced budget over the business cycle and cap deficit spending at some low level except in periods of actual economic contraction.

The CW set of policies is perennially knocking the economy back from approaching full employment because the productive capacity is not in place to employ those people because the economy has not previously been allowed to approach full employment. Long term public investment in infrastructure and R&D, required to maintain productivity growth, are under constant budgetary pressure, while the focus of the private investment they complement are biased toward the short term by the risk premium required by the volatile interest rates generated by the monkeying around with interest rates.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Sep 3rd, 2008 at 11:30:36 AM EST
[ Parent ]
By law, Fed has two (the third is on the paper but is ignored) goals: price stability and close to the full employment. ECB has only price stability written into its charter, and this won't be changed unless a new treaty is made.

There was a vicious fight at the Jackson Hole symposium this year, between Willem Buiter and Alan Blinder. See the round-up of the symposium here, links to Buiter/Blinder fight are in the very last paragraph.

The WSJ blog said, in particular:

Mr. Buiter slams the Federal Reserve, European Central Bank and Bank of England for what he says was a mishandling of the financial crisis and monetary policy over the past year. He gives the worst marks to the Fed, saying it's too close to Wall Street and financial markets -- responding to their needs to the detriment of the wider economy. Mr. Buiter, a former member of the BOE's Monetary Policy Committee, said the Fed overreacted to the economic slowdown -- misjudging the importance of financial stability to the overall economy -- and created a deeper inflation problem as a result.

An essence of Blinder's remarks, from the same WSJ source:

One day a little Dutch boy was walking home when he noticed a small leak in a dike that protected the people in the surrounding town. He started to stick his finger in the hole, but then he remembered his moral hazard lesson. "The companies that built this dike did a terrible job," the boy said. "They don't deserve a bailout. And doing that would just encourage more shoddy construction. Besides, the dumb people who live here should never have built their homes on a floodplain." The boy continued on his way home. Before he arrived, the dike burst and everyone for miles around drowned, including the little Dutch boy.

Mr. Blinder continued: "You might have heard an alternative version of this story circulating around the Fed."

In this kindler, gentler version, the little Dutch boy, somewhat desperate and very worried about the horrors of the flood, stuck his finger in the dike and held it there until help arrived. ... It was painful. The little Dutch boy would much rather have been somewhere else. But he did it anyway. And all the foolish people who live behind the dike were saved from the error of their ways.

As you see, Buiter is aghast at the very thing those two French papers seem to agree on: too much flexibility by the Fed. However, Buiter isn't really worried about Fed's flexibility regarding the economy, he's more concerned about Fed caring too much about the Wall Street's perception of the economy.

by Sargon on Wed Sep 3rd, 2008 at 12:07:19 PM EST
Given the current state of monetary policy theory, not having as an explicit gdp growth target doesn't say much. The 2 % inflation target can be seen as the limit of the extent to which the ECB can "stimulate" the economy.

This way of directing central bank policy aims at curbing the ECB's leeway in times of crises and ensure that it isn't "captured by political interests". In normal times however, given the number of strategies available to keep the inflation in range, we can expect the ECB to pick the most 'stimulating' one.

As for those two French paper, I believe they placate the notion that Keynesian policies shouldn't be used to smoothen the business cycle out -- more precisely, by not more than than 3 % of GDP. Buiter on the other hand is more interested in the banking sector and the extent of oversight and regulation it seems to require. At the core, it seems to me, is the notion that the existing banking sector is the only viable one: it is not only that changing it would require massive loss of wealth [I know, for whom is unclear] but also that we don't know of better alternatives.

Buiter, as far as I know, points mostly to the moral hazard argument and the impossibility of oversight in a context of "regulatory capture". I have yet to read his most recent paper, presented at the Jackson Hole Conference, where I think he introduces new policies. I will do that soon, as I am curious as to what he would propose, and the extent to which it follows the rightfully hailed Swedish model of bank rescue.

Rien n'est gratuit en ce bas monde. Tout s'expie, le bien comme le mal, se paie tot ou tard. Le bien c'est beaucoup plus cher, forcement. Celine

by UnEstranAvecVueSurMer (holopherne ahem gmail) on Wed Sep 3rd, 2008 at 01:01:24 PM EST
[ Parent ]
the focus on GDP is itself profoundly flawed. All the "growth" in the US in the past 30 years has only gone to a small number of people.

The most recent cycle has seen median incomes end up below where they were at the beginning of the cycle, for the first time in a very long while.

Beyond the fact that GDP as a measure of the overall economy is not very good, its repartition is becoming the biggest problem.

Don't forget: "growth" = "growth for the top 0.1%'s incomes" these days. Thus GDP goes only so far.

Should we worry that the European institutional framework is less favorable to the ultra rich?

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Wed Sep 3rd, 2008 at 03:39:34 PM EST
Is there a more realistic alternative to GDP?  I'm clueless but are there other measures that would highlight more accurately where the growth has occurred and what this actually means with respect to those who have been losing out?

My thought is that GDP can only keep being used to boast about how well a country is doing for a finite time. Surely a plateau will be reached where although there is still growth for the top 0.1% the detriment of this disparity of wealth distribution is then taking chunks out of the economy through the social problems that are arising or becoming worse as a result?

by In Wales (inwales aaat eurotrib.com) on Thu Sep 4th, 2008 at 07:32:53 AM EST
[ Parent ]
The problem is with the insistence on using a single number. I don't think GDP is a useless quantity, but there's no reason why it (or any other single statistical aggregate) needs to be the be-all and end-all of the health of an economy.

The "problem" is that as long as you use more than one dimension to measure something, ranking becomes impossible. For me, the absence of a linear ranking is a good thing.

Anyway, the origin of GDP can be traced back to the work of Kuznets:

Kuznets is credited with revolutionising econometrics, and this work is credited with fueling the so-called Keynesian "revolution". An important book of his is National Income and Its Composition, 1919-1938. Published in 1941, it contains a historically significant work on Gross National Product. His work on the business cycle and disequilibrium aspects of economic growth helped launch development economics. He also studied inequality over time, and his results formed the Kuznets Curve.

...

Kuznets's life work was the collection and organization of the national income accounts of the United States (1934, 1941, and 1946). Kuznets was interested in statistical fact finding focusing specifically on seasonal fluctuations, secular movements, national income estimation, and economic growth. He computed national income back to 1869. He broke it down by industry, by final product, and by use. He also measured the distribution of income between rich and poor. Although Kuznets was not the first economist to try this, his work was so comprehensive and meticulous that it set the standard in the field.

Kuznets helped the U.S. Department of Commerce to standardize the measurement of GNP. He disapproved, however, of its use as a general indication of welfare, writing that "the welfare of a nation can scarcely be inferred from a measure of national income".

Keynes had the following to say about National Income and Inflation:
That the units, in terms of which economists commonly work, are unsatisfactory can be illustrated by the concepts of the national dividend, the stock of real capital and the general price-level:

...

Thirdly, the well-known, but unavoidable, element of vagueness which admittedly attends the concept of the general price-level makes this term very unsatisfactory for the purposes of causal analysis, which ought to be exact.

...

But the proper place for such things as net real output and the general level of prices lies within the field of historical and statistical description, and their purpose should be to satisfy historical or social curiosity, a purpose for which perfect precision--such as our causal analysis requires, whether or not our knowledge of the actual values of the relevant quantities is complete or exact--is neither usual nor necessary. To say that net output to-day is greater, but the price-level lower, than ten years ago or one year ago, is a proposition of a similar character to the statement that Queen Victoria was a better Queen but not a happier woman than Queen Elizabeth--a proposition not without meaning and not without interest, but unsuitable material for the differential calculus. Our precision will be a mock precision if we try to use such partly vague and non-quantitative concepts as the basis of our quantitative analysis.




A vivid image of what should exist acts as a surrogate for reality. Pursuit of the image then prevents pursuit of the reality -- John K. Galbraith
by Migeru (migeru at eurotrib dot com) on Thu Sep 4th, 2008 at 07:44:23 AM EST
[ Parent ]
the GDP is effectively a number representing average income (as an aggregate). Focus on a number representing median incomes or on the number representing, say, the lowest 5% of income would lead to very different policies (working towards improving the lot of the middles classes in the first case, and of the poor in the second case).

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Thu Sep 4th, 2008 at 09:39:28 AM EST
[ Parent ]
How Keynesian US actually is, or can be?

There will be no happy "recapitalize and privatize" ending to this saga. The bill to the taxpayer is now growing rapidly - along with GSE [Government Sponsored Gnterprises] exposure - and will balloon into the trillions over the coming years and decades. And for how long the holders of GSE debt and MBS [Mortgage Backed Securities] will be allowed such handsome returns at taxpayer expense is a quite intriguing question.

I also read and hear too much about the continued need for "Keynesian" stimulus. Regrettably, the system has been in non-stop government (fiscal and monetary) stimulus mode for years now. It may have been indirect at the time, but it is now apparent that GSE obligations should be included today right along with debt owed directly by the Treasury.

Before all is said and done, the taxpayer will also be on the hook for enormous losses from various federal guarantees of deposits, student loans, pensions, and the like. The bottom line is that a whole range of direct and indirect federal guarantees - especially since the 2001/02 recession - have played an integral role in spurring credit and economic bubbles. "Keynesian" ammunition - fired way too early and freely in order to sustain multiple bubbles - has definitely buoyed the US bubble economy, although such measures will have only limited effect down the road when they're sorely needed.

This author may be right the US economy was in non-stop stimulus mode for years, though that "bubble" stimulus was far from Keynesian. How much Keynesian "ammunition" was inside the bubbles? What would Keynes would do now?

by das monde on Thu Sep 4th, 2008 at 04:32:19 AM EST


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