Anatomy of the Global Economy
Pain without Purpose
J. Bradford DeLong
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BERKELEY – Three times in my life (so far), I have concluded that my understanding of the world was substantially wrong. The first time was after the passage in 1994 of the North America Free Trade Agreement (NAFTA), when the flow of finance to Mexico to build factories to export to the largest consumer market in the world was overwhelmed by the flow of capital headed to the United States in search of a friendlier investment climate. The result was the Mexican peso crisis of later that year (which I, as US Assistant Secretary of the Treasury, had to help contain).
My second epiphany came in the fall and winter of 2008, when it became clear that large banks had no control over either their leverage or their derivatives books, and that the world’s central banks had neither the power nor the will to maintain aggregate demand in the face of a large financial crisis.
The third moment is now. Today, we face a nominal demand shortfall of 8% relative to the pre-recession trend, no signs of gathering inflation, and unemployment rates in the North Atlantic region that are at least three percentage points higher than any credible estimate of the sustainable rate. And yet, even though politicians who fail to safeguard economic growth and high employment tend to lose the next election, leaders in Europe and the US are clamoring to enact policies that would reduce output and employment in the short run.
Am I missing something here?
I had thought that the fundamental issues in macroeconomics were settled in 1829. Back then, even Jean-Baptiste Say no longer believed in Say’s Law of business-cycle frequencies. He knew very well that a financial panic and excessive demand for financial assets could produce deficient demand for currently-produced commodities and for labor, and that while such a short-run breakdown of Say’s Law might be temporary, it was nonetheless highly destructive.
Armed with that insight, the disease of the business cycle should be addressed in one or more of three ways.
1. Don’t go there in the first place. Avoid whatever it is – whether an external drain under the gold standard or a collapse of long-term wealth as with the collapse of the dot-com bubble or a panicked flight to safety as in 2007-2008 – that creates a shortage of, and excess demand for, financial assets.
2. If you fail to avoid the problem, then have the government step in and spend on currently produced goods and services in order to keep employment at its normal levels to offset private-sector spending cuts.
3. If you fail to avoid the problem, then have the government create and provide the financial assets that the private sector wants to hold in order to get the private sector to resume its spending on currently produced goods and services.
There are a great many subtleties to how a government should attempt to pursue each of these policy options. Attempts to carry out one of the three may exclude or interfere with attempts to carry out the others. And, if inflationary expectations become embedded in an economy, it may be impossible for any of the three cures to work. But that is not our situation today.
Likewise, if the perceived creditworthiness of the government is shaken, then intervention from some outside lender of last resort might be essential for either the second or third cure to work. But that, too, is not the situation today in the core economies of the North Atlantic.
Yet, somehow, all three of these cures are now off the table. There is no likelihood of reforms of Wall Street and Canary Wharf aimed at diminishing the likelihood and severity of any future financial panic, and no likelihood of government intervention to restore the normal flow of risky finance through the banking system. Nor is there any political pressure to expand or even extend the anemic government stimulus measures that have been undertaken.
Meanwhile, the European Central Bank is actively looking for ways to shrink the supply of financial assets that it provides to the private sector, and the US Federal Reserve is under pressure to do the same. In both cases, it is claimed that further expansionary asset-provision policies run the risk of igniting inflation.
Yet no likelihood of inflation can be seen when tracking price indexes or financial-market readings of forecast expectations. And no approaching government debt crisis in the core economies can be seen when tracking government interest rates.
Nevertheless, when you listen to the speeches of policymakers on both sides of the Atlantic, you hear presidents and prime ministers say things like: “Just as families and companies have had to be cautious about spending, government must tighten its belt as well.”
And here we reach the limits of my mental horizons as a neoliberal, as a technocrat, and as a mainstream neoclassical economist. Right now, the global economy is suffering a grand mal seizure of slack demand and high unemployment. We know the cures. Yet we seem determined to inflict further suffering on the patient.
J. Bradford DeLong, a former US Assistant Secretary of the Treasury, is Professor of Economics at the University of California at Berkeley and a Research Associate at the National Bureau for Economic Research.
Copyright: Project Syndicate, 2011.
www.project-syndicate.org
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Psarabiflora 11:15 01 Mar 11
See: Wisconsin. Cutting the salaries (or jobs) of ~299,000 state employees might yield short term budgetary benefits, btu how many will be pushed over the financial edge as a result of an 8-12% pay cut?
Worse still, those lost wages-- in the form of increased employee contributions to health and pension benefit plans-- will magically disappear from the local, state, and perhaps even the national economies. "No ripple effect for you!"
It all seems so bltantly obvious that the rape of the middle class will continue until morale improves... and yet it's all so very, very, petty; if I'm gonna get screwed, it would be nice if they would tell me I'm pretty.
lukehlee 06:32 01 Mar 11
Most people agree with the adage that if you don't diagnose the problem correctly, the odds are you won't prescribe the right medicine. So, have we diagnosed our economic situation correctly and prescribed the right economic policies over the last several years? Obviously not, for look at the mess we are now in.
I would strongly suggest we have made a serious mistake in the market over the last 20 to 30 years of the Modern Information Age, and it created an economic death spiral in the economy. Strangely, our economic experts have not considered this at all in their ruminations about the economy.
What mistake? Please see this slide: “What Should We Do for the Economy? Fix the Mistake...” http://t.co/RzpDqj4
guydej 07:03 01 Mar 11
"Yet no likelihood of inflation can be seen when tracking price indexes"
Uh? Maybe not in the US. However, in the Eurozone the rate of inflation has risen steadily to 2.4 per cent currently, while here in the UK it is around 5 per cent and accelerating - more than twice the Bank of England's target level. Oil is well above $100 per barrel, cotton prices are at record levels and in the Middle East soaring food prices have been a significant contributor to the recent mass uprisings in Egypt and Tunisia. Meanwhile, in India consumer prices are rising by 10 per cent and in China by about 5 per cent, according to the official figures. Many unofficial estimates suggest that the real rises are considerably higher.
In these circumstances, to suggest that inflation is invisible or non-existent seems a tad complacent. Which is not to deny that tightening fiscal and monetary policies too sharply would risk precipitating a downturn in growth. But surely the story here is that economic policymakers in much of the world are between a rock and a hard place.
Devising exit strategies from crisis-induced stimulus programmes always promised to be tricky. And so it is proving.
lyndscott 04:57 02 Mar 11
Poor governance, criminality, power ..... pick it. 30 years, more ? When criminals inflitrate our government, the outcome is predicatable. Can anyone say Bill Clinton & Robert Rubin ? But, what do I know, I'm a nothing, I used to be an American Citizen, now, according to WAll St. & our government, I am a nothing, just pockets to be emptied until I can't even afford food , let alone make a mortgage payment !
jschmidt 06:49 02 Mar 11
Prof. DeLong is viewing cultural and political events through his econ lens to the exclusion of other more fundamental aspects. Regular people -- those with regular jobs who pay regular taxes and who are concerned about their children and therefore the country's generational future -- aren't as concerned about next year's GDP as they are about the undeserving distribution of rewards. They haven't learned such terms as "regulatory capture," "moral hazard," and "Keynesian multiplier," but they intuitively grasp the exclusive and predatory nature of the CEO/board syndicate, the unfairness in bank bailouts, the cronyism among politicians and public employee unions, wasteful depletion of the treasury -- fundamentally, ill-gotten gains and unjust exactions, particularly of the past three years. To regular people, GDP and even personal income rank subordinate to ethical justice -- the opposite of most economists' views. To return to Prof. DeLong's title, the "purpose" of the "pain" is to return to a more just economy, even if smaller.
FRoxo 03:40 03 Mar 11
How can developed world expand private consumption and investment on the perception of increased unsustainability of pension’s schemes?
And how can governments increase their debts?
And in EU how can governments create and provide financial assets?
carlson73 05:21 03 Mar 11
Technically you are right of course, but in reality many people are willing to suffer a worse short term, to actually regain control of their government's spending which they now realize they have not had for 15 to 20 years. Seriously, most Americans now have no reason to believe in politicians, technocrats, especially financial/economic technocrats who missed two massive bubbles completely, or the leaders of the biggest financial firms in the world-at least from an effective policy perspective.
They are taking the conservative posture of saying, we don't believe you guys any more, so we want policies we understand even if they are not "optimal", at least we know that in the long run they will work.
The problem is of course that what politicians are hoping to do is make enough of a difference to avoid having to take action on the BigFour, but in the long run they will have to act there as well.
JGBHimself 06:03 04 Apr 11
Now, you are talking! However, like all politicians, see what that gets you - all those disagree-con-ments (sp?).
Said you: "Am I missing something here?" and "Three times in my life (so far), I have concluded that my understanding of the world was substantially wrong."
Said we: Well, setting aside that proves you have never been "in (then out of) love", or divorced, what you have put your finger on is The Fact: that not only do they not know what they're doing, they did not understand what they were doing, why it didn't work, what c/sh/would work, and what is about to happen to them, due to their stupidity.
The number of the employed/participants in this country is about equal to when W was elected - over that decade we have NOT provide even one (1) new job. There are, however, 30 million more of U.S.
As Psarabiflora points out to U.S. that means far fewer of U.S. are paying into local, state & federal budgets; AND into SS, Medicare & Medicaid.
How many 99's over 62 have been forced to take early SS to survive? How many between 55 and 62 will not survive to do that? How much more will the rest of U.S. have to contribute to "cover" their lost contributions to their own SS, Medicare & Medicaid costs?
Assuming also, of course, that by cutting government employees at all levels, we will eliminate the costs of their pensions. And that they do not already HAVE fully vested pensions - that they can, now, collect. And that by cutting taxes that will eliminate the debts for un-funded pension obligations we already have. Less people paying into/for their pensions; less funds to pay for our part of their pensions; millions with "life sentences" - those of U.S. paying for it - both inside and outside the walls of those gated communities.
Permit U.S. to ask you: Are WE missing something?
[not your very good article, of course]
RalphMus 10:01 01 Mar 11
Brad de Long is 100% right. All I can add is an explanation for Atlantic governments’ absurd behaviour: it’s basically just economic illiteracy, and as follows.
1. The comparison between countries and families is nonsense: the comparison confuses macro and micro.
2. The economic illiterates are worried that more stimulus means more debt. The solution to that problem is to let the deficit accumulate as additional monetary base rather than additional debt (which was actually Keynes’s preferred policy).
But the illiterates would respond to the latter suggestion by chanting “inflation”. They fail to see that additional money does not cause inflation UNTILL it causes excess demand and extra demand is exactly what is needed. David Hume pointed this out in his essay “Of Money” 250 years ago. So the illiterates are a 250 years behind the times.
No on second thoughts, Ancient Rome had a credit crunch, which they dealt with by distributing money to all and sundry. The illiterates are 2,000 years behind the times.