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Fixing the Right Hole

LONDON – The “laws of holes” are as unforgiving as the laws of physics.  If you find yourself in a hole and want to get out, the first thing you do is to stop digging. If you confront a number of holes to fix and want to know which to fix first, you choose the one which poses the greater danger. These laws are particularly true when applied to government finance.

When John Maynard Keynes talked of persistent under-employment, he did not mean that, following a big shock, economies stay frozen at one unchanging level of depressed activity. But he did think that, without external stimulus, recovery from the lowest point would be slow, uncertain, weak, and liable to relapse. His “under-employment equilibrium” is a form of gravitational pull rather than a fixed condition.

This is a situation that Alan Greenspan, the former chairman of the United States Federal Reserve, described as a “quasi-recession,” a better term than “double-dip recession.” It denotes an anemic recovery, with bursts of excitement punctuated by collapses. It is the situation we confront today.

Contrary to Keynes, orthodox economists believe that, after a big shock, economies will “naturally” return to their previous rate of growth, provided that governments balance their budgets and stop stealing resources from the private sector.  The theory underlying this way of thinking was set out in the July Bulletin of the European Central Bank.