The Fear Factor

The dominant macroeconomic paradigm since the early 1980’s does not include unemployment as a factor, and it does not assign an independent role to confidence. But confidence is a scientific concept that can be inferred from observing asset price movements.

LOS ANGELES – The debate over fiscal expansion versus consolidation continues to divide the developed world. In response to the global recession of 2008, the United Kingdom embarked on an austerity program while the United States enacted an $800 billion fiscal stimulus. Despite a softening economy, British Prime Minister David Cameron is promising to stay the austerity course. Obama, too, is sticking to his guns with his recent proposal for an additional $450 billion of government expenditure and tax cuts to help boost employment.

Unemployment in the US has remained above 9% for 22 of the last 24 months. While some are supporting additional stimulus, others are calling for UK-style austerity. But would either of these approaches reduce unemployment most effectively, or would a new round of  “quantitative easing” (an unconventional form of economic stimulus by which the central bank purchases financial assets) work better?

With Nobel prize-winning economists on both sides of the current debate about how to solve the unemployment problem, the public is rightly confused. Paul Krugman and Joseph Stiglitz are calling for an even larger fiscal stimulus to target government spending on education and infrastructure investment. On the other side, Robert Mundell, Myron Scholes, and Reinhard Selten have called for “draconian measures” to tame debt levels.

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