The Keynesian Cure

BERKELEY amp#45;amp#45; It is not yet foredoomed that the world economy will undergo a substantial recession in the next three years or so: we might still escape. But governments should play it safe by starting to take more steps now to cushion, soften, and shorten the period of high unemployment and slow or negative growth that now looks very likely.

It is a fact of nature – human nature, at least – that prudent and appropriate policies now will later seem excessive. At some point, the world economy will begin expanding rapidly again. But it would be most imprudent to assume that the turning point is right now, and that things are as bad as they will get.

Perhaps the best way to look at the situation is to recall that three locomotives have driven the world economy over the past 15 years. The first was heavy investment, centered in the United States, owing to the information technology revolution. The second was investment in buildings, once again centered in the US, driven by the housing boom. The third was manufacturing investment elsewhere in the world – predominantly in Asia – as the US became the world economy’s importer of last resort.

For 15 years, these three locomotives kept the world economy near full employment and growing rapidly. When the high-tech boom ended in 2000, the Federal Reserve orchestrated its replacement by the housing boom, while investment in Asia to supply the US market was chugging along at an increasing pace.