US infrastructure could create those jobs

Some alarming figures have been banded about with regard to America’s infrastructure. It is estimated that over 700,000 bridges are rated as structurally deficient. In 2009 Americans lost approximately $78 billion to traffic delays – inefficient use of time and petrol costs. Also crashes which to a large extent have been caused by road conditions, cost a further $230 billion.

According to the American Society of Civil Engineers the US needs to spend $2.2 trillion bring their infrastructure up to standard. The Congressional Budget Office estimated in 2011 that for every dollar the federal government spent on infrastructure the multiplier effect was up to 2.5. Other indicators state that every $1 billion spent on infrastructure creates 18,000 jobs, almost 30% more than if the same amount were used to cut personal income taxes. – The Economist

Positive Externalities from infrastructure.

Investment in infrastructure has a lot of positive externalities – faster traveling time for consumers and companies, spending less time on maintenance. Research has shown that the completion of a road led to an increase in economic activity between 3 and 8 times bigger than it initial outlay with eight years after its completion. But what must be considered is that now is the best time to invest in infrastructure as it is very cheap – much cheaper than it will be when the economy is going through a boom period.

Chinese growth = blow up bridge and rebuild it.

Another very useful clip from Paul Solman of PBS News. China has for quite a few years now gone down the route of government planning to keep economic activity buoyant. Assumptions have been made that in 10 years time there will be 200 cities in China with over 1 million people and 8 being over 10 million. However a recent blog post showed that there are ghost towns in certain areas of China with empty housing estates.

An example of artificially creating growth, as well as building host cities, is have a 7 year old bridge (built to last for 40 years) blown up and rebuilt. This generates jobs for construction industry including contractors for different aspects of the bridge. This likens to Keynesian policy where J.M.Keynes said that you should dig holes and fill them in to keep people employed. The Soviet Union found that central planning is good at mobilising resources, but is not good at sustaining innovation, or incentives that promote long-term growth. What China needs is more domestic consumption and move away from a reliance on government investment projects and export revenue. As ever Paul Solman explains things well.

“We should repair our highways” says The Economic Naturalist

Robert Frank author of “The Economic Naturalist” and “The Darwin Economy” recently wrote a piece in The New York Times advocating tradiitonal Keynesian stimulus policy. With the US election on the horizon both Obama and Romney will be focusing on how to kick-start the economy. Obama has been a keen believer in infrastructure investment as a way to get American back into work whilst Romney has recognised the clear link between spending and employment.

In 2009 it was estimated that US roads, bridges and other infrastructure were in disrepair by the order of $2 trillion. There are many with the skills to do these jobs that are currently unemployed. Furthermore the longer you leave the repairs the more expensive it becomes. Some have said that this just puts the government into further debt but Frank argues that:

The same logic applies to overdue infrastructure investments. Yes, paying for them requires more government debt. And while austerity advocates fret that such projects will impoverish our grandchildren, they concede that the investments can’t be postponed indefinitely, and that they’ll become much more expensive the longer we wait.

It seems that there is great opportunity to stimulate growth in the economy.

Professor Bernanke v Chairman Bernanke

In a recent edition of The New York Times magazine Paul Krugman wrote an article discussing the role of Ben Bernanke as an academic versus that of being the Fed Chairman.

When the financial crisis happened in 2008 it seemed that there could be no better person to be Fed Chairman. Having studied the Great Depression and written various academic papers on this and the crisis in Japan in 1990’s economists felt that Bernanke was the man for the job. Although the Fed has done a lot to rescue the financial system there is still major concerns about the labour market and the rising long-term rate of unemployment. Remember that the Fed has a dual mandate of Price Stability and Maximum Employment. In order to stimulate growth in the economy, especially when inflation is low, central banks lower interest rates but when the Fed Funds Rate reached 0 – 0.25% on the 16th December 2008 they basically ran out of ammunition as rates couldn’t go any lower. Here you tend to get stuck in what we call a “liquidity trap” in that monetary policy is no longer effective. When Japan was going through very slow growth in the 1990‘s, in which it experienced deflation, Professor Bernanke stated that Japanese policy makers should be a lot more active in trying to stimulate growth and inflation. With interest rates already at 0% he suggested that monetary authorities were not proactive enough to experiment with other policies even though they might have been radical. This all harks back to the days of FDR (Franklin D Roosevelt) in which he created work schemes, infrastructure projects etc, in order to boost employment. I have summarised Paul Krugman’s article below in a table format which shows Bernanke policies for the US economy as a Professor v Chairman.

So why hasn’t he taken on the role of the Academic Bernanke? Krugman suggests that:

this is the effect of bullies and the Fed Borg*, a combination of political intimidation and the desire to make life easy for the Fed as an institution. Whatever the mix of these motives the result is clear: faced with an economy still in desperate need of help, the Fed is unwilling to provide that help. And that, unfortunately, make the Fed part of the broader problem.

*Krugman is a keen “Star Trek” fan and compares the Federal Reserve to a Borg — a race of beings that act based on the wishes of a hive mind, and present major threats to the Starfleet and the Federation.

Keynes 1926 pamphlet could have been written today.

Diane Coyle runs a blog called “The Enlightened Economist” which is very good for reviews of recently published economics books. One of her recent posts talked of the republished 1926 pamphlet by John Maynard Keynes – ‘The End of Laissez Faire’. Though Keynes states that an economy should be free of government intervention he suggests that government can play a constructive role in protecting individuals from the worst harms of capitalism’s cycles, especially concerns about levels of unemployment. Diane Coyle produces a quote (see below) from the book which is ironically similar to what is the anti-capitalist sentiment today. She also suggests that we need to go beyond the state versus market debate and recongize that the two type of systems need to work together to alleviate problems such unemployment, externalities, uncertainty, well-being etc.

“Many of the greatest economic evils of our time are the fruits of risk, uncertainty, and ignorance. It is because particular individuals, fortunate in situation or in abilities, are able to take advantage of uncertainty and ignorance, and also because for the same reason big business is often a lottery, that great inequalities of wealth come about; and these same factors are also the cause of the unemployment of labour, or the disappointment of reasonable business expectations, and of the impairment of efficiency and production. Yet the cure lies outside the operations of individuals; it may even be to the interest of individuals to aggravate the disease.”

He then goes on to say

“I believe that the cure for these things is partly to be sought in the deliberate control of the currency and of credit by a central institution, and partly in the collection and dissemination on a great scale of data relating to the business situation, including the full publicity, by law if necessary, of all business facts which it is useful to know. These measures would involve society in exercising directive intelligence through some appropriate organ of action over many of the inner intricacies of private business, yet it would leave private initiative and enterprise unhindered. Even if these measures prove insufficient, nevertheless, they will furnish us with better knowledge than we have now for taking the next step.”

Keynes v Monetarist – Powerpoint download

Here is a powerpoint on “Keynesian and Monetarist Theory” that I use for revision purposes. I have found that the graphs are particularly useful in explaining the theory. The powerpoint includes explanations of:

- C+I+G+(X-M)
- 45˚line
- Cicular Flow and the Multiplier
- Diagrammatic Representation of Multiplier and Accelerator
- Quantity Theory of Money
- Demand for Money – Liquidity Preference
- Defaltionary and Inflationary Gap
- Extreme Monetarist and Extreme Keynesian
- Summary Table of “Keynesian and Monetarist”
- Essay Questions with suggested answers.

Hope it is of use – 45˚line shown. Click the link below to download the file.
Keynes v Monetarist Keynote

Stand-Up Economist

Thanks to colleague Warren Baas for this a great clip from Standup Economist Yoram Bauman at the 2010 American Economic Association conference. Some great recipes for economists looking at Keynesian and Monetarist methods. Also jokes about the financial crisis, “What to expect when you’re expecting the Nobel Prize”, and some of the Nobel prize jokes from his Cartoon book Introduction to Economics.

Debt according to Krugman

Paul Krugman wrote an interesting piece on his blog (New York Times) about how those in Washington DC have no idea what they are talking about when in comes to debt. Although the US economy was technically going through a recovery last year, the levels of unemployment have been worringly high – 9%. However there is concern in Congress about the rising budget deficit and the need to reign in government spending.

Krugman explains that Washington isn’t just confused about the short run; it’s also confused about the long run. Those concerned about deficits portray a future where we have to pay back what we have borrowed – it is not like taking out a mortgage and struggling to paying it back. Krugman looks at government debt in two ways:

1. Although households have to pay back debt governments don’t – all they need to do is ensure that debt grows more slowly than their tax base. As the US economy grew (and the tax revenue for the government) the debt from WW II became immaterial and was never repaid – see graph below.

2. What is unique with regard to US debt is that it is not like an individual who owes debt to a bank. Essentially the US debt is money that is owed to the US themselves. Foreigners do hold a significant amount of government debt in teasury bonds but every dollar’s worth of foreign claims on the US is matched by 89 cents’ worth of US claims on foreigners. Furthermore because foreigners tend to put their assets into safe US investments, the US actually earns more from its assets abroad than it pays to foreign investors.

Nations with responsible governments willing to impose modestly higher tax rates when the situation warrants it have historically been able to live with much higher levels of debt than today’s conventional wisdom would lead you to believe. The UK has had debt exceeding 100% of GDP for 81 of the last 170 years. Keynes suggested of the need to spend your way out of recession when the UK was deeper in debt than any other adanced nation today, with the exception of Japan. Krugman states that the US doesn’t have a government that is responsible ie. willing to impose higher taxes. Debt matters BUT more government spending is needed to reduce unemployment.

The Tolerance of Inequality

John Plender from the FT recently looked at the tolerance of inequality in the capitalist system today. Stewart Lansley, an author of “The Cost of Inequality” says that the modern economy appears to have only two routes:

1. the super-rich who are racing ahead on the autobahn at unlimited speeds
2. everyone else who has stalled in the slow lane in a 50km zone

Before 2007 those in he slow lane enjoyed enjoyed rising living standards maninly due to their ability to borrow more money using their property as collateral. Since the crisis they have struggled to service unmatched levels of debt whilst finance has come to play a new role as “a cash cow for a global super-rich elite”. However according to Plender this is nothing new – the industrial revolution saw large differences in income distribution as did the 1920’s and 30’s. This was when John Maynard Keynes wrote about a more humane form of capitalism and was notably scathing of what he called “individualist capitalism and the money motive.”

Although the despair of earlier recessions are not prevalent today ie. soup kitchens, 25% unemployment, and extreme poverty, the conerns seem to focus on the unfairness of the system. Top of the agenda is the banking system which in the 1930’s was concerned with deposit-taking and lending but today has become incredibly complex system which they themselves do not always understand and whose social utility is not apparent to the lay person – including the head of the UK Financial Services Authority who stated that the business of banking has become far too large. Historically this is not new. Keynes remarked

“To convert the business man into the profiteer is to strike a blow at capitalism, because it destroys the psychological equilibrium which permits the perpetuance of unequal rewards. The businessman is only tolerable so long as his gains can be held to bear some relation to what, roughly and in some sense, his activities have contributed to society”

Solution – Reduce the Power of the Lobbyist
The economic system of late has also rewarded those that have taken risks and failed ie. bailouts from the government. Surely this is against what the definition of capitalism is. So where to from here? Mancur Olson a institutional economist has argued that nations decline because of the lobbying power of distributional coalitions, or special-interest groups, whose growing influence fosters economic efficiency and inequality. In the 1970’s it was trade unions and business cartels whilst today it is finance professionals on Wall Street and in London. Jeffrey Sachs in his recent book entitled “The Price of Civilisation – Economics and Ethics after the Fall” noted the total lobbying outlays by sector during 1998-2011. The table shows those sectors that receive the most funding are in the deepest strife for reasons tied to regulatory failures. Each of these sectors – finance, health care, transport, agribusiness etc – have landed cushy federal contracts, subsidies, tax breaks, and slack regulation and inattention. Not surprisingly finance, real esate, healthare, and pharmaceutical companies rank amongst the lowest in public approval in Gallup polls.

“These industries epitomize the destructive policies produced by the corporatocracy, and the public knows it.” Jeffrey Sachs

Below is a presentation by Jeffrey Sachs at LSE in December last year. Well worth a look but it is long.

A2 Revision: Keynes 45˚ line

Always a popular question in the multi-choice and usually in one part of an essay. Make sure that you are aware of the following;

Common Errors:
1. C and S are NOT parallel
2. The income level at which Y=C is NOT the equilibrium level of Y which occurs where AMD crosses the 45˚ line.
To Remember:
1. OA is autonomous consumption.
2. Any consumption up to C=Y must be financed.
3. At OX1 all income is spent
4. At OB consumption = BQ and saving= PQ
5. Equilibrium level of Y shown in 2 ways
a) where AMD crosses 45˚ line
b) Planned S = Planned I – point D

Remember the following equilibriums:
2 sector – S=I
With Govt – S+T = I+G
With Govt and Trade – S+T+M = I+G+X

A2 Revision – New Classical to Extreme Keynesian

The main competing views of macroeconomics (Keynesian vs Monetarist) is part of Unit 5 in the A2 syllabus and is a popular topic in the essay and multiple-choice papers. Begg covers this area very well in his textbook. In looking at different schools of thought it is important to remember the following:

Aggregate Demand - the demand for domestic output. The sum of consumer spending, investment spending, government purchases, and net exports
Demand Management – Using monetary and fiscal policy to try to stabilise aggregate demand near potential output.
Potential Output – The output firms wish to supply at full employment after all markets clear
Full Employment – The level of employment when all markets, particularly the labour market, are in equilibrium. All unemployment is then voluntary.
Supply-side policies – Policies to raise potential output. These include investment and work incentives, union reform and retraining grants to raise effective labour supply at any real wage; and some deregulation to stimulate effort and enterprise. Lower inflation is also a kind of supply-side policy if high inflation has real economic costs.
Hysteresis – The view that temporary shocks have permanent effects on long-run equilibrium.

There are 4 most prominent schools of macroeconomics thought today.

New Classical – assumes market clearing is almost instant and there is a close to continuous level of full employment. Also they believe in rational expectations which implies predetermined variables reflect the best guess at the time about their required equilibrium value. With the economy constantly near potential output demand management is pointless. Policy should pursue price stability and supply-side policies to raise potential output.

Gradualist Monetarists – believe that restoring potential output will not happen over night but only after a few years. A big rise in interest rates could induce a deep albeit temporary recession and should be avoided. Demand management is not appropriate if the economy is already recovering by the time a recession is diagnosed. The government should not fine-tune aggregate demand but concentrate on long-run policies to keep inflation down and promote supply-side policies to raise potential output.

Moderate Keynesians - believe full employment can take many years but will happen eventually. Although demand management cannot raise output without limit, active stabilisation policy is worth undertaking to prevent booms and slumps that could last several years and therefore are diagnosed relatively easily. In the long run, supply-side policies are still important, but eliminating big slumps is important if hysteresis has permanent effects on long-run equilibrium. New Keynesians provide microeconomics foundations for Keynesian macroeconomics. Menu costs may explain nominal rigidities in the labour market.

Extreme Keynesians - believe that departures from full employment can be long-lasting. Keynesian unemployment does not make real wage fall, and may not even reduce nominal wages and prices. The first responsibility of government is not supply-side policies to raise potential output that is not attained anyway, but restoration of the economy to potential output by expansionary fiscal and monetary policy, especially the former.

Do Central Banks need to reinvent policy?

To some the role of central banks was of prime importance in the financial crisis and the substantial increases in the incomes of those employed in the financial sector.

Since the days of stagflation in the US and UK in the 1970’s inflation has been the number one target for central bankers. US President Jimmy Carter’s attempts to follow Keynes’s formula and spend his way out of trouble were going nowhere and the newly appointed Paul Volcker (US Fed Governor in the 1970’s) saw inflation as the worst of all economic evils. Below is an extract of an interview from the PBS series “Commanding Heights”

“It came to be considered part of Keynesian doctrine that a little bit of inflation is a good thing. And of course what happens then, you get a little bit of inflation, then you need a little more, because it peps up the economy. People get used to it, and it loses its effectiveness. Like an antibiotic, you need a new one; you need a new one. Well, I certainly thought that inflation was a dragon that was eating at our innards, so the need was to slay that dragon.”

The policy of the time was Keynesian – inject more money into the system in order to get the economy moving again. This was also the case in the UK in the early 1970’s but Jim Callaghan’s (Labour PM in the UK ousted by Thatcher in 1979) speech in 1976 had reluctantly recognised that this policy had run its course and a monetarist doctrine was about to become prevalent. Below is an extract from the speech.

“We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment. That is the history of the last twenty years”

With this paranoia about inflation central bankers began to implement a monetary policy targeting inflation in the medium term. In NZ the Reserve Bank Act 1989 established “price stability” as the main objective of the RBNZ. “Price stability” is defined in the PTA (Policy Target Agreement) as keeping inflation between 1 to 3% (originally 0-2%) – measured by the percentage change in CPI. Around the world central banks were adopting a more independent approach to policy implementation and with targeting inflation a new prevailing attitude seemed to be like an osmosis and suggesting that low prices = macro-economic stability as well. Also, raising interest rates is an unpopular political move and governments could now blame the central bank for this contractionary measure.

However, the rise of asset prices were largely ignored by central banks and although inflation remained relatively stable, this was in part due to the disinflation of the emerging markets that were now becoming more a part of the global market. Therefore with low inflation, central banks could afford to lower interest rates and ultimately stimulate a lot of borrowing which increased asset prices. The Rethinking Central Banking report (written by a group of economists, financiers and policy makers) recommend an “international monetary policy committee” which can look at the bigger picture in the global economy.

According to Jeremy Warner in the Daily Telegraph:

The bottom line is that central banks need to be much more open about precisely what their objectives are, mindful of the international implications of what they do, and clear about what circumstances would trigger particular courses of action.

A2 Revision – Keynesian and Post-Keynesian Period

Following on from my post yesterday, I discussed with my A2 class today the end of the Gold Standard and the new era of self-regulating markets that started in the 1980′s under Reagan (US) and Thatcher (UK). This relates to Unit 5 in the A2 syllabus – Main schools of thought on how the macroeconomy functions – Keynesian and monetarist.

Robert Skidelsky, in his book “Keynes – The Return of the Master”, outlined the Keynesian and Post-Keynesian periods. The Keynesian period was the Bretton Woods system whilst the “New Classical” Washington consensus system succeeded it. Both are outlined below:

The Bretton Woods system was designed to improve the rules and practices of the liberal world economy which had grown up sporadically in the 19th century. However in 1971 the fixed exchange rate system collapsed (see post Fixed exchange rates and the end of the Gold Standard) and the full employment objective was cast aside. Futhermore controls on capital were removed in the 1990′s. The new system introduced was more free market based and took the name of the Washingotn Consensus System.

According to Skidelsky the two regimes were shaped by two different philosophies. The Bretton Woods system broadly reflected the Keynesian view that an international economy needed strong political and institutional supports if it was to be acceptably stable. The Washington consensus was driven by free market principles of self-regulation and limited government intervention.

Keynes biographer looks to Plan C for UK economy

Robert Skidelsky, the biographer of John Maynard Keynes, last week wrote in The Guardian about the stagnant state of the UK economy since the Chancellor of the Exchequer (equivalent to the Finance Minister in NZ) George Osborne delivered his austerity budget of 2010.

Fiscal contraction. Osborne promised to take out £112bn over four years with the intention of restoring confidence of the markets. According to Osborne the reduction in government borrowing is equivalent to transferring money to the private sector. The private sector will have £83bn more (£112bn – £29bn in higher taxes) to spend and private spending is seen more beneficial than government spending. Therefore aggregate demand (AD) should increase and the economy should grow at a higher rate. Fiscal contraction is the royal road to a buoyant recovery.

Fiscal Expansion. That money should not be taken out of the circular flow. Taking £112bn out of the economy will be a net subtraction from AD. The £83bn cuts in public spending because the first effect will be to reduce employment, and hence reduce the national income. Fiscal contraction is the royal road to stagnation.

Most analysts seem to agree that another bout of quantitative easing is in order as it did help to stabilise the UK economy in 2009-10. But the printing of money does not ensure that it is spent. As Keynes put it:

“If… we are tempted to assert that money is drink which stimulates the economy to activity, we must remind ourslves that there may be several sips between cup and lip”

Skidelsky proposes a Plan C in which much money will be spent by areas like green projects, transport infrastructure, social housing and export-orientated businesses. A National Investment Bank would enable the Chancellor to continue to breach public austerity while silently undermining its depressive effects.

Below is a video of Skidelsky at the OECD conference in Paris last year talking about how to get out of the recession.

Keynes v Hayek Rap – Round 2

From EconStories

According to the National Bureau of Economic Research, the Great Recession ended almost two years ago, in the summer of 2009. Yet we’re all uneasy. Job growth has been disappointing. The recovery seems fragile. Where should we head from here? Is that question even meaningful? Can the government steer the economy or have past attempts helped create the mess we’re still in?

In “Fight of the Century”, Keynes and Hayek weigh in on these central questions. Do we need more government spending or less? What’s the evidence that government spending promotes prosperity in troubled times? Can war or natural disasters paradoxically be good for an economy in a slump? Should more spending come from the top down or from the bottom up? What are the ultimate sources of prosperity?

Keynes and Hayek never agreed on the answers to these questions and they still don’t. Let’s listen to the greats. See Keynes and Hayek throwing down in “Fight of the Century”!

Keynes hovers over the Institute for New Economic Thinking

Two recent articles on the second meeting of the Institute for New Economic Thinking had connotations of John Maynard Keynes – Niall Ferguson in Newsweek and Will Hutton in the Observer.

The economic conference, to debate the current crisis, has been likened to Keynes’ farewell speech at the Bretton Woods conference back in 1944. He wanted an end to balanced budgets, public austerity, national sovereignty and freedoms for finance at home and abraod. His desire was regulations that would acknowledge countries’ interdependence and create global institutions and a global currency to give governments room for manoeuvre to act intelligently and creatively to stimulate jobs, trade and growth. For the IMF to now be used as a bailout facility for speculators and overextended banks at the same time that governments introduce draconian budget cuts is exactly was Keynes was NOT in favour of. He was a believer in short-term government deficits to combat depressions and would regard the current state of the US fiscal position as disastrous. The federal debt could hit 344% of GDP by 2050. Interest payments would absorb nearly all federal tax revenues. Furthermore the USA’s reliance on foreigners to finance its borrowing habit is against what Keynes believed in.

The US could keep borrowing US$1 trillion a year but there are two possibilities to try and reduce their dependency on overseas borrowing:

1. Eliminate the deficit largely through deep spending cuts and Medicare reform.
2. Modest tax cuts and tax hikes on millionaires and billionaires.

According to Will Hutton – the good news is that there are a lot of a very good and iconoclastic economists from many countries who want to take up the fight again. It’s a race against conventional thinking – and time.

‘Sputnikonomics’

Sputnik was the first Earth-orbiting artificial satellite. It was launched into a low Earth orbit by the Soviet Union on 4 October 1957. Although it only transmitted a beeping noise it changed the world forever. The chain of events sparked by Sputnik set man walking on the moon and led to a total overhaul of the American education system. Sputnikonomics is the term given after Obama’s State of the Union address last month. He said that in order for America to compete better against China, India and other emerging economies, our society had to invest in more long term infrastructure.

Although the Republicans confronted Obama for suggesting more spending after QE2, Sputnikonomics encompasses something disparate. The stimulus was a Keynesian measure which focused on stimulating demand but Obama’s plan is to improve long-term growth rates by boosting supply. This means greater productivity and increasing the pace of innovation – a supply-side policy – and one which was similar to that of Thatcher and Reagan in the 1980′s. But with major budgetary problems why spend more? The return on investment from the building of the Interstate Highway System in the 1950′s and 1960′s has been estimated at 35% annually. And investments in military technology during the original Sputnik moment gave us, among other things, satellites, the microchip, G.P.S., and the Internet, the cumulative benefits of which are incalculable.

Is Santa our saviour?

Here is a great piece from the BBC World Service programme “Business Daily”. Below is the transcript but if you would like to listen to the Irish brogue of Colm O’Regan click the link below.

Santa and Shale Gas – Friday 23th December 2010

Austerity and how Santa Claus maybe able to help out

by Colm O’Regan

Austerity – listen to the word. Even if you didn’t know what it meant the combination of consonants and vowels alone give you the feeling that there won’t be any biscuits with the tea.

This Christmas austerity is all the rage. Across Europe governments used to ‘sugar coat’ bad news but now delight in unveiling swingeing cuts. At EU summits Finance Ministers congratulate each other on their ability to take brave unpopular decisions and how much they are tightening their belts. Oh yes a word about belt tightening – national governments are warning us to adjust are waists size at the same time we are told that consumers need to have more confidence and spend to stimulate more growth so we need to buy need belts and tighten those – Oh and VAT is being raised and that belt will cost more. Of course this is not proper austerity not like the old days. My mother, born in 1935, didn’t see an orange until she was 11 years old– the war and rationing made for a very gray life – there is nothing as austere as that now. I didn’t eat asparagus until I was 27 years old but that was more due to an unsophisticated palate rather than an embargo enforced by U-boats lurking offshore. In future years it is unlikely that our children will be listening to our tales of economic hardship. To save money we cancelled our cable subscription and watched TV online. Smart phones – I was 35 before I got my first smart phone and look at you now with your microchip embedded in your neck. If you want to watch TV you just have to think about it, we had to press a button. But although we don’t plumb to the depths of previous lean times we have formed a grim relationship with financial prudence. Consumers are hoarding money for “a month of rainy Sundays”. Companies are delighted to take the opportunity to freeze or cut wages whether they have to or not – a wage rise now is seen as the height of hedonistic success like bringing one’s employees to a strip club. But we can’t cut and save and wait forever. How could we break free from this worthy cycle? We need a stimulus but from where? If there is one person who could encourage us to loosen the shackles its Santa Claus. Santa is better equipped that most to ride out the current economic storm. He has a committed, and by all accounts, free workforce. He maintains very high market share and because part of Lapland is outside the Euro he has a bit more flexibility when it comes to his fiscal policy. As the creator of millions of toys each year, which he just gives away, Santa is just the type of Keynesian thinker Europe needs. Unlike President Obama’s financial package which has been beset by allegations of waste and mismanagement – Santa is very careful about who benefits from his financial largesse. Each year he makes a list and checks it twice. So lets hope that Santa leads the way and shakes us out of our love affair with thrift so we can austerity for posterity.

QE2 – why all the fuss?

The Federal Reserve (US central bank) second round of quantitative easing (QE2) has its critics – the Chinese and German governments, economist Joseph Stiglitz, and most Republican congressmen. The Fed is currently running out of options and once interest rates can’t be cut anymore it is resorting to buying up longer-term government bonds. This will hopefully keep long-term interest rates low and create more money in the economy and make investments other than government bonds more appealing. Therefore why all the fuss?

- China and Germany are worried that QE2 will increase the supply of US$ on the market and therefore weaken its value. This will make Chinese and German imports more expensive and US exports more competitive which ultimatley means job growth.
- Joseph Stiglitz says that economies always recover but without a stimulus it will take a long time. Short-term unemployment needs to fall and this requires more government spending – not quantitative easing (QE2). As Keynes said in the long-run we’ll recover but in the long-run we are all dead.
- The Republicans basically object to QE2 because it is there job to make sure that Obama is a one-term President. Would they be criticising Fed Chairman Bernanke if the Republicans were in office? I think not.

According to James Surowiecki of The New Yorker the attacks on QE2 are hysterical and people are accusing the Fed of injecting high-grade monetary heroin into the system which they assert will generate artifically high stock and commodity prices around the world. The reality is that stock prices have fallen over the last few weeks since QE2 as American banks have trillions of dollars to lend but consumers are continuing to reduce their debt. The biggest risk to the US is not that the economy will experience high levels of inflation in a couple of years (pipeline effect) or a stock market bubble or currency war. The reality is that there could still be well over 15 million people unemployed.

Why is the Austrian school of economics not talked about?

With the aftermath of the financial crisis there has been little mention of the Austrian school of economics led by Frederick von Hayek. The Economist Buttonwood column last week mentioned the fact that when you actually look at the Austrian theory of business cycles there are a lot of similarities with that of the last couple of years. Below are the main characteristics of the Austrian beliefs followed by what happened during the financial crisis:

1. Interest rates are held at too low a level, creating a credit boom. Low financing costs persuade entrepreneurs to fund too many projects. The Fed and ECB definitely kept rates at levels that encouraged borrowing.
2. Capital is misallocated into wasteful areas. Too many houses, apartments were built in Spain and Ireland as well as in the US. The vast majority are lying empty or still unfinished which keeps downward pressure on house prices

Maybe this lack of exposure for the Austrian school in media circles is because their panacea for the crisis is to do nothing and let the market run its course. This is in contrast to the monetarists who propose tax cuts and lower interest rates and the Keynesians who would support deficit spending. As a politician you can’t be seen to do nothing especially leading up to an election. Remember US President Jimmy Carter during the 1970′s, when the best thing was to let the economy run its course through the cycle instead he increased government spending and inflation hit 14% and interest rates 21.5%. Ronald Reagan won the election (as did Margaret Thatcher in the UK) and economic policy changed drastically.