In a muddled world economy, the Great Stalemate baffles policymakers

We have the Great Depression as a model on what works and what doesn'tTopic A, the core agenda for world leaders, has become clear: how to fill the economic middle with jobs that can put Europe back to work, get incomes climbing in the United States and absorb a bulge of young people in parts of Asia and the developing world. But deep into the world’s financial crisis response, and as officials wrap up annual spring meetings of the International Monetary Fund and the World Bank, there is no consensus on how to proceed. Europe remains locked in a feud over more spending in hopes of job growth now versus. austerity and potential for growth later. The U.S. fiscal policy debate seems deadlocked. Developing nations are growing, but struggling over how to fix a massive infrastructure shortfall that could crimp their ability to build a large enough workforce in future. The world enjoyed the Great Moderation through years of growth, then endured Great Recession. Now, welcome to the Great Stalemate. “What’s the next step? How do you [stimulate] real economy? None seems to have good answer,” said Changyong Rhee, chief economist for Asian Development Bank and a close observer of debate over world economic policy. “Everyone is watching. Economic theory has its limits.” There has been little in this week’s meetings of the IMF and World Bank to suggest progress. IMF has shifted gears over the past three years and now agrees that Europe should ease its austerity drive, at least in the countries that can still borrow, such as Germany and United Kingdom, and do more for short-term growth. There’s been little response. If anything, the eurozone seems more bogged down, its acute risks diminishing but no grand consensus on how to improve short-term conditions have saddled nations such as Spain+Greece with depression-level unemployment rates. The broad statements coming from groups such as IMF imply that there’s a solution out there, somewhere, that could in short order start generating jobs and satisfy the new mantra of “inclusive growth” for older workers, long-term unemployed, women and the less-skilled. Domenico Lombardi, a former member of IMF executive board and now director of the global economy project with the Centre for International Governance Innovation, said he regards those public statements as “a diversion” from the fact that there is a fundamental disagreement among and within the nations about how to proceed. Europe, pro-austerity clique centered on Germany and more successful north remains entrenched, leaning against any short-term assault on joblessness, Domenico Lombardi said. In the struggling southern European nations, the reforms needed to improve economic performance are lagging, meaning there’s not enough preparation for what might create jobs down the road. “We are navigating by sight”, Servaas Deroose, the European Commission’s mission chief in Greece, said in a Friday seminar at the Peterson Institute for International Economics on Europe’s response to the crisis. “There is no model available” for simultaneously sorting out a set of problems that cuts across banking, government and national economic structure (…..)



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15 Responses to In a muddled world economy, the Great Stalemate baffles policymakers

  1. The International Monetary Fund recently held a conference that should concern most people despite its arcane subject — “Rethinking Macro Policy II.” Macroeconomics is the study of the entire economy, as opposed to the examination of individual markets (“microeconomics”). The question is how much “macro” policies can produce and protect prosperity. Before the 2008-09 financial crisis, there was great confidence that they could. Now, with 38 million unemployed in Europe and the United States — and recoveries that are feeble or nonexistent — macroeconomics is in disarray and disrepute. Among economists, there is no consensus on policies. Is “austerity” (government spending cuts and tax increases) self-defeating or the unavoidable response to high budget deficits and debt? Can central banks such as the Federal Reserve or the European Central Bank engineer recovery by holding short-term interest rates near zero and by buying massive amounts of bonds (so-called “quantitative easing”)? Or will these policies foster financial speculation, instability and inflation? The public is confused, because economists are divided. Perhaps the anti-economist backlash has gone too far, as George Akerlof, a Nobel Prize-winning economist, argued. The world, he said, avoided a second Great Depression. “We economists have not done a good job explaining that our macro policies worked,” he said. Those policies included: the Fed’s support for panic-stricken financial markets; economic “stimulus” packages; the Troubled Assets Relief Program (TARP); the auto bailout; “stress tests” for banks; international cooperation to augment demand.

    Fair point. Still, the subsequent record is disheartening. The economic models that didn’t predict the crisis have also repeatedly overstated the recovery. The tendency is to blame errors on one-time events — say, in 2011, the Japanese tsunami, the Greek bailout and the divisive congressional debate over the debt ceiling. But the larger cause seems to be the models themselves, which reflect spending patterns and behavior by households and businesses since World War II. “The events [stemming from] the financial crisis were outside the experience of the models and the people running the models,” Nigel Gault said in an interview (…..)

    The irony is rich. With hindsight, excessive faith in macroeconomic policy stoked the financial crisis. Deft shifts in interest rates by central banks seemed to neutralize major economic threats (from the 1987 stock crash to the burst “tech bubble” of 2000). Prolonged prosperity promoted a false sense of security. People — bankers, households, regulators — tolerated more risk and more debt, believing they were insulated from deep slumps. But now a cycle of overconfidence has given way to a cycle of under-confidence. The trust in macroeconomic magic has shattered. This saps optimism and promotes spending restraint. Scholarly disagreements multiply. Last week, a feud erupted over a paper on government debt by economists Kenneth Rogoff and Carmen Reinhart.

    The larger lesson is: We have moved into an era of less economic understanding and control.

  2. F.D.R. told us that the only thing we had to fear was fear itself. But when future historians look back at our monstrously failed response to economic depression, they probably won’t blame fear, per se. Instead, they’ll castigate our leaders for fearing the wrong things. For the overriding fear driving economic policy has been debt hysteria, fear that unless we slash spending we’ll turn into Greece any day now. After all, haven’t economists proved that economic growth collapses once public debt exceeds 90 percent of G.D.P.? Well, the famous red line on debt, it turns out, was an artifact of dubious statistics, reinforced by bad arithmetic. And America isn’t and can’t be Greece, because countries that borrow in their own currencies operate under very different rules from those that rely on someone else’s money. After years of repeated warnings that fiscal crisis is just around the corner, the U.S. government can still borrow at incredibly low interest rates. But while debt fears were and are misguided, there’s a real danger we’ve ignored: the corrosive effect, social and economic, of persistent high unemployment. And even as the case for debt hysteria is collapsing, our worst fears about the damage from long-term unemployment are being confirmed. Now, some unemployment is inevitable in an ever-changing economy. Modern America tends to have an unemployment rate of 5 percent or more even in good times. In these good times, however, spells of unemployment are typically brief. Back in 2007 there were about seven million unemployed Americans — but only a small fraction of this total, around 1.2 million, had been out of work more than six months. Then financial crisis struck, leading to a terrifying economic plunge followed by a weak recovery. Five years after the crisis, unemployment remains elevated, with almost 12 million Americans out of work. But what’s really striking is the huge number of long-term unemployed, with 4.6 million unemployed more than six months and more than three million who have been jobless for a year or more. Oh, and these numbers don’t count those who have given up looking for work because there are no jobs to be found (…..)

    ACHTUNG – So we are indeed creating a permanent class of jobless Americans. ONLY americans ?? !!!!

  3. Professor Uziel Nogueira says:

    A NYT article yesterday announced the creation of a $ 300 million scholarship program to establish an elite international education program at Tsinghua University in Beijing. Stephen A. Schwarzman, Chairman and Chief Executive Officer of Blackstone Investment Group, is leading the initiative with a $ 100 million donation. Question: If the US business elite are betting their money on China, what difference can more government spending make to reverse the economic decline?

  4. NC: Well the simplistic answer is that the government can replace the lost demand those business would create with their money. If it did so economic thinking goes eventually due to the multiplier effect of how money is spent that demand would create more demand, which would eventually reenergize the economy and eventually allow the government to move out of the realm of having to artificially create demand. Look at how WWII managed to do so through massive deficit spending. That’s the simple econ 101 answer and by in large it appears to have been vindicated by the policies of this recession.

  5. Professor Uziel Nogueira says:

    If government spending (regardless of debt level) plus money printing is the answer for US economic woes, why the Obama administration can’t see the light?

  6. (…..) Reinhart and Rogoff admitted the arithmetic errors but claimed, incorrectly, that it was still true that high public debt levels were correlated with slower growth. But their self-defense failed to address the point made by sensible economists when the study first came out:

    Correlation is not causation. It’s obvious that after Wall Street blew up the economy, the recession caused lower tax revenues, and higher spending on unemployment, food stamps and stimulus programs to forestall an all-out Depression. Government deficits and public debt rose as a result of the crisis, not as a cause.

    The IMF, once a bastion of austerity economics, has admitted its errors, warning that austerity is now sabotaging recovery. As the fund lowered its growth projections for next year, IMF Managing Director Christine Lagarde called on the United States and many countries in Europe to focus more on growth and less on trimming budget balances this year, warning, “We need growth, first and foremost.” So, will the “Fix the Debt” austerity claque, the Republican Tea Party Caucus and McConnell get out of the way so the president and Democrats can pass jobs programs to put people to work? Don’t count on it. As the case for austerity was eviscerated, Simpson and Bowles came out with yet another austerity plan, once more calling for urgent reforms to cut Social Security and Medicare benefits in order to avoid economic collapse. Sadly, austerity’s reign of misery continues, even as it has been demolished in theory and practice. President Obama has ceded ground to the austerity hawks, proposing cuts to Social Security and Medicare as means to reduce government debt. On the other side of the Atlantic, austerity is spreading economic contraction across Britain and the continent. The Federal Reserve is even under pressure to roll back its expansionist monetary policy. We will be freed of austerity’s grip only when those in power return to common sense, fact-based politics and when we hear much more from the unemployed and the immiserated and much less from bankers and their favored economists.

  7. Every institution has its founding myths. Assumptions that, in the best case are only partly true, but still vital to getting the day’s work done. Among the European Union’s founding myths is that its officials, though they may come from different countries, set aside their national identities to work together for European unity. But doubts about this assumption arise repeatedly. For instance, when Mario Draghi became head of the European Central Bank and many Northern Europeans suggested that mega-inflation was a foregone conclusion. Since Draghi is Italian, a country where two-digit price increases aren’t unusual, he’s had to work that much harder to emphasize his reliability. Then there is European Commission President José Manuel Barroso, who has tried to ensure that he isn’t perceived primarily as a Portuguese man. As the Commission’s leader, he is expected to embody cross-border consensus more than any other. Since Monday, however, it seems possible that even Barroso doesn’t always leave his national identity at the door. In a think-tank dialogue in Brussels, Barroso cautiously criticized the austerity measures that the EU has so far imposed on the mainly Southern European members states in economic crisis. While the policy may be “fundamentally right,” he said, it had “reached its limits.” In the short-term, “a stronger emphasis on growth” is needed, he added. The commotion created by his statements was great, particularly in the English-language press. “Era of Austerity Has Run its Course, EU Says,” a Reuters headline read. “Limit Austerity, EU Official Says,” was the headline in the Wall Street Journal. The angry reaction from Germany wasn’t long in coming. “Growth cannot be purchased with new debts,” Foreign Minister Guido Westerwelle warned.

    “The Commission president is putting the euro rescue in question,” said Herbert Reul, who as head of the German conservatives in the European Parliament even belongs to the same party family as Barroso.

    Perhaps the perturbation was so great because Barroso is one of the last people expected to make such criticisms. He is thought to be bland and hasn’t earned a reputation for taking clear positions in the euro crisis — much less against German Chancellor Angela Merkel, to whom he owes much of his controversial re-election (…..)

  8. (…..) As King struggled with the crisis, he concluded that the biggest vulnerability was the solvency of the banking system itself. The crash wasn’t just a liquidity squeeze caused by toxic assets; the problem was that big banks around the world were undercapitalized and, in many cases, insolvent. To deal with this solvency crisis, King pushed the banks to recapitalize and, later, to accept more regulation. This upset a financial elite that, as King says, was the only sector of the British economy that had escaped the market revolution of the Margaret Thatcher years. The lords of finance waged a losing battle against King’s tougher standards. For King, the past decade reinforced the lessons Keynes drew from the 1930s: One is the psychological quirkiness of investors, which Keynes described as “animal spirits” on the upside and “extreme liquidity preference” on the down. Then and now, monetary policy could not persuade frightened people to spend and invest. As a result, the Western economies in 2013 remain stuck at high unemployment and low output levels. The second Keynesian lesson was the need for some international structure to balance surplus and deficit nations. Keynes’s framework was the Bretton Woods system of the World Bank and IMF. Those global institutions are weak, but the real crisis has been within the euro zone, which has no effective internal balancing mechanism: It lacks a federal structure to transfer money from surplus Germany to deficit Greece, and it lacks flexible internal exchange rates that could allow a Greece or Spain to devalue its currency and find its own equilibrium.

    Europe has responded to the crisis with the very British approach of muddling through, but King predicts it won’t work. Creating a true federal union, while an admirable goal, will be the work of a hundred years; the only quick way for countries to adjust is the breakup of the euro zone. King thinks the euro zone must confront the basic choice between accepting a transfer union or changing the membership of the monetary union.

    “Muddling through” isn’t a serious option. Keynes’s gift was to look beyond the technical questions of economics to the big issues. That’s what the sharp-witted King has tried to do, too. Suffice it to say that he’s the only person I’ve ever seen who could intellectually intimidate former Treasury secretary Larry Summers. King couldn’t fix the British economy, but he did understand it.

  9. Economic debates rarely end with a T.K.O. But the great policy debate of recent years between Keynesians, who advocate sustaining and, indeed, increasing government spending in a depression, and austerians, who demand immediate spending cuts, comes close — at least in the world of ideas. At this point, the austerian position has imploded; not only have its predictions about the real world failed completely, but the academic research invoked to support that position has turned out to be riddled with errors, omissions and dubious statistics. Yet two big questions remain. First, how did austerity doctrine become so influential in the first place? Second, will policy change at all now that crucial austerian claims have become fodder for late-night comics? (…..) Yet austerity maintained and even strengthened its grip on elite opinion. Why? Part of the answer surely lies in the widespread desire to see economics as a morality play, to make it a tale of excess and its consequences. We lived beyond our means, the story goes, and now we’re paying the inevitable price. Economists can explain ad nauseam that this is wrong, that the reason we have mass unemployment isn’t that we spent too much in the past but that we’re spending too little now, and that this problem can and should be solved. No matter; many people have a visceral sense that we sinned and must seek redemption through suffering — and neither economic argument nor the observation that the people now suffering aren’t at all the same people who sinned during the bubble years makes much of a dent.

    But it’s not just a matter of emotion versus logic. You can’t understand the influence of austerity doctrine without talking about class and inequality (…..)

  10. Ralph: Orwell, whom I know you admire, said in one of his great essays that he admired Dickens because Dickens was “generously angry” — angry with the pervading selfishness at the heart of too many people. Dickens, according to Orwell, saw no possible political redemption unless the heart of human beings could be radically changed. And this, I think, is the essence of our problem. The governing motive driving all too many Congressmen and women is a desire to be plutocrats — to get as close to the upper 1% as possible. The motive is not to advance the interests of the poor, the Hispanics, the African-Americans, the middle class. What they say on the stump, when campaigning, is what they say to get elected. Once in office, they have time only for the rich and their lobbyists. I don’t see how we are going to change this.

  11. Bruce Rozenblit: I would like to add another dimension to this excellent analysis. Yes, the policy of austerity has been heavily pushed by those that have more money than they know what to do with. But austerity could not be implemented unless the politicians that support it were elected into office. The 1% can use their money to finance campaigns, but ultimately, it takes the citizenry to cast the ballot. What the austerity crowd has skillfully done, is frame the entire argument (snow job might be more accurate) into an us against them crusade. They divided America into the “makers” and the “takers”. The makers would be hard working white and rural while the takers would be urban and primarily of color. The deficit is created by unjustly stealing money from the righteous makers and giving it to the lazy, slacker, parasite takers. By marketing austerity in this fashion, the 1% easily mustered enough votes to implement austerity. They leveraged off of the misguided perceptions of many rural folks that big cities are packed with people that just don’t want to work and contribute to society. We must cutoff their welfare for the good of us all. These non-working people are thought to be primarily people of color.

    Austerity is then yet another example of successful racial politics in action. If austerity doesn’t work, they can blame President Obama for somehow messing it up. He is also a person of color. How convenient.

  12. Victor:

    I wouldn’t write off so fast, as Krugman does, the notion that a continuing depression “serves the interests of the [super] wealthy.” It’s true a booming economy is good for everyone, but throughout history and throughout the world, the super rich have opted for systems that maximize the disparity between rich and poor, even if that meant constraining overall development. With that disparity came power over the multitude. After all that disparity was what made being rich worthwhile.

  13. Professor Uziel Nogueira says: The academic debate between Prof PK and opponents on federal spending and debt reached a stalemate. He takes his case directly to the public in his weekly column in the NYT. The readers divided between converters and skeptics debate a novel macroeconomic policy approach. That is, higher public debt is a good thing; debt ceiling is a just a political creation of the GOP.Thus, increasing public spending combined with limitless amounts of dollars is the solution to end unemployment in the US. So far, the Department of Treasury, White House and Congress are not convinced of the arguments presented by Prof Krugman and converters.

  14. The Middle Class is in a funk, its view of the future growing dim as fear rolls in like a storm. An Allstate/National Journal Heartland Monitor poll released Thursday found that while most Americans (56 percent) hold out hope that they‘ll be in a higher class at some point, even more Americans (59 percent) are worried about falling out of their current class over the next few years. In fact, more than eight in 10 Americans believe that more people have fallen out of the middle class than moved into it in the past few years. The poll paints a picture of a group that is scared to death about its station in life. By the way, 58 percent of respondents in the poll viewed themselves as either middle class (46 percent) or upper middle class (12 percent). According to the poll, Americans see a middle class with less opportunity to get ahead, less job security and less disposable income than the middle class of previous generations. Respondents were most likely (52 percent) to say that losing a job would put them at the greatest risk of falling out of their current class, followed by an unexpected illness or injury in the family. Most of those polled believe that higher education is the key to staying in the middle class, but many worry about its prohibitive cost and inaccessibility. And who did most of them say is responsible for making it worse for the middle class? Congress, chief executives of major corporations and big financial institutions. Of those who blame politicians, there is some evidence that Republicans get more of the blame than Democrats. A CNN/ORC poll released last month found that 32 percent of respondents thought that Democrats favor the middle class compared with 27 percent who believed the same of Republicans. Sixty-eight percent of those polled believed that Republicans favor the wealthy, compared with 24 percent who believed that Democrats do. This anxiety about a shrinking middle class is understandable (…..)

  15. Professor Uziel Nogueira says: The only surprise of Pew Research Center study showing a shrinking middle class is how fast it is happening. Three mega trends go against middle class employment and well paid jobs. First, industrial manufacturing can now be done cheaply and efficiently anywhere in the world. The trend of domestic jobs being shifted overseas by US based transnational corporations cannot be reversed easily. Besides, machines are rapidly replacing humans in assembly lines and routine office work. Second, the largest source of employment in the US is the service sector, intensive in labor but presenting a highly uneven pay grid. Healthcare and the financial industry are good examples. In both cases, a few extremely financially rewarded professionals at the top and a vast majority of medium and low paid workers. Healthcare is under tremendous pressure to lower costs and wages (in real terms) will certainly come down. The financial industry, post 2009 meltdown, will not generate profits as easily as it did in the past. Except CEOs, wages will be lower than those paid in the past.

    Third, even well paid jobs thought to be immune to foreign competition are no longer safe. Lawyers — the dominant profession in the US — are already under pressure. The big US law firms are outsourcing work previously done by their highly paid professionals to overseas firms specialized in legal research. The same trend is taking place in the media, including newspapers and marketing.


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