Triumphant return of John M Keynes

It is imperative that we not just respond adequately to the current crisis but undertake the long-run reforms that will be necessary if we are to create a more stable, more prosperous and equitable global economy, says Joseph E Stiglitz

WE ARE all Keynesians now. Even the right in the United States has joined the Keynesian camp with unbridled enthusiasm and on a scale that at one time would have been truly unimaginable. For those of us who claimed some connection to the Keynesian tradition, this is a moment of triumph, after having been left in the wilderness, almost shunned, for more than three decades. At one level, what is happening now is a triumph of reason and evidence over ideology and interests. Economic theory had long explained why unfettered markets were not selfcorrecting, why regulation was needed, why there was an important role for government to play in the economy. But many, especially people working in the financial markets, pushed a type of ‘market fundamentalism’. The misguided policies that resulted — pushed by, among others, some members of US President-elect Barack Obama’s economic team — had earlier inflicted enormous costs on developing countries. The moment of enlightenment came only when those policies also began inflicting costs on the US and other advanced industrial countries. Keynes argued not only that markets are not self-correcting, but that in a severe downturn, monetary policy was likely to be ineffective. Fiscal policy was required. But not all fiscal policies are equivalent. In America today, with an overhang of household debt and high uncertainty, tax cuts are likely to be ineffective (as they were in Japan in the 1990s). Much, if not most, of last February’s US tax cut went into savings. With the huge debt left behind by the Bush administration, the US should be especially motivated to get the largest possible stimulation from each dollar spent. The legacy of underinvestment in technology and infrastructure, especially of the green kind, and the growing divide between the rich and the poor, require congruence between short-run spending and a long-term vision. That necessitates restructuring both tax and expenditure programmes. Lowering taxes on the poor and raising unemployment benefits while simultaneously increasing taxes on the rich can stimulate the economy, reduce the deficit, and reduce inequality. Cutting expenditures on the Iraq war and increasing expenditures on education can simultaneously increase output in the short and long run and reduce the deficit. Keynes was worried about a liquidity trap — the inability of monetary authorities to induce an increase in the supply of credit in order to raise the level of economic activity. US Federal Reserve chairman Ben Bernanke has tried hard to avoid having the blame fall on the Fed for deepening this downturn in the way that it is blamed for the Great Depression, famously associated with a contraction of the money supply and the collapse of banks. And yet one should read history and theory carefully: preserving financial institutions is not an end in itself, but a means to an end. It is the flow of credit that is important, and the reason that the failure of banks during the Great Depression was important is that they were involved in determining creditworthiness; they were the repositories of information necessary for the maintenance of the flow of credit. BUT America’s financial system has changed dramatically since the 1930s. Many of America’s big banks moved out of the ‘lending’ business and into the ‘moving business’. They focused on buying assets, repackaging them, and selling them, while establishing a record of incompetence in assessing risk and screening for creditworthiness. Hundreds of billions have been spent to preserve these dysfunctional institutions. Nothing has been done even to address their perverse incentive structures, which encourage shortsighted behaviour and excessive risk taking. With private rewards so markedly different from social returns, it is no surprise that the pursuit of self-interest (greed) led to such socially destructive consequences. Not even the interests of their own shareholders have been served well. Meanwhile, too little is being done to help banks that actually do what banks are supposed to do — lend money and assess creditworthiness. The federal government has assumed trillions of dollars of liabilities and risks. In rescuing the financial system, no less than in fiscal policy, we need to worry about the ‘bang for the buck’. Otherwise, the deficit – which has doubled in eight years – will soar even more. In September, there was talk that the government would get back its money, with interest. As the bailout has ballooned, it is increasingly clear that this was merely another example of financial markets mis-appraising risk – just as they have done consistently in recent years. The terms of the Bernanke-Paulson bailouts were disadvantageous to taxpayers, and yet remarkably, despite their size, have done little to rekindle lending. The neo-liberal push for deregulation served some interests well. Financial markets did well through capital market liberalisation. Enabling America to sell its risky financial products and engage in speculation all over the world may have served its firms well, even if they imposed large costs on others. Today, the risk is that the new Keynesian doctrines will be used and abused to serve some of the same interests. Have those who pushed deregulation ten years ago learned their lesson? Or will they simply push for cosmetic reforms — the minimum required to justify the megatrillion dollar bailouts? Has there been a change of heart, or only a change in strategy? After all, in today’s context, the pursuit of Keynesian policies looks even more profitable than the pursuit of market fundamentalism! Ten years ago, at the time of the Asian financial crisis, there was much discussion of the need to reform the global financial architecture. Little was done. It is imperative that we not just respond adequately to the current crisis, but that we undertake the long-run reforms that will be necessary if we are to create a more stable, more prosperous and equitable global economy.

(The author, professor of economics at Columbia University, is recipient of the 2001 Nobel Prize in Economics)

(Source: Economic Times)

Who will let the dollar go down?

Asian economies have to creatively invest their resources in productive activities instead of parking them in US treasuries. That’s the only way Asia can bring the world economy out of recession, says Neeraj Kaushal.
IN THE United States, half a million jobs evaporated last month, over 1.2 million were lost in the last three months. Businesses are closing down every day. Banks are afraid to lend, credit market continues to be tight. Consumer confidence is dwindling. Most forecasts suggest that the US gross domestic product will decline by 4% to 5% on an annualised basis in fourth quarter of 2008, and the economy will continue to experience a decline in GDP in 2009. Every expert and non-expert has declared that the US economy is in the worst recession since the 1929 Great Depression. But the US dollar is unfazed; it continues to enjoy strong confidence in a world economy shaken by financial turmoil. The greenback is getting stronger every day just as the US economy is plunging deeper into recession. Since August, the dollar has appreciated 17% against the rupee, 23% against the euro, and 34% against the British pound. Couple of weeks ago, the dollar strengthened somewhat even against the Chinese currency, renminbi. News reports suggest that the recent decline in export orders is putting pressure on the Chinese government to allow the renminbi to depreciate against the dollar — by five or even 10%. Dollar’s resurgence is a puzzle when compared with how currencies of other countries collapsed in national or regional financial crises in the past two decades. The Argentine peso depreciated 75% against the US dollar during the Argentine economic and financial crisis during 1999-2002. In the 1994 Mexican peso crisis, the Mexican currency fell 55% against the dollar. During the 1997 Southeast Asian financial turmoil, Thai bhat, Indonesian rupiah, Korean won experienced huge depreciations as did the currencies of Malaysia, the Philippines and other Southeast Asian economies. Financial crises in these countries not only caused substantial depreciations of their currencies, but also flight of foreign, and sometimes even domestic, capital. So far there is no shine off the value of the dollar, nor any major flight of foreign capital from American shores. What’s with the greenback? Against all odds, how has it regained in the past four months what it lost against most currencies in the previous three years? Clearly, the dollar has benefited from the fact that it continues to be the international currency of exchange, trade and reserve. The strengthening of the dollar is also helped by the fact that Japan and the economies of the euro zone are as deeply sunk in recession as is the American economy and growth in China and India is projected to be lower than it had been in the previous few years. Most of all, fright in world financial markets has sent investors running away from risky assets towards the US dollar and US treasury bonds. In the worst financial crisis since the Great Depression, the dollar has regained almost half of what it lost in the past six years. Consequently, American businesses are becoming less competitive as compared to foreign businesses. This will dampen demand for American exports and increase its imports. American multinational corporations will also find that returns to their investments abroad decline, when expressed in dollars. American travellers, who have suffered erosion in their purchasing power abroad during the past seven years will, however, benefit from the current strengthening of the greenback. HOW will the dollar fare once the full impact of the US government’s $700-billion bailout package becomes known is not clear. Will investors start shunning US treasury bonds once they realise the full import of US fiscal deficit? Will foreign investors’ confidence in the US economy fade with the prospects of its future economic growth? If the answer to these questions is yes, then it is clear that the ‘global’ economic recession has not yet led to the much needed correction in the global financial system. While the world economy is looking towards Asia, in particular China and India, for economic growth in the coming five years, Asian economies in turn depend heavily on US consumers. The recent depreciation of the Chinese yuan, said to be triggered by the slackening of export orders, is an indicator. A weak Chinese currency is expected to keep US demand for Chinese goods buoyant, while the recession in the US would dampen it. However, if the US economy remains in a prolonged recession, it would be foolish to expect that somehow the US would continue to increase its purchase of goods from the rest of the world to keep the world economy going, and it would be foolish and even dangerous to keep financing American imports through debt. If China continues to use its reserves to prop up the dollar, it will seriously weaken its own position and reduce its policy options. Any future dollar depreciation would only result in a decline in the value of Chinese reserves. China can keep its economy growing at double digits by using its $2 trillion reserves to bring prosperity to its people, by creating more jobs and paying workers higher salaries. China can also provide its own people consumer goods at low prices, same as it has been doing for American consumers for decades. China can redeploy its reserves to increase investment in other Asian economies. The Chinese government has announced a $600-billion initiative to boost its economy over the next two years. The boost constitutes 14% of China’s GDP, and can help China maintain its potential economic growth even with slackening of US imports. According to the most recent forecast of the world economy by the International Monetary Fund, advanced economies will experience almost a one percentage point reduction in their GDP in 2009. It is clear from these forecasts that world economic growth in the next two to three years would heavily depend on Asian economies. Asian economies have to creatively invest their resources in productive activities instead of parking them in US treasuries. That’s the only way Asia can bring the world economy out of recession.

(The author teaches at Columbia University)

(Source: Economic Times)