It took bad thinking and bad policy by many players to get us into the state we’re in; rarely in the course of human events have so many worked so hard to do so much damage.
But if I had to identify the players who really let us down the most, I think I’d point to European institutions that lent totally spurious intellectual credibility to the Pain Caucus. Specifically:
- The Organization for Economic Cooperation and Development, which a year ago demanded both fiscal austerity and a sharp rise in interest rates in the United States, because, well, just because. Recently the O.E.C.D. surveyed Britain and concluded that inflation is likely to decline, unemployment to rise, and that the nation should therefore … continue with fiscal austerity and raise rates. As a correspondent wrote, “What planet are they living on? What planet am I living on?”
- The European Central Bank, which completely bought into the doctrine of expansionary austerity, despite overwhelming evidence that it was false, and proceeded to raise rates in the face of a deeply depressed economy — which is possibly the straw that will break the euro’s back.
- The Bank for International Settlements, which called for tighter monetary policy from central banks just three months ago, to fight a nonexistent inflationary threat. Did I mention that inflation expectations, as measured by the difference between yields on ordinary and index bonds, have been plunging like a stone?
I haven’t developed a full theory of the sociology going on here. But these organizations should be doing some agonized soul-searching, asking how they got it so wrong while posing as high priests of economic expertise.
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Maybe (probably) I’m reading too much into this, but I was struck by a recent headline in The Financial Times: “I.M.F. Warning Over Stimulus Policies.” Because if you actually read the story, the International Monetary Fund is actually warning about austerity policies.
As Alan Beattie, an editor at The Financial Times, reported on Sept 20: “Escalating risks to the global economic recovery mean the U.S. and other major economies should not sharply tighten short-term fiscal policy, the International Monetary Fund has warned.”
I suspect that the headline is the result of a Freudian slip; whether it is or not, there’s no question that last year austerity fever swept through the ranks of Very Serious People like a dance craze, and that both policy makers and the media are having a hard time returning to reality. Part of the problem is that they stuck their necks out so far on behalf of magical thinking, in which fiscal contraction is actually expansionary. Now it’s difficult to back down without in effect conceding that they have no idea what they’re talking about, which happens to be the simple truth.
Confusion About Ireland
I see that the economist Tyler Cowen has decided (as revealed in several entries in his blog, Marginal Revolution) that a small uptick in Irish gross domestic product and a decline in interest rates from nosebleed levels to levels that only signal a significant default somehow refutes Keynesian economics.
I really wonder about the state of economics education. Look, standard Keynesian models, open-economy version, tell a very clear story about what happens when a country pegs its exchange rate at a level that leaves its industry uncompetitive.
The country doesn’t stay depressed forever: High unemployment leads to actual or, at least, relative deflation, which gradually improves cost-competitiveness, which leads to rising net exports and gradual expansion.
In the long run, full employment is restored; it’s just that in the long run we’re all, well, you get the picture.
That was John Maynard Keynes’s whole point in “The Economic Consequences of Mr. Churchill,” an essay written in 1925 — not that the return to a gold standard at too high a parity would mean depression forever, but that it would subject Britain to years of unnecessary suffering. Seeing some growth in Ireland, then, is not at all a refutation of Keynesian economics — it’s exactly what you’d expect, given that Ireland is, in fact, gradually achieving an “internal devaluation” via relative deflation.
What would have posed an intellectual puzzle would have been a rapid bounce back to full employment.
And that isn’t happening.
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Paul Krugman joined The New York Times in 1999 as a columnist on the Op-Ed page and continues as a professor of economics and international affairs at Princeton University. He was awarded the Nobel in economic science in 2008.
Mr Krugman is the author or editor of 20 books and more than 200 papers in professional journals and edited volumes, including “The Return of Depression Economics” (2008) and “The Conscience of a Liberal” (2007). Copyright 2011 The New York Times.