Economies and bubbles: a scary scenario

Paul Krugman used his New York Times column yesterday to blog about a remarkable address by Larry Summers to an IMF research conference.  It’s important because, if true – and it’s all too plausible – it paints a grim picture of how the world economy could be in the process of sinking into a permanent recession.  Inevitably the spectre of Japanese-style secular stagnation stalks discussions of how the world economy could develop.

In summary, the argument runs:

  • The economy is currently in a situation where the real rate of interest is effectively negative, but obviously constrained by the zero bound (in the real world you can’t have a negative interest rate) which means that saving hurts the economy and seeking to reduce deficits results in recession. This is the situation in which Keynes’ scenario of spending on anything simply to get the economy moving starts to have an effect;
  • But Summers notes that the same is true of private spending; it makes far more economic sense in the short-to-medium term to be profligate than prudent, as long as it doesn’t store up problems in the long term;
  • But, crucially, this may not be a temporary state of affairs;  because in recent decades we have seen a number of consumption bubbles that have not led to inflationary pressures (although there has been a considerable increase in property prices and household debt, there has not been wage-driven, capacity-squeezed inflation). So, the argument runs, bubbles serve a vital purpose – that of providing short intervals of full employment.  Without those bubbles, full employment would not have been achieved;
  • One factor in all this is the change in demography; during the period from 1960-85, when the US economy was generally achieving growth without bubbles, the population was expanding at a steady 2% per year, boosting demand. But that is no longer the case.
  • So in other words, there is reason to believe that the present conditions – which are inherently deflationary – may not be as exceptional as some policy-makers are suggesting.  Given that the official policy line is for governments and central banks to intervene less, the prospects are for a long recession.  Again, the example of Japan comes strongly to mind.

What I take from this is something rather scary about the state of modern capitalism. Summers argues paradoxically that the reform of the banking system that sensible people on the centre-left see as a prerequisite for avoiding future crises is actually a bad thing, because it could choke off the only conditions in which people could get back to work.

Krugman argues that in the world in which Summers describes, we have to accept that personal saving is a vice, not a virtue; collectively, it makes things worse.  He flirts with the idea of actually having negative interest rates, so that deposits fall in value.  Whether this is meant seriously or not, it gives an indication of how mixed up our economic debate is; in Britain the Government likes to use the analogy of a household maxing out its credit card, but if Krugman and Summers are right the responsible citizen is the one who goes on a spending spree. Pointedly, Krugman argues that giving people the expectation of earning a return on their investments in the current climate is basically a form of dependency culture for rentiers.

In policy terms, all of this leads in one direction – that Governments who want a way out of austerity need fundamentally to rethink their policy approaches, in a way that will lead to a situation in which some form of inflation is the norm; and that’s a huge shift from the political rhetoric of the last 35 years.  Politically it seems to me that on the left at least we simply cannot accept a world in which we are in perpetual boom and bust (let alone the current policy of bust and more bust); the collateral human damage is just too vast.  If Summers and Krugman are right, economists and politicians on the left have to find an alternative.

And, crucially, that means that left and centre-left parties cannot afford to let economic orthodoxy set the agenda

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2 thoughts on “Economies and bubbles: a scary scenario

  1. To read these viewpoints is frustrating in many ways.

    The underlying assumption it would seem is that growth is a pre-requisite for stability. It simply must be achieved and all policy should hold this to be true.

    This is an assumption that has been attacked time and time again, and freely admitted as an illogical underpinning of the system we have by those directed to reform it.
    http://www.stiglitz-sen-fitoussi.fr/documents/rapport_anglais.pdf

    Yet the true will has never been there by governments, or central banks, whoever it may be, to seek a real alternative in recent times. Can kicking is in vogue.

    And so we arrive in a world in which:

    – savers are taxed for attempting to prepare for the future through negative interest rates and derided as ‘rentiers’;
    – aggregate incomes no longer support increasing levels of debt;
    – debt flows increasingly into paper speculative assets in bubble fashion because we simply don’t have the productive investments available to absorb it;
    – zombie companies exist only because interest rates remain at such low levels allowing them to re-finance when the debt collectors come knocking;
    – the money multiplier is under pressure for the above reasons as money is returned to pay off debt at much earlier stages in the economic cycle

  2. Pingback: Hard Work: why we need to change the way we think about work, pay and benefits | Notes from a Broken Society

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