first some basic fundamentals...
Let us see what happens in an economic depression.
To put it simply economics is a play of supply and demand. In depression the demand goes down. Now what is this demand? Demand is for goods and services. For example if am a skilled laborer, (mechanical engineer for eg) suddenly I will find there s no demand for my skill (no construction work is happening).
How to manage a depression?
Before going to that we have to understand the three schools of thought in economics. They are 1)Keynesian school or demand side economics also known as salt water economics as the costal schools of economics were main proponents of this 2) classical or supply side economics;renamed now as neoclassical and also known as fresh water economics cuz the main proponents of this school were from mainland schools of economics in US like chicago and 3) Monetarism
So how does Keynesian economics solve my problem (jobless mechanical engineer) in economic depression? (in other words what is this talk about increasing govt spending?)
This theory postulates that solution comes best from increasing the demand for goods and services. In my case for eg, since private sector will be reluctant to start new construction projects, the government will have to put in money and start new construction projects so that I will get job. So to stimulate growth, the government should increase government spending (investments in infrastructure such as dams and roads,). Now as all of these may not be yielding immediate returns or profit, the government debt (budget deficit) will rise. So what should government do then? What it shouldn’t do (and what US congress is going to do)is to go into austerity measures and spending cuts to bring down the deficits . Now not only will I loose my job but also my insurances and health care. What government should do on the other hand to reduce the debt is to increase taxes on high income group (congress on other hand is talking of tax cuts!!). so in short Keynesian solution is a short term high fiscal deficit intervention by government.
In short government should take hands on attitude and make major fiscal policy adjustments and get into the market aggressively. It shouldn’t bother about short term rise in fiscal deficit. If anything increasing fiscal deficit is a good indicator of a pro active government fiscal policy in times of depression.
Ok. So what’s the neoclassical / supply side economics solution for getting me job? (in other words what does the tea party movement want or are they complete idiots ? )
Supply-side economics suggests that cutting taxes on the wealthiest people allows business owners to create more jobs and thus the wealth will pass down from top to bottom by "Trickle-down economics’”. A high fiscal deficit led increased government spending will only hurt private investment as government will take over the projects which would have gone to private companies. since private investment will be more profit oriented and market savvy , I will get job in a construction company which will be well managed and profit driven in future with pay hikes instead of government owned public sector company which will be stagnant and probably nonprofit based.
In short government should just lay off and not interfere. Its primary aim should be to cut its budget deficit. Low fiscal deficit is seen by investors (by a AAA rating!!) as an indicator of good governance and can help attract large levels of private domestic and foreign investment .Since tax cuts should be the policy during depression the deficit can only be reduced by spending cuts and austerity measures
So what does Monetarism say about giving me job during depression? (in other words why we hear always about interest cuts ? )
Monetarism based strategy today is usually the first line of defense against depression. Let’s see what it is about. As we saw earlier, according to Keynesians, the recession has to be managed by increased government spending (deficit spending), increased taxation & through a fiscal policy that allows it.
Friedman and colleagues from Chicago school of economics postulated that it was the contraction of money circulating that causes recession and hence the management should be to release more money by reducing interest rates, decreasing mandatory reserve requirements of banks etc. so, in my case first the Reserve Bank will reduce the interest rates which in turn allows the other banks to borrow more money from reserve bank and they also will cut the interest rates. Now once banks cut interest rates, people who are wealthy will start putting less money in bank (and put it to construction work in my case) and I will be able to take loans from bank at s cheaper interest rate too.
In short, in contrast to Keynesian school it advocates against government intervention in market done by increased spending by high fiscal deficit which will only cause inflation or increasing taxes & increased regulations .Today the primary tool for controlling inflation is monetarism based. So its been said we live in times of the central banker. Ben Bernanke, Subha rao et al owe their importance to monetarism
Ok, fine. So what’s this AAA rating problem and tea party noise? (In other words, how did obama et al screw it up?)
As we have seen the first tine of defense today of governments is monetarism based. Meaning cut the interest rates of banks. US central bank can’t do it cuz the interest rates are already almost zero! Gosh, how did that happen? Well before the 2008 depression there was a dot com bubble which burst in US. In order to get away from that depression banks reduced the interest rates. Even after the economy stabilized they didn’t raise e the rates (as it was helping the private sector) which lead to economy overheating again in form of housing bubble. So now they can’t use monetarism now as rates can’t be lowered below zero! So that option is out
Now, the solution of supply side economics or in tea part terms, tax cuts!. The supply side economics fails in time of depression due to two reasons. One, it banks on trickledown economics meaning if my employer is given tax cuts, his income will increase. But if he doesn’t pass it down to me in form of increased number of jobs trickling won’t happen. In a time of depression only a nonprofit minded establishment like govt will be ready to invest its money. Secondly, supply side postulates strict fiscal discipline or in other words keeping the fiscal deficit low. This means at time of tax cuts, to reduce the deficit govt will have to cut its expenditure by cutting the money it gives to social security measures. Meaning it’s a double whammy for me. My employer who became rich is not giving me the job and I have lost my health insurance too!!!
So that leaves US govt with only with the Keynesian solution ( as it was in 1930’s). Now what did obama administration do? It started off by making right noises. But in the end when it announced the stimulation package it did two interesting things. One a mistake and another a sleight of hand. Mistake was that the package announced was too small as they tried for bipartisanship. The sleight of hand was that major part of this govt spending went to bail out rich investment banks and little went to actual job creation. Naturally though the US debt raised, the job creation didn’t take place. in short i didnt get any job though i read in papers govt is spending trillions of dollars for getting me job!!!
Now enter tea part movement & AAA rating. Tea party leaders started pointing out the faulty implementation of policy of govt stimulus as the fault of the policy itself. It’s like blaming the surgical procedure for the inefficiency of surgeon! The best part is the rating agencies. these are the very agencies that gave AAA rating to investement banks in 2008 till the day before they became bankrupt!!! if anything not loosing AAA rating should be a warning sign!!
No comments:
Post a Comment