Will we see a replay of the financial crash of 2008?
Modern macroeconomics arose from attempts to explain severe inflations and deflations after World War I – just as classical macroeconomics had tried to make sense of the British price swings following the Napoleonic wars of the early 19th century. So it is no surprise to find that macroeconomics still focuses on explaining puzzling events.
Exhibit I is the strange spurt in national economies around the world as 2011 begins. Most seem to be growing more rapidly than was anticipated a year ago. Global output may rise 5% this year, according to The Economist, with developing economies like China’s and India’s outstripping Western economies.
A few trouble spots blur the crystal ball. The fourth-largest economy in Europe, Spain, may crash just as Greece and (to a lesser extent) Ireland have. Unemployment remains near depression levels in the United States and hinders its ability to fuel the world economy by importing from it. Throughout the world, including in Kazakhstan, banks remain weak. Are we truly out of the financial woods?
The answer to this question depends on the framework that we apply to it.
When Irish eyes are frowning
Keynesian economists worry mainly about incipient pessimism in weak economies. In addition to restrained spending in the United States, consumers may also cut back in Greece, Ireland, Spain, Portugal, and even in the United Kingdom, in anticipation of crashes to come, which may thus become rather self-fulfilling prophecies. The solution is to calm the public’s nerves with public spending. If the government spends freely, reviving factories and jobs, then consumers will surely follow.
On the other hand, monetarist economists regard economies as inherently stable. Some, like Ireland’s, may suffer for the moment from overextended banks, but this is just a correction needed to bring the banks back to snuff; it is not a psychological crisis among consumers that requires the consolation of government. The government should not spend its way out of the crisis but instead punish wayward banks and let the industry recover on its own.
To monetarists, the Keynesian policy of free public spending just adds fuel to economies already basically healthy. Sooner or later, the extra money will fuel spending when the economies already are producing as much as they can. Since output cannot rise, prices will. The Keynesian stimuli will just lead to inflation. In the United States, much of the bitter debate over the chairman of the central bank, the Federal Reserve, Ben Bernanke, turns on the fact that he is an apparent monetarist now pursuing a Keynesian increase of the money supply. Keynesians counter that Bernanke is coping with high unemployment and his seeming reversal vindicates Keynes.
The New Classical Economists, maligned for failing to predict the crash of 2008, reinforce the monetarist point that economies are basically sound; sooner or later, they return to full employment. In fact, New Classical economists go further than monetarists, arguing that economies almost always remain at full employment unless
government tampers with them. The crash of banks and asset markets in 2008 was mainly the fault of governments that encouraged bad lending, for political reasons, and hence prolonged it.
In summary, Keynesian economists see lasting psychological flaws in the economy; monetarists see a sound economy that is vulnerable to fluctuations in the supply of money; and New Classical economists see almost-always sound economies that can be overturned only by government incompetence. The three schools differ basically on whether government intervention is a necessity or an evil.– Leon Taylor, tayloralmaty@gmail.com
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