Two Economists, Two Different Views

Two different economists and two different views are out there in today’s New York Times and Washington Post. Economists disagreeing with each other! Well, that will shock no one, of course. What is more noteworthy is the simplicity of one argument and the sophistication of the other. And the best argument doesn’t come from the Nobel Prize winner.

Paul Krugman’s stance in the NYT is again all about the need for another Fed stimulus. But over at the Post Mohamed El-Erian, the CEO of Pimco, the investment management company, has a far greater grasp, I think, that the crisis we are in is as much a structural one as cyclical.

Nobel Prize winner Krugman places most of the political blame for the non-recovery recovery on Republican obstructionism and Democratic timidity. El-Erian sees the political dimension of the crisis in less partisan terms – the whole political elite is failing to understand what is happening, is his take.

Here’s El-Erian: “What is critical to keep in mind is that this situation is part of a broad, multiyear process driven by national and global realignments. It’s a secular phenomenon that needs to be better understood and navigated — by recognizing its structural dimensions and by urgently broadening the excessively cyclical policy mindsets that abound…

Policymakers must break this active inertia by implementing a structural vision to accompany their current cyclical focus. Measures are needed to address key issues, which include the change in drivers of growth and employment creation; the high risk of skill erosion and lost labor productivity; financial deleveraging in the private sector; debt overhangs; the uncertain regulatory environment; and the unacceptably high risks facing the most vulnerable segments of society.

Specific measures would include pro-growth tax reform, housing finance reform, increased infrastructure investments, greater support for education and research, job retraining programs, removal of outdated interstate competition barriers and stronger social safety nets.”

And Krugman? “The Fed has a number of options. It can buy more long-term and private debt; it can push down long-term interest rates by announcing its intention to keep short-term rates low; it can raise its medium-term target for inflation, making it less attractive for businesses to simply sit on their cash. Nobody can be sure how well these measures would work, but it’s better to try something that might not work than to make excuses while workers suffer.” Although for Krugman a stimulus would be the thing. Damn those Republicans!

El-Erian, it strikes me, is right.

Green Shoots of Recovery — Wishful Thinking

The stock market is up. Goldman Sachs has announced a profit.  All of a sudden the chatter on the evening cable shows is of the green shoots of recovery, with declarations being made that we have turned the corner on what only a few months ago was being described as the worst recession since the Second World War…no, the worst slump since the Depression. 


On the Lou Dobbs show on CNN tonight, Cato Senior Fellow Alan Reynolds talked of us coming out of the recession by the third quarter. I know Alan, and like him, but I think he is way off the mark and so too with the other upbeat commentators. The huge response by governments and central banks across the globe – a response Alan criticized – has no doubt slowed the pace of the slump but there remains plenty to worry about.

 The latest economic report from the OECD makes for grim reading. “Economic activity is expected to plummet by an average 4.3 percent in the OECD area in 2009 while by the end of 2010 unemployment rates in many countries will reach double figures for the first time since the early 1990s,” says the OECD’s Economic Outlook Interim Report.

It continues: “Amid the deepest and most widespread recession for more than 50 years, international trade is forecast to fall by more than 13 percent in 2009 and world economic activity to shrink by 2.7 percent. The big emerging economies will also suffer abrupt slowdowns in growth.”

 Several underlying problems remain. Banks are still not lending and investors remain skeptical about investing in banks for good reason: the policies introduced in Britain and the US aimed at cleaning up banks’ toxic debts are too limited.

And the threat of contagion is still there, with the Austrian, Swiss, Swedish and Germans banks highly vulnerable weighed down as they are by loans they made to the credit and investment-thirsty countries of Central Europe.

A second problem rests with what kind of recovery we can expect. The scale of the global recession will have undermined the productive potential of the US and other Western economies with investments not having been made in future efficient production and with the skills base weakened by job losses. All of that means that when the recovery does come – the OECD thinks next year at the earliest – we can only expect it to be very insipid.

Higher taxes needed to pay down the massive debt the governments of the US, Britain and some other Western states are taking on, such as Ireland, will further undermine recovery.

Lastly, nothing is being done about the huge trade and borrowing imbalances that brought us to where we are: in the States, the administration is focusing on stimulating demand (by borrowing, again) and in China the leadership is investing in productive infrastructure to produce the goods Americans will buy with the money they will borrow from China.