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Thursday, June 17, 2010

"Paradox of Thrift" versus "Confidence in the Markets"

Who is correct, Keynes who argued that budget cuts in a recession make things worse -- his "paradox of thrift" -- or the austerians who say that budget cuts restore "confidence in the markets" and make things better? Hopefully, by now, you know how I see it:

Once again we must ask: ‘Who governs?’, by Robert Skidelsky, Commentary, Financial Times: In 1974, Edward Heath asked: “Who governs – government or trade unions?” Five years later British voters delivered a final verdict by electing Margaret Thatcher. The equivalent today would be: “Who governs – government or financial markets?” No clear answer has yet been given, but the question may well define the political battleground for the next five years. ...
The implicit premise of the coming retrenchment is that market economies are always at, or rapidly return to, full employment. It follows that a stimulus, whether fiscal or monetary, cannot improve on the existing situation. All that increased government spending does is to withdraw money from the private sector; all that printing money does is to cause inflation.
These propositions are a re-run of the famous “Treasury view” of 1929. By contrast, Keynes argued that demand can fall short of supply, and that when this happened, government vice turned into virtue. In a slump, governments should increase, not reduce, their deficits to make up for the deficit in private spending. Any attempt by government to increase its saving (in other words, to balance its budget) would only worsen the slump. This was his “paradox of thrift”. ...
Politicians clamouring for cuts in public spending ... talk about the need to restore “confidence in the markets”. The argument here is that deficits do positive harm by destroying business confidence. This collapse of confidence may come in several forms – fear of higher taxes, fear of default, fear of inflation. Deficits thus delay the natural (and rapid) recovery of the economy. If markets have come to the view that deficits are harmful, they must be appeased, even if they are wrong. ...
We are about to embark on a momentous experiment to discover which of the two stories about the economy is true. If, in fact, fiscal consolidation proves to be the royal road to recovery and fast growth then we might as well bury Keynes once and for all. If however, the financial markets and their political fuglemen turn out to be as “super-asinine” as Keynes thought they were, then the challenge that financial power poses to good government has to be squarely faced.

    Posted by on Thursday, June 17, 2010 at 04:23 AM in Budget Deficit, Economics | Permalink  Comments (151)


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