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Friday, December 05, 2008

"A Triumph of Reason and Evidence"

Joseph Stiglitz:

Getting bang for your buck, by Joseph Stiglitz, Project Syndicate/Comment is Free: ...For those of us who always claimed some connection to the Keynesian tradition, this is a moment of triumph, after having been left in the wilderness, almost shunned, for more than three decades. At one level, what is happening now is a triumph of reason and evidence over ideology and interests.

Economic theory has long explained why unfettered markets were not self-correcting, why regulation was needed, why there was an important role for government to play in the economy. But many, especially people working in the financial markets, pushed a type of "market fundamentalism". ...

Keynes argued not only that markets are not self-correcting, but that in a severe downturn, monetary policy was likely to be ineffective. Fiscal policy was required. But not all fiscal policies are equivalent. In America today, with an overhang of household debt and high uncertainty, tax cuts are likely to be ineffective (as they were in Japan in the 1990s). Much, if not most, of last February's US tax cut went into savings.

With the huge debt left behind by the Bush administration, the US should be especially motivated to get the largest possible stimulation from each dollar spent. The legacy of under-investment in technology and infrastructure, especially of the green kind, and the growing divide between the rich and the poor, requires congruence between short-run spending and a long-term vision.

That necessitates restructuring both tax and expenditure programs. Lowering taxes on the poor and raising unemployment benefits while simultaneously increasing taxes on the rich can stimulate the economy, reduce the deficit and reduce inequality. Cutting expenditures on the Iraq war and increasing expenditures on education can simultaneously increase output in the short- and long-run and reduce the deficit. ...

Ben Bernanke has tried hard to avoid having the blame fall on the Fed for deepening this downturn in the way that it is blamed for the Great Depression, famously associated with a contraction of the money supply and the collapse of banks.

And yet one should read history and theory carefully: preserving financial institutions is ... a means to an end. It is the flow of credit that is important, and the reason that the failure of banks during the Great Depression was important is that they were involved in determining creditworthiness; they were the repositories of information necessary for the maintenance of the flow of credit.

But America's financial system has changed dramatically since the 1930s. Many of America's big banks ...  establish[ed] a record of incompetence in assessing risk and screening for creditworthiness. Hundreds of billions have been spent to preserve these dysfunctional institutions. Nothing has been done even to address their perverse incentive structures...

The neo-liberal push for deregulation served some interests well. Financial markets did well through capital market liberalisation..., even if they imposed large costs on others.

Today, the risk is that the new Keynesian doctrines will be used and abused to serve some of the same interests. Have those who pushed deregulation 10 years ago learned their lesson? Or will they simply push for cosmetic reforms – the minimum required to justify the mega-trillion dollar bail-outs? ... It is imperative that we not just respond adequately to the current crisis, but that we undertake the long-run reforms that will be necessary if we are to create a more stable, more prosperous and equitable global economy.

I will be pleased to find out I am wrong about this, but I don't think it's possible to give the economy the boost it needs in the short-run and reduce the deficit at the same time. We can still design policies with an eye toward longer run goals such as reducing inequality, but a deeper downturn than is necessary will hurt the people in the middle and bottom of the income distribution the most. First and foremeost we need to be sure that we provide enough help for the economy.

    Posted by on Friday, December 5, 2008 at 06:39 PM in Economics, Financial System, Fiscal Policy | Permalink  TrackBack (0)  Comments (48)

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