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Transcript
NS3040 Winter Term 2015 Adjusting to Global Economic Change Overview • Robert A. Levine, “Adjusting to Global Economic Change: The Dangerous Road Ahead,” Rand, 2009 • Main Points: • Crisis that began in 2008 latest in a series of over exuberance-based financial bubbles • Fortunately governments and central bankers learned how to cope based on the 1930s great depression • Crisis may be imposed on longer-term economic shifts that make it extremely difficult to handle • Similar situation to the stagflation period in 1970s – monetary and fiscal policy ineffective due to shift in incomes to OPEC countries • Current crisis may be compounded by the shift in world income to East Asia – especially China 2 1929-1939 I • Up to the 1930s public policy mainly ignored bubbles collapses • Assumed that free markets and new technologies worked things out – often with considerable misery • Change in views in 1930s – not merely a financial crash, but more importantly a collapse of aggregate demand • Federal Reserve did not recognize problem and instead contracted the money supply • Hoover Administration balanced budget by cutting public spending – compounded demand problem • Congress made things worse by passing Smoot-Hawley tariff – setting off a trade war which reduced US exports 3 1929-1939 II • Classical economics predicted a recovery once wages and prices started to fall – did not happen • Keynes criticized classicals – lacked feedback loops – what works for individual does not work for economy as a whole • Keynes solution – put more purchasing power into economy – government deficits, easy money policies • Roosevelt apparently not a Keynesian – he just felt public works/make work programs might help reduce unemployment • Keynesianism not clear on what caused depression – overshooting of investment, under consumption – no consensus 4 1929-1939 III • Schumpeter, an anti-Keynesian Austrian economist explained the depression in a business-cycle framework • Cycles built around innovation and “creative destruction” • New innovations set off an investment wave – demand increases with eventual overshooting and contraction • Three main cycles – usually one is on the upswing making it easier to come out of recession • Depression a case where all cycles are down at same time. 5 1929-1939 IV • Three theories of the Depression – Classical, Keynesian and Austrian • Classical explanation -- Stock market crash – bubble based on the overexertion of post World War I speculation • Keynesian – subsequent down turn make worse by contractionary monetary and fiscal policies • Schumpeterian/Austrian – above factors made worse by being on ebb-side of along Schumpeterian wave stemming from the automobile-airplane-radio revolution. 6 1929-1939 V 7 1929-1939 VI • Chart seems ambiguous about Keynesian policies in 1930s • Federal budge in balance in 1930 and 31 • Then rose sharply in 1932 and 1933 – drop in revenues • First year of Roosevelt administration deficit went to 5% and then around 3 percent after that • New Deal deficit finance seemed to work – unemployment started down from more than 25% in 1933 to 15% by 1940 • Levine suggests it took WWII to get us out of depression – controversial, Marxian explanation • Remember from Deutsche Bank paper, the Austrians explain the slow recovery to reduction in credit by the banking system • Post War inflationary pressures due to high spending 8 rates 1940-65 I 9 1940-65 II • After war Congress removed wage and price controls – inflation accelerated • Federal Reserve targeted interest rates – very low to reduce cost of government deficit • Phillips Curve may have developed • Kennedy Administration first Keynesian one in U.S. • Successful tax cut in 1964 actually caused a surplus in the Federal Budget • Vietnam financing largely through borrowing – inflationary pressures again • Large U.S. deficits and outflow of dollars put too much stress on Bretton Woods System – collapsed in early 1970s. 10 1972-1986 I • OPEC prices increases 1973-74 – more stress on system • Cost-push inflationary pressures developed • Dilemma – contract economies due to inflationary pressures or keep them at full employment and risk more inflation • West chose full employment since traditional antiinflationary approaches ineffective – not demand pull inflation. • Monetary and fiscal policies to reduce demand and inflation would bring about stagnation of economic growth • Stimulating demand to restore employment accelerates inflation • Result – period of stagflation • Many Western governments fell due to poor economic 11 performance – increase in misery index 1972-1986 I 12 1972-1986 III • In U.S. Reaganomics introduced – tax cuts, antiinflationary monetary policy • Risky – interest rates had to fall fast so lower taxes might stimulate investment leading to growth and more revenues with a federal budget going to surplus • Did not happen – inflation came down fast, but nominal rates slow to drop – result very high real rates of interest and little investment – federal deficit larger • Finally, falling oil prices helped the economy gain some traction 13 1986-2000 I • IT revolution begins – example of a Schumpeterian innovative long wave • Ended the period of modest economic growth in the 1980s – Misery Index improves 14 2000-2008 I • IT wave probably crested in early 2000s • Unfortunately the timing coincided with new phase in global economy similar to that in 1970s • Shift in incomes to Asia • Not zero sum, but because of rigidities in economies hard to adjust to shift in demand toward Asian countries • Levine claims that there is a pattern between the income shares of US in world economy and the Misery Index • Other associated factors – rise in price of oil due to rapid Chinese economic growth • Losses in manufacturing jobs due to rapid industrialization in China • Both factors result in sub-optimal growth in U.S. up to 2008 15 2000-2008 II 16 2000-2008 III • Problem – Shift share not a Schumpeterian process – he focused on the upside that was brought about by technological growth • On other hand fits in his framework – shift share can begin a long-run declining wave – a trough, with mirror image effects on well-being and shorter cycles. • A rising Schumpeterian wave will eventually fall as the initial technologies run their course and investment overshoots. • There is less evidence as to whether downward movements also contain seeds of their own reversal. • The 1970s stagnation began to end with OPEC overshot and lost control over oil process, but finally ended only by IT revolution. 17 Prospects I In 2008 -• New shift-share long trough triggered by credit crisis • In U.S. consumption is down with investment likely to follow • Will increase unemployment and produce a downward spiral? • Need for Keynesian stimulus, but will it be large enough? • Problem with Keynesian economics now is leakages into imports – not an issues in original 1930s version. • Means countries will have to coordinate economic policies -- 18 Prospects II • Possible Scenarios • 1. Shift share analysis wrong – once credit crisis is over coordinated monetary and fiscal polices may restore growth in a tolerable time • Additional wise policies developed and emerging economies spread prosperity to developing countries • 2. Downward spiral may continue – stimulus insufficient • No international coordination – may be period of increased protectionism and long stagnation • 3. Turnaround policies may be effective but shift/share correct • Emerging economies may grow quickly -- outpace developed countries • Growth restored -- oil prices start going up • Stagflation in developed countries until a new Schumpeterian wave sets in 19 Prospects III Policy Responses (Levine) • Both classical and Keynesian theories suggest turnaround possible • Classicals (Monetarists) stress use of monetary policy • Keynesians cite liquidity trap and prefer fiscal policy • However, stimulus in one country not likely to be effective – may need a new Bretton Woods to provide framework for new global environment • If shift share correct U.S. policy complicated by fact that growth is likely to lead to prosperity for some but real declines for major portions of the population 20