High time for all of us to 'buck up'
Saturday, 23 February 2008
Samuel Brittan
MANY years ago we had a family friend of Lithuanian Jewish descent who had picked up a smattering of idiomatic English expressions. One of these was "buck up".
Looking at much of the comment on the credit crunch, I feel like saying that myself. Surely we know by now that market economies do not move in a straight line but are subject to periodic setbacks of varying strength. The late Christopher Dow in his mammoth study, Major Recessions , defined these as occasions when gross domestic product showed a clear absolute fall between one year and the next. The UK has experienced five of these since 1920: 1920-21, 1929-32, 1973-75, 1979-82 and 1989-93. Output fell in these by a cumulative 10 per cent relative to trend. Allowing for the subsequent recovery periods, the net effect was to reduce trend growth from 3 to 2 per cent a year. Not a pretty story, yet hardly enough to justify many wishful-thinking commentators claiming each time that the final crisis of capitalism is at last upon us. What is more irritating is the way members of the financial elite also like to bathe in pessimism and say to each other: "The crisis is worse than you think" and then speculate on which will be the next enterprise to succumb. Other misleading clichés uttered at such times are "the old rules no longer apply" and "traditional remedies no longer work".
One of the reasons I went into economics was a puzzle about involuntary unemployment: the paradox of unsatisfied wants side-by-side with idle hands. While there are enough genuine problems because of the scarcity of real resources to satisfy everything we should like to do, depressions associated with lack of spending are an unnecessary extra; and there are more than enough ways of stimulating citizens or governments to spend more. It took John Maynard Keynes' elaborate theory to persuade policymakers of the obvious.
Of course there is more to say. Not all unemployment is caused by deficient demand. It may reflect trade unions or other interest groups insisting on real rewards that price people out of work. If we try to remedy this by pushing purchasing power into the system we merely get an accelerating inflation. This wage- push unemployment was important in the UK in the 1970s but now remains a threat only in Germany and perhaps other parts of the euro area.
A more subtle complication is that recessions serve a purpose in weeding out unviable investments or obsolete enterprises that have blossomed in the boom phase. This is Joseph Schumpeter's belatedly famous "creative destruction". But while we may have to pause while the weeding process proceeds, there is no need to tolerate a downward spiral in which workers and corporations slash their spending on perfectly viable activities. Such a "secondary depression" can indeed be checked by injecting enough spending power by monetary or fiscal stimulation or a mixture of both. Yet when Dominique Strauss-Kahn, the head of the International Monetary Fund, called for such policies on a selective basis a few days ago, some reacted as if the Pope had embraced the teachings of Martin Luther.
It is far from obvious that we face a major worldwide recession. The euro area, China and the UK seem to be working at the safety limits of capacity and even in the US the indicators leave room for argument. If national authorities overreact to a threatened downturn the result might be to overstimulate the economy in the next upward phase. One way to understand this is to think of a badly set thermostat that reacts so slowly to a temporary cold spell that we are all boiling by the time the heating has been turned up.
Such overstimulation risks taking us into higher rates of inflation that are then very painful to get down. Alan Greenspan in the unjustly neglected, more speculative second half of his autobiography suggests, on the basis of the historical record, that without something like a gold standard the average world inflation rate will by 2030 be at about 4½ per cent. Nevertheless we would not be doing too badly on other real indicators. The snag is that unless policymakers put up a show of aiming at something like 2 per cent inflation, the end result could be much more than 4½ per cent.
The ideal stimulus for the world today was outlined in the Financial Times leader on January 29. The main push would come from Asia and the euro area. There would be only a modest stimulus in the US. Unfortunately such a package goes against the beliefs or prejudices of policymakers in these areas. The US is still fighting the ghost of the Depression of the 1930s, the European Central Bank is hung up on sound finance and the Chinese authorities are terrified of taking risks with domestic stability.
From time to time I have been tempted to say that a globalised world needs a globalised financial policy. The trouble is that everybody would then be right or wrong together, thus magnifying any policy errors. The existing mixture of reactions, while far from ideal, may be the best compromise available. But my main moral is still "buck up". While we cannot avoid modest fluctuations, there is no need to talk ourselves into another depression.
MANY years ago we had a family friend of Lithuanian Jewish descent who had picked up a smattering of idiomatic English expressions. One of these was "buck up".
Looking at much of the comment on the credit crunch, I feel like saying that myself. Surely we know by now that market economies do not move in a straight line but are subject to periodic setbacks of varying strength. The late Christopher Dow in his mammoth study, Major Recessions , defined these as occasions when gross domestic product showed a clear absolute fall between one year and the next. The UK has experienced five of these since 1920: 1920-21, 1929-32, 1973-75, 1979-82 and 1989-93. Output fell in these by a cumulative 10 per cent relative to trend. Allowing for the subsequent recovery periods, the net effect was to reduce trend growth from 3 to 2 per cent a year. Not a pretty story, yet hardly enough to justify many wishful-thinking commentators claiming each time that the final crisis of capitalism is at last upon us. What is more irritating is the way members of the financial elite also like to bathe in pessimism and say to each other: "The crisis is worse than you think" and then speculate on which will be the next enterprise to succumb. Other misleading clichés uttered at such times are "the old rules no longer apply" and "traditional remedies no longer work".
One of the reasons I went into economics was a puzzle about involuntary unemployment: the paradox of unsatisfied wants side-by-side with idle hands. While there are enough genuine problems because of the scarcity of real resources to satisfy everything we should like to do, depressions associated with lack of spending are an unnecessary extra; and there are more than enough ways of stimulating citizens or governments to spend more. It took John Maynard Keynes' elaborate theory to persuade policymakers of the obvious.
Of course there is more to say. Not all unemployment is caused by deficient demand. It may reflect trade unions or other interest groups insisting on real rewards that price people out of work. If we try to remedy this by pushing purchasing power into the system we merely get an accelerating inflation. This wage- push unemployment was important in the UK in the 1970s but now remains a threat only in Germany and perhaps other parts of the euro area.
A more subtle complication is that recessions serve a purpose in weeding out unviable investments or obsolete enterprises that have blossomed in the boom phase. This is Joseph Schumpeter's belatedly famous "creative destruction". But while we may have to pause while the weeding process proceeds, there is no need to tolerate a downward spiral in which workers and corporations slash their spending on perfectly viable activities. Such a "secondary depression" can indeed be checked by injecting enough spending power by monetary or fiscal stimulation or a mixture of both. Yet when Dominique Strauss-Kahn, the head of the International Monetary Fund, called for such policies on a selective basis a few days ago, some reacted as if the Pope had embraced the teachings of Martin Luther.
It is far from obvious that we face a major worldwide recession. The euro area, China and the UK seem to be working at the safety limits of capacity and even in the US the indicators leave room for argument. If national authorities overreact to a threatened downturn the result might be to overstimulate the economy in the next upward phase. One way to understand this is to think of a badly set thermostat that reacts so slowly to a temporary cold spell that we are all boiling by the time the heating has been turned up.
Such overstimulation risks taking us into higher rates of inflation that are then very painful to get down. Alan Greenspan in the unjustly neglected, more speculative second half of his autobiography suggests, on the basis of the historical record, that without something like a gold standard the average world inflation rate will by 2030 be at about 4½ per cent. Nevertheless we would not be doing too badly on other real indicators. The snag is that unless policymakers put up a show of aiming at something like 2 per cent inflation, the end result could be much more than 4½ per cent.
The ideal stimulus for the world today was outlined in the Financial Times leader on January 29. The main push would come from Asia and the euro area. There would be only a modest stimulus in the US. Unfortunately such a package goes against the beliefs or prejudices of policymakers in these areas. The US is still fighting the ghost of the Depression of the 1930s, the European Central Bank is hung up on sound finance and the Chinese authorities are terrified of taking risks with domestic stability.
From time to time I have been tempted to say that a globalised world needs a globalised financial policy. The trouble is that everybody would then be right or wrong together, thus magnifying any policy errors. The existing mixture of reactions, while far from ideal, may be the best compromise available. But my main moral is still "buck up". While we cannot avoid modest fluctuations, there is no need to talk ourselves into another depression.