The history of macroeconomic thought has been one of lively debate between different schools.
First there is debate between those who favour active government intervention (Keynesians) to manage aggregate demand and those who favour a rules-based approach of targeting some variable, such as the money supply (as advocated by monetarists) or the rate of inflation (as pursued by many central banks), or a hybrid rule, such as a Taylor rule that takes into account a weighted target of inflation and real output growth.
Second there is debate about the relative effectiveness of monetary and fiscal policy. Monetarists argue that monetary policy is relatively effective in determining aggregate demand, which in turn affects output in the short run but only prices in the long run. Keynesians argue that monetary policy can be weak in the short run if the economy is in recession. Quantitative easing may simply be accompanied by a decline in the velocity of circulation. It’s not enough to make more money available and keep interest rates close to zero; people must have the confidence to borrow and spend. Keynesians argue that in these circumstances fiscal policy is more effective.
Third there is the debate about the size of the state and the extent of government borrowing. Libertarians, following the views of economists such as Hayek, argue that reducing the size of the state and reducing government borrowing will create a more dynamic economy, where the private sector will expand to take up the slack created by a reduction in the size of the public sector. Their approach to policy involves a mixture of cutting deficits and market-orientated supply-side policy. Economists on the left, by contrast, argue that economic growth is best stimulated in the short term by increases in government spending and that supply-side policy needs to be interventionist, with the government investing in infrastructure, research and development, education and health. Such growth policies, they argue can be targeted on the poor and help to arrest the growing inequality in society.
These debates have been given added impetus by the global financial crisis in 2008 and the subsequent recession, slow recovery and possibility of a slide back into recession. The initial response of governments and central banks was to stimulate aggregate demand. Through combinations of expansionary fiscal policy, interest rates cut to virtually zero and programmes of quantitative easing, the world seemed set on a course for recovery. But one result of the policies was a massive expansion in government deficits and debt. This led to increasing criticisms from the right, and a move away from expansionary to austerity fiscal policies in order to contain debts that were increasingly being seen as unsustainable. And all the while the debates have raged.
The following podcast and articles look at the debates and how they have evolved. The picture painted is a more subtle and nuanced one than a stark ‘Keynes versus Hayek’, or ‘Keynesians versus monetarists’.
Podcast
Keynes v Hayek: The debate continues BBC Today Programme, Nicholas Wapshott and Paul Ormerod (23/12/11)
Articles
Von Hayek Revisited – Warts and All CounterPunch, David Warsh (26/12/11)
Fed up with Bernanke Reuters, Nicholas Wapshott (20/12/11)
Paul Krugman Versus Milton Friedman Seeking Alpha, ‘Shareholders Unite’ (6/12/11)
Keynes Was Right New York Times, Paul Krugman (29/12/11)
Keynes, Krugman, and Austerity National Review Online, William Voegeli (3/1/12)
The Madness of Lord Keynes The American Spectator, Samuel Gregg (19/12/11)
Central Bankers vs. Natural Stock Market Cycles in 2012 The Market Oracle, David Knox Barker (28/12/11)
Now is the time to eat, drink and be merry Financial Times, Samuel Brittan (29/12/11)
Questions
- To what extent is quantitative easing consistent with (a) Keynesian and (b) monetarist approaches to macroeconomic policy?
- What is meant by the ‘liquidity trap’ and what are its implications for monetary policy? Have we witnessed a liquidity trap since the beginning of 2009?
- What are the arguments for and against an independent central bank?
- Explain Milton Friedman’s assertion ‘that it was the Fed’s failure in 1930 to pursue “open market operations” on the scale needed that deepened the slump’.
- What are the implications of growing government deficits and debt for policies to avoid a slide back into recession?
On Tuesday 29 November, the Chancellor of the Exchequer delivered his Autumn Statement. This presented the outlook for the UK economy, with forecasts supplied by the independent Office for Budget Responsibility (OBR). It also contained details of government fiscal measures to tackle various macroeconomic problems, including economic slowdown and high levels of national debt.
The outlook for the UK economy came as no surprise. Things are looking much bleaker than a few months ago. The OBR, along with other forecasters, has downgraded its predictions of the UK’s growth rate. Although it is still forecasting positive growth of 0.9% this year and 0.7% in 2012, these rates are well below those it predicted just eight months ago. In March it forecast growth rates of 1.7% for 2011 and 2.5% for 2012.
To make things worse, its growth forecasts are based on the assumptions that the eurozone crisis will be resolved with little or no effect on the UK. But even if that were so, the debt reduction plans in the eurozone are likely to drive the eurozone back into recession. This, in turn, will impact on UK exports, more than 50% of which go to eurozone countries.
The OBR forecasts that national debt will be 67% of GDP this year and will rise to 78% by 2014/15 but then start to fall. Government borrowing is forecast to be £127bn this year, falling to £120bn in 2012/13 and then more substantially each year after that to £24bn in 2016/17.
So what measures were included in the Autumn Statement? These are detailed in the articles below, but the key ones were:
• a programme of credit easing, which will underwrite up to £40bn in low-interest loans for small and medium-sized businesses.
• £5bn of public money to be invested in infrastrucuture projects and a further £5bn in the next spending round. Agreement had been reached with two groups of pension funds to invest a further £20bn of private money in infrastructure projects.
• an additional £1.2bn for capital investment in schools.
• A cap on public-sector pay increases of 1% per year for the two years after the current two-year pay freeze.
The following videos and articles give details of the forecasts and the measures and give reactions from across the political spectrum.
Webcasts
George Osborne: Key points from chancellor’s speech BBC News, Andrew Neil 29/11/11)
Autumn Statement 2011: George Osborne – my plan to ‘see Britain through The Telegraph on YouTube (29/11/11)
UK economy slows to crawl Reuters (29/11/11)
George Osborne’s autumn statement – video analysis Guardian, Larry Elliott (29/11/11)
Autumn Statement: Osborne reveals state of UK economy BBC News, Nick Robinson (29/11/11)
Autumn Statement: Why is the deficit not shrinking? BBC News, Hugh Pym (29/11/11)
Autumn Statement: Robinson, Flanders and Peston analysis BBC News, Nick Robinson, Stephanie Flanders and Robert Peston (29/11/11)
Can the UK economy be ‘re-balanced’? BBC Newsnight, Paul Mason (29/11/11)
Articles
Autumn Statement 2011: main points The Telegraph, Rachel Cooper (29/11/11)
The Autumn Statement at a glance WalesOnline, Rhodri Evans (30/11/11)
Autumn Statement Summary 2011 TaxAssist Accountants (29/11/11)
Into the storm The Economist (3/13/11)
A battalion of troubles The Economist (3/12/11)
Weapons of mass construction The Economist (3/12/11)
Mr Osborne’s unwelcome statement BBC News, Stephanie Flanders (29/11/11)
£30bn of extra cuts keep Osborne on track, just BBC News, Paul Mason (29/11/11)
Autumn Statement 2011: Commentators give their verdict The Telegraph (30/11/11)
Autumn Statement 2011: concern remains but ‘Plan A-plus’ welcomed The Telegraph, Graham Ruddick (29/11/11)
Autumn statement: George Osborne’s cutting fantasy is over Guardian, Robert Skidelsky (29/11/11)
Hoarding for the apocalypse? I really wouldn’t blame you Guardian, Zoe Williams (30/11/11)
Reports and data
Autumn Statement 2011 – documents HM Treasury (29/11/11)
Economic and fiscal outlook – November 2011 Office for Budget Responsibility (29/11/11)
Autumn statement 2011: the key data you need to understand George Osborne’s speech Guardian DataBlog (29/11/11)
How much will the autumn statement cost and how will the economy change? Guardian DataBlog (29/11/11)
Questions
- Compare the OBR’s March and November 2011 forecasts.
- What factors explain the differences in the two sets of forecasts?
- For what reasons might national debt in the future turn out to be higher or lower than that forecast by the OBR?
- What will be the impact on aggregate demand of the measures announced in the Autumn Statement?
- What will be the impact on aggregate supply of the measures announced in the Autumn Statement?
- Why may a recession impact not just on aggregate demand but also on long-term aggregate supply?
- Why may increased pessimism by both consumers and producers make it more difficult for the government to meet its macroeconomic objectives?
The following podcast from the BBC Radio 4’s series, A Point of View is by John Gray, emeritus professor of European thought at the LSE and author of False Dawn: The Delusions of Global Capitalism. In the podcast, he considers whether Marx, the great 19th century thinker, was right to predict the demise of capitalism.
Marx’s picture of the end of capitalism and the stages of society that would succeed it have been dismissed by most academics and commentators as quite false. Marx predicted that as capitalist economies became increasingly unstable and unequal, so workers would rise up in revolution. What would follow would be a socialist state in which the means of production would be collectively owned and output and distribution would be planned. As socialist economies became wealthier and life was perceived to be fairer, so the need for state control would diminish. Eventually the state would wither away and the ultimate stage of communism would be reached, where there would sufficient resources to reward everyone according to their needs.
Two of the key criticisms of Marx’s analysis are: (a) capitalism was overthrown in only a few countries and (b) in the countries that did adopt central planning, such as the Soviet Union and Eastern European countries, the state did not wither away; instead, they reverted to capitalism.
But whilst Marx’s analysis of a post-capitalist world may have been flawed, his analysis of the weaknesses and tensions of capitalism have been prophetically correct in many regards. As John Gray says:
It’s not just capitalism’s endemic instability that he understood, though in this regard he was far more perceptive than most economists in his day and ours.
More profoundly, Marx understood how capitalism destroys its own social base – the middle-class way of life. The Marxist terminology of bourgeois and proletarian has an archaic ring.
But when he argued that capitalism would plunge the middle classes into something like the precarious existence of the hard-pressed workers of his time, Marx anticipated a change in the way we live that we’re only now struggling to cope with.
Listen to the podcast and try to assess whether we are witnessing a 21st century version of Marx’s 19th century vision.
A Point of View: The revolution of capitalism (article) BBC Radio 4, John Gray (4/9/11)
A Point of View: The revolution of capitalism (podcast) BBC Radio 4, John Gray (4/9/11) (see alternatively)
Has Western capitalism failed? BBC News (23/9/11)
Questions
- Why, according to Marx, do capitalist societies contain the seeds of their own destruction? What role would the middle classes play in this?
- Why does capitalism transform everything it touches?
- Explain what is meant by ‘creative destruction’.
- How would Marxists respond to the criticisms of their analysis that the middle classes have got proportionately bigger and that, with the advent of the minimum wage, even the poorest workers are protected?
- To what extent has the experience of the developed world since the banking crisis of 2007/8 lent weight to the Marxist analysis?
- John Gray says that “Today there is no haven of security.” What does he mean by this and is there an answer within capitalism?
- And here’s a hard question to finish with: if capitalism does contain the seeds of its own destruction, what will succeed it? Will it be something other than capitalism and, if so, what? Or will it be a new variety of capitalism and, if so, what will it look like?
The debate about how much and how fast to cut the deficit has often been presented as a replaying of the debates of the 1920s and 30s between Keynes and the Treasury.
The justification for fiscal expansion to tackle the recession in 2008/9 was portrayed as classic Keynesianism. The problem was seen as a short-term one of a lack of spending. The solution was seen as one of expansionary fiscal and monetary policies. There was relatively little resistance to such stimulus packages at the time, although some warned against the inevitable growth in public-sector debt.
But now that the world economy is in recovery mode – albeit a highly faltering one in many countries – and given the huge overhang of government deficits and debts, what would Keynes advocate now? Here there is considerable disagreement.
Vince Cable, the UK Business Secretary, argues that Keynes would have supported the deficit reduction plans of the Coalition government. He would still have stressed the importance of aggregate demand, but would have argued that investor and consumer confidence, which are vital preconditions for maintaining private-sector demand, are best maintained by a credible plan to reduce the deficit. What is more, inflows of capital are again best encouraged by fiscal rectitude. As he argued in the New Statesman article below
One plausible explanation, from Olivier Blanchard of the IMF, is that the Keynesian model of fiscal policy works well enough in most conditions, but not when there is a fiscal crisis. In those circumstances, households and businesses react to increased deficits by saving more, because they expect spending cuts and tax increases in the future. At a time like this, fiscal multipliers decline and turn negative. Conversely, firm action to reduce deficits provides reassurance to spend and invest. Such arguments are sometimes described as “Ricardian equivalence” – that deficits cannot stimulate demand because of expected future tax increases.
Those on the other side are not arguing against a long-term reduction in government deficits, but rather that the speed and magnitude of cuts should depend on the state of the economy. Too much cutting and too fast would cause a reduction in aggregate demand and a consequent reduction in output. This would undermine confidence, not strengthen it. Critics of the Coalition government’s policy point to the fragile nature of the recovery and the historically low levels of consumer confidence
The following articles provide some of the more recent contributions to the debate.
Keynes would be on our side New Statesman, Vince Cable (12/1/11)
Cable’s attempt to claim Keynes is well argued — but unconvincing New Statesman, David Blanchflower and Robert Skidelsky (27/1/11)
Growth or cuts? Keynes would not back the coalition – especially over jobs Guardian, Larry Elliott (17/1/11)
People do not understand how bad the economy is Guardian, Vince Cable (20/5/11)
The Budget Battle: WWHD? (What Would Hayek Do?) AK? (And Keynes?) PBS Newshour, Paul Solman (29/4/11)
Keynes vs. Hayek, the Rematch: Keynes Responds PBS Newshour, Paul Solman (2/5/11)
On Not Reading Keynes New York Times, Paul Krugman (1/5/11)
Would a More Expansionary Fiscal Policy Be Effective Right Now? Yes: On the Invisible Bond Market and Inflation Vigilantes Once Again Blog: Grasping Reality with a Prehensile Tail, Brad DeLong (12/5/11)
Keynes, Crisis and Monopoly Capitalism The Real News, Robert Skidelsky and Paul Jay (29/4/11)
Questions
- What factors in the current economic environment affect the level of consumer confidence?
- What are the most important factors that will determine whether or not a policy of fiscal consolidation will drive the economy back into recession?
- How expansionary is monetary policy at the moment? Is it enough simply to answer this question by reference to central bank repo rates?
- What degree of crowding out would be likely to result from an expansionary fiscal policy in the current economic environment? If confidence is adversely affected by expansionary fiscal policy, would this represent a form of crowding out?
- Why may fiscal multipliers have ‘turned negative’?
- For what reasons might a tight fiscal policy lead to an increase in aggregate demand?
- Your turn: what would Keynes have done in the current macroeconomic environment?
The recession caused a large rise in unemployment in many countries. In the USA the rise has been particularly steep, where unemployment now stands at 14.5 million, or 9.8% of the labour force. Unemployment has continued to rise despite renewed growth in the US economy, where the latest annual real GDP growth is 2.6% (measured in Q3 2010). The rise in unemployment has been blamed on ‘sticky wages’ – i.e. the reluctance of wage rates to fall.
But are wages genuinely sticky as far as the average worker is concerned? They may be in many specific jobs with specific employers, but many workers made redundant then find work in different jobs at lower rates of pay. For them, their wage has fallen, even if particular jobs are paying the same as before.
So what are the consequences of this? Does the willingness of workers to accept lower paid jobs mean that the labour market is flexible and that people will thus price themselves into work? If so, why is employment still rising? Or does a reduction in real wages for many people dampen spending and hence aggregate demand, thereby reducing the demand for labour? If so, why is GDP rising?
The following articles look at the apparent stickiness of wages and the implications for the labour market and the macroeconomy.
Articles
Downturn’s Ugly Trademark: Steep, Lasting Drop in Wages Wall Street Journal, Sudeep Reddy (11/1/11)
The Causes of Unemployment Seeking Alpha, Brad DeLong (13/1/11)
Sticky, sticky wages The Economist blogs: Free Exchange, R.A. (11/1/11)
The Causes of Unemployment New York Times blogs: Wonkish, Paul Krugman (16/1/11)
America’s union-bashing backlash Guardian, Paul Harris (5/1/11)
Data
Federal Reserve Economic Data: FRED Federal Reserve Bank of St. Louis (US macroeconomic datasets)
United States GDP Growth Rate Trading Economics
US unemployment statistics Bureau of Labor Statistics
Questions
- Why might nominal wages be sticky downwards in specific jobs in specific companies?
- Why might nominal average wages in the economy not be sticky downwards?
- Why is unemployment rising in the USA?
- Why might there be a problem of hysteresis in the USA that provides an explanation of the reluctance of unemployment to fall?
- Why might a fall in wages end up being contractionary?
- What lessons can be learned from the Great Depression about cures for unemployment?
- How might unemployment be brought down in the USA?
- Why may making wages somewhat more flexible, as opposed to perfectly flexible, not be a good thing?