The current recession has seen the re-emergence of many of the intellectual battles fought amongst economists between the two worlds wars and again from the 1960s to the 1980s. The current debate has hinged around the appropriate policy response to the current recession. Is the solution a Keynesian one of stimulating aggregate demand; or is it a new classical one of keeping public spending under control to make room for private spending and to allow the market to function to best effect? And what about banking reform? What are the arguments here? The following articles by Lord Skidelsky examine the debate.
Robert Skidelsky, Economists clash on shifting sands Financial Times (9/6/09)
Robert Skidelsky, Economic reform needs a dose of reality Guardian (27/7/09)
See also the following video:
Robert Skidelsky, The financial challenge of our times Guardian (2/3/09)
Questions
- Explain the ways in which economics is (a) similar to and (b) different from the natural sciences.
- For what reasons would new classical economists criticise the fiscal stimulus packages pursued by many countries in the past few months?
- Under what circumstances would a fiscal stimulus crowd out private spending? Do these circumstances apply (a) today; (b) over the next two years?
- Why may crowding out in practice depend on issues of confidence?
- What ‘Keynesian lessons’ have been learned from the banking crisis and recession?
Preliminary figures for Quarter 2 UK GDP suggest that the UK economy has been declining faster than many had expected. Does this mean that the recession in the UK will be more prolonged, or can we expect a return to growth by the end of the year? How much does the outcome depend on policy decisions taken now and what should be done in terms of quantitative easing and other policy measures?
The answers to these questions depend to some extent on the reliability of the figures, which, after all, are only preliminary estimates. Past estimates have tended to understate the level of output and growth, but could the latest estimates understate the depth of the recession? The following articles look at the figures and their implications for policy. The two articles from The Economist look at the global context.
UK economy continues to contract BBC News (24/7/09)
Recession Britain Guardian (24/7/09)
‘Shocking’ GDP figures raise fears of long road to recovery Herald (25/7/09)
Hopes of early end to recession dashed Independent (25/7/09)
Treasury defiant on growth despite gloom over GDP Times Online (26/7/09)
UK GDP: What the economists say Guardian (24/7/09)
Hamish McRae: The GDP figures were profoundly gloomy … but they were wrong Independent (26/7/09)
The shrinking economy BBC News, Stephanomics (24/7/09)
Here comes August, the cruellest month of all Observer (26/7/09)
Rebalancing global growth: a long way to go Economist (23/7/09)
Unpredictable tides Economist (23/7/09)
Gross domestic product, Preliminary estimate, 2nd quarter 2009 Office for National Statistics, Statistical Bulletin (24/7/09)
Gross domestic product, Preliminary estimate, 4th quarter 2008 Office for National Statistics, Statistical Bulletin (24/7/09)
Questions
- What factors will determine whether the UK economy starts to growth again by the end of 2009?
- Plot the quarterly growth rate of GDP from 2007 Q1. Plot two lines on the same graph: one from the 2008 Q4 estimates and one from the 2009 Q2 estimates (see last two links above). How would you explain the discrepancies between the figures?
- What policy measures would you recommend to the Bank of England and the government in the light of the GDP estimates?
- ’The deeper and longer the recession, the more will potential (as well as actual) output fall.’ Do you agree with this statement? Explain your answer.
- Referring to the two Economist articles, what conditions are necessary for sustained long-term economic growth?
The global economy has been in a recession since December 2007, but have we now passed the worst of it? Whilst companies are still going bankrupt, unemployment is still rising, the housing market is still looking pretty gloomy and government debt surely can’t go up anymore, there are indications that we’ve reached the bottom of the recession. There are murmurs that the economy may start to recover towards of the end of the year.
But, of course, economics wouldn’t be economics if there wasn’t considerable disagreement. Many still believe that the worst is yet to come. According to the OECD, the recession is ‘near the bottom’. Yet, output in the UK is still set to decline by 4.3% in 2009, and by 2010 the budget deficit is predicted to have grown to 14%. Unemployment is at its highest since November 1996, but US consumer confidence is said to be rising and the pound is climbing. Read these articles and make up your mind about the state of the UK and global economy!!
Business and Consumer Surveys (After following link, click on chart) European Commission, Economic and Financial Affairs (29/6/09)
Pound climbs against euro as King sees signs recession easing Bloomberg, Lukanyo Mnyanda, Gavin Finch (20/6/09)
Bank says banking crisis easing BBC News (25/6/09)
First signs of optimism returning to some parts of financial services CBI PRess Release (29/6/09)
Darling and King agreed on tentative recovery Guardian, Ashley Seager (17/6/09)
Sharp contration for UK economy BBC News (30/6/09)
Housing market knocked by price falls Moneywise (22/6/09)
OECD says recession ‘near bottom’ BBC News, Steve Schifferes (24/6/09)
US Federal Reserve says recession is ‘easing’ Telegraph, James Quinn (24/6/09)
Public borrowing at record levels BBC News (18/6/09)
Leading index suggests recession easing UPI.com (18/6/09)
US consumer confidence up in June BBC News (26/6/09)
Blow for housing market as prices fall The Independent, David Prosser (22/6/09)
Most UK businesses freeze pay as recession bites, CBI says Telegraph, Peter Taylor (23/6/09)
Questions
- What are the typical characteristics of a recession? Do the current statistics of the four main macroeconomic objectives fit in with what economic theory tells us?
- Which policies would governments normally implement to get a economy into the expansionary/recovery phase of the business cycle and how do they work?
- Why is consumer confidence so key to economic recovery?
- What type of banking regulation is needed to prevent a similar crisis happening again?
- Movements in the housing market are often seen as indicators of the state of the economy. Why is this?
The early part of the current recession, dating from April 2008, had much in common with the Great Depression dating from June 1929. But the Great Depression lasted three years. So does this grim prospect await the world this time round? Or have we learned the lessons of the past and will the policies of giving economies a large fiscal stimulus, combined with bank rescues and quantitative easing, help to pull the world out of recession this year? The following articles look at the issues.
The recession tracks the Great Depression Martin Wolf, Financial Times (16/6/09)
A Tale of Two Depressions Barry Eichengreen, Kevin H. O’Rourke, Vox (4/6/09)
Economics: How the world economy might recover its poise Financial Times (15/6/09)
Weak recovery in sight but damage from crisis likely to be long-lasting, says OECD OECD (24/6/09)
OECD sees strongest outlook since 2007 Financial Times (24/6/09)
Press Release Board of Governors of the US Federal Reserve System (24/6/09)
You might also like to watch the following two videos. The first uses historical footage to examine the Wall Street Crash of 1929 and the Great Depression that followed. The second is an interview with Joseph Stiglitz about whether the recession of 2008/9 is heading for another Great Depression.
The 1929 Crash (1 of 6) Nibelungensohn, YouTube (27/2/09). Note that you can link to the other five parts of this from this link.
Joseph Stiglitz: ‘This is worse than the Great Depression’ NBC Nightly News (10/2/09)
Questions
- Why may the past be a poor guide to the present and future?
- What dangers are there from the policies of expanding aggregate demand through fiscal and monetary policies?
- Explain why the ‘race to full recovery is likely to be long, hard and uncertain.
In a recession, the government’s budget will go into cyclical deficit as tax revenue falls and government spending on unemployment and other benefits rises. Provided the deficit is purely cyclical, it can be seen as desirable since it acts as an automatic fiscal stabiliser, boosting aggregate demand and helping to pull the economy out of recession. Once the economy returns to potential national income (i.e. a zero output gap), the deficit would disappear. At potential national income (Yp), government expenditure (including benefits) will equal tax revenue. The budget is in balance.
Again, provided that the deficit is only cyclical, discretionary expansionary fiscal policy that further deepens the deficit will not be a problem for public finances in the future. Once the economy pulls out of recession, the discretionary policy can be relaxed and the higher national income will eliminate the cyclical deficit.
But the problem the Chancellor of the Exchequer faced in the Budget (on 22/4/09) was not just one of tackling the recession. The UK economy has seen a massive growth in the structural deficit. His forecast is for the total deficit to be £175bn in 2009. But, according to calculations by the Institute for Fiscal Studies, even when the recession is over and the output gap has been closed, there will still be an annual deficit of around £140bn. This is not cyclical; it’s structural.
So why is there this huge structural deficit? And what is the solution? Will the solution slow down recovery? The following articles look at the issues.
Budget 2009: Tightening the Squeeze? Institute for Fiscal Studies (23/4/09)
We should start by admitting we’ve failed as an economy: Hamish McRae Independent (22/4/09)
Budget 2009: Experts cast long shadow over Darling’s sunny outlook Guardian (23/4/09)
Budget 2009: Economist warns of spending cuts and tax rises Guardian (23/4/09)
The chancellor’s Budget dilemma: Stephanie Flanders BBC News (23/4/09)
For a global perspective on structural deficits, see:
Why the ‘green shoots’ of recovery could yet wither Financial Times (22/4/09)
Outlines of the main Budget measures can be found at:
Budget 2009: Need to know Times Online (23/4/09)
At-a-glance: Budget 2009 BBC News (22/4/09)
Full details for the Budget can be found from the Treasury’s Budget site
Questions
- Explain the terms ‘cyclical deficit’ and ‘structural deficit’.
- Draw a diagram showing how government expenditure (including benefits) and tax revenue vary with national income. The diagram should show the sitation with no structural deficit: i.e. the two lines should cross at potential national income. Illustrate (a) a cyclical deficit where actual national income is below potential national income (a negative output gap) and (b) a cyclical surplus where actual national income is above potential income (a positive output gap).
- Now, on the same diagram, shift the two lines to illustrate a situation of structural deficit.
- Consider whether the government should attempt to increase or reduce the budget deficit at a time of recession.
- Why has the structural deficit become so severe over the past year?
- How quickly should the government set about tackling the structural deficit?