A Contagion of Bad Ideas. Not Only Slaves to Defunct Economists, but Slaves to Bad Ideas.

I’m still away on the road (which is why comments and questions in the last week have gone unanswered).  However, while I’m away, here’s a point made by Joseph Stiglitz at Project-Syndicate.org.  John Maynard Keynes famously said that today’s policy-makers are the slaves of defunct economists.  Joseph says, and I agree, that today’s policy makers are really the slaves of not only defunct economists, but some very bad and discredited ideas from those economists.  It’s these bad ideas that are hurting us the most.

Stiglitz observes the urgency with policymakers on both sides of the Atlantic are eagerly pursuing contractionary policies at a time when growth is negligible and unemployment persists at a very high level. In the U.S., the Republicans threatened a government shutdown and/or default if the government didn’t significantly cut spending while refusing to raise taxes even on the very rich who have benefitted so much in the last decade. President Obama surrendered to the Republicans’ desire for contractionary policy, taking the Democrats with him.  All of this in a mistaken belief that somehow cutting spending, balancing the government budget, and reducing government debt (which leads to increased private debt) would somehow help the economy.  The problem is that while there are economic theories and economists who argue that such policy will work, these policies were discredited a long, long time ago.  Further these failed theories have never shown that they would work.  The historical evidence refutes the austerity position.

In Europe, it’s worse.  European leaders, having set  up a currency union (Eurozone) that stripped member nations of valuable fiscal policy tools, are convinced that cutting spending (which slows an economy) will balance their budgets and calm bond markets.  Unlike the U.S., which has it’s own central bank and therefore ends up paying very low interest rates on government debt (there’s no risk of default), Greece, Italy, Ireland, Spain, and the others are all paying significant and rising interest rates on government debt.  Without their own central bank and wearing the Eurozone-imposed fiscal strait jackets, these countries continue to cut, their economies weaken and shrink, and their deficits just get bigger.  Why?  Because you can’t cut spending faster than tax revenues drop from the slower economy that the spending cut produced.  Nonetheless, the European leaders persist.

Stiglitz concludes in A Contagion of Bad Ideas:

The end of the stimulus itself is contractionary. And, with housing prices continuing to fall, GDP growth faltering, and unemployment remaining stubbornly high (one of six Americans who would like a full-time job still cannot get one), more stimulus, not austerity, is needed – for the sake of balancing the budget as well. The single most important driver of deficit growth is weak tax revenues, owing to poor economic performance; the single best remedy would be to put America back to work. The recent debt deal is a move in the wrong direction.

There has been much concern about financial contagion between Europe and America. After all, America’s financial mismanagement played an important role in triggering Europe’s problems, and financial turmoil in Europe would not be good for the US – especially given the fragility of the US banking system and the continuing role it plays in non-transparent CDSs.

But the real problem stems from another form of contagion: bad ideas move easily across borders, and misguided economic notions on both sides of the Atlantic have been reinforcing each other. The same will be true of the stagnation that those policies bring.

Joseph E. Stiglitz is University Professor at Columbia University, a Nobel laureate in economics, and the author of Freefall: Free Markets and the Sinking of the Global Economy.

Copyright: Project Syndicate, 2011.  Excerpts republished with permission.


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