Os copio el ensayo que he escrito para mi clase de inglés, que es un resumen de lo que dijo ayer Robert Solow en la fundación Rafael del Pino.

Economics is said to be the study of productive activities subject to the constraint of scarce resources. In this framework, the production is mainly determined by the technology and the amount of resources available.

From this optic, the current crisis would look like a paradox. Although the data on economic activity are picture an extremelly pessimistic situation, today’s capacity is larger than it was some months ago since net investment has not turned negative yet. The fundamentals of the economy -what determines how much can be produced- remain strong, but the economic agreggates are weaker than never. The collapse of the financial side of the real estate sector , just of one branch of the economy, has plunged the whole world system into a deep crisis.

In any crisis, there is also an opportunity to learn for the future. The first lesson is that the collapse of the financial system has amplified the recession that would have taken place on the real economy. While capacity remains strong, both investment and consumer demand are weaker today. The loss of wealth has reduced spending from household- especially in durable goods- and this in turn has made banks and other financial operator more cautious about lending causing a “credit crunch” which has fed the collapse on the real side.

The second lesson that could be drawn is that about the relation between the business cycles in the financial and the real economy. The financial economy works as a pandemonium, a chaotic system with self-induced equilibria, vulnerable to cycles of collective irrationality. In a context of internationalisation of the financial system, the number of critical nodes that could launch a collective crisis are multiplied. Therefore, the financial sector has become a source of instability even when the real economy is mainly stable. The lesson that should drawn is therefore that the real economy should be somehow insulated from the instabilities of the financial system.

Which remedies are available for government in order to curb the crisis? In the orthodox policy mix, the first line of defense against recession was classically monetary policy. There are mainly three reasons for this. Firstly, it’s effect works faster than fiscal policy and the stimulus is transmitted with shorter lags, secondly, its effects are distributively more neutral- while fiscal policy usually causes income transfers among groups and finally monetary policy is usually free from political pressure since in most western countries central banks are ruled independently. Therefore, interest rate cuts combined with automatic stabilizers was were usually enough to curb recessions in conventional scenarios. The trouble is that the current context is not a conventional scenario and old rules don’t apply any more. One lesson that should be drawn from the crisis is that the real estate bubble was largely driven by the policy of low interest rates from the Fed and therefore any solution worth of that name should avoid the mistakes of the past. Moreover, monetary authorities, especially in the US -the ECB has been more cautious until now, maybe because the Eurozone is largely subject to asymmetrical shocks- have already exhausted their room of maneuverer. Finally, the context of a credit crunch makes the usual channel of transmission of monetary stimulus- the credit market- unlikely to work. Robert Solow quoted Paul Samuelson’s father who was running a bank during the Great Depression: “How would I lend money to anyone who is crazy enough to borrow”- that is, the recession has amplified the adverse selection problems that are already present in the financial market. These facts suggest that conventional monetary stimulus will be insufficient.

Therefore, one should look at fiscal stimulus, that is, either tax cut of increased spending. Returning to the conventional policy mix, tax rebates were usually preferred since they allow individual to spend their money in their preferred way, while the government is usually more likely to make wasteful spending. Here again, normal rules do not apply. In a context of uncertainty, it is likely that that temporary extra income coming from the tax cut would be saved rather than spent, partly because it is temporary and partly because there is uncertainty about the future and therefore tax cuts will do a poor job boosting aggregate spending.

The preferred option is therefore likely to be fiscal spending, which used to be the policy of last ressort. Public spending will really be spent and therefore its effect is almost granted. When private demand is absent, government should replace it. Moreover, since the other alternatives- monetary policy and tax cuts- are not likely to be effective, this is the only alternative. This does not mean, of course, that spending does not arise troubles. Firstly, it usually doesn’t work fast enough, mainly, because public spending needs to be planned and planning requires time. This is even more true in a country such as the US where government lacks both the habit and the means of high spending. On the other hand, if public spending is done fast enough, it is likely to be poorly planned and therefore spent on wastefull items. Concerning fiscal stimulus, Europe has an added problem. The degree of trade integration forces government to reach an agreement for coordinated fiscal stimulus. Despite this fact, stimulus plans in the Eurozone have remained largely national untill now.

How large should the stimulus package be? Solow considered that the German plan -less than 1,5- was for sure insufficient. On the other hand, Obama’s plan is now being discussed for something like 2% or 3% of GDP in the next two years. This magnitude seem appropriate and other countries should imitate it.

The last point concerns budget deficits. Any form of fiscal stimulus will, almost by definition, cause budget deficit and therefore increase the debt. One is allow to wonder that temporary stimulus will turn into chronic budget deficit that will not be cured in the long run. However, it should be reminded that the fiscal stimulus is aimed at sustaining prosperity and that budget surpluses are essentially breeded by economic growth.

This entry was posted on Jueves, Febrero 5th, 2009 at 22:09 and is filed under Crisis, la llamada de Cthulu y el avance imparable de la RPA, English Version, ciencia recreativa . You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.