Chapter 7. Throwing caution to the wind!

References [ CPB | General | Scientific ]     Summary

Authors

Arjan Lejour & Mark Roscam Abbing
Contact: Arjan Lejour

In this chapter

Keynes's body of thought is loathed and feared. Why?

Keynesian stimulus policy is back - with a vengeance!

Which poses the greatest danger: deflation or inflation?

Top economists disagree on the effectivity of policy and the risk of over- and undershooting in policy.

The credit crunch makes stimulation essential. This means that the burden is passed onto the shoulders of our children and grandchildren.

References

CPB

Centraal Economisch Plan 2009.

The CPB's viewpoint on Keynesian policy during the crisis. The text covers issues such as declining demand, the consequences for public debt, the long-term government finances, the design of the stimulus policy and the US incentive package..

General

The crisis of the early 1980s

Bart Nauta and Hans Langenberg, 2007, Werkgelegenheid in de periode 1969-2006: crisis begin jaren '80 vormde keerpunt, Sociaaleconomische trends 4, pp 24–30.

A comprehensive overview of the crisis in the 1980s with a special focus on the consequences for the labour market. Naturally, the regular CPB publications (Central Economic Plan and Macro-economic Exploration) from the 1980s provide an even more detailed picture (but are, unfortunately, not available online).

Keynes's theory

John M. Keynes, 1938, The General Theory of Employment, Interest and Money.

Keynes's best known work. In this book, he describes (among many other things) his theory on managing economic highs and lows by means of budgetary and monetary policy - now known as 'Keynesian policy'. This book also ended up on the list of the world's most harmful books. Click here to view the complete list

Robert Skidelsky, 2009, Economists clash on shifting sands, 9 June.

Skidelsky is Keynes's number one biographer. His conclusion is that not everyone quotes or interprets Keynes correctly.

Monetary policy

Ben Bernanke, 2002, Deflation, making sure ‘it’ doesn’t happen here, The Federal Reserve Board speech, 21 November.

Fed chairman Bernanke knew as early as 2002 how to employ an 'unorthodox' monetary policy in tackling the crisis. In this speech, he explains it all.

Economists disagree

Gregory N. Mankiw, 2006, The Macroeconomist as Scientist and Engineer, Harvard.

This paper gives both a brief summary of the history of economic thought (from the emergence of Keynesian thought, to the demise and the rebirth) as well as the divide between economic theory and practical applicability.

Olivier Blanchard, 2008, The state of Macro, NBER working paper no 14259.

Blanchard concluded in 2008 that economists are slowly starting to agree on the main points of the theory. Given the heated debates on monetary and budgetary policy at the moment, he might just reconsider his viewpoint.

Weblog of the conservative economist Eric Rasmusen.

A broad overview of the entire discussion (or rather controversy) among economists on the desirability of stimulus policy can be found here.

The future of the Stability and Growth Pact

Paul de Grauwe, 2009, The politics of the Maastricht convergence criteria, 15 april.

De Grauwe is highly critical of the Maastricht criteria (and thus the Stability Pact) - the criteria are used as political instrument.

Marcos Poplawski Ribeiro, Roel Beetsma en Andreas Schabert, 2008, A comparison of debt and primary-deficit constraints.

Support for amending the Stability Pact: it is far more important to look at national debt.

Otmar Issing, 2009, Why a common eurozone bond isn’t such a good idea, Europe’s world.

Article on the risk of European bonds. A joint European bond means that individual countries are no longer held accountable for irresponsible budget policy, which is why such a bond is not a good idea at all.

Public Finance in the EMU, 2009, European Economy 5/2009, provisional version.

The effects of stimulating on public debt - it accumulates dramatically.

Scientific

Monetary policy

Athanasios Orphanides, 2003, Monetary Policy in Deflation: The Liquidity Trap in History and Practice, Federal Reserve Board.

Whereas Krugman is concerned about the deflation monster, Orphanides argues in this article that it can only surface if policy errors are made as had happened in the 1930s and in Japan.

The effectiveness of stimulus policy

Conclusies van de Europese Raad, top 11-12 December 2008.

Jean Pisany-Ferry, André Sapir and Jakob von Weiszacker, november 2008, A European recovery program, Bruegel policy Brief 2008/9.

David Saha and Jakob von Weiszacker, April 2009, EU stimulus Packages: estimating the size of the European stimulus packages for 2009: an update, Bruegel policy contribution 2009/2.

The three sources listed above give a good overview of the elements of the stimulus packages in Europe.

OECD, March 2009, Economic outlook interim report Chapter 3: The effectiveness and scope of fiscal stimulus.

The OECD study on the effectiveness of budgetary stimulus policy (i.e. how big are the multipliers). Conclusion: Sadly, it is not a very effective policy.

Kenneth N. Kuttner and Adam S. Posen, 2001, The great recession; lessons for macroeconomic policy from Japan, Brookings Papers on Economic Acticity 2.

On the effectiveness of stimulus policy in Japan. One of the conclusions is that both monetary and budgetary policy was reversed prematurely.

Post-crisis policy, exit strategy

Jean Pisani-Ferry and Indhira Santos, March 2009, Reshaping the global economy, Breugel Policy contribution 2009/4.

Jean Pisani-Ferry and Bruno van Pottelsberghe, April 2009, Handle with care! post-crisis growth in the EU, Bruegel Policy letter 2009/2.

Both of these publications examine the importance of a good exit strategy and the opportunities for European coordination.

Summary

Keynes is back! Current monetary and budgetary policies aim to stimulate the demand for goods and services in order to beat the current economic crisis by unprecedented policy means. The theory of Keynes has been criticised for decades but now inspires many policymakers and politicians. This chapter discusses current monetary and budgetary policies in Europe and the US. It agrees with most of the current policies but also asks how we can avoid the pitfalls of Keynesian policies: high inflation risk and high government debts. Central bank policies to buy directly from governments and firms are welcomed because the pain of deflation could be much worse than the pain from inflation, although the inflation risk is much bigger than the risk of deflation. However, monetary policies have been devoted to combating inflation for a long time, so central bankers could be seduced to curtail quantity-relaxing policies too early. In Europe, budgetary stimulating policies are automatically activated by the automatic stabilizers: less tax revenues and more social spending. Together with more explicit budgetary measures, government debts could rise considerably. In some countries, government debt was already high, so it is imperative to present credible plans to lower debt. However, the stimulating fiscal policies should not be curbed too soon at the first signs of economic recovery, as this could undermine economic recovery. Two other conditions for credible strategies have to be met as well. The first is that governments have to commit to a deficit-reducing strategy, to which capital markets will then respond with lower interest rates and higher credit ratings. The second condition is that this policy does not comprise higher tax burdens. Higher taxes reduce the incentives to work, to start new businesses and to innovate. This hampers economic growth, which is a key factor in reducing government debt (at least in relation to GDP).

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