Posts Tagged ‘macroeconomics’

And the Winner is (should be)…. Fiscal Policy!

September 4, 2015 4 comments

So, Mario Draghi is disappointed by eurozone growth, and is ready to step up the ECB quantitative easing program. The monetary expansion apparently is not working out as planned.

Big surprise. I am afraid some people do not have access to Wikipedia. If they had, they would read, under “liquidity trap“, the following:

A liquidity trap is a situation, described in Keynesian economics, in which injections of cash into the private banking system by a central bank fail to decrease interest rates and hence make monetary policy ineffective. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war.

In a liquidity trap the propensity to hoard of the private sector becomes virtually unlimited, so that monetary policy (be it conventional or unconventional) loses traction. It is true that the age of great moderation, and three decades of almighty central bankers had made the concept fade into oblivion. But, since 2008 we were forced to reconsider the effectiveness of monetary policy at the so-called zero lower bound.Or at least we should have…

So, had policy makers taken the time to look at the history of the great depression, or at least to open the Wikipedia entry, they should have learnt that when monetary policy loses traction, the witness in lifting the economy out of the recession, needs to be taken by fiscal policy. In a liquidity trap the winner is fiscal policy.  Or at least it should be. Here is a measure of the fiscal stance, computed as the change in government balance once we exclude cyclical components and interest payments.

2015_09_LiquidityThe vast majority of EMU countries undertook a strong fiscal tightening, regardless of the actual health of their public finances. This generalized austerity, an offspring of the Berlin View, led to our double dip recession, and to further divergence in the eurozone, that would have needed coordinated, not synchronized fiscal policies. Well done guys…

And yet, Mario Draghi is surprised by the impact of QE.

What is Mainstream Economics?

November 29, 2013 14 comments

Paul Krugman and Simon Wren-Lewis have been widely criticized (for example here) as defending  “mainstream” economics that spectacularly failed during the crisis (and before).

My (very short) take on this: I do believe that Krugman has a point, a very good one, when claiming that standard textbook analysis is (almost) all you need to understand the current crisis, and to implement the correct policy solutions.
The point is what we define as “textbook analysis”. Krugman refers to IS-LM models. But these, that starting in the 1980s virtually disappeared from graduate curricula because supposedly too simplistic, not grounded on optimization, not intertemporal, and so on and so forth.
I personally was exposed to these ideas in my undergraduate studies in Italy, and I still teach them (besides using them to discuss the crisis with my students). But they were nowhere to be found during my graduate studies at Columbia (certainly not a freshwater school). None of the macro I studied in graduate school (Real Business Cycle models, or their fixed-price variant proposed by New Keynesians) as interesting as it was intellectually, could give me insight on the crisis. I simply do not need to use it.

The IS-LM model with minor amendments (most notably properly accounting for expectations to deal among other things with liquidity traps) remains a powerful tool to understand current phenomena. The problem is that it is not mainstream at all. What bothers me in Krugman’s post is the word “standard”, not “textbook analysis”.