SUNDAY, SEPTEMBER 19, 2010
My paper at World Congress of Social Economics :The global financial crisis, the re-emergence of Keynes and the role of quantitative easing.
My paper at World Congress of Economics
July 3, 2010
This past week I participated in an excellent academic congress which gathered together about 100 economists, economic historians, political economists, and development specialists at Concordia University in Montreal for the thirteenth world congress of this association. People attended from Europe, Japan, China, India, the Middle East, North and South America, New Zealand and Africa. The association founded in 1941 is committed to encouraging research and publication in economics and policy which links ethics, society and social concerns to economic analysis.There were many excellent papers and keynote presentations by Pierre Fortin of UQAM in Montréal, Sakiko Fukuda -Parr of the New School in New York and Mihaly Simai of the institute for World Economics, Corvinus University in Budapest. the conference program is available on the net at the association's web site,www.socialeconomics.org
Here is an excerpt from the paper I presented on ''The Global Financial Crisis, the Re-emergence of Keynes and the Role of Quantitative Easing
The global financial crisis, the re-emergence of Keynes and the role of quantitative easing.
By Harold R.Chorney Professor of Political economy, Concordia university
Paper presented to the thirteenth World Congress of Social Economics, Concordia University, Montréal, June 30,2010.
Introduction:
More than twenty five years ago I began to write about problems of public finance.( Chorney, 1984) At the time that I began to do so, I never would have believed that I would still need to be writing a critique of fiscal conservative dogma almost twenty five years later !
The staying power of previously discredited bad ideas was much greater than I surmised at the time. The staying power of herd behaviour based on shallow derivative analysis was stronger than I understood. 1 It was not for nothing that John Maynard Keynes once stated that if his revolution in economic thought were ever to be reversed it would be extraordinarily difficult to reinstate it. Not because he believed he was wrong, but because he knew that the forces of reaction and stubborn resistance to progressive economic thought were so deeply entrenched.
Sadly, he and Michal Kalecki who predicted that the Keynes breakthrough would be reversed once business became ‘’boom tired’’and there would be no shortage of economists to justify business’s anti-deficit spending prejudice were both very right about this.(See, M. Kalecki, Essays in Economic dynamics, The politics of the trade cycle; Kalecki was the Polish Jewish economist who ought to be considered the co-discoverer of Keynesian economics because of his essays on the investment process, unemployment and economic dynamics that he published in the early 1930s before Keynes’ General Theory which contained the essence of Keynes’ own argument. He was eclipsed by Keynes , in part because he published his work in Polish, but also, of course, because Keynes was already a world famous economist because of being at Cambridge and having authored the Economic Consequences of the Peace which had made him world famous in 1920.Keynes to a small extent and certainly Joan Robinson later acknowledged the significance of Kalecki’s work.(See in particular,A.Asimakopulos, ‘’Kalecki and Robinson’’ in Mario Sebastiani, Kalecki’s Relevance Today, London: the Macmillan Press, 1989.See also Michael Kalecki, ''Political Aspects of Full employment, Political quarterly,Vol. 14, 1943, pp.322-331 reprinted in E.K.Hunt & Jesse Schwartz, eds. A Critique of Economic Theory, Harmondsworth:Penguin , 1972, pp.420-30.)
The cataclysmic near total destruction of Wall street in the great crash of derivatives and the fraud ridden sub prime housing market in the 2008 slaughter on Wall street has thoroughly frightened the world .Although as I write in the spring and early summer of 2010 ,circumstances are significantly improved and much but not all of the fears of another great depression have dissipated.In many respects we have not seen something as dramatic since 1929. Alan Meltzer in the Wall Street Journal(‘’What Happened to the ‘Depression’’’ Wall Street Journal Aug.31, 2009 )disputes this comparison of the crash and the subsequent deep slump as the worst crisis since the depression of 1929 ,but I don’t find Meltzer completely convincing, although I am an admirer of his outstanding History of the Federal Reserve(Allan Meltzer,A History of the Federal Reserve, Vol.1:1919-1951 , Chicago: University of Chicago Press, 2003, 800 pages; see also,Barry Eichengreen and Kevin O’Rourke , A tale of two depressions :What do the new data tell us ?: http://www.voxeu.org/index.php?q=node )
It is true that almost two years later we find that unemployment is just below 10 % as compared to 20 % in the great depression; the slump in U.S. GDP is 3.5 % versus the over 20 % fall in 1930; and the technical end of the recession in terms of the resumption of positive growth this time is 18 months in the U.S. versus over 3.5 years in 1929-1933.
But these results are after the most massive and co-ordinated monetary and fiscal stimulus since world war two. Furthermore, no other recession since the thirties involved a more widespread and systemic crisis in the financial sector which was of a global nature.
When we add up these factors it does seem persuasive that the crisis as it appeared in the fall of 2008 was the worst since the great depression. (On the financial crisis and its roots in the sub prime housing market, Ponzi finance and the derivatives created on this market see among others: Henry M.Paulson,Jr. On The Brink, Inside the Race to Stop the Collapse of the Global Financial System, N.Y. :Business plus, 2010; Scott Patterson, The Quants:How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It, N.Y.: Crown Business, 2010; Joseph Stiglitz, Freefall:Free Markets and the Sinking of the Global Economy , N.Y.,Allen Lane, 2010; William Cohan; House of Cards:A Tale of Wretched Excess on Wall Street,N.Y.:Random House Doubleday, 2009; Benoit Mandelbrot & Richard Hudson, The Misbehaviour of Markets:A Fractal View of Financial turbulence, N.Y.:Basic Books, 2004; Kevin Phillips, Bad Money:Reckless Finance, failed politics, and the Global Crisis of American Capitalism, N.Y.:Viking, 2008; Haroldchorneypoliticaleconomist.piczo.com; Nouriel Roubini & Stephen Mihm, Crisis Economics:A crash course in the future of finance, N.Y.&London: the Penguin Press, 2010; Paul Jorion, La Crise:Des subprimes au seisime financier planétaire,Paris, France: Fayard, 2008; Richard Posner, A failure of Capitalism:The crisis of 08 and the descent into depression, Cambridge, Mass. and London U.K., 2009; Bill Bamber & Andrew Spencer,Bear Trap: The Fall of Bear Stearns and the Panic of 2008, New York :Brick Tower Press, 2008; Richard Bookstaber,A Demon of Our Own Design: Markets, Hedge funds and the Perils of Financial Innovation,Hoboken N.J., John Wiley & sons, 2007 )
The mood in the world’s financial capitals has been uniformly cautious but slightly upbeat as the stock market has boomed since its nadir in March of 2009. At that point, the Dow had fallen to the 6600 range from its August 2007 high of 14147.
In April, 2010 as I wrote this it had a value of over 10,800.(July 3, now 9686. it has fallen over 1100 points since April)) Some investment analysts, including my personal broker are becoming nervous about another major fall in values since price to earnings ratios have steadily risen above accepted norms, but others remain bullish. Robert Schiller has shown that before the crash, price to earnings ratios were at the highest they had been in more than fifty years and hence he correctly anticipated a crash once the bubble burst. (See the Yale University You tube video, A panel discussion on the national financial crisis, April 14, 2009 with Robert Shiller,Jean Geanakoplos, Frederick Beinecke and Richard Levin.April 14, 2008. http://www.youtube.com/watch?v=ilApxQjhs_s) In late May the stock market jitters had driven the Dow once again below 10,000 but it quickly rallied to 10,130 on May 26, 2010. Currently, June 28, 2010 it sits at Dow 10,138.
It is impossible to predict accurately with complete confidence what will happen in the coming months. Canada, for one, has been experiencing robust growth of 6.1 % in its first quarter 2010 GDP and a strong dollar in recent months. The dollar had reached parity and above but then slipped back to 94-95 cents U.S. It is now June 22, 2010 at 96.43 U.S.(94.1 as of July 3, 2010)
But unemployment in Canada is still high at 8.1 %.(7.9 % as of June, 2010 )In Montréal, for example unemployment is above 9 % and in certain categories, like 16- 25 years of age it stands at over 20 %. If growth continues at the current rate, however, unemployment slowly should begin to fall substantially. Unfortunately, the Bank of Canada chose to raise interest rates by 25 basis points on June 1, 2010. This then was followed by small but significant rises in mortgage and line of credit rates which will slow the recovery. It is too soon to say that the bank is headed off on a premature line of interest rate rises as it made clear in its announcement that further rate rises might not occur depending upon conditions. But it would have been better not to have raised the rate at this point when there is still so much slack in the economy and no threat of inflation.
But growth is much slower in both Europe and the U.S. Growth in China is still strong at 11.9 % in the first quarter of 2010 but slowing and Japan is still experiencing slow growth and deflation.(See tables 1 & 2 below)
Nervous behaviour will continue and unfortunately the decision of the OECD in May of this year to urge governments to cut their deficits and begin to raise interest rates based on faulty monetarist logic is bound to have a negative effect upon growth thereby feeding back into a volatile market. This IMF OECD policy thrust has been confirmed by the G20 meeting in Toronto. Anti-Keynesian deficit hysteria has reappeared after its temporary banishment immediately following the crash in 2008.
This pessimism is because the market correctly assumes using Keynesian logic that cutbacks in government spending in search of illusory premature budget balance will contract aggregate demand and slow the economy. The recent emergency conservative-Liberal Democrat budget released by the new Chancellor Gordon Osborne is an excellent case in point. This budget projects British unemployment as increasing on account of the austerity budget yet it proposes substantial and even draconian cuts and damaging tax increases. The budget is resolutely anti-Keynesian but at least the former Labour government now in opposition is strongly attacking the budget on Keynesian grounds. Canadian Prime Minister Stephen Harper unfortunately has praised the budget as setting Britain on the right track.
Unfortunately, the recent G20 meeting in Toronto opted to endorse a statement which committed countries to reduce their deficits by 50 % by 2013 and stabilize or reduce their debt to GDP ratios by 2016. The statement is fairly open ended, has no penalties for non compliance and permits countries to vary their policies to fit their circumstances but the fact that it was raised on the agenda by Canada and backed by many European countries and eventually once modified agreed to by the Obama administration is a sign of the tenacity of the fiscal conservatives and the lobbying power of the bond market traders.So far the markets have reacted by lowering their expectations of growth and profits and selling stock and bidding up the price of bonds.
On Wall Street all of the leading major investment banks in 2008 have either failed, like Lehman brothers, been bailed out by the government with TARP money like Goldman Sachs or by major competitors with the help of government money, like Bear Stearns by J.P.Morgan ; Morgan Stanley by Mitsubishi UFI or Merrill Lynch by Bank of America.(See Paulson for details) The Federal Reserve has pumped several trillions of dollars into the economy.
Similar events have taken place in Great Britain, Germany, Spain, Belgium, Netherlands, Iceland, Dubai and France. Two of the world’s largest automotive companies G.M. and Chrysler have gone bankrupt and been restructured with government money. A number of others are undergoing restructuring. The AIG insurance company, the largest insurance company in the world has been taken over by the U.S.government and bailed out of bankruptcy with loans that totalled more than 100 billion dollars. The two U.S.Government enterprises tasked with provided mortgage funds to the banks and homeowners, Fannie Mae and Freddie Mac were also both taken over by the government. (Paulson)A number of the companies have received government aid in order to keep them operating. The laissez-faire myth of totally private enterprise operating without state aid lies shattered by recent events. As well, as Ormerod , Stiglitz,Krugman,Galbraith, myself and other Keynesians, post-Keynesians and progressive economists have pointed out these events have shattered the claims of the rational agents rational expectations theorists (RARE macrotheorists) and real business cycle theorists about the inherent rationality of markets. Ormerod shows how an even more extreme idealization of these models appeared as late as 2008 called dynamic stochastic general equilibrium models which macrotheorists believed contained the cutting edge of insight into the general equilibrium nature of the macroeconomy. Only months later, the collapse of Bear Stearns followed and the collapse of the Wall street investment banks was underway. Hegel’s owl took flight at dusk !
Many small and large banks have failed, and millions of people have lost their jobs. There are as of April 2010, 46 million unemployed in thirty OECD countries. The unemployment rate stands at 8.7 % for these countries with youth unemployment above 19 %.
Table 1.1
Unemployment rates in selected OECD countries and trade and currency associations as of April 2010 (except where noted)
Spain 19.7 %
Slovakia 14.1
Ireland 13.2
Portugal 10.8
France 10.1
U.S. 9.7 (9.5 June)
Sweden 9.1
Italy 8.9
Canada 8.1
Germany 7.1
G7 8.4
EU 9.7
Eurozone 10.1
Japan 5.2(May, 2010)
Netherlands 4.1
Norway 3.5
South Korea 3.2 (May, 2010)
Source: OECD, all data except where noted as of April, 2010.
The deep recession has been a global phenomenon stretching from Russia to China to Japan to North America to Europe . Africa and Latin America have been affected. The European union has been going through a crisis over the levels of debt taken on by its member states, even though a rise in state indebtedness to finance stimulus is a sound Keynesian policy. Furthermore, in a number of countries the level of debt to the GDP is well below historical maxima and in the case of the U.K even below levels reached during the early 1970s.( Haroldchorneypoliticaleconomist, ‘’U.K. National Debt to GDP, 1916 to 1998, ‘’April 21, 2010; and ‘’ Spain, Debt and the Chicken Little squad, May 29, 2010 ; and OECD cited in Rudiger Dornbusch, Dollars, Debts and deficits, p.172, Table lll.2)Greece , Portugal , Ireland and Spain, the so called PIGS have been at the centre of this crisis.
Austerity has been imposed upon Greece in return for it obtaining the support of the European Central Bank (ECB), the European Union and the IMF. Again this is a very unfortunate tendency since unemployment is elevated in each of these countries with Spain in the worst shape suffering from close to 20 % unemployment, up from 10 % in 2006.( Eurostat; FT)
The new Conservative /Liberal coalition government of Great Britain has foolishly declared war on its deficit, despite its net debt to GDP ratio being a bit less than 60 %, a fifth of what it was at the end of the second world war. Indeed, the significant deficit which Gordon Brown the Labour P.M. had undertaken in response to the crisis was a factor in his defeat in the election. The new government intends to slash government expenditures by as much as 6 billion pounds in 2010 and by as much as 40 million pounds over the next four years. ( The U.K. budget, June 22, 2010;F.T.various issues May 2010;See also my letter to the F.T. April 26 , 2010 on British debt in historical perspective and the British office for national statistics) Global trade has been negatively affected.
If one scans publications like the Wall Street Journal, the Financial Times, The New York Times, The Guardian, Le Monde and The Globe and Mail there is a growing sense of the enormous size of the crisis that we are passing through and the widespread shock about the level of destruction of financial assets and the wiping out of stockholder value that occurred. It appears that we have saved ourselves from another great depression,but only just and that prospect was widely being discussed over the past 12 months. Now the topic of discussion is a double dip recession. See the pessimistic analysis of Nouriel Roubini in his RGE monitor for this perspective.
Growth has resumed in the U.S. which has now had three consecutive quarters of growth since the summer of 2009. Unemployment however remains above 9 % in the U.S. Growth in Canada has also been positive, but unemployment is still above 8 %.
TABLE 2
First quarter growth rates in GDP 2010; annual rates of 2009 growth; 2008; 2007;
Q1/10 09 08 07
Canada 6.1 %* 0.4 2.7 2.7
U.S. 3.0 * -2.4 0.4 2.7
China 11.9 %* 9.1 12.75
Japan 0.8 % -5.2 -1.2 2.4
Taiwan 13.27 % *
India 8.6 % * 7.4 9.0 9.2
Germany 0.2 % -4.9 1.3 2.5
France 0.1 % -2.6 0.2 2.4
Italy 0.5 % -5.0 -1.3 1.5
U.K 0.3 -4.9 0.5 2.6
Spain 0.1 -3.6 0.9 3.6
Greece -0.8 -2.0 2.0 4.5
Belgium 0.3f -3.0 1.0 2.9
Denmark 0.4f -4.9 -0.9 1.7
Ireland -0.3f -7.1 -3.0 6.0
Czech 0.4f -4.1 2.5 6.1
Austria 0.3f -3.5 2.0 3.5
Finland 0.4f -7.8 1.2 4.9
Sweden 0.3f -5.1 0.4 3.3
Norway 0.4f -1.6 1.8 2.7
Switz. 0.4 -1.6 1.9 3.6
Euro zone 0.2 -4.1 0.6 2.8
EU 27 0.2 -4.2 0.7 2.9
Source: Eurostat; OECD.
f forecast for Q1,
* annualized basis
Monetarist economists like Alan Meltzer writing in the Wall Street journal (August 31, 2009 ‘’What Happened to the Depression ‘’)insisted as the recovery began to make its appearance that the data shows that this recession is more like that of 1973-75, rather than the great depression.
That may well turn out to be true in terms of duration and maximum unemployment rate, but not in terms of the scope of the financial collapse and subsequent panic. Also remember that is only after a massive intervention by governments around the world and the expenditure of several trillion dollars in stimulus funds and dramatically lowered interest rates for a prolonged period.(U.S. 787 billion$ plus Troubled assets relief program(TARP) 700 billion and Troubled assets loan facility(TALF) funds in the form of loans of 500 billion,UK 80 billion $,Germany 80 b $, France 60 b $. Japan 81 billion, China 586 billion) that the economy has partially recovered. Not all of the TARP and TALF funds were utilized but the initial enormous commitments were necessary to restore relative calm to the markets.
Over time much of these monies advanced as loans have been repaid with interest so that the final cost of the bailout will be much less than the headline figures initially announced. For example G.M. and many of the investment banks have repaid billions of dollars of loans with interest as of spring 2010. Critics like Joseph Stiglitz have pointed out that the repayments were smaller than they should have been given the risks that the government took on and that private market loans would have demanded and received a higher rate of return.
The degree of widespread financial panic, bank failure, scandal and Ponzi finance, and stock market collapse, the spike in oil prices, as well the pressure of the collapse in investment and consumption all have to be taken into account. All of this far exceeded the events of 1973-75, a period with which I am personally very familiar .
The fact that the recession has now technically ended is much more the consequence of the policies implemented to treat it, rather than as Meltzer argues , the self recuperative power of market forces. For it was the unregulated forces of the market that led to this mess in the first place.
It is useful to remember that the value of shares in the Dow Jones index fell by 47 % from September 1929 to November 1929.They ended the year at 65 % of their September value. They did not regain their 1929 value until the early 1950s.(Kindleberger, p.105) The S&P index fell to just 25% of its 1929 peak by 1932(Kindleberger, fig.8 p.120 )The prices of primary products fell by a third world wide. The GDP in the US fell from its 1929 high by 29 % from 1929 to 1932/33.The number of unemployed rose from 1.6 million in 1929 to 12.8 million by 1932/33.(R.A.Gordon , Business cycles,p.429) The slump in Britain and Canada was just as severe. For example, disposable income fell to 51 % of the 1929 level by 1933 in Canada. By 1933, 20 % of the work force was unemployed in Canada. (A.E.Safarian, The Canadian Economy in the Great Depression, p.86 &p75)
This time the slump in the stock market was initially even greater than in the first part of 1929. From their peak in August of 2007 until their low point in March of 2009 stocks fell from Dow 14141 to Dow 6600 a fall of about 53 %. But since the low point of last March they recovered to Dow 10800,in April 2010, a fall of about 23.6 % from their peak. Their current level as of June 28 is Dow 10,138.
So talking about the possibility of a depression along these lines is a very serious proposition and given what governments know about how to avoid these problems it is still possible but unlikely. A serious prolonged period of high unemployment is however much more likely. This is particularly so because governments the world over are still obsessed with deficit hysteria. Growth has resumed but the unemployment rate is dropping very slowly. This is often the case after a major downturn. Paul Krugman in the New York Times has been very pessimistic about the prospects for a depression, particularly since the G20 countries have rather foolishly adopted a commitment to cut deficits in half by 2013 and stabilize or reduce debt to GDP ratios by 2016.
I sympathize with Krugman’s frustration over the widespread ignorance among politicians of economic history and their apparent rush to repeat the errors of history. But given the rather open ended language of the commitment and the recognition that each country will have to deal with their own circumstances it is possible we will be lucky and deficit reduction approaching these targets will take place largely because of the resumption of growth. Nevertheless, the risk of depression is in fact strengthened by austerity policies at such a critical point in a fragile limited recovery. It is a very bad reality that the U.S.congress is now apparently opposed to further stimulus measures and that fiscal conservatives dominate governments throughout most of the G20.
Typically it takes two or more years after the end of a recession for the unemployment rate to drop substantially. Sometimes a full 4 or 5 years after the end of the recession the rate is still higher than what it was just prior to the recession. For example, in the U.S. after unemployment rose in 1990 from its low of 5.2 % it took more than five years for the rate to drop to this level again.( See the U.S. Bureau of Economic analysis historical statistics)
This past summer, 2009, the first signs of the beginning of an economic recovery made their appearance. Positive growth appeared in both the U.S. and Canadian economy in the third and fourth quarter of 2009.This means that the recession in Canada was technically 10 months long while the one in the US was 18 months in duration. The European recession appears to have begun in the 2nd quarter of 2008 and may have ended in the third quarter of 2009. Although the formal recession in terms of positive GDP growth may have ended, unemployment continued to rise in both Canada and the U.S. and in Europe. The rate for August 2009 rose to 8.7 % in Canada and to 9.7 % in the U.S. The U.S. rate then peaked at 10 % in the U.S. and has now declined to 9.7 % while the Canadian rate peaked at 8.7 % and is now 8.1 %
The rate in the fall of 2009 in France was 9.8 % , Germany 7.7 %,the U.K. 7.7 %,7.0 % in Belgium, 18.5 %in Spain, 9.2 % in Sweden, 5.7 % in Japan. )
By November 2009 the rates were 7.5 % in Germany, 10 % in France, 8.1% in Belgium, 19.4 % in Spain, 9.7 % in Greece, 8.7 % in Sweden, 13.5% in Ireland. The rate in Greece has since risen to 10.3 %.
By January 2010 the rate had worsened in a many countries and improved slightly in several ,the overall rate for the euro area in January 2010 was 9.9 % and for the European union 9.7 %. In January 2010 the rate was: Belgium 8.0%,; France 10.1 %; Germany 7.5 %; U.K. 7.8 %; Spain 18.8 %; Sweden 9.1 %; Italy 8.6 %; Ireland 13.8 %; Greece 9.7 % (Sept.2009) now Feb 2010 10.3 %;Luxembourg 5.9 %; Norway 3.3 %; Netherlands 4.2 %; Denmark 7.3 %; Japan 4.9 %; Poland 8.9 %; Czech republic 8.2 %; Slovakia 13.7 % ; Canada 8.2 %(Feb.2010) and the U.S. 9.7 %(Feb.2010)
Net job losses continued in the U.S. during the summer with August showing a net loss of over 200,000 jobs, the lowest number in many months but still a large number. In Canada in August largely because of part time employment rises there were net job gains even as the rate rose because of discouraged workers rejoining the labour force. The broader measure of unemployment that includes all marginally attached and discouraged workers and those working part-time when they would rather be working full time rose to 16.8 % in the U.S. in August up from 10.7 % in August 2008. Since the start of the recession the U.S. has lost over 7.1 million jobs. (U.S. Bureau of Labour Statistics, statistics Canada, labour force survey)
This has improved in both Canada and the U.S. with the latest data showing that in February the U.S. lost only 22,000 jobs.
At present however there are close to 15 million people unemployed in the U.S. and another 21 million unemployed in Europe.(U.S. Bureau of labour statistics; Eurostat)
The origins of quantitative easing
In September 2008 I wrote in my internet blog(Haroldchorneypoliticaleconomist.piczo.com) and in comments posted in The Wall Street Journal, the Financial Times, The New York Times and in The Globe and Mail that the crash in the financial markets and the accompanying paralysis of the financial system was grave enough to warrant drastic action. I called for large deficit spending and zero interest rates as well as central bank intervention through quantitative easing to keep the rates as low as possible. The governments and central banks did exactly that. Many economists urged what I urged on the fiscal policy front and also on the conventional monetary policy front. But very few also urged quantitative easing.
This notion of quantitative easing which is essentially temporary greater monetization of a portion of the government’ debt than is normally the case, is facilitated by the central bank purchasing treasuries directly in the money markets to prevent any crowding out from occurring. It is a policy idea that I first presented in Canada back in the 1980s and 1990s in a series of published works in edited collections, monographs and journals. As far as I know I was one of the first, if not the first economist in the modern era to advocate this policy. (Harold Chorney, The Deficit:Hysteria and the Current Crisis, Ottawa: The Canadian Centre for Policy Alternatives, 1984 reprinted with a new preface in Harold Chorney& Phillip Hansen,Toward a Humanist Political Economy.
Harold Chorney, The Economic and Political Consequences of Canadian Monetarism, paper presented to the British Association of Canadian Studies, University of Nottingham, April 12, 1991 forthcoming in On stimulus, deficits and surpluses.
Harold Chorney, The Deficit and Debt Management: an Alternative to Monetarism, Ottawa: The Canadian Centre for Policy Alternatives, 1989.
Harold Chorney, ‘’A Regional Approach to Monetary and Fiscal Policy’’ in J. McCrorie and M.Macdonald, The Constitutional Future of the Prairie and Atlantic Regions of Canada, Regina; Canadian Plains Research Centre, University of Regina, 1992.
Harold Chorney, Debts, Deficits and Full Employment in Robert Boyer and Daniel Drache, States Against Markets:The Limits of Globalization, New York& London: 1996.)
Like all good ideas it had been discussed in history before.
It is useful to know that Keynes himself approved of this approach. In March of 1930 before the Macmillan Committee in the U.K. of which Keynes was both a member and also a major witness he argued in favour of this policy as follows.
The early 1930s Japanese finance minister Korekiyo Takahashi introduced it in Japan. There was also a foreshadowing of it in the Glass Steagall act of Feb.27, 1932. The act on an emergency basis permitted the U.S.Fed ‘’to count government securities together with eligible commercial paper as reserves against the system’s liabilities.’’
As Friedman and Schwartz point out this meant that government debt could now be counted as part of the 60 % collateral other than gold required against federal Reserve notes.(Milton Friedman& Anna Jacobson Schwartz, A Monetary History of the United States, 1857-1960 , p.191. and Charles Kindleberger, The World in Depression, 1929-1939, p.183) This then led to a very large open market purchase of government issued debt by the Fed , despite substantial internal opposition on the grounds that the action would be inflationary.
Allan Meltzer points out that in 1932 there was heated debate about the Fed buying U.S. treasuries as part of its effort to rescue the economy from the depression. Previous to this debate and the decision to actually acquire treasury debt as part of a strategy of quantitative easing the Fed largely restricted itself to the real bills doctrine about which debt instruments the Fed should acquire in conducting monetary policy.
Meltzer shows that this debate also occurred in Great Britain in the nineteenth century when there was a need for the Bank of England to purchase treasuries in the open market. (Meltzer, A History, p.37) To a certain extent the debate between the currency school and the banking school turned on these issues of which debt instruments it would be legitimate for the central bank to purchase and hold. (Meltzer, p.43)
In the twentieth century the issue of the central bank buying treasuries re-emerged during the financing of the first world war and there was a clear bias in favour of the real bills doctrine. But Meltzer points out that ‘’Most commentators point out(correctly) that it is no more inflationary for the Federal Reserve to buy the bonds directly(or in the open market) than to lend the money to the banks at below market rates so that banks can either purchase the bonds or finance the public’s purchases. The increase in the monetary base is the same. (p.87) Nevertheless, during the 1920s right up until the crash of 1929, monetary policy was dominated by a doctrine called the Riefler-Burgess doctrine which was compatible with the conservative real bills doctrine and was very restrictive in terms of what it regarded as legitimate central bank purchases.. Winfield Riefler and W. Randolph Burgess were the two banking economists who developed the doctrine and Meltzer draws upon his research with Karl Brunner in describing the significance of their work. (p.161)
It was not until the passage of the Glass Steagall act in 1932 that more flexibility was introduced which permitted the Fed to substitute government paper for commercial paper or real bills . (Meltzer, p.357) During the spring of that year the Fed acquired over 654 million dollars of government securities. The rate of purchase was over 100 million a week. But this first use of quantitative easing was a very limited experiment which ended by August of 1932.(p.358 ff) At the time there was no obvious immediate positive response in the economy and the general conservatism of central bankers, economists and business people was enough to halt the program. Once Roosevelt replaced Herbert Hoover and Mariner Eccles became the chairman of the Fed and Lauchlin Currie one of Roosevelt’s principal economic advisers other possibilities developed. Harry Hopkins also played a major role.
Initially, of course, Roosevelt had campaigned on balancing the books. But once he was in office he gradually realized how a bad a policy that would be. Under the influence of Eccles and Currie and the real circumstances of the depression he came to support deficit spending and work creation relief programs. Meltzer draws extensively on Currie’s and Eccles’ writings and speeches . He also uses a work by R. Sandilands on Currie’s life and political economy and develops a very important profile of these extraordinary people. ‘’Eccles and Currie, separately, developed the idea of countercyclical fiscal policy that later became identified with Keynes’ General theory.
Eccles like Keynes wanted not just spending but government investment to replace private investment during recessions.’’ (p.420) Just to be clear, private investment declines during a recession. Indeed that is its hallmark and that is what causes the slump.
Eccles believed that mal-distribution of income was responsible for the depression because first it promoted a speculative bubble and a productive capacity that far exceeded the effective demand that was possible given the distribution of income and wealth. He was a strong advocate of budgetary deficit spending and an accommodating monetary policy. But Meltzer points out that Eccles believed simply increasing the money supply and lowering rates would not work unless it was accompanied by major fiscal actions promoting investments through deficit finance. Meltzer traces the origins of the famous expression pushing on a string and the notion of the liquidity trap to both Eccles and one his supporters, congressman Alan Goldsborough in an exchange during Eccle’s testimony before the House committee on banking and finance in 1935.
Most critics of this policy of Keynesian stimulus and an accommodating monetary policy make dire warnings about the risk of inflation.
In fact, of course, the U.S. was experiencing exactly the opposite, deflation at the time. This was a definite change in central banking that was in fact a form of quantitative easing. In the past the fetish of the gold standard and the doctrine of real bills had dominated central bank thinking. (Real bills were notes, drafts and bills of exchange issued by banks on the basis of commercial transactions.)One would have had to go back to the civil war issuance of greenbacks, a purely fiat currency which largely financed the war to find non gold nor silver nor real bills backed currency. A number of otherwise conservative economists backed the decision of the central bank, pointing out the deflationary circumstances. Milton Friedman later complained that the Fed had not been expansionary enough.(see his discussion of the Glass –Steagall act of 1932., p.191 Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States. But given the climate of opinion it is understandable. Just as today we have ferocious opposition to quantitative easing and deficits despite the clear necessity of these policies if we are to avoid the disaster of the 1930s.
The purchase of treasury debt to forestall interest rate rises thus became a normal part of monetary policy. It was strongly exercised during the 1940s and fifties in the U.K. (See R.Sayers Modern Banking, fifth edition, Oxford: Clarendon Press, 1960, p.136 ff and his discussion of the Chancellor of the Exchequer Hugh Dalton’s drive to lower interest rates in 1946-47. See also ch.8 on Commercial Bank liquidity and lending policy. Pp.157ff)
There has been a long history of debate with respect to the central bank and its power to exert influence over the whole range of interest rates from the short term where it clearly has absolute power, to longer portions of the yield curve where its powers are more ambiguous.
Abba Lerner had discussed important aspects of central bank authority in the 1940s in his work on functional finance. In Japan the Minister of Finance had resorted to this policy of quantitative easing in the 1930s. But for the most part this critical policy innovation had been forgotten by the high point of monetarism in the 1980s and the decades which followed.
When I first discussed it in the early 1980s I was ridiculed by Bank of Canada economists and called foolish for proposing such an ” inflationary” idea. Other critics claimed it was simply social credit theory, an idea associated with the funny money movement of the 1930s and the ideas of a British engineer Major Douglas. Indeed, when Abba Lerner first wrote his classic work on functional finance , a senior Canadian Dept. of Finance official A.N.McLeod claimed that it bordered on social credit or at least would be interpreted by them as supporting their argument and would cause inflation..( Memorandum for Mr. Bryce Re:My comments on Lerner’s ‘’Functional finance’’ RG File 04747-251 Finance Central files, Ottawa, April 24, 1944 ) Even my current editor, an historian by training has claimed that it was social credit.
It is in fact neither social credit nor automatically inflationary. Rather it represents a sophisticated approach to using both monetary and fiscal policy in fighting a slump and a collapse in confidence of which Keynes himself privately approved .(See David Colander,‘’Was Keynes a Keynesian or a Lernerian,’’ Journal of Economic Literature, Dec.1984, pp1572-1575 )
I explained then and am glad to see it has now been accepted that it need not be inflationary when the threat is deflation and depression. Rather, it becomes a very useful tool to ward off deflation and prolonged depression. I was , of course, pleased to see it embraced by most if not all of the central banks and the I.M.F. during 2009. The Japanese resorted to this policy when they sought recovery from the bursting of their real estate bubble. The Fed, the Bank of England and the Bank of Japan have all resorted to it during this period of crisis. Inflation , in the sense of price increases beyond three percent, for the time being is nowhere to be seen. In the U.S. core inflation is still below 2 %.Even the ultra conservative Bank of Canada considered using it. The European Central Bank initially refused to use it but during the Greek sovereign debt crisis they relented somewhat and unfortunately belatedly.
In response to the banking and credit panic and the severe slump that followed, liquidity needed to be injected by the central banks. Interest rates needed to be cut. Large budget deficits needed to be undertaken to finance infrastructure and investments that are labour intensive in education, health care, social policy, the military and the environment. The 787 billion dollar bailout rescue package passed by the American Congress in early October, 2008 ,the Economic Emergency Stabilization Act., was intended to stimulate the economy and create employment. To a certain extent it has succeeded but its success has been limited by the failure to spend the funds expeditiously and by bureaucratic problems with its administration. Only by the end of 2010 will the majority of the monies actually be expensed. It has also been undermined by simultaneous cutbacks by state and local governments.
July 3, 2010
This past week I participated in an excellent academic congress which gathered together about 100 economists, economic historians, political economists, and development specialists at Concordia University in Montreal for the thirteenth world congress of this association. People attended from Europe, Japan, China, India, the Middle East, North and South America, New Zealand and Africa. The association founded in 1941 is committed to encouraging research and publication in economics and policy which links ethics, society and social concerns to economic analysis.There were many excellent papers and keynote presentations by Pierre Fortin of UQAM in Montréal, Sakiko Fukuda -Parr of the New School in New York and Mihaly Simai of the institute for World Economics, Corvinus University in Budapest. the conference program is available on the net at the association's web site,www.socialeconomics.org
Here is an excerpt from the paper I presented on ''The Global Financial Crisis, the Re-emergence of Keynes and the Role of Quantitative Easing
The global financial crisis, the re-emergence of Keynes and the role of quantitative easing.
By Harold R.Chorney Professor of Political economy, Concordia university
Paper presented to the thirteenth World Congress of Social Economics, Concordia University, Montréal, June 30,2010.
Introduction:
More than twenty five years ago I began to write about problems of public finance.( Chorney, 1984) At the time that I began to do so, I never would have believed that I would still need to be writing a critique of fiscal conservative dogma almost twenty five years later !
The staying power of previously discredited bad ideas was much greater than I surmised at the time. The staying power of herd behaviour based on shallow derivative analysis was stronger than I understood. 1 It was not for nothing that John Maynard Keynes once stated that if his revolution in economic thought were ever to be reversed it would be extraordinarily difficult to reinstate it. Not because he believed he was wrong, but because he knew that the forces of reaction and stubborn resistance to progressive economic thought were so deeply entrenched.
Sadly, he and Michal Kalecki who predicted that the Keynes breakthrough would be reversed once business became ‘’boom tired’’and there would be no shortage of economists to justify business’s anti-deficit spending prejudice were both very right about this.(See, M. Kalecki, Essays in Economic dynamics, The politics of the trade cycle; Kalecki was the Polish Jewish economist who ought to be considered the co-discoverer of Keynesian economics because of his essays on the investment process, unemployment and economic dynamics that he published in the early 1930s before Keynes’ General Theory which contained the essence of Keynes’ own argument. He was eclipsed by Keynes , in part because he published his work in Polish, but also, of course, because Keynes was already a world famous economist because of being at Cambridge and having authored the Economic Consequences of the Peace which had made him world famous in 1920.Keynes to a small extent and certainly Joan Robinson later acknowledged the significance of Kalecki’s work.(See in particular,A.Asimakopulos, ‘’Kalecki and Robinson’’ in Mario Sebastiani, Kalecki’s Relevance Today, London: the Macmillan Press, 1989.See also Michael Kalecki, ''Political Aspects of Full employment, Political quarterly,Vol. 14, 1943, pp.322-331 reprinted in E.K.Hunt & Jesse Schwartz, eds. A Critique of Economic Theory, Harmondsworth:Penguin , 1972, pp.420-30.)
The cataclysmic near total destruction of Wall street in the great crash of derivatives and the fraud ridden sub prime housing market in the 2008 slaughter on Wall street has thoroughly frightened the world .Although as I write in the spring and early summer of 2010 ,circumstances are significantly improved and much but not all of the fears of another great depression have dissipated.In many respects we have not seen something as dramatic since 1929. Alan Meltzer in the Wall Street Journal(‘’What Happened to the ‘Depression’’’ Wall Street Journal Aug.31, 2009 )disputes this comparison of the crash and the subsequent deep slump as the worst crisis since the depression of 1929 ,but I don’t find Meltzer completely convincing, although I am an admirer of his outstanding History of the Federal Reserve(Allan Meltzer,A History of the Federal Reserve, Vol.1:1919-1951 , Chicago: University of Chicago Press, 2003, 800 pages; see also,Barry Eichengreen and Kevin O’Rourke , A tale of two depressions :What do the new data tell us ?: http://www.voxeu.org/index.php?q=node )
It is true that almost two years later we find that unemployment is just below 10 % as compared to 20 % in the great depression; the slump in U.S. GDP is 3.5 % versus the over 20 % fall in 1930; and the technical end of the recession in terms of the resumption of positive growth this time is 18 months in the U.S. versus over 3.5 years in 1929-1933.
But these results are after the most massive and co-ordinated monetary and fiscal stimulus since world war two. Furthermore, no other recession since the thirties involved a more widespread and systemic crisis in the financial sector which was of a global nature.
When we add up these factors it does seem persuasive that the crisis as it appeared in the fall of 2008 was the worst since the great depression. (On the financial crisis and its roots in the sub prime housing market, Ponzi finance and the derivatives created on this market see among others: Henry M.Paulson,Jr. On The Brink, Inside the Race to Stop the Collapse of the Global Financial System, N.Y. :Business plus, 2010; Scott Patterson, The Quants:How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It, N.Y.: Crown Business, 2010; Joseph Stiglitz, Freefall:Free Markets and the Sinking of the Global Economy , N.Y.,Allen Lane, 2010; William Cohan; House of Cards:A Tale of Wretched Excess on Wall Street,N.Y.:Random House Doubleday, 2009; Benoit Mandelbrot & Richard Hudson, The Misbehaviour of Markets:A Fractal View of Financial turbulence, N.Y.:Basic Books, 2004; Kevin Phillips, Bad Money:Reckless Finance, failed politics, and the Global Crisis of American Capitalism, N.Y.:Viking, 2008; Haroldchorneypoliticaleconomist.piczo.com; Nouriel Roubini & Stephen Mihm, Crisis Economics:A crash course in the future of finance, N.Y.&London: the Penguin Press, 2010; Paul Jorion, La Crise:Des subprimes au seisime financier planétaire,Paris, France: Fayard, 2008; Richard Posner, A failure of Capitalism:The crisis of 08 and the descent into depression, Cambridge, Mass. and London U.K., 2009; Bill Bamber & Andrew Spencer,Bear Trap: The Fall of Bear Stearns and the Panic of 2008, New York :Brick Tower Press, 2008; Richard Bookstaber,A Demon of Our Own Design: Markets, Hedge funds and the Perils of Financial Innovation,Hoboken N.J., John Wiley & sons, 2007 )
The mood in the world’s financial capitals has been uniformly cautious but slightly upbeat as the stock market has boomed since its nadir in March of 2009. At that point, the Dow had fallen to the 6600 range from its August 2007 high of 14147.
In April, 2010 as I wrote this it had a value of over 10,800.(July 3, now 9686. it has fallen over 1100 points since April)) Some investment analysts, including my personal broker are becoming nervous about another major fall in values since price to earnings ratios have steadily risen above accepted norms, but others remain bullish. Robert Schiller has shown that before the crash, price to earnings ratios were at the highest they had been in more than fifty years and hence he correctly anticipated a crash once the bubble burst. (See the Yale University You tube video, A panel discussion on the national financial crisis, April 14, 2009 with Robert Shiller,Jean Geanakoplos, Frederick Beinecke and Richard Levin.April 14, 2008. http://www.youtube.com/watch?v=ilApxQjhs_s) In late May the stock market jitters had driven the Dow once again below 10,000 but it quickly rallied to 10,130 on May 26, 2010. Currently, June 28, 2010 it sits at Dow 10,138.
It is impossible to predict accurately with complete confidence what will happen in the coming months. Canada, for one, has been experiencing robust growth of 6.1 % in its first quarter 2010 GDP and a strong dollar in recent months. The dollar had reached parity and above but then slipped back to 94-95 cents U.S. It is now June 22, 2010 at 96.43 U.S.(94.1 as of July 3, 2010)
But unemployment in Canada is still high at 8.1 %.(7.9 % as of June, 2010 )In Montréal, for example unemployment is above 9 % and in certain categories, like 16- 25 years of age it stands at over 20 %. If growth continues at the current rate, however, unemployment slowly should begin to fall substantially. Unfortunately, the Bank of Canada chose to raise interest rates by 25 basis points on June 1, 2010. This then was followed by small but significant rises in mortgage and line of credit rates which will slow the recovery. It is too soon to say that the bank is headed off on a premature line of interest rate rises as it made clear in its announcement that further rate rises might not occur depending upon conditions. But it would have been better not to have raised the rate at this point when there is still so much slack in the economy and no threat of inflation.
But growth is much slower in both Europe and the U.S. Growth in China is still strong at 11.9 % in the first quarter of 2010 but slowing and Japan is still experiencing slow growth and deflation.(See tables 1 & 2 below)
Nervous behaviour will continue and unfortunately the decision of the OECD in May of this year to urge governments to cut their deficits and begin to raise interest rates based on faulty monetarist logic is bound to have a negative effect upon growth thereby feeding back into a volatile market. This IMF OECD policy thrust has been confirmed by the G20 meeting in Toronto. Anti-Keynesian deficit hysteria has reappeared after its temporary banishment immediately following the crash in 2008.
This pessimism is because the market correctly assumes using Keynesian logic that cutbacks in government spending in search of illusory premature budget balance will contract aggregate demand and slow the economy. The recent emergency conservative-Liberal Democrat budget released by the new Chancellor Gordon Osborne is an excellent case in point. This budget projects British unemployment as increasing on account of the austerity budget yet it proposes substantial and even draconian cuts and damaging tax increases. The budget is resolutely anti-Keynesian but at least the former Labour government now in opposition is strongly attacking the budget on Keynesian grounds. Canadian Prime Minister Stephen Harper unfortunately has praised the budget as setting Britain on the right track.
Unfortunately, the recent G20 meeting in Toronto opted to endorse a statement which committed countries to reduce their deficits by 50 % by 2013 and stabilize or reduce their debt to GDP ratios by 2016. The statement is fairly open ended, has no penalties for non compliance and permits countries to vary their policies to fit their circumstances but the fact that it was raised on the agenda by Canada and backed by many European countries and eventually once modified agreed to by the Obama administration is a sign of the tenacity of the fiscal conservatives and the lobbying power of the bond market traders.So far the markets have reacted by lowering their expectations of growth and profits and selling stock and bidding up the price of bonds.
On Wall Street all of the leading major investment banks in 2008 have either failed, like Lehman brothers, been bailed out by the government with TARP money like Goldman Sachs or by major competitors with the help of government money, like Bear Stearns by J.P.Morgan ; Morgan Stanley by Mitsubishi UFI or Merrill Lynch by Bank of America.(See Paulson for details) The Federal Reserve has pumped several trillions of dollars into the economy.
Similar events have taken place in Great Britain, Germany, Spain, Belgium, Netherlands, Iceland, Dubai and France. Two of the world’s largest automotive companies G.M. and Chrysler have gone bankrupt and been restructured with government money. A number of others are undergoing restructuring. The AIG insurance company, the largest insurance company in the world has been taken over by the U.S.government and bailed out of bankruptcy with loans that totalled more than 100 billion dollars. The two U.S.Government enterprises tasked with provided mortgage funds to the banks and homeowners, Fannie Mae and Freddie Mac were also both taken over by the government. (Paulson)A number of the companies have received government aid in order to keep them operating. The laissez-faire myth of totally private enterprise operating without state aid lies shattered by recent events. As well, as Ormerod , Stiglitz,Krugman,Galbraith, myself and other Keynesians, post-Keynesians and progressive economists have pointed out these events have shattered the claims of the rational agents rational expectations theorists (RARE macrotheorists) and real business cycle theorists about the inherent rationality of markets. Ormerod shows how an even more extreme idealization of these models appeared as late as 2008 called dynamic stochastic general equilibrium models which macrotheorists believed contained the cutting edge of insight into the general equilibrium nature of the macroeconomy. Only months later, the collapse of Bear Stearns followed and the collapse of the Wall street investment banks was underway. Hegel’s owl took flight at dusk !
Many small and large banks have failed, and millions of people have lost their jobs. There are as of April 2010, 46 million unemployed in thirty OECD countries. The unemployment rate stands at 8.7 % for these countries with youth unemployment above 19 %.
Table 1.1
Unemployment rates in selected OECD countries and trade and currency associations as of April 2010 (except where noted)
Spain 19.7 %
Slovakia 14.1
Ireland 13.2
Portugal 10.8
France 10.1
U.S. 9.7 (9.5 June)
Sweden 9.1
Italy 8.9
Canada 8.1
Germany 7.1
G7 8.4
EU 9.7
Eurozone 10.1
Japan 5.2(May, 2010)
Netherlands 4.1
Norway 3.5
South Korea 3.2 (May, 2010)
Source: OECD, all data except where noted as of April, 2010.
The deep recession has been a global phenomenon stretching from Russia to China to Japan to North America to Europe . Africa and Latin America have been affected. The European union has been going through a crisis over the levels of debt taken on by its member states, even though a rise in state indebtedness to finance stimulus is a sound Keynesian policy. Furthermore, in a number of countries the level of debt to the GDP is well below historical maxima and in the case of the U.K even below levels reached during the early 1970s.( Haroldchorneypoliticaleconomist, ‘’U.K. National Debt to GDP, 1916 to 1998, ‘’April 21, 2010; and ‘’ Spain, Debt and the Chicken Little squad, May 29, 2010 ; and OECD cited in Rudiger Dornbusch, Dollars, Debts and deficits, p.172, Table lll.2)Greece , Portugal , Ireland and Spain, the so called PIGS have been at the centre of this crisis.
Austerity has been imposed upon Greece in return for it obtaining the support of the European Central Bank (ECB), the European Union and the IMF. Again this is a very unfortunate tendency since unemployment is elevated in each of these countries with Spain in the worst shape suffering from close to 20 % unemployment, up from 10 % in 2006.( Eurostat; FT)
The new Conservative /Liberal coalition government of Great Britain has foolishly declared war on its deficit, despite its net debt to GDP ratio being a bit less than 60 %, a fifth of what it was at the end of the second world war. Indeed, the significant deficit which Gordon Brown the Labour P.M. had undertaken in response to the crisis was a factor in his defeat in the election. The new government intends to slash government expenditures by as much as 6 billion pounds in 2010 and by as much as 40 million pounds over the next four years. ( The U.K. budget, June 22, 2010;F.T.various issues May 2010;See also my letter to the F.T. April 26 , 2010 on British debt in historical perspective and the British office for national statistics) Global trade has been negatively affected.
If one scans publications like the Wall Street Journal, the Financial Times, The New York Times, The Guardian, Le Monde and The Globe and Mail there is a growing sense of the enormous size of the crisis that we are passing through and the widespread shock about the level of destruction of financial assets and the wiping out of stockholder value that occurred. It appears that we have saved ourselves from another great depression,but only just and that prospect was widely being discussed over the past 12 months. Now the topic of discussion is a double dip recession. See the pessimistic analysis of Nouriel Roubini in his RGE monitor for this perspective.
Growth has resumed in the U.S. which has now had three consecutive quarters of growth since the summer of 2009. Unemployment however remains above 9 % in the U.S. Growth in Canada has also been positive, but unemployment is still above 8 %.
TABLE 2
First quarter growth rates in GDP 2010; annual rates of 2009 growth; 2008; 2007;
Q1/10 09 08 07
Canada 6.1 %* 0.4 2.7 2.7
U.S. 3.0 * -2.4 0.4 2.7
China 11.9 %* 9.1 12.75
Japan 0.8 % -5.2 -1.2 2.4
Taiwan 13.27 % *
India 8.6 % * 7.4 9.0 9.2
Germany 0.2 % -4.9 1.3 2.5
France 0.1 % -2.6 0.2 2.4
Italy 0.5 % -5.0 -1.3 1.5
U.K 0.3 -4.9 0.5 2.6
Spain 0.1 -3.6 0.9 3.6
Greece -0.8 -2.0 2.0 4.5
Belgium 0.3f -3.0 1.0 2.9
Denmark 0.4f -4.9 -0.9 1.7
Ireland -0.3f -7.1 -3.0 6.0
Czech 0.4f -4.1 2.5 6.1
Austria 0.3f -3.5 2.0 3.5
Finland 0.4f -7.8 1.2 4.9
Sweden 0.3f -5.1 0.4 3.3
Norway 0.4f -1.6 1.8 2.7
Switz. 0.4 -1.6 1.9 3.6
Euro zone 0.2 -4.1 0.6 2.8
EU 27 0.2 -4.2 0.7 2.9
Source: Eurostat; OECD.
f forecast for Q1,
* annualized basis
Monetarist economists like Alan Meltzer writing in the Wall Street journal (August 31, 2009 ‘’What Happened to the Depression ‘’)insisted as the recovery began to make its appearance that the data shows that this recession is more like that of 1973-75, rather than the great depression.
That may well turn out to be true in terms of duration and maximum unemployment rate, but not in terms of the scope of the financial collapse and subsequent panic. Also remember that is only after a massive intervention by governments around the world and the expenditure of several trillion dollars in stimulus funds and dramatically lowered interest rates for a prolonged period.(U.S. 787 billion$ plus Troubled assets relief program(TARP) 700 billion and Troubled assets loan facility(TALF) funds in the form of loans of 500 billion,UK 80 billion $,Germany 80 b $, France 60 b $. Japan 81 billion, China 586 billion) that the economy has partially recovered. Not all of the TARP and TALF funds were utilized but the initial enormous commitments were necessary to restore relative calm to the markets.
Over time much of these monies advanced as loans have been repaid with interest so that the final cost of the bailout will be much less than the headline figures initially announced. For example G.M. and many of the investment banks have repaid billions of dollars of loans with interest as of spring 2010. Critics like Joseph Stiglitz have pointed out that the repayments were smaller than they should have been given the risks that the government took on and that private market loans would have demanded and received a higher rate of return.
The degree of widespread financial panic, bank failure, scandal and Ponzi finance, and stock market collapse, the spike in oil prices, as well the pressure of the collapse in investment and consumption all have to be taken into account. All of this far exceeded the events of 1973-75, a period with which I am personally very familiar .
The fact that the recession has now technically ended is much more the consequence of the policies implemented to treat it, rather than as Meltzer argues , the self recuperative power of market forces. For it was the unregulated forces of the market that led to this mess in the first place.
It is useful to remember that the value of shares in the Dow Jones index fell by 47 % from September 1929 to November 1929.They ended the year at 65 % of their September value. They did not regain their 1929 value until the early 1950s.(Kindleberger, p.105) The S&P index fell to just 25% of its 1929 peak by 1932(Kindleberger, fig.8 p.120 )The prices of primary products fell by a third world wide. The GDP in the US fell from its 1929 high by 29 % from 1929 to 1932/33.The number of unemployed rose from 1.6 million in 1929 to 12.8 million by 1932/33.(R.A.Gordon , Business cycles,p.429) The slump in Britain and Canada was just as severe. For example, disposable income fell to 51 % of the 1929 level by 1933 in Canada. By 1933, 20 % of the work force was unemployed in Canada. (A.E.Safarian, The Canadian Economy in the Great Depression, p.86 &p75)
This time the slump in the stock market was initially even greater than in the first part of 1929. From their peak in August of 2007 until their low point in March of 2009 stocks fell from Dow 14141 to Dow 6600 a fall of about 53 %. But since the low point of last March they recovered to Dow 10800,in April 2010, a fall of about 23.6 % from their peak. Their current level as of June 28 is Dow 10,138.
So talking about the possibility of a depression along these lines is a very serious proposition and given what governments know about how to avoid these problems it is still possible but unlikely. A serious prolonged period of high unemployment is however much more likely. This is particularly so because governments the world over are still obsessed with deficit hysteria. Growth has resumed but the unemployment rate is dropping very slowly. This is often the case after a major downturn. Paul Krugman in the New York Times has been very pessimistic about the prospects for a depression, particularly since the G20 countries have rather foolishly adopted a commitment to cut deficits in half by 2013 and stabilize or reduce debt to GDP ratios by 2016.
I sympathize with Krugman’s frustration over the widespread ignorance among politicians of economic history and their apparent rush to repeat the errors of history. But given the rather open ended language of the commitment and the recognition that each country will have to deal with their own circumstances it is possible we will be lucky and deficit reduction approaching these targets will take place largely because of the resumption of growth. Nevertheless, the risk of depression is in fact strengthened by austerity policies at such a critical point in a fragile limited recovery. It is a very bad reality that the U.S.congress is now apparently opposed to further stimulus measures and that fiscal conservatives dominate governments throughout most of the G20.
Typically it takes two or more years after the end of a recession for the unemployment rate to drop substantially. Sometimes a full 4 or 5 years after the end of the recession the rate is still higher than what it was just prior to the recession. For example, in the U.S. after unemployment rose in 1990 from its low of 5.2 % it took more than five years for the rate to drop to this level again.( See the U.S. Bureau of Economic analysis historical statistics)
This past summer, 2009, the first signs of the beginning of an economic recovery made their appearance. Positive growth appeared in both the U.S. and Canadian economy in the third and fourth quarter of 2009.This means that the recession in Canada was technically 10 months long while the one in the US was 18 months in duration. The European recession appears to have begun in the 2nd quarter of 2008 and may have ended in the third quarter of 2009. Although the formal recession in terms of positive GDP growth may have ended, unemployment continued to rise in both Canada and the U.S. and in Europe. The rate for August 2009 rose to 8.7 % in Canada and to 9.7 % in the U.S. The U.S. rate then peaked at 10 % in the U.S. and has now declined to 9.7 % while the Canadian rate peaked at 8.7 % and is now 8.1 %
The rate in the fall of 2009 in France was 9.8 % , Germany 7.7 %,the U.K. 7.7 %,7.0 % in Belgium, 18.5 %in Spain, 9.2 % in Sweden, 5.7 % in Japan. )
By November 2009 the rates were 7.5 % in Germany, 10 % in France, 8.1% in Belgium, 19.4 % in Spain, 9.7 % in Greece, 8.7 % in Sweden, 13.5% in Ireland. The rate in Greece has since risen to 10.3 %.
By January 2010 the rate had worsened in a many countries and improved slightly in several ,the overall rate for the euro area in January 2010 was 9.9 % and for the European union 9.7 %. In January 2010 the rate was: Belgium 8.0%,; France 10.1 %; Germany 7.5 %; U.K. 7.8 %; Spain 18.8 %; Sweden 9.1 %; Italy 8.6 %; Ireland 13.8 %; Greece 9.7 % (Sept.2009) now Feb 2010 10.3 %;Luxembourg 5.9 %; Norway 3.3 %; Netherlands 4.2 %; Denmark 7.3 %; Japan 4.9 %; Poland 8.9 %; Czech republic 8.2 %; Slovakia 13.7 % ; Canada 8.2 %(Feb.2010) and the U.S. 9.7 %(Feb.2010)
Net job losses continued in the U.S. during the summer with August showing a net loss of over 200,000 jobs, the lowest number in many months but still a large number. In Canada in August largely because of part time employment rises there were net job gains even as the rate rose because of discouraged workers rejoining the labour force. The broader measure of unemployment that includes all marginally attached and discouraged workers and those working part-time when they would rather be working full time rose to 16.8 % in the U.S. in August up from 10.7 % in August 2008. Since the start of the recession the U.S. has lost over 7.1 million jobs. (U.S. Bureau of Labour Statistics, statistics Canada, labour force survey)
This has improved in both Canada and the U.S. with the latest data showing that in February the U.S. lost only 22,000 jobs.
At present however there are close to 15 million people unemployed in the U.S. and another 21 million unemployed in Europe.(U.S. Bureau of labour statistics; Eurostat)
The origins of quantitative easing
In September 2008 I wrote in my internet blog(Haroldchorneypoliticaleconomist.piczo.com) and in comments posted in The Wall Street Journal, the Financial Times, The New York Times and in The Globe and Mail that the crash in the financial markets and the accompanying paralysis of the financial system was grave enough to warrant drastic action. I called for large deficit spending and zero interest rates as well as central bank intervention through quantitative easing to keep the rates as low as possible. The governments and central banks did exactly that. Many economists urged what I urged on the fiscal policy front and also on the conventional monetary policy front. But very few also urged quantitative easing.
This notion of quantitative easing which is essentially temporary greater monetization of a portion of the government’ debt than is normally the case, is facilitated by the central bank purchasing treasuries directly in the money markets to prevent any crowding out from occurring. It is a policy idea that I first presented in Canada back in the 1980s and 1990s in a series of published works in edited collections, monographs and journals. As far as I know I was one of the first, if not the first economist in the modern era to advocate this policy. (Harold Chorney, The Deficit:Hysteria and the Current Crisis, Ottawa: The Canadian Centre for Policy Alternatives, 1984 reprinted with a new preface in Harold Chorney& Phillip Hansen,Toward a Humanist Political Economy.
Harold Chorney, The Economic and Political Consequences of Canadian Monetarism, paper presented to the British Association of Canadian Studies, University of Nottingham, April 12, 1991 forthcoming in On stimulus, deficits and surpluses.
Harold Chorney, The Deficit and Debt Management: an Alternative to Monetarism, Ottawa: The Canadian Centre for Policy Alternatives, 1989.
Harold Chorney, ‘’A Regional Approach to Monetary and Fiscal Policy’’ in J. McCrorie and M.Macdonald, The Constitutional Future of the Prairie and Atlantic Regions of Canada, Regina; Canadian Plains Research Centre, University of Regina, 1992.
Harold Chorney, Debts, Deficits and Full Employment in Robert Boyer and Daniel Drache, States Against Markets:The Limits of Globalization, New York& London: 1996.)
Like all good ideas it had been discussed in history before.
It is useful to know that Keynes himself approved of this approach. In March of 1930 before the Macmillan Committee in the U.K. of which Keynes was both a member and also a major witness he argued in favour of this policy as follows.
''My remedy in the event of the obstinate persistence of a slump would consist, therefore, in the purchase of securities by the Central Bank until the long term market-rate of interest has been brought down to the limiting point....(with respect to the 1930s slump) the Bank of England and the Federal Reserve Board (should) put pressure on their member banks...to reduce the rate of interest which they allow to depositors to a very low figure, say 1/2 per cent...(and) these two central institutions should pursue bank-rate policy and open market operations à outrance.''
(See Report of the Committee on Finance and Industry (Macmillan report), 1931 Vol II, p.386. cited in Benjamin Higgins,'' Keynesian Economics and Public Investment policy'' in Seymour Harris,ed. The New Economics, Keynes' Influence on theory and public policy, N.Y.:Alfred A.Knopf, 1948, p.470 note 9.See also Peter Clarke, The Keynesian revolution in the making 1924 - 1936, Oxford:the Claredon Press, 1988.pp.150ff )
Later in the General Theory developed his ideas of fiscal stimulus further and appeared to give more emphasis to fiscal policy in the context of a multiplier enhanced stimulus. But monetary policy was always part of his tool kit and it should remain part of ours.
The early 1930s Japanese finance minister Korekiyo Takahashi introduced it in Japan. There was also a foreshadowing of it in the Glass Steagall act of Feb.27, 1932. The act on an emergency basis permitted the U.S.Fed ‘’to count government securities together with eligible commercial paper as reserves against the system’s liabilities.’’
As Friedman and Schwartz point out this meant that government debt could now be counted as part of the 60 % collateral other than gold required against federal Reserve notes.(Milton Friedman& Anna Jacobson Schwartz, A Monetary History of the United States, 1857-1960 , p.191. and Charles Kindleberger, The World in Depression, 1929-1939, p.183) This then led to a very large open market purchase of government issued debt by the Fed , despite substantial internal opposition on the grounds that the action would be inflationary.
Allan Meltzer points out that in 1932 there was heated debate about the Fed buying U.S. treasuries as part of its effort to rescue the economy from the depression. Previous to this debate and the decision to actually acquire treasury debt as part of a strategy of quantitative easing the Fed largely restricted itself to the real bills doctrine about which debt instruments the Fed should acquire in conducting monetary policy.
Meltzer shows that this debate also occurred in Great Britain in the nineteenth century when there was a need for the Bank of England to purchase treasuries in the open market. (Meltzer, A History, p.37) To a certain extent the debate between the currency school and the banking school turned on these issues of which debt instruments it would be legitimate for the central bank to purchase and hold. (Meltzer, p.43)
In the twentieth century the issue of the central bank buying treasuries re-emerged during the financing of the first world war and there was a clear bias in favour of the real bills doctrine. But Meltzer points out that ‘’Most commentators point out(correctly) that it is no more inflationary for the Federal Reserve to buy the bonds directly(or in the open market) than to lend the money to the banks at below market rates so that banks can either purchase the bonds or finance the public’s purchases. The increase in the monetary base is the same. (p.87) Nevertheless, during the 1920s right up until the crash of 1929, monetary policy was dominated by a doctrine called the Riefler-Burgess doctrine which was compatible with the conservative real bills doctrine and was very restrictive in terms of what it regarded as legitimate central bank purchases.. Winfield Riefler and W. Randolph Burgess were the two banking economists who developed the doctrine and Meltzer draws upon his research with Karl Brunner in describing the significance of their work. (p.161)
It was not until the passage of the Glass Steagall act in 1932 that more flexibility was introduced which permitted the Fed to substitute government paper for commercial paper or real bills . (Meltzer, p.357) During the spring of that year the Fed acquired over 654 million dollars of government securities. The rate of purchase was over 100 million a week. But this first use of quantitative easing was a very limited experiment which ended by August of 1932.(p.358 ff) At the time there was no obvious immediate positive response in the economy and the general conservatism of central bankers, economists and business people was enough to halt the program. Once Roosevelt replaced Herbert Hoover and Mariner Eccles became the chairman of the Fed and Lauchlin Currie one of Roosevelt’s principal economic advisers other possibilities developed. Harry Hopkins also played a major role.
Initially, of course, Roosevelt had campaigned on balancing the books. But once he was in office he gradually realized how a bad a policy that would be. Under the influence of Eccles and Currie and the real circumstances of the depression he came to support deficit spending and work creation relief programs. Meltzer draws extensively on Currie’s and Eccles’ writings and speeches . He also uses a work by R. Sandilands on Currie’s life and political economy and develops a very important profile of these extraordinary people. ‘’Eccles and Currie, separately, developed the idea of countercyclical fiscal policy that later became identified with Keynes’ General theory.
Eccles like Keynes wanted not just spending but government investment to replace private investment during recessions.’’ (p.420) Just to be clear, private investment declines during a recession. Indeed that is its hallmark and that is what causes the slump.
Eccles believed that mal-distribution of income was responsible for the depression because first it promoted a speculative bubble and a productive capacity that far exceeded the effective demand that was possible given the distribution of income and wealth. He was a strong advocate of budgetary deficit spending and an accommodating monetary policy. But Meltzer points out that Eccles believed simply increasing the money supply and lowering rates would not work unless it was accompanied by major fiscal actions promoting investments through deficit finance. Meltzer traces the origins of the famous expression pushing on a string and the notion of the liquidity trap to both Eccles and one his supporters, congressman Alan Goldsborough in an exchange during Eccle’s testimony before the House committee on banking and finance in 1935.
Most critics of this policy of Keynesian stimulus and an accommodating monetary policy make dire warnings about the risk of inflation.
In fact, of course, the U.S. was experiencing exactly the opposite, deflation at the time. This was a definite change in central banking that was in fact a form of quantitative easing. In the past the fetish of the gold standard and the doctrine of real bills had dominated central bank thinking. (Real bills were notes, drafts and bills of exchange issued by banks on the basis of commercial transactions.)One would have had to go back to the civil war issuance of greenbacks, a purely fiat currency which largely financed the war to find non gold nor silver nor real bills backed currency. A number of otherwise conservative economists backed the decision of the central bank, pointing out the deflationary circumstances. Milton Friedman later complained that the Fed had not been expansionary enough.(see his discussion of the Glass –Steagall act of 1932., p.191 Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States. But given the climate of opinion it is understandable. Just as today we have ferocious opposition to quantitative easing and deficits despite the clear necessity of these policies if we are to avoid the disaster of the 1930s.
The purchase of treasury debt to forestall interest rate rises thus became a normal part of monetary policy. It was strongly exercised during the 1940s and fifties in the U.K. (See R.Sayers Modern Banking, fifth edition, Oxford: Clarendon Press, 1960, p.136 ff and his discussion of the Chancellor of the Exchequer Hugh Dalton’s drive to lower interest rates in 1946-47. See also ch.8 on Commercial Bank liquidity and lending policy. Pp.157ff)
There has been a long history of debate with respect to the central bank and its power to exert influence over the whole range of interest rates from the short term where it clearly has absolute power, to longer portions of the yield curve where its powers are more ambiguous.
Abba Lerner had discussed important aspects of central bank authority in the 1940s in his work on functional finance. In Japan the Minister of Finance had resorted to this policy of quantitative easing in the 1930s. But for the most part this critical policy innovation had been forgotten by the high point of monetarism in the 1980s and the decades which followed.
When I first discussed it in the early 1980s I was ridiculed by Bank of Canada economists and called foolish for proposing such an ” inflationary” idea. Other critics claimed it was simply social credit theory, an idea associated with the funny money movement of the 1930s and the ideas of a British engineer Major Douglas. Indeed, when Abba Lerner first wrote his classic work on functional finance , a senior Canadian Dept. of Finance official A.N.McLeod claimed that it bordered on social credit or at least would be interpreted by them as supporting their argument and would cause inflation..( Memorandum for Mr. Bryce Re:My comments on Lerner’s ‘’Functional finance’’ RG File 04747-251 Finance Central files, Ottawa, April 24, 1944 ) Even my current editor, an historian by training has claimed that it was social credit.
It is in fact neither social credit nor automatically inflationary. Rather it represents a sophisticated approach to using both monetary and fiscal policy in fighting a slump and a collapse in confidence of which Keynes himself privately approved .(See David Colander,‘’Was Keynes a Keynesian or a Lernerian,’’ Journal of Economic Literature, Dec.1984, pp1572-1575 )
I explained then and am glad to see it has now been accepted that it need not be inflationary when the threat is deflation and depression. Rather, it becomes a very useful tool to ward off deflation and prolonged depression. I was , of course, pleased to see it embraced by most if not all of the central banks and the I.M.F. during 2009. The Japanese resorted to this policy when they sought recovery from the bursting of their real estate bubble. The Fed, the Bank of England and the Bank of Japan have all resorted to it during this period of crisis. Inflation , in the sense of price increases beyond three percent, for the time being is nowhere to be seen. In the U.S. core inflation is still below 2 %.Even the ultra conservative Bank of Canada considered using it. The European Central Bank initially refused to use it but during the Greek sovereign debt crisis they relented somewhat and unfortunately belatedly.
In response to the banking and credit panic and the severe slump that followed, liquidity needed to be injected by the central banks. Interest rates needed to be cut. Large budget deficits needed to be undertaken to finance infrastructure and investments that are labour intensive in education, health care, social policy, the military and the environment. The 787 billion dollar bailout rescue package passed by the American Congress in early October, 2008 ,the Economic Emergency Stabilization Act., was intended to stimulate the economy and create employment. To a certain extent it has succeeded but its success has been limited by the failure to spend the funds expeditiously and by bureaucratic problems with its administration. Only by the end of 2010 will the majority of the monies actually be expensed. It has also been undermined by simultaneous cutbacks by state and local governments.
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