Column: Are we back to the past?

Oct 28 2013, 03:21 IST
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SummaryMonetary policy that the Keynesians had written off has been rampant in the US, the UK and Japan

With the centenary of the First World War approaching, there are peculiar things happening to the global economy which echo the past. For one thing, we are in the fifth year of recession, something which was not supposed to happen after the advent of Keynesian economics. Yet, no country has relented and reflated with an aggressive fiscal policy. Monetary policy which the Keynesians had written off (You cant push on a string as the cliche went) has been rampant in the US and the UK and Japan. Only the ECB has been prevented legally from an outright QE operation.

The surprise though is that everywhere in the developed economies, there are signs of revival. The US recovery has been around for a while though the Fed still does not feel confident enough that it can start tapering. It has fixed a single target figure for unemployment which it is waiting to be reached before tapering. Unemployment figures are notoriously countercyclical and tend to stay stubbornly up just as the economy is reviving due to workers previously out of the labour force coming back in and re-registering as seeking work. This is the opposite of the discouraged worker effect. The signal is thus somewhat like the thermostat in your shower and may lead you to delay action for too long and then overdo the reaction. This is why a single target number is the worst signal to give to the markets but let that be.

The surprise is that, thanks to its dysfunctional legislative system, there is an enforced budget cut happeningsequestration as it is called. Despite this slight fiscal tightening, the US economy is recovering with growth in the range of 2-3%. This is below the historical path of 1992-2007 but then that growth rate proved unsustainable without excessive borrowing. So, one would expect the US economy to converge to a growth path at a lower secular rate than before.

The UK economy seems to have finally turned the corner in the third quarter of 2013. The UK has adopted a tight fiscal path which aims to eliminate the budget deficit in five to seven years. This was an explicit anti-Keynesian strategy. The UK Chancellor of the Exchequer George Osborne was much criticised by the IMF and many Keynesians. There were dire predictions of a double-dip recession. Despite all that, the economy has turned around and is set to go one growing at

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