A Depression, After All!

It’s taken central bankers four years, but they have finally conceded that the western economy is locked into a depression, not a recession. What they have yet to admit is that their policies will protract the crisis. The rest of us need to prepare for a drawn-out trauma with no end in sight.

Ben Bernanke, Chairman of the US Federal Reserve, has formally pronounced the level of unemployment (over 9%) a “national crisis”. But he and the Obama administration have not the slightest clue about what to do to jump-start the American economy back on to a growth path.

The same policy shambles exists in the UK. Sir Mervyn King, Governor of the Bank of England, formally admits that Britain – and the world – is locked into the worst financial crisis ever. But all he can do is throw more fuel on the fire. The money-printing strategy buys time (at best); but will allow the economy to get further out of control as consumers and investors realise that the nation is politically rudderless.

Confirmation of the poverty of economic policy came with the announcement of this year’s Nobel prize winners in economics. Christopher Sims and Thomas Sergeant are professors at Princeton and New York universities. Their work was in the field of rational expectations. They demonstrated that people are rational in their behaviour. Is that really worth a prize of almost $1m – to demonstrate that people behave rationally when they spend their money?

Dancing with Shadows

The damage which this pair has caused – by default – is measured by the rate of unemployment in the western economy today. Their empirical work reinforced the prejudices of the ideologues who constructed the gambling models that fired up the financial speculators on Wall Street and the City of London. The theory of markets which was constructed on the notion of rational expectations legitimised the behaviour that drove millions of people into debts they could not repay. Low-income families that should not have bought houses lost their meagre savings through the foreclosures that followed the collapse of the sub-prime mortgage market.

Academics, and the consultants who advise politicians, continue to shadow box their way through the depression. They catalogue the symptoms of the crisis, but they are incapable of tracking the problems back to their source. Consequently, they are not prescribing reforms that could restart growth and prevent the next boom/bust.

I spelt out the grounds for fearing the onset of a depression back in 2005 in Boom Bust: House Prices, Banking and the Depression of 2010. In that, I explained how governments could forestall the depression by redesigning the tax system. They took no notice. Furthermore, they remain immune to proposals for financial reforms that would create the incentives to hire people and leave more money in their pockets.

The outlook is grim. But nothing is to be gained by deceiving people into thinking that the future is anything but a deeper disaster in the making.

* For a more detailed critique of Thomas Sargent, read John Kay, “The Random Shock that Clinched a Brave Nobel Prize”, Financial Times, 19 October 2011

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