Saturday, September 17, 2011

After the Double Dip

Even though most industrialized economies are groaning under stagnant growth and high unemployment, elite opinion has it that the really important thing is to reduce fiscal deficits.  This is orthodoxy in the US and gospel in Europe.  Largely because of procyclical policy we are staring at a possible second dip into the Great Recession.

Among the many nasty outcomes of such a re-dip, one is sure to be a further deterioration in public debt-GDP ratios.  Everything conspires to this: tax revenues will fall, transfers to the swelling ranks of the poor and unemployed will rise, and the denominator—GDP itself—will shrink.  “Responsible fiscal policy” will be a victim of the downturn, and nothing can be done about it.

So let’s look ahead.  Suppose we end up in this second dip, and government debt undergoes a new round of expansion: what then?  If current debt-to-GDP ratios are “unsustainable”, what will the guardians of fiscal responsibility say about the even higher levels on the horizon?  Is this another sort of doom loop, a downward spiral of economic collapse and self-defeating austerity?

I don’t have a crystal ball, but a little ground-level political economy is the next best thing.  I predict that all concern about fiscal rectitude will be thrown out the window as soon as the next downturn takes hold.  A sudden consensus will emerge everywhere that governments must borrow to the hilt in order to bail out investors and set a floor under effective demand.  In fact, today’s austerian orthodoxy will vanish from public memory, as if it never existed.

After this it becomes a bit more difficult to forecast.  As with all models, the political economy model (the dominant class of wealth-holders spans the feasible political space) ends up extrapolating from the past.  It tells us that, after private portfolios are again rebalanced toward publicly issued assets in the crisis, concern will shift back to the solvency of sovereigns, and austerity will once more be on the table.  But this assumes that learning does not take place.

And it also assumes that, in the next panic, there is no force, internal to the financial elite or outside them, that ejects them from the driver’s seat.

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