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It is a Wicksell-Hayek recession.

India, Oct. 12 -- My own view has been for some time that the recession was not a Keynesian one; i.e., it did not arise from lack of effective demand. It is a Wicksell-Hayek recession where overexpansion of credit, caused by excessively low interest rates leads to mal-investments. It is the banking system that becomes the problem as it ceases to function. This theory was popular before Keynes wrote his General Theory. After Keynes's triumph, economists forgot about banking and credit cycles and modelled every crisis as a result of lack of effective demand to be cured by fiscal action. Macroeconomics became an income-expenditure story with output playing a passive part and finance totally absent. Recovery was assured by fiscal action almost automatically.

But a Wicksell-Hayek recession is not amenable to fiscal reflation. Indeed, Hayek took the extreme point of view that it would make things worse by distorting prices further. There is some point to what he says. Despite nearly zero interest rate, there is little investment. Consumers are not spending the money they get but are saving it. After all, they entered the crisis with a high level of debt. Such credit as is being taken up goes into corporate deleveraging. We have already seen this in the Japanese recovery from its banking crisis. The recovery is long, slow and tepid.

And Desai says we see similar situation now:

There is reason to believe that this may be the case again. There are longer-run forces impinging at the same time. One is the loss of competitiveness of the western economies relative to the so-called emerging economies. This is along run shift, which Keynesian policies are unable to correct. The exchange rate wars are partly a form of tariff war to allow the older industrial countries to withstand the competition of the newer ones, especially China. But the reason for the loss of competitiveness is also in the economic theory underlying. Neoclassical as well as Keynesian economics makes no distinction between value and price. Sub-prime housing is just as valuable as widgets if the stock market says so. Classical economics made a distinction between the two and took the value of the product-its cost of reproduction-as the measure of wealth. Sub-prime housing does not become wealth because there is a house price bubble nor does it become valueless when the bubble bursts. It remains whatever the cost of building a house is.

Through the long expansion, western economies invested in activities by looking at the market bubble. Now they have few productive investments that can allow them to compete. In Keynesian economics, it does not make a difference if you dig ditches and fill them up again as long as wages are paid and spent on consumption goods. But at the end of the day, you have not added to the wealth of the economy.

Well it is great to keep getting different views and ideas from so many economists. Most are plucking events/theories from history and drawing parallels with current story. All this is very insightful and helps one take key lessons from history. However, in doing this few show as the theory/event is distinct but actually is all interlinked.

Take Lord Desai's idea of Wicksell-Hayek theory of recession. Minsky's version of crisis also says the same thing (unless I have got it all completely wrong). He said the same thing that increasing confidence in finance soon turns into a Ponzi scheme where the game continues till it lasts. And it lasts pretty badly as people are leveraged etc. Then this idea of importance of finance was brought by Bernanke in his research on Great Depression and Financial Accelerator. Even Keynes was fully aware of the importance of financial crisis leading to recession.

Whatever theory/idea you take, economic history is surely a great research area.

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Publication:Blogs/Bloggers
Geographic Code:9INDI
Date:Oct 12, 2010
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