Wednesday, January 7, 2009

Macro Simplicity

Martin Wolf is able to encapsulate the basic macro dilemma in the space of just one FT column.

Given the persistent structural current account deficit, how large does the fiscal deficit need to be to balance the economy at something close to full employment? Assuming, for the moment, that the private sector runs a financial surplus of 6 per cent of GDP and the structural current account deficit is 4 per cent of GDP, the fiscal deficit must be 10 per cent of GDP, indefinitely.

And to get to this point the fiscal boost must be huge. A discretionary boost of $760bn (€570bn, £520bn) or 5.3 per cent of GDP is not enough. The authors argue that "even with the application of almost unbelievably large fiscal stimuli, output will not increase enough to prevent unemployment from continuing to rise through the next two years".

Now think what will happen if, after two or more years of monstrous fiscal deficits, the US is still mired in unemployment and slow growth. People will ask why the country is exporting so much of its demand to sustain jobs abroad. They will want their demand back. The last time this sort of thing happened – in the 1930s – the outcome was a devastating round of beggar-my-neighbour devaluations, plus protectionism. Can we be confident we can avoid such dangers? On the contrary, the danger is extreme. Once the integration of the world economy starts to reverse and unemployment soars, the demons of our past – above all, nationalism – will return. Achievements of decades may collapse almost overnight.

I suppose this is because, for all the complexity, the basic macro forces that are moving the world these days are remarkably simple.  In fact, they are the same ones you could have heard Warren Buffett explaining all the way back in 2003.  Little has changed in the interim, unless way more of the same is considered a change.  We are still consuming more than we produce, and the Chinese are still producing more than they consume.  The fundamental question remains how long this can go on.  Or rather, the question is how, and how quickly, we can back down from the disequilibirum. 

By the way, the paper cited in Wolf's column is worth reading, but you should sit down beforehand.

No comments: