di Giacomo Saibene
On 26 June 2011 the Bank for International Settlement, the world’s oldest international financial organization based in Basel, Switzerland, published it 81st Annual Report. Amidst the authorities’ concerns regarding the Greek debt crisis, the prospects of failure to raise the U.S. debt limit on the 2nd of August, and the nomination of a new IMF managing director, the BIS report provides the following major insights, which regard fiscal and monetary policy in particular and can be summarized through the following sentences:
“…While investor distrust forced European politicians to act repeatedly over the past year, fiscal imbalances in other countries, including the United States, the United Kingdom and Japan, had little market impact. Nonetheless, recognising the risks associated with waiting, the UK government that took office in May 2010 announced a range of austerity measures. Rating agencies provided further confirmation of the fiscal dangers facing major advanced sovereigns…”
“…Fiscal authorities need to act quickly and decisively before disaster strikes again… and must take swift and credible action to bring debt levels down to sustainable levels. This requires taking short-term measures to reduce deficits in the aftermath of a costly recession while addressing longer-term challenges arising from structural imbalances…”
“…Central bankers have their work cut out for them as well. They confront distortions exacerbated by years of extraordinarily accommodative monetary conditions. Prime among the challenges is the increasing risk to price stability. Output gaps are closing, commodity prices have been surging, and inflation is rising around the globe. The dangers are most acute in emerging market economies, but they also extend to the core advanced economies…”
“…Controlling inflation in the long term will require policy tightening. And with short-term inflation up, that means a quicker normalisation of policy rates…”
Obviously, what the BIS is asking for is a tighter fiscal policy, so as to reduce government deficits and reach fiscal consolidation, accompanied by a tighter monetary policy, so as to reduce inflation risks and to return to a ‘normal’ monetary policy. However, what about unemployment? Aren’t those tightening measures a threat to any employment recovery? Isn’t still the output gap – the difference between potential and actual output – very large? This is what the report says about it:
“…The economic losses produced by the Great Recession, such as the destruction of human capital due to long-term unemployment, may weigh on growth for years to come. Second, growth in the years before the crisis was boosted by a series of unsustainable imbalances whose correction may reduce growth until the excesses have been reabsorbed…”
“…Today, with hindsight, it is clear that conventional measures of economic slack at that time were grossly overestimated. The rise in the unemployment rate was due in large part to structural changes in labour markets. The slowdown in economic activity was mistakenly attributed mainly to insufficient demand rather than to a substantial slowing of potential output growth. In other words, the estimated output gap was thought to be quite large and persistent, whereas in reality it was not…”
In others words, there is no output gap, or at least it is largely overestimated, while unemployment is a structural problem that cannot be addressed by the standard policy solutions. Thus, unemployed must remain unemployed.
Krugman already criticized the logic behind this BIS report, in his celebrated blog. However, I would like just to recall what none else than John M. Keynes had already said in 1929. The focus is to highlight that the poor state of the current debate, which is entirely committed to every problem but unemployment, has an important historical comparison. In fact, already eighty years ago a high unemployment rate was accepted by conventional wisdom as ‘normal’ and unnecessary to resolve. But let the words of Keynes vividly rejects this idea, making the point about the key problem of unemployment, which must not be taken out of the current debate, as unfortunately it is seeming to happen:
“…Except for a brief recovery in 1924 before the return to the gold standard, one-tenth or more of the working population of this country [England] have been unemployed for eight years – a fact unprecedented in our history. The number of insured persons counted by the Ministry of Labour as out of work has never been less than one million since the initiation of their statistics in 1923. To-day (April 1929) 1,140,000 work-people are unemployed… Since 1921 we have paid out to the unemployed in cash a sum of about £500,000,000 – and have got literally nothing for it. This sum would have built a million houses; it is nearly double the whole of the accumulated savings of the Post Office Savings Bank; it would build a third of all the roads in the country; it far exceeds the total value of all the mines, of every description, which we possess; it would be enough to revolutionise the industrial equipment of the country; or to proceed from what is heavy to what is lighter, it would provide every third family in the country with a motor car or would furnish a fund enough to allow the whole population to attend cinemas for nothing to the end of time. But this is not nearly all the waste. There is the far greater loss to the unemployed themselves, represented by the difference between the dole and a full working and by the wage, loss of strength and morale. There is the incalculable toss of retarding for a decade the economic progress of the whole country…”
“…The Census of Production of 1924 calculated that the average value of the net annual output of a British workingman when employed is about £120. On this basis the waste through unemployment since 1921 has mounted up to approximately £2,000,000,000, a sum which would be nearly sufficient to build all the railways in the country twice over. It would pay off our debt to America twice over. It is more than the total sum that the Allies are asking from Germany for Reparations. It is important to know and appreciate these figures because they put the possible cost of Mr Lloyd George’s schemes into its true perspective. He calculates that a development programme of £100,000,000 a year will bring back 500,000 men into employment. This expenditure is not large in proportion to waste and loss accruing year by year through unemployment, as can be seen comparing it with the figures quoted above. It only represents 5 per cent of the loss already accumulated on account of unemployment since 1921. It is equal to about 2ó per cent of the national income. If the experiment were to be continued at the rate of £100,000,000 per annum for three years, and if the whole of it were to be entirely wasted, the annual interest payable on it hereafter would increase the Budget by less than 2 per cent. In short, it is a very modest programme. The idea that it represents a desperate risk to cure a moderate evil is the reverse of the truth. It is a negligible risk to cure a monstrous anomaly…”
“…The objection, which is raised more frequently, perhaps, than any other, is that money raised by the State for financing productive schemes must diminish pro tanto the supply of capital available for ordinary industry. If this is true, a policy of national development will not really increase employment. It will merely substitute employment on State schemes for ordinary employment. Either that, or (so the argument often runs) it must mean Inflation. There is, therefore, little or nothing that the Government can usefully do. The case is hopeless, and we must just drift along… …In relation to the actual facts of to-day, this argument is, we believe, quite without foundation… But the argument is not only unplausible. It is also untrue…”
“…But not all credit-creation means Inflation. Inflation only results when we endeavour, as we did in the war and afterwards, to expand our activities still further after everyone is already employed and our savings are being used up to the hilt. The suggestion that a policy of capital expenditure, if it does not take capital away from ordinary industry, will spell Inflation, would be true enough if we were dealing with boom conditions. And it would become true if the policy of capital expenditure were pushed unduly far, so that the demand for savings began to exceed the supply. But we are far, indeed, from such a position at the present time. A large amount of deflationary slack has first to be taken up before there can be the smallest danger of a development policy leading to Inflation. To bring up the bogy of Inflation as an objection to capital expenditure at the present time is like warning a patient who is wasting away from emancipation of the dangers of excessive corpulence…”
“…The whole of the labour of the unemployed is available to increase the national wealth. It is crazy to believe that we shall ruin ourselves financially by trying to find means for using it and that ‘Safety First’ lies in continuing to maintain men in idleness…”
Clearly, Keynes intensely highlights that the real problem is unemployment, since it is a total waste of precious resources for the Society as a whole. The arguments opposed to any tentative to recover from deep unemployment had been already recognized in 1929 as unplausible and untrue, besides being destructive for the country. Probably, this is happening again in 2011, after the harsh experience of the Great Recession of 2007/09: almost nothing is being done to restore employment, all over the world, or at least it is commonly believed to have done everything as possible.
In the last few weeks, financial markets all over the world severely plunged, vanishing all the gains built up since September 2010, as shown in figure 1 below. Many concerns were raised about the downgrading of the U.S. government debt by S&P, which occurred on Friday 5th of August 2011, as a possible explanation of this plunge. However, contrasting this view, the U.S. Treasury’s yields are plunging too, a sign that investors are buying Treasuries more than ever (figure 2), not flying away from them. This reaction is exactly what one would expect when the growth’s prospects of the economy are falling.
Figure 1. The stock market. S&P500, NASDAQ, and DOW index. 16 Aug 2010–10 Aug 2011.
Source: Yahoo Finance.
Figure 2. U.S. 10-years Treasury Yield, percentage points, Sept 2009 – August 2011.
Source: Yahoo Finance.
So what? Maybe it is economic growth that really frightens markets, and not the deficits or the debts. In other words, it is the prospect of a recovery turning into a second Great Depression, with the unemployment rate remaining unsustainably high, see figures 3 and 4. Accordingly, the Federal Reserve, in the meeting of August the 9th 2011, decided to maintain the its policy of zero interest rates until mid-2013, since “economic growth so far this year has been considerably slower than the Committee had expected” and “the Committee now expects a somewhat slower pace of recovery over coming quarters than it did at the time of the previous meeting”.
Figure 3. Employment-Population Ratio, seasonally adjusted, percent, 1995-2011.
Figure 4. Unemployment rate, seasonally adjusted, percent, 1995-2011.
In the U.S. the overall median personal income for all individuals over the age of 18 was $25,149 in the year 2005. Thus, the loss deriving from unemployment can be grossly – and very prudently – estimated by assuming to reduce the current unemployment rate, 9.1% as of in May 2011 to a hypothetical unemployment rate of 5%, as of in September 2005. The net result is a loss of approximately 6 millions wages, amounting to 150 billions of U.S. dollar, or 1% of U.S. GDP yearly. Policy actors must now seriously face this problem, directly; otherwise we will remember this decade as another lost decade, the return of the Great Depression.