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Economics & Finance

Are we really in a recovery?

Shellie Karabell |
Europe Recovery

It’s the infamous tug-of-war between Wall Street and Main Street: stock markets are recovering nicely and bondholders are being repaid, but unemployment lines are increasing and governments are finding their coffers falling deeper into the red because of lower tax revenues. Is this really a recovery? INSEAD Knowledge put several questions on the economy to a handful of professors. Here are some of their answers…

Jean Dermine, Professor of Banking and Finance

Is it worth allowing inflation to rise if it also means unemployment declines?

Economists have shown that only unexpected inflation can have positive impact on employment. Once it is anticipated, inflation is built into wages and prices with no effect on employment. Even worse, inflation is shown to affect the poor, who cannot protect the value of their savings. So please, let us not discuss a trade-off between inflation and unemployment.

Should government policy be aimed at decreasing sovereign debt or creating jobs (thereby stimulating the economy directly) in an attempt to end the recession?

Again, this might not be a trade-off. If sovereign debt leads people to save more as they anticipate taxes in the future, an increase in deficit might have no positive impact on the economy.

Are we at risk for inflation, deflation, stagflation? Which is worse?

Risk of stagflation: unemployment and inflation driven by commodity prices. This is the worst, as experienced in the 1970s.

What would you say to Federal Reserve Chairman Ben Bernanke and/or European Central Bank (ECB) President Jean-Claude Trichet?

Let us stop this benign neglect on the value of the dollar.


Douglas Webber, Professor of Political Science

Should government policy be aimed at decreasing sovereign debt or creating jobs (thereby stimulating the economy directly) in an attempt to end the recession?

I think that, as a consequence of the failure of governments in the United States and Europe to regulate the financial sector more effectively in the wake of the global financial crisis, there remains a quite significant risk that in the not too distant future much the same thing could recur as happened in 2008-2009. Attempts to regulate appropriately have failed either because of divergences of interest between the governments of the largest economies that have prevented very much from being agreed and implemented at the international level (G20), and/or because in the US in particular the crisis unfortunately did not suffice to break the political power of the country's financial sector.


Theo Vermaelen, Professor of Finance

Why is the private sector not hiring?

I am not surprised at the failure of the so-called government stimulus programmes to create jobs or growth. When the government spends money, it has to get the money from somewhere. It either has to tax me or borrow money from me, so government spending replaces private investment and consumption. Moreover, government bureaucrats, as they are spending other people's money, don't care whether this money is spent wisely. So the solution is less government, not more. Unfortunately many have used the crisis as an attack on capitalism and free markets and this has made things worse. The Economist has an interesting recent article that claims that the most successful Western economy during the past decade is Sweden, which did exactly the opposite of everyone else: stimulate private ownership and reduce government spending, taxes and debt.

What would you say to Mr Trichet ?

Stop buying overvalued Greek bonds with taxpayers’ money. Greece should have been forced to restructure its debt a long time ago. By painting itself into a corner, the ECB is now resisting this restructuring because everyone would see on the books what the market already knows: The ECB (which is all of us) has paid dearly for an unsuccessful attempt to manipulate Greek interest rates. The argument that the Greeks have to be bailed out to save the European banks from being bailed out makes little sense. When taxpayers bail out a bank they can insist on getting an equity stake, which gives them an opportunity to recover the subsidy when the bank recovers. To wit, because of these equity stakes the US government has actually made money on bailing out banks (The Economist, 11 June 2011, page 77). If you bail out the Greek government you can't get equity kickers (unless they would throw in a few islands…)

Claudia Zeisberger, Affiliate Professor of Decision Sciences

Should government policy be aimed at decreasing sovereign debt or creating jobs (thereby stimulating the economy directly) in an attempt to end the recession?

Let’s take Japan as an example over the last 20 years, where the government tried

every trick in the book to stimulate the economy: low interest rates (zero as a matter of fact); government spending (bridges to nowhere); tremendous increase in government debt (sounds like the US?); strict immigration laws (protectionism or xenophobia). And despite all of that the result was deflation. Most economists will say deflation was a result of policy mistakes. The truth, nevertheless, can be found in demographics: declining young population, meaning no innovation, no demand for housing, loans, investments and a country with a defensive deleveraging mindset, rather than an expansionary one. This gives us a clear roadmap for other countries: India is exactly the opposite (hiring the most people in the world). You can ask yourself: where does your country stand. The answer lies in demographics.

Are we at risk for inflation, deflation, stagflation? Which is worse?

I'd like to answer your inflation question with a story from a demographic development angle, taking a long-term outlook and focus on the elephant in the room - China.

Ancient Chinese dietary wisdom councils one to Qi Fen Bao, or eat only until you are seven parts (70 percent) full. This old adage recognises that health is optimised by leaving the table before you are completely full.

The Chinese authorities may well consider relaunching this, in order to battle rapidly escalating food prices, which rose by 11.7 percent in May from the previous year. Food costs were a major contributor to the 5.5 percent May increase in consumer prices, which escalated fears that China will export inflation across Asia and potentially worldwide.

Based on population dynamics, which recognises demand as a prime determinant of inflation, and in line with previous bouts of Japanese, US and Chinese inflation cycles, food prices should soon fall of their own accord. Inflation fears are excessive, and the best policy is to let prices find their own level. Raising interest rates will not depress appetite.

China is a large and growing country. Many logically believe that an expanding population directly translates into increased demand for food, and they project this vision far into the future. This has indeed been the case for the past half century. The total caloric consumption of China quadrupled from one trillion kcal in 1961 to four trillion kcal in 2011. Malthusian overpopulation and famine fears were not without justification.

All of this is about to change. The elderly, who consume progressively less food as they age, are growing in number, while the youth demographic, who consume the most calories, is shrinking. Over the next few years, food demand should level out and then fall.

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