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Let The Battle Begin . . . as usual

While there are many schools of thought on economics, we have, for convenience, concentrated on the Big Three.  First, there is the Austrian school, which advocates a balanced budget at all times.  It is often called the “tough love” school.  Then, there is the Keynesian school, which advocates deficit spending when the economy has slack and budget surpluses when the economy is doing well.  It is often called the “sin now, repent later” school.  Lastly, there is the Supply-side school, which advocates tax cuts to stimulate growth.  They are often ridiculed for advocating a tax cut to cure the common cold.  Supply-side economics is U.S. based and largely ignored outside the U.S.

Europe is now having a heated debate between Austrians and Keynesians — between austerity and stimulus.  As the European crisis worsened, the Austrian economists have prevailed in pushing austerity.  However, Keynesian economists are staging their own “surge”.  The leader of the International Monetary Fund has urged European leaders to back off austerity and begin stimulating the economy — by increased deficit spending.  The battle has been joined.

There are many protests against austerity all over Europe.  After all, nobody wants to work another year before retirement or for Grandma to take a 1% retirement cut.  Voters don’t like austerity, and the bad news for  European politicians is that . . . voters vote!  The politicians will be pushed toward the Keynesian school.

The European financial crisis is off the front page today, but the parliament of Cyprus has just decided to vote on the Troika package, which it will probably reject, putting Cyprus back on the front page.  The Cypriots may pull Lord John Maynard Keynes out of his grave to lead them.

Part of the intellectual basis for pushing austerity has been the highly-regarded 2009 book by Carmen Reinhart and Ken Rogoff called This Time is Different:  Eight Centuries of Financial Folly.  They concluded that a nation is condemned to slow growth once the debt-to-GDP ratio reached 90%.  (The U.S. is now at 100%.)  However, there is recent scholarly criticism of their research, including mathematical errors.  While I cannot speak to that criticism, I can see it powering the new “surge” by the Keynesians in Europe.

It is an unexplained oddity that the stock market has swooned during the Spring for the last three years, each time due to some European misstep.  Can we expect the same this Spring?  Why wouldn’t we?