Dismal ideas

Soft US jobs data for May are testing battling economic ideas. With employment and GDP growth sub-par, Keynesian and monetary stimulus theories, for instance, are losing credibility. The winner for now is Carmen Reinhart and Kenneth Rogoff’s thesis that too much debt stunts growth.

Only 69,000 jobs were created in the US economy last month, according to Friday’s report. The figures were made worse by downward revisions for March and April. The three most recent readings followed three rather better ones over the winter, but even so a six-month average of 174,000 jobs gained per month is a disappointing trend after a deep recession. Thursday’s latest estimate that first-quarter GDP grew at a 1.9 per cent annual rate was also weaker than the initial report.

Four years on from the 2008 crisis, it’s possible to start looking at the implications for economic theory. Fiscal and monetary policies in the United States — and to a large extent globally — have been as stimulative as conceivable. They have brought trillions in extra deficits and debt for Washington alone, along with four years of near-zero interest rates. Yet the continuing sluggishness of the recovery suggests that the stimulus advocated by followers of Maynard Keynes and the monetary generosity adopted by Federal Reserve Chairman Ben Bernanke don’t represent a reliable response, at least in the prevailing circumstances. Conversely, the Austrian school of thought suggesting that the heavy, misplaced investment in housing in the run-up to the crisis needs to be worked off, exerting a downward force on output for several years, is becoming more tenable — though the politics of this approach make it difficult to implement.

Of course, economic theories are at best gross simplifications of a complex reality. But they can still guide policy in helpful or counterproductive directions. This far from the crisis, evidence is mounting that further quantitative easing or other policies that flood markets with cheap money would be highly questionable.

The ideas laid out in Reinhart and Rogoff’s 2009 book, This Time is Different, are particularly eye-catching given the reality. The two economists postulated that excessive debt would cause structural damage and a lengthy period of sluggish growth and high unemployment. If that’s what happening, working down the debt — rather than encouraging more borrowing with ultra-low interest rates — should be the priority.