The most important economics related story of 2012 (only a
slight exaggeration) – Krugmenistan vs. Estonia (BusinessWeek article):
-----
My Comments on the article:
It is wonderful to see excellent, well-argued ripostes being made by little known economists from a country (Estonia) that few
Americans have heard about.
Far too often, it is assumed that nearly all the important
progress in the field of Economics originates in the US and that the rest of the
world has little to contribute. The recent crisis has taught us of the dangers arising from groupthink (in academia and on Wall Street).
For instance, many pay undue attention to the policy related ramblings of Paul Krugman, despite the fact that he is NOT a career macroeconomist (he is an (Nobel Prize winning) international trade economist). Krugman, utilizing the wide reach of the NYTIMES, often makes highly simplistic and narrow-minded arguments regarding critical macro issues which negatively affect real world policy debate.
The article, Krugmenistan vs. Estonia, is probably best feature story BusinessWeek has done
in ages.
First key point from the article –
The article notes:
“In his blog post,
Krugman started his graph—and his logic—when Estonia’s GDP had reached its
peak, in 2007. Wages were high, and unemployment was low. Good for most
citizens, and for most citizens now things are still worse than they were then.
But if you move Krugman’s graph all the way back to 2000, you see slow, steady
growth in GDP, then a short boom, then a hard crash, and now growth leveling
back off to where it would have been without the boom. In the boom years, says
Varblane, “GDP growth was not real. It was artificial,” fueled by cheap debt
from abroad. The peak, Krugman’s point of comparison, was not “real,” he says.”
Relevance to America: The US GDP for several years prior to
the Great Recession was artificially inflated by real estate and equity market
bubbles and debt fueled consumption. To repeatedly call for massive fiscal and monetary stimulus to get back
to 2007 levels of unemployment rate as quickly as possible seems utterly misguided. Years of
structural changes are needed to get the American economy on a new sustained
growth path and just throwing more money won’t fix the problem (that was nearly
three decades in the making).
The second key point from the article –
“Large countries have
the luxury of a discretionary currency policy. Small countries have a credibility
problem no matter what they do.”
Relevance: Decades ago, Ronald McKinnon (1963, “Optimal
Currency Areas”, AER Vol 53 (1)), showed the limited significance of nominal
exchange rate devaluations for small open economies attempting to restore competitiveness.