Recession may be Hayekian:

Everyone is upbeat about the revival of the economies the world over. India post-general election 2009 is feeling better with its stock markets almost on the verge of a bull rally if not a bull market. Ben Bernanke, the Federal Reserve Chairman whose term has been extended for another 4 years by President Obama last week, sees the “green shoots”. Japan posted a slight growth in its GDP numbers. France and Germany are officially out of recession with modest growth.

This is all the good news. But the underlying question is: is this growth sustainable? Nouriel Roubini, Economics Professor, Stern school of business, New York, who predicted the collapse feels that this could be a W-shaped curve. He says that the growth is due to the massive fiscal stimulus and the loose monetary polices by governments and central banks respectively, the world over. It isn’t based on fundamentals of the economies. Thus he feels that when the stimulus is reduced and the tightening of monetary policies is done, it should result in a recession again. This growth is catalyzed by fertilizer and performance enhancing drugs i.e. low interest rates and the slush liquidity with quantitative easing. In short, all actions are being taken with the recession being thought of as one which has a solution in Keynesian policies.

But is this a Keynesian recession? Political parties and businessmen the world over like it to be Keynesian since it can immediately be stimulated and the political bosses are in the executioners’ position. This recession though seems like a Hayekian one where there is wide misallocation of resources.

Hayekian recession is of the type when there is gross misalignment of resources i.e. structural changes in the economy and they take more time to recover. A fundamental issue is affected and merely pumping in money will not change the situation.

The current recession, as mentioned earlier, seems to be a structural one. Cheap money from Asian and OPEC countries entered US. These countries tried to keep their currency under-valued to gain cost-advantage. China has kept its Renminbi and Yuan low and has most of its foreign reserves in US treasuries. This money sent long –term interest rates in the US tumbling. Thus people bought houses and invested in stocks, commodities resulting in a bubble in assets, stocks and commodities. It was exaggerated by financial innovation but based on unsound economic fundamentals. The Keynesian stimulus being used is re-fuelling those bubbles again due to slush liquidity. This could also result in inflation rearing this ugly head if timely withdrawal of the stimulus is not done. Political will, will stop the withdrawal but the central bankers have to do it, for long term good.

The resulting collapse now is Hayekian which will take more time to recover. The US will need to save more and the rest of the world needs to spend more. The early this happens, the early the imbalance will be restored for sustainable growth.