Thursday, December 20, 2012

Financial recovery and recovery in the "real" economuy

Yanis Varoufakis describes the experience of the eurozone with austerity policies, in the context of describing why the non-financial sector may not recover as fast as the financial sector (Will the real economy rebound, following Wall Street’s resuscitation? And what of Europe? – Interviewed by El Confidencial 12/20/2012):

Rapid, unregulated growth is usually built on the back of a financial sector bubble; also known as irrational exuberance. Credit expands fast, increasingly risky bets are placed and a portion of this is channelled into productive investments in industry (the real economy, as you put it). Then the bubble bursts, liquidity disappears and the real economy entered a vicious cycle, of having to pay back unsustainable debts through austerity that causes investment to plummet, debt-to-income ratios to remain prohibitively high and, alas, growth to turn increasingly negative. In this sense, the answer to your question is bleak: No, there is no guarantee that industry will grow faster than the financial sector now. In fact, quite the opposite: Since governments and central banks are financing the banks, to refloat them, the financial sector is in the process to recovering, and growing again, while at the same time the real economy is continuing to shrink. Especially in the Periphery of the Eurozone where the impossibility of devaluation, coupled with the disproportionate burden of adjustment falling on the deficit countries, guarantees a depression. This is precisely what is meant by the trap of negative growth and high debt. It is a phenomenon that we first encountered in the 1930s, from which Europe seems to have learned almost nothing.
It really is sobering to see the extent to which policymakers in both Europe and the US have ignored the practical lessons of the Great Depression in the current extended crisis.

This reminds me, "depression" doesn't have the same kind of precise technical definition that "recession" does. I generally use the term to describe the current situation in Europe and the US, in which recovery from the recession that began in 2007 is slow, interest rates in the US are are up against the zero bound, and growth is fragile enough that a negative shock in aggregate demand could easily push economies back into recession. Varoufakis in that statement uses it more specifically for the conditions eurozone "periphery" countries like Cyprus, Greece, Ireland, Italy, Portugal and Spain are facing.

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