Recession: Keynesian or Hayekian

In the Times of India I hear is all about “infotainment”, with more information less entertainment in economic times. So as far ET columnists go hardly can one hold them the standards of an academic debate, loose ends are quite natural. But what about sheer inconsistency, or gross error?

Swami ET article today is titled “Beware: Recession maybe Hayekian”. My faint smile on reading the title  soon disappeared when I read this

“The current recession looks more Hayekian than Keynesian. A Keynesian recession represents a sudden fall in demand, and can be remedied within six months by pumping enough purchasing power into the economy. A Hayekian recession, however, is caused by misallocation of resources over a long period, driven by unrealistic interest rates, ending in a bust that requires years of structural adjustment. Such a recession can last a decade (as in Japan in the 1990s)”.

Swami goes on to argue that many a crises have been Keynesian and successfully solved by government spending. My contention here is not that Keynesians are wrong, that point I have already made. But that one cannot argue that some recessions are Keynesian others Hayekian!

The Hayekian method involves a complete reject of the aggregate demand and supply framework. Hayek rejects and warns us against the very idea of “capital” as a homogenous commodity at the very beginning of “Pure Theory of Capital”, turning our attention to the structure of capital in a system of production.

Moreover Swami makes no mention of why there might be a fall in aggregate demand in the first place to cause a Keynesian recession. And since we are talking about a Keynesian syndrome, the cause must be independent of central bank policies. For people like Krugman, Stiglitz the cause may lie in “animal spirits”, which is consistent with their political philosophy. But what about Swamy who won the Bastiat Prize.

Also note that though he says this recession is Hayekian, there is no mention of “central banking”, “centrally determined price of capital”, etcetera.

Infotainment is all good, but an article with absolutely no academic grounding is a real pity. And I am not entirely sure whether such writing does Austrian economics and libertarian politics any good. Your call.

Also read my earlier critique of a Swami ET piece here.

And another incorrect portrayal of Hayek by Meghnad Desai  (he offered a Marx-Hayek solution to US crisis) here.

Existing Home Sales Yields Good News Triplet

Tuesday we reviewed a dozen areas where home prices are rising. Wednesday yielded the release of home sales data with three more significant pieces of great news.

1. Sales of previously owned homes rose for the second month in a row in May. The improvement was 2.4% better than the sales rate in April.

2. Inventories of existing homes continue to decline rapidly. Inventory levels are now below the 10 month mark for all existing homes for sale. That level is down over 15% from a year earlier. There is now only a 9 month supply of existing single family homes on the market.

3. What may be the best news in Tuesday’s home sale data is the fact that the number of distressed sales has drop precipitously. Earlier in the year close to 50% of sales were distressed. May’s data shows that level down to 33%

It is no wonder then that home prices in many cities are beginning to recover.

Wages in Banking

Early in the financial crisis, Raghuram Rajan put compensation issues into the centre of thinking about what has gone wrong. In recent weeks, in India, this dimension has come to life. P. Vaidyanathan Iyer had a story in Indian Express saying that RBI had blocked the compensation packages of the CEOs of three private banks: ING Vysya Bank, Axis Bank and Development Credit Bank. Something similar might be taking place with HDFC Bank also.

See Anita Bhoir in Mint on CEO compensation of private banks in India. In the case of Axis Bank, the compensation of the outgoing CEO (P. J. Nayak) in 2007-08 was Rs. 1.5 crore. This is a firm with a market value of Rs.25,000 crore today, which reported a net profit of Rs.1041 crore in that year. I would also reckon that of all Indian banks, Axis Bank is a cut apart in terms of the corporate governance culture, and the say that the outside board members have in the affairs of the firm.

I have an article in Financial Express today, where I say that concerns about ownership, governance and compensation are important components of the regulatory process in finance. But what is needed is a sophisticated analysis of the incentives that these three elements (in combination) induce. This requires a subtle understanding of economics and incentives. An approach of merely blocking high wages is one of giving in to the populist politics of envy. Conversely, improving compensation structures of PSUs requires not just shifting to a higher level of wages under an old-style wage formula, but a full rethink of the incentive implications of a wage formula.

See Alex Edmans and Xavier Gabaix on voxEU on designing the right mechanism for executive compensation, and we get a flavour of the kind of subtlety that RBI needs to bring into this.

Also see: statement by Timothy Geithner on compensation on 10 June, a debate between Gary Becker and Richard Posner, and a blog post by Jayanth Varma.

Join the forum discussion on this post - (2) Posts