Scott Sumner  

Why I'm a supply and demand-sider

The euro and the Greek blackma... My Failed Gotcha...

I first got into blogging in 2009 out of frustration over Fed policy. The US obviously had a huge demand shortfall, and the Fed wasn't doing enough to address the problem. Indeed I believe the Fed caused the huge demand shortfall.

So most people think I'm a demand-side economist. (Some even equate "demand-side" with "Keynesian," which would make Milton Friedman roll over in his grave.) But like Friedman, I'm also a supply-side economist. Indeed perhaps even more so than Friedman. Much of my academic work focused on the Great Depression, and I ended up convinced that both supply and demand shocks played a big role. The negative supply shocks were caused by counterproductive policies under Hoover and FDR, notably the NIRA.

Now I find people criticizing me for not advocating that Greece leave the euro to solve its unemployment problem. In one sense that's a fair criticism, as it seems to go against my earlier views on the Great Depression, where I praised FDR for leaving the gold standard. Perhaps Greece should leave the euro. But first a few words of caution:

1. I hear people say that 25% unemployment is a disaster, which was caused by the euro. That's partly true. But back in 1994, Spain had 24% unemployment and was not using the euro. Indeed unemployment in Spain exceeded 20% for about 5 years during the 1990s. Evidently not being on the euro is not a cure-all.

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2. Proponents of devaluation like Paul Krugman often cite Argentina, where devaluation led to rapid recovery after a year of turmoil. I also cite Argentina, but only half agree with Krugman. I cite it as a cautionary case, where well-meaning but foolish neoliberal reformers adopted a fixed exchange rate, and the resulting deflation (and falling NGDP) ended up discrediting capitalism in Argentina. So yes, they got a fast recovery, but also an anti-capitalist government. Just a few years ago Krugman was still defending this government. I haven't seen him do any recent posts on Argentina, for obvious reasons. And as far as I can tell, the Syriza government has policy views that are similar to those of Latin American leftists. The head of the party even named his son after Che Guevara. So let's just say they are pretty unsavory characters to be in charge of a democratic European country.

If Sunday's referendum had provided three options:

1. Continued rule by Syriza.
2. A new government, and German monetary policy.
3. A neoliberal government and leaving the euro.

Then my choice would be easy---option three. But that option is not on the table. As it is I lean toward option two, because I'm very afraid of Greece being ruled by a party that despises capitalism. In the short run, demand shocks are the most important, but in the long run it is supply-side factors that matter most. Ten years from now, Greece's economic performance will depend on how many neoliberal reforms have been enacted, not on what they did with their exchange rate back in 2015.

Despite all that, I can see why people might disagree with me. The option of leaving the euro certainly seems tempting. But when you are both a supply and demand-sider, the choices don't look quite as easy. Obviously the Spanish government didn't believe that devaluation would solve all their problems in the 1990s, even though they could have easily done so, as they still had the peseta.

Update: Commenter dlr pointed out that Spain did devalue on several occasions during the early 1990s, and by a total of over 30%. That of course strengthens my point.

PS. I like this comment by Alberto Mingardi:

Tsipras has attempted to blackmail the creditors, by agitating the spectre of a Greek default as the Lehman Brothers of the European crisis. The European authorities have acted so far seconding their instincts: that is, muddling through. But when push came to shove, they couldn't just accept the Greek terms, because of their most likely political effects: that is, suggesting to the Portuguese and Spanish that a deal on any terms could be ultimately made, and thus voters could heedlessly vote for anti-austerity parties.
If the EC gives in to Syriza, and gives them far better terms then they were willing to offer mainstream parties, then why wouldn't voters in other European countries also elect radical leftist parties?

Comments and Sharing


COMMENTS (17 to date)
Greg G writes:

Great post Scott. I have always been amazed at how many people think we have to choose whether it is demand or supply that is more important before you even get to the specifics. You can drive off the road on either side.

Tim Worstall writes:

" But back in 1994, Spain had 24% unemployment and was not using the euro."

True, but it was part of the Exchange Rate Mechanism and pegged to the DMark.

The euro isn't the first or only attempt to get countries to fix their rates.

Jose Romeu Robazzi writes:

Prof. Sumner,

Congratulations on this excellent post. Puting "tags" on people really does not help, and besides nothing is black and white anyway.

But this Greek crisis got me thinking: is it impossible to ease monetary conditions for the private sector of a country whose government is bankrupt and that does not control the accounting unit ? Is it really impossible to disentangle the "accounting unit" functon of money from its "means of payment" function ?

Putting in specific terms: is it really impossible to try to boost AD in Greece without leaving the Euro ? If the government is broke, can't we find a way to buy private assets and provide means of payment to the private sector ?

dlr writes:

Excellent post, though I disagree with the main thrust I think you make some fair points. I'm least excited about this argument: Obviously the Spanish government didn't believe that devaluation would solve all their problems in the 1990s, even though they could have easily done so, as they still had the peseta.

I mean...

(1) Have you now started applying EMH to central banker policy? Of all people, I wouldn't imagine you presuming a random CB's monetary policy as optimal.

(2) I don't understand what you're saying in the first place since Spain actually devalued the Peseta multiple times in the early 90s against the DM culminating in March of 95 and the net devaluation was something like 30-40% and unemployment did decline despite a still famously imperfect supply side.

TallDave writes:

Open the laboratories of democracy in Europe. Let Syriza control the drachma, let Europeans learn another economic lesson. How long will Syriza last once inflation reaches double digits?

Kevin Erdmann writes:

Maybe the worst legacy of the crisis will be that, since the worst Fed decisions came in the month after the Lehman failure, a lack of intervention in Lehman will be considered the cause.

Mr. Econotarian writes:

The real problem with Greece is that it is ranked last in economic freedom and highest in corruption in the Eurozone.

There is evidence that Greek labor costs have now re-adjusted down, perhaps it was a painful to pull those sticky wages to where they needed to be, but that seems mostly over.

If that is true, the only monetary benefit from de-Euroizing would be ability of the government to spend devalued money.

What Greece needs is radical pro-market, de-regulatory reforms. Which would increase growth, and thus solve their fiscal problems as well.

Scott Sumner writes:

Thanks Greg.

Tim, True, but as I said they were free to devalue at any time. My only point is that some people seem to be suggesting this sort of disaster could only occur with the euro. Actually it also happened before the euro. The high unemployment is Europe is partly demand side, but it's far from being all demand side.

Update, see dlr below:

Jose, At this point I think their only solutions are lower wages and/or higher productivity (i.e deregulation.)

dlr, Oops, I forget that they did that. Fortunately that strengthens my argument, and pretty much eliminates Tim's argument.

Talldave, My fear is that Syriza will do a lot of damage.

Kevin, Good point.

Mr Econotarian:

All good points. You said:

"The real problem with Greece is that it is ranked last in economic freedom and highest in corruption in the Eurozone."

Even worse, they ranked last among all developed countries, anywhere in the world.

Andrew Wallen writes:

Greece's political elite appear to have exploited the EMU as a reputational commons (using the better monetary reputation to leverage a fiscal expansion). Prior to convergence, Greece showed a strong effort toward meeting the Maastricht Treaty criteria with their deficit consistently falling. They did not meet the standards, but made progress. Post convergence, the deficits become steadily worse. Some of this may be attributed to unanticipated GDP decreases, but not all.

James in london writes:

When I was a young pre-internet Austrian it always seemed to me that Friedman was a Keynesian insofar as he championed demand-management. Monetarism vs Keynesianism always seemed a bit of a dubious dispute.

However, self-confessed Keynesians always seem anti-neoliberals first and macroeconomists second.

It has always seemed to me that Keynes himself was quite a chameleon. Perhaps a demand and then a supply-sider.

Anon writes:

Is there any scientific literature on which way the corruption - economic freedom causality runs? E.g. does corruption lead to lack of economic freedom or vice versa?

I'm sure it's far more complicated than a simple A -> B, but just curious to see if there's been any work done around that.

Andrew Wallen writes:

Anon, As an anecdotal response to your question, I spent a year in Afghanistan. Corruption and degree of economic freedom were not necessarily distinct from one another. They were endemic to the institutional structures, particularly the institutions North called informal constraints ("sanctions, taboos, customs, traditions, codes of conduct"). Institutional structures favored the political elite (corruptly) and as a matter of course, restricted economic freedom. Just one example ... could be an anomaly.

maynardGkeynes writes:

Forgive me if you've all heard this, but I love the (probably apocryphal) story Che told about how he got his job as finance minister. At drowsy, late night meeting of the Cuban leadership in late 1959, Fidel Castro looked around the room and asked, "which of you is a good economist.” According to Che, "I thought he said 'which of you is a good communist,' so I raised my hand."
"Good," said Fidel, "you're in charge of the economy."

Anand writes:

I don't see how dlr's point strengthens your argument. From the graph I see that after 1995, when it devauled, Spain's unemployment rate fell steadily. When it was pegged to the DMark, the rate was very high. That was Tim's argument, as I understood it.

Anand writes:

Ok, situation is a bit more complex. There were lots of devaluations staring about 1992. Peseta fell like a stone against the Mark until March 1995, recovered a bit in 1996 (is this "overshooting"?) and then stayed flat.

I am confused about cause and effect by the above, and also not sure what else was going on in Spain's economy at that time.

CJPDevon writes:

As an economist myself, I will forbear from commenting on that component of the Greek situation. As exemplified by the other comments, it's complicated...

The larger political context is perhaps relevant to how the Greek population has reacted. There are 28 countries in the EU, 19 in the Euro, about 600 members of the European Parliament, and God (perhaps) knows how many Eurocrats.

When things go seriously wrong, Mrs Merkel meets Mr Hollande to decide what to do... The Greek population might wonder who is running their country, and for whose benefit -- and vote accordingly.

European countries differ widely in their attitudes to government, taxes, rule of law, etc. it is not a matter of "better" or "worse", just different. And some countries need different conditions and degrees of flexibility to accommodate their particular histories and mores. There is a very interesting piece in yesterday's Daily Telegraph by William Hague, summarising a talk he gave to EU leaders many years ago on the likely outcome of the euro project. No degree in economics needed to understand...

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