It is unsurprising that my profession has suddenly became enamoured with studies of financial cycles. Up until the GFC mainstream macroeconomics (theories and models) mostly ignored financial markets and banking, thinking that they were largely peripheral to understanding the business cycle. The only linkage between the financial sector and the real economy that was considered was via interest rates – the impact on investment spending and the demand for loanable funds to fund investment impacting back onto interest rates. Even within this limited context, the theories developed were hopelessly deficient and incapable of explaining anything that relates to the real economy. But now – more brash than ever – my profession is busily conjuring up financial markets to fit into their Dynamic Stochastic General Equilibrium (DSGE) models, despite these models being next to useless. In March 2009, Willem Buiter said that DSGE models “excludes everything relevant to the pursuit of financial stability.” More recent research from the BIS (link below in the text) has highlighted some salient facts about the relationship between financial cycles and business cycles. What that research implies is that push for fiscal austerity is without foundation and will not only damage the real economy but will, in the process, prolong the financial downturn and prevent a resolution that could provide the springboard for sustainable growth.

I often get E-mails from readers – some hostile others more reasonable – telling me that I should stop arguing for more economic growth. The reasoning is relatively straightforward – the Earth is buckling under the rapacious resources demands of the capitalist system and not only is that process likely to be finite, notwithstanding substitution via technological advances, but also in the process of exhaustion the amenity declines. The argument juxtaposes ecological claims with other claims relating to the desirability of the current neo-liberal dominated system which relies, seemingly, on creating more inequality, a reduction in government oversight and allows the worst aspects of the capitalist system to run amok. However, somewhere along the way, the 99% or whatever percentage it is (I think it is substantially lower than 99) miss the boat. The current crisis is used to demonstrate that conjecture. I haven’t time to reply to all the E-mails and I try to provide “collective” replies (which should tell you something in itself) via my blog posts. So today I am addressing that issue. The message is simple – I am very sympathetic to localised, new economy-type collective ways of organising social and economic activities. I support egalitarianism and co-operative solutions rather than competitive, dog-eats-dog approaches. I don’t mind working and giving my surplus to aid those who are unable for whatever reason to achieve the same material outcomes by their own hand. I am happy with consolidation rather than growth. But despite the romantic appeal of all this – as the solution – we have to understand that there is still something called a monetary system and a currency to deal with. Localised solutions are still constrained by the sovereign state they are located in and their fortunes are determined in no small way by the way the currency-issuing government conducts its fiscal policy. There is no escape from that.

The head of the IMF gave an extraordinary interview to the UK Guardian (May 25, 2012) – Christine Lagarde: can the head of the IMF save the euro?. It is extraordinary because of the language used by the IMF boss and the almost shameless increase in the intensity of Troika bullying of Greece at its prepares for another round of national elections to attempt to resolve the impasse that was left after the last election. The Troika know full well that the majority of people in Greece hate austerity and support an alternative growth-oriented policy agenda. The Troika also knows that its spin that austerity means growth is not resonating with European voters who can read the newspapers and understand the blatant untruth of the fiscal contraction expansion narrative. So they are exploiting the irrational view held by the majority of Greeks that they are better off staying with the Euro. By making out that the issue is about membership of the Euro, the Troika are introducing fear into the voting process to reinforce the TINA line that austerity is the only show in town. The Greek voters will succumb to that fear because they do not appreciate that membership of the Euro is austerity under current arrangements.

The International Labour Organization (ILO) released its Global Employment Trends for Youth 2012 report today (May 22, 2012). It is harrowing reading and I will consider it later in the week. It tells us that youth unemployment is rising and will be unlikely to see any improvement until at least 2016. The ILO recommend a raft of government initiatives which would require budget deficits to expand. But, of-course, the dominant political narrative is to cut deficits in the false belief that this will engender growth. Exactly the opposite is happening and for good reason. I came across an article from 1982 today which tells us why austerity is dangerous and damaging. It also conditions us to understand that budget deficits are neither good nor bad but policy choices can be.

I have been reading about the Great Depression lately and comparing the sort of pressures that governments were placed under during that time to cut deficits which were rising on the back of a collapse in economic activity to what is going on today. There are many interesting parallels and déjà vu experiences. That research took me into some literature on the way the governments bow to industry demands as aggregate demand collapses. In turn, that led me to the way the military-industrial complex operates. Which took me into another literature on the role of the military-industrial complex in creating wars to provide markets for their goods – the merchants of death. And so it goes. That is the nature of research – it just takes one on a journey and usually to destinations previously not imagined. But this journey also clarifies some issues that readers regularly write to me about. The relationship between Modern Monetary Theory (MMT) as a macroeconomic framework and issues that issues that lie below the aggregate level – such as distributional issues. There are links clearly (for example, income distribution affects aggregate demand) but in other ways what is “good” at the macro level may well be downright disastrous at the micro level. But in dealing with the disaster at the micro level, we always have to be mindful of the way dealing with that disaster impacts on the aggregates. This is particularly important in considering issues relating to trade. The military-industrial complex is an excellent case study of these challenges. Here are some early thoughts.

Last night’s Federal Budget in Australia proved once again how dominant the macroeconomic myths are in policy development. You can read my pre-Budget comments – Budget 2012: a recipe for disaster – and apart from the 2011-12 deficit being larger than the Government planned as a result of the slowing economy undermining its estimated tax revenue (in other words, the Government was overly optimistic in its forecasts last year) I would not have written much different after seeing all the Budget documents. It remains the largest fiscal consolidation attempted in one fiscal year (equivalent to 3 per cent of GDP) at a time that GDP is growing around 2.5 per cent.and I cannot see private spending growth picking up to fill the gap. Outcome – a movement towards recession. Conclusion – poor fiscal management. But the Budget Papers that the Government releases are always interesting reading and one day I plan to trace the evolution of the shifts in macroeconomic ideology through the way the papers are presented (format, tables, and narratives). There you learn what the economists in Treasury think and the ideas espoused are generally applicable to the international debate given that the tentacles of the dominant paradigm of the day spread widely. In Budget Paper No 1, Statement 4 – Building Resilience Through National Saving we are provided with a demonstration lesson of how a fiat monetary system does not work and a classic depiction of the way the mainstream narrative deceives the citizens.

Today has been a busy pre-Budget night day (the Treasurer delivers the 2012-13 Budget tomorrow night). I was invited to write an Op Ed for the ABC’s The Drum – a site which explores news and analysis in more detail than the usual 750 word newspaper column. The Drum column is reproduced below. I have also been wondering about the implications for Europe and beyond of the election outcomes in France and Greece. I suspect the latter will be more interesting given Hollande will be unlikely to rock the boat too much. But I need to read more of the French literature that has emerged in the last 24 hours to really get a feel for what is likely to happen there. I will have more to say about the Australian federal budget when it is actually unveiled tomorrow night but it looks like being the case that Australian government is about to deliver a 5000-odd word suicide note.