As party leaders in Canada fall over themselves to pledge their fiscal conservatism, with the possible exception in certain respects of Liberal leader Justin Trudeau global markets have gone through a crushing drop of 1000 points in the Dow on opening yesterday after huge losses in the Asian markets and a sell off in Europe. The final drop was over 550 points on Wall street and todays market as of this afternoon has rallied back some 300 of those points on the Dow. I should point out I have a small retirement fund that is invested in the market so readers should not misconstrue my remarks as offering any sort of advice.
I believe along with other Keynesians and post Keynesians that markets in stocks and commodities and financial instruments are fundamentally capable of huge irrational panic driven swings. After all how else can we have a Dow fall 1000 points on opening yesterday driven by futures speculators trading on bad news from China and a day later rising 250 points ? Which is the right price, Friday’s price before the crash,Monday mornings’ price after or todays mid afternoon price that the market has rationally yielded ?
As I have written in my long paper on the origins of quantitative easing and the roots of the 2008 crash(After the crash,Rediscovering Keynes and the Origins of Quantitative Easing) throughout its history there have been many such irrational panics and speculative bubbles bursting. That is why the well being of the economy is too important to leave to the supposed wisdom of the financial markets. It is too soon to conclude that all will be well since the market has recovered some of its losses today so far. We shall see. The Chinese have cut their interest rates which may help their markets which in any case are prone to wild speculation akin to a casino. So what about our politicians. It is long overdue for them to understand that the role of the central bank and the Government through the application of fiscal and monetary policy is to moderate the irrational swings which the financial markets can transmit to the overall economy in order to foster solid real growth and low unemployment and moderately low inflation. At the moment there is no risk of inflation. The risk in a world of falling commodity prices is in fact the opposite too low an inflation rate .
The supposed wisdom of financial markets about appropriate fiscal policy and always balancing the books should be ignored since the financial markets are quick to call for government intervention to bail them out whenever their excessive behaviour gets them into trouble. If the turbulence continues and damages the real economy then governments need to be prepared to invest in infrastructure, education and social services financed by deficits if necessary to stimulate and stabilize the economy. These expenditures should be separated out from the current expenditure account and should be financed over a longer time period so that they are balanced over the longer cycle. The financial markets are neither wise nor rational but they are a central part of modern capitalism so they must be properly understood by policy makers. Simply repeating the ” balance the books” mantra will not do.