Saturday, December 31, 2011

The trans-Atlantic politics of bailouts and austerity

The distinguishing characteristic of the dismal landscape is the policy gridlock that has gripped a deeply divided American political establishment. Europe too suffers the same malaise.

But this has not prevented the US Government and the Federal Reserve from rescuing financial institutions with an extraordinary tax payer sponsored bailout. However, the equally beleaguered tax-payers themselves have not benefited similarly. The unemployment rates remain high and and large numbers of mortgage holders continue to have negative equity on their houses. It is therefore no surprise that aggregate demand remains weak and economy anemic.

The graphic below represents the stark choice facing policymakers in the US. Shockingly, the second group's request comes on the back of the massive financial sector bailouts.

Fixing the financial market regulation system is proving a difficult, with little unanimity on the details. The graphic below is illustrative of this and much of macroeconomic policy making itself. The policy responses to the sub-prime bubble and its consequent Great Recession resembles the parable of the blindmen and the elephant.

Even as US was experimenting with monetary accommodation, the Europeans pumped for fiscal austerity.

Predictably, this austerity experiment threatens to unravel the Euro Project itself.

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