Column : Multiple equilibria

Dec 17 2012, 00:19 IST
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SummaryThe global economy is poised in a delicate state. It is in some sort of transition but it is difficult to say what sort of equilibrium it will end up in.

The combined outcomes of EU crisis, US fiscal cliff, slowdown in China & India are difficult to predict

The global economy is poised in a delicate state. It is in some sort of transition but it is difficult to say what sort of equilibrium it will end up in. There are multiple equilibria possible and where we end up could be determined as much by some random shock as systematic trends.

Consider this. The western economies have slipped down from their dynamic path of 1992-2007. The eurozone is struggling not to break up or to mire itself into stagnation for the foreseeable future. It has plans such as a fiscal union and a banking union, which, if implemented, can allow it to grow again. Most likely outcome at present seems to be stagnation unless the stronger northern members of the eurozone can fork out the resources to bankroll the deficit countries. The harsh adjustments going on in Ireland, Spain, Portugal and Greece are proceeding at various paces but they all are slimming down not growing.

The Maastricht Treaty was signed by many European Union members without realising that they were signing up to a denationalised currency, which was one of Hayek’s most radical proposals. The euro cannot be created by the governments as the European Central Bank (ECB) cannot buy sovereign debt in the primary market. The consequences of this were not felt while excess savings from Asia were keeping interest rates low. A denationalised currency is like the Gold Standard. For a while, Asia supplied the extra liquidity like the California Gold Rush did in the 19th century. Now, the exogenous supply of liquidity is exhausted and the eurozone has to innovate to adapt to this new situation.

The US is poised on a cusp. If the fiscal cliff can be overcome, we may enter 2013 to face up to the serious challenge of long-run debt reduction. The US has perhaps the best surprise in its shale gas discoveries. If that fructifies, the US may change its international trade balance greatly. That raises its long-run growth prospect as well as the world’s growth prospect by making oil cheap, as shale gas is a cheaper substitute. The eurozone also has shale gas but it may refuse to sanction exploration because of environmental considerations. The US has no such compunctions.

If the fiscal cliff is hit and there is legislative gridlock, then the prospect is a

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