It's been a volatile start to 2016 and here our guest economist John Hearn gives us all his latest thoughts.

Be sure to follow John on Twitter here and check all his blogs here and as always we encourage your comments and debate in the comments section below.

Another nice mess you`ve gotten me into.........

.....was Ollie`s accusation to Stanley, but in the case of the current state of the world economy you can insert your own person to blame. It may be George, David, Janet, Barack, Mark, Abe, Mario, Christine or you may like to go back further and accuse Gordon, Alistair, Tim, Hank, Ben, Bill or even Alan. However behind all these powerful decision makers was an academic who we can describe as an interventionist economist.

For simplicity, and in respect of the economy, we can divide economists into interventionists and non-interventionists. The non-interventionists believe capitalism is strong and just needs rules to see fair play and free competition. The profit motive, free enterprise, private property rights and markets will then cause the economy to grow at an acceptable rate and generate the income and wealth that will make us all better off. In contrast the interventionists believe that capitalism is weak and broken, prone to boom and bust cycles and the cause of unacceptable differences in wealth and income.

You may hear the non-interventionists referred to as Austrian, free market monetarists, capitalists or right wing economists. The interventionists may be grouped together as Keynesians, Minskyites or left wing economists. It is important to note that there are relatively few non-interventionist economists around and no politician or decision maker ever listened to them as they do not want to be told to minimise intervention and leave the economy alone to its own devices and mechanisms for allocating resources. From this it is reasonable to deduce that today`s economic problems must be the result of following the advice of interventionist economists.

On my blog I have catalogued the mistakes of interventionists from "Decades of mistakes: what the Bank of England got wrong..." through "What really happened in the 70s" to "Are demand management policies the solution or mass delusion?" This means that here I shall just give you a brief reminder of what has caused today`s economic problems:-

  • Creating a single currency in the Eurozone

  • The Federal Reserve/ US regulatory system`s role in the collapse of Lehman Brothers

  • The 2009 G20 meeting which instigated fiscal deficits and growing national debts around the world

  • Central Banks zero or near zero interest rate policies (ZIRPs)

  • A misunderstanding about the role that QE plays in monetary policy

Just a little more on two of the above: large fiscal deficits and ZIRPs do not do what the flawed macroeconomic models predict. They do not cause economies to grow. In fact they do the very opposite and distort resource allocation making it more inefficient and they create bubbles in asset prices that eventually burst and are the cause of our current problems.

From here and now we have two possible scenarios only one of which will solve our problems, while the other will be our next failed attempt at managing the economy.

Scenario one from the non-interventionist school explains how it is necessary to reduce government intervention in the economy by following two simple rules and one new policy.

  • Raise the official Central Bank rate to a market rate and set a rule that it cannot be reduced below 4%. It would be preferable for all Central Banks to act in concert on this point to avoid volatility in the forex markets.

  • Set a balanced budget rule that governments must observe over a 3 year term

  • Introduce supply side policies to free up markets and create more flexibility.

Both of the rules above have zero political kudos and even though they are the only solution to our problems they will not even be considered or discussed and anyone who mentions them will be considered unhinged and one step removed from reality.

Scenario two from the interventionists will work from the assumption that we have not had enough intervention and they will suggest even more aggressive demand management policies with:-

  • Negative rates of interest

  • Increased government spending and continuing large fiscal deficits

Now this does have political kudos and from various interventionist economists we are already hearing about:-

  • Helicopter money

  • Debt jubilees

  • Negrates

  • Peoples QE

  • Money drops to selected citizens

  • Increased government spending on infrastructure projects

We already have central bankers, politicians and parties voicing some of these solutions and I suspect, in one form or another, more demand management will be adopted.

The result will be that economies will continue to decline (low or negative growth), asset bubbles will reflate again and then burst probably for the last time as there will be no further room for manoeuvre. Capitalism will become a distant memory as it will have been blamed for all our problems and most of the world`s major economies will be under state control: Karl Marx or was it Grouch Marx will have been proved right.

John Hearn 12/2/16