The Hindu Business Line : Search for the Holy Grail

All that can be said with certainty is that the risks to real economies from financial market turbulence have never been more than in present times.

THERE is an explosion in economic research, especially in the US. The reason is clear.

Every school, every theory - be it Keynes', Friedman's or Marx's - has failed to fully account for the way the global economy has behaved in the last fifty years. The fifties and sixties were the high points for Keynesian economics, which believes essentially in fiscal stimulation to ensure that aggregate demand in a market economy is sufficient to maintain full or near-full employment.

It was the perfect prescription for the war-ravaged countries of Western Europe, with funding coming in large measure through the US's Marshall Plan.

The Soviet Union's economic policies did not differ substantially from Keynesianism, except in the matter of ownership of the society's assets. Like the US and Europe, the USSR too poured huge amounts of investment into infrastructure and capital goods.

Its economy also grew apace like its Western counterparts. In the seventies, the whole situation changed with the breakdown of the fixed exchange rate system devised at Bretton Woods after World War II. (Keynes was one of the architects). The gold anchor of currencies disappeared. With that inflation concerns heightened and double-digit inflation surfaced. The monetarists now had their day.

They argued that central banks were too accommodative of the fiscal deficits of Governments. To contain inflation, it was essential to curtail the growth of money supply and raise interest rates. At the same time, Governments must curb spending.

As Chairman of the Federal Reserve, Mr Alan Greenspan's predecessor, Mr Paul Volcker did precisely that. He pushed interest rates up to 20 per cent levels and saw his rewards when inflation collapsed in the course of the eighties, helped by the plunge in the price of oil, which had caused 70s inflation in the first place.

The nineties have seen a comeback of sorts for Keynes' economics. Interest rates reached lows not seen for decades.

Liquidity has never been better. Global investments in a wide cross-section of industries and services and rising productivity have kept prices in check even amidst fiscal indiscipline on the part of Governments.

But all the horrendous predictions on inflation have come to naught, throwing the monetarists into disarray. Their attempt has been to fill up old wine in a new bottle in the guise of `rational expectations' theory.

Meanwhile, financial market volatility has increased sharply with large intra-day and inter-day fluctuations in stocks, currencies and bonds.

No wonder, there is a sharp divergence in forecasts for 2005 - some analysts seeing US growth in the region of 4-5 per cent and others a slowdown.

Predictions for the dollar range from an end to its weakening to a further crash.

All that can be said with certainty is that the risks to real economies from financial market turbulence have never been more than in present times.

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