“It has been clear for years,” writes David Ignatius in the Washington Post, “that you can’t have a single European currency but 16 different fiscal policies in the euro zone; this mismatch subverts the necessary process of economic adjustment for chronic debtors such as Greece. Yet the politicians of Europe haven’t been able to address this core weakness.” 

Ignatius writes that “It was the central insight of John Maynard Keynes that the self-correcting mechanisms of classical economics didn’t always work. Markets got stuck at less than full employment. The market forces that should have restored full use of idle workers and machines didn’t work — partly because individuals got scared and preferred to hold cash rather than invest in productive assets, no matter how low interest rates fell.”

“This was why Keynes argued for government intervention to nudge the economy from the low-output trap where it had gotten stuck,” says Ignatius. “It wasn’t that he liked government spending, but that he recognized that markets sometimes overreact — amplifying the fears and preferences of individuals into collective behavior that makes everyone worse off. We have been seeing a contemporary version over the past several weeks, with frightened investors bouncing the global economy like a Ping-Pong ball.

“The lesson for Keynesians in the 1930s,” says Ignatius, “was that government intervention could compensate for market failure. A similar faith in government — not simply in the efficacy of fiscal policy but in the ability of democratic political systems to solve problems — propelled the spread of American democratic values around the world after the defeat of fascism in 1945 and, later, after the collapse of communism in 1989. Free markets and democratic political systems weren’t just desirable; they seemed inevitable.”

The scariest aspect of the current political-economic crisis is that it tests this faith in democratic governance. The political systems in the United States and Europe have proved unable over the past year to solve crucial financial problems. The political system has been no more self-regulating than the economic.

Excerpts from this article are cited here strictly for educational purposes. Students are encouraged to read the full article in the Washington Post online at: http://www.washingtonpost.com/opinions/democracy-challenged/2011/08/09/gIQAQvRb4I_story.html

 

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