Do markets understand politics?

[by JSC7]

Ezra Klein weighs in on Tyler Cowen weighing in on the Krugman/Rogoff debate about what debt-to-GDP ratio America can stand before growth starts to feel a drag. Klein says that maybe we shouldn’t be worrying about the specific number, but rather how well our political system can deal with the problem in general. Money quote:

But the driver behind that question is not how much debt we have, it’s whether our political system can make the difficult choices to deal with that debt. So long as the political system is working reasonably well, we can get out from even quite a lot of debt. But the more it breaks… the more it has reason to worry.

What I think is worth asking, if that’s the case, is how well our business world understands the political system. We talk a lot about how politicians don’t understand economics, but what if the reverse is true? Even assuming no change in the system itself, it’s a pretty opaque system to someone who isn’t involved in it (not relevant to the budget, but all the stuff coming out of the Top Secret America report can’t be an anomaly). But, of course, you have to factor in the political systems ability to change itself, especially in response to crises (like a ballooning deficit). I don’t know how many people on Wall Street have a good sense of this.

Especially when it comes to the budget deficit, you can see the possibility of a self-reinforcing feedback loop. Businesses think that government will respond reasonably to a large deficit, and so U.S. Treasury prices stay low, but because Treasury prices stay low, the government doesn’t feel an imperative to fix the problem, and maybe even continues to make it worse. If that’s a threat, then I’m glad we’re having debates about what debt-to-GDP levels are feasible, because it at least gives us a chance to point to a concrete number and say, okay, now we have a problem, rather than relying on markets to correctly predict politicians or vice-versa.

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1 Response to “Do markets understand politics?”



  1. 1 Election Politics Trackback on July 24, 2010 at 3:02 am

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This is a group blog. JSC5 currently writes from the US. JSC7 writes from behind the Great Firewall of China.

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