Korean central bank reduces interest rate

   The Korean central bank, Bank of Korea, cut the benchmark interest rate down to 3 per cent yesterday (July 12). Most experts had predicted no change. There are conflicting factors in the economy a combination of slowing economic growth but also higher inflation expectations.
    No doubt the recent lowering of rates in China and Europe had some influence on the  decision. Korean Treasury Bond yields fell below 3.25 per cent. This is a record low since the beginning of the financial crisis.
   Tim Condon an analyst from Singapore said:"The BOK's move is not an issue because I figure the neutral level of the policy rate is 2.75 percent. Another 25-bps rate cut will come in August or September. Inflation is no longer a problem. Possibly rate cuts by central banks in Europe and China affected the BOK's rate decision,"  The Korean Finance ministry has revised the forecast for growth in 2012 from 3.7 per cent to 3.3 per cent. 
    External conditions are the main reason for adjusting the growth predictions. Europe is not yet recovering from its crisis and Chinese growth is slowing somewhat. The new forecast is in line with that of  the OECD (Organization for Economic Cooperation and Development) which in May forecast growth of 3.3 per cent in South Korea.
  The rate of inflation in South Korea slowed in June to 2.2 per cent, well within the target of  between 2 and 4 per cent. This may have also influenced the decision to lower the interest rate. For more see this article.

Paul Krugman condemns austerity policies

Krugman uses the title "Death of a Fairy Tale" in his NY Times blog article. Krugman calls the austerity policy employed in many European countries a destructive economic doctrine.

Krugman claims that economic textbooks suggest that in severely depressed economies governments should spend more to take the place of falling demand rather than cutting spending to try and balance budgets. No doubt Keynesian liberal oriented textbooks suggest this but not all economists would go along.

The "austerians" as Krugman calls them argue that austerity measures restore confidence to investors and hence the economy will grow rather than continue in recession. As Krugman puts it the confidence fairy will come and reward policy makers for their virtue.

The results of austerity policies throughout the European countries where it has been employed are evident. Even more contraction of GDP, increasing unemployment, social unrest, and little or no sign of recovery. Krugman seems genuinely puzzled by the continuation of austerity policies in the face of empirical evidence that they do not work. Krugman suggests that perhaps the cause is an irrational fear of increased debt levels. But there are good reasons for austerity policies from a capitalist viewpoint that Krugman's analysis ignores.

Austerity policies have the effect of lowering wage demands and weakening unions. This means that labor costs will go down and this is a positive for capital and investors in the longer run. Austerity policies shrink the social safety net and pension payments and this can lead to lower taxation rates since the government requires less revenue. Finally as part of austerity measures state assets and services are sold off providing investment opportunities as the assets often are sold at fire sale prices. The money is used to pay off debt.

While in the short run the austerity policies may reduce growth, policy makers are beginning to recognize this as a problem. The response will no doubt be to provide even more incentives for business to begin investing in countries where austerity policies reign but to keep most of the austerity policies in place. In the long run they are good for investor confidence since they lead to lower labor costs, provide investment opportunities, and reduce government services that do not directly help business. A temporary decrease in GDP may be a small price to pay for policies that do help capital in the longer term. For more see this article.

U.S. economy exceeds expectations but stocks slump on Europe worries

While some economic data released recently about the U.S. economy exceeded expectations U.S. stock indices went down today. Both Fitch Ratings and Moody's Investors Service said that the recent agreement at the summit of European leaders has not done much to relieve pressures on those European governments that are struggling with huge debts and high borrowing costs.

The warnings were enough to reverse a rally that has been going on in U.S. for a couple of weeks in spite of the fact U.S. indicators show the economy is outperforming expectations the most in nine months. An Economic Surprise Index went to 85.7. This is the highest since March 9.

November unemployment although still very high, hit the lowest level in two years. Manufacturing is also growing quickest in five months. Nevertheless Ben Bernanke head of the Federal Reserve said that there were significant downside risks facing the U.S. economy. For much more see this article.