austerity substitute trust
Here is a common view, not incorrect as far as it goes:
Struggling euro-zone economies like Greece, Portugal, Spain and Italy cannot cut their way back to growth. Demanding rigid austerity from them as the price of European support has lengthened and deepened their recessions. It has made their debts harder, not easier, to pay off.
And here is a useful Paul Krugman post on austerity, perhaps the best single (brief) statement of his views on European austerity. Three observations:
1. I have yet to see a numerical analysis of European fiscal austerity which adjusts for a) falling ngdp, b) the collapse of their banking systems, c) and the collapse of M3 and money markets in some of these regions, noting that in Italy there are partial (very recent) signs of a money market turnaround. The blame gets pinned on the fiscal austerity.
2. I have yet to see a numerical analysis of European fiscal austerity which considers the prospect of later catch-up growth. This can make the costs of austerity much smaller, though of course from discount rates and habit formation there is still a cost.
3. Ideally it really would be better to say “Italy, I trust you to cut spending later, after your economy has recovered.” This cross-national trust is not present, least of all with Greece but also elsewhere. What is the best available policy in the absence of this trust, knowing that the periphery nations have to send some kind of credible signal to the wealthier nations of the North, in return for ongoing aid?
You can think of those three points as the “frontier reasons” why not all economists agree on European austerity. There are indeed some “dY/dG denialists,” but there are too many attacks on them and not enough explorations of the real issues.
Ironically, postponing austerity is most likely to succeed when there is lots of trust in a country (and in fact whether or not that trust is deserved). You can imagine the Swedes agreeing to themselves “we’ll cut spending three years from now” but the Greeks not, not without external constraint. Thus, writers who unmask the depravity of the American polity, and who polarize opinion, are oddly enough doing harm to the anti-austerity point of view.
You will find an alternative perspective on intellectual strategy here.
Paul Krugman’s post on the topic was revealing, compared especially to the analytic and rhetorical flourish which he applies to criticizing austerity. You can’t fault his IQ or his knowledge of the situation, there simply isn’t much convincing to put forward. Here is Ryan Avent, in a good post but I think it also fails to put forward a workable solution:
What, then, are the alternatives to austerity? Well, first up would be an integration that would help break the diabolical loop now gutting the periphery. Creating a euro-zone-wide safe asset and a euro-zone-wide set of institutions to stand behind damaged banks would help accomplish that. America doesn’t expect Delaware to shoulder the costs of failures of banks headquartered in Delaware. That’s an important contributor to the stability of the American federal system. The euro-zone must recognise that it is the failure to build appropriate euro-zone-wide institutions—equal in scope to the considerations and resources of the central bank—that is contributing to soaring yields around the periphery and creating the illusion of the need for dramatic austerity in places that could do without it.
I call this the “Germany pays for everything and accepts all the risk of moral hazard” approach. Potential German liabilities could run in the trillions of euros and the “ball and chain” lasts forever. I know all about Connecticut and Mississippi, but without a common electorate, not to mention a common national identity, I don’t see how this is possible. Keep in mind that Eurozone-wide deposit insurance in essence serves as an implicit guarantee to the parent national governments as well, for Modigliani-Miller-like reasons.
It is like doing African development policy by suggesting that America send one-third of its gross national product to Mozambique. Maybe it is moral to do so (though I doubt that), but in any case it is not really a policy proposal. Lack of a common identity is a constraint, not a policy choice, except at fairly small margins or at moments of extraordinary cultural transformation (hint: this is not one of them , especially when there are seventeen nations involved).
Just to (imperfectly) integrate the relatively small unit of East Germany cost West Germany almost $2 trillion dollars.
By the way, will the periphery nations give much (any?) control over their finances to Germany? Clearly not, and thus we are back to the idea being dead as a doornail.
There is no common fiscal policy without a common electorate, not for long at least.
Ryan Avent also supports looser monetary policy for the eurozone, as do I. It’s worth trying. But keep in mind, the further along is a financial crisis, the more emergency monetary policy takes on a more purely redistributive element. You end up having to stick the money somewhere quite specific and forget about ever getting it back. Nominal reflation helps with some problems when done well in advance of crunch time, but right now it is a question of solvency for many of the parties involved. It’s already ineffective for the ECB to be doing three-year loans to rotten banks at one percent, against very low value collateral, how much more of a boost are we to expect?
Just how much monetary policy needs to be done? At this point, we’re not talking about a move from price stability to say four percent eurozone inflation (which I would nonetheless favor, and favored all the more a year or two ago), rather much more would be required. We’re running up against the same constraints which prevent the de facto Eurobonds from taking off. Revisit the well-known point that in a financial crisis fiscal and monetary policy blur together, and we return to the notion that solutions are based on massive cross-border redistribution. On top of all that, arguably the deflationary pressures in Greece, and possibly Spain, are already past the point of control from the ECB side, given the ongoing collapse in private lending.
My previous post presented this:
I’ve now had some time to look at the paper, and here are a few observations:
1. I am of course open to publishing a rebuttal from R&R, but on a first read the authors make a strong case for their claim that the core Reinhart-Rogoff result — concerning the growth slowdown at debt at 90% of gdp — is based on a coding error and some data exclusion issues. Please reread my earlier post on “the smell test.”
2. That said, as Ray Lopez mentions, including in the data the postwar bouncebacks of some Anglo countries (NZ, Australia, and Canada), as recommended by the critics, is not obviously going to improve the quality of the answer. For instance the Kiwis have postwar growth rates of 7.7, 11.9, -9.9, and 10.8 percent, across the late 1940s. Are those numbers — which were combined with high postwar levels of debt — relevant to current fiscal policy issues? I say no, while admitting this may lead us to throw out other data points as well. I don’t know what is the non-cherry-pick answer here or if there even is one.
3. It is perhaps unfortunate in this age of the internet that rebuttals must be presented so quickly, but so be it. It will be interesting to hear from R&R.
4. Not too long ago I reread R&R to ascertain whether they actually present the 90% level as an emergency cliff of sorts. I concluded they did not, although there were some sentences that a reader could take out of context toward confirming such an interpretation.
5. In the paper by the critics, the pp.7-9 discussion of “weighting by country” vs. “weighting by country-year” is very interesting, but the fact that it matters as much as it does makes me more skeptical about the entire enterprise. Whether you should weight by population is important too.
6. I am seeing a large number of tweets which both misrepresent R&R or misrepresent their influence on current policies of “austerity.”
7. My own view, as you can read in The Great Stagnation, is that the primary mechanism is slow growth causing high debt/gdp ratios, not vice versa. In any case this is by far the most important issue, whether or not you agree with my take on it.
8. The “case for austerity” didn’t rest much on R&R in the first place, rather on the notion that the bills have to be paid, dawdling on adjustment is not always so easy, and the feasible sum of international redistribution is quite low. For this reason the UK should be relatively uninterested in immediate austerity and many nations in the eurozone periphery more interested.
9. In the blogosphere, the ratio of blog posts “attacking austerity” to “proposing constructive alternatives to austerity” is at least ten to one. That too tells you something. Many of the alternatives proposed would indeed pass a Benthamite cost-benefit test, at least if implemented as desired, but they are simply inconsistent with incentives and the relatively selfish nature of individual behavior.
10. The most interesting question to me is a rather squirrelly and subjective one: how should this episode change the relative ratios of what I read? Should I in fact read fewer quantitative economics papers, instead (at the margin, of course) preferring more narrative history? This is not the first time that an extremely influential major empirical result has been overturned or at least thrown into serious doubt.
Critics of “austerity” are often weak or a bit mumbly on what is the relevant alternative or counterfactual. When it comes to the U.S., the relevant alternative is borrowing more, but in many cases, such as in the European periphery, the alternative is/was more aid.
So, in these cases, a multiplier of one means that a dollar of aid — the alternative to the fiscal consolidation — is worth a dollar. I find that easy to believe. It’s not really a claim about fiscal policy or Keynesian economics.
A multiplier of 1.4 means that a dollar of aid brings $1.40 in benefits. Imagine receiving aid, and not just benefiting from the dollar, but avoiding a fire sale of your assets or investing the money wisely or maybe just avoiding a civil collapse. That’s more of a stretch, but also not outside the realm of the possible.
As the IMF becomes more critical of austerity, the IMF therefore should believe in higher rates of return to aid. But does it?
@Yannikouts nailed it here:
It’s one thing IMF economists to argue for softer austerity and a totally other thing to convince IMF Board members to commit to extra funds
Few people believe in austerity when it is someone else’s money on the line. Here is my earlier post How emigrants try to run their fiscal policies.
Lisbon plans to lift income tax revenue by more than 30 per cent[this coming year], raising the effective average rate by more than a third from 9.8 to 13.2 per cent. Anyone receiving more than the minimum wage of €485 a month, including pensioners, will also pay an extraordinary tax of 3.5 per cent on their income.