The wisdom of Simon Johnson

As conventionally measured, both Ireland and Spain had responsible fiscal policies during the boom, but they were building up big contingent liabilities, in the form of irresponsible banking practices.


Fiscal austerity will not help, but fiscal expansion is also unlikely to do much – although presumably it could increase headline numbers for a quarter or two. The private sector needs to grow, preferably through exporting and through competing more effectively against imports.

The whole column is excellent.


I read this as saying the Euro ends.

I would disagree. Spain has government cost structures that require tulip mania type bubbles in economic activity to sustain.

And they were the conservative, careful ones. Most countries were spending so much even in the good times that they had to borrow.

Fiscal austerity will not help, but fiscal expansion is also unlikely to do much

Someday we'll look back on this as that strange time when tax cuts were called "fiscal expansion."

I think that the subjects implied here are on the spending side, not the taxing side of fiscal policy.

Yes, but the implication has been wrong -- de Rugy already established that "austerity" in practice has usually meant taxes go up and spending stays about the same.

Maybe it is time to start changing banking policy:

1. Kill the 30 year mortage except for first time buyers
2. Push credit reporting to 5 years
3. double the interest on home equity loans

You know that other countries have significantly different mortgage structures, right?

I spent a month in Ireland in 2010, listening to a lot of local radio and news. They kept talking about features of local mortgages that just wouldn't happen in the U.S. (like a pure floating rate, not an ARM).

Canada just altered mortgage rules to reduce amortization from 30 to 25 years and drop the LTV from 85% to 80%.

And the problem in the US right is first time buyers can't find an affordable house.

The piece ends on a sceptical note that the periphery will never be like Germany. There are two examples that could to some extent counter this commonly held wisdom. Britain governed Malta and Cyprus for several decades, and these countries and their institutions, unlike some of their culturally very similar neighbours, tend to work pretty well. The real question is, I believe, if we can find an institutional setting compatible with democracy that can implement such a change in Greece, Spain or Italy.

I thought Cyprus was having difficulties, only delayed, and Malta's just so small that no one really cares what happens there?

The main problem of Cyprus is its exposure to Greece. Both Malta and Cyprus are indeed small. You must be from a large country and must have travelled in isolation through those vast lands during the Icelandic crisis to be able to say so carelessly that small countries do not matter. What I meant above was that certain things which are distant goals of "structural reform" in the larger peripheral countries actually tend to work in those countries. For example, you get a proper receipt when travelling by taxi.

Nice dig. If I'm wrong, I'm wrong, not a Philistine.

Yes, very dismal comment by Simon Johnson. Of course peripheral Europe won't become like Germany. But peripheries have tended relentlessly to become more like core countries generally. Dependistas used to say the Latin American periphery could not develop *because of* of the very existence of the core. But in the last 40 years there have been big changes.

The European periphery can make capitalism its target. It's really not so difficult.

It will be easier if they think of the task as one of subtracting rather than adding components. "Removing the obstacles to growth" as the economic historian Eric Jones has so nicely put it. Good leadership and stoicism among the population are key variables. The Spanish have traditionally been very stoic. They were after all the small numbers of conquistadores who miraculously (stoically) conquered Latin America. Endurance in the face of temporary hardship is in the blood of many European peripheries.

I keep thinking of Ireland and Spain as evidence of the problem of having a banking system that operates on an international scale, thanks a single currency and a free trade area, but with only a national bank stop and regulatory scheme. Money flows in and out easily, allowing for the boom, but leaving just the local government holding the bag when the bust comes.

Which brings me back to my theme of the need for the ECB to act as a true lender of last resort.

I read his new book - mentioned in the post - it's very good, too.

I've not read that one, but I was not impressed with 13 Bankers, but maybe that's because I had been reading his blog and didn't think the book added much new.

"As conventionally measured, both Ireland and Spain had responsible fiscal policies during the boom."

I don't see much proof for this. Spain's budget doubled from 2002 to 2009. That doesn't strike me as responsible.

The Spanish government's taxation methods don't strike me as particularly responsible, either.

Ummm, when did the private debts of banks become contingent liabilities for Ireland? After the crash, wasn't it?

Yes. They were contingent on the government being bullied (by foreigners) into accepting them.

Bailing out bank bondholders is a bad idea whose time should have passed.

At the time when Ireland assumed the debts of the banks, it was not realized that they were so badly underwater or that the recession would be so severe. So this was supposed to be a grand gesture to restore confidence. (As in "We have nothing to fear but fear itself.")

You would do better to ask why they chose to make them so. Answer that, and you will understand why the governments weren't so fiscally responsible after all.

Spain was not fiscally responsible. Spain had surpluses during the boom only because of their progressive tax system. That system creates revenue volatility which, when revealed by an economic reversal, is inherently insolvent.

With revenue volatility, expenses must grow at a much slower rate than revenue growth to reduce shortfall risk.

Saying that Ireland and Spain had "… irresponsible banking practices…" is exactly like saying that North Carolina and New York had irresponsible banking practices, i.e. absolute nonsense meant to disguise the truth of the matter. Shame on you Cowen, if it's still possible for you to be shamed.

More and more, I think this is all about oil.

As for Greece and Spain, there are three outcomes:

- default (depart and devalue)
- inflate
- pay it back in real money

Each of these is subject to cost-benefit analysis. It's not voodoo, it's a definable problem.

As for governance, when we are seriously willing to discuss the aligning of incentives for politicians, then we can make Greece more like Germany. That we are unwilling to seriously discuss the topic is not the fault of the Greeks.

Latest article:

"High oil prices are caused by consumers, not speculators"

It argues that price inelastic oil demand causes oil price spikes. Inelastic Chinese demand can cause price spikes even if US demand is price elastic, as it has been recently. There's no need for financial speculation; oil price spikes can be caused endogenously.

"The private sector needs to grow, preferably through exporting and through competing more effectively against imports."

Indeed. In other words, Greece and Ireland (and why not Spain and Italy?) need to reduce the price of non-tradables relative to tradables; ie, to devalue (Doesn't anybody read James Meade anymore?) Either they leave the Euro or Euro prices need to rise. [Hint: ECB is failing to stabilize NGDP. ] I like the house painting analogy; one can leave the house immobile and move the brush or immobilize the brush and move the house. Germany seems to prefer the move-the-house solution. Markets remain skeptical.

Having spent a month in Spain each year through this era, paying RE tax and the "non-resident income tax" while enjoying the friendships of people most of whom work for banks or, in some fashion, the government, I find the approbation of Spain's budget policies through the era very surprising. While the central government kept reasonable balance, the comments above of Williits and Michael Hamilton add to the picture. However, the autonomous regions over-spent like wild. The regional politicians controlled most of the cajas, which lent frivolously. The local governments allowed over-building to gain the permit fees and, some, to sell land. To top this off and magnify the Hamilton comment, the Gonzalez and Zapatero governments passed labor laws which were guaranteed to cause tremendous grief and expense if a serious recession occured. The overall picture was never "responsible." All this without touching on the staggering corruption which ruined much of the Costas aesthetically by ignoring the Law of the Coast or allowing excessive density inland.

In Greece, successive governments overspent – financed by borrowing — as they sought to stay popular and win elections.

This is the crux of the democratic problem. Voters want the "free money" promised by politicians, or at least gov't money, that is, Other People's Money. But after it is borrowed and spent, the Other People do not, now, agree. The socialists argue, as long as somebody is rich (i.e. about twice your income or more), those rich can be taxed for the gov't.

In the Bush Tax Cut boom years of 2002 -- 2006, responsible governments were reducing gov't costs and total debt.
No gov't that increased costs during the good years was responsible.

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