Category: Current Affairs

Europe's "stress tests" were intended to gauge the ability of large banks to weather an economic storm. But the exams relied on some surprisingly docile economic assumptions.

In some of the 20 countries that conducted the tests, regulators figured that property values would keep rising or hold steady in a worst-case economic scenario.

In other cases, unemployment rates in a double-dip recession crept up by as little as 0.1 percentage point from the tests' so-called benchmark scenario, which is based on current economic conditions.

In Austria, for instance, the recession scenario involved house prices rising two percent the first year and rising 2.7 percent the year after.  Here is further information.  What would a rational Bayesian say?  What would Will Wilkinson say? – "My kingdom for a futarchy!"

Here is further comment.

The British economy grew at the fastest pace in four years in the second quarter and German business confidence surged to a three-year high this month, indicating Europe’s recovery may be stronger than forecast.

U.K. gross domestic product rose 1.1 percent in the three months through June, almost twice as fast as the 0.6 percent gain predicted by economists in a Bloomberg News survey, the Office for National Statistics said in London today. In Munich, the Ifo institute said its business climate index, based on a poll of 7,000 executives, jumped to 106.2 this month, confounding expectations of a decline.

The article is here.  Again, that's not the final word by any means (e.g., UK spending cuts haven't happened yet), but it's worth a note.  We need a macroeconomic framework — not just AD, AD, AD – where such reports are not absurd outliers.

A correspondent from Spain writes to me:

I want to proudly show you
some renewed sentiment on Spain. On new info, new probability said
Bayes. Now we have new info, now I'm bullish on Spain. And happy for
being able to show it !

http://www.sintetia.com/analisis/espana-esta-de-rally

We
are experiencing a good and consistent rally. On debt, equity and CDS.
Everywhere. This is isolated from other peripherals, so the reading if
this may be even more bullish on implicit spanish risk alone.

I really think we deserve it. We've taken all the steps to see this:
reforms, austerity, and changes in the Savings and Loans entities.

In general I take a more cautious interpretation of market price movements, but I did think it was worth passing this along.  The graphs behind the link are striking (they cover some other countries too).  If you are curious, here is a Bloomberg update article on Spain.  In particular, there was a very recent decision and budget vote:

The budget shortfall was 11.2
percent of gross domestic
product last year and the government aims to cut it to 6 percent
in 2011 by paring public workers’ pay by 5 percent, reducing
infrastructure investment and raising taxes.

The extra yield investors demand to hold
Spanish debt
rather than German equivalents reached a euro-era high of 233
basis points on June 17. The spread narrowed to 169 basis points
yesterday from 176 basis points a day earlier.

I don't view this story as over, by any means, but that's the latest.  The market is rewarding a more cautious fiscal policy from Spain.

Real, constant quality land values have increased by nearly 800% since the first quarter of 2003, with half that rise occurring over the past two years. State-owned enterprises controlled by the central government have played an important role in this increase, as our analysis shows they paid 27% more than other bidders for an otherwise equivalent land parcel.

That's from Beijing and the source is here with hat tip to Felix Salmon.  It's hard being a (short-run) China pessimist, since the juggernaut seems to keep on rolling.  But yes, I still am.

Here is my latest NYT column, excerpt:

Far from embracing this social democratic model, American Keynesians have criticized it for relying too heavily on exports and not enough on spending and debt. Yet it is not just the decline in the euro‘s value that supports the German resurgence.

Most of the other euro-zone economies are not having comparable success because they did not make the appropriate investments and reforms. Moreover, the euro is still stronger than its average value since 2001, which suggests that the recent German success is not attributable only to a falling currency.

In any case, the Germans are exporting much quality machinery and engineering (not just glitzy autos), which can help other nations recover. It is an odd state of affairs when the relatively productive nations are asked to change successful policies because of an economic downturn.

I would add a few points:

1. I am not sure why the American left so near-unanimously lines up behind Keynesian recommendations these days.  (Jeff Sachs is an exception in this regard.)  There are other social democratic models for running a government, including that of Germany, and yet a kind of American "can do" spirit pervades our approach to fiscal policy, for better or worse.  Commentators make various criticisms of Paul Krugman, but putting the normative aside I find it striking what an American thinker he is, including in his book The Conscience of a Liberal.  Someone should write a nice (and non-normative) essay on this point, putting Krugman in proper historical context.

2. You sometimes hear it said: "Not every nation can run a surplus," or "Can every nation export its way to recovery?"  Reword the latter question as "Can every indiviidual trade his way to a higher level of income?" and try answering it again.  Productivity-driven exporting really does matter, whether for the individual or the nation.  It stabilizes the entire global economy,

3. There really is a supply-side multipler, and a sustainble one at that.

4. The phrase "fiscal austerity" can be misleading.  Contrary to the second paragraph here, even most of the "austerity advocates" think that the major economies should be running massive fiscal deficits at this point.  (And Germany had a short experiment with a more aggressive stimulus during the immediate aftermath of the crisis.)  They just don't think it works for those deficits to run even higher.

5. The EU is an even less likely candidate for a liquidity trap than is the United States.  That said, how to distribute and implement additional money supply increases would be a serious political problem for the EU.  Simply buying up low-quality government bonds would work fine in economic terms, but worsen problems of moral hazard, perceived fairness, and so on.  This problem should receive more attention.

Other than "Chinese baby lusts after German automobile," how else would you title this photo?

The most obvious way in which sticky wages impede employment is by keeping the cost of hiring workers above the equilibrium wage. The standard story explains that sticky wages increase unemployment. The standard story, however, is not the only and perhaps not the most important transmission mechanism.

Wages are the largest component of costs thus sticky wages keep costs high and profits low.  The point is obvious once stated but it has implications for how we look at sticky wages.  Tyler, for example, writes:

[Consider] illegal immigrant Mexican construction workers, a group which lost jobs in large numbers following the crash. Are they — who often came from $1 a day environments — also supposed to have sticky wages? They are out of work in massive numbers.

The focus here is on the unemployed workers with the argument implicit that it's the stickiness of their wages which counts (which makes sense given the standard story).  But suppose that the problem is that firms can't get capital to expand–perhaps because the banking system is not working well–then what matters for firm expansion is free cash flow.  But sticky wages keep firm costs high, reducing free cash flow and inhibiting expansion. In this argument, the stickiness that matters is the sticky wages of the employed workers.

A story which focuses on employed workers has several advantages.  First, the wages of employed workers are clearly more sticky than the wages of unemployed workers–in fact, if you are employed real wages are up slightly. Moreover, since more than 90% of workers are employed this type of argument has leverage.  

If there are fixed costs, new firms do not arise instantly so infra-marginal sticky wages can be important for a number of "balance-sheet" reasons in addition but related to the free cash flow story such as debt constraints or various coordination and risk reasons.  

Ireland climbed out of recession on Wednesday with the economy
returning to growth in the first quarter [2.7 percent], after suffering one of the
deepest downturns of any advanced industrialised economy.

Don't get too giddy with optimism: the Irish economy had declined fifteen percent.  Still, it's far too early to judge the Irish experiment in pre-emptive fiscal austerity to be a failure.  The full story is here.