Archive for the Category Eurozone


How bad is the Italian debt situation?

Tyler Cowen recently linked to a John Cochrane post, discussing Larry Kotlikoff’s views on public debt sustainability.  Here’s Cochrane:

(By the way, if you’re feeling superior and taking comfort that Europe will go first off the cliff, Kotlikoff disagrees. Europe’s debts are larger, but their social programs are better funded, so their fiscal gaps are much lower than ours. The winner, it turns out, is Italy with a negative fiscal gap. Answering the obvious question, Kotlikoff offers

“What explains Italy’s negative fiscal gap? The answer is tight projected control of government- paid health expenditures plus two major pension reforms that have reduced future pension benefits by close to 40 percent.”Don’t get sick or old in Italy, but perhaps buying their bonds is not such a bad idea.)

I am a bit skeptical of that claim; so I decided to check with God, er . . . I mean I decided to check with the ultimate arbiter of truth, the asset markets:

Screen Shot 2017-04-24 at 4.13.10 PMAs you can see, Italian 10-year bonds offer considerably higher yields than German, French and Dutch bonds, and even higher yields than Spanish bonds. Italy has a massive public debt (third largest in the world), an economy that has shown almost no growth since 2000, and a very dysfunctional political system (which the voters recently decided not to reform.)

I greatly respect Kotlikoff, and even more so John Cochrane.  But I respect the markets far more than any mere mortal.   So unlike Kotlikoff and Cochrane, I remain relatively pessimistic about the Italian debt situation.

PS.  I am back from 5 days in Turks and Caicos (is there a law in the Caribbean mandating nothing but Bob Marley music at resorts?), and I am starting to get caught up.

I have a new post on Bretton Woods as an example of the guardrails approach to policy, and another post commenting on the French elections.

My guardrails post is intended to address tiresome criticism of NGDP targeting by people who have never bothered to actually read what I have written on the topic. No, neither the current lack of interest in NGDP futures trading nor the risk of market manipulation pose any kind of problem for the system I am actually advocating.  (Unless you believe, “Bretton Woods could not possibly have worked because speculators would have manipulated the market.”)

It was not “inability”

Over at Econlog, I have a post discussing Bernanke’s views on price level targeting.  Here I’d like to nitpick a couple passages from Bernanke’s post:

As price-level targeting and “make-up” policies are closely related, they could be combined in various ways. For example, by promising to return the price level to trend after a period at the zero lower bound, the Fed could use the language of price-level targeting to make precise its commitment to make up for its inability to respond adequately during the period when rates are at zero.

It was not inability to cut rates that prevented the Fed from acting after Lehman failed in September 2008.

It was not inability that caused the Fed to raise the interest rate on reserves in October 2008.

It was not inability that caused the Fed to refuse to cut rates to zero in November 2008.

It was not inability that caused the Fed to refuse to do negative IOR, when Sweden adopted the policy in 2009.

It was not inability that caused the Fed to prematurely end QE1 in late 2009.

It was not inability that caused the Fed to prematurely end QE2 in mid-2011

It was not inability that caused the Fed to prematurely talk about tapering in 2013.

It was not inability that caused the Fed to prematurely raise rates in 2015.

Now Fed policy is roughly appropriate.  But it was obviously too contractionary for many, many consecutive months and years, just as had been the case in Japan.  Just to refresh your memories, Bernanke’s paper that criticized the BOJ on almost precisely the same grounds as I criticized the Fed was entitled:

Japanese Monetary Policy:  A Case of Self-Induced Paralysis?

And the answer he gave was a resounding yes.  That’s not to say the Fed’s job is easy.  I might have done no better than Bernanke, if I were in his shoes.  There are all sorts of political pressures within the Fed and also from the outside.  It’s a very hard job.  But it’s never about inability; it’s about the Fed’s willingness to do whatever it takes.  It’s willingness to show what Bernanke once called “Rooseveltian resolve”.

One other quibble:

Support for a higher inflation target seems to be increasing along with worries about the ZLB. In a recent post entitled “The case for a higher inflation target gets stronger,” Stephen Cecchetti and Kermit Schoenholtz cite four arguments in favor:

  1. the persistent decline in normal interest rates;

  2. findings (like those of KR) that the frequency and severity of future ZLB episodes may be worse than previously thought, even given the low level of normal interest rates;

  3. some evidence, drawn from a study of the 1970s, that the costs of higher inflation might be less than previously believed; and

  4. calculations that suggest that standard inflation measures may overstate actual increases in the cost of living by more than had been understood.

I don’t have a big problem with this, but I don’t really like point four.  If higher inflation is a good idea, it has nothing to do with the fact that “standard inflation measures may overstate actual increases in the cost of living”.  There are several theories about the welfare cost of inflation, but none of them hinge in any way on the question of whether the BLS properly accounts for quality changes, or the substitution effect, or the new product effect.  The welfare costs of inflation have to do with things like menu costs for adjusting prices, or excess taxation of capital income when inflation is high.  Point four creates the misleading impression that economists want to control inflation so that consumers will benefit from a dollar that loses 2% of its purchasing power each year in terms of . . . what?  Utility?

I also disagree with this:

Second, although quantifying the economic costs of inflation has proved difficult and controversial, we know that inflation is very unpopular with the public. This may be due to reasons that economists find unpersuasive—e.g., people may believe that the wage increases they receive are fully earned (that is, not due in part to prevailing inflation), while simultaneously blaming inflation for eroding the purchasing power of those wages.

The thing that is unpopular with the public is called “inflation” by the man on the street, but it has nothing to do with inflation as defined by economists.  I talk a lot about how the American public in 1990 thought inflation was higher than in 1980.  But an even better example occurred in Europe, where polls showed that Europeans believed that inflation jumped dramatically after the euro was introduced.  I had European students tell me this with a straight face, back when I taught at Bentley.  I’m not sure what Europeans were annoyed about in 2002, but it was not “inflation” as the concept is understood by economists.  We need to stop trying to please a deeply confused public that doesn’t understand our terminology, and instead produce a macroeconomic environment with stable NGDP growth, stable growth in incomes, and stable employment growth.  They liked it in the 1990s, and they would like it now.

I vaguely recall reading that there were more complaints about inflation than deflation during the Great Depression.  (Can someone confirm?)

PS.  Here’s today’s headline from the FT:

Sign ‘Trumpflation’ sputtering as consumer prices fall

I’m still skeptical of the Trump reflation story.  Monetary offset is still in place, and supply side gains are likely to be a couple tenths of a percent at best, assuming he can get anything through Congress.

HT: rtd

About that eurozone “liquidity trap”

Just a year ago, Keynesians were telling us that the eurozone was stuck in a “liquidity trap” and that the ECB was “out of ammo”.  Instead, Europe needed fiscal stimulus.  Now markets are predicting that the ECB will raise rates within the next 12 months:

Screen Shot 2017-03-07 at 9.12.20 PMObviously if the eurozone actually were stuck in a “liquidity trap” then it would be absolutely insane to raise interest rates this year.

For years I’ve been arguing that the sluggish NGDP growth we see in many developed countries is due to contractionary monetary policies.  Central banks are perfectly capable of delivering faster NGDP growth, they simply don’t want to.

Prediction:  Even as the ECB raises rates, we’ll still hear from the usual suspects that “fiscal austerity” is the problem, even though the US has done just as much austerity over the past 5 years, if not more.

Suggestion:  Those who don’t think the supply side of the economy is important should take a look at Germany and Greece, both operating under the exact same monetary policy.


Greg Ip on trade imbalances and demand

Ramesh Ponnuru sent me a WSJ article by Greg Ip:

If workers lose their jobs to imports and central banks can’t bolster domestic spending enough to re-employ them, a country may be worse off, and keeping those imports out can make it better off.

This occurs only in certain conditions, says a new paper by Harvard University’s Larry Summers and two co-authors, but those conditions may now be present.

Mr. Summers, a former Treasury secretary, is no protectionist and no fan of Mr. Trump, whose election, he warns, could lead to recession in the U.S. and financial crisis abroad. But he does worry that chronically weak demand could make protectionism both respectable and irresistible.

Others, such as New York Times columnist Paul Krugman and Michael Pettis at Peking University have already noted how in a world with too little demand, one country’s trade surplus inflicts unemployment on the country with a deficit.

Even if Summers, Krugman and Pettis are correct (and I think they are wrong) the argument does not apply to the world we live in today.  Thus Greg Ip is mistaken when he says “but those conditions may now be present.”  They are not.

Let’s start with the US.  The US is not at the zero bound, and the Fed is expected to raise rates in a few days because they think that failing to do so would result in excessive AD.  So if protectionism somehow miraculously boosted AD in the US, the Fed would simply raise rates even faster to prevent any stimulative effect on AD.

Now it’s true that the Eurozone and Japan are both at the zero bound.  But both economies have very large current account surpluses, so obviously trade deficits are not depressing output in those two regions.  Even very depressed areas such as Italy run surpluses.

In fact, unemployment has almost nothing to do with trade “imbalances” (a term I hate).

Update:  Dilip sent me the following, from Jared Bernstein and Dean Baker:

In this context, the trade deficit was subtracting from demand in the domestic economy. Spending that could have employed people who needed jobs in the U.S. was instead employing people in Germany, China, and other countries from which America imports goods and services. In principle, the U.S. government could have looked to spur other channels of demand to offset the trade deficit, but as a practical matter this is often not easy to do: The most straightforward way to generate demand is through additional government spending, but there are major political obstacles to running large budget deficits even at times when it would be beneficial to the economy.

No, the most straightforward way to boost demand is to adopt a more stimulative monetary policy.  But that won’t happen because the Fed currently thinks it’s better to slow the growth in demand by raising its target interest rate.  (And they may well be correct.  The consensus of private sector forecasters was that we were roughly on target for 2% inflation, even before the recent bump up in TIPS spreads):


Is Europe moving away from austerity? Will it matter?

Here’s a NYT headline:

Europe May Finally End Its Painful Embrace of Austerity

And here’s the claim:

As Europe has grappled with the trauma of a devastating financial and economic crisis, policy makers have consistently relied on one approach to managing the damage — budget austerity.

Shrink government spending by trimming pensions and cutting social programs, the logic runs, and the markets will gain confidence in the tough-minded people in charge. Confident markets make for happy markets. Money will pour in, and good times will roll.

Even as prosperity has remained painfully elusive across much of Europe, leaders have time and again renewed their faith in the virtues of this harsh medicine.

Until now.

Some policy makers are flashing tentative signs that they may be prepared to slacken their grip on public coffers to spur growth and improve the lot of ordinary people suffering joblessness and diminished wealth. In the clearest sign of this shift, the heavily indebted Italy is increasingly inclined to challenge Germany — the guardian of austerity — to loosen European purse strings.

Of course everything is relative, and European fiscal policy has not been particularly austere.  But even so, can we assume that a slackening of “austerity” will boost growth? Veronique de Rugy of the National Review reports:

The Congressional Budget Office recently released its Monthly Budget Review for September 2016. It includes a revised estimate of the deficit for 2016. It isn’t much different than the one projected in August. The document makes it hard to ignore that in 2016 the deficit grew by $149 billion, from $439 billion in 2015 to $588 billion at the end of FY2016. This explains why we haven’t heard president Obama brag about how the deficit is shrinking in a while.

Normally the deficit falls during expansions.  How did the economy respond to this loosening of “austerity”?  RGDP growth slowed to less than 1.3% during the past four quarters, as the Fed tightened policy.  As a result of our foolish fiscal policy, fiscal authorities will now have less room for “stimulus” during the next recession, as the deficit will be starting from a higher base.  Of course this will come as no surprise to readers of this blog.  The austerity of 2013 (when the deficit plunged from about $1,050 billion to about $550 billion between calendar year 2012 and 2013), coincided with an increase in GDP growth. But like Chicago Cubs fans, Keynesians never give up hope.

Now let’s look at the UK:

Before the June 23 vote for “Brexit,” the man in charge of the budget, the chancellor of the Exchequer, George Osborne, was publicly pursuing the aim of delivering a budget surplus by 2020. The target required cuts.

But as the political class absorbed the ballot result, interpreting it as a demand for redress from communities reeling from high unemployment and wage stagnation, Mr. Osborne acknowledged that his goal could no longer be achieved.

His successor, Philip Hammond, has raised the ante.

In a speech at an annual gathering of the governing Conservative Party on Monday, the new chancellor declared that the government would borrow more to finance new infrastructure projects — presumably creating construction and manufacturing jobs.

While reading this, I spied a link in the right column, to another NYT story, this one from May 25th:

‘Brexit’ Could Spell More Austerity for Britain, Study Warns

That’s pretty scary, but could the prediction be trusted?  The NYT says yes:

LONDON — Prime Minister David Cameron’s campaign to keep Britain in the European Union was bolstered on Wednesday by a report from one of the country’s most authoritative economic research bodies, which concluded that a withdrawal from the bloc would lead to up to two more years of public spending cuts or tax increases.

A frequent critic of government economic plans, the research body, theInstitute for Fiscal Studies, this time delivered some welcome news for Mr. Cameron.

Of course it could be trusted (the NYT signals), it came from “one of the country’s most authoritative economic research bodies”, which is also “A frequent critic of government economic plans”.  So we aren’t talking about one of those nutty right-wing outfits, like the Adam Smith Institute or the IEA.

NYT readers never need fear leaving their cosy intellectual cocoon, where fiscal stimulus produces growth miracles, and a continent where governments spend 50% of GDP is struggling because of “austerity.”  Yes, the Trumpistas are even worse (and also oppose austerity), but then I don’t expect much from the “stupid party”. I do expect more from the Times.