Living in Terror of Dead Economists

Kenneth Rogoff has a piece on the Project Syndicate that is revealing of today’s intellectual climate. What does he say?

1. The eurozone problems are structural, and stem from a monetary and economic integration that was not followed (I’d say accompanied) by fiscal integration (a federal budget to be clear). Hard to disagree on that
2. Without massive debt write-downs, no reasonable solution to the current mess seems feasible. Hard to disagree on that as well
3. Some more inflation would be desirable, to bring down the value of debt. Hard to disagree on that as well.

In a sentence, intra eurozone imbalances are the source of the current crisis. Could not agree more…

Unfortunately, Rogoff does not stop here, but feels the irrepressible urge to add that

Temporary Keynesian demand measures may help to sustain short-run internal growth, but they will not solve France’s long-run competitiveness problems [...] To my mind, using Germany’s balance sheet to help its neighbors directly is far more likely to work than is the presumed “trickle-down” effect of a German-led fiscal expansion. This, unfortunately, is what has been lost in the debate about Europe of late: However loud and aggressive the anti-austerity movement becomes, there still will be no simple Keynesian cure for the single currency’s debt and growth woes.

The question then arises. Who ever thought that a more expansionary stance in the eurozone would solve the French structural problems? And at the opposite, why would recognizing that France has structural problems make it less urgent to reverse the pro-cyclical fiscal stance of an eurozone that is desperately lacking domestic demand? Let me try to sort out things here. This is the way I see it:

Who’s Rebalancing

Just a quick note. The two largest surplus economies have lately decided to take radically different paths.  China expressed concern for the imbalances lying behind its large current account surplus, and pledged since at least 2009 to re-balance its growth model towards higher domestic demand. I had already discussed that a little more than one year ago, noticing how the challenge for China was to steer away not only from exports, but also from excessive investment. In the same piece I had argued that while China seemed fully conscious of its contribution to the global imbalances that had led to the crisis, Germany had decided to walk the opposite path.

And here we are. With  timely synchronization, we learn that wages in Bavaria will increase  by 5.6% over the next two years,  maybe triggering a more generalized increase. Or maybe not. While in China they increased 17% in the year 2012.

Even taking into account differences in inflation and in growth, the difference is revealing. China is actually playing the game it committed to. Not only it tries to reduce its dependence on foreign demand; but, domestically, it is trying to boost consumption and to curb investment.

In the meantime Germany is stuck with its small-country syndrome: export-led growth and restraints to domestic demand (both public and private). In spite of recent troubles, austerity remains the course Europe is following (with disastrous results). It is telling that even when partially acknowledging that austerity did not bring the fruits she hoped for, Angela Merkel can only suggest, as an alternative, structural reforms to boost competitiveness. Expanding domestic demand has not, is not, and will not be an option for the German government.

The Berlin View is alive and kicking.

Raepetita Iuvant

Yesterday Eurostat published  growth flash estimates for a number of EU countries. As expected, they do not look good. In 2013 Q1 the eurozone has lost 1 per cent of its GDP with respect to the first quarter of 2012 (-0.7 for the EU 27). It is the longest recession since the inception of the single currency, and it brings with it record unemployment at 12.1 per cent.

Not surprising, I said, because in spite of increasing talks about softened austerity, austerity ain’t over. In many countries, government final consumption in real terms (the G in national accounting equations, just to be clear) sharply decreased. And this is, surprise, correlated with subsequent growth:

Countercyclical no More

Browsing national accounts may be an inexhaustible source of insight on the current debate about austerity. Take this figure, which shows the evolution of real GDP and of its components for the US and the EMU, making the first quarter of 2008 equal to 100.

I tracked in particular the evolution of private (consumption plus investment) and public expenditure on good and services.

It Ain’t Over ’til It’s Over

Update: just a link to Wolfgang Munchau, who seems to make a similar argument.

Austerity partisans had a couple of rough weeks, with highlights such as the Reinhart and Rogoff blunder, and Mr Barroso’s acknowledgement that the European periphery suffers from austerity fatigue.
In spite of the media trumpeting it all over the place, and proclaiming the end of the austerity war, it is hard to believe that eurozone austerity will be softened. Sure, peripheral countries will obtain some (much needed) breathing space. But this is neither a necessary nor a sufficient condition for a significant policy reversal in the EMU.

Cockroach Ideas and Weak Arguments

Helene Mees in a Project Syndicate Comment weighs into the dispute between Paul Krugman and the Commission officials, siding with Rehn and his people.
Mees’ criticism of Krugman is two-sided. First, she argues, Krugman omits to say that the OMTs program is subject to heavy conditionality, and that the signature of the fiscal compact was a necessary precondition for the adoption of the program. I don’t get it. The ECB is very vocal on austerity and on structural reforms, and it is clear that the OMTs program was adopted only at the very last minute, facing the perspective of eurozone collapse. A number of economists, including myself, welcomed the OMTs while criticizing the heavy conditionality attached to it. The very fact that the OMTs was reluctantly adopted shows that even austerity partisans cannot deny the fact that the EMU is desperately lacking a proper lender of last resort, of which the OMT is a pale surrogate. The more non-Keynesian institutions are forced to adopt Keynesian solutions, the more Krugman’s point is vindicated. I fail to see how the opposite could be true.

The Commission on Portugal: Is This for Real?

A quick note on Portugal. Let’s start from three facts:

• Austerity did not work. Portugal is in a recessionary cycle. The economy will shrink by 2.3 per cent this year, more than twice as much as the previous government forecast (and the slowdown of exports to the rest of the eurozone, is not helping).
• Austerity is self defeating: the deficit-to-GDP ratio widened from 4.4 per cent in 2011 to 6.4 per cent last year, and is forecasted to be 5.5 per cent in 2013. Far above the target of 3 per cent that the government had agreed with the Troika. My guess is that it will be even larger than that.
• The magic wand of confidence is not magic. The budgetary cuts did not boost private spending, and expectations remain gloomy. The Financial Times article cites the Portuguese daily Público writing “Portugal has entered a recessionary cycle. People have no reason to believe the future will be any better. The [adjustment] programme has failed and has to be changed.” So long for the confidence fairy…

Is this surprising? Not at all. Austerity is likely to be recessionary and self-defeating, when a number of conditions are met. (a) Monetary policy is at the zero lower bound, and cannot compensate the recessionary effects of budget cuts with interest rate reductions. (b) Trading partners are also in a slump (and/or they are also implementing austerity measures), and hence exports can not substitute for decreased domestic demand. (c) The private sector is deleveraging, and subject to a credit crunch.

Wishful Thinking

Yesterday I published a note on OFCE le blog (in French), analyzing one possible outcome of the recent Italian elections: A center-left minority government, with external support of the Cinque Stelle movement led by comedian Beppe Grillo. The last part of the post argues that if a convergence between the Democratic Party and Beppe Grillo were to be found (at the moment the scenario is rather unlikely), it would happen on a number of progressive issues, like for example minimum citizenship income. But then, I conclude, this has implications for Europe as a whole. Here is a translation of the last paragraphs: It is clear  that the convergence could hardly happen within the bounds of the current fiscal consolidation. An agreement would therefore need a prior reversal of austerity that, it is worth repeating, was disavowed by the voters. This would not be easy for the Democratic Party that, like the Socialist Party in France, made the choice of fiscal discipline, and has kept a very ambiguous position along all the electoral campaign. But in turn, this has implications for Europe as a whole. European leaders in the next weeks may face a choice between demanding that Italy stays the course of fiscal consolidation, condemning the third economy of the eurozone to political paralysis and probably social chaos; or, accept that a new government is formed, that will most likely abandon austerity.  In both cases it will be impossible to act as if nothing had happened. Europe could be forced to rethink its own economic strategies, that are failing not only in Italy. An some countries reluctantly embracing fiscal consolidation (France to name one) could take the opportunity to challenge austerity as the only policy for growth.

Let’s be clear, here. I am totally aware that at the moment this is nothing more than wishful thinking. But hey, you never know…

It’s the Denominator, Stupid!

This weekend’s news was the downgrade of the UK by Moody’s. Chancellor Osborne took this as a sign that austerity should be strengthened even more, probably because he had little choice (never put all your eggs in one basket…). And yet, if only somebody in Downing Street bothered going through the text, they would have read this:

The key interrelated drivers of today’s action are:
1. The continuing weakness in the UK’s medium-term growth outlook, with a period of sluggish growth which Moody’s now expects will extend into the second half of the decade;
2. The challenges that subdued medium-term growth prospects pose to the government’s fiscal consolidation programme, which will now extend well into the next parliament;
3. And, as a consequence of the UK’s high and rising debt burden, a deterioration in the shock-absorption capacity of the government’s balance sheet, which is unlikely to reverse before 2016.

Thus, Moody’s analysts clearly state the direction of causality:

Surprise! Spillovers Exist!

Eurostat GDP data are out. The eurozone is in recession, and it is worse than expected (-0.6% in 2012). Austerity is not working, and is recessionary. Wow, who would have said it…

Seriously, so long for the widespread optimism of a few weeks ago. The crisis is not over, we actually are in the middle of it. The way I see it, things will get worse before they get better (if they do get better).

Also interesting, Germany’s export-led growth strategy is  panting. The fourth quarter of 2012 was rather bad (worse than in France, for example), and this is due to lower investment on one side, and to weaker trade (exports fell more than imports). Here is an excerpt of today’s press release of the German statistical office, Destatis:

In a quarter-on-quarter comparison (adjusted for price, seasonal and calendar variations), signals from the domestic territory were rather mixed according to provisional calculations: household and government final consumption expenditure went up slightly. In contrast, gross fixed capital formation in construction decreased a bit and gross fixed capital formation in machinery and equipment was down markedly on the third quarter of 2012. The decline of the gross domestic product at the end of 2012 was mainly due to the comparably weak German foreign trade: in the final quarter of 2012, exports of goods went down much more than imports of goods.

Germany stubbornly refuses to accommodate austerity in the periphery with a domestic impulsion. This makes adjustment for the rest more painful, and impacts expectations at home. This is why investment dropped significantly. My take on this is that if Germany had been only moderately more expansionist at home, expectations would not have been dashed (even if slightly increasing, in January the IFO index of German business confidence stagnates at around 104 at the moment, after hitting an all time high of 115.40 in February of 2011). And investment figures would be substantially better.

So, we learned today that austerity does indeed reduce growth, and that it spills to other countries. Two surprises in one day. It will need a hell of an effort to forget all of this before tomorrow!