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:

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.

Stones Keep Raining

Paul Krugman  hits hard on one of the most cherished american myths, the golden years of Reaganomics. He shows that using the middle class as a benchmark (the median family income of the economy), the Reagan decade saw a disappointing performance; this, not only if compared to the longest expansion in post war history, during the Clinton presidency, but also with respect to the much less glorious 1970s.

But, maybe, Krugman is telling a story of inequality, and not of sluggish growth. The fact that median income did not grow much during the Reagan years may not mean that growth was not satisfactory, but simply that somebody else grasped the fruits.

For curiosity, I completed his figure with average yearly growth rates for two other series: Income of the top 5% of the population, and the growth rate of the economy.

Well, it turns out that Reaganomics yielded increasing inequality and unsatisfactory growth. And well beyond that, median income consistently under-performed economic growth in the past forty years.

What seems extremely robust is the performance of the top 5% of the population. Their income increased significantly more than output over the past decades. It is striking  in particular, how the very wealthy managed to cruise through the current crisis, when income of the middle class was slashed.

Nothing new, Ken Loach in 1993 said it beautifully: it is always raining stones on the working class. But I guess it does no harm to remind it from time to time…

Bringing Krugman to Europe

Well, not him, actually (I wish I could); I need to content myself with his latest post on austerity. Krugman argues that austerity is happening (it is trivial, but he needs repeating over and over again), showing that in the US expenditure as a share of potential GDP is back to its pre-crisis level (while unemployment remains too high, and growth stagnates).

I replicated his figure including some European countries, and with slightly different data. I took OECD series on cyclically adjusted public expenditure, net of interest payment. This is commonly taken as a rough measure of discretionary government expenditure. I also re-based it to 2008, as most stimulus plans were voted and implemented in 2009. Here is what it gives:

Austerity and Ideology

Wolfgang Munchau has another interesting editorial on austerity, in yesterday’s Financial Times. He argues that the US may become the next paying member of the austerity club, thus making the perspective of another lost decade certain.

Munchau’s article could be the n-th plea against austerity, as one can by now read everywhere (except in Berlin or in Brussels; but this is another story). What caught my attention are two paragraphs in particular.

Be Smart, Borrow More!

Larry Summers has a very interesting piece on yesterday’s Financial Times.

He argues that a few countries (the US, Germany, Japan, the UK; I would also add France) enjoy extremely low borrowing rates, both short and long run. In particular, real rates (nominal rate minus inflation) are negative or zero for maturities up to 5 years, and extremely low for longer ones.  Summers’ conclusions are then straightforward:

• Focusing on further quantitative easing is not particularly useful;  given the already very low rates, further reductions are unlikely to trigger private spending (it has a name: liquidity trap. And Paul Krugman has been insisting a lot on this, for example here)
• More importantly, government should borrow now, like crazy, taking advantage of the favorable conditions to reinforce their long term fiscal sustainability. This is what any reasonable CEO would do, and there is no reason why governments should act differently.

Summers makes a point that is almost obvious: Any project that has positive expected return would improve the country’s fiscal position, if financed with debt at negative real rates: This is the time for example to borrow to buy government buildings that are currently leased. Or to accelerate the rate of  replacement of aging capital; or again, to engage in long term infrastructure building/renovation. Makes sense, right? It makes so much sense, that chances are that it will not be done…

I would like to add two considerations. The first is to stress that to get private demand started, it is important that growth perspectives are stronger. Firms today do not invest, not because of borrowing costs, but because even at very low interest rates, expected demand is so low that investment is not profitable. The second is that, for Europe, increased borrowing in Germany, France and the UK would be crucial. Countries enjoying low rates could not only significantly improve their long term prospects, as Summers argues. They could also sustain demand in countries that are consolidating, thus favoring the rebalancing I have repeatedly argued for.

European Suicide

Not that he needs it, but I feel I must advertise this New York Times editorial by Paul Krugman, on the looming European catastrophe. As usual, it is masterly written. I just want to add one remark: The economic suicide of Europe happens because of ideological blindness. We are trapped in a doctrinal approach to economics and economic policy. There is nothing you can do against fundamentalism.

Should the title of this blog change from Gloomy to Desperate?

Go West and Take the Best

Paul Krugman has an interesting piece on federal and local expenditure in the United States, where he shows that the consolidated fiscal stance has been considerably more restrictive with Obama than during the Reagan era. This is not what retained my attention, nevertheless. Krugman does not mention that most of the US states (the exception being Vermont) have some form of balanced budget amendment. Krugman himself had warned a while ago that this made the task of the federal government in fighting the recession particularly hard. But once again, this is not the point I want to make.

Aliens to the Rescue

An excellent post by Paul Krugman on Germany’s flawed view of the Eurozone. He points to the obvious: unless we trade with Mars, it is plain impossible that all countries base their growth on exports. If the Germans want to sell their Mercedes to Italians, they need to be willing to buy our pasta (I feel so original…).

Germany’s success rests on other countries’ excess consumption, and on converging interest rates, that for a decade led to capital flows into the EMU periphery to finance consumption of German goods. In a sentence, and simplifying: without Greece, Germany would not be in place to lecture other countries today.

The least Germany could do is to give back something through an expansion of domestic demand that could make the adjustment in the periphery less painful. I had myself made this point a while ago. I also remember an old editorial by Martin Wolf that ended saying something like “If Germany wants the rest of Europe to be more German, it needs to be less German itself”. I Could not agree more…

Instead, German leaders and economists  spend their time perpetuating the false narrative of expansionary fiscal contractions, so well debunked by Krugman and De Long among others. The obvious does not seem so obvious to them…

I come back to my first post.  Solidarity and symmetry seem bad words in today’s Europe, but to me are the keys to the exit from the EMU crisis (and if you read Jean Monnet, the founding fathers had the same ideas…)

Paul Krugman on the End of the Euro

There is no need to write a post on the latest developments in Italy and in the eurozone. Paul Krugman says better than I could, how close we are to Armageddon.
There is only one very minor point of dissent, that for once makes me less pessimist than he is. I give more importance to the Italian internal factors than he does. If a solution is found to the current political turmoil, there may be a truce in the speculative attacks, and the spreads may go down to more manageable levels.
It remains true that without a rapid u-turn of the ECB, speculation will not be defused.