Various teaching links

1.  A banking union for the Eurozone.
2.  How the EU structures have to evolve with the Eurozone
3. Anton Jevčák, European Commission
   
   Did nominal exchange rate flexibility matter during the global recession? A Czech and Slovak case study 
    
4. Marco Buti and Nicolas Carnot, European Commission
   
   The debate on fiscal policy in Europe: beyond the austerity myth.  The EU defends its approach.
   
   5. Price and Cost Competitiveness - 3rd quarter 2012 and link to data, http://ec.europa.eu/economy_finance/db_indicators/competitiveness/data_section_en.htm.
   
5. Data on public opinion of the Euro.  October 2012 attitudes for Euro-area countries.  Seems like a lot of support in Greece still for example.
6. Remarkably prescient and clear review of the optoins for Monetary Union from Charlie Bean,, Economic and Monetary Union in Europe.  Clear statement of conditions for beneficial monetary union and the final conclusion, that fiscal policy will be too constrained, is very insightful.
7. A typically elegant and well-explained piece on debt by Mankiw and Ball.
8.  A great piece by Simon Wren-Lewis on fiscal councils.  To my view this is the key to the austerity argument.  Any government can raise public spending, what's much harder is to cut it again.  To those who say "we must use fiscal policy now, at the zero lower bound, with unemployed resources" they foget to then say "and when the economy has recovered we cut back on fiscal policy and use monetary policy".  That means the argument is about not austerity but the timing of austerity.  Do populations trust governments to cut back later?  I think the expenses scandal, hacking etc. has left people in the UK suspicious of politicians. So trust has fallen. So an expansionary then contractionary fiscal policy is just not credible (without some institutional fix). 
9. Brad De Long on Olivier Blanchard on macro models

10. Olivier Blanchard: Suppose you are writing two textbooks, one undergrad, one grad. In the undergraduate textbook, it seems to me that when teaching the IS-LM, we have the same interest rate on the IS and the same interest rate on the LM. Basically, the policy rate that the central bank chooses by the LM curve goes into the IS curve when corrected for expected inflation. I think what we have learned is that these [two interest rates] can be incredibly different. So I would have an r and an rb, and have a machine in the middle--the banking system which would, depending on its health, determine the spread. It seems to me that if I want to communicate one message, that message is what I would communicate to undergrads.

    
    I think De Long tries to write this type of model here and l  here. 
    
    I like this as a way of understanding those who favour austerity. As De Long says, the austerity argument is right in the Greek case, where the non-credible promise of more spending simply raises spreads and so crowds-out any possible rise in government spending.

Various teaching links

1. Competiton and collusion in beer

http://www.nytimes.com/2013/03/03/magazine/beer-mergers.html?hpw&pagewanted=all&_r=0


2.  Update on Ireland: does it show austerity is working?
http://blogs.ft.com/ft-long-short/2013/03/04/ireland-poster-child-for-austerity/

And Ireland v Greece.  

3.
A very good piece on bank capital requirements. Lets have them so that banks don't need a bailout. And they are not expensive.


To give a taste, the article links to a John Chochrane piece..


"Capital" is not "reserves," and requiring more capital does not reduce funds available for lending. Capital is a source of money, not a use of money. When, as Ms. Admati and Mr. Hellwig gleefully note, the British Bankers' Association complained in 2010 about regulations that would require banks to "hold"—the wrong verb—"an extra $600 billion of capital that might otherwise have been deployed as loans to businesses or households," it made an argument both "nonsensical and false," contradicting basic facts of a bank balance sheet. Requiring more capital does not require banks to raise one cent more money in order to make a loan. For every extra dollar of stock the bank must issue, it need borrow one dollar less.

Capital is not an inherently more expensive source of funds than debt. Banks have to promise stockholders high returns only because bank stock is risky. If banks issued much more stock, the authors patiently explain, banks' stock would be much less risky and their cost of capital lower. "Stocks" with bond-like risk need pay only bond-like returns. Investors who desire higher risk and returns can do their own leveraging—without government guarantees, thank you very much—to buy such stocks.

4 
Have millionaires left the UK due to top tax rates?  No, but they stashed $18bn away in a "one-off tax avoidance exercise".  

Various links

1.  Will QE lead to more inflation, paying negative rates on reserves and all that.  Tim Harford.

2. Bank Bonus are a symptom of the structural problems in banks.  John Authurs.

Do countries need to exit the Euro? Maybe not..

Charles Wyplosz writes about the Euro prospects here.  He makes the interesting point that countries in Eurozone have seen very high adjustments in relative unit labour costs even within the Euro.  The OECD economic outlook shows this

Various teaching links

Price gouging still with us
http://cheaptalk.org/2012/10/29/price-gouging/

Science key to growth
http://www.nytimes.com/2012/10/29/opinion/want-to-boost-the-economy-invest-in-science.html

World data visualisation
http://marginalrevolution.com/marginalrevolution/2012/10/visualization-data-for-world-development.html

Too big to fail still with us and what to do
http://economix.blogs.nytimes.com/2012/11/01/too-big-to-fail-remains-very-real/#more-157343

US recessions and the current US recovery

I wrote about the recession here for the UK. In the US, Krugman and Taylor are having an argument:

1. Taylor says the US recovery is very weak relative to that from other financial crises, and blames policy.
2. Krugman says this is politics and the US recession is just what you would expect from a financial crisis.

Reinhardt and Rogoff have this graph:




There are two questions:
 
Q1.  is the US recovery, starting from the bottom of the cycle, currently slower than the 1930s?
Looking at the slope of the 2007 line starting from the bottom of the V, it grows slower than the wide dotted line, but about the same/faster as the small dotted line.   As Jim Hess has correctly pointed out to me, correcting an earlier mistake, the wide dotted line excludes the 1930s, and the narrow one includes it.  So the 1930s must have been slower recovery and hence current recovery is faster.  Score one for Krugman.

Q2.  are US recessions, starting from the peak, longer to get back to the peak, when they are financial crises?  Yes they are, according to Reinhardt/Rogoff  comparing different recessions according to type.  Score one for them and Krugman.

So its two different questions being compared.

How to reduce public debt: lessons from history

How have countries in the past reduced their public debt?  By inflation? By spending cuts?  Most people would probably say inflation.  So what do we know?

Paul Krugman points us to Chapter 3 of the IMF World Economic Outlook entitled The Good, the Bad, and the Ugly: 100 Years of Dealing with Public Debt Overhangs".  It's really good.  Here's my take on it.

1. Public debt has reached very high levels





 2.  So what's to worry about?  The worry is getting on an unsustainable path so that the stock of debt relative to GDP rises too fast.  here's the formula that tells you how it evolves and so how to get it down:




where
b=Debt/GDP ratio
i = interest on the debt
pi== inflation
g = real GDP growth rate
d= primary deficit-to-GDP ratio.
and e an error due to accounting adjustments and the like (ignore this).

What do we learn from this?  I find it more instructive to write this as the change in b so we can see directly how the change in debt/GDP evolves.  this gives

change in b= (i--g)/(!+i-+g)b(t-1)+ d+ e  (ignoring some terms in g).  The bottom line of this is very close to 1, so let us write it as

 



So what?  Have a look at the co-efficient on b(t-1), the first bracket.

a. As a matter of maths, if the bracket very large then the change in b depends very much on last year's b. That's bad: it says, the more debt you had last year, the bigger the increase this year.  This comes from the effects of interest that accumulates the debt burden and growth that relieves the debt/GDP ratio.

b. If in fact the top line is zero, that would be good.  Last years' debt would have no impact on debt growth.  So the only thing that drives Db would be the deficit, if one controlled that all would be well.

c. As a matter of data it turns out that over most periods, guess what, the top line is zero.   That is to say, the real interest rate typically is about the growth rate.  Indeed, in good times, the real interest rate is below the growth rate, and so the debt burden can be cut just thru growth.

d. all this shows cutting the debt burden can happen in a number of ways

• low real interest rates. in turn that means
• low nominal interest rates and/or
• high inflation.  So you can see the scope for surprise inflation getting rid of the debt.
• high growth
• low primary deficit

So how in history did economies get out of their debt problems? The IMF pick a number of countries and periods and show this:



The top left is the UK between the wars.  They pursued a very tight money policy with high interest rates, lowed spending all in order to try to deflate their way back to the gold standard.  As the low blue panel shows, cutting spending did some of the work.  But tight money raised the interest rate, and low inflation meant high real interest rates, and all that worked against the reduction programme.  As did very slow growth.

Other countries have been trying different ways. The US in the 40s+ did it by inflation and some growth.  The Japanese are not cutting spending etc.

What do the IMF conclude?

For countries currently struggling with high public
debt burdens, the historical record offers both instructive
lessons and cautionary tales.

The first lesson is
that fiscal consolidation efforts need to be complemented
by measures that support growth: structural issues need to be addressed and monetary conditions
need to be as supportive as possible. In Japan,
for example, weaknesses in the banking system and
corporate sector limited monetary policy efficacy and
led to weak growth, which prevented fiscal consolidation.
As a result, debt continued climbing until these
issues were addressed. In Italy, Belgium, and Canada,
debt did not fall until monetary conditions were supportive.
Here, reforms to wage-setting mechanisms
that broke the wage-price spiral were an important
contributor to the establishment of the supportive
monetary environment. Furthermore, monetary easing
also fostered exchange rate depreciation, which
supported external demand and growth.

The case of the United Kingdom reinforces this
message but also offers a cautionary lesson for countries
attempting internal devaluation. The combination
of tight monetary and tight fiscal policy, aimed
at significantly reducing the price level and returning
to the prewar parity, had disastrous outcomes.
Unemployment was high, growth was low, and—
most relevant—debt continued to grow. Although
the price level reduction the United Kingdom was
attempting to achieve is larger than anything likely
to happen as a result of internal devaluation today,
similar dynamics are evident. A reduction in the
price level, a necessary part of internal devaluation,
comes at a high cost, and determining whether the
cost outweighs the benefit to competitiveness from
internal devaluation requires further work.

The case of the United States, although supporting
the general finding about the contribution of
monetary policy, points to more outside-the-box
possibilities. U.S. monetary policy was very supportive
in the immediate postwar years as a result of limits
on nominal interest rates and bursts of inflation.
This particular combination quickly reduced the
debt ratio while growth remained robust.

A second lesson is that consolidation plans
should emphasize persistent, structural reforms over
temporary or short-lived measures. Belgium and
Canada were ultimately much more successful than
Italy in reducing debt, and a key difference between
these cases is the relative weight placed on structural
improvements versus temporary efforts. Moreover,
both Belgium and Canada put in place fiscal frameworks
in the 1990s that preserved the improvement
in the fiscal balance and mitigated consolidation
fatigue.

A third lesson is that fiscal repair and debt reduction
take time—with the exception of postwar
episodes, primary deficits have not been quickly
reversed. A corollary is that this increases the vulnerability
to significant setbacks when shocks hit. The
sharp increases in public debt since the Great Recession—
including in the relatively successful cases of
Belgium and Canada—exemplify such vulnerability.
Furthermore, the external environment has been an
important contributor to outcomes in the past. The
implications for today are sobering—widespread
fiscal consolidation efforts, deleveraging pressures
from the private sector, adverse demographic trends,
and the aftermath of the financial crisis are unlikely
to provide the supportive external environment that
played an important role in a number of previous
episodes of debt reduction. Expectations about what
can be achieved need to be set realistically.

And the IMF make threee suggestions

Based on these lessons, we suggest a road map for
successful resolution of the current public debt overhangs

 First, support for growth is essential to cope
with the contractionary effects of fiscal consolidation.
Policies must emphasize the resolution of underlying
structural problems within the economy, and monetary
policy must be as supportive as possible.

Second, because debt reduction takes time, fiscal consolidation should focus on enduring structural change.

Third, while realism is needed when it comes to expectations about future debt trajectories and setting debt targets in a relatively weaker global growth environment, the case of Italy in the 1990s
suggests that debt reduction is still possible even without
strong growth.

All this goes to show how deeply endogenous all these relationships are.  To those calling for fiscal expansion, the reply is often "what will the markets think" i.e. that a rise in d might cause a rise in i which compounds the problem. Somehow if we are to have a Keynesian expansion we have to find a way to do it without raising interest rates: some new mechanism by which investor will trust future governments who promise to spend now that they will cut in the future.  As ususal then, the answer to our problems is innovation: we need some institutional mechanism that ensures spending either really will be cut later, or that spending does really enhance growth.

So the most obvious one would be to try for the latter. We have to have a policy that will help us have some growth: the lesson for the UK in the 1930s, as Krugman observes, was that the austerity was undone by slow growth.  That says to me that any increased spending should proritise the science budget and the internet (good for growth) and building housing (likewise).

Update.
 The always excellent Tim Taylor, Conversable Economist, blogs on this too. 
and the Maths of all this are well set out in Ley, 2010, Fiscal and external sustainability.