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Blogging the Zombies: Expansionary Austerity – Reanimation

December 20th, 2011

<h3>Expansionary Austerity – Reanimation</h3>

 

The idea of expansionary austerity first emerged in the early 1990s, in the context of the formation of the eurozone. The creation of a monetary union between countries with no capacity to undertake a co-ordinated fiscal policy was seen as requiring convergence on a more conservative fiscal stance than had been possible during the chaos of the 1970s and 1980s. The agreements made at Maastricht in 1992 , and later formalised at the Growth and Stability pact required countries wishing to join the eurozone to hold deficits below 3 per cent of GDP and public debt below 60 per cent Check

With unemployment still high in many European countries, there was some reluctance to implement the austerity measures required by the Maastricht criteria. So, there was a lot of interest in analyses claiming to show that austerity could, in fact, be expansionary.  A series of such analyses were produced by Albert Alesina and a series of co-authors, most notably Silvia Ardagna.

Some of these papers provided econometric analyses, which tried to show that reducing government expenditure and budget deficits would lead to stronger economic growth. Statistical analysis is rarely as convincing as a good story, however, and the most influential work in this literature was a series of stories about individual countries, entitled ‘Tales of Fiscal Adjustment’ by Alesina and Ardagna.

Although this work had only a modest impact at the time it appeared, it but it become part of the thinking of many anti-Keynesians, particularly in Europe So, when European governments found themselves struggling with apparently unsustainable levels of public debt in the aftermath of the global financial crisis, advocates of austerity measures could argue that the policies they proposed would accelerate economic recovery.

This claim led to a re-examination of the econometric work undertaken by the advocates of expansionary austerity. Some of the most important work was done by the IMF and by one of Alesina’s former co-authors, Roberto Perotti.  The conclusions reinforced the common-sense Keynesian view that contractionary fiscal policy (that is, austerity) is contractionary in macroeconomic terms.

The IMF critiques convinced most professional economists, at least those open to empirical evidence. But what about the success stories told by Alesina and Ardagna. Such stories can’t be refuted by statistical analysis. Rather it’s necessary to examine the historical accuracy of the account that is offered. I decided to look at the story told by Alesina and Ardagna about my own country Australia. I expected to find points of disagreement, but I was surprised to find much more. The section on Australia is full of glaring factual errors, even though Alesina had spent time there as a guest of the central bank.

To mention just a few of the most glaring errors

* Alesina and Ardagna attribute the policy of austerity to a leftwing government elected in 1985. In fact, the government was elected in early 1983 at the depths of a severe recession. It implemented an expansionary policy. The recovery was well under way when the government took measures, beginning in 1984 to wind back the budget deficit

* Alesina and Ardagna assert that the main budget savings came from  “cuts in transfer programmes .. mainly concentrated on unemployment insurance.” Spending on unemployment benefits fell, but not because of cuts. The unemployment rate was falling and expenditure fell as a result. This is the standard Keynesian “automatic stabilisers” at work

* Most strikingly of all the write ‘Australia is a clear case of an‘expansionary fiscal contraction’. GDP grew faster during and in the aftermath of the adjustment, both in absolute terms and relative to the G7 countries. A private investment boom was associated with profits and easier access to credit following the financial deregulation process that took place in 1985–6.”

This is like the story of the man who jumps off a tall building and says, as he passes the 25th floor “All good so far”. Writing in 1998, Alesina and Ardagna must surely have been aware that, almost immediately after their story ends, Australia entered the worst recession in its postwar history. 

Australia’s recession was triggered by contractionary monetary policy, but its severity was largely due to the collapse of the investment boom, which was dominated by speculative investment projects undertaken by so-called ‘entrepreneurs’ who took advantage of financial deregulation to build conglomerate empires that failed in the crisis, almost taking down the banking system with them.  The Australian experience of the 1980s was a preview of what would happen in the US and Europe in the 2000s.

To sum up, the tale told by Alesina and Ardagna bears zero relation to the actual history of Australia in the 1980s. The most revealing point about their account is their eagerness to shift the burden of adjustment to a crisis onto its most vulnerable victims – the unemployed. The 1990s literature on expansionary austerity was a warning of what was to come after the global financial crisis.

The crisis and its aftermath

For a brief period after the eruption of the crisis in 2008, it seemed that everyone was a Keynesian.  With interest rates already at or near zero in most countries, the fear of disaster led governments of all political persuasions to engage in large-scale fiscal stimulus

The only exceptions to this trend were countries such as Iceland and Ireland where the financial crisis had resulted in the rapid collapse of an over-expanded financial sector.  Decisions to guarantee the debts of failing institutions, while perhaps inevitable, were disastrous for the fiscal position of the governments concerned. Public debt  increased massively and suddenly, leaving governments with with no room to stimulate the real economy through higher public expenditure and lower taxes.

Unsurprisingly, the combination of financial collapse and enforced fiscal austerity produced severe recessions, made more dramatic by the fact that the countries most affected were precisely those which had enjoyed unprecedented prosperity as a result of the financial sector boom. Conversely, Australia, where the domestic banking system remained stable, and a large-scale fiscal stimulus was introduced before the effects of the global crisis were felt, avoided recession altogether.

The experience of the crisis was entirely in line with the Keynesian analysis. Nonetheless, with the immediate danger of global economic collapse in the past, there was a substantial push to restore the status quo ante, in which fiscal policy played a marginal role. The key players here were central banks, for whom the era of inflation targeting had meant an immense increase in power and prestige. Despite having presided over the near-collapse of the financial system they were supposed to manage, and despite continuing double-digit inflation, central banks were keen to treat the crisis as a temporary aberration, with no lessons for the future.

Emblematic of this view is the widely-publicised statement of outgoing ECB President Jean-Claude Trichet at a press conference in September 2011 

⁠1I will say the following: first, we were called to deliver price stability! We were called on by all the democracies of Europe to deliver price stability and, in particular, of course by the 17 democracies that asked us to issue the currency in their 17 countries. We have delivered price stability over the first 12-13 years of the euro! Impeccably! Impeccably!  I would like very much to hear some congratulations for this institution, which has delivered price stability in Germany over almost 13 years at approximately 1.55% – as the yearly average of inflation – we will recalculate the figure to the second decimal. This figure is better than any ever obtained in this country over a period of 13 years in the past 50 years. So, my first remark is this: we have a mandate and we deliver on our mandate! And we deliver in a way that is not only numerically convincing, but which is better than anything achieved in the past.

 

http://www.ecb.int/press/pressconf/2011/html/is110908.en.html

Bad as the return to inflation targeting was, it did not imply a resurrection of the austerity policies that had failed so disastrously in the Great Depression. Although proposals for further discretionary stimulus met with increasing resistance, governments initially maintained a neutral or expansionary policy

All of that changed in early 2010 with the emergence of the Greek sovereign debt crisis. In … the major ratings agencies downgraded Greek government debt, beginning a downward spiral so steep that default became virtually inevitable. As of October 2011, the market prices of Greek bonds and credit default swaps implied a default probability close to 100 per cent, with likely losses of 60 per cent.

For many years, Greek governments had used a wide range of expedients to increase borrowing while appearing to remain within, or close enough to, the limits on debt and deficits set by the ‘Stability and Growth’ Pact under which the eurozone was established. A notable , and well-publicized, instance was a bogus currency swap set up with the assistance of Goldman Sachs.

http://www.spiegel.de/international/europe/0,1518,676634,00.html

The real story however, involved the big French and German banks. Under the Basel II system of financial regulation, they had been freed from prescriptive controls on the assets they were required to hold. Instead, they were required to maintain a low-risk portfolio, where risk was assessed by credit ratings agencies.  

This system encouraged banks  to hold AAA-rated assets, since these were considered as virtually riskless. Unfortunately, low risk usually means low return and banks were hungry for profits. So, there was a massive potential gain to anyone who could find a way of making risk invisible, producing a AAA-rated asset with the high return that risky borrowers were willing to pay.It was for this reason that European banks piled into the subprime derivatives created on a massive scale in the US, often raising the money to do so on the US wholesale market. 

Within Europe, the creation of the euro provided another way of adding risk while staying within the Basel II guidelines.  Bonds issued by eurozone countries with high public debt, such as Greece and Italy, carried a small but significant risk premium. On the other hand, for regulatory purposes, such debt was effectively treated as risk-free.

The role of the banks, and of the Basel II system was not immediately apparent (even now, the idea that European investments in subprime assets reflected ‘dumb bankers in Dusselsorp’ has a fair bit of currency. Instead, attention was focused almost entirely on the profligacy of Greek governments, … in the civil service and rampant tax evasion.

The real problems came when this analysis was extended to the rest of the heavily indebted periphery – commonly referred to in such accounts as the PIGS (Portugal, Italy, Greece and Spain) group, sometimes with Ireland thrown in as a second ‘I’. This was unfair and inaccurate, particularly as regards Spain and Ireland, which had been running budget surpluses in the years leading up to the crisis. Even Italy was reducing its ratio of debt to GDP, and adopting measures aimed at a gradual return to fiscal sustainability.

The fiscal crisis in these countries was driven by the need to bail out the financial sector, and by the collapse in revenues that resulted from the bursting of financial bubbles. In Ireland, for example, under pressure from the ECB, the government agreed to guarantee all the debts of the major banks, pledging  as collateral $20 billion euros from the National Pension Reserve Fund (the equivalent of the Social Security Trust Fund  in the US). Most of this money, and tens of billions more from other sources, appears to have been lost.

The injustice of making hospital workers, policy and old age pensioners pay for the crisis, while the bankers who caused it are receiving even bigger bonuses than before, is glaringly obvious. So, just as with trickle down economics, it was necessary to claim that everyone would be better off in the long run.

It was here that the zombie idea of expansionary austerity emerged from the grave. Alesina and Ardagna, citing their dubious work from the 1990s, argued … They attracted the support of central bankers, ratings agencies and financial markets, all of whom wanted to disclaim responsibility for the crisis they had created and get back to a system where they ruled the roost, and profited handsomely as a result.

The shift to austerity was politically convenient for market liberals. Despite the fact that it was their own policies of financial deregulation that had produced the crisis, they used the pretext of austerity to push these policies even further. The Conservative government of David Cameron in the UK [formally a coalition with the Liberal Democrats led by Nick Clegg, but Clegg has proved utterly ineffectual in all respects].

Although the term ‘expansionary austerity’ was not much used in the US, the swing to austerity policies began even earlier than in the US and Europe. After introducing a substantial, but still inadequate fiscal stimulus early in 2009, the Obama Administration withdrew from the economic policy debate, preferring to focus on health policy and wait for the economy to recover.

Meanwhile the Republican party, and particularly the Tea Party faction that emerged in 2009, embraced the idea, though not the terminology, of expansionary austerity and in particular the claim that reducing government spending is the way to prosperity. In the absence of any effective pushback from the Obama Administration, the Tea Party was successful in discrediting Keynesian economic ideas.⁠2 

Following Republican victories in the 2010 Congressional elections, the Administration accepted the case for austerity and sought a ‘grand bargain’ with the Republicans. It was only after the Republicans brought the US to the brink of default on its debt in mid-2011 that Obama returned to the economic debate with his proposed American Jobs Act. While rhetorically effective, Obama’s proposals were, predictably, rejected by the Republicans in Congress.

At the state and local government level, austerity policies were in force from the beginning of the crisis. Since they are subject to balanced-budget requirements, state and local governments were forced to respond to declining tax revenues with cuts in expenditure. Initially, they received some support from the stimulus package but, as this source of funding ran out, they were forced to make cuts across the board, including scaling back vital services such as police, schools and social welfare.

The theory of expansionary austerity has faced the test of experience, and failed. Wherever austerity policies have been applied, recovery from the crisis has been halted. At the end of 2012, the unemployment rate was above 8 per cent in the US, the UK and the eurozone. In the UK, where the switch from stimulus to austerity began with the election of the Conservative-Liberal Democratic coalition government in 2010, unemployment rose rapidly to its highest rate in 17 years. In Europe, the risk of a new recession, or worse, remains severe at the time of writing (December 2011).

Although the US economy shows some superficial signs of recovery, the underlying reality is arguably even worse than in Europe. Although unemployment rates have fallen somewhat, this mainly reflects the fact that millions of workers have given up the search for work altogether. The most important measure of labor market performance, the employment-population ratio (that is, the proportion of the adult population who have jobs) fell sharply at the beginning of the crisis and has never recovered (Graphs to come here).

 The reanimation of expansionary austerity represents zombie economics at its worst. Having failed utterly to deliver the promised benefits, the financial and political elite, raised to power by market liberalism has pushed ahead with even greater intensity. In the wake of a crisis caused entirely by financial markets and the central banks and regulators that were supposed to control them, the burden of fixing the problem has been placed on ordinary workers, public services, the old, and the sick.

With their main theoretical claims, such as the Efficient Markets Hypothesis and Real Business Cycle in ruins, the advocates of market liberalism have fallen back on long-exploded claims, backed by shoddy research. Yet, in the absence of a coherent alternative, their policy program is being implemented, with disastrous results.

 

 

 

1 The question referred to German concerns about the limited ‘quantitative easing’ undertaken by the ECB. It is striking that, three years into the deepest recession since the 1930s, Trichet is most concerned to defend himself against charges that he is not hawkish enough!

2 It’s worth observing that, although the Tea Party now claims to have been motivated by anger at the bailout of the banks, which took place under the Bush Administration, it did not begin to organize until after the inauguaration of Barack Obama. The precipitating event was a widely publicised rant by a Chicago commodities trader, Rick Santelli. Mr Santelli whose job would have disappeared if the financial system had not been bailed out was not, of course, complaining about the trillions of dollars spent to rescue Wall Street and its offshoots in Chicago and elsewhere. Rather, he was objecting to the much more modest help given to families who had taken out mortgages they could no longer afford to buy houses that had collapsed in value.

Posted via email from John’s posterous

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  1. James Haughton
    December 20th, 2011 at 10:58 | #1

    I query this bit “At the state and local government level, austerity policies were in force from the beginning of the crisis. Since they are subject to balanced-budget requirements, state and local governments were forced to respond to declining tax revenues with cuts in expenditure.”
    There’s no particular reason why state and local governments can’t borrow and run a deficit. The question is whether they have a good credit rating that will survive borrowing so that they can borrow at a reasonable interest rate, and whether, during a financial crisis, a national government or central bank is prepared to guarantee their debts, as the Australian commonwealth did for state debts during the GFC IIRC.
    Of course, as the contrast between bond prices in the UK, US, Japan on one side and Eurozone states on the other shows, whether you control your own currency significantly affects your creditworthiness, since those with a central bank can always pay their debts in nominal terms.
    Some mention of the fact that much of the Eurozone’s crisis is due to the refusal of the ECB to buy or guarantee member government debts might be made. As might the Financial Times’ characterisation of JC Trichet as Jack Nicholson in “A Few Good Men”.

  2. Andrae
    December 20th, 2011 at 17:09 | #2

    I feel the final sentence of footnote 2 understates the issue.

    “Rather, he was objecting to the much more modest help given to families who had taken out mortgages they could no longer afford to buy houses that had collapsed in value.”

    I would instead suggest:

    “Rather, he was objecting to the much more modest help given to families who had taken out mortgates they could no longer afford, to buy houses at prices inflated by the negligent lending practices of the major banking institutions, that had collapsed in value dispite earlier reassurances by people such as Santelli.”

  3. gerard
    December 20th, 2011 at 20:30 | #3

    “Writing in 1998, Alesina and Ardagna must surely have been aware that, almost immediately after their story ends, Australia entered the worst recession in its postwar history.”

    you mean writing in 1988?

  4. Jadams
    December 20th, 2011 at 23:52 | #4

    @James Haughton
    Actually, all except 1 US state may not deficit spend.

  5. Jadams
    December 20th, 2011 at 23:52 | #5
  6. Red
    December 21st, 2011 at 02:27 | #6

    Europe has a debt problem, sovereign debt. Eventually this will need to be addressed, and it’s obvious that time is now.

    Europe could take the Krugman road of creating more debt and delaying the problem (pretend there isn’t one) or it could start fixing the problem. Eventually though that decision will be made for it. With or without their consent.

    When you’ve pawned the lot, and not even the leg-breakers are willing to lend another cent, you’ve reached rock bottom and you’re forced to face your moment of clarity. I’d suggest it’s better for Europe to address the problem before that moment.

    Of course austerity measures will cause large parts of Europe at least a severe recession, perhaps worse. That’s unfortunately the price of lax monetary judgement. If they’re sensible they’ll learn the lesson for the future.

    A big night on the booze will surely mean a heavy hangover the next day. If a person told you to just keep on drinking to avoid it, you’d think of them as the classic idiot. Taking on more debt to cure a debt problem is exactly the same head in the sand stupidity.

    Forget ideology, only a fool would not advise Europe to begin taking debt reduction measures, and I’ve absolutely no doubt the same fool would’ve advised them not to take such measures ten years ago.

    Problems never just go away if you ignore them, they only get worse.

  7. John Quiggin
    December 21st, 2011 at 05:05 | #7

    Red, you’ve really been drinking the Kool-Aid, haven’t you. You’ve forgotten the global financial crisis already. With the exception of Greece, the debt problems Europe is now facing arise almost entirely from the bubble and bust. To take the most extreme example, Ireland, which is now undergoing extreme austerity, was running budget surpluses before the crash. The Irish debt crisis arises entirely from the bailout of the banks. The same is true to a greater or lesser extent of Spain, Portugal. Even Italy was reducing debt until the crisis.

    Europe’s main problem is that, unlike the US and UK, the ECB is unwilling to print euros (more precisely to expand the supply of base money) to deal with the unsustainable public and private debt created by the bad practices of the financial sector.

    The failure here has been one of central banks, not governments.

  8. WadeJ
    December 21st, 2011 at 07:24 | #8

    @Jadams
    The balanced budget amendments (at least here in Illinois) means that the interest has to be accounted, for, but it doesn’t mean the state can’t go into debt to run and expansionary budget.

  9. James Haughton
    December 21st, 2011 at 08:29 | #9

    Ah, OK. I interpreted JQ as saying there was a fiscal/economic requirement for states to balance their budgets, but in fact it’s a legal one. But of course, laws can be repealed or amended.

  10. Troy Prideaux
    December 21st, 2011 at 09:12 | #10

    Ok, dumb questions – the primary cause of the GFC was from massive asset devaluation eg. property devaluation from a bubble-bust situation? This basically resulted in a massive devaluation in the worth of the financial loans for those assets which effectively wiped billions if not trillions of dollars from the financial institution’s books? That money just disappeared yes?
    So, essentially, a fair whack of that lost money needs to be replaced to both maintain the solvency of the financial system (as has been done by taxpayers) and to control economic decline?

    hummm… so essentially, the poor taxpayers and public servants loses valuation on their primary asset(s) and have to essentially bail out the banks and cop austerity measures on top. If this is the case (and I’ve likely got some wires twisted) I can understand why more money needs to be created to stimulate economic growth.

  11. may
    December 21st, 2011 at 11:54 | #11

    dumb question from the other side of the coin.

    the GFC was caused by price inflation/bubbles in house prices of USA ,pushed by too-easy loans that were aggregated then chopped into sections,then sold as backed by ratings agencies safe-as-houses securities?

  12. Tim Peterson
    December 21st, 2011 at 12:27 | #12

    @may

    The asset price bubble was not just in the US but also in Europe.

  13. Red
    December 21st, 2011 at 12:30 | #13

    John Quiggin, you can blame a number of things, and without doubt some will buy it. I know it’s a Sovereign debt problem (government debt) because the bond market tells me it is. Plain as a mirror shows me my face.

    Large parts of Europe have borrowed heavily for a long period to cover current expenditure, borrowing also to pay interest on past current expenditure borrowings. Included with such borrowing they’ve never halted in racking up future liabilities – to yes, be covered again by even more borrowing or at least an ill-defined miracle. The conclusion can only ever end at the same destination, no matter the path travelled.

    Europe could indeed print money (depreciate the asset), and bond holders will be forced to take the haircut. The majority of bond holders of course are European banks, which will indeed have some nasty flow-on effects. However, will future bond be so willing to take a possible future haircut? What happens if they’re not? Is a money printing exercise any real difference from a partial default?

    The more interesting question would be why Europe faces this situation whilst the USA isn’t at the immediate moment. The answer of course lay in that intangible thing known as investor confidence and sentiment. An intangible that Europe is finding out that can turn on a dime, and one that when it turns badly, it’s best to have the house in order.

    Europe doing anything other than taking austerity measures now, and that does include with all the ramifications that come with it, will be nothing more than delaying for an even worse future outcome. Personally I have stong doubts anyone from future investors to the future European generation is going to pick up that tab.

    There’s ideology and there’s pure irrationality (we’re almost there), it’s past time for Europe to stop talking and take its medicine.

  14. Tim Peterson
    December 21st, 2011 at 12:34 | #14

    @John Quiggin

    The architects of the Euro were very concerned that the central bank would be forced to accomodate defecits, that is why they introduced the debt/deficit criteria in the Maastricht agreement.

    Of course in the current situation a reasonable amount of quantitative easing by the ECB would not be inflationary, but the concerns of the founders of the Euro are still reflected in ECB policy. The ECB still has some short term interest rate ‘ammunition’, and maybe they will soften up on QE once this runs out as the short rate hits zero in the Eurozone recession next year.

    Britain is much better off outside the Euro!

  15. Troy Prideaux
    December 21st, 2011 at 12:52 | #15

    @Red
    “The more interesting question would be why Europe faces this situation whilst the USA isn’t at the immediate moment.”

    I’m guessing, because the US can & effectively has and is printing money to help pay for the bailouts and servicing that $15T (or whatever it is) debt?

  16. Red
    December 21st, 2011 at 13:04 | #16

    The banking bubble was created by governments. Governments skew an investment base.

    They do this by impositions on one classs of investment versus another. Europe for example by creating ridiculously high tax rates that penalise local workers and investors in such as manufacturing. They do this by creating arcane industrial relations conditions that have no reality in relation to competitors. They do this by not only encouraging sloth and ignorence, but by rewarding it at the expense of its opposite. etc, etc, etc.

    Europe was only going to have a future of smart high paying jobs, like banking. Just ask England. The Chinese and other assorted ignorents were going to pick up the slack with the crap stuff. These simples would be working long, hard, and dirty, whilst some Europeans “banked”, and the ever growing list of indolent happily lived of the fat.

    I do hope poor silly old Ken Henry is taking note of the results.

    Europe is now facing more than a financial crisis, it’s facing a crisis of its soul.

    BTW Central Banks (governments) control the money supply, you know, the stuff that banks used for their bad loans, the stuff you want to create more of. They also ipso facto control their banks due prudence.

    Who’s ultimate responsibility and fault was it again?

  17. Troy Prideaux
    December 21st, 2011 at 13:34 | #17

    @Red
    @Red
    “The banking bubble was created by governments. Governments skew an investment base. ”
    Ultimately the buck has to stop with governments and regulators. But I’m under the impression there’s more of a problem with the influence powerful interest groups can have on the process of government than skewing investment bases.

    “Europe for example by creating ridiculously high tax rates that penalise local workers and investors in such as manufacturing. They do this by creating arcane industrial relations conditions that have no reality in relation to competitors.”

    Could be true for parts of Europe, but I’d certainly swap our manufacturing productivity per capita with Germany’s.

  18. James Haughton
    December 21st, 2011 at 13:38 | #18

    Red, you ought to check the archives of this blog, where JQ shows that unemployment in Europe is lower than in the US, when you take into account the number of unemployed that each area locks up in jails. Or for that matter Krugman’s demonstration that productivity per worker-hour is the same in France and the US.; it’s just that the french work fewer hours, a standard work/leisure tradeoff that no economist could/should object to.
    For that matter, you should check a little economic history: Governments have never “paid off” their debts – They don’t need to do anything beyond pay the interest, which economic growth does for them. If they did, it would collapse the banking system as banks would lack bonds to hold, and cause deflation and recession as money was withdrawn from circulation. People who “loan to government”, that is, buy bonds, don’t want their loan paid back; they want a risk-free income generating security. Much Government debt as a % of GDP is at historic lows which is part of the problem.
    Furthermore, European state debt is not “sovereign” debt, because they don’t mint their sovereigns any more, the ECB does. The idea that US/Japan/UK bond prices are so much better than Europe’s because of “invester psychology” is silly – are investors Disney lemmings? Is the current US Congress with its constant 11th hour grandstanding on debt ceilings, taxes and special interest pandering that much more credible than the Italian government? Is Japan doing incredibly well compared to France? No, it’s because the sovereigns will never default – at worst they might devalue a little with inflation, but that’s hardly likely in a recession.

  19. Freelander
    December 21st, 2011 at 16:49 | #19

    @James Haughton

    You can’t really count those in jail because when they are out of jail most of them are self-employed and thus don’t contribute to the unemployment statistics anyway. The greater numbers who present as candidates for jail in the US is simply further evidence of that country’s relative abundance of entrepreneurial zeal. (Something, as we know, lacking in France because the French don’t even have a word for entrepreneur.)

  20. snuh
    December 21st, 2011 at 17:29 | #20

    Of course austerity measures will cause large parts of Europe at least a severe recession, perhaps worse. That’s unfortunately the price of lax monetary judgement. If they’re sensible they’ll learn the lesson for the future.

    i think you mean “fiscal” rather than “monetary” judgment. although, somewhat ironically, as written that is a correct statement.

    BTW Central Banks (governments) control the money supply, you know, the stuff that banks used for their bad loans, the stuff you want to create more of. They also ipso facto control their banks due prudence.

    kind of notably, in the euro zone the ECB controls the money supply, not “central banks (governments)” whatever that means. even though borrowing costs are rising for countries in the euro zone, this is not so in many other countries in europe (even ones with extremely high levels of taxation and inefficient (by your standards) labour regulations, like sweden). it is the euro/ecb that is facing “a crisis of its soul”, not europe at large.

  21. plaasmatron
    December 21st, 2011 at 21:45 | #21

    not sure where Dusselsorp is, or if the misspelling is intentional, but I think you mean Düsseldorf

  22. Freelander
    December 22nd, 2011 at 01:33 | #22

    @Red

    Yes. Have to agree with your logically consistent analysis. It is all the government fault. Markets are perfect and can process myriad information to achieve the best of all possible worlds but they do have one glaring weakness. Governments time and again and without any effort can pull the wool over their eyes, even unintentionally, and cause them to do the daftest of things. This of course, is hardly the fault of markets. No. Of course, government is to blame. Maybe we should just get rid of all governments. Just outlaw them. Um. Outlaw, would need to have a law to do that. Umm. How would that work?

  23. Red
    December 22nd, 2011 at 09:41 | #23

    James Haughton, actually Europe does have a “sovereign debt” crisis. Individual states may not print Euro’s, however they borrow individual to cover individual budgets. They do this on the debt market.

    I don’t think, in fact I’m sure, printing money has’nt helped the USA. Sure, it’s delayed the outcome, however that’s still to be seen. Certainly on the Q1 unemployment was promised not to go over 8%, wasn’t it? You can only print so much at any rate, people simply won’t invest in something they know will constantly be devalued at a later date.

    Most economists are hardly investors, certainly not Keynesian economists. Those that can’t do are unfortunately bound to teach. Which reminds me of a funny thing I heard about 12 months ago. When a certain fund manager in an interveiw was asked about one Paul Krugman and his “Noble theories”, he replied with a smile, we’re heavy gold, there should be more Krugman’s.

    Krugman marched into Japan about a decade ago, how “quantative easings” is it now?

  24. Freelander
    December 22nd, 2011 at 10:09 | #24

    @Red

    They don’t have to borrow on the debt market. As many have said they could borrow from banks at about 2 percent (amongst other things). The ECB is willing to lend banks so this is an easy way out and avoid the ECB’s irrational reluctance to lend to the countries directly in what has become an ugly crisis. As JQ has said repeatedly, the problem is solvable (in this and other ways). The problem is not a lack of solution(s); the problem is a lack of resolve to act to grasp one or any of these solutions.

    As for certainly not Keynesian investors… Well, Keynes was a different sort of economist investor, whereas Irving Fischer and later the Nobel Prize winners in Long Term Capital showed that they new how to lose money investing, Keynes showed that he knew how to make money. To non-dunderheads that might say something.

  25. Tim Peterson
    December 22nd, 2011 at 13:19 | #25

    The IMF blog has an article (http://blog-imfdirect.imf.org/2011/12/21/2011-in-review-four-hard-truths/) where Olivier Blanchard says:

    “Some preliminary estimates that the IMF is working on suggest that it does not take large multipliers for the joint effects of fiscal consolidation and the implied lower growth to lead in the end to an increase, not a decrease, in risk spreads on government bonds.”

    Food for thought!

  26. Tim Peterson
    December 22nd, 2011 at 13:34 | #26

    Some thoughts on expansionary contraction:

    If we are dealing with countries with floating currencies and where the zero lower bound on interest rates does not bind, then fiscal and monetary policies can be co-ordinated so that a fiscal contraction is (approximately) balanced in its effects on demand by lower interest rates. The net effect is expansionary over the medium run as investment is ‘crowded in’.

    This is theoritically possible at zero short interest rates via quantitative easing, but we don’t have good estimates of the effect of such a policy, so it is very hit and miss.

    Of course none of this applies to the original context that expansionary contraction came up in, the pre-Euro fixed exchange rate system in the EU as it was preparing for the Euro.

  27. reason
    December 22nd, 2011 at 20:12 | #27

    “Most strikingly of all the write”

    Should be they write.

  28. reason
    December 22nd, 2011 at 20:15 | #28

    @Troy Prideaux
    No you haven’t got anything wrong, that is how it really is.

  29. reason
    December 22nd, 2011 at 20:17 | #29

    @Red
    You should read Krugman – you are simply wrong about almost everything here. The key difference is who has there own currency (and so can print money to avoid default) and who doesn’t. And the austerity (medicine) is self-defeating – “the beatings will continue until you cheer up”.

  30. Freelander
    December 22nd, 2011 at 21:33 | #30

    Printing is a form of default and the capacity to solve debt problems by printing is grossly exaggerated in the minds of some. If you print to pay back a significantly sized debt, or even the interest payments on that debt, first, except in a liquidity trap, you have runaway inflation, second, your currency can collapse and perfectly good local companies may have their balance sheets destroyed if they have foreign debt, with wailing and gnashing of teeth all round, third, you may find it difficult to get anyone to buy any newly minted government bonds so unless you do some drastic fiscal policy contractions the printing press will need to move the economy into hyperinflation and Zimbabwe here you come. Greece is probably lucky to be in the Euro; one less policy instrument to abuse.

  31. Troy Prideaux
    December 22nd, 2011 at 23:00 | #31

    @Freelander
    That makes a lot of sense Freelander, at least for 95% of the cases where money doesn’t just disappear, however, in this particular case where it appears as though trillions of dollars have just disappeared off the face of the planet; then one would perhaps naively assume the risk of inflation by replacing some of that is low?

  32. James Haughton
    December 23rd, 2011 at 09:14 | #32

    @Freelander
    Explain, please, how significant quantitative easing by the US Fed, the UK Bank of England, and the Central Bank of Japan has completely failed to bring about any of the consequences you bewail here.

    PS At the risk of being seen to be as snarky as I in fact am, I think Red’s line “I don’t think, in fact I’m sure” will forever stand as the motto of Austrians and right-wing zombies everywhere. They don’t think, but they’re sure.

  33. Freelander
    December 23rd, 2011 at 12:06 | #33

    @James Haughton

    “except in a liquidity trap”

    The additions are not to paper money at the moment but to numbers in banks, like your deposits in your bank account are not paper money but are just numbers in an account. People and banks and business are scared and are not using a lot of money by either not lending it because they don’t trust that they will get it back or by not spending it because they wonder what the hell will happen. As a result money that is being put in the system by QE is not being used and not influencing prices or goods, services or assets.

    Same thing has been going on in Japan which has been in a rolling recession for about twenty years now.

    If we ever get back to normal times, in our lifetimes, the money introduced by something like QE will either fuel a rise in the CPI or asset inflation or both, and dramatic increases will lead to hyperinflation.

    As far as money on a large scale in normal times resulting in hyperinflation there are numerous examples. The times we are in at the moment are not ‘normal times’ at all. Everyone is sh*t scared and even those who might claim to know are highly uncertain about what will happen next. Humans in this type of situation behave quite differently to normal times. Humans in these times have a big demand for what Keynes called precautionary monetary balances. Holding on to a lot of extra money (if they are lucky enough to get it) as a safety blanket. That is why the extra money isn’t having much impact at the moment.

  34. Freelander
    December 23rd, 2011 at 12:08 | #34

    prices for goods, services or assets.

  35. may
    December 23rd, 2011 at 13:47 | #35

    Freelander :@James Haughton
    You can’t really count those in jail because when they are out of jail most of them are self-employed and thus don’t contribute to the unemployment statistics anyway. The greater numbers who present as candidates for jail in the US is simply further evidence of that country’s relative abundance of entrepreneurial zeal. (Something, as we know, lacking in France because the French don’t even have a word for entrepreneur.)

    but doesn’t USA have the largest prison population per of population in the world?
    and the corporate incarceration “industry” uses the inmates as low or no wage labour for a very large range of products that are sold in competition with products that are produced by waged labour?

    sold in a “perfect” market,prices can still be lower and profit margins higher for those goods sold by the incarceration “industry”.

    so how can this be not counted?

  36. Freelander
    December 23rd, 2011 at 15:18 | #36

    Of course the US has the largest prison population. In that great country entrepreneurial self-employment is everyones birthright with all grasping to get their fair share of the American Dream. Unfortunately there is still a heavily regulated crimes industry with many entrepreneurs not only suffering under red tape but literally bound with walls and chains. Not to worry; the next republican president will make nothing illegal. With total deregulation government sanctioned prisons will be empty as the their country moves to private provision of justice.

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