Time for a new tailor

It’s rare to take on Paul Krugman in an argument and win, and I agree with him most of the time anyway (these two facts are correlated!). So, this is the first time, and will probably be the last, when I can claim a win in such an argument.

Krugman has long criticised the eurozone on the grounds that it is not an optimal currency area and that the European Central Bank must therefore pursue an unsatisfactory “one size fits all” policy, too contractionary for economies that are doing badly and too expansionary for those that are doing well. Back in February, I argued that in fact ECB policy was “One size fits nobody” and that even Germany was vulnerable to its contractionary effects.

The latest statistics suggest that German growth was already stalling then. Today, Krugman is also pointing to a “one size fits none” policy.

At this point, it’s time for a suit of clothes, and that means a new tailor. And, in that respect, the bad news may have a silver lining.

The silver lining can be seen in today’s New York Times, which reports new proposals from Merkel and Sarkozy, pushing in the direction of fiscal union. They refer to a requirement for a “golden rule” balanced budget requirement to be enshrined in EU member constitutions. Assuming that the “golden rule” refers the standard interpretation of “budget balance over the cycle”, and not the crazy US Republican proposal for annually balanced budgets, this is, in essence the “hard Keynesianism” Henry Farrell and I have been pushing for some time. I haven’t yet read the fine print, but it’s hard to see how this proposal can be made acceptable to the periphery without an accompanying shift away from hardline austerity and monetary contraction in the short run. That means, in particular, overriding the opposition of the European Central Bank.

At the personal level, the impending departure of Jean-Claude Trichet provides the ECB with an ideal opportunity to dump his failed policies. His designated successor Mario Draghi (ex GS, and widely regarded as a Trichet clone) does not look promising, but he has both an ideal opportunity and some strong incentives to make a break with the past.

19 thoughts on “Time for a new tailor

  1. I am about to stick my neck out to have my head chopped off when I disagree on the description of the problem.

    1. ‘austerity programs’. The ECB has done an excellent job in getting the Berlisconi government announcing a 5% additional tax for 2 years on income between Euro 90,000 and Euro 150,000 and 10% on income greater than Euro150,000. This measure is directed at both, the national budget deficit and the growth in wealth inequality. ‘Hard Keynesian’ policies are insufficient to achieve this.

    2. ‘cycle’. IMHO, the GFC is not representable by a ‘business cycle’ and a counteracting budget cycle. Therefore ‘hard Keynesian’ measures are not sufficient to deal with the actual problem.

    3. The GFC reflects a fundamental problem in institutional design in the financial part of ‘the economy’ (financial deregulation was a big mistake and having rating agencies is inconsistent with a ‘competitive market’ because these unelected ‘agencies’ are price setters). Sarkozy and Merkel have agreed on a financial transactions tax and they want it to be introduced for all EURO countries. This measure is a step in the right direction regarding the nature of the problem.

    4. Greece is not a ‘peripheral country’ in the EU. Its significance in the cultural history of Europe cannot be measured in terms of macro-economic variables. One cannot cut off a crucial member of a complex society only because this member has a cash flow problem. Problems are there to be solved. What if Greece were to copy the ‘intellectual property right’ ideology of Google and Microsoft and Greece were to charge a fee for the usage of its letters world wide? Microsoft would have to pay a bit too.

    Is Greece’s apparent problem with financial accounting as significant as S&P’s and Moody’s problem in distinguishing the pay-off characteristics of debt and equity? I should say the answer is “NO”. Moreover, in contrast to S&P and Moody’s, Greece is not a price setter.

    5. I agree that ‘one size fits none’ but for different reasons.

  2. Rather than “Hard Keynesian-ism” I would probably advocate “”Empirical MMT-ism”. Not only is there no need for balanced budgets annually, there is not any prima facie case for balanced budgets over the full cycle (any cycle).

    The key would be to set the real unemployment goal at 2% (frictional unemployment); real unemployment meaning that under-employment, hidden unemployment and workforce discouragement are not ignored. Then government policy, regulation, a reserve employment force, a mimimum living wage and budget deficits/surpluses consistent with maintaining 2% unemplyment and about 4% to 6% inflation would be employed. This would likely mean a persistent moderate government net deficit over the long term.

    Higher taxes, higher pubic spending and government policy to ensure better equity across society would be required. These policies would work very well. That is why the plutocrats are so afraid of them. They know it would work and increase the overall well being of the greatest number but it would reduce the wealth, power and privilege of the top 1%.

  3. No currency area is ‘an optimal zone’, but that is really irrelevant because the advantages of a common currency far outweigh the aesthetic critiques provided by economists. The US has never been ‘an optimal zone’ either but their having a common currency has given them enormous benefits, and they would have had large benefits even if they had not become the reserve currency. One important benefit they have enjoyed both as a reserve currency and by being a large currency zone has been lower interest rates.

    One small country that has enjoyed lower interest rates is Switzerland, but this has been for a different reason. Switzerland has long specialised in specialist banking services, in particular, money laundering, tax evasion, and the ever helpful, looking the other way when money comes into their country from shady activities elsewhere. In one way, it is suprising that the rest of the world has let them get away with providing these, seemingly unhelpful, services for so long. But then, those services have been extremely beneficial to Western governments and the elites in a variety of countries, so maybe not so surprising at all. Even the Swiss are finding a need to synthetically join the Euro zone.

    The volume of nonsense that has been talked about ‘Europe’, the ‘EU’ and the ‘Euro zone’ over the years has been staggering. Unfortunately, often what has passed for analysis has simply been wishful thinking. Americans have been the worst in talking down the Euro, perhaps because, at least subconsciously, they recognise what America has to lose if people wake up and switch to the Euro as the global reserve. The British who still deam imagine an empire have been bad as well. Of course, they didn’t join because that would be an admission that the days of empire are over (never mind how long ago it was that they were over).

    Really, what type of idiot thinks the US Federal Reserve and the US Congress should be trusted, in preference to the ECB, when it comes to operating the world reserve currency?

    Europe and the Euro zone are having problems currently. There have been a few sources for those troubles including, deregulation of the banking industry, and deregulation more generally, and imported problems from the cowboy activities in the US unregulated finance industry.

  4. I like the cut of your jib, Ikonoclast. The capitalist system is intrinsically self-destructive, as we can see with the current global system collapse. Not only is the neo-feudal plutocracy that capitalism always ends up delivering (except when the Bosses are frightened by the spectre of socialism)morally pernicious and spiritually necrotic, but it is also immensely destructive. At the moment every life-sustaining system, from climate stability to biodiversity, fresh water resources, top-soil, oceanic health, fisheries etc, is in full collapse or nearing it. Why? Because the innate and inescapable priorities of market capitalism are profit maximisation and capital accumulation. Nature, in every shape and form, is an ‘externality’ to be ignored. The capitalists spend more money on mendacious PR telling us that everything is going smoothly, than they do on environmental protection or repair. To be concentrating so much attention on the detritus of the great financial larcenies and hubristic chicanery of recent decades as our planetary house burns down around us is insane. We must establish a steady-state economy, globally, without destructive growth (the metaphor of the cancer is inescapable) distribute wealth worldwide and labour, mightily and cleverly (and we’ll need luck as well) for generations, just to restore the health of the planetary biosphere and ensure our species’ future. To devise an economics that fits those absolute and undeniable necessities is the only fit work for the ‘dismal scientists’. Everything else is denialism and as pointless as re-arranging the antimacassars on the deck-chairs on the ‘Titanic’.

  5. William Black on the constraints imposed upon the peripheral countries by the core, and the opportunities for speculation compounding the political and monetary sludge:


  6. They refer to a requirement for a “golden rule” balanced budget requirement to be enshrined in EU member constitutions.

    What is said in constitutions is routinely ignored unless they enable and motivate concerned parties to take action in court and seek a remedy. So whilst I like the idea of such a rule I do wonder at what happens if it is ignored. I’d suggest a constitutional clause that allows taxpayers a proportional discount on their liabilities if the government fails to stick to the rule book.

    I’m a fan of EU monetary union but my support ends if they launch a Eurobond or get serious about a fiscal union. One of the nice things about the EU is that every nation get’s a veto vote on any changes to EU taxation.

    The solution in Greece is a debt default. The uncertainty will end when the default is done and dusted. The creditors may be wiped out but the economy won’t be and it will bounce back quick enough. And Greece won’t be able to borrow much after a default and so will be forced to balance the books. And of course people will be more cautions about lending to governments which would be a good thing.

  7. In constitutions what is written down is largely irrelevant; the interpretation is all important. The US of A has been, perhaps, the greatest example of this. Unwritten constitutions, where most have a very good understanding of what is unwritten, and what is, and isn’t consistent with the ‘tradition’ seem to have a better track record. This seems to have been a strength for the British ‘Constitution’. With an unwritten constitution, specious ‘interpretation’ is more difficult because so many ‘know’ what it means, so a specious reinterpretation is more likely to be howled down by protest.

  8. MMT proposition: “national government that issues its own currency can never become bankrupt in terms of liabilities accumulated in that currency”.

    By the same logic, individuals who issue their own currency IOUs can never become bankrupt in terms of liabilities accumulated in their own currency IOUs. With billions of currency denominations the question arises why bother with ‘money’ at all. Barter seems to be more ‘efficient’.

  9. @Ernestine Gross

    As long as those IOUs who have taken the IOUs have agreed to demand nothing else for their IOU except another IOU. That is, no convertibility into anything else has been pledge. However, although the individual doesn’t go bankrupt in this imaginary world, they might starve. Zimbabwe ended up finding it difficult to find anyone happy to exchange real goods and services for their currency and that is the sanction.

    I agree with you that the GFC is simply solved by Keynesian policies, however some of the understandable secondary impacts, the fall in consumption due to a fall in confidence, were to some extent address by those types of measure. Unfortunately, the real problems stemming from deregulation of the finance industry, the clear failure of the rating agencies, and so on, have yet to be adequately addressed. I suppose doing a 180 degree turn with the machinery of government where bureaucrats and politicians alike have been engaged in a remarkable homage to the magic of unfettered markets can not be expected to be a quick process, but they don’t even seem to have made a serious start. The activities of the finance sector haven’t been fixed and as well as present problems the threat that they will dream up new ways of creating new problems has not been lessened.

    As for the Greeks ‘intellectual property’, surely that became the Romans when they made their (canti)levered buyout!

    I haven’t read any of this MMT stuff, so can’t pass judgement.

  10. @Ernestine Gross

    The key point is that sovereign governments do things which an individual cannot. They issue currency by fiat and levy taxes payable only in that currency. Further, they enforce these systems by laws and the laws (ultimately) by a legal monopoly on physical force. An individual can not do these things nor does he/she possess any of the necessary attendant apparatus or powers. Thus the comparison is invalid.

    The MMT proposition “national government that issues its own currency can never become bankrupt in terms of liabilities accumulated in that currency” though containing a core of truth is perhaps tendentious and idealised. We need to ask what happens in practice (and in a world of floating currencies) when a government follows this path to an extreme. Clearly, the extreme leads to hyperinflation. I suspect the extreme will also lead to the functional equivalent of bankruptcy (for a small country anyway) if not technical bankruptcy according to that nation’s own accounting. Other nations and businesses would not accept their currency.

    On the other hand, MMT shows us that insisting on balanced budgets for their own sake (year on year or over the cycle) is an unecessary absurdity and a clear case of the tail wagging the dog. Balanced budgets are a kind of accounting fiction. Fiction in the sense that they are claimed to be necessary (in and of themselves) to the real economy when they are not. It is a form of letting an arbitrary accounting norm determine and indeed distort outcomes in the real economy. What is necessary in the real economy (under social democratic and humane principles) is full employment first and inflation in an acceptable band (which will likely be higher than the current band acceptbale to the Reserve Bank in Australia). Deficits and surpluses should be run to meet these requirements. There is no instinsic reason why a moderate net deficit cannot be run indefinitely. Furthemore mechanisms (by regulation) need to be put in place to ensure that wage inflation is not supressed more than price inflation (which situation if allowed is highly inequitable).

  11. @gerard

    Unfortunately Roubini is wrong (not about Marx) but about government debt. In his talk, Roubini clearly equates government debt to private debt as if they are the same thing. They are not the same thing. Roubini says delevereging is necessary in the private sector (correct) and necessary in the public sector (incorrect). If government “deleverages” (austerity budgets) at the same time as the private sector is necessarily deleveraging and defaulting then, hey presto! Depression!

    He dismisses out of hand the possibility of inflating (deficit spending) the economy out of debt and out of depression. In this he is wrong.

    I am not impressed by Roubini and Krugman. They are the “least worst”of US economists/commentators but they are still half wrong most of the time.

  12. @Ikonoclast

    I have to confess, my post @10 was a little tongue-in-cheek in reaction to some promotional lines I’ve come across on some blogs.

    On other matters, IMHO, the separation of monetary economics, macro-economics and finance is not helpful because everything is related to everything else.

    But I agree with you that the primary objective is the material welfare of humans (which depends on the material world, ie including the environment).

  13. @Ikonoclast
    We need to ask what happens in practice (and in a world of floating currencies) when a government follows this path to an extreme.

    I think the idea is spending from any source does not push past the capacity of the economy – so a sane government would not only not do this, but could also alter the public/private mix and drain excessive demand through selective taxation (#with the caveat I am a lay-reader of macro-economics and MMT). There’s not much point learning MMT through a student …

    Cheers ….

  14. @Ernestine Gross

    Sorry Ernestine, it did cross my mind that you were being ironic but after a re-reading I could find not any real hint of it. You fooled me with the deadpan delivery. Then, of course, I went in with all my typical, literal-minded pedantry. But where else (except on blogs like these) can a mere B.A. (and not in economics) carry on like a pork chop thinking that he can set Professors right in their area of expertise? It’s the only way a retired and isolated never-been can buff his intellectual ego.

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