Month: July 2015

Consider Olivier Blanchard and Daniel Leigh: Growth Forecast Errors and Fiscal Multipliers:

This strongly suggests to me that of the 7%-points by which Greek growth fell below IMF estimates in 2010-2011, 5%-points of that were due to the fiscal consolidation that the IMF had forecast would be imposed on Greece. Consider that the IMF had already expected the Greek economy under baseline to shrink by 4%-points, and for fiscal consolidation to shrink the Greek economy by 3%-points, and we have 8/14 of the damage to the Greek economy relative to a counterfactual forecast under some zero-spending-austerity baseline was due to austerity.

I find this hard to square with the very-sharp Olivier Blanchard’s contribution of today:

Olivier Blanchard: Greece: Past Critiques and the Path Forward: “The decrease in output was indeed much larger than had been forecast…

…Multipliers were larger than initially assumed.  But fiscal consolidation explains only a fraction of the output decline.  Output above potential to start, political crises, inconsistent policies, insufficient reforms, Grexit fears, low business confidence, weak banks, all contributed to the outcome…

That is, this statement seems to me to be true if and only if “only a fraction” is replaced by “more than half”.

Let us back up: In 1829 economist John Stuart Mill pointed out that “Say’s Law”–Jean-Baptiste Say’s claim that potential supply in the form of workers eager to work at the prevailing wage necessarily called forth the demand in the form of the desire to spend backed up by income to employ them, that there could be an excess supply of some currently-produced goods and services only if there was an offsetting excess demand for others–was wrong. In a monetary economy there can–and often is–be a large excess demand for safe liquid cash money that can only be produced by a credit-worthy government, and a counterbalancing excess supply of all currently-produced goods and services: a “general glut” of commodities.

It is the job of a government conducting stabilization policy–and of an international agency located, cough, cough, near Pennsylvania Avenue in Washington DC–to make Say’s Law true in practice even though it is false in theory. How are governments and international agencies supposed to do this? By creating the safe liquid cash money that the private sector wants to hold in order to induce it to spend its full-employment income on currently-produced goods and services, and to fill in remaining gaps by itself serving as a liquidity-provider, a credit-guarantor, a lender, a buyer, and an employer of last resort when necessary.

In the case of Greece in 2009-2010 the New York financial crisis meant that spending in Greece by the private sector was going to go way down. The three components of aggregate demand for work done in Greece were: (i) private spending in Greece; (ii) public spending in Greece; (iii) exports. It was the job of the ECB and of the Greek government–and of the EU and the IMF that stood behind them–to do some combination of:

1. making Greeks feel rich and safe so that they would be willing to spend their full-employment incomes on useful consumption and productive capital goods;
2. filling in holes in private domestic demand by boosting public spending; plus
3. boosting Greek exports–boosting outside demand for work done in Greece.

Now comes Olivier Blanchard to say that since 2009 the ECB, the EU, and the IMF:

• couldn’t do (3) because the Greek drachma is pegged irrevocably to the German deutschmark, and
• couldn’t help the Greek government do (2) because Greek government finances were already unsustainable.

That would seem to leave (1). To some extent, you can achieve (1) by lowering interest rates and promising to keep them low enough for long enough to make more investment projects in Greece profitable, and to make the Greeks feel richer and thus be more eager to spend. And some, like Ben Bernanke, think that this is–or ought–to be enough:

Ben Bernanke: Why are interest rates so low, part 2: “As Larry [Summers]’s uncle Paul Samuelson taught me…

…in graduate school at MIT… at a negative (or even zero) interest rate, it would pay to level the Rocky Mountains to save even the small amount of fuel expended by trains and cars that currently must climb steep grades…

But the ECB appears to be unwilling or unable to pursue (1) a la Bernanke to the limit…

And that then leaves the Texas 1991 solution:

Paul Krugman: What A Real External Bank Bailout Looks Like: “Texas after the savings and loan crisis of the 1980s…

…The cleanup from that crisis cost [U.S.] taxpayers about $125 billion… around 60 percent… in Texas (pdf)… $75 billion in… outright transfer. Texas [annual] GDP was about $300 billion in 1987… giving… [it] 25 percent of its [annual] GDP… And in the US it wasn’t even treated as an interstate political issue…. If Texas had been an independent country in 1986-87 it would have experienced a huge financial and fiscal crisis…

Why was the United States government willing to do this? Because Texas is part of the United States, and also part of our civilization. Indeed, the “part of the United States” is not crucial to the expenditure of the resources of U.S. taxpayers, as everybody who remembers the Marshall Plan–or, indeed, remembers the much larger amount of resources spent on destroying a Nazi Germany that was not in any sense an imminent threat to the U.S. in the 1940s–knows.

There is no fundamental real flaw in the real economy that is our societal division of labor and our system of production, distribution, and consumption that requires that a quarter of Greeks eager to work at the prevailing wage be unemployed for a decade. It is only a flaw in the monetary system we have collectively constructed to help manage this real economy that is trying to enforce that result. And if one rules out other ways–cough, cough, devaluation–and finds that the only way to avoid that result is by truly massive fiscal transfers to Greece, than it is the obligation and duty of the ECB, the EU, and the IMF to make such transfers. As the U.S. government did to Texas in 1991.

“But that will leave the Greeks too rich and the Germans too poor!” the masters of the Eurozone say:

Jared Bernstein: Greece’s Electorate Punches Back Hard at Austerity: “As one German economist put it to me…

How do you think the people of Manhattan would like bailing out Texas?…

And the German government has the power to block fiscal transfers–even if they are the only remaining way to make Say’s Law true in practice–if it thinks they make Germans and Germany too poor.

And it is at this point that I note that at the left edge of my desk I have the brand-new biography A Complex Fate of mid-century American journalist William Shirer, and beneath it is William Shirer’s masterwork: The Rise and Fall of the Third Reich. And in that bottom-most book, there is a quote from one Hans Frank:

A thousand years shall pass and the guilt of Germany will not be erased…

Until 2934, every politician speaking for anything calling itself “Germany” needs to believe that they are in an open-hearted and open-handed gift-exchange relationship with all the other peoples of Europe in which they do not count the cost and do not stint their share if they can be of assistance. And if the politicians of anything calling itself “Germany” do not believe that, they need to at least have the decency to pretend to believe that. Until 2934.

Must-Read: Paul Krugman: Policy Lessons From The Eurodebacle: “Greece I tell you. What we learn… is that fiscal austerity plus hard money is a deeply toxic mix…

…For comparison, look at everyone’s favorite example of successful austerity, Canada in the 1990s… gross debt of roughly 100 percent of GDP… a pretty big fiscal adjustment–6 percent of GDP according to the IMF’s measure of the structural balance, which is about a third of what Greece has done…But unemployment fell steadily. What was Canada’s secret?… Easy money and a large currency depreciation…. So, how does this play into U.S. policy debates?… The policy mix that is now de facto GOP orthodoxy: sharp cuts in government spending (maybe offset by tax cuts for the rich, but these won’t provide much stimulus), combined with a monetary policy obsessed with fears of dollar ‘debasement’. That is, the conservative side of the US political spectrum, while holding up Greece as a cautionary tale, is actually demanding that we emulate the policy mix that turned Greek debt into a complete disaster.

Must-Read: Robert Pindyck: The Use and Misuse of Models for Climate Policy: “Integrated assessment models (IAMs) have flaws that make them close to useless…

…as tools for policy analysis… create a perception of knowledge and precision that is illusory, and can fool policy-makers into thinking that the forecasts the models generate have some kind of scientific legitimacy…. A simpler and more transparent approach to the design of climate change policy is preferable…. What really matters for the SCC is the likelihood and possible impact of a catastrophic climate outcome: a much larger-than-expected temperature increase and/or a much larger-than-expected reduction in GDP caused by even a moderate temperature increase. IAMs, however, simply cannot account for catastrophic outcomes. Unless we are ready to accept a discount rate that is very small, the “most likely” scenarios for climate change simply don’t generate enough damages–in present value terms–to matter. That is why the Interagency Working Group, which used a 3 percent discount rate, obtained the rather low estimate of $33 per ton for the SCC…

Must-Read: Luigi Zingales: Who is the legitimate leader on the European side? That is the real question: “Tsipras was not part of the Brussels’ elite…

…was challenging the legitimacy of the Brussels’ elite. You can be a crook, you can be an unelected leader and – if you are one of them – your legitimacy will never be questioned in Brussels or Frankfurt. But if you are not… you will be openly undermined even if you had democratically won a clear mandate. As a result, from day one – everybody from Junker to the Eurogroup – was trying to make this government fall…. This was extremely antidemocratic and underhanded. Now it cannot continue…. The Institutions do not need to accept Tsipras’s conditions, but they have to negotiate with him in good faith. The no vote does not necessarily mean Grexit, unless the Institutions want so…. The Institutions will also have to avoid at all costs to let Mario Draghi be the de facto killer of Greece…. Greece’s future in the euro cannot depend on a technicality. It is a political decision that should be taken by legitimately elected leaders. On Greece side, there is Tsipras. Who is there on the European side?…

I truly do not understand this argument by the very sharp Daniel Davies:

Daniel Davies: Comment on Greece, Decision Theory, and the Sure-Thing Principle: “If Greece stays in the Euro it is likely to need constant transfers forever…

…If it leaves, but stays in the EU, then these can be reduced from a level in the tens of billions to something like what Romania or Bulgaria get….

The reason, of course, the transfers can then be reduced is that a Greece out of the euro re-denominates its debt in Greekeuros–drachmas–which go to a substantial discount vis-a-vis the euro, thus devalues, begins to have an export boom, and sees a strong economic recovery. What’s the problem?

Daniel continues:

Greece also loses political influence, and so can’t cause as many problems as it has in the past about things like the Balkans or Turkey…

So the Former Yugoslav Republic of Macedonia gets to call itself “Macedonia” (or “North Macedonia” or “Heartland Macedonia” or whatever), the chances of resolving Cyprus go up, etc. In short:

There’s a lot of favourable things about Greek Euro exit from the point of view of creditor states….

But then he turns on a dime:

I still think losing Greece would be a net negative for Europe (and a tragedy for Greece, albeit that if the EU had spare capacity to make transfers, Romania is a more needy candidate)…

Why is economic recovery–casting the German austerity boat anchor over the side–a tragedy for Greece?

The old argument was that Greek exit from the euro would administer a massive deflationary shock to the European economy as everybody scrambled for safety and thus dumped their southern European sovereign-debt bonds for northern European ones, that it was important to avoid such a deflationary confidence shock, and that as a result Europe would supply enough transfers to make staying in the euro more attractive to Greece than the disruption of exit followed by recovery. That chain of argument has turned out to be wrong.

Does Daniel think that the deflationary shock is not there? That would seem to be implied by his statement that Greece is a “financial liability” to the creditor states. But in that case why have we been dinking around for five years now?

Must- and Should-Reads:

• Must-Read: Richard Kogan: CBO Contradicts Itself — Long-Term Budget Picture Improving, Not Worsening
• Must-Read: Raj Chetty: Behavioral Economics and Public Policy: A Pragmatic Perspective
• Must-Read: Hoyt Bleakley and Jeffrey Lin: History and the Sizes of Cities
• Mary Daly et al.: Finding Normal: Natural Rates and Policy Prescriptions
• Nick Bunker: Are estimates of the long-term U.S. unemployment rate too high?
• Must-Read: Ali Alichi et al.: Avoiding Dark Corners: A Robust Monetary Policy Framework for the United States
• Dan Drezner: “The only lesson that the United States should draw from Greece is that the United States is not Greece…”
• Must-Read: Benjamin Golez and Peter Koudijs: Four Centuries of Return Predictability
• Must-Read: Paul Blustein: Laid Low: The IMF, the Euro Zone and the First Rescue of Greece
• Must-Read: Brendan Duke: New Data Illustrate the Failure of the Trickle-Down Experiment
• Dan Alpert: Greece Descended Into Circus With No Ringmaster

Might Like to Be Aware of:

• Doug J.: “[Charles Lane of] the Washington Post is edging closer to calling for a coup in Greece…”
• Ria Misra: [Chien-Shiung Wu’s] Experiment That Overturned A Basic Law of Physics](http://io9.com/the-experiment-that-overturned-a-basic-law-of-physics-1715265897)
• Must-Read: Nate Silver: The Polls Were Bad in Greece. The Conventional Wisdom Was Worse
• ASU Media Literacy Course
• Must-Read: Ethan Sacks: ‘Star Wars’ Standalone Film Will Be Han Solo Prequel – NY Daily News

Over at Grasping Reality: Hoisted from Five Years Ago: Paul Krugman: The Conventional Superstitions of Austerity (2010): “Calculated Risk points us to a speech by Kevin Warsh…

…that strikes me as almost the perfect illustration of the predicament we’re in, in which policy is paralyzed by fear of invisible bond vigilantes. Warsh isn’t an especially bad example — but that’s the point: this is what Serious People sound like these days. The bottom line of Warsh’s speech — although expressed indirectly — is that it’s time for fiscal austerity, even though the economy remains deeply depressed; and no, the Fed can’t offset the effects of fiscal contraction with more quantitative easing. In short, the responsible thing is just to accept 10 percent unemployment. And why is this the responsible thing? On fiscal policy: “market forces are often more certain than promised fiscal spending multipliers…”

Um, but those market forces are currently willing to lend money to the US government at an interest rate of 3.05 percent. But never mind: “unanticipated, nonlinear events can happen…”

So it’s these ‘unanticipated, nonlinear events’ that are ‘more certain’ than the direct effects of fiscal policy? I’m confused…

Must-Read: Richard Kogan: CBO Contradicts Itself — Long-Term Budget Picture Improving, Not Worsening: “The Congressional Budget Office’s (CBO) new report…

…on the budget picture opens by saying, “The long-term outlook for the federal budget has worsened dramatically over the past several years,” blaming the Great Recession and the steps taken to address it. But CBO’s own data, in that very report, show that’s not the case.

Must-Read: Raj Chetty: Behavioral Economics and Public Policy: A Pragmatic Perspective: “The debate about behavioral economics…

…the incorporation of insights from psychology into economics—is often framed as a question about the foundational assumptions of economic models. This paper presents a more pragmatic perspective on behavioral economics that focuses on its value for improving empirical predictions and policy decisions. I discuss three ways in which behavioral economics can contribute to public policy: by offering new policy tools, improving predictions about the effects of existing policies, and generating new welfare implications. I illustrate these contributions using applications to retirement savings, labor supply, and neighborhood choice. Behavioral models provide new tools to change behaviors such as savings rates and new counterfactuals to estimate the effects of policies such as income taxation. Behavioral models also provide new prescriptions for optimal policy that can be characterized in a non-paternalistic manner using methods analogous to those in neoclassical models. Model uncertainty does not justify using the neoclassical model; instead, it can provide a new rationale for using behavioral nudges. I conclude that incorporating behavioral features to the extent they help answer core economic questions may be more productive than viewing behavioral economics as a separate subfield that challenges the assumptions of neoclassical models.