Must-Read: Brad Setser: Post-Brexit

Must-Read: Post-Brexit vote, in Europe at least: It is not the Great Recession. Odds are that it is not the Lesser Depression. Odds are that it is the Longer Depression…

Brad Setser: Follow the Money: “A few thoughts, focusing on narrow issues of macroeconomic management…

…The U.K. has been… supplying the rest of Europe with demand—something other European countries need. This… will shape the economic fallout. The fall in the pound is a necessary part of the U.K.’s adjustment… will spread the pain from a downturn in British demand to the rest of the euro area. Brexit uncertainty is thus a sizable negative shock to growth in Britian’s euro area trading partners, not just to Britain itself… knock[ing] a cumulative half a percentage point off euro area growth over the next two years…. The euro area… has fiscal capacity to counteract this shock…. The euro area could provide a fiscal offset, whether jointly, through new euro area investment funds or simply through a shift in say German policy on public investment and other adjustments to national policy…. [But] I would bet that the euro area’s aggregate fiscal impulse will be negative in 2017—exactly the opposite of what it should be when a surplus region is faced with a shock to external demand….

The euro area would also benefit from additional focus on the enduring overhang of private debt…. Euro area banks should have been recapitalized years ago, with public money if needed…. But in key countries they were not…. And Europe’s new banking rules are now creating additional incentives for delay…. Putting public funds into the banks does not addresses popular concerns about the way the global economy works. Forcing retail investors to take losses in the name of new European rules does not obviously build public support for ‘more’ Europe. Keeping bad loans at inflated marks on the balance sheet of weak banks undermines new lending, and makes it hard for private demand growth to offset the impact of fiscal consolidation. There is no cost-free option, economically or politically….

A conception of the euro area that focuses on the application of common rules with only modest sharing of fiscal risks… designed… too restrictively, with too much deference to Germany’s desire to avoid being stuck with other countries’ bills…. Something will need to give, eventually.

June 30, 2016


Brad DeLong
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