Must-Read: Timothy B. Lee: Brexit Isn’t the Most Serious Threat to the EU — the Euro Is

Must-Read: Timothy B. Lee: Brexit Isn’t the Most Serious Threat to the EU — the Euro Is: “David Beckworth makes the case that the economic woes of eurozone countries like Spain and Greece…

…can ultimately be traced back to the euro itself… other problems… made worse by the ECB’s tight-money policies…. Without reforms, eurozone countries could continue suffering from slow growth and abnormally severe recessions for decades to come. That, in turn, will fuel public resentment against the EU and increase the danger that other countries will follow the UK’s lead. And the euro isn’t just a mistake–it’s a mistake that’s going to be hard to fix. Any country that tries to leave the euro risks triggering a financial crisis. And while deeper economic integration could help to mitigate the euro’s problems, the political obstacles could be insurmountable. Brexit wasn’t great news for the future of the EU. But the common currency is likely to create much bigger headaches for European leaders in the years to come.

Must-Read: Danny Yagan: Enduring Employment Losses from the Great Recession?: Longitudinal Worker-Level Evidence

Must-Read: Danny Yagan: Enduring Employment Losses from the Great Recession?: Longitudinal Worker-Level Evidence: “The severity of the Great Recession varied across U.S. local areas…

…Comparing two million workers within firms across space, I find that starting the recession in a below-median 2007-2009-employment-shock area caused workers to be 1.0 percentage points less likely to be employed in 2014, relative to starting elsewhere. These enduring employment losses hold even when controlling for current local unemployment rates, which have converged across space. The results demonstrate limits to U.S. local labor market integration and suggest hysteresis effects culminating in labor force exit.

Must-Read: Paul Krugman: Against Eurotimidity

Must-Read: Paul Krugman: Against Eurotimidity: “The authors really are the best and brightest…. So I’d really like to say nice things…

…Unfortunately… is this really all they can offer? I understand that in the effort to reach consensus one must trim back the more intellectually daring and politically difficult parts of what an individual economist might propose. But in this case the search for consensus seems to have leached out practically all the substance…. They’re calling for liquidity support in times of crisis, and I think debt relief if necessary. But that’s sort of how Europe is already trying to muddle through. They don’t call for fiscal integration; they don’t even call for a euro-wide system of deposit insurance. I’m really not sure what they are proposing, beyond neatening up the organization chart. They allude to the possibility of secular stagnation, which some of us consider a clear argument for fiscal stimulus and higher inflation targets. But all they suggest is… structural reform, the universal elixir of elites.

The only really new thing I thought I saw was the declaration that “the level of expenditure – rather than the deficit – is the main problem” coupled with a call for expenditure rules. But where is that coming from? There is no correlation between economic performance in the euro crisis and the level of government spending as a share of GDP — Austria has a big government, Ireland and Spain small ones by European standards. And absent some clear evidence that big G was the problem, why declare that national sovereignty on the size of the public sector must be reduced?… From a macro perspective, Europe is a depressed economy with inflation well below a reasonable target, desperately in need of more demand, with this aggregate problem exacerbated by the problems of adjustment within a single currency. And here we have a manifesto calling for smaller government and structural reform. The authors of the manifesto aren’t neoliberal ideologues. So what happened?

In Which I Call for Academic Scribblers and Funct Economists to Enter into Utopian Frenzy with Respect to the Institutional Design of the Eurozone

Long Term Government Bond Yields 10 year Main Including Benchmark for Germany© FRED St Louis Fed

Must-Read: From my perspective, this piece at makes many too many bows to conventional-wisdom idols with not just feet but bodies and heads of clay. Thus I cannot sign on to it.

Eleven observations:

  1. The situation is dire. The Eurozone as currently constituted has been a macroeconomic disaster.

  2. The forecast that the authors make is that on the current policy path “economic health will eventually be restored, unemployment will decrease, and the periphery countries will regain competitiveness” is not a real forecast. I think that this is not a real forecast: if it were a real forecast, it would have a date attached, no?

  3. Thus the framing of needed policy changes as things needed to improve “resiliency” just in case things do not “go as forecast” substantially underplays the seriousness of the problem. Fewer readers will pick up on the “things rarely go as forecast” to understand that the forecast is not a forecast.

  4. The first and most obvious feature of the Eurozone is that its interest rates are at the zero lower bound and its economy lacks aggregate demand. A depressed economy at the zero lower bound needs fiscal expansion. If for some reason normal fiscal expansion is feared to be unwise by some holding veto points, the economy needs helicopter drops–backed up by strong commitments by central banks to raise reserve requirements to curb the velocity of outside money should it suddenly become higher rather than lower than desirable.

  5. The bank regulatory system needs responsibility for banks’ rescue to be transferred from national governments to the ESM now. Without that transfer, nation-level governments will continue to make the political calculation that letting supervisory and regulatory standards slide is the more attractive course. It may be true “this is the kind of political step that seems unlikely to be feasible in the near term”. But that does not keep it from being needed now. The purpose of a document like this is to set out what is needed–not to reassure people by claiming that whatever is not politically possible now is not needed now.

  6. Public debt is too high if and only if market interest rates now and forecast for the foreseeable future are about to undergo a rapid and massive jump upward. Right now g > r–which means that public debt is not too high but too low.

  7. How governments should hedge against interest rate increases in a world where g > r is an interesting research question. The obvious route is simply to sell consols. Then, when the real consol rate is higher than the societal return on additional government expenditures, we can talk about what the target debt-to-GDP ratio should be and how to get there. But those who are unwilling to advocate the sale of consols as the obvious way to manage public debt risk have, as long as g > r, no standing to complain that public debts are too high–let alone to set out the proposition that public debt is too high as a self-evident truth.

  8. A massively-underfunded ESM is not “the right institution to deal with [government debt] default”. It is the wrong institution. It is worse than no institution at all, because it allows people to claim that there is a backstop when there is, in fact, no backstop.

  9. The “structural reform” agenda is more-or-less orthogonal to the macroeconomic institution redesign agenda. To even hint that energy that would otherwise be devoted to macroeconomic institution design should be diverted to lobby for structural reform is in its essence a call to do less on macroeconomic institution redesign. And that strikes me as unhealthy.

  10. Now I think that I do understand why the economists below–who are, by and large, among the best economists in the world in their wisdom and in their understanding of the European situation–have made the rhetorical choices that they have. They want to appeal to practical men, who believe they are exempt from any trace of utopian frenzy.

  11. But if the Eurozone is to be a good thing for Europe rather than a millstone around the neck of the continent, I think that utopian frenzy is needed.

Here is the column:

Richard Baldwin, Charlie Bean, Thorsten Beck, Agnès Bénassy-Quéré, Olivier Blanchard, Peter Bofinger, Paul De Grauwe, Wouter den Haan, Barry Eichengreen, Lars Feld, Marcel Fratzscher, Francesco Giavazzi, Pierre-Olivier Gourinchas, Daniel Gros, Patrick Honohan, Sebnem Kalemli-Ozcan, Tommaso Monacelli, Elias Papaioannou, Paolo Pesenti, Christopher Pissarides, Guido Tabellini, Beatrice Weder di Mauro, Guntram Wolf, and Charles Wyplosz.: Making the Eurozone more resilient: What is needed now and what can wait?: “Britain voted to leave the EU. This is terrible news for the UK…

…but it is also bad news for the Eurozone. Brexit opens the door to all sorts of shocks, and dangerous political snowball effects. Now is the time to shore up the Eurozone’s resiliency. The situation is not yet dire, but prompt action is needed. This VoxEU column – which is signed by a wide range of leading economists – identifies what needs to be done soon, and what should also be done but can probably wait if markets are patient.

The UK’s choice to leave the EU was, we believe, a historic mistake. But the choice was made; we must now turn to damage control – especially when it comes to the euro.

The Eurozone is growing, albeit slowly. If all goes as forecast, economic health will eventually be restored, unemployment will decrease, and the periphery countries will regain competitiveness.

But things rarely go as forecast – as we were so forcefully reminded last week. Brexit was the latest – but certainly not the last – shock that will challenge the monetary union.

The question is: Is the Eurozone resilient enough to withstand the bad shocks that it is likely to face in the months and years to come?

For many observers, the answer is ‘no’. To survive the next bad shock, they argue, Europe’s monetary union needs major reform and deeper political integration. As such deeper integration is extremely difficult in today’s political climate, pessimism is the order of the day.

We do not share this pessimism. The Eurozone’s construction has surely followed a convoluted process, but the fundamental architecture is now in place. Yes, some measures are needed to strengthen this architecture. And yes, more ambitious steps would improve resilience further, but these will have to wait for a political breakthrough.

The purpose of this essay is to identify what needs to be done soon, and what would be good to do but can probably wait. To avoid the mind-numbing details that often cloud discussions of Eurozone reform, we paint our arguments with a broad brush. (We will follow up with further documents with much greater detail on specific reform proposals.)

On banks and the financial system: Think of a good financial architecture for the Eurozone as achieving two main objectives in coping with another bad shock: 1) reducing the risk of bank defaults; and 2) containing the broader economic effects when defaults do occur.

This architecture is largely built. Both supervision and regulation are now largely centralised. Supervision is improving and stress tests are becoming more credible with each iteration. The Single Resolution Mechanism is in place and private-sector bail-in rules have been defined. The Single Resolution Fund can provide some recapitalisation funds if and when needed. If they turn out not to be enough, the European Stability Mechanism (ESM) can, within the context of a macroeconomic adjustment programme, add more. In the longer term, a euro-wide deposit insurance scheme could improve resiliency, but this will take time.

So what more needs to be done soon?: Mostly to make sure that the rules in place can be enforced. Italy provides two cases in point. First, non-performing loans have steadily increased and are carried on the books at prices substantially above market prices. Second, the Italian government has proven very reluctant to apply the bail-in rules. The credibility of the rules is at stake. Either they have to be applied, or credibly modified.

What are the measures that would be good to take, but can probably wait?: Diversifying the portfolios of banks so that there are more resilient to domestic shocks would clearly be desirable. The focus has been on decreasing the proportion of domestic sovereign bonds in banks’ portfolios. This would be good, but domestic sovereign bonds represent a relatively small proportion of banks’ portfolios. Decreasing banks’ overexposure to domestic loans would also be an important step towards boosting resiliency. A different approach would be to transfer the responsibility for banks’ rescue from national governments to the ESM. But this is the kind of political step that seems unlikely to be feasible in the near term.

On public finances: Public debt is high, even if, for the time being, low interest rates imply a manageable debt service. Just as for the financial system, a resilient public finance architecture needs to:  1) reduce the risk of default; and 2) contain the adverse effects of default, if it were to occur nevertheless.

On both counts, much remains to be done: Reducing the risk of default is best achieved through a combination of good rules and market discipline. Neither is really in place. The accumulation of rules has made them unwieldy, unenforceable, and open to too many exceptions. They can and should be simplified. In most countries, the level of expenditure – rather than the deficit – is the main problem. High expenditure makes it difficult to raise taxes and balance the budget, leading to dangerous debt dynamics. Thus, a focus on expenditure rules, linking expenditure reduction to debt levels, appears to be one of the most promising routes. Market discipline, on the other hand, will not work if the holders of the debt do not know what will happen if and when default takes place. This takes us to the second objective.

The Eurozone has put in place the right institution to deal with default, namely the ESM. Like the IMF, the ESM can, under a programme, help a country adjust. In its current form however, the ESM falls short of what is needed. First, the ESM’s ‘firepower’ is too small compared to the sort of shock-absorbing operations it may be called on to undertake in the case of a large Eurozone nation getting into debt trouble. Second, given its current decision-making procedures, markets cannot be sure that action will be taken promptly. Higher funding or higher leverage, and changes in governance such as replacing the requirement of unanimity by a more flexible one, are needed to make the ESM able to respond quickly and fully to a country in trouble. Third, the current structure is silent on who should negotiate a public debt restructuring in the extreme case where one was needed. Putting an explicit process in place should be a priority; the ESM is the natural place for it.

What other measures which would be good to have, but can probably wait?: Initiatives to address the legacy of high public debt would bolster Eurozone resiliency and thus would be very useful. However, as low interest rates are likely for some time to come, debt service is manageable, and debt forecasts show that debt-to-GDP ratios will slowly decline (absent a bad shock). Since proposals for dealing with legacy national debts would require the sort of political willpower that seems in short supply for now, such plans cannot be realistically put on the ‘do now’ menu, even if they are may be necessary in the future.

Another set of measures would implement stronger risk sharing, and transfer schemes to further reduce the impact of domestic shocks on their own economy. Proposals run from euro bonds to fiscal transfer schemes for countries subject to bad shocks. These measures would make the Eurozone more resilient and thus may be desirable. But, equally clearly, they would require more fiscal and political integration than is realistic to assume at this point. We believe that the Eurozone can probably function without tighter fiscal integration at least for some time.

We end with two sets of remarks:

Solvency and liquidity: Whether it is with respect to banks or states, the two issues facing policymakers are how to deal with solvency and liquidity problems. We have argued that, when solvency is an issue, the ESM is the right structure to address it (assuming a public debt restructuring procedure is in place). With respect to liquidity, we believe that, in addition to the liquidity facilities of the ECB, which can address sudden stops on banks, the Outright Monetary Transactions (OMT) is the right structure to address sudden stops facing states. One step that could be taken soon is a clearer articulation of how to combine the two. This would clarify the role of the ECB, and eliminate a source of criticism about the allocation of roles between the ECB and other Eurozone structures such as the ESM. The resulting clarity would make it easier for markets and investors to be assured that Europe’s monetary union could deal effectively with any future shocks.

Structural reforms: In any country, at any point, some pro-growth structural and institutional reforms are desirable. Is there a particularly strong argument for them in the case of the Eurozone? To some extent, yes. The institutional problems of the euro are made worse by low growth, and demographic change. If the structural and institutional reforms delivered higher growth, this would be good by itself – ignoring distribution effects – and it would allow for faster improvement in bank and state balance sheets.

Those specific structural reforms which allow for faster adjustment of competitiveness, be it through faster cost adjustment or faster reallocation, would also improve the functioning of the monetary union. Implementing such reform is a slow and difficult process, but necessary nonetheless. The Eurozone will never be a well-functioning monetary union until it is much more of an economic union as well.

We have stressed that actions need to be taken soon, while others are more long term, but the long-term questions do need to be discussed without delay.

Do you support this view?: Starting next week, we will open this column to endorsement by economists. Details to be posted on Monday.

Must-Read: Paul Krugman: Brexit: The Morning After

Must-Read: I disagree with Paul Krugman: not “Brexit just brings to a head an abscess that would have burst fairly soon in any case…” but rather: Brexit evolves antibiotic-resistant bacteria and brings to a head an abscess that would probably have drained itself gradually–and could still have been treated…

Paul Krugman: Brexit: The Morning After: “A number of people deserve vast condemnation here, from David Cameron…

…who may go down in history as the man who risked wrecking Europe and his own nation for the sake of a momentary political advantage, to the seriously evil editors of Britain’s tabloids, who fed the public a steady diet of lies. That said, I’m finding myself less horrified by Brexit… than I myself expected. The economic consequences will be bad, but not, I’d argue, as bad as many are claiming…. Brexit will make Britain poorer. It’s hard to put a number on the trade effects of leaving the EU, but it will be substantial…. Assurance of market access has a big effect in encouraging long-term investments aimed at selling across borders; revoking that assurance will, over time, erode trade even if there isn’t any kind of trade war. And Britain will become less productive as a result.

But right now all the talk is about financial repercussions–plunging markets, recession in Britain and maybe around the world, and so on. I still don’t see it. It’s true that the pound has fallen by a lot compared with normal daily fluctuations. But for those of us who cut our teeth on emerging-market crises, the fall isn’t that big…. This is not a world-class shock. Furthermore, Britain is a nation that borrows in its own currency….

Now, it’s true that world stock markets are down; so are interest rates around the world, presumably reflecting fears of economic weakness that will force central banks to keep monetary policy very loose. Why these fears? One answer is that uncertainty might depress investment. We don’t know how the process of Brexit plays out, and I could see CEOs choosing to delay spending until matter clarify. A bigger issue might be fears of very bad political consequences, both in Europe and within the UK…. The European project… is in deep, deep trouble [with] Brexit… probably just the beginning…. Lots of people are now very pessimistic about Europe’s future, and I share their worries. But those worries wouldn’t have gone away even if Remain had won…. At the European level… I would argue that Brexit just brings to a head an abscess that would have burst fairly soon in any case. Where I think there has been real additional damage done, damage that wouldn’t have happened but for Cameron’s policy malfeasance, is within the UK itself…. So calm down about the short-run macroeconomics; grieve for Europe, but you should have been doing that already; worry about Britain.

Must-Read: Martin Wolf: David Cameron, the Ex-Prime Minister, Took a Huge Gamble and Lost

Must-Read: The very sharp Martin Wolf sees structural recession in Britain’s near future.

People minimizing risk are going to leave Britain. People who would otherwise locate in Britain and are risk-shy are going to pause and wait and see. The Bank of England needs to drop the value of the pound by enough to try to maintain full employment in Britain–but not by so much as to make investors feel that investments in Britain are unsafe and so lose the pound its exorbitant privilege.

As Keynes wrote at the beginning of his Tract on Monetary Reform back in 1923:

I dedicate this book, humbly and without permission, to the Governors and Court of the Bank of England, who now and for the future has a much more difficult and anxious task entrusted to them than in former days…

Martin Wolf: Brexit: David Cameron, the Ex-Prime Minister, Took a Huge Gamble and Lost: “The fearmongering of Boris Johnson, Michael Gove, Nigel Farage, The Sun and the Daily Mail has won…

…The UK, Europe, the west and the world are, this morning, damaged. The UK is diminished and will, quite possibly, end up divided. Europe has lost its second-biggest and most outward-looking power. The hinge between the EU and the English-speaking powers has been snapped…. It is, above all, a victory of the disappointed and fearful…. The geography of the outcome reveals that this has also been a revolt of the provinces against a prosperous and globalised London. It is also a revolt against the establishment…. The UK might not be the last country to suffer such an earthquake….

The UK is now at the beginning of an extended period of uncertainty that, in overwhelming probability, foreshadows a diminished future. The Conservatives… will have to do what the Brexiters failed so egregiously to do during their mendacious campaign, namely, map out a strategy and tactics for unravelling the UK’s connections with the EU. This will probably consume the energies of that government and its successors over many years. It will also involve making some huge decisions… [abandon] membership of the single market. At best, the UK might participate in a free trade area in goods. Meanwhile, the rest of the EU, already burdened with so many difficulties, will have to work out its own negotiating positions. I expect them to be tough ones….

The UK economy is going to be reconfigured. Those businesses that have set up in the UK to serve the entire EU market from within must reconsider their position…. Manufacturers… will have to consider how to readjust…. Many will ultimately wish to relocate. Businesses who depend on their ability to employ European nationals must also reshape their operations…. In the short term, however, it will be difficult for businesses to make such decisions sensibly…. This uncertainty has always been the most obvious result of a vote to leave….

The UK’s decision to join the EU was taken for sound reasons. Its decision to leave was not. It is likely to be welcomed by Ms Le Pen, Mr Trump and Vladimir Putin. It is a decision by the UK to turn its back on the great European effort to heal its divisions. It is, for me, among the saddest of hours.

Must-Read: Matthew Yglesias: Financial markets are begging the US, Europe, and Japan to run bigger deficits

Must-Read: Matthew Yglesias: Financial markets are begging the US, Europe, and Japan to run bigger deficits: “The international financial community wants to lend money this cheaply…

… [so] governments should borrow money and put it to good use. Ideally that would mean spending it on infrastructure projects that are large, expensive, and useful–the kind of thing that will pay dividends for decades to come…. But if you don’t believe there are any useful projects or if your country’s political system is simply too gridlocked to find them, there are easy alternatives. Do a broad-based tax cut…. The opportunity to borrow this cheaply (probably) won’t last forever, and countries that boost their deficits will (probably) have to reverse course, but while it lasts everyone could be enjoying a better life instead of pointless austerity.

Must-Read: FOMC: Press Release–June 15, 2016

Must-Read: Somebody really should have dissented from this press release: if 0.5% is the forecast of the appropriate Fed Funds rate in 2018, zero is the appropriate Fed Funds rate now.

But who? Charlie Evans or Lael Brainard? I would bet Lael, based solely on the Fed convention that a Governor’s dissent is a much bigger deal than a Regional Bank President’s dissent. But that is only a guess: I do not know…

Https www federalreserve gov monetarypolicy files fomcprojtabl20160615 pdf

FOMC: Press Release–June 15, 2016: “The pace of improvement in the labor market has slowed while growth in economic activity appears to have picked up…

…Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation declined; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months…. The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will strengthen. Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term…. Against this backdrop, the Committee decided to maintain the target range for the federal funds rate…. In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation…. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data…

Must-Read: Larry Summers: Fed’s Current Strategy Ill Adapted to the Realities

Must-Read: Larry Summers is right.

If the Phillips Curve today still had the short-run slope in the gearing of expected inflation to recent past inflation that it appeared to have at the start of the 1980s, there might–but only might–be a case for the Federal Reserve’s current policy.

There is no reason for internal comity between the Board of Governors and the regional bank presidents to be a concern: Bernanke and Yellen have now had three full regional bank-appointment cycles to get bank presidents who are on the same page as the Board of Governors. The Federal Reserve always has and is understood to have the freedom to raise interest rates to maintain price stability when incoming data suggests that it is threatened: there is no need for talk to highball the chances of future rate increases when the current data flow does not suggest it will be needed. Thus I see no reasons at all to support a Fed policy posture other than that one that Larry Summers recommends: “signal[ling] its commitment to accelerating growth and avoiding a return to recession, even at some cost in terms of other risks…”

Larry Summers: Fed’s Current Strategy Ill Adapted to the Realities: “The current hawkish inclination of the Fed, with its chronic hope and belief that conditions will soon permit interest rate increases, is misguided…

…The greater danger is of too little rather than too much demand. A new Fed paradigm is therefore in order…. I would guess that from here the annual probability of recession is 25-30 percent. This seems to me the only way to interpret the yield curve. Markets anticipate only about 65 basis point of increase in short rates over the next 3 years. Whereas the Fed dots suggest that rates will normalize at 3.3 points, the market thinks that even 5 years from now they will be about 1.25 percent. Markets are thinking that recession will come at some point and when it does rates will go to near zero…. This implies that if the Fed is serious… about having a symmetric 2 percent inflation target then its near-term target should be in excess of 2 percent. Prior to the next recession–which will presumably be deflationary–the Fed should want inflation to be above its long term target…. The Fed’s dots forecasts refer to a modal scenario of continued recovery… [with] inflation rising to 2 percent only in 2018. Why shouldn’t they prefer a path with more demand, inflation at target sooner, more stimulus as recession insurance, and a small margin of extra inflation as a buffer against the next recession?….

The logic that led to the adoption of the 2 percent inflation target years ago suggests that it is too low now…. The case for a positive inflation target balances the benefits of stable money with the output cost of lowering inflation and two ways that positive inflation is helpful—the periodic need to have negative real rates, and inflation’s role in facilitating downward adjustment in real wages given nominal rigidities. All of the factors pointing towards a higher inflation target have gained force in recent years…. Experience has proven that Yellen was correct to be skeptical of the idea very low inflation rates would improve productivity. And it is plausible that the error in price indices has increased with the introduction of new categories of innovative and often free products…. If a two percent inflation target reflected a proper balance when it first came into vogue decades ago, a higher target is probably appropriate today….

Long term inflation expectations are depressed and declining…. The Fed has in the past counterbalanced declines in market inflation expectation measures by pointing to the relative stability in surveys-based measures. This argument is much harder to make now that consumer expectations of inflation have broken decisively below their all-time lows even as gas prices have been rising…. The Fed’s summary employment conditions index has been flashing yellow since the beginning of the year. Declines in this measure have presaged recession half of the time and uniformly been followed by rate reductions rather than rate increases….

The right concern for the Fed now should be to signal its commitment to accelerating growth and avoiding a return to recession, even at some cost in terms of other risks. This is not the Fed’s policy posture. Watching the Fed over the last year there is a Groundhog Day aspect. One senses they really want to raise rates and achieve a more ‘normal’ stance. But at the same time they do not want to tighten when the economy may be slowing or create financial turmoil. So they keep holding out the prospect of future rate increases and then find themselves unable to deliver. But they always revert to holding out the prospect of rate increases soon, partly for internal comity and partly to preserve optionality. Over the last 12 months nominal GDP has risen at a rate of only 3.3 percent. We hardly seem in danger of demand running away. Today we learned that Germany has followed Japan into negative 10 year rates. We are only one recession away from joining the club…

Must-Read: Dani Rodrik: Brexit and the Globalization Trilemma

Must-Read: Time to fly my Neoliberal Freak Flag again!

I see this very differently than the extremely-sharp leader of the Seventh Social-Democratic International Dani Rodrik does. The Greek and the Spanish electorates vote loudly that they want to stay in the EU and even in the Eurozone at all costs, rather than threaten to exercise their exit option. The German electorate votes loudly that they want fiscal austerity at all costs. The policies are a result of those–democratic–decisions. The problem is not that Europe has too little democracy. The problem is that it has the wrong kind. Issues of fiscal stance are technocratic issues of economic governance in order to balance aggregate demand with potential output–to make the demand for safe, liquid, stores of value at full employment equal to the supply of such assets provided by governments with the exorbitant privilege of issuing reserve currencies and whatever other actors (if any) maintain credibility as safe borrowers. They are not properly what Angela Merkel and company have turned them into: things for the Germany electorate to vote on as it participates in what Dani Rodrik rightly calls a morality play about prudence and fecklessness. The monetary issue of whether to stay in the Eurozone or to pursue adjustment-through-depreciation is also a technocratic issue of economic governance in order to maximize speed and minimize the pain of structural adjustment. It is not properly what it has become: a thing for the Greek and Spanish electorates to vote on in a different morality play, one of whether the Mediterranean is or is not a full part of “Europe”.

Harry Dexter White and John Maynard Keynes were good democrats. Neither would say that Europe’s economic problems now are the result of a deficiency of democracy. They would say that it is the fault of their IMF–that their IMF should have blown the whistle, declared a fundamental disequilibrium, and required one of:

  1. the shrinkage of the eurozone and the depreciation of the peso and the drachma back in 2010
  2. a wipeout of Greek and Spanish external debts, and a fiscal transfer program from the German government to Greece and Spain and to German banks if German authorities wished to avoid such a shrinking of the eurozone.

We did not have such an IMF back in 2010. But that we did not have such an IMF is not the result of a deficiency of democracy in Europe.

Or so I think: I could be wrong here.


Dani Rodrik: Brexit and the Globalization Trilemma: “My personal hope is that Britain will choose to remain in the EU…

…without Britain the EU will likely become less democratic and more wrong-headed…. Exit poses significant economic risk to Britain…. But there are also serious questions posed about the nature of democracy and self-government in the EU as presently constituted. Ambrose Evans-Pritchard (AEP) has now written a remarkable piece that… has little in common with the jingoistic and nativist tone of the Brexit campaign….

Stripped of distractions, it comes down to an elemental choice: whether to restore the full self-government of this nation, or to continue living under a higher supranational regime, ruled by a European Council that we do not elect in any meaningful sense, and that the British people can never remove, even when it persists in error…. We are deciding whether to be guided by a Commission with quasi-executive powers that operates more like the priesthood of the 13th Century papacy than a modern civil service; and whether to submit to a European Court (ECJ) that claims sweeping supremacy, with no right of appeal….

The trouble is that the EU is more of a technocracy than a democracy (AEP calls it a nomenklatura). An obvious alternative to Brexit would be to construct a full-fledged European democracy…. But as AEP says,

I do not think this is remotely possible, or would be desirable if it were, but it is not on offer anyway. Six years into the eurozone crisis there is no a flicker of fiscal union: no eurobonds, no Hamiltonian redemption fund, no pooling of debt, and no budget transfers. The banking union belies its name. Germany and the creditor states have dug in their heels….

Democracy is compatible with deep economic integration only if democracy is appropriately transnationalized as well…. The tension that arises between democracy and globalization is not straightforwardly a consequence of the fact that the latter constrains national sovereignty…. External constraints… can enhance rather than limit democracy. But there are also many circumstances under which external rules do not satisfy the conditions of democratic delegation…. It is clear that the EU rules needed to underpin a single European market have extended significantly beyond what can be supported by democratic legitimacy. Whether Britain’s opt out remains effective or not, the political trilemma is at work….

When I was asked to contribute to a special millennial issue of the Journal of Economic Perspectives… I viewed the EU as the only part of the world economy that could successfully combine hyperglobalization (‘the single market’) with democracy through the creation of a European demos and polity…. I now have to admit that I was wrong in this view (or hope, perhaps). The manner in which Germany and Angela Merkel, in particular, reacted to the crisis in Greece and other indebted countries buried any chance of a democratic Europe…. She treated it as a morality play, pitting responsible northerners against lazy, profligate southerners, and to be dealt with by European technocrats accountable to no one serving up disastrous economic remedies…. My generation of Turks looked at the European Union as an example to emulate and a beacon of democracy. It saddens me greatly that it has now come to stand for a style of rule-making and governance so antithetical to democracy that even informed and reasonable observers like AEP view departure from it as the only option for repairing democracy.