Relevant and even prescient commentary on news, politics and the economy.

The Euro area is ‘miserable’

For all of our economic problems here in the US, a simple measure of ‘misery’ illustrates that US households are less miserable in March 2011 than those in the Euro area.

The chart below illustrates the simple ‘misery index’, which is the unemployment rate plus inflation. The blue line is a 45-degree line; those countries below it have seen their misery index fall on a y/y basis. Not one Euro area economy misery index fell since this time last year – French and German misery indices are unchanged despite improving employment. In contrast, the US misery index improved over the year with labor market conditions.

The problem is, that European fiscal austerity is clinching aggregate demand, raising inflation (via higher taxes) and producing unemployment. Consumers and firms alike are feeling this in Europe.

In the US, fiscal policy has been accommodative enough to allow for private sector deleveraging while keeping the economy on an upward trajectory. However, food and energy price inflation in April stabilized the misery index compared to last year (not shown) – i.e., it’s no longer improving. Unless the labor market shows marked improvement in coming months, US misery will turn “Euro” as inflation batters consumers amid elevated unemployment. Please see Marshall Auerback’s piece at the New Deal 2.0 regarding QE2 – QE2: The Slogan Masquerading as a Serious Policy.

Rebecca Wilder

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Euro area GDP report: unbalanced

Today Eurostat released their estimate of Euro area growth for the first quarter of 2011. The economy grew smartly, or 0.8% on the quarter on a seasonally- and working day- adjusted basis. On the face of it, Euro area growth, which is 3.3% on an annualized basis, dwarfs the 1.8% seen in the US economy. Really, though, it’s joint German and French growth that tower US Q1 GDP growth.

Eurostat doesn’t explicitly highlight how inordinately unbalanced is growth across the region in their report . Germany and France alone accounted for roughly 72% 78% of the quarterly growth of Euro area GDP.

(As I highlight below, the Euro area quarterly growth rate in the chart is slightly different to that in the Eurostat report since some euro area members are missing. The cross-sectional contribution should be roughly unchanged during the revisions, though.)

Update: This chart has been re-posted with only slight modifications from the original. It does not change the article’s premise in any way. H/T to Philippe Waechter in comments below.


READ MORE AFTER THE JUMP!

If final demand was growing so quickly in Germany, I would say that the Euro area is adjusting more healthily than I had expected. Spenders become savers and vice versa, and capital flows adjust current account balances (and trade) accordingly. Germany spends more at home and abroad, while the Periphery less so. This does seem to be occurring according to the Federal Statistical Agency:

In a quarter-on-quarter comparison (adjusted for price, seasonal and calendar variations), a positive contribution was made mainly by the domestic economy. Both capital formation in machinery and equipment and in construction and final consumption expenditure increased in part markedly. The growth of exports and imports continued, too. However, the balance of exports and imports had a smaller share in the strong GDP growth than domestic uses.

Euro area average growth is likely slow down a bit, as the global economy moves toward a tightening bias and fiscal austerity clenches demand further. However, the outlook for the Euro area as a whole does look increasingly reliant on the trajectory of German and French economic conditions. This is a risk, especially since Germany is an export-driven economy.

As a comparison, 2005 saw growth as broadly more balanced, where Germany and France contributed a smaller 50% to total Euro area growth.


The Q1 2011 growth trajectory (top chart) is entirely consistent with ECB targeted at the core countries.

Rebecca Wilder

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What? Greece has to raise capital in 2012 and meet a 7.5% deficit target this year?

Over the last couple of months, a string of events made policy makers and investors alike say, what? Greece must raise capital next year and meet a 7.5% deficit target this year? Yes, they do, unless circumstances change. It’s near impossible to bet successfully on what Euro area policy makers are going to do, so let’s just review the facts here.

Greece missed its 2010 budget deficit target by near 1%, 9.6% of GDP projected (see .pdf page 45) vs. 10.5% actual (see Eurostat release, .pdf). The 2011 target is 7.5% of GDP.

Greece needs to raise roughly 30 bn euro in the private market next year – see .pdf page 50 here, where the IMF projects that Greece will finance 40.3bn in 2012, up from the 11 bn required in 2011. Furthermore, they’ll need to issue debt with longer maturity than the 3-month bills they’ve been marketing this year. At 1200 basis points over German bunds on a 10yr note, Greece cannot ‘afford’ this and is very unlikely to be tapping markets for term loans anytime next year.

Greece’s privatisation plan – selling state-owned assets – is probably too aggressive, amounting to roughly 4% of GDP per year through 2015 (10 bn euro average per year, see .pdf of presentation here, as a percentage of average GDP spanning 2010-2012).

But here’s something that is really important, and another reason why I do not believe that Greece would voluntarily default until at least next year: they’re expected to run a primary surplus in 2012. I take note that one can challenge the IMF’s forecast, but it’s the best information that I have at this time.

The chart illustrates the IMF’s 2011 and 2012 primary balance forecast across the Euro area (16) from the April 2011 World Economic Outlook. Those countries above the zero axis are expected to run 2012 primary surpluses – Greece, Germany, and Italy.

The primary balance is general government net lending (borrowing) excluding net interest expense. Better put: if the government runs a primary surplus, tax revenues are sufficient to pay all the government’s bills except the interest payments on the outstanding debt. Restructuring when an economy is in primary surplus makes much more sense.

If Greece runs a primary surplus in 2012, it will have a strategic ‘default card’ to play. This year it doesn’t, or Greece still needs the EFSF/EU/IMF to finance its spending. Next year, Greece can say “hey, we don’t need your money anymore.”

What to expect

Barring an immediate secession, I anticipate that Greece’s ‘circumstances’ will change in one of two ways over the near term: (1) Greece terms out its loans – a very soft restructuring – in the amount of 30 bn euro (or roughly thereabouts), or (2) the EFSF raises another 30 bn – that’s what it’s for.

On default, there’s a body of literature that attempts to quantify the costs of sovereign default – see the Economist article for a short literature review. Broadly speaking, the true economic impact could be ‘short-lived’ but is difficult to measure (see specifically this IMF paper).

It all comes down to this: I’m Greece, and I’ve put through structural reform that gets me a primary surplus next year – why subject the economy to further depressionary austerity measures rather than haircut my creditors and start from scratch? It’s been done before (see Table 2 of this paper). Or, I’m Germany (or France), do I want to write a check to Greece? Or recapitalize my banks outright.

Rebecca Wilder

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The re-balancing of trade within the Euro area: some improvement but not enough

I thought that the whole point of fiscal austerity was to turn the balance of trade and capital flow within the Euro area: debtors becoming savers and capital flows out of the Periphery and into to the core. We’re seeing the outset of such a shift; but it’s probably too slow in the making.

The chart below illustrates the trade balance (exports minus imports) within the Euro area (17) for key austerity – Ireland, Greece, Spain, and Italy – and core – Germany, France, and the Netherlands – countries. The data span the last six months and are normalized by the European Commission’s 2010 GDP estimate for each country (listed on the Eurostat website).

(Let me be clear here: the trade balances illustrated below include only trade flows within the Euro area.)

It should be noted that this is an incomplete picture, since there are 17 Euro area countries. However, the following point is worth noting: the balance of trade is arduously improving in Spain and Greece at the cost of just a small share of surplus in the core. To me, policy makers are grasping at straws when they stick to the ‘exports will grow the Periphery out of their debt problems’ story.

* The Netherlands’ intra-Euro area trade surplus increased near 2 pps to 22.6%.
* Italy’s intra-Euro area trade deficit hovered at just under -1% of GDP.
* Spain’s trade deficit improved somewhat, falling roughly 50 basis points to -0.5% of GDP – probably nothing to write home about, given that the economy’s facing a 20%+ unemployment rate.
* The Greek trade deficit improved 90 bps to -5.3% of GDP.
* Ireland remains as open as ever.
* The German surplus dropped 15 bps to 1.3% of GDP.

It is true, that the re-balancing will take time. Some will argue that it’s extra-euro area trade that will provide the impetus for growth in some of these countries (Spain, Ireland, Greece, the usual suspects). However, while exports to the extra-Euro area market have played an important role in some growth trajectories – Spain, for example – intra-Euro area trade is critical. Below I list the average share of total export income derived from within the Euro area:

Average share of exports (source: Eurostat and Angry Bear calcs)
40.9% 38.8% 41.5% 55.7% 48.6% 43.8% 62.0%
Germany Ireland Greece Spain France Italy Netherlands

How much more austerity and ‘competitiveness’ will it take to turn the tide here? Probably more than some are willing to give. A nominal devaluation is needed. Without that, it’s ultimately ‘bailout’ or ‘default’, or both.

A side note: it would have really helped if the ECB allowed prices in Germany, for example, to overshoot the 2% Euro area inflation target.

Rebecca Wilder

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Greece will not be ‘allowed’ to default until policy shores up the Irish bond market

Just look at Tracy Alloway’s imagery at FT Alphaville, and you’ll know what’s expected: an imminent Greek default. I still argue no, although European policy tactics are quite enigmatic and their next move is really anyone’s guess. Alas, here’s mine.

Assuming that Greece does not secede from the Euro area, I give you three reasons why Greece will not be allowed to default soon (at least the next 12 months, given current market conditions). I say ‘allowed’ because true to the IMF legacy, EU/Euro area officials very likely see restructuring as a ‘gift’ for good fiscal behavior.

(1) Moral hazard is an important issue in Europe, and Greece has only begun its austerity program. We’ll need confirmation that they are not on track in order to assess the timing of default, in my view.

Ironically, the EU/IMF/Euro area are sticking to the ‘exports will grow the Greek economy’ story. I say ironically because Greece was exporting a larger share of GDP before the recession, average 22.6% spanning 2005-2007, than it is now, 19.8% in 2010 (average Q1-Q3).

(2) The banking system’s not ready. Unless the Germans want to instantly recapitalize the Landesbanks this year, I’d argue that the Euro banking system remains overly exposed to mark-to-market accounting (i.e. holding the assets at fair value not wishful thinking) for all of the crappy debt that it holds on balance.

In fact, the German banks purchased 11bn 1.1bn euro in Greek sovereign bonds in January. That’s the most current data available; but I bet they’re simply moving debt out of the Greek banks and corporates and into the sovereign as the probability of default rises (see chart below).

(3) This one’s critical: policy makers must shore up Ireland and Portugal in order to avoid a quick contagion across the European banking system. They haven’t done that yet. In fact, the Finnish election results exposed the tenuous negotiation process overall.

See, the Greek yield curve is inverted – so are the Portuguese and Irish yield curves, albeit to a much lesser degree. The point is, that Portugal and Ireland are very close to the Greek brink.
(read more after the jump!)

Inversion matters. Currently a Greek 10yr bond yields 14.5% with a euro price of 59, while a 2-yr bond yields 21.4% with a euro price of 73. Bond investors are going for the cheapest bond not the highest yield (at the end of the yield curve) as a bet on a binary situation: haircut or no haircut. When a curve is inverted, it’s all about price not yield.

Portugal and Ireland are already inverted and close to the Greek brink. If Greece were to restructure without a full-fledged backstop from the Euro area governments, the Portuguese and Irish curves would swiftly turn over. And if European policy makers could stop the contagion there, then that would be a true feat….

Spain, the economic ‘line in the sand’, would be next. We saw last week how markets view the Spanish sovereign, still risky. Bond yields on the Spanish 10yr broke out of a 4-month trading band, hitting 5.55% on April 18 (latest number is 5.47%).

More on Ireland

I assure you, that it’s too early to deem the Irish sovereign as impervious to the Irish banking system’s fake asset base. The banking system is living on emergency liquidity assistance (ELA) and the ECB’s marginal refinancing operations (currently Irish banks can borrow as much as they want on a short-term basis from the ECB at the current rate, 1.25%).

By my calculations, the Central Bank of Ireland (via the ELA) and the ECB are subsidizing – I say subsidizing because market funding costs are proxied by the sovereign borrowing costs of 10% – 16% of the Irish banking system’s balance sheet. As such, profit margins are thin, and mortgage rates are running low at 3-4%. (see CBI website for plenty of data.) These funding costs are not sustainable – not to mention the Irish stress tests assume that they remain fixed at Q4 2010 levels (see exhibit 2 in Appendix C of the stress test documentation). Nonperforming loans will rise.

I leave you with this illustration of possible non-performing loans when mortgage rates rise on the following:

(A) ECB rate hikes – mortgages are tied to 12-month euribor and most Irish mortgages are variable.
(B) the dissipation of record-low bank borrowing costs (this also is another post, but the ECB has yet to release its medium-term funding program for Ireland).

Note: if/when they do default, Kash at the Street Light blog provides an overview of some technical considerations.

Rebecca Wilder

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ECB policy is tightening – has been for some time

Update: Nouriel Roubini front pages this post on Euromonitor here.

The ECB dove in and hiked its policy rate by 25 basis points to 1.25%. I had the pleasure of listening to Wolfgang Munchau on Thursday, and he reiterated what I reluctantly understood: the ECB’s strict inflation target is ridiculously simple for such a complex region; but more importantly, the Governing Council is just itching to tighten.

Eurointelligence blog highlights the various interpretations of the ECB’s shift in policy: Thomas Mayer at Deutsche Bank suggests that the ECB’s normalization is appropriate, while David Beckworth and others (links at Beckworth’s site) are more sympathetic to the impact on the Periphery. They highlight that relative price fluctuations could facilitate the much-needed redistribution of capital flows (i.e., the current account); and furthermore, that ECB policy is even too tight for the core (a google translation of Kantoos Economics). Yours truly has written extensively about this – among others, here’s one, another, and another. Who’s right? Ultimately time will tell.

But I do suspect that we haven’t seen the end of this crisis. The ECB is squeezing out liquidity when more liquidity is needed. Furthermore, the core remains subject to export shocks via external demand; and there’s building evidence that global growth will slow (see this excellent post on global PMIs by Edward Hugh).

It’s ironic, too. While the ECB is currently being heralded or chastised for raising rates, monetary and financial conditions in Europe have been tight for some time, both on a relative and stand-alone basis!
(read more after the jump!)

First, the ECB’s bond purchase programs, the Securities Market Programme and the Covered Bond Purchase program, amount to just 1.4% of 2010 Eurozone GDP. In stark contrast, the size of the Fed’s program broke 16% (and is rising) and the Bank of England’s purchase program remains firm at around 13% of GDP.


The asset purchase programs are emergence liquidity programs and are not normal monetary policy tools. But while the Fed and the BoE do not sterilize their flows, the ECB does. And my interpretation of ECB rhetoric and policy as of late is that they want out of the secondary-bond purchase business. For example, they’ve slowed their SMP purchases markedly in 2011 (see the ad-hoc announcements here).

Second, Eurozone financial conditions have been tightening since August 2010, while those in the US and England loosened up. Goldman Sachs constructs a financial conditions index, which is comprised of real interest rates (long and short), real exchange rates, and equity market capitalization. I love this index (subscription required), as it represents a broad measure of monetary policy pass-through.

Even though the ECB just started its rate-hiking cycle, they’ve been effectively tightening for some time.

I would say that Eurozone (as a whole) growth prospects are seriously challenged at this time, especially by comparing monetary policy to that in England and the US. We’ll see if the ECB’s able to push its target rate back to 2.5-3% through 2012 – I suspect that may be just a pipe dream, as tight liquidity and a slowing global economy drag economic growth.

The ECB’s actions imply to me that they still do not understand the following: Europe faces a banking crisis not a fiscal crisis!

Rebecca Wilder

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Guest Post: RJs Aggregator – The Ryan Plan

Today RJs Aggregator presents opinion across the web regarding proposed Republican budget cuts for fiscal year 2012. Of note, AB authors Ken Houghton and Kash also contributed to the debate.

Guest Post: The RJs Aggregator – The Ryan Plan

by RJ

House Republicans Propose $4 Trillion in Cuts Over Decade – “House Republicans plan this week to propose more than $4 trillion in federal spending reductions over the next decade by reshaping popular programs like Medicare1, the Budget Committee chairman said Sunday in opening a new front in the intensifying budget wars2. Appearing on “Fox News Sunday,” the chairman, Representative Paul D. Ryan3 of Wisconsin, also said Republicans would call for strict caps on all government spending that would require cuts to take effect whenever Congress exceeded those limits. “We are going to put out a plan that gets our debt on a downward trajectory and gets us to a point of giving our next generation a debt-free nation,””

The Republican budget: Praising Congressman Ryan - The Economist – “BARACK OBAMA, as we unhappily noted when he produced his budget in February, has no credible plan for getting America’s runaway budget deficit under control. Up to now the Republicans have been just as useless; they have confined themselves to provoking a probable government shutdown in pursuit of a fantasy war against the non-security discretionary expenditures that make up only an eighth of the total budget, rather than tackling the long-term problem posed by the escalating costs of entitlements. Now that has changed. On April 5th Paul Ryan, the young chairman of the House Budget Committee, laid out a brave counter-proposal for next year’s budget and beyond (see article)—brave both in identifying the scope of the problem and in proposing the kind of deeply unpopular medicine that will be needed to cope with it. It is far from perfect; but it is the first sign of courage from someone with actual power over the budget.”

(Read much more after the jump!)

Paul Ryan To Boldly Take On Big Poor - “You know how you have been reading for weeks and weeks about how the bold Republican budget, crafted by Prince of Boldness Paul Ryan, will boldly address the deficit problem that President Obama refuses to address? . First, reports the Hill, Ryan will not touch Social Security, which is immensely popular with the middle class. Second, reports Politico, he will take a huge whack out of Medicaid, which primarily benefits the poor: Budget Committee Chairman Paul Ryan has made clear to POLITICO in February that he intends to target Medicaid and Medicare for savings. While Medicaid is easiest to win consensus on, Medicare is the biggest debt driver. I love the part about how Medicaid the the “easiest to win consensus on.” Why is that? Because it’s wasteful? No, Medicaid is super-cheap — so cheap the program routinely has trouble finding doctors willing to accept it. It’s easiest to win consensus on because its beneficiaries have the least political power.”

What Paul Ryan’s budget actually does - “Paul Ryan’s plan for Medicare and Paul Ryan’s plan for Medicaid rely on the same bait-and-switch: They use a reform to disguise a cut. In Medicare’s case, the reform is privatization. The current Medicare program would be dissolved and the next generation of seniors would choose from Medicare-certified private plans on an exchange. But that wouldn’t save money. In fact, it would cost money. As the Congressional Budget Office has said (pdf), since Medicare is cheaper than private insurance, beneficiaries will see “higher premiums in the private market for a package of benefits similar to that currently provided by Medicare.” In Medicaid’s case, the reform is block-granting. Right now, the federal government shares Medicaid costs with the states. That means their payments increase or decrease with Medicaid’s actual rate of spending. Under a block grant system, that’d stop. They’d simply give states a lump sum at the beginning of the year and that’d have to suffice. And if a recession hits and more people need Medicaid or a nasty flu descends and lots of disabled beneficiaries end up in the hospital with pneumonia? Too bad.”

Moment of Blather – “David Brooks’s commentary on Paul Ryan’s “budget proposal” is entitled “Moment of Truth.” Brooks falls over himself gushing about his new man-crush, calling it “the most comprehensive and most courageous budget reform proposal any of us have seen in our lifetimes.” “Ryan is expected to leap into the vacuum left by the president’s passivity,” he continues. Gag me. First of all, Ryan’s plan is not “comprehensive” by any stretch of the imagination. Ryan’s plan does limit taxes to 19 percent of GDP and outlays to 14.75 percent of GDP by by 2050, producing a huge surplus. How does he achieve this budgetary miracle? In part, he does it by waving his magic wand. This is what the CBO has to say (emphasis added):“The proposal specifies a path for all other spending [other than Medicare, Medicaid, and Social Security] (excluding interest) that would cause such spending to decline sharply as a share of GDP—from 12 percent in 2010 to 6 percent in 2022 and 3½ percent by 2050; the proposal does not specify the changes to government programs that might be made in order to produce that path.”

Rivlin: ‘I don’t support the version of Medicare premium support in the the Ryan plan’ – Ezra Klein – ““Alice Rivlin and I designed these Medicare and Medicaid reforms,” Paul Ryan said on “Morning Joe” yesterday. “Alice Rivlin was Clinton’s OMB director… she’s a proud Democrat at the Brookings institution. These entitlement reforms are based off of those models that she and I worked on together.” But Rivlin — who is all that Ryan says she is, in addition to a former vice chair of the Federal Reserve — is not supporting the reforms as written in Ryan’s budget. I spoke with her this morning to ask why. A lightly edited transcript of our conversation follows.”

Generational Divide Colors Debate Over Medicare’s Future – “The Republican budget released on Tuesday1 is a daring one in many ways. Above all, it would replace the current Medicare2 with a system of private health insurance plans subsidized by the government. Whether you like3 or loathe that idea4, it would undeniably reduce Medicare’s long-term funding gap — which is by far the biggest source of looming federal deficits. Yet there is at least one big way in which the plan isn’t daring at all. It asks for a whole lot of sacrifice from everyone under the age of 55 and little from everyone 55 and over. Representative Paul Ryan5, the Wisconsin Republican who wrote the plan, calls the budget deficit an “existential threat” to the United States. Then he absolves more than one-third of all adults from responsibility in dealing with that threat.”

The cost of Medicaid savings - “Already Rep. Ryan’s budget plan has received a lot of attention. By now you well know that one way it aims to save money is by turning Medicaid into a state block grant program. It is important to recognize that there is a cost to those savings: worse health for low-income individuals. Yet some proponents of Medicaid cuts deny this cost, citing evidence that does not support their case. In a NEJM paper by Harold Pollack, Uwe Reinhardt, and two of us (Austin and Aaron) that published today at 5PM, we emphasize just that. It’s short and ungated, so please read it. In it, we press those who claim Medicaid is worse for health than being uninsured to cough up their causal theory as to how this could be the case.”

Medicaid Savings in Ryan’s Plan Would Come At the Expense of the Poor » “The “Path to Prosperity” budget proposed by House Budget Committee Chairman Paul Ryan (R-WI), includes a plan to revamp Medicaid —which currently provides federal funding to states on an “as-needed” basis to help cover the health care costs of the poor and disabled—into a block grant program. This one initiative alone, according to the budget bill’s supporters, would save $750 billion over ten years. There is little in Ryan’s budget proposal to support just where these savings will come from, but it’s easy to imagine that state caps on Medicaid enrollment, cuts in covered benefits and lowered physician reimbursement, along with an increase in co-pays for beneficiaries will all play an essential role.”

Death Panels are starting to sound awfully good right about now – “Jill – Think about it: How would you rather check out of this God-forsaken level of reality? Would you rather be in a warm bed somewhere, perhaps lying on sheets nice and warm out of the dryer, with the sun streaming in your window and soft music playing into your room, perhaps with the aroma of peppermint, or fresh bread, or whatever your favorite aroma might be, while a doctor slips a needle into your arm and you wooze into a delightful drowsiness and then unconsciousness, and then another needle containing the drug that stops your heart is administered…or would you prefer to die out in the street, old, sick, and alone, huddling from a bitter wind, because you have no home, no shelter, no food, and no medical care? I know which one I’d take. But it’s hard to imagine that the GOP will be kind and compassionate enough to offer the elderly the first one, not if the current House majority gets its way: House Republicans are preparing to introduce a 10-year budget Tuesday that will eliminate Medicare and replace it with a private insurance system that closely resembles the new health care law, and end Medicaid as an entitlement program all together.”

Ryan plan to slash Medicaid will cost the economy nearly two million private sector jobs – “Currently, Medicaid provides comprehensive health coverage to the elderly, disabled, children, and low-income adults.[1] The cost of providing health care coverage is split between the federal government and the states. House Budget Committee Chairman Paul Ryan (R.-Wisc.) released a budget resolution this week that would “block grant” Medicaid, meaning that it would give states a fixed amount of money rather than provide a fixed share of the total costs. Because these grants would grow more slowly than the expected inflation rate for health care costs, this proposal would have the federal government shift an increasing amount of the coverage costs onto states, who will be in turn forced to cut health benefits and other services, cut public investments such as education and transportation, or raise taxes. Using a standard macroeconomic model that is consistent with private- and public-sector forecasters, we find that a $207 billion cut would result in a loss of 2.1 million jobs over the next five years, or 2.9 million full-time equivalent jobs.[3]

Challenge to the Heritage Foundation; Preposterous Unemployment Estimate Revisited – Mish – “In No Path to Prosperity: Ryan’s Incredulous Budget-Balancing Proposal, Preposterous Unemployment Estimate I blasted the Heritage Foundation’s estimate of 4% unemployment rate by 2015. In the above referenced article, I did unemployment math two different ways to show just how silly a 4% unemployment projection is. In an effort to be as fair to the Heritage Foundation as possible, I will do the math a third time factoring in a few more variables. Before doing so, please note that Bernanke estimates it takes 125,000 jobs a month to hold the unemployment rate steady. Thus, in a Bernanke scenario we would need 1.5 million workers a year to break even. I find that number reasonable.”

Long-Term Analysis of a Budget Proposal by Chairman Ryan – “CBO Director’s Blog – In response to a request from House Budget Committee Chairman Paul Ryan, CBO has conducted a long-term analysis of a proposal to substantially change federal payments under the Medicare and Medicaid programs, eliminate the subsidies to be provided through new insurance exchanges under last year’s major health care legislation, leave Social Security as it would be under current law, and set paths for all other federal spending (excluding interest) and federal tax revenues at specified growth rates or percentages of gross domestic product (GDP). CBO analyzed major provisions of the proposal as they were described by the Chairman’s staff. CBO has not reviewed legislative language for the proposal, so this analysis does not represent a cost estimate for legislation that might implement the proposal.”

CBO: GOP Budget Would Increase Debt, Then Stick It To Medicare Patients - “The nonpartisan Congressional Budget Office’s initial analysis of the House GOP budget released today by Rep. Paul Ryan (R-WI) is filled with nuggets of bad news for Republicans. In addition to acknowledging that seniors, disabled and elderly people would be hit with much higher out-of-pocket health care costs, the CBO finds that by the end of the 10-year budget window, public debt will actually be higher than it would be if the GOP just did nothing. Under the so-called “extended baseline scenario” — a.k.a. projections based on current law — debt held by the public will grow to 67 percent of GDP by 2022. Under the GOP plan, public debt would reach 70 percent of GDP in the same window. In other words, the spending cuts Republicans would realize in the first 10 years would be outpaced by deficit increasing tax-cuts, which Ryan also proposes. After that, debt projections under the plan improve decade-by-decade relative to current law. That’s because 2022 would mark the beginning of the Medicare privatization plan. 04 05 Ryan Letter (scribd)”

Ryan’s Budget Plan Is Ridiculous, But It Could Shift the Debate – “Ezra Klein has helpfully assembled a summary of the Ryan GOP budget. As you can see, while everyone’s talking about the privatization of Medicare and block-grant of Medicaid, there are plenty of other pieces worth discussing here even without any of that. Ryan would reduce discretionary spending to pre-2008 levels and freeze it for five years. He would repeal the Affordable Care Act and Dodd-Frank entirely. He would block grant the food stamp program, giving a set amount of money indexed to inflation, regardless of economic conditions. He would eliminate all changes to Pell Grants, kicking them back to 2008 levels. And he would use the savings from all that to make the Bush tax cuts effectively permanent, but actually do worse than that, by changing the tax code to lower the top individual and corporate tax rates to 25% and making up the revenue on the poor. So this is a pretty pathetic budget. And it also happens to be a complete fiction. The numbers are not to be trusted at all. Ryan assumes $1.4 trillion in savings from health care repeal when the Congressional Budget Office scores repeal as increasing the deficit. He uses “dynamic scoring” to perpetuate a fiction that tax cuts will increase tax revenue. He sets unrealistic spending caps without determining how to get there or how future Congresses not bound by his budget will abide by them. Worst, he assumes a world-historical low unemployment rate based on a Heritage Foundation study that claimed the Bush tax cuts would lead to the same kind of prosperity (hint: they didn’t). Indeed, by 2021, Ryan assumes a 2.8% unemployment rate, which is how he achieves the revenue needed to make the numbers work. Included with this projection is an implausible housing boom.”

Magical thinking won’t create jobs: Heritage forecasts for Ryan plan are fantasy – “Rep. Paul Ryan (R-Wisc.) has produced a magical budget that “strengthens the safety net” by slashing trillions of dollars from Medicaid and Medicare. He also proposes to “strengthen” Social Security by dismissing the $2.4 trillion Social Security trust fund as valueless, based on “dubious accounting.” It is no surprise, therefore, that the economic analysis Ryan holds up to support his plan is pure fantasy. According to Ryan: “A study just released by the Heritage Center for Data Analysis projects that The Path to Prosperity will help create nearly one million new private-sector jobs next year, bring the unemployment rate down to 4% by 2015, and result in 2.5 million additional private-sector jobs in the last year of the decade.” The Heritage Center’s forecasts for the Ryan plan are even bolder in the out years: It predicts unemployment will fall to an unprecedented 2.8% by 2021.”

Memory Hole Alert – Krugman – “Wow. Yesterday afternoon I downloaded the tables from that Heritage report that’s the basis for the Ryan plan. The first page looked like this: You can see the unemployment forecast, with the amazing 2.8 percent prediction, in the fourth set of figures. But go to the same place right now, and you get this: Yep — they took the offending number out. I mean, really, guys — this is all over the blogosphere; did you really think you could get away with pretending it was never there? Anyway, you now know what kind of people we’re dealing with. Update: For reference, here they are (pdf files): As of yesterday. As of today.”

Paul Ryan Does Wall Street’s Bidding In Budget - “House Republicans — led by House Budget Committee Chairman Paul Ryan (R-WI) — released their 2012 budget today. The plan includes a giant tax cut for the wealthy, as well as a complete dismantling of Medicare and Medicaid. But it also includes a gift for Wall Street, in the form of a repeal of the provisions of the Dodd-Frank financial reform law that protect taxpayers from having to bail out failed financial institutions.The provisions in question — which Ryan dubbed “permanent bailout authority” in a Wall Street Journal op-ed today, reviving a key GOP talking point from the financial reform debate — are actually two distinct parts of the financial reform law.”

Why is Paul Ryan’s Budget Trying to Dismantle Financial Reform?“It’s not enough to gut programs for low-income Americans. Paul Ryan wants to roll the clock back on Wall Street to 2008. The budget Paul Ryan released yesterday has huge cuts that are likely to fall on the poorest Americans while offering all kinds of bonuses to the top 1%. Others will be talking about how it eliminates Medicare and Medicaid. I want to talk about how it dismantles one of the few regulations put on Wall Street post-crisis. Let’s back up with a high-level overview.”

Taking Note: Congressman Ryan’s Doublethink – “One of the main reasons that the conservative movement continues to dictate the terms of domestic policy debates is its mastery at applying language that resonates favorably with the public to deeply unpopular ideas. Representative Paul Ryan’s “Path to Prosperity,” starting with the title, is full of more instances of “holding two contradictory beliefs in one’s mind simultaneously” than George Orwell himself could have conjured. Some examples of doublespeak (a term Orwell did not coin) in Ryan’s plan, along with translations into plain English that would more accurately inform the public:”

Representative Ryan’s Roadmap: Interesting Implied Macro Impacts – “I’ve read and re-read the Heritage Foundation’s analysis of how the projections for the Ryan plan were developed. I’m sure it’s my own failing, but I still don’t quite understand what is going on. And this is after Heritage took down their original documentation that indicated unemployment would eventually hit 2.8%.[0] (Here is National Journal’s take on the original Heritage analysis.) Even ignoring the unemployment number (which seems to have moved a bit, although not reported in the document), I thought it worthwhile to mention the other oddities of the report. First, it is important to note that the simulation forecasts relative to the CBO alternative fiscal scenario, rather than extended baseline, as would typically be the case. Obviously, this makes the Ryan plan “look better” in terms of budget deficits and (given Heritage’s modeling approach incorporating substantial supply side effects) in terms of growth. Second, it is very interesting to take a look at the forecasts. For GDP (Figure 1), the forecasts imply a noticeable increase, amounting to a 2.4% higher GDP (in log terms, relative to baseline) by 2021. Perhaps reflecting the assumptions built into the model, despite reduced effective personal tax rates (see Appendix 3 tables), personal tax receipts are higher (Figure 2).”

The Ryan Plan Is “Fundamentally Immoral” – “Even people not particularly enamored with government involvement in health insurance hate the Ryan plan for Medicare: You put the load right on me, Democracy in America: Paul Ryan’s plan to replace Medicare with a system of vouchers for seniors to buy health care on the private market … ends the guarantee that all American seniors will have health insurance. The Medicare system we’ve had in place for the past 45 years promises that once you reach 65, you will be covered by a government-financed health-insurance plan. Mr. Ryan’s plan promises that once you reach 65, you will receive a voucher for an amount that he thinks ought to be enough for individuals to purchase a private health-insurance plan. … If that voucher isn’t worth enough for some particular senior to buy insurance, and that particular senior isn’t wealthy enough to top off the coverage, or is a bit forgetful and neglects to purchase insurance, there’s no guarantee that that person will be insured. It’s up to you; you carry the risk.”

Ryan Plan Unconstitutional Under Senate GOP Balanced Budget Amendment – “Under the balanced budget amendment proposal unveiled last Thursday with all 47 GOP senators on board, the blueprint presented by House Budget Committee Chairman Paul Ryan on Tuesday would be unconstitutional until sometime after 2030. It’s not that Ryan’s budget plan doesn’t balance; excluding interest payments, it would balance starting 2015, which does clear the bar set by the balanced budget amendment. But primary (or noninterest) spending, though down sharply from close to 23% of GDP this year, would remain at 17% of GDP or higher beyond 2030. Never mind that Ryan and his GOP cohorts have just taken on tremendous political risk by proposing to turn Medicare into a fixed-payment voucher for buying private health coverage or that he would cut $750 billion in Medicaid costs this decade while providing flexibility — and shifting responsibility — to the states.”

Ryan Plan’s “Path to Prosperity” Is Just for the Wealthy, CBPP: “House Budget Committee Chairman Paul Ryan’s name for his budget — “The Path to Prosperity” — is a cruel joke. For the last three decades, nearly all the gains of economic growth have gone to the tiny sliver of people at the top of the income scale. The challenge for policymakers is how to restore opportunity for middle- and lower-income Americans by once again widening the path of prosperity. Unfortunately, Chairman Ryan’s plan would narrow it further.For the wealthy, Ryan’s proposals are pure gold:

  • A typical hedge fund manager would benefit from Ryan’s extension of the Bush tax cuts for high-income people; the average person making at least $1 million a year would get $125,000 a year in tax breaks.
  • Heirs to multi-million-dollar estates would benefit from Ryan’s estate tax proposal, which would let them inherit the first $10 million in estate value entirely tax-free.
  • High-income investors would benefit from Ryan’s elimination of Medicare taxes on their investment income.
  • And large numbers of high earners would benefit from Ryan’s call to cut the top rate to 25 percent, the lowest in 80 years.”

$3 Trillion Here, $3 Trillion There – “Krugman OK, $2.9 trillion. Anyway, pretty soon you’ll be talking about real money. Richard Rubin and Stephen Sloan direct us to a new Tax Policy Center assessment of the tax cuts in the Ryan plan (all, repeat all, of which go to top incomes and corporations) The people at TPC are careful to say that this is not a full assessment of the Ryan plan, because The proposed resolution includes measures to broaden the individual and corporate tax bases, but lacks sufficient detail for an estimate including those provisions. I’ll say. In fact, the proposal says it will broaden the tax base, but says nothing whatsoever about how. And it would take an awful lot of broadening to make up for the revenue losses, which are estimated at $2.9 trillion. As Rubin and Sloan point out, even completely eliminating the mortgage interest deduction wouldn’t be enough to close more than a fraction of the gap.And what does the chairman of the Ways and Means Committee have to say? His spokesperson says, The pro-growth tax reform proposal included in Chairman Ryan’s budget proposal is both revenue neutral and holds revenue at historical norms. I believe that translates as, “We believe in voodoo. Also, arithmetic has a well-known liberal bias.””

RJ: In all, Paul Krugman has 18 blog posts on the Ryan plan in addition to his regular column, which for the most part I haven’t included here; for his complete analysis, drill back through his blog to the Apr 5th post titled Groundhog Day on the Budget.

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Germany is competitive on a relative basis as measured by productivity, standard of living or prices

The point of this article is to demonstrate that Germany has enjoyed increased ‘competitiveness’ as measured by productivity levels and relative prices. But the clarity of Germany’s ‘competitiveness’ cannot be established by using German data in the form of a black box – a bird’s-eye view of the region is the only way to see this.

In a very well written piece, Kantoos highlights that the German current account surplus is more a function of reduced investment and productivity passing through to low market-clearing wages than it is ‘competitiveness’, per se. While I agree with his economic analysis, I disagree that Germany is not competitive – Italy, yes; Germany, no.
(read much more after the jump!)

The term ‘competitiveness’ is rather non-discriminatory. It can refer to a lot of things. Below, I discuss national competitiveness, i.e., measuring a country’s relative position in the global market place. In contrast, micro-level competition – firms compete in various industries for market share and profits – is not really relevant here. The fact that we’re talking about a nation’s competitiveness means that it’s not clear how to measure competitiveness. Let’s explore.

In order for Germany to be deemed sufficiently ‘uncompetitive’ globally, relatively weak productivity gains would have left German wages relatively low compared to major trading partners. And by extension, Germany’s standard of living must also have suffer compared to its trading partners. From what I can see, only relative wages have been surpressed. Therefore, I conclude that Germany is competitive.

Exhibit 1: German productivity gains over the last decade – I use the period 2000-2008, so as to not bias the results downward from the global recession – have not been striking, but positive nevertheless.


German productivity has increased on a cumulative basis compared to Euro area trading partners, like France and Italy. Notably, the Euro area average is down, which is probably biased by Italy’s 8.7% cumulative drop in productivity. So on a relative basis, Germany’s productive and second only to Spain in this sample (notably Spain gained a whopping 4.1%!). (Also, please see Chart 18 of this ECB research paper for a broader comparison – it’s a .pdf file).

Exhibit 2: Despite the relatively weak productivity gains, albeit positive I remind you, the standard of living has increased in line with other Eurozone economies, like France, and surpassed others, like Italy.

This chart, to me, illustrates that productivity gains have been ‘competitive’ enough to support decent growth in the average standard of living (as measured by real per-capita GDP from the IMF).

And to really hammer down the point, please see page 24 in a recent ECB research report, Chart 18 referenced above, on the impact of the global recession on Euro area competitiveness. Germany’s 2000-2008 annual average productivity gains are in line with many other European economy, but wage compensation is relatively muted. In fact, German average annual compensation per employee is the lowest of the cross-section (according to Chart 18). My point is, that productivity gains were not fully passed on to workers via nominal compensation gains (probably a better comparison would be real compensation per employee).

Exhibit 3: It’s all about levels; and Germany’s 2010 average income is relatively high (measured in GDP per-capita PPP dollars for comparability across exchange rate regimes).


The German standard of living (i.e., relative per-capita GDP) fairs well against a cross-section of developed economies in Europe and abroad. Average income (standard of living) is the fourth highest behind Norway (for comparison to Kantoos’ article), the US, and Canada. Italy runs low current account deficits (trade is pretty well balanced), and average income falls at the bottom of this sample. That’s very uncompetitive in the relative sense.

The second issue that I mentioned is measurement – i.e., there’s a problem with using just unit labor costs to measure ‘competitiveness’ (see a recent Naked Capitalism article to the point).

However, no matter how you look at relative prices – the real exchange rate, relative export prices, relative unit labor costs, relative GDP deflators, etc. – Germany stands out as very ‘competitive’, or at least ‘exportable’. I have no direct chart to support my previous statement; but the European Commission does. The EC publishes a quarterly report on price and cost competitiveness; and according to the most recent report, 2Q 2010 (.pdf), Germany is very competitive by any measure of relative prices(see pages 15-16 of the .pdf).

In conclusion, it’s difficult for me to see how Germany is not ‘competitive’ on a relative basis, if ‘competitive’ is either (1) standard of living and relative productivity gains, or (2) in a relative prices sense.

I would state here that within the Eurozone, a healthy rebalancing of current accounts is underway (i.e., typical creditors dissaving and typical debtors saving). This would be made much easier if the ECB would run looser policy and allow German inflation to overshoot, effectively facilitating the relative price adjustements. Please see David Beckworth’s article to this point.

Rebecca Wilder

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Guest Post: The RJS Aggregator – Government deficits and MMT

Introduction: Here’s another timely compilation of economic commentary by Rj from the Global Glass Onion. His thread highlights a recent interchange between straight Keynesian economists, Paul Krugman, for example, and Modern Monetary Theorists (MMT), like Jamie Galbraith, Bill Mitchell, Randy Wray, and Warren Mosler.

I’ll add just one link to The RJS Aggregator today. At his Benzinga column , Randy Wray describes the monetary mechanics of MMT, which is the cornerstone of several theories (like how government deficits drive down short rates through reserve creation). Rebecca Wilder

Guest Post: RJs Analysis: The debate about government deficits – MMT

by RJ

The Austerity Delusion, by Paul Krugman - “Portugal’s government has just fallen in a dispute over austerity proposals. Irish bond yields have topped 10 percent for the first time. And the British government has just marked its economic forecast down and its deficit forecast up.What do these events have in common? They’re all evidence that slashing spending in the face of high unemployment is a mistake. Austerity advocates predicted that spending cuts would bring quick dividends in the form of rising confidence, and that there would be few, if any, adverse effects on growth and jobs; but they were wrong.It’s too bad, then, that these days you’re not considered serious in Washington unless you profess allegiance to the same doctrine that’s failing so dismally in Europe.Why not slash deficits immediately? Because tax increases and cuts in government spending would depress economies further, worsening unemployment. And cutting spending in a deeply depressed economy is largely self-defeating; any savings achieved at the front end are partly offset by lower revenue, as the economy shrinks.”(Read more after the jump!)

Krugman Is Wrong: The United States Could Not End Up Like Greece – Dean Baker – “I have to disagree with Paul Krugman this morning. In an otherwise excellent column criticizing the drive to austerity in the United States and elsewhere, Krugman comments: “But couldn’t America still end up like Greece? Yes, of course. If investors decide that we’re a banana republic whose politicians can’t or won’t come to grips with long-term problems, they will indeed stop buying our debt.” Actually this is not right for the simple reason that the United States has its own currency. This is important because even in the worst case scenario, where the deficit in United States spirals out of control, the crisis would not take the form of the crisis in Greece. Greece is like the state of Ohio. If Ohio has to borrow, it has no choice but to persuade investors to buy its debt. However, because the United States has its own currency it would always have the option to buy its own debt.”

Deficits and the Printing Press – Paul Krugman – “Right now, deficits don’t matter — a point borne out by all the evidence. But there’s a school of thought — the modern monetary theory people — who say that deficits never matter, as long as you have your own currency. I wish I could agree with that view — and it’s not a fight I especially want, since the clear and present policy danger is from the deficit peacocks of the right. But for the record, it’s just not right. Suppose that we eventually go back to a situation in which interest rates are positive, so that monetary base and T-bills are once again imperfect substitutes; also, we’re close enough to full employment that rapid economic expansion will once again lead to inflation. Suppose, now, that we were to find ourselves back in that situation with the government still running deficits of more than $1 trillion a year, say around $100 billion a month. And now suppose that for whatever reason, we’re suddenly faced with a strike of bond buyers — nobody is willing to buy U.S. debt except at exorbitant rates. So then what? The Fed could directly finance the government by buying debt, or it could launder the process by having banks buy debt and then sell that debt via open-market operations; either way, the government would in effect be financing itself through creation of base money. So we’re talking about a monetary base that rises 12 percent a month, or about 400 percent a year. Does this mean 400 percent inflation? No, it means more — because people would find ways to avoid holding green pieces of paper, raising prices still further.”

Krugman, Galbraith, and others debate MMT – “Paul Krugman slugs it out with our colleague Jamie Galbraith and many other “modern monetary theory” partisans at Krugman’s New York Times blog website. Jamie’s most recent retort is at the top of this page of the blog site. Many of the points raised in the discussion there are central to our work here at the Levy Institute and to the views of Galbraith and others in our macro research group”.

A Further Note On Deficits and the Printing Press – Paul Krugman – “A followup on my printing press post: I think one way to clarify my difference with, say, Jamie Galbraith is this: imagine that at some future date, say in 2017, we’re more or less at full employment and have a federal deficit equal to 6 percent of GDP. Does it matter whether the United States can still sell bonds on international markets? As I understand the MMT position, it is that the only thing we need to consider is whether the deficit creates excess demand to such an extent to be inflationary. The perceived future solvency of the government is not an issue. I disagree.”

Paul Takes Another Swipe at MMT - The Modern Monetary Theory (MMT) approach to economics must be starting to make some waves, because today, Paul Krugman, followed his earlier attack on it and his debate with Jamie Galbraith and others last summer, with another swing at MMT. The debate last summer was an extensive one at Paul’s blog site at the New York Times, and, in addition, there were a number of posts at other sites replying to Paul. The debate was a classic in the developing conflict of views between the “deficit doves” (represented by Paul) and the “deficit owls” (represented by Jamie Galbraith and other MMT writers). Given the earlier debate, you’d expect that Paul’s second try at MMT would reflect a bit of learning on his part, and also a characterization of the views of MMT practitioners that is a little more fair than he provided in his first attempt. This post will analyze Paul’s new attack and assess how much he’s learned. But first, I’ll review the earlier debate.

The Euro Straitjacket – Paul Krugman – I think Dean Baker and I are converging on deficits and independent currencies. He asserts that having your own currency makes a big difference — you can still end up like Zimbabwe, but not like Greece right now. I’m fine with that. Specifically, the reason Greece (and Ireland, and Portugal, and to some extent Spain) are in so much trouble is that by adopting the euro they’ve left themselves with no good way out of the aftereffects of the pre-2008 bubble. To regain competitiveness, they need massive deflation; but that deflation, in addition to involving an extended period of very high unemployment, worsens the real burden of their outstanding debt. Countries that still have their own currencies don’t face the same problems. I like to use this picture, showing deficits and debt as of the end of 2010: Source.
Dear Paul Krugman, You Do Not Understand MMT – Paul Krugman is out with another misrepresentation of MMT. For some reason, he has come to the false conclusion that MMTers believe deficits don’t matter. He says:“Right now, deficits don’t matter — a point borne out by all the evidence. But there’s a school of thought — the modern monetary theory people — who say that deficits never matter, as long as you have your own currency. But for the record, it’s just not right.”This is an absurd misrepresentation of the MMT position and proves that he has not taken the time to fully understand MMT. In my treatise on the subject I specifically say this is not the case:“Some people claim that MMTers say deficits don’t matter. That is a vast misrepresentation of MMT. No MMTer would ever say such a thing. Deficits most certainly do matter. Maintaining the correct level of deficit spending is, in many ways, a balancing act performed by the government. It is best to think of the government’s maintenance of the deficit like a thermostat for the economy.

The MMT solvency constraint - Steve Randy Waldman – “It is good to see Paul Krugman prominently discussing “modern monetary theory”, although I don’t think his characterization is quite fair. I am an MMT dilettante, so I’ll apologize in advance for my own mischaracterizations. But I think the MMT view of stabilization policy can be summed up pretty quickly: …I think this is a clever and coherent view of the world. I do not fully subscribe to it — in my next post, I’ll offer point-by-point critiques. But first, let’s see where I think Paul Krugman is a bit off in his characterization: A 6 percent deficit would, under normal conditions, be very expansionary; but it could be offset with tight monetary policy, so that it need not be inflationary. But if the U.S. government has lost access to the bond market, the Fed can’t pursue a tight-money policy — on the contrary, it has to increase the monetary base fast enough to finance the revenue hole. And so a deficit that would be manageable with capital-market access becomes disastrous without.

More on Modern Monetary Theory – “I view this debate as another round of “deficits don’t matter,” which was the hue and cry from both the left and the right a decade or so back as we were digging the hole we’re now in. Let me say at the outset that I sympathize with the goals of Jamie Galbraith and others who would like to see the Fed finance Great Depression-type jobs programs, education, and other investments in human and physical capital. It is what the country needs.However, I view the problem not as insufficient aggregate demand but as our broken social contract, our broken government, our broken American dream. Printing more money will just go into the pockets of the plutocracy if the banking bailouts and the Stimulus are any indication. MMT is a joke in the present monetary historical context.”

Paul Krugman gets it wrong…. Again. – I’d say the deficit debates were heating up again, but I don’t think they’ve let up since before last year’s Peterson Foundation Fiscal Summit (orthodoxy for neoliberal deficit hawks) and the grass roots Fiscal Sustainability Teach-In and Counter-Conference, both held on April 28, 2010. The Teach-In provided an important corrective, known as Modern Monetary Theory (MMT), to the false narratives of both deficit hawks and deficit doves. Yesterday, Paul Krugman’s blog post Deficits and the Printing Press (Somewhat Wonkish), once again showed his ignorance of MMT, and in the process misinformed his readers (my emphasis): Right now, deficits don’t matter.. But there’s a school of thought — the modern monetary theory people — who say that deficits never matter, as long as you have your own currency. I wish I could agree with that view. But for the record, it’s just not right. The bolded statement, as I’ll show below, is completely false.

James-Galbraith-responds-to-Paul-Krugman – There are many excellent comments on the recent Paul Krugman vs. MMT story (see an excellent summary of the comments here), but I wanted to highlight the comment by James Galbraith, which really cuts to the chase: What do you mean, exactly, by the phrase, “solvency of the government”? According to my dictionary (Webster’s Third New International) an entity is “solvent” when it is “able… to pay all legal debts.” If you will look in your wallet, you will find, on any Federal Reserve Note: “This Note is Legal Tender for All Debts Public and Private.” Can we agree that the United States government, of which the Federal Reserve is a part, can always produce the Federal Reserve Notes required to pay its public debts? It follows, without any possibility of misunderstanding or error, that the United States Government is always going to be solvent.

billy blog » Letter to Paul Krugman – “Dear Paul..We are both academics and have been trained to PhD level in economics. We should therefore understand the difference between good scholarship and bad scholarship whether the final outcome is a peer-reviewed journal article, published book or Op-Ed piece for a popular media publication (such as the New York Times). Examples of poor scholarship:

  • 1. Representing an argument by relying on statements by critics of the argument as a reliable construction of the argument.
  • 2. Creating a stylisation of an argument that is could not be constructed from a thorough reading of the primary sources in the field. This is the, straw person tactic.
  • 3. Presenting analytical arguments to support an attack on a school of thought which are erroneous.
  • 4. Making stuff up – this embraces the previous three examples. I refer to your two articles in the New York Times:
  • (a) Deficits and the Printing Press (Somewhat Wonkish) – March 25, 2011 and then what seems to be a qualifying article –
  • (b) A Further Note On Deficits and the Printing Press – March 26, 2011.”

Paul Doubles Down On Ignorance, Misconstrual, and Vague Scenarios – “After the scorching he received in many of the comments on his printing press post Paul Krugman decided to dig his MMT blogging hole even deeper. He says: “. . . I think one way to clarify my difference with, say, Jamie Galbraith is this: imagine that at some future date, say in 2017, we’re more or less at full employment and have a federal deficit equal to 6 percent of GDP. Does it matter whether the United States can still sell bonds on international markets? The most important thing to note about this scenario illustrates Paul’s penchant for simplistic examples that mean nothing without further context. There are many ways in which Paul’s scenario can be fulfilled, and they would make a big difference in the reactions of the bond markets, even if the Government chose not to manage bond interest rates to drive them down to zero. For example, let’s say that the world still desires to send the United States more goods and services than it receives from us, about 3% of US GDP more, and let’s also say that the US private sector wants to run a surplus of 3% of GDP; then the Government will be running a deficit of 6% because its deficit must equal the sum of the absolute value of the negative current account balance, and the private sector savings surplus. In that realization of Paul’s scenario, would the US have any trouble selling bonds? It’s very doubtful, since what would those who exported to us do with USD they received in payment for their goods and services, except to buy our bonds?”

If you like large error bounds - “And lousy correlation coefficients, then the Modern Money Theorists are right. We can regulate money with printing and taxes. Unfortunately, 90% of the economy has much better estimates of taxes and printing then the MMT folks. The economy figures this stuff out before taxes go haywire. The economy is much more accurate about itself than Martin Wolf, Paul Krugman or the MMTs. If you want to be a good economist, I suggest you would have at least the same accuracy as the economy. How can we have an economic theory that depends on economic agents reading our columns? I get that entanglement is part of economics, the same as in physics. But it is too far fetched to go from a NYT op ed to the demand for eggs. The economy lives on information, suggest the economists keep up.”

US Employment and Wages, Modern Monetary Theory, Trade, and Financial Reform – Jesse – “On another note, there is renewed discussion of ‘Modern Monetary Theory,’ and some have asked me again to address this, as I have done previously. I have only this to add. I see no inherent problem with the direct issuance of non-debt backed currency as there is sufficient evidence that it can ‘work.’ Indeed, my own Jacksonian bias toward central banking would suggest that.I think the notion that the Fed is some objective judge of what is best for the public welfare without effective oversight or restraint is anti-democratic and probably un-Constitutional, at least in spirit, as it has been implemented. And this notion that the FED and the discipline of the interest markets could reliably emulate an external restraint on excessive money creation is deeply flawed.The problem becomes then how to implement a fiat currency without the discipline of issuing debt through private markets. This is the important point that most MMT adherents seem to ignore, but it is their greatest area of strength.”

What’s the difference between government bonds and bank notes? – Ed Harrison – “In light of a recent post by Randy Wray, I’d love to have some readers here answer my question. The Treasury doesn’t have to issue [government] bonds at all. In fact, since the Treasury does control the electronic printing press, it could legitimately buy stuff with money it prints out of thin air. Sounds a bit like counterfeiting, doesn’t it? But, let’s step back for a second: what is the functional difference for the federal government between Treasury securities and bank notes? Both are liabilities of the federal government. But liabilities of what? The only obligation they enforce on the government is the promise to repay with more paper (or electronic bank credits, if you will). For all intents and purposes, bank notes, reserve deposits, and Treasury securities are fungible: they are obligations to be repaid in the same fiat currency.”

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Greece is not Argentina

I politely disagree with the conclusions of the article written by my Angry Bear colleague, Kash, where he envisages Greece defaulting in 2011 similarly to Argentina in 2001.

I do agree, that the macroeconomic initial conditions in Greece scream default (actually, if you focus just on the measurable factors, like the current account, debt levels, or fiscal imbalances, Greece is much worse than Argentina in 2001 – see Table 4 of this IMF paper to see Argentina’s initial conditions and compare them to Greece in 2009 using the IMF World Economic Outlook Database).

Where I disagree, arguing that Greece is not like Argentina, is that the debt crisis in Argentina didn’t bring down the banking system of Latin America overall. In contrast, the default of Greece has the potential to do just that in Europe.

Update: see David Beckworth’s Macro Market Musings includes Rebecca’s thoughts on ECB

In Argentina, the Latin American banking system (and sovereign bonds, for that matter) was quite resilient in the face of the sovereign default in Argentina. Uruguay was the exception, whose two largest private banks, Banco Galicia Uruguay(BGU) and Banco Comercial (BC), which account for 20% of the country’s total, saw near-term liquidity pressure and an ensuing banking crisis in 2002 (see this IMF paper for a history of banking crises). All else equal, the IMF reports only minor impact to the region as a whole:

With the possible exception of Uruguay, economic and financial spillovers from the Argentine crisis appear to have been generally limited to date—as indicated, for example, by the muted reactions of bond spreads in most other regional economies and their declining correlation with those of Argentina, together with other favorable trends in financial market access and the general stability of exchange rates over recent months.


In contrast, the European banking system is highly interconnected. For example, according to the German Bundesbank, Germany’s bank exposure to Spain was roughly 136 bn euro in December 2010, where most of it is held in the form of Spanish bank paper, 56.4 bn euro, and Spanish enterprises, 58.3 bn euro; the rest is in sovereign debt. Furthermore, German banks are sitting atop 25 bn euro in (worthless) Greek paper, primarily in the form of sovereign debt. Euro area countries are exposed to other banks AND the sovereign; but more importantly, the ones that save (run current account surpluses) are the ones holding the worthless (in some cases) bank and government debt. (read more after the jump)

Bank risk is a big risk in Europe. Based on the consolidated banking data at the Bank for International Settlements (BIS), German banks hold 22% of the Greek external debt load i.e., bank debt + sovereign debt + corporate debt), while French banks hold 32% (see Tables below). Furthermore, German banks accumulated 20% of all Irish external debt, 14% of Italy’s, and 21% of Spain’s.

So the question is, not what will happen if Greece defaults, per se; but will a Greek default set off a chain reaction liquidity crunch that challenges asset valuations in the other Euro area banking systems (for bank paper and sovereign paper)? I suspect that it will, since the European banks are still building their capital buffers.

My point is, the Germans are partial to NOT letting Greece default. All fiscal austerity aside, the Germans have demonstrated that they’d rather write a check than take the writedowns, at this time. Therefore, from this perspective, I find it very unlikely that Greece defaults this year (or next, really).

Now, you’re probably thinking: well, it’s in Greece’s best interest to default. Willem Buiter calls Greece leaving the Euro area ‘irrational’. An irrational chain of events must be put in place in order to presage such a disorderly default (see 8. ‘Break-Up Scenarios for the euro area’ in the publication). We’re not there yet, since Greece is still in asset-selling austerity mode.

It’s political repression.

BIS data representation I: in Shares of external debt outstanding (click to enlarge)

BIS data representation II: in levels of external debt outstanding (click to enlarge)

Rebecca Wilder

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