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The Euro Area Precedent for Policy Failure

by Rebecca Wilder

The Euro Area Precedent for Policy Failure

Last weekend, a leaked Troika report (Troika = ECB + EC + IMF) revealed that European policy makers now comprehend that the Greek policy prescription is not working (bold by yours truly):

The growth and fiscal policy adjustments assumed under the program individually have precedent in other countries’ experience, but experience to date under the program suggests that Greece will not be able to set a new precedent by realizing at the same time and from very weak initial conditions a large internal devaluation, fiscal adjustment, and privatization program.

Rob Parenteau and Marshall Auerback sum up the implications of this point (1 A.):

On the first page of the document is not only a pretty open and blatant admission that expansionary fiscal consolidation (EFC) has proven to be a contradiction in terms, at least in Greece, but there is also a serious policy incompatibility problem, at least over the intermediate term horizon, with efforts at internal devaluation (ID) – that is, attempting nominal domestic private income deflation in order to improve trade prospects when one has a fixed exchange rate constraint.

I agree with Rob and Marshall – the grand plan does not work. Greece will (of course) not be able to set a new precedent of public sector and private sector deleveraging amid weakening external demand and a fixed exchange rate. However, I’d like to focus here on the ‘precedent in other countries’ experience’. What precedent?

One might point to Canada’s mid-1990s budget initiative that dropped program spending from 16.8% of GDP in 1993-1994 to 12.1% in 1999-2000 as a candidate for precedent. Marshall Auerback and Stephen Gordon refuted this claim as applicable to current conditions. However, we now have economic data available with which to compare the Canadian austerity experience to that of the Euro area.

What’s happened in Europe over the last year: Divergence. Since the middle of 2010, fiscal austerity and a drive for internal devaluation to ‘increase competitiveness (whatever that is) slashed GDP growth on a quarterly basis for all countries under the European Financial Stability Facility (EFSF) program – Greece, Ireland, and Portugal – while nonprogram countries enjoyed the economic benefits associated with a robust global recovery (through 2010). Note: fiscal austerity and ‘reform’ are pre-conditions to accessing funding at the EFSF. Not coincidentally, since Q1 2010, no Euro area countries have contracted except program countries (rounding to the nearest tenth) through Q2 2011.

The chart above illustrates the major Euro area (EA) economic (EA 12 less Luxembourg) recoveries since the peak in EA real GDP, Q1 2008. The legend lists the latest Q2 2011 reading as an index to the Q1 2008 EA peak – the difference over 100 represents the accumulated growth in real GDP. Only Belgium, Austria, and Germany retraced, or fully recovered, the lost EA real GDP. EA economic activity is 2% below pre-recession levels. Notably, Ireland, Greece, and Portugal are struggling amid tight financial conditions and the crimping of domestic demand (internal devaluation).

Since austerity and raising the primary balance is a  condition for EFSF funding access, a contracting economy is to be expected, right?

Wrong – in fact, the Canadian economy experienced no real GDP contraction spanning the years 1994-2000 when the structural fiscal balance turned from a 6.9% deficit to a 1.5% surplus. All the while, GDP maintained a 4% average annual growth rate and did not contract on a quarterly basis (after revisions). Admittedly, the Canadian economy did not grow in Q2 1995 and Q3 1995, but improved smartly thereafter.

I point you again to Marshall Auerback and Stephen Gordon for the whys. But basically, easy monetary policy, depreciation of the currency, and robust US demand fostered the fiscal shift in Canada. None of these conditions exist in the Euro area, so those program (austerity) countries – Ireland, Greece, and Portugal – suffer contraction.

As an aside, some may point to Ireland as a success story, since it posted two consecutive quarters of reasonably strong growth in the first half of 2011. Sure, Ireland eventually grew – it is a very open economy, so has an innate ability to generate net export income. But importantly, look how far the economy fell (see first chart). The economy saw 10.7% in accumulated contraction spanning Q1 2008 to Q4 2010 – the 3.5% rebound spanning the first half of 2011 pales in magnitude. I point you to Edward Hugh’s commentary for a sobering read on Ireland.

Finally, I leave you with a potent illustration of what not to do when it comes to fiscal austerity: Portugal vs. France.

Portugal was doing all right – better than France, even – until they ran into 2010 financial stability problems that forced the government to start ‘cutting’. Portugal started to contract in Q4 2010, applied for funding in April 2011, and contracted thereafter. Economic Intelligence Unit sees Portugal contracting throughout 2012 (no link). The Euro area prescription for austerity is tantamount to economic collapse amid a fixed exchange rate and meager global growth prospects.

The EA policy plan for fiscal austerity is setting a precedent, all right, a precedent for policy failure.

Originally published atThe Wilder View…Economonitors

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Dave Dayen Is Wrong

And not in a good way, when he says:

I understand that Republicans are just playing the culture war game here, trying to link Warren and the loony left. I don’t know how that will play in, er, Massachusetts. And the world has moved on from the Hard Hat riots and the 1972 campaign. The hard hats have been brutalized just as much as the rest of us in this economy.

No, no, no.

The “hard hats” have been brutalized much more than “the rest of us” in this economy. And the economy before that. And, basically, every one since 1986,* Bruce Bartlett’s protestations notwithstanding.

Note especially that having all those English Literature and Anthropology majors with degrees hasn’t hurt.

*The data only breaks down from 1992 onward, so you’ll have to wait for my tribute to the 1986 “tax reform” act.

cross-posted from Skippy, the Bush Kangaroo

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The Kimel Curve and the Kitchen Sink, Part 1: All Years

by >Mike Kimel

I’ve been writing about the relationship between tax rates and growth since I started blogging in 2006. A lot of those posts have focused on the quadratic relationship between tax rates and growth. That is, it turns out that if you take US data going back to when the BEA started keeping track, 1929, you can easily build a model of the following form:

% change in real GDP from t to t+1 = a + b*Top Marginal Tax Rate at time t
+ c* Top Marginal Tax Rate squared at time t

I have modestly referred to that as the Kimel curve. Now, it turns out that for most variations on that theme I’ve come up with, b is positive, c is negative, and both are significant at the 5% or 10% level. That allows you to find a top marginal tax rate that maximizes growth… which turns out to be somewhere between 60% and 70% depending on how the model is specified.

In this post I want to address a few criticisms by running two additional regressions with more or less the form. Parts of this may get a bit wonky but I’m going to keep it so that even if you’ve never done any statistical analysis, hopefully you’ll be able to follow the outcomes.

In the first regression, I’m going to account for a few additional facts:
1. By going with every single observation the BEA produces, I’ve been accused of “cherry picking.” So I’m going to throw in a dummy variable for Hoover.
2. I’ve been told the only reason growth was so quick during the New Deal was that there was a bounceback effect from the Great Depression… so I’m throwing in a dummy variable for FDR’s peacetime years (i.e., 33-41).
3. I’ve been told WW2 biases the results…. so there’s a third dummy for 1942-1944, the fast growing years in WW2.
4. I’ve also included two demographic variables: the percentage of Americans 35 to 44 and the percentage of Americans 45 – 54. The latter group tends to be the highest income group these days, but in an earlier era more focused on manual labor, those 35 to 44 might have been higher paid.
5. For grins, I threw in a dummy variable which is equal to 1 if the President is a Republican and 0 otherwise.

So… here’s what it looks like:

So what does it all mean? Well, this set of variables explains about 43% of the observed variation in growth rates over the period for which we have data (see the adjusted R2). There’s obviously room to improve the model, variables I’m not accounting for, etc.

The percentage of Americans 35 to 44 has a positive coefficient and is almost significant at 10%. We’re almost at the point where we’d be comfortable saying as that percentage increases, growth increases. The percentage of Americans 45 – 54 has a negative coefficient, but isn’t close to being significant.

Not surprisingly, the Hoover dummy is associated with economic shrinkage, FDR’s peacetime period is associated with positive growth, and 1942 – 1944 is associated with even faster economic growth.

The Republican dummy is not significant – any difference in the growth rate observed between the two parties can be explained by other factors. Which other factors?

Well, the top marginal tax rate and the top marginal tax rate squared are both significant – the former is positive and the latter is negative, which means they trace out the desired upside-down-U shape.

Oh… and the top of the curve happens when tax rates are at 64%. That is, the fastest growth rates seem to occur when the top marginal tax rate is around 64%. Now, I’ve had post after post on this topic, and the top of the curve always seems to occur in more or less in the same place. It isn’t a coincidence folks.

I’ll post results of the second regression in my next post in the series. That regression will focus on the period since Reagan took office and thus will only include data from 1981 to the present. What does it say? Well, a hint: if you don’t like the results shown in this post, you won’t be happy about that one either. But remember, I’m just the messenger. The data is what the data is, and if it isn’t showing what you think it should, its up to you figure out what’s wrong with the analysis or with the data, to pontificate wisely and inaccurately, to ignore the evidence, or to change your mind.

If anyone has a line on a good inequality series with annual data that goes back to 1929, please let me know. I’d like to drop it into the model. I’d also love a good proxy for regulation. Don’t be afraid to offer other suggestions for data to drop into the mix are welcome too. I’m like a DJ, I take requests, but it helps if you can point to whatever data you want me to use.

As always, if you want my spreadsheets drop me a line at “mike” period “kimel” (note – one m only in my last name!!!!) at

Thanks to Bill McBride for pointing toward the demographic data and m. jed for suggesting its use.

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Rick Perry’s 20-20 Vision

Charles Pierce sums up the true issue:

It is on days like this that I don’t envy political economists. They’re the ones that are going to have to take this Message from Goobertown seriously. They’re going to have to score it. They’re going to have to do the math, such as it is, and try to find a coherent formation in this unwieldy parade of hackneyed talking points (Kill the Estate Tax and Save the Family Farm!) and tired applause lines (The Job Creators Are Uncertain!). They’re the ones who are going to have to find a way to square the utter abandonment of the progressive income tax, a balanced-budget amendment to the Constitution, a return to explosively inflationary health-care costs, an unchained and undoubtedly newly amok financial-services industry, and the partial privatization of Social Security, all of which Goodhair has managed to wedge into “Cap, Balance, and Grow (!).”

(By now, I figure the political economists are going to be hopelessly drunk and firing rubber bands at each other.)

They’re the ones who are going to have to tell the family of the sad-eyed young intern in the corner that their son, a Wharton grad with a brilliant future, studied this plan for a couple of hours and then screamed, “But it doesn’t make sense!” prior to trying to feed himself into the fax machine in a vain attempt to get as far as possible from any place where this nonsense is taken seriously.

Personally speaking, I’m not bothering. When you’ve already lost Pete Davis, you can pretty much give up on anyone believing your economics will work:

Governor Rick Perry (R-TX) proposed his tax reform plan today and wrote this Wall Street Journal op-ed. Unfortunately, it’s just a slapdash of slogans. If this plan were enacted as proposed, it would lose a lot of revenue, reward the rich, and complicate filing for most taxpayers.

Giving taxpayers the option would also mean that only those who pay less would opt in, guaranteeing significant revenue loss. [OPENING QUOTE ADDED, sans original links; go read the whole thing]

And Andrew Samwick piles on with the politics:

And now we have another version of the flat tax, as if the crushing irrelevance of Steve Forbes to the primaries in 1996 and 2000 were not an indication of how unproductive the discussion will ultimately be. What are the prospects that a Republican President would actually be able to implement such a change if elected? They are equal to the chance that Republicans will both retain control of the House and secure a filibuster-proof majority in the Senate in 2012. In other words, absolutely zero.

Personally speaking, I don’t think the odds on that election scenario are “absolutely zero” (but I count people like Ben Nelson, who fellated George W Bush from the beginning, referring to him in interviews as “the King,” as part of that “filibuster-proof majority”). But the rest of the analysis is spot-on.

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I Agree with Joe Gagnon

Regular readers will recall that I have been very skeptical of claims that the Fed can cause a large reduction in unemployment by declaring a nominal GDP target and/or buying long term Treasuries. Joe Gagnon is very prominent advocate of unconventional policy, so I was surprised to find that I so strongly agreed with so much of what he wrote in this post. After the jump I will quote him and ask readers if the statements are familiar, because they are what I regularly write.

The Fed’s decision in September to sell short-term Treasuries and buy long-term Treasuries (known as Operation Twist) has put downward pressure on long-term interest rates. But, with the 10-year yield already down to about 2 percent, the scope for further reductions is somewhat limited. One percent is probably the effective lower bound on the 10-year Treasury yield.

Some have proposed that the Fed announce a desired path for the future price level (or future nominal GDP) that is higher than that currently expected by the markets. It is argued that such an announcement would raise inflation expectations, lower real interest rates, and stimulate economic activity. However, it is not clear that such an announcement, by itself, would have much effect. Indeed, during the past two years, there has been little tendency for market forecasts to move toward Fed forecasts. To increase its effectiveness, any such announcement should be accompanied by concrete actions to push market conditions in a supportive direction.

The best option available is a massive program of MBS purchases.

here are several reasons for the Fed to focus on the market for housing finance:

The market for agency MBS is one of the largest markets in which the Fed is allowed to operate. The Fed is not allowed to buy equity, real estate, or corporate debt.
MBS yields are the most important factor behind mortgage rates. As investors have flocked to the perceived safety and liquidity of Treasuries, the spread between mortgage rates and yields on 10-year Treasury notes has risen considerably. Fed purchases are especially effective at reducing those interest rates whose spreads to Treasuries are wider than normal.

Note two things. Gagnon stresses the importance of quality as well as quantity. He thinks it is important for the Fed to buy low quality assets. Also Gagnon is sticking to static supply and demand. He isn’t counting on expectations management.
Note that he cares about the covariances with say house prices of the assets the Fed buys not all stochastic assets add equally to the relevant risk. Finally note that the policy he advocates is the policy I have been advocating

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A bleg: Request for Some Demographic Data

By Mike Kimel Hi. I’m looking for the US population aged 35 to 44 and 45 to 54 from 1929 to the present. I’m having a great deal of trouble extracting it from the Census. Does anyone have that data, ideally from a publicly available source? If so, please drop me a line at “mike” period “kimel” (one m only) at Thanks.

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This Is What You Get When Policy Makers Become Complacent

By Rebecca Wilder 

This Is What You Get When Policy Makers Become Complacent

The prospects for domestic demand in the US are not bright. The labor market barely generates jobs and fiscal policy is a drag. Americans are consuming; but there’s unlikely sufficient nominal income growth to stabilize consumption expenditure growth at current levels.

We’ve seen years where consumption growth outpaced income growth; but those periods of consumption were financed through leverage build – with financial conditions tight, the possibility of financing consumption outside the labor market is deteriorating (see the Banking and Finance section of the latest Fed Beige Book, not encouraging).

Consumption growth cannot outpace income growth indefinitely. Unless we get a true policy kick (by fiscal policy, admittedly), the cyclical recovery could be a thing of the past.

That was nominal growth – in real terms and on a historical basis, the story is just as bad. Don’t let anybody tell you that real consumption growth. At 1.8% Y/Y in August is anything but miserable, especially given that its annual pace is 1 ppt below the long run average, 2.8% Y/Y. Long run real income growth is even worse at 2.5 ppt BELOW the long run average, 2.8% Y/Y.

Uh huh – yes, the US economy has definitely avoided the ‘recession scare’…right. As I see it, the problem with policy these days is not size nor level, rather complacency.

originally published at The Wilder View… Economonitors

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Cato has truly shocked me….stupefied really

by Michael Halasy
Cato has truly shocked me….stupefied really.

Those who have followed me at Angry Bear will recall my series on tort reform that I wrote this past year. In particular, I wrote a piece on the possible safety risks that patients would be exposed to, with a 0.02% increase in patient mortality with a 10% reduction in medical malpractice liability costs…

Well, just the other day, I received an update from Cato. Now, Michael Cannon is a good guy, and while he and I simply don’t agree on … well much of anything from a health policy perspective, his colleague, Shirley Svorny, wrote this:

More broadly, patients derive protection from an interdependent system of physician evaluation, penalties, and oversight that includes hospital and health maintenance organization credentialing and privileging activities, specialty boards, and the medical malpractice insurance industry. Underlying nearly all of these activities is the threat of legal liability for negligent injuries. Reducing physician liability for negligent care by capping court awards, all else equal, will reduce the resources allocated to medical professional liability underwriting and oversight and make many patients worse off. Legislators who see mandatory liability caps as a cost-containment tool should look elsewhere.

I believe that I have been consistent with this…over and over. There are some reforms that could work. So called “indirect” reforms. Joint and Severability reform, mandatory periodic payments, dedicated malpractice courts, patient compensation funds, etc. etc. But direct reforms, IE; caps on noneconomic damages DO NOT WORK.

So, I have to (gulp) swallow some pride, and tip my hat to Cato….Now I need to go take a shower. I feel a little dirty.

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Health Care Thoughts: Accountable Care Part II

Health Care Thoughts: Accountable Care Part II

Accountable care organizations (ACOs) are the keystone of PPACA  (Obamacare) as far as restraining costs and improving quality.
Early this year there was great excitement about ACOs in the provider community, but the publication of the (first phase) Medicare ACO rules threw cold water on everything.
The rules were at best complicated and convoluted and providers ran for the hills. The administration tried calming the fleeing providers with fast track and modified programs, without much success.
On October 20th the Obama administration published revised Medicare ACO rules. Most of us are still reading and analyzing, but the early response seems more favorable. A more detailed analysis will follow soon.
The administration finally got smarter and announced modifications to antitrust policy so Obama’s DOJ would not be wrecking the work of Obama’s DHHS.
Bad news though, employers and insurers see the possibility of intense ACO activity as anti-competitive.
Tom aka Rusty Rustbelt

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Presimetrics Review

Noted for the record: author Piaw Na reviews Mike Kimel‘s Presimetrics at Piaw’s Blog:

This is a great book to read if you’ve got a statistical bent and are willing to follow the data rather than your pre-conceived notions….Many people like to say that they’re data-driven, but most people actually have prejudices that lead them to believe what they believe, as opposed to actually looking into data and correlations. This book goes a long way towards providing those who want data the actual data with which to base their beliefs on….This is the kind of book that deserves to sell better than it does. Highly Recommended.

I left out all the good parts, so Go Read the Whole Thing.

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