Central Bank Independence and the Role of the Dollar

The attack on the Fed's chairman, Jerome Powell, has correctly led to a rebuke of Donald Trump's behavior. That does not mean that the notion of central bank independence cannot be questioned, or that is necessary for either price stability or the international position of the dollar. These are just a few things that seem exaggerations that have been discussed recently. As I noted before, the return of central bank independence (rule based monetary policy), and the return of austerity, together with the critiques of tariffs (and the resurgence of free trade) have brought back the Victorian Consensus to the center of policy discussions. A terrible mistake.

But on the issue at hand, for example, Justin Wolfers suggested that inflation will accelerate as a result of the attack on Powell (and Lisa Cook, one might add). I discussed inflation here several times. There is no risk of anything even close to this kind of inflation, simply because what caused the increase in prices was, for the most part, the depreciation of the Turkish lira, and the pass-through in the US is very limited.

 

The graph below shows that there is a clear correlation between the two variables. Inflation in the US remains subdued (see today's BLS report, with inflation at about 2.7%, which is not that much above the target of 2%; also I still have to find someone that shows that 2% is much better than say 3% for any particular reason.)

 

Today, Barry Eichengreen suggested in his Financial Times column that:

 

Besides the issue that it is highly controversial that reducing interest rates would be highly inflationary, or that 2.7% is some sort of a problem, there is the issue of why would investors run from the dollar and cause a crash. In his view, ultimately a question of confidence. The conventional view is that a reserve currency must be backed by trust. Trust in the legal system, in the persistence of political stability, and the protection of property rights, and sound macroeconomic management. According to this perspective, actions like U.S. actions regarding Venezuela, tax cuts that increase the burden of public debt, threats to the independence of the Federal Reserve, or the rise of authoritarian politics under the Trump administration might undermine confidence in the dollar.

 

However, there's another view, one that I explore in a this paper, arguing that power, rather than trust, underpins reserve currency status. John Maynard Keynes famously compared money to language: the dominant currency is like the dictionary, and the one that writes the dictionary controls the language. From this standpoint, the dollar’s dominance is reinforced by U.S. geopolitical and military strength.

 

Barry correctly notes that the main argument against the demise of the dollar is that there is no alternative (not that TINA). He suggests that agents could run to gold, but essentially notes that gold is a bubble and that is very risky.

 

Neither the attack on the Fed, nor the intervention in Venezuela, to mention the two things that have been discussed the most in this eventful new year so far, would lead to inflation or a demise of the dollar. As Keynes said about Lloyd George, the leader of the Liberals, that he disliked (to put it mildly): "The difference between me and some other people, is that I oppose Mr Lloyd George when he is wrong and support him when he is right." Trump might be wrong about how he is going about changing the way we the US runs monetary policy. But on the need to reduce the rates, and the notion that central bank independence is not necessary for price stability, he might not be wrong.

 

PS: The rise of the dollar to hegemonic position between the collapse of the pound, the Tripartite Agreement in 1936 and Bretton Woods, occurred before the Treasury-Fed Accord of 1951 that made the Fed independent of the Treasury.

 

Some brief thoughts on the Great Shutdown

First GDP numbers of the Great Shutdown were out yesterday. As it can be seen in the graph, GDP shrunk by about 4.8%. The data reflects only the first weeks of the stay at home lockdown of the economy in March, as the BEA report points out. Numbers will get considerably worse.

You must add to this the increase in unemployment insurance claims, which since the crisis started has gone up by more than 26 million, as reported by the Labor Department. Note that the unemployment rate is still at 4.4% and that it would take a while for numbers to reflect the collapse in jobs. Also, the series are measured in different ways, so many that lost their jobs, and filed for benefits (and might not even have received them) will not look for jobs (what would be the point), and, as a result would not count as unemployed. Expect the participation rate to fall. At any rate, the true unemployment rate as we speak, 26 plus another 5 million or so unemployed before the crisis, would be closer to about 19%. This is a crisis of biblical proportions.

But that is not my main concern. There are many ways in which fiscal and monetary policy could mitigate the worst effects of the crisis. The problem for me is that almost nobody is talking about the size of the effort that would be required for the economy to get out of this deep hole. Imagine that unemployment does get to something like almost a third of the labor force, as suggested by some Fed officials.

I've been playing around with some scenarios. This is not forecasting, which I don't consider a particular useful approach. This scenario is based on very simple assumptions using a simple Keynesian (yes, as in Keynesian cross) model, and some simple stock-flow accounting definitions, even though I don't have a fully consistent accounting model (on that and Godley and stock-flow models see this old post). I also assume certain parameters and sizes of shocks (even though I played with different numbers; on Godley and his view of the role of parameter estimation and model architecture see this other old post). Other than the simple multiplier (in this scenario of 1.2) and Okun's Law (3:1 ratio in this case), there are only assumptions about autonomous spending (government in this case, with some assumptions for this year at least informed by current events), and my concerns are essentially about what those mean in terms of the political economy of fiscal policy.

So, in my scenario output falls by about 8% next year, and recovery starts immediately, but GDP only surpasses the previous level in 2022/23, in the third year of the crisis. That's with a lot of fiscal stimulus, by the way. And in part the result of that is that the debt-to-GDP ratio goes to, in this scenario, about 180%, after 9 years (I had others with considerably more). Japanese levels of debt. I see no problem, but not everybody agrees, and, of course, that's the problem. Since the social forces that push for austerity are still around.

The scenario also implies that unemployment spikes (less than the number I gave above; so I guess a lot of discouraged workers and disguised unemployment), and it takes almost a decade to come down to reasonable numbers.

As with Godley, my interest in this is NOT to make predictions. I have no clue if this is going to happen or not (most likely not). My point is that in all my scenarios, huge fiscal stimulus was followed by moderate stimulus (not austerity*), and yet in all the debt-to-GDP ratio would go considerably up. It shouldn't be a surprise. In a crisis with a collapse in demand, that destroys jobs and income, and that workers and corporations are heavily indebted, it is unavoidable that the federal government would be required to pick up the tab, run higher deficits, and accumulate debt.

But are we prepared for that scenario? Republicans already called for less government, less taxes, and reduction in all types of spending (particular social spending, which is frankly nuts in the context of a pandemic). More surprisingly, Mitch McConnell seems to want States and municipalities to go bankrupt, that is, not do the normal thing in federations, which is to make the only entity with ability to borrow in its own currency to borrow (at zero rates really) and transfer resources. He basically wants the US to look more like Europe, and not the more social spending part, but the absence of a federal fiscal pact part. That's dangerous. And a Biden presidency (oh man, this hurts!), if it happens (consider the alternative; is it too early for a beer?), would have to deal with that and discussions about the debt ceiling (am I glad a grabbed a beer?). Oh well.

* In my scenarios, austerity makes things worse, making the recovery slower, and tax revenue growth too, btw.

PS: The other post on Godley's approach to macro modeling here.

The IMF Program in Ecuador: A New Report by Mark Weisbrot

Thirty pieces of silver

As they discuss the new candidate for the International Monetary Fund (IMF), and it seems that the lead candidate for Lagarde's position is the former Dutch finance minister Jeroen Dijsselbloem, a pro-austerity member of the Labor Party (which I guess is at least nominally on the left), it is worth reading the new CEPR report on the possible effects of IMF programs in Latin America, more specifically the one in Ecuador, now that the country has been brought back into the fold of well-behaved nations (after expelling Assange from their London embassy, in the post-Correa period).

From the abstract:

This report examines Ecuador's March 2019 agreement with the International Monetary Fund (IMF) and finds that Ecuador is likely to have lower GDP per capita, higher unemployment, and increased macroeconomic instability under the program. Even the program itself, the authors note, projects Ecuador to have a recession this year and increased unemployment for each of the first three years of the program. But these projections are optimistic, the report concludes. [Full report here]

I'll have more on the IMF and Argentina soon. Also, something on Brazil, for those interested in the situation in Latin America.

Lara-Resende and MMT in the Tropics

So André Lara-Resende, who I discussed here before, is again writing on the crisis of macroeconomics (in Portuguese and you might need to have a subscription), and now instead of embracing the Fiscal Theory of the Price Level (FTPL), has supposedly embraced Modern Money Theory (MMT). Many US MMTers cheered this as a demonstration of the reach of MMT in other countries. I would be less cheerful.

Lara-Resende, let me explain to non-Brazilian readers, was a student of Lance Taylor at MIT, and then a professor at the Catholic University in Rio, being a key author of inertial inflation, an heterodox view of inflation, that was central for the failed Cruzado Stabilization Plan back in 1986. He then participated in the successful stabilization of the economy with the Real Plan, when Fernando Henrique Cardoso was the finance minister in 1994, and during the latter's presidency a short lived president of the development bank (BNDES, in the Portuguese acronym) -- and not the central bank as many in the US have suggested (that was Persio Arida, his frequent co-author on inflationary inertia). Btw, he fell as the head of the bank because he was recorded in conversations with the president (Cardoso) on issues related to the privatization process of the telecommunications sector, in which they seemed to favor a particular group. The development bank during this period was essentially used to promote privatization as a part of the so-called Washington Consensus policies. Also, by the 1990s all the economists from the Catholic University had adhered to the Washington Consensus, and moved away from heterodoxy in the same way Cardoso distanced himself from Dependency theory, and still remain essentially aligned with neoliberal policies to these days. Lara-Resende included, as we will see.

Note that he does say that the four pillars of the new macro are that money and taxes are connected, that the government has no financial constraint, but only a real (capacity) constraint, that money is endogenous (the central bank sets the interest rate), and that the Domar rule holds and stability of debt-to-GDP ratios require the interest rate to be lower than the rate of growth. He also says inflation is all about expectations, and the Quantity Theory of Money (QTM) does not hold, something he had already said in his previous op-ed. Many (too many) interpreted this as being Chartalist Money, Functional Finance and Endogenous Money and as such as a version of MMT. Including some analysts in Brazil, with whom I fully agree on their critiques of Lara-Resende's policy conclusions, like the sharp critique by Guilherme Haluska here (also in Portuguese). Note, however, in my previous post on him, that he thought that the FTPL was an heterodox view of the macroeconomy, and he is explicit in his new op-ed that his ideas follow from his last book, in which he defends the FTPL.

In his book what he refers to "heterodox" is the experience with alternative monetary policies after the 2008 crisis, meaning Quantitative Easing, simply because it does not follow the QTM. In his words, from the 2017 book: “The result of the heterodox policies of the central banks in advanced economies, after the financial crisis of 2008, raised serious doubts about some fundamental points of the foundations of macroeconomic theory" or in the original if you don't trust me as a translator (I don't): "O resultado da experiência heterodoxa dos Bancos Centrais dos países avançados, depois da crise financeira de 2008, levantou sérias dúvidas sobre alguns pontos fundamentais da teoria macroeconômica." He does say that one of the pillars of the new macro paradigm is in his 2017 book, but my guess is the ideas are essentially the same. He used the language of MMT, and cited Knapp and Lerner to promote the same neoliberal policies of the 1990s, and the same ideas he defended a couple of years ago using FTPL.

So it is clear that the pillars are essentially of some weird New Classical story of the FTPL, in which fiscal dominance is central to the argument, and there is endogenous money, because of the neo-Wicksellian twist in modern macro. Yes, the QTM does not hold, but it is the expectations about future inflation that matter, and those are tied, in Lara-Resende's views, to fiscal policy (or at least were two years ago). The argument is the fiscal dominance one, that monetary policy has to deal with the unsustainable debt, so inflation is a fiscal phenomenon, and fiscal adjustment is needed. He was and is for austerity! He does use an MMT rhetoric and cites Abba Lerner for sure (more on that below), and that's a testament of the current relevance of MMT and its role in shaping the Bernie and Ocasio-Cortez's progressive views (something positive as I noted in my last post).

His argument is that Brazil is on the wrong side of the Domar stability condition, and, hence, the debt-to-GDP ratio is increasing (in domestic currency), and that something has to be done about it. Not sure why. Note that I always say that in domestic currency there is no default, and one of my complaints about MMT is that they do not pay attention to debt in foreign currency (at some point Warren Mosler was against capital controls and for flexible exchange rates, since the former were not necessary and the latter would solve external problems). But Brazil is not borrowing in foreign currency, and is sitting on top of a mountain of foreign reserves (something like US$ 380 billion, last time I checked, someone correct me if I'm wrong). Then he argues that inflation is all caused by excess demand in the developmentalist period, the period from the 50s to the 80s. However it is unclear why that is still a problem, or why there was excess demand, if it wasn't as a result of fiscal policy.

Fiscal reform, and, in particular, the pension reform are needed not to raise revenue (here is an MMT theme), in his view. He suggests that the reasons are that the pension system is unfair, and that in Lerner's fashion [sic] tax cuts are needed to promote the reduction of bureaucracy and allow for the expansion of more effective private investment.* These should be complemented with trade liberalization, a lower interest rate with a digital currency (bitcoin?) and fiscal adjustment, because the State is "bloated, inefficient and patrimonialist" (in the original: "Estado inchado, ineficiente e patrimonialista").

With friends like these, who needs enemies?

* It's true that Brazil has relatively high levels of taxes, in comparison to developing countries, but the problem is not that they are high, per se, but instead that they are regressive.

Arguments for austerity, old and new

Here what I think may be is Fernando Cardim de Carvalho's last published paper (who passed away recently), published in Intervention. From the abstract:

Much of the criticism directed at austerity programs implemented after the 2007/2008 financial crisis, more forcefully in the eurozone, have relied on the same arguments Keynes and others raised against the (British) Treasury View developed in the 1920s and 1930s. Austerity, however, has been proposed most insistently in the 2010s by European authorities, led by the German Federal Ministry of Finance, the Bundesfinanzministerium (BMF). While the arguments for austerity then and now share some common elements, there are enough original arguments being presented by the BMF to make many of the criticisms ineffective. The paper reconstructs both views, the Treasury's and the BMF's, to show and evaluate their similarities and their differences.

There is also an obituary by Fernando Ferrari here (subscription required).

The End of Brazilian Democracy

As noted in my previous post on this, there was a good chance that the Neo-Fascist candidate Jair Bolsonaro would win the election in Brazil. And he did, with approximately 39 percent of all votes. There are only a few things that I want to point out about this.

The Workers' Party (PT) candidate received about 32 percent of all votes. Note that 29 percent or so did not vote, in one way or another. So PT maintained almost one third of the electorate in this election, while its rival in the previous 6 elections (PT was the winner or close runner up going back to 1989), the Social Democrats (PSDB), has vanished. And the defeat of PT was possible only with years of judicial harassment, the illegitimate imprisonment of the party leader (Lula), the blocking of his candidacy, precluding him from giving interviews, and the relentless media campaign against PT, tarnishing the party as corrupt. In that sense, the result is not unexpected, and puts in question the meaning of democracy in Brazil, to say the least.

The second important point is that the economic situation will certainly not improve, for those that think that the Brazilian problem was  simply  political instability. In fact, the incoming administration would be a more radical version of the neoliberal post-coup government of the last two years. They are trying to negotiate social security reform, meaning cutting off benefits, and partial privatization, before the end of the year to avoid the political costs associated with it. That on top of the labor reform that was approved last year. The notion is that one would allow for higher savings, since people would be forced to save for retirement, and the other would allow for lower wages, with one leading to higher investment and the other to higher employment. Of course, the logic behind that is hard to sustain, and the evidence regarding this kind of structural reforms is very clear about their failures. Expect lower wages, and higher poverty in old age. And no growth.

The rest is based on the vague rhetoric of the minimal state, meaning spending less (and also taxing less), liberalization and privatization, with a strong geopolitical alignment with the United States (meaning leaving aside even right wing governments in Latin America, like Macri in Argentina). The question is whether they will really promote fiscal adjustment. Paulo Guedes, the incoming minister of the economy (with the finance and planning ministries unified) has suggested that a zero deficit will be pursued (an idea that seems that of an ideological fanatic rather than someone with experience in this matters). It also seems that there will be a greater willingness to allow for a more depreciated real, perhaps creating an exchange rate target. Note that these discussions were very superficial and went hand in hand with the revived idea of using the external reserves for financing the buying of public debt in reais.

I'm more skeptical than Luis Nassif about the the possibility of higher growth related to the competitiveness of a depreciated real. Btw, this was a well-known New Developmentalist proposition, and I'm not sure how it fits with Guedes's Chicago Boy credentials. At any rate, if that happens expect more inflation, and additional contractionary effects of the depreciation. On the second point, the use the reserves to pay down debt in reais there is nothing good to say. It's preposterous. There is no need to use dollars to finance debt in domestic currency. And the whole point of that huge pile of dollars is to avoid a crisis like the Argentine one.

Perhaps, the last two issues that I want to emphasize are the more important ones, and somewhat counter intuitive, relating to his relation to populism and corruption. There is a widespread view that the incoming president is nationalist and that somehow links him to other right-wing populists in the world, like Trump. While it's true that his origins are in a sort of right-wing militaristic nationalism, it is clear that he was willing very fast to shed any ideas regarding the protection of national economic interests. His economic policies will promote free trade and privatization, and will go in the opposite direction of the global trends. Unlike Trump that has been somewhat nationalistic in his trade renegotiations with the North American partners and more clearly with China, Bolsonaro will give up any leadership role in Latin America and discard Mercosul. In part that is the result of Bolsonaro adapting to the needs of the political system in Brazil, and understanding that in order to get elected he would have to signal to the local elites his willingness to promote neoliberal policies.

And that's the most important thing that everybody missed with his election. No, he is not the result of the vote of people tired with corruption. Some (perhaps many) uninformed voters might have that as their main reason for voting him. He's an entrenched politician, with almost three decades in congress (even if an irrelevant one). Bolsonaro is the enthronization of the corruption, meaning the normal back and forth pork barrel politics that allows for policies to be passed in congress. He is the product of that. The elites thought they could use congress, for the impeachment, and the Car-Wash (Lava-Jato) operation against corruption to deliver the government to a PSDB candidate. They failed partially. Bolsonoro rather than the PSDB was the lucky inheritor of the destruction of Brazilian democratic institutions.

But the coalition that was behind the coup is still in power. That is clear with the acceptance of a cabinet position by Sergio Moro, the Car-Wash judge.* That is, the same coalition that allowed all administrations to govern since the return of democracy will be put in place with an increasing role of smaller parties (many connected to Evangelicals; this should be part of another discussion, since it did have a role in his rise, but here again he used that more than representing these movements). And the corruption will continue, but it will not be investigated.

People that voted for him were tired of the inability of PSDB to win elections, and they were essentially anti-PT because they hated the social improvements of the good decade of growth and inequality reduction. The key to the victory was wiping out of one third of the vote, creating high levels of abstention. These are people in the middle, that decided that between a right-winger flirting with authoritarian rule and PT there was no good alternative (and the media, including the international one, facilitated that message). Perhaps, the epitome of that behavior was the ex-president Fernando Henrique Cardoso. Even Cardoso, that Bolsonaro had suggested in the past should have been murdered by the military, said he would not vote for him, but did not endorse Haddad, the PT candidate.

So in my view, the one third of the vote indicates that PT will remain, in spite of all these pressures, the main left of center party in the country in the near future. PT is NOT dead (we will see in the next few years, but that's my bet). Second, expect neoliberal policies to worsen the economic crisis in course. Bolsonaro is not a nationalist in the mold of Trump, although he has authoritarian tendencies, and democracy is at risk. And he is the result of a corrupt bargain to promote the return of the same ruling elites that were in place before PT. How long can he govern without economic recovery, you may ask. Look south to Argentina for an answer. Three years into a disastrous administration it's still unclear that the Peronist left could mount a viable alternative in next year election. So we will have very though years ahead.

* He is the judge responsible for Lula's process, and that paved the way to Bolsonaro's victory (even though he probably preferred a PSDB victory) is going to be the equivalent of the attorney general, the minister of justice.

Alan Blinder on Fiscal Adjustment

Alan Blinder published recently two columns on the WSJ (here and here) on the need to exercise fiscal restraint. In both cases he complains that the fiscal deficit is too large. Note that he is not saying that this is always the case, he emphasizes that in the second and most recent piece. The reason, as always, is that we are close to full employment. In his words:

"... today we are back at full employment, or perhaps beyond it, ad economic growth kooks solid. The economy doesn't need fiscal stimulus."

Blinder one must note was strongly for hiking rates in the mid to late 1990s, when he was the vice chairperson at the Fed, exactly for the same reasons (see this old piece in The American Prospect).  So at least he is coherent. We cannot grow too fast, since that would cause inflation. And we have a tendency to be at full employment (note that a few years back almost everybody said full employment, the natural rate, was about 6%, not the 4% or so we have). But if he is coherent, he has also been almost always wrong.

And we are not at full employment. The employment-population ratio (seen below) has finally started to recover in the last three years, but it is still well below the peak before the recession, and the participation rate (not shown but available here) has been stagnant.

That means that too many people remain discouraged about the situation in the labor market, and that when we look at broader measures of unemployment that look at those marginally attached to the labor market the level of unemployment is closer to 8% (see here). And let's not forget that the last two decades saw an impressive decline in manufacturing jobs that reduced the availability of good jobs. So the issue is not just the number of jobs, but the quality of those. It should NOT be a surprise that Trump won in some Rust Belt states.

Dems, and their economists (like Blinder), should be more sensible about the need to create more jobs, and particularly good jobs if they want to regain the White House and Congress. I would suggest that austerity is a terrible strategy. This is what you should expect from the Progressive-Neoliberal branch of the party, as it was aptly called by Nancy Fraser.

President Trump and Fiscal Policy: Austerity Big Time?

I can already see some of the cuts ;)

The Hill suggests that we should expect a huge decrease in government spending. According to them:

Overall, the blueprint being used by Trump’s team would reduce federal spending by $10.5 trillion over 10 years. The proposed cuts hew closely to a blueprint published last year by the conservative Heritage Foundation, a think tank that has helped staff the Trump transition.

In all fairness, I am not, or at least was not until now, expecting big spending cuts and austerity. I expected the cuts in social programs, like say health, to be more than compensated by military and infrastructure spending. The recent historical record is that all Republicans since Gerald Ford have increased spending and the fiscal deficit. Maybe the Hill is right, and President Donald will throw the economy into a recession, following the rightwing/lunatic fringe's ideological hate of Big Government. That would make Trumponomics very different than Reaganomics. To be seen soon. Btw, this increases the degree of uncertainty about his presidency.

Special issue of Nova Economia on Austerity and (Lack of) Growth

Editorial Introduction - Fiscal Austerity and Economic Growth
Laura Barbosa de Carvalho
PDF (English)

Neoliberalism, trade imbalances, and economic policy in the Eurozone crisis
Engelbert Stockhammer, Collin Constantine, Severin Reissl
PDF (English)

The Greek public debt problem
Michalis Nikiforos, Dimitri B. Papadimitriou, Gennaro Zezza
PDF (English)

Aggregate demand and the slowdown of Brazilian economic growth in 2011-2014
Franklin Serrano, Ricardo Summa
PDF (English)

Fiscal consolidation in developed and emerging economies
Paulo André Camuri, Frederico G. Jayme Jr., Ana Maria Hermeto
PDF (English)

Macroeconomic regime and labor market: the Argentine experience of the past two decades
Luis Beccaria, Roxana Maurizio
PDF (English)

Currency crisis and external fragility: a Minskyan interpretation applied to the Brazilian economy between 1999 and 2013
Victor Hugo Rocha Sarto, Luciana Togeiro de Almeid
 PDF (English)

Cassidy on the productivity puzzle

John Cassidy is one of the best economic journalists around (together with Jeff Madrick probably). And not only because he has written about one of my mentors, Wynne Godley. In his last column he tackles the issue of productivity. And again I should say he is on the right track. He first gives a simple example of technological change from the donkey to the truck delivery system. Almost imperceptibly he tells you that you would change from one to another technology if: "you can find enough customers." Exactly, why would you invest in the new technology, the truck, if nobody is demanding more deliveries which would make the truck cost effective.

At any rate, he suggests three explanations for the current productivity slowdown (or the new concerns about it, since the Great Recession; this had temporarily vanished in the late 1990s when productivity picked up as a result of the so-called New Economy, i.e. information technology). The first, is that it's all a measurement problem, which in all fairness is not very credible. Then there is the Robert Gordon story that the third Industrial Revolution is less technologically dynamic. A supply-side story. And lastly, he hits the nail with the Kaldor-Verdoorn story. It is the slowdown in growth, mostly resulting from austerity. As the figure below shows productivity and GDP growth are highly correlated, and the question is whether you believe Gordon (with causality from productivity to GDP) or vice-versa, like Kaldor (Godley's intellectual hero, btw).

On Marx and other 19th century critical economists he might be wrong. But that is a topic for another post. On the calculations for Kaldor-Verdoorn go here (my method avoids the need to calculate potential GDP; on potential GDP see this interesting posts here, here and here by JW Mason).

Ending austerity policies to open a new time in Europe

Stop praying and change your vote!

The management of the economic crisis has had devastating consequences for our country, as well as for the eurozone as a whole. The fiscal austerity and wage reduction policies imposed over the last few years have unnecessarily prolonged the recession across the continent and generated deep social fractures by increasing economic and social inequalities.

Fiscal austerity and wage reduction policies have led us to a lost decade. Across the Eurozone, we haven’t yet regained pre-crisis level of per capita income, and in Spain this indicator is still 5% below its 2007 level. In our country, only one in three jobs lost during the crisis has been recovered, job precariousness has aggravated, and 29% of the population lives at risk of poverty or social exclusion.

Read full manifesto against austerity here. I'm number 50 of more than 177 signatories.

John Cochrane on economic growth

There are three kinds of lies, "lies, damned lies, and statistics," supposedly said Benjamin Disraeli. This applies to John Cochrane piece in the Wall Street Journal today. Cochrane says that:

"Sclerotic growth is America’s overriding economic problem. From 1950 to 2000, the U.S. economy grew at an average rate of 3.5% annually. Since 2000, it has grown at half that rate—1.76%. Even in the years since the bottom of the great recession in 2009, which should have been a time of fast catch-up growth, the economy has only grown at 2%. Last week’s 0.5% GDP report is merely the latest Groundhog Day repetition of dashed hopes."

That is all true, and I myself complained about slow growth last week. However, this gives a false impression that the slowdown is a very recent thing, of the 2000s. In all fairness there has been a slowdown in growth going back to the 1970s or at least the 1980s. Growth since 1973 has been around 2.8%, and 2.6% since 1980, the years of the first oil shock and the productivity slowdown, and the beginning of the Reagan revolution respectively.

Yes, it is true that growth has further slowed down since the last recession (1.8% since 2000, and 1.2% since 2008), but growth has not only been slower over the last three decades (which, by the way go hand in hand with worsening income distribution), but also it has been more dependent on financial bubbles. And the last three recessions have been associated to the burst of a bubble. And given the structural conditions of the US economy, it seems that only with a bubble we will have healthier growth again.

The point is that an economy that depends on excessive accumulation of private debt, and debt-driven consumption bubbles is more volatile and prone to crisis. And that is associated both to financial deregulation and worsening income distribution. Certainly not to what Cochrane sees as the main American problem: "that the U.S. economy is simply overrun by an out-of-control and increasingly politicized regulatory state. If it takes years to get the permits to start projects and mountains of paper to hire people, if every step risks a new criminal investigation, people don’t invest, hire or innovate."

The notion that further deregulation would lead to a spurt of growth is preposterous. Yeah, because deregulating the financial sector has worked so well.  By the way, investment is a result of growth (accelerator) as well as innovation (Kaldor-Verdoorn). The problem is not enough spending on a sustainable basis, because party politics impedes public investment, and income inequality makes private spending more unstable. Austerity and inequality, not excessive regulation are behind low growth. But at least he is right that growth did not slowdown because of lack of innovativeness or a savings glut.

The Central Bank as sugar daddy

Complex technical stuff indeed

Pascal Blanqué and Amin Rajan complain about unconventional monetary policy, low or negative rates and Quantitative Easing, which they mostly blame on Greenspan and the excessive reliance on the lender of last resort (LOLR) function of the central banks (even though this precedes Greenspan). They say:

The US example shows all too clearly that the longer such unconventional policy remains in place, the harder it is to exit. Most likely, ultra-low rates will remain a fact of life for the foreseeable future, with no return to a scenario in which asset prices mostly reflect their intrinsic worth... Negative interest rates are a dangerous comfort blanket. They show that the proverbial punch bowl will continue to be replenished while the party is on. Investing is now mostly about second guessing the central banks’ next move, which even central banks themselves are not sure about.

I have a more benign view of unconventional monetary policy. It is there to support expansionary fiscal policy. But that has been like waiting for Godot. What the US example really shows is that, in the absence of significant fiscal expansion, monetary policy is not sufficient to get the economy out of the hole. You need to use the low rates, which allow government to borrow on the cheap, and boost public investment. Infrastructure spending used to be a no brainer.

So the problem is not the central bank as a sugar daddy, but the stagnation policy which results from a consensus that budgets have to be balanced, and spending reduced. The legacy of almost four decades of conservative economics, which, by the way, has been accepted by too many left of center parties.

Moody's upgrades Argentina credit rating status

Mainly because of their "expectation that Argentina will settle holdout creditor claims which will result in a lifting of court injunctions and clear the way for Argentina to access international capital markets." Fair enough, access to capital markets would lift the balance of payments constraint, even if the agreement is a complete surrender to the Vultures demands. But the most interesting argument for the improvement in the credit rating is that it results from "economic policy improvements since the Macri administration took office last December." So what happened since December (btw, mostly what I said it would).

The figure above from The Economist shows that inflation went up, and the economy was thrown into a recession. Fiscal deficits will likely increase, in spite of spending cuts, and reduction in public employment, since with the recession revenue will fall (Moody's expects the deficit to be about 5% GDP).

And yes fiscal deficits in domestic currency are mostly irrelevant for the discussion of ability to pay foreign obligations in dollars (the only reason to care is if the deficits are caused by more spending, and lead to current account deficits, which do increase the needs for foreign currency, which is not the case in Argentina now). Actually, I also think that the economy will eventually improve (that was the plan all along), just in time for the next presidential election.

The problem of course is that growth will accelerate very likely with an increase in current account deficits, as much as it happened during the Menem years in the 1990s. A more depreciated currency will do very little to solve that problem, which will likely be possible because the government will push ahead with international borrowing. Foreign debt driven growth essentially. But we know what tends to happen with this kind of policy.

There is a long history of external debt cycles in the country. This kind of frivolous economic policies, that push short term political gains (Macri's reelection like Menem in the past) at the expense of sustainable policies (it's the current account, not the fiscal idiot!) is what should be termed populism. Current account populism that is.

PS: Moody's does not even say anything about Macri's name appearing in the Panama papers.

Latin American corner: When will they ever learn?

By Naked Keynes (Guest Blogger)

The latest IMF World Economic Outlook (April 2016) projects stagnation in World Growth (3.1% and 3.2% in 2015 and 2016) both in advanced economies (4.0% and 4.1% in 2015 and 2016) and emerging market and developing economies (1.9% and 1.9% for 2015 and 2016). The prospects for 2017 are hardly any better with an estimate of 3.5% for global output and continuing stagnation of advanced economies. But things could get worse.

The current outlook scenario depends on very optimistic assumptions which as mentioned in the report (p. 18) are “subject to sizable downside risks.” These include: (i) improved conditions for economies under stress; (ii) successful rebalancing in China; (iii) improved economic activity in commodity exporters; (iv) resilient growth (whatever this may mean) in emerging and developing economies other than commodity exporters.

The stagnation and possible reduction in world growth is not traced to transitory shocks or disruptions, or god forbid to demand conditions. It is rather traced directly to the production function (the core of mainstream economic theory) and more precisely to a decline in potential GDP levels and growth due to population aging, slow growing investment and total factor productivity (See also IMF, WEO, April 2015). This reasoning with its specific conditions not only applies to developed economies but also to developing economies including Latin American economies. In the case of Latin American economies the slow growth is traced to weak productivity and investment caused by government intervention.

The IMF assessment has two major and dangerous implications for future growth.

The first is that demand policies and more generally counter cyclical policies are simply out of the question. Government and economics agents must adapt to lower potential GDP (natural GDP) levels and growth. The IMF is thus restating its case for pro-cyclicality (contractionary policies) during a slowdown. Counter-cyclicality is only justified to rein in spending during an upward or boom phase of the economic cycle.

The second is that the only way to revamp growth is through supply side policies which even if successful (something unlikely as illustrated by the experience of Latin America) could take years to implement. It is not coincidental that the IMF WEO third chapter is titled Time for a Supply-Side Boost? Although the chapter focuses on advanced economies, mainstream economists in Latin America are preaching exactly the same policies for developing countries.

In short, the policy proposals point to reinforcing the fundamental failures of capitalist economies: continuing and self-fulfilling low growth, unemployment and poverty, inequality, and instability. When will they ever learn?

Budget’s exercise to achieve financial stability at cost of real economy in India

By Sunanda Sen* (Guest Blogger)

Success achieved by the Indian economy , as highlighted in the recent budget of the central government rests on four pillars which include current GDP growth rate at 7.6%, drop in inflation ( as measured by the CPI index) around 6%, a record stock of official reserve at $350bn and most importantly, a reduced fiscal deficit at 3.5% of current GDP.

Looking beyond the official figures to convey the positive note, one comes across reservations; first that the GDP growth, calculated by the earlier method so long followed, would have generates a rate around 5% and no more. Second that the stock of official reserves have much to do with inflows of short term and volatile capital flows which may evaporate without much warnings. Third the comfortable inflation at present may also not last very long if the current lows in oil and commodity prices reverse. Finally, to come to the much proclaimed claim of achieving growth via financial stability with reductions in the ratio of fiscal deficit to the GDP , the argument. as pointed out below, does not stand scrutiny.

Lets spell out what a reduced fiscal deficit implies for the economy. Unlike the earlier practice of meeting the deficit with money printed by the Reserve Bank with the consent of the government, the gap now can only be met by additional borrowings of the state from the capital market. Incidentally, that too is considered ‘harmful’ in terms of what is considered as ‘prudent’ fiscal practices, with state borrowings likely to preempt borrowings by private agencies.

As for the fiscal deficit which is necessarily funded with market borrowings, it simultaneously generates fiscal liabilities in terms of interest payments which incurs corresponding expenditures in the fiscal budget . In addition to the fiscal deficit, the budget document provides two more estimates of the deficit. Of the latter the ‘primary deficit ‘ is arrived at by deducting interest payments from the fiscal balance. With the fiscal deficit at 3.5% and interest payments alone accounting for 3.3% of GDP , the estimated primary deficit comes to less than 0.3% of GDP. This, going by the major heads of expenditure in the primary budget, would imply cuts in social sector spending and capital expenditure, the two major heads of spending in primary budget other than defense. It is little surprise that subsidies on food accounting the budget at less than 0.9% of GDP.

What, then the budget has offered for the economy in general? The adherence to fiscal deficit target may project financial stability and a better investment climate to those who have faith in the magical consequences of a smaller deficit as a curb to inflation and its conducive effects on investment. It is. However, another matter that reduced public spending as goes with cuts in fiscal deficit may actually turn out to be a dampening factor for investment. Above will be matched by the inability of the state to instill demand by its own spending, as capital expenditure and social sector spending both of which are potentially income generating, and in addition, redistributive, an aspect which is crucial in the context of the prevailing inequality and poverty in the country.

While recognizing the uncertain as well as the depressive trends in the global economy which could disrupt a smooth sailing of the domestic economy, the budget seeks to instill confidence by taking comfort in what it observes as a path of macro-economic stability in India by achieving a pace of non-inflationary growth. The complacency is definitely over-rated, with a total absence of any proposed firewall to counter the current and future shocks to the economy as may arise from a sudden withdrawal of speculative and short term capital flows , as for example has been the case with recent turmoils in the global financial markets with the turbulence in the Chinese stock and currency market. Nor is there any attempt to prepare the economy to weather further shortfalls in export earnings as may arise with recession as well as protectionism in the global economy.

Thus it may look rather disconcerting that notwithstanding the problems with the vagaries of global finance, the budget announces further opening of financial market with schemes for new derivatives to be launched by the Security and Exchange Board of India (SEBI) and options for insurance companies to invest in stock markets. The moves are in accord with the on-going facilitation at an official level to risk taking in markets, which include the use of derivatives like futures as hedging instruments . Little, if any concern is there on part of the government to arrest the spate of speculation in stocks, property , currency and even in commodities.

The economy today is much dominated by finance which has little to do with the real economy of output and jobs . With uncertain markets generating the need to hedge financial assets by using derivative instruments like futures, options and swaps , the gains and losses therefrom are like transfers across the economy which do not account for changes the GDP. A rise in stock market transactions which pushes up stock indices like the Sensex thus has no reason to be associated with simultaneous or a lagged response with a rising GDP in the real economy. Speculation in uncertain markets of the economy has been used to operate with shadow banking practices much of which are responsible for the growing incidence of NPAs in the PSUs and the large number of scams in the economy.

The budget is remarkably tolerant of those developments, as can be gathered by its enthusiasm in further opening the floodgates of speculation in the economy. Nor is it preparing the economy against job losses in the event of further shortfalls exports which may be at the corner.

Do we then brand the recent budget as one more attempt to achieve the so-called ‘financial stability’ at the cost of the real economy?

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* Sunanda Sen is a former professor of economics at Jawaharlal Nehru University (JNU). She can be reached at sunanda.sen@gmail.com

The strange and misunderstood reasons for the Brazilian crisis

Almost done for the year. So do not expect many posts before the end of the ASSA conference (January 5). But as I promised, here are some brief thoughts on the Brazilian crisis.

Brazil is a mess. The economy is collapsing, with an estimated decline of about 3.5% in GDP this year (perhaps worse), and inflation has accelerated, to two digit levels, way above what used to be the upper limit of the inflation target band. Worse, politically the country is paralyzed, with an impeachment process in course with a very uncertain outcome.

The conventional view is sort of split on why this happened. Some suggest that it was the slowdown of the international economy, and the decline in commodity prices, that forced Brazil to adjust (for example, that would be Simon Romero's story in the NYTimes, if you add corruption to the mix; more on that below). The alternative is more explicit about the negative effects of the Workers' Party (PT in Portuguese) policies, suggesting that they reduced confidence and, hence, investment (something along these lines can be seen in the Wall Street opinion pages; see here; subscription required).

In the policy/confidence variation version the argument is that the government spent too much, in particular, in the second Lula administration, and more so in the aftermath of the Global Financial Crisis. There was an attempt to reduce fiscal spending with Dilma Rousseff's election (in this interpretation mostly disguising the spending with creative accounting, more on that below), but that was temporary, and only after Dilma's reelection did the fiscal problems became unsustainable and required adjustment.

Both stories are flawed. First, even though the global economy is growing slowly, and some peripheral economies like China are also slowing down, Brazil has no clear external problem. Current account is negative, but the country is in no danger of an external crisis or default on its foreign obligations, in particular because it is sitting on a huge pile of international reserves. As I noted before Standard & Poor's actually agrees with that view on the justification that they used to reduce Brazilian grading status (last week Fitch's followed the lead and also downgraded Brazil's debt), since they do not cite the external situation as a problem.

So the notion that Brazil needed a fiscal adjustment, to throw the country in a recession, and reduce imports, and solve the external problem seems unfounded. The same is true for the notion that a huge depreciation of the real was needed. In fact, the depreciation has only contributed to the acceleration of inflation, with no impact on the external accounts. Exports have tanked (since the global economy is not doing well), and so did imports (given the recession). Inflation will also have a significant impact on real wages, and will worsen income distribution (which had improved during the PT administration).

But what about the internal problems (both S&P and Fitch actually do blame the fiscal problems). This arguments is even worse, and has some serious logical limitations. Note that this suggests that fiscal deficits in domestic currency might be unsustainable and that inflation results from excessive demand associated to too much government spending. I have discussed this several times in the blog, so I won't delve too much into it.

There is no way a country can default on debt in its own currency. By definition you can  always print money. And yes inflation might follow, but not because printing money causes inflation. The argument implies that economy is generally, and certainly Brazil is not, at full employment. Hence, money printing might lead to more spending and more output, not inflation. However, another effect might be a fear of depreciation, and a run for dollars, and the depreciation might have an inflationary impact.

In other words, the reasons for austerity are not connected really to fear of domestic default. Austerity could be used to solve a current account problem, which is not the case in Brazil, as we saw, or it might be a way of leading to a recession, increasing unemployment and reducing the bargaining power of workers, as Kalecki noted long ago. It is a way to discipline the labor class. And that is what is going on in Brazil (on the slowdown of the economy essentially following the same argument see this paper by Serrano and Summa).

The government could actually spend itself out of the recession (don't worry, it won't). And by the way, since revenue responds to the level of activity, the fiscal outlook would improve. So if the Brazilian crisis is not external and is not fiscal, what caused this crisis. It is a self-imposed political crisis. The relevant question is why is this policy implemented by a left-of center government.

One has to first remember that on some level PT always accepted the conventional thinking when it came to fiscal issues. Lula famously said in his letter to the Brazilian people that he wanted "fiscal equilibrium to be able to grow," suggesting that he had incorporated the notion of contractionary expansion. But, in all fairness, there was some dissent within the party, and with the Plan of Acceleration of Growth (PAC in Portuguese) and, in particular, after the 2008 crisis, it seemed that PT was ready to use government spending to promote economic development. So why after winning the close election last year, in which Dilma decried the economic program of the Social Democratic Party of Brazil (PSDB in Portuguese) did she essentially adopted it?

It is clear that part of the government accepted that fiscal expansion had gone too far, and that workers' demand, and the real wages, were too high. The political pressure was certainly felt, and in addition the nagging issue of corruption might have also played a role. Also, for some reason the so-called New Economic Matrix (which in my view, I might be wrong) was very conventional, trying to reduce interest rates and promoting a moderate fiscal adjustment was seen as a failure for the wrong reasons. The lower interest rates, and the more depreciated currency should have stimulated growth, while the adjustment should have controlled prices. Obviously this New Developmentalist idea failed, since depreciation fueled inflation (which wasn't high, just at the higher end of the target at around 6.5%) and the economy slowed down.

However, the lesson taken from this experiment was that the government lost credibility, since the fiscal adjustment wasn't strong enough and the delays in the payments to public banks (the infamous 'pedaladas'), in particular the development bank (BNDES in Portuguese), were behind the crisis. In this view all depends on 'confidence fairies.' That is, the lack of confidence reduced domestic investment, and lowered growth. A terrible side effect of the generalized acceptance of this view is that now the political use by the opposition of the delays in payments to the public banks, something that was not new, in the impeachment procedures will create a permanent legacy, reducing the ability of future governments trying to pursue expansionist policies.

Finally, a word on the issue of corruption. Yes, there is a significant corruption scandal in Brazil, and before anybody complains, I do hope they get everybody and that the people that are proven guilty end up in paying the price (jail presumably; by the way, if they had something on the president it would have been used for impeachment, rather than a bureaucratic budget issue). I just want to note that there is no evidence (I haven't seen any credible evidence at least) that corruption is worse now, than say with the military back in the 60s and 70s, when most of the connections with big construction firms started. Also, the problems at the state oil company (Petrobras) being investigated go at least back to the Cardoso government. And corruption is not a problem of the government coalition per se. Members of the opposition are involved too, and an impeachment would actually bring to power some of the most evidently corrupt politicians in the country. In that sense, if corruption has not changed, it can hardly be seen as having caused the economic situation. Corruption is just one of the elements used by political groups to obtain advantages.

The problems of corruption that matter in Brazil are associated to the fact that one cannot govern without basically paying for political favors in congress and that means paying the main political force there, the Brazilian Democratic Party Movement (PMDB in Portuguese). It is well known, for example, that Cardoso payed for changing the constitution and allowing his re-election, to cite an example that is old enough, and not connected to the current government. But the country did grow significantly in the past, in spite of corruption.

And, by the way, the susbtitution in the Finance Ministry, with the appointment of my ex-classmate (at all levels, undergraduate, master's and PhD courses) Nelson Barbosa, is unlikely to lead to any significant changes in policy. The fiscal adjustment will continue as he very clearly announced.

How is austerity working for you?

So and old post was getting lots of hits. Turns out some guy linked to it a while ago. Not sure why this happened only now, after 2 years. If Google Translate is accurate (my experience is that it's not always the case) this is what he says:

"Social geographer Ewald Engelen is a Keynesian. Throw money at the economy and everything will be fine, is his theory. He fulminates and tweets all day that the government must spend. This morning Ewald put a link to the Naked Keynesianism, a site that is pro-spending money. Critics on this blog believe that the Netherlands is sick, sicker than in the mid-seventies, when our production lagged behind because we had found gas and with our backs to the sun lay staring. Look at that chart. Go to it!"

I love that Keynesian is like a dirty word (that's actually the reason the blog has its name). I should change the subtitle of the blog to "a pro-spending money blog." The it is this post.

Take away the obvious confusion about calling the Dutch economic sick (he obviously doesn't know about the well established Dutch Disease very well), how well has austerity worked after two more years.

The average rate of growth of the Dutch economy since the crisis hit is -0.3%. And the economy only started to recover from the second dip last year, with the impressive figure of 0.9% growth. Austerity is a success indeed!

Comparative Austerity: Does Cameron re-election show that austerity works?

Here, as per the comments, an update picture of austerity in the UK in comparison to Greece and the US. I added Germany too this time. Data from the International Monetary Fund (IMF, WEO Database). Figures for 2014 and 2015 are estimates.

This graph shows total government expenditures rather than just consumption. Note that the UK has pursued austerity, but it has not been particularly more austere than the US. Germany has pursued moderate, very moderate, fiscal expansion. The decline in government spending in Greece has no parallel, as should be expected, since the country was forced to pursue austerity policies.

Again, this shows that David Brooks notion "that there were two countries that did what we call austerity," meaning Germany and the UK, and that is connected to the fact that "the two strongest political leaders right now in Europe are Angela Merkel and David Cameron," so that this is a vindication of austerity policies is, as I had noted before, preposterous.

David Brooks wrong on austerity: it's not what they say, but what they do, that matters

So just heard David Brooks say at the PBS News Hour -- it says something about the state of media in this country that PBS (not surprised about the NYTimes) would have such a blatant ideologue as a commentator -- suggest that the election in the UK, which is doing better than other countries in Europe, proves that austerity works.

Obviously the UK economy sucks, and Labor promised austerity too, but the point is that Brooks suggested that the UK (and Germany) had austerity while others didn't. Not that he checks data ever. So I did. Below government final consumption in constant prices in Greece (blue) and the UK (red).

As you can see it's true that the UK has done better, simple because of less austerity, in fact, looking at just government consumption the UK doesn't seem to be pursuing austerity at all. So the fact that the governments in the UK and Germany are for austerity, while the current Greek one, at least nominally, it's not, does not mean that they do pursue austerity more aggressively than the rest of Europe. Unless Brooks thinks that what matters is what you say, not what you do.

PS: Below the same comparing the US and Greece. The US actually is more austere than the UK, but not nearly as much as Greece.