Mario Draghi’s pledge to do “whatever it takes” to save the euro has been widely hailed as a watershed event. Both the markets and euro politics have since been operating on the premise that the euro’s survival is ensured. Unfortunately, that is not a safe assumption at all. Not only because even agreement on the Single Supervisory Mechanism, the easiest element in any banking union-to-be, proved to be anything but easy. But even more so since concentrating energies on preventing future crises is somewhat premature anyway, as long as the current one remains largely unresolved. The point is that the policy strategy that has been adopted for overcoming the crisis, with or without any ECB liquidity promise in support of government bonds (i.e. Outright Monetary Transactions), is doomed to fail. The underlying causes of the crisis have been thoroughly misdiagnosed, and the medication ill-conceived as a result, while reforms of the flawed euro policy regime are so ill-designed as to ensure the euro’s final demise.
The ultimate fear of the Maastricht regime’s designers was that fiscal profligacy of nations lacking Germany’s legendary “stability culture” could usher Euroland into hyperinflation. The Bundesbank’s worst nightmares seemed to come true when Greek budget deficit (ratio) numbers were revised strongly upwards in 2009. So the ill-named pact that has so far failed to deliver on either stability or growth was further strengthened, with fiscal discipline henceforth to be anchored in national law. Irrespective of the collateral damages already endured, the big austerity stick will keep on bashing the Euroland economy for years to come.
This ignores the key flaws in the Maastricht regime of the EMU and the true causes of the crisis. One original sin was to put no one in charge of minding the store of the giant integrated euro economy. No demand management was foreseen in good times, no lender of last resort in bad. Predictably, the Euroland economy has proved prone to protracted domestic demand stagnation and conspicuous reliance on exports for its meager growth, while crisis management has been by trial and error; and errors with no end it would seem. The second original sin was to forget what fifty years of European monetary cooperation were all about, namely to forestall the risk of beggar-thy-neighbor currency devaluation. The euro provided the coronation of that very endeavor in the sense that exchange rates disappeared with national currencies. But this only meant that under the EMU trends in national unit labor costs have taken on the role of determining intra-union competitiveness positions alone. The golden rule of monetary union therefore requires that national unit labor cost trends stay aligned with the common inflation rate that union members have committed to – when they didn’t.continue reading…
Paul Krugman points out today that once you take into account the lingering effects of the recession, it may very well be the case that there is no significant near-term budget shortfall at all. Once the economy has recovered, the budget may already be destined to come in at a level that would stabilize public debt as a share of GDP. The real problem we have in the short-run is that budget deficits are too low—and shrinking—not that they are too high and growing.
The least unpersuasive case for worrying about the federal budget deficit focuses on the long-term increases in Medicare and Medicaid that will result if health care costs follow their projected, steep upward pathway. If you accept this case (which should not simply be accepted as gospel), then you can stop listening to any purported “grand bargain” plan that does not address this projected rise in health care costs.
Yet, if the news reports have any validity, the “entitlement reform” side of the fiscal cliff negotiations has become focused on a proposal to increase the Medicare eligibility age by two years. This would deliver roughly $5 billion in savings to federal government in 2014. You might say that, given the hardship it would cause to so many near-retirees, this seems like an awfully small sum. But it’s worse than that. While this policy change might save the government $5 billion, it would increase health care spending system-wide by twice as much. In other words, the grand deficit bargain is centered on a proposal that makes the problem of rising health care costs worse.
There is a tried-and-true method of controlling health care costs—but it requires moving in precisely the opposite direction as this proposal. Many other countries are facing shifting patterns in government spending due to aging populations, but the United States is unique in the developed world in the amount of money it spends, per person, on health care; all in order to obtain slightly inferior health outcomes. Pick any wealthy country at random, and if the United States were to spend the same amount, per person, as this randomly selected country, the projected long-term US budget shortfall would disappear—completely. Why? The answer is that many other countries (with universal coverage) use the bargaining power of a government payer to control the per-unit cost of health care services. Raising the eligibility age for Medicare, making the government insurance pool smaller and sicker, moves us in the opposite direction.
You can either commit yourself to “reducing the size of government,” or you can commit yourself to getting health care costs under control, but you’ll have a hard time doing both.
Registration is now open for the Levy Institute’s fourth Hyman P. Minsky Summer Seminar, to be held on the Bard College campus in June 2013. The annual Summer Seminar provides a rigorous discussion of both the theoretical and the applied aspects of Minsky’s economics, and is geared toward recent graduates, graduate students, and those at the beginning of their academic or professional careers. Application deadline: March 31, 2013. Apply early, as space is limited. See here for more information.
Stephanie Kelton appeared on NPR’s “On Point” this week with Paul Krugman and Stan Collender to discuss (do I really need to finish this sentence?) the fiscal cliff.
You can listen to or download the podcast here. (Kelton enters at roughly the 13.20 mark)
James Galbraith and Randall Wray spoke about returning full employment to the policy agenda at an event in Helsinki on Monday organized by the Foundation for European Progressive Studies and supported by the Kalevi Sorsa Foundation and the Finnish Confederation on Trade Unions (SAK).
Wray focused on Minsky’s under-discussed work on poverty and full employment (the Levy Institute is currently putting together a new book containing a collection of Minsky’s published and unpublished writings on the topic): “Minsky wrote almost as much on poverty, unemployment, and employment policy as he had on financial instability.” Video of the presentations is below:
Last week, a short walk from the Brandenburg Gate, the Levy Institute held its most recent Hyman P. Minsky Conference on Financial Instability. The two day conference in Berlin featured a mix of central bankers, academics, politicians, and financial practitioners and dealt with issues related to the eurozone debt crisis, the Federal Reserve, signs of instability in China, Dodd-Frank and financial reform, the payments system (including the threat of cyber attacks and the potential destabilizing effect of the development of alternative payments technologies), indexes of financial fragility, and a host of other intriguing topics.
On the first day, Vítor Constâncio, Vice President of the European Central Bank, delivered a morning speech that highlighted the poverty of the dominant economic thinking underlying the flawed institutional design of the European Monetary Union, with its centralized monetary policy and decentralized fiscal and financial stability policy.
“In the pre-EMU economic modelling world,” said Constâncio, “there was no need to counter financial imbalances and financial instability as the financial sector did not play a crucial role from a macroeconomic perspective. Similarly, under the assumption of self-equilibrating markets, there was no need to monitor macroeconomic imbalances and disequilibria on the labour, product or financial markets. With an assumed stable private sector, apart from exogenous shocks, the only source of instability acknowledged were governments and their fiscal profligacy.” In running through the flaws in these theoretical assumptions, Constâncio noted Minsk’s remark in Stabilizing an Unstable Economy that “… for an economic theory to be relevant, what happens in the world must be a possible event in the theory.”
Against that background, Constâncio traced a path for reform of the eurozone structure. He also included a discussion of the reasoning behind the European Central Bank’s policy on Outright Monetary Transactions (OMT)—the ECB’s bond purchasing program, designed to bring down rising interest rates on peripheral government debt—and said after the speech that he expects Spain to apply for the program. He portrayed OMT as a way of getting peripheral nations out of “a vicious circle of rising interest rates, falling growth and deteriorating public finances.” (In other words, as a way of getting out of what Greg Hannsgen and Dimitri Papadimitriou have dubbed a “fiscal trap.” OMT, Hannsgen and Papadimitriou observe, partially moves the EMU away from its effectively “metallist” currency setup.)
From 2009 to 2012, the US federal deficit shrank from 10.1% of GDP to 7% of GDP. That’s the fastest deficit reduction we’ve seen in six decades—and all before the fiscal cliff has kicked in. Here’s the chart from Jed Graham:
Put this alongside a record-setting contraction of government employment and a 7.9 percent unemployment rate, and what you have is a portrait of fiscal irresponsibility. A lot of this deficit reduction has to do with the fact that the economy is now growing (albeit feebly), instead of contracting, but looking at this chart should also reinforce how dangerous and unnecessary it is that we’ve decided to create an austerity crisis at this moment. (This “austerity crisis,” by the way, should really be understood to include both the possibility of going over, and staying over, the fiscal cliff AND the possibility of the cliff being replaced by a “grand bargain” on deficit reduction.) The last time the deficit was reduced at a faster rate was in 1937, when the government embraced a hard pivot to austerity and the economy tumbled back into recession.
But don’t worry, we aren’t reliving the history of the 1930s. Not exactly. We are combining fiscal irresponsibility with regulatory negligence. The Financial Stability Board (FSB) reported on Sunday that the shadow banking sector, after contracting in 2008, has rebounded nicely and is doing just fine. Although it hasn’t quite seen the growth it did prior to the crisis, when it doubled in size from 2002 to 2007 (from $26 trillion to $62 trillion), the shadow banking sector reached $67 trillion globally in 2011—a new record, and “equivalent,” says the FSB, “to 111% of the aggregated GDP of all jurisdictions.”
Amity Shlaes, whose main claim to fame is an allegedly new history of the Great Depression, thinks we may be in trouble as a result of the election. Looking beyond her alarmingly alliterative title (“2013 Looks to be a Lot Like 1937 in Four Fearsome Ways!” Oooh! Scary!) she has some valid points. Of course she is talking about the stock market not the real economy, which produces the jobs and the economic benefits most people rely on for a living. And, unfortunately, she doesn’t realize where she is right.
But first, what are the four fearsome factors that will drive us to doom? First, a federal spending spree before the election. Shlaes uses “the old 19% rule” as a benchmark to argue that because federal government spending in 2012 “when the crisis was long past” was 24.3% of GDP, clearly the Obama administration was spending up a storm. To argue that the crisis is long past, one must be willing to ignore the employment crisis that still hasn’t left us, but let’s give her this one. Whether this is a problem given current economic conditions is another story. If it’s the debt implications you’re worried about, it is worth noting that revenues as a percentage of GDP are also quite low historically speaking, just over 15% for the last few years (see CBO’s historical budget data).
Shlaes’ second fear factor is a bath of cold water afterwards. Roosevelt restored budget balance in 1937 and since that very topic (and who David Petraeus was or was not sleeping with) is all people are talking about in Washington these days it seems likely we’ll get spending cuts and tax increases in the next budget. The “depression within the Depression” was the result of exactly this fiscal restraint. This is where Shlaes is quite right, though she doesn’t actually come out and say this: whether the President and Congress jump off the fiscal cliff together, which would reduce spending across the board, or avoid it by cutting spending on everything but defense instead, we are in for poor economic performance indeed.
Shlaes’ third scary thing is the fearsome attack on the status quo. In 1937, this meant raising the top marginal rate from 56% (where it had been raised by Hoover in 1932 from 25%) to 62% (this actually passed in 1936) and the undistributed profits tax. This, and Roosevelt’s attempts to pack the Supreme Court meant that (stock) markets “shivered.” Note that this year, Obama is talking about raising the top rate to, um, 39.6%, which is where it was before the Bush tax cuts. Remember how much markets were “shivering” in the 1990s? Me neither.
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