Scoop!

by John Quiggin on October 6, 2011

When I read Evelyn Waugh long ago, many thoughts passed through my mind, but I can safely say that the idea of writing a blog post starting “Henry and I have a piece in the Daily Beast …” was not among them. Nevertheless:

Henry and I have a piece in the Daily Beast on the politics and economics of saving the euro, along lines that will be familiar to readers here. Some reactions from Ezra Klein and Paul Krugman.

{ 94 comments }

1

Barry 10.06.11 at 12:22 pm

Frankly, it was a bag o’ nothing. They should do this, they should do that. I agree, but so what? IMHO, there’ll have to be default by a few countries to put the fear of – well, the Great Depression and Hitler – into the hearts of the N. European bankers.

2

SamChevre 10.06.11 at 12:47 pm

Is this a typo?

These two steps would dilute or even wipe out shareholder equity in many banks, and impose heavy losses on debtors… The reality is that all lenders bore some responsibility for creating the economic bubble and all must pay their fair share to resolve the crisis.

It makes perfect sense if the boded word were creditors, but if it is debtors I’m having trouble making it fit the rest of the piece.

3

Tim Worstall 10.06.11 at 1:01 pm

You’re calling for the European Treaty to be completely renegotiated (more parliament powers, a Senate, etc).

Last time this was tried it started in 2001, became the European Constitution in 2004, required various referenda a couple of which failed to pass it, then it became the Lisbon Treaty and came into force in 2009.

Umm, are we really thinking that the euro is just going to stumble on until 2019? That there won’t be a resolution one way or the other before then?

4

Sev 10.06.11 at 1:55 pm

#3 “Umm, are we really thinking that the euro is just going to stumble on until 2019? That there won’t be a resolution one way or the other before then?”

Based on the purest of superstition, I’m thinking more in terms of a month than a decade; the history of financial crises arriving in October (at least in the US), something about new fiscal year, sobriety of winter chill, falling leaves, meager harvest… being that this is Europe we’re talking about, YMMV, but the month is young…

5

ajay 10.06.11 at 2:31 pm

4 might be a bit pessimistic; I am pretty sure that the euro is going to still be around in three weeks’ time.

6

bert 10.06.11 at 2:32 pm

Up to a point, Lords Quiggin and Farrell. Which is a way of trying to avoid saying I agree with Worstall.

Sod it. I agree with Worstall.
For all kinds of reasons, but mainly for the time constraints Tim concentrates on, this is not any kind of response to the current crisis. It’s also a significant evolution from your previous “hard Keynesianism” effort, and not an improvement.
The comments are revealing. Lots of useful information about the Bilderberg Group, George Soros, etc.
Are you hoping for Op-Ed tenure?

7

John Quiggin 10.06.11 at 3:03 pm

@2 D’oh! I’ll get that fixed ASAP

To everyone else. The point is not that nothing should be done until the constitution has been rewritten. It’s that the rescue effort has to be accompanied by a push for a genuinely democratic union.

I’m not surprised to see Tim W taking this rather snarky reading, but I am surprised to lots of others following. I agree the comments are revealing, but none of them misread the piece in this way.

8

Barry 10.06.11 at 3:12 pm

John, because basically it’s the same old same old.

9

bert 10.06.11 at 3:43 pm

Well, you’re not helped by the subhead (“the radical solution that could stave off disaster”), which is presumably nothing to do with you.
But you appear to be looking under the lamppost because the light’s better there. I mean this sincerely and without snark. One obvious point: a highly centralised Europe is one thing, a Europe with a proper democratic mandate is another. Crisis measures that involve grabbing for one will likely leave out the other.
If we’re talking about the faraway longterm, as Wolfgang Schäuble is careful to, then fine. But I doubt that’s what the Daily Beast paid you (or neglected to pay you) for. I’ve no problem with you proposing “an elected European President, who controls a beefed up European Commission with the power to initiate legislation … an invigorated European Parliament with real authority over a larger budget [and] a new European Senate, with veto power”. But does it cut it as commentary on this crisis? No, no, no.

10

Kevin Donoghue 10.06.11 at 3:59 pm

Politics can make strange bedfellows. I think the fact that more of us sound like Tim W these days is not an indication that his political philosophy is gaining lots of new converts. Rather it’s an indication that Merkozy, Trichet and Co. have managed to make a lot of us very sceptical about the desirability of saving the euro. It’s hard to see it being saved in a way that doesn’t enhance the power of the banksters.

Admittedly I was always somewhat doubtful of the euro, thanks to Krugman and a bunch of Irish economists who shared his views about the impracticality of making a currency union out of such diverse members. But Trichet, in particular, showed a massive drawback in the form of a very powerful and, for all practical purposes, utterly unaccountable bureaucracy. That’s a feature, not a bug, so if you dislike it as much as I do then the sooner the system collapses the better.

11

William Timberman 10.06.11 at 3:59 pm

Europe may yet have better luck with this than it has in the past, especially if the only alternative is to sit back and wait for WWI. I agree that if the present leadership can continue to fake things, they probably will — it’s the easier course. Only when it becomes obvious that there truly are no credible alternatives is it conceivable that any of them would seriously consider engaging John and Henry’s modest proposals, let alone put Joschka Fischer’s United States of Europe on the table in Brussels.

So tell me, does anyone here really think that the status quo ante has a future? I mean, honestly, if the latest whiz-bang is leveraged Eurobonds, isn’t it perfectly reasonable to consider that the end might be nigh?

12

Walt 10.06.11 at 4:18 pm

The problem is that if the euro zone collapses suddenly, it will lead to incredible economic chaos, that would probably rival the Great Depression. Europeans roped themselves together and lowered themselves over a cliff. While at this point they all wish they weren’t tied together, they can’t untie without falling.

13

michael e sullivan 10.06.11 at 4:18 pm

Any help with the Evelyn Waugh reference here? The last 10 minutes spent on google and reading famous quotes from his writings has not helped me figure it out.

14

michael e sullivan 10.06.11 at 4:20 pm

I hang my head in shame. terrible google fu, though I did figure it out on my next try after posting that. dammit.

15

John Quiggin 10.06.11 at 4:29 pm

I’ll reply in numbered points for ease of reference:

1. I don’t think austerity etc can restore the status quo ante

2. I also don’t see a non-catastrophic way out of the euro – I’m not sure if other commenters have a different analysis or just more tolerance for catastrophe

3. So, to restate the argument of the article, what is needed in the short run is a restructuring/partial default for Greek debt and large-scale quantitative easing/inflation for the rest. *In the long run*, the only solution is fiscal union with hard Keynesian rules, and that can only be managed with a democratic union.

16

Steve Williams 10.06.11 at 4:45 pm

I enjoyed reading the article, and I basically agree that the course you have charted would be generally helpful. However, for a couple of reasons, I don’t think it will, or can, ever come to fruition.

Essentially, Europe is stuck between Karlsruhe and Dublin. The German Constitutional Court has made it clear that they won’t countenance any solution to the crisis that includes permanent fiscal transfer, as you note in the article, which means that all of the actually workable economic fixes are essentially dead in the water. Understandably, then, you have turned your attentions to the political side of the equation. However, the solution you propose would involve changes to the Constitution far bigger than the Lisbon Treaty. Recall that Ireland (and I believe one or two other countries?) are constitutionally required to hold a referendum before they can become a signatory to any of these treaties. Are Irish voters in the mood to humour their European overseers? It took them two goes to give the ‘right’ answer last time, and that was during the boom . . .

The second point is that, while he might have said it snarkily, Worstall is right about time. Basically, one of two results is possible from the current position in the crisis:

1) Greece Defaults / Euro Falls / An Economic & Political Disaster Hits Europe, & Subsequently The World

In the apocalyptic scenario, there certainly will be a need for constitutional reform across Europe, but it will hardly be being done under propitious circumstances. It’ll probably be a panicked case of saving whatever is worth saving, and severing ties to save contagion spreading. Under these circumstances, the idea of sovereignty going from the nation state to the centre seems highly unlikely.

2) Eurozone Politicians Kick The Can Down The Road Successfully

Everyone seems to have written off this as a possibility. It seems to have worked quite well with Ireland, although I understand that Greece’s situation is much worse. However, just supposing they manage to kick it so far down the road, or kick it enough times, that it really does go away, then the crisis moment will be gone, and with it the impetus for constitutional reform. Governments will be too busy mopping their brows to take risky steps. In any case, from the point of view of governments outside the Eurozone – nearly 50% of the total, and including Britain – the main lesson from the crisis has seemed to be that nation state independence is the best guarantee of avoiding contagion. And really, can you see David Cameron being helpful in negotiations like these in, say spring 2015?

17

bert 10.06.11 at 5:47 pm

Fiscal union would need more than hard Keynesian rules, which in the end boil down to a this-time-we-really-mean-it Stability Pact. It’d need ongoing fiscal transfer. And not as a series of supply side investments on the model of the structural funds, but instead something conceived and justified as a system of continental macroeconomic management.
The obstacles to fixing Europe’s democratic deficit are well known. But even assuming they can be successfully overcome, I’m not convinced people will be prepared to swallow all of the above. What’s more, none of that would prevent a future screwup in private sector lending, which contributed massively to the banking crisis we’re now facing.

I realise that you’re looking for a solution, and I’m sorry to be so sunk in negativity. In mitigation, there’s a lot of it about. If I have a hope, it’s for Steve’s option 2, above. Greece defaults. The worst contagion fears (eurozone collapse, worldwide bank runs) turn out to be Y2K-bug hyperventilation. And the non-Greek PIIGS are slowly nursed back to health. But I admit this seems less likely with every day that passes. If enough people look around to see which banks can’t be trusted, it could all get very bad very quickly.

18

Scott 10.06.11 at 6:48 pm

I never went to school so I have no substantial point to make. All that I want to say, speaking as part of the working class untermenchen is that I’m glad that I’m too old to be drafted if the bullets start firing.

40 is too old, isn’t it?

19

John Quiggin 10.06.11 at 7:29 pm

I have to say, the UK relief at being out of the euro seems overstated to me. There are some benefits from devaluation, and more contingent benefits from the fact that BoE policy is more sensible than that of the ECB, but from afar austerity in the UK looks much the same as in the rest of the periphery.

20

john c. halasz 10.06.11 at 7:47 pm

You’ve skipped the other possibility that has been mooted: that Germany (et alia) leave the Euro.

21

Lemuel Pitkin 10.06.11 at 7:58 pm

Just to be clear, hard Keynesianism is the idea that budgets should be in balance over the business cycle. This idea:

* Has no basis in anything Keynes wrote.

* Implies that the debt-GDP ratio goes to zero in the long run, without any explanation of why this is desirable.

* Implies that desired private savings exactly equals desired business investment at full employment, without any explanation why this should be so.

* Does not rest on any analysis of why the magic number of zero is preferable to some other small positive or negative number.

* Is based on the idea that the inadequacy of policies to boost aggregate demand in Europe is due to a lack of fiscal space, when this is only true for Greece. Most of the worst hit countries were in fact following the hard (pseudo-)Keynesian prescription of running surpluses prior to the crisis.

In short, it’s an idea held up by nothing but repeated assertion, that keeps staggering forward regardless. A zombie, if you like.

22

Henri Vieuxtemps 10.06.11 at 8:00 pm

40 is too old, isn’t it?

You can still clear minefields; even a monkey can do it.

23

John Quiggin 10.06.11 at 8:37 pm

@LP I’ve said to you before that “I don’t have a problem with the point that the correct objective of fiscal policy is maintaining stable and sustainable ratios of debt and net worth to GDP. “Balancing the budget over the cycle” is intended (by me, at any rate) as a shorthand for this objective. ”

Since you repeat the same claims as before, ignoring the errors I pointed out last time around , I think it is clear which is the zombie argument.

If you have a problem with a stable debt/GDP target, why don’t you spell that out?

24

bh 10.06.11 at 8:49 pm

JQ @ 10.06.11 at 4:29 pm — Barry Eichengreen has an article here (http://www.voxeu.org/index.php?q=node/729) that’s a few years old, but still gives a good idea of just how nasty a Euro breakup could be. It’s worth checking out the whole (short) article, but basically:

1) The transition would require a massive amount of internal redenomination to get everything — contracts, taxes, wages, etc — out of pricing in Euros and into DM/Lira, etc. That’s of course been done before in the other direction. But the adoption process was much slower, much more planned, and occurred under far better macroeconomic circumstances. Reversing it quickly in response to a crisis would be considerably harder.

The real killer to me, though, is

2) If a country leaves the Euro, it will do so primarily for the chance at devaluation. Investors will know this, and they’ll try to plan ahead. If, for example, Italy plans to revert to the Lira, deposit holders will know that, after the transition, their funds will exchange for some value substantially below the 1-to-1 Euro ratio they’re getting now. So the incentive to pull those deposits out of Italian banks will be irresistible, triggering massive bank runs that would likely wipe out any benefit from devaluation.

I’d also suggest that the Euro, for all its problems, isn’t tied that closely to banker misbehavior. The ECB’s policy has been appalling, but there’s no reason it couldn’t be replicated on a smaller scale. And bankster shenanigans can be executed in any currency. I understand the “just blow it up!” impulse, but I’m pretty sure that explosion would damage a lot of important stuff without doing much damage to the real villains.

FWIW, I wasn’t in favor of Euro adoption at the time it happened, and (I think) I’m generally more concerned with the Optimal Currency Area issue than JQ. But “should the Euro have been adopted” is a different question than “would it help to dissolve it now.”

25

dbk 10.06.11 at 8:52 pm

Yes, the JQ/HF proposal is a fine solution, but alas, the clock is ticking, ticking …

Meanwhile, Greece retained Lee Buchheit of Cleary Gottlieb (NYC) to represent its sovereign (default) interests some months ago. Buchheit was the legal technocrat who oversaw Iceland’s default, and has already (2010) outlined how he envisions a Greek default at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1603304.

The Greek press is estimating a 50%+ haircut when d-day arrives; the smoke-and-mirrors in Brussels/Frankfurt/Athens, it is claimed, is basically intended to afford breathing room for French and German banks exposed to Greek sovereign debt (likely sliced and diced in the form of AAA CDOs) to re-capitalize. The general suspicion is that the announcement is being postponed for (soon) after the G-20 meeting in Cannes Nov. 3-4.

26

Henri Vieuxtemps 10.06.11 at 8:58 pm

They should all devaluate by the same ratio, and keep the euro. Peg it to the dollar, just like the Swiss pegged their franc to the euro a few weeks ago.

27

John Quiggin 10.06.11 at 9:06 pm

In fact, in the actual article where we introduced the term “hard Keynesianism” Henry and I never used the terminology of “balancing the budget over the cycle” and, in response to commenters who did use it I noted “The proposition that on an economically correct interpretation of “budget balance over the cycle”, standard measures of the budget balance will *show a small deficit on average*. This is true, and complicates the story, but doesn’t affect the validity of a Keynesian prescription of deficits in slumps, surpluses in booms.”

In other words, your whole argument is based on a misreading.

28

bert 10.06.11 at 9:09 pm

bq. Even a monkey can do it.

Or a Frenchman.
Scott, you should be fine. You’ll be back here with us ancient fucks, fighting over who gets to eat the rat you found.

29

bh 10.06.11 at 9:11 pm

HV @ 8:58pm — I don’t think that would accomplish much. The issue here is with imbalances within the Eurozone. A synchronized move might make the Eurozone more competitive overall, but it wouldn’t help the peripheral countries devalue vs. the core, which is what’s really needed.

And I’m not sure why you’d want to peg to the dollar. That seems like just compounding the original mistake, creating an even-larger effective currency zone without the needed fiscal integration.

30

Watson Ladd 10.06.11 at 9:15 pm

Henri, now that Germany might be entering a recession devaluation makes sense. But there is an issue: what will the ECB target? Right now it only targets inflation, and cannot target anything else. (An act of monumental collective stupidity). As a result it probably cannot announce openly another target. But that will lead to the temptation to bid the Euro up, making devaluation harder to accomplish.

31

fgw 10.06.11 at 9:15 pm

Isn’t the obvious paradox that while you can “imagine” how wonderful a more politically integrated Europe would be if only it were truly democratic, I don’t really see the voters agreeing that what they need is a democratically legitimate European president and Senate. I imagine the enthusiasm would be close to American’s enthusiasm for a democratically empowered President of NAFTA. And I also imagine at least Germany’s court would rule such a transfer of sovereignty unconstitutional.

32

bh 10.06.11 at 9:16 pm

… adding that there’s a much simpler way out of the devaluation issue, which is to have a positive inflation target sufficient to allow the depressed countries to adjust with only relative deflation. But with inflation-o-phobe flat earthers controlling every meaningful lever, that seems as unrealistic as anything else.

33

Watson Ladd 10.06.11 at 9:19 pm

bh, good point! I’d forgotten that this was inflate away the debt and not boosting output.

34

bh 10.06.11 at 9:43 pm

Thanks, Watson. As you say, though, the worsening German economy may mix things up a bit. Or at least I hope it does…

35

Henri Vieuxtemps 10.06.11 at 11:33 pm

The issue here is with imbalances within the Eurozone.

I know, there are serious imbalances within the Eurozone, that’s an empirical fact. But I don’t understand how it’s logically possible to have significant imbalances within a relatively homogeneous (wrt infrastructure, levels of taxation, skills, etc) region with common currency, no tariffs, and no borders. It doesn’t seem to make sense; imbalances should self-correct. Something’s missing from the typical analysis.

36

Watson Ladd 10.06.11 at 11:40 pm

Henri, I’m not sure that the Eurozone is that homogenous. Some areas are going to be magnets for certain kinds of economic activity, while others languish. Would a bright young Greek stay in Athens or move to Berlin or Frankfurt where there are industries rewarding skills?

37

chris 10.07.11 at 12:06 am

I also don’t see a non-catastrophic way out of the euro – I’m not sure if other commenters have a different analysis or just more tolerance for catastrophe

Suppose:

1. There is no non-catastrophic way to get out of the euro, and

2. There is no non-catastrophic solution to the current crisis that can be achieved while staying in the euro, and

3. The euro is at least partially responsible for the current situation, and the limited menu of possible policy responses.

Then the best thing to do is to take the catastrophic outcome that gets you out of the euro, because if you take the catastrophic outcome that keeps you in the euro, you’re also setting yourself up for more euro-caused crises later. Catastrophe later may or may not be preferable to catastrophe now, but catastrophes now *and* later is clearly worse than either one alone.

1 is your own premise, and 3 seems pretty clear at this point, so any argument for staying in the euro must refute 2. How?

38

chris 10.07.11 at 12:10 am

Would a bright young Greek stay in Athens or move to Berlin or Frankfurt where there are industries rewarding skills?

Depends; is he bright enough to speak German? ISTM that the assertion that there are no borders is somewhat fictional when there are still language barriers.

39

Lemuel Pitkin 10.07.11 at 12:10 am

But in the same article, you say,

Keynesianism demands more, not less, fiscal rectitude in normal times than does the orthodox theory of balanced budgets that underpins the EU. John Maynard Keynes argued that surpluses should be accumulated during good years [no he didn’t, you just made this up] so that they could be spent to stimulate demand during bad ones. … If anything, “hard” Keynesianism suggests that the problem with the macroeconomic rules governing the euro is not that they are too tough and too detailed but that they are not tough or detailed enough. States in the eurozone should not be allowed to run moderate budget deficits in boom years, the Keynesian argument goes; instead, they should be compelled to run budget surpluses.

You are arguing that if European states had run surpluses during the good times, they could have avoided the collapse in demand after 2007. But of course, Iceland, Ireland and Spain were all running substantial budget surpluses in the years leading up to the crisis, so the idea that this offers some protection against crises is evidently false. That’s strike one.

You say that governments should run surpluses during “good times”, without providing any evidence that desired private savings exceeds desired business investment at full employment. There is no a priori reason to assume this will be the case; if it’s not, then full employment will require either a budget deficit to fill the gap, or an export surplus. That’s strike two.

More broadly, there’s no analysis of *why* good-times surpluses are desirable, except for a vague claim that the surpluses can then be “spent” in recessions. This implies that government are unable to borrow, an assumption that you understandably don’t spell out since it’s so obviously silly. In fact, there is no evidence that countercyclical policy needs to be paid for in advance, except in the context of a foreign-exchange constraint. We’ll call that a foul.

You explicitly say that current rules are “not tough enough”, “lack rectitude”, and should be “stricter”. The current limit of 3% average deficit over the cycle, assuming 5% nominal growth, implies a debt-GDP ratio converging to 60%. You evidently think the targets should be lower. How much lower? And how do you know? Since the published piece gives no hint of an answer, that’s strike three.

40

Lemuel Pitkin 10.07.11 at 12:16 am

(response to JQ @27)

41

john c. halasz 10.07.11 at 12:47 am

Maybe it’s time to better address “hard Keynsianism”, i.e. the New Keynesian account of the inter-temporal budget constraint, and how accurate such thinking is. In the first place, it needs to be replaced with the Wynne Godley account of national income accounts, (i.e. GDP, etc.), stressing inter-sectoral balances in any given period, between the private business sector, the private household sector, the government sector, and the foreign sector, (i.e. the trade/CA imbalance), which, as a matter of accounting identity, must always sum to zero, regardless of what happens behaviorally/causally. (If an IMF acolyte such as Martin Wolf gets it, WTF?) The core Euro-zone problem, (as also, more generally, the global crisis problem), is rooted especially in those CA imbalances. Only Greece is especially afflicted by excessive public deficits due to a bloated, inefficient public sector, (and rampant tax-evasion and corruption, primarily, by elementary logic, on behalf of the rich), while AFAICT Portugal is just a matter of a backward, generally inefficient economy in advanced productivity terms. Spain and Ireland were, in fact, poster-children of neo-liberal fiscal restraint, except for the huge burgeoning of private debt-loads and corresponding CA deficits, which then got transferred onto the public fisc, by hook or by crook. IT”S THE OVERALL DEBT PROFILE THAT MATTERS, NOT JUST THE PUBLIC DEBT!

The second point is that, by the same auspices, public debt is providing “savings” to the private and foreign sectors, depending on the exact situation and profile. But public debt is not eo ipso public spending, i.e. consumption, (even if that does good stead in maintaining fairly equitable READ) . A good part of public debt might just as well be accounted public investment spending, it being a mere convention of N.I.P.A. accounting that it amounts to sheer spending, (since the inventors of N.I.P.A. despaired of accounting for the productivity of governmental activities, a gross simplification for “technical” reasons). Public spending is not just necessary to maintaining functions and institutional supports for the operation of “private” markets, and for controlling the distribution of income/wealth and opportunity-structures in ways that don’t diminish READ, but public investment and publicly-guided industrial policy, (as well as regulation of other sectors, of course), is essential to maintaining and developing a viable economic structure under continuing technical and global change.

The “hard public budget constraint” is based on a bias toward the “private” corporate and financial economy, as the source of investment and economic growth and “stabilization”, based on the “crowding out” hypothesis of the effects of public spending, whether debt-financed or monetized. But it fails to consider the “crowding-in” hypothesis, that public investment, regulation, and policy guidance provides opportunities for renewed private investment, especially in the light of the need for increased resource efficiency and the resistance of market-dominant incumbents. I.e. the restructuring of economic production-systems, in a non-IMF, financialized sense. Given the high “hurdle rate” of “private” investment, when faced with high, upfront, fixed capital costs, (which incumbents, kinda by definition, have already incurred and will seek to defend, by hook or by crook). A fine example of this point is the Obama/Geithner administration’s proposal for an “infra-structure development bank”, which is just standard neo-liberal fare, “private-public partnership”, since, by most estimates, the only difference between public borrowing and “PPP”, is that the latter will cost between 200-300 bps. more in interest costs, just a further example of the effects of “financialization”.

Finally, there is the question of on just what basis the path of public debt is projected. Leaving aside the prospect that some debt monetization could induce salutary forms of inflation , which conventional monetary policy apparently can not, thereby burning off some of the excess accumulation of private debt-loads by increasing nominal GDP and thereby also increasing the feasability of direct principal reductions, as well, the projection of future public debt levels is not only frequently , (or, beyond a few years out, continuously), wrong, but some economic pathway, (or “model”), needs to be provided to make the case of “unsustainable” public,- (and private!),- debt burdens going forward. As can be seen, e.g . in disputes over this issues between Krugman and Jamie Galbraith, some special assumptions are being assumed without being provided, (such as maybe the continuance of high CA deficits, or the failure to contain health care costs in line with the OECD average, etc.). Hectoring about public debt levels without any further analysis and differentiation is just more of the same-old. Since it is the debt/GDP ratio and not the deficit that is the issue,- (and not just the public debt!),- which will vary, increase or diminish, for various situational reasons, not least economic cycles and growth rates, why shouldn’t the problem of debt-GDP ratios be resolvable through future “growth” paths, rather than relying on present “prudence”, (which all to frequently, is and has been no such thing)?

But the why should Quiggin, an Aussie, or Farrell, an ex-pat Irishman in the U.S., really care about the euro-zone crisis, except for merely idealistic reasons of normative prescriptivism? Unless, of course, it’s that we’re all bound together by the system of globalized, financialized capitalism, like a knife-fight in a chain-gang.

42

Lemuel Pitkin 10.07.11 at 1:06 am

The core Euro-zone problem, (as also, more generally, the global crisis problem), is rooted especially in those CA imbalances. Only Greece is especially afflicted by excessive public deficits due to a bloated, inefficient public sector… Spain and Ireland were, in fact, poster-children of neo-liberal fiscal restraint

Right.

Leaving aside the prospect that some debt monetization could induce salutary forms of inflation

Yes. A minor dishonesty in the hard Keynesianism piece that I didn’t mention is their claim that higher growth and inflation “helped” reduce debt-GDP ratios in the postwar decades. In fact, in most countries higher nominal GDP growth (plus low interest rates) did all or almost all the work, and fiscal “rectitude” little or none.

A good part of public debt might just as well be accounted public investment spending

Right. An implicit premise of the hard Keynesianism piece is that governments cannot or should not borrow to finance investment spending. This is directly contrary to Keynes’ own views, of course.

why should Quiggin, an Aussie, or Farrell, an ex-pat Irishman in the U.S., really care about the euro-zone crisis

Here we part ways. This is too cynical. It seems clear that John Q. and Henry wanted to argue for more countercyclical public spending in the Eurozone, but felt it would be more palatable to the audience they were trying to reach if they packaged it in a rhetoric of “hardness” (which really is laid on pretty thick — I’ve resisted the obvious jokes so far, but…) And who knows, they may be right in the sense that Foreign Policy wouldn’t have printed the piece otherwise. But it’s not OK to make bad arguments for good policy.

43

Lemuel Pitkin 10.07.11 at 2:17 am

A minor dishonesty in the hard Keynesianism piece that I didn’t mention is their claim that higher growth and inflation “helped” reduce debt-GDP ratios in the postwar decades. In fact, in most countries higher nominal GDP growth (plus low interest rates) did all or almost all the work

Actually I should withdraw this. I know it is true for the US and for lots of other countries, but I’m not sure how true it is for Europe. I strongly suspect it is, but that’s not enough confidence to justify the term dishonest. So I apologize for that.

44

Henri Vieuxtemps 10.07.11 at 7:10 am

Orange county (home of 3 million people) defaulted about 15 years ago; I don’t think it even made the headlines at the time. The US didn’t fall apart, the dollar didn’t cease to exist.

45

Tim Worstall 10.07.11 at 8:52 am

“In the long run, the only solution is fiscal union with hard Keynesian rules, and that can only be managed with a democratic union.”

No, that’s one of two possible long term solutions. The other is to break up the euro, possibly even the EU.

Of course, my personal prejudices, being UKIP as I am, are for the second. But stating that the only possible solution is fiscal union is pre-supposing that a continuation of the eurozone/EU is in itself a desirable goal.

And whether that is so or not is actually the discussion that should be taking place.

46

John Quiggin 10.07.11 at 11:54 am

@LP&jch If the rate of interest is equal to the rate of growth of nominal income (and it’s usually close), then the debt/income ratio is stable if and only if the primary budget balance (excluding debt service) is zero. So, if you want a stable debt/income ratio and you also want to run substantial deficits during recessions, you have to run (primary) surpluses at other times. As someone put it neatly, this isn’t class warfare, it’s math.

The real question is why you are both so keen on deficits. Unless deficits stimulate an increase in real output, they require a reduction in private expenditure, whether this is achieved through siegnorage, issue of domestic debt or deferred through overseas borrowing.

The standard Keynesian story (whether or not it has scriptural authority) is that deficits expand real output in recessions, but not when the economy is at full employment.

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Salient 10.07.11 at 1:54 pm

If the rate of interest is equal to the rate of growth of nominal income (and it’s usually close), then the debt/income ratio is stable if and only if the primary budget balance (excluding debt service) is zero.

That equivalence doesn’t make sense to me; I wish I understood this better. Allow me a couple moments of stupidity to sort this out.

Suppose you run a balanced budget during times when there is a tight labor market, setting whatever target levels of unemployment are deemed appropriate for each sector of the economy.

When unemployment exceeds the target for a particular sector, suppose you pay people to undertake training and/or accept public-sector jobs that would exercise skills relevant to that sector, and you make the cost of hiring cheaper by reducing those employers’ payroll taxes. Make sure that the offered pay rate is between, uh, say, 80% – 90% of what roughly equivalent jobs were paying in the private sector. (Enough of a decrease so that still-employed folks have little incentive to switch, but still high enough to sustain non-leisure expenses for newly unemployed folks.)

To pay for it, don’t borrow, per se, just mint-and-print whatever amount of money is necessary.

I gather that, under this circumstance, banks will want to increase interest rates to compensate for the risk of inflation. Accordingly, we’d need to penalize them for attempting to charge interest in excess of some proportion deemed acceptable, depending on the time horizon. As a result, banks will probably have a hard time turning a consistent profit, because they won’t be allowed to charge rates that far exceed the future value of present money–so banking won’t be a terribly alluring profession to wealth-accumulation-seekers, and probably many banks will have to convert to nonprofit entities, e.g. credit unions. (Shucks. What a shame.)

Even with anti-usury laws firmly in place to ensure inflation is stable, this set of policies will still lead to a higher mean rate of inflation. That’s ok, so long as there’s a strong safety net–we don’t want people saving up money long-term, the value of hoarded money should decrease in a nontrivial way over the course of a generation. I don’t really understand why we want to construct an economy in which it makes any sense for individuals to hoard or save long-term.

In general. Taxes serve to reduce the available money supply, and that’s literally the whole point of taxes; public sector expenditures serve to increase the money supply, an increase which we stabilize via taxation; everything the government does is basically a particular form of manipulating or redistributing the money supply. I don’t really understand why we interpret taxation and expenditure (and public borrowing and etc) in any other context than that.

…I acknowledge this may be incoherent and/or might be ignoring crucial factors, and I’ll be happily receptive to any explanation of how I’m just being dumb.

48

Carl Weetabix 10.07.11 at 2:12 pm

“Yet politics is not a morality play”

But it is – it’s just how you understand the bigger picture.

That is, depending on how you look at the current situation, exercising your proposed solution for Europe would look very moral indeed and in fact perhaps be punishing the right actors.

49

Lemuel Pitkin 10.07.11 at 3:45 pm

@46

Both the Maastricht rules and the original “hard Keynesian” piece say nothing about primary deficits. They both refer to overall deficits.

If you want to switch to arguing about primary deficits, fine. But then you should acknowledge that the vast majority of European countries *were* running substantial primary surpluses in the period leading up to the crisis. Over the decade 1998-2007, Austria, Belgium, Estonia, Finland, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Slovenia and Spain all ran primary surpluses on average, mostly quite large. So if you are now redefining “hard Keynesianism” to refer to primary surpluses, that makes nonsense of your claim that it is stricter than the current regime, or that failure to follow it had anything to do with the crisis.

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John Quiggin 10.07.11 at 5:14 pm

@LP you’re clearly not arguing in good faith. I pointed to a number of links making it clear that I had always been talking about primary deficits, and that any simplification was just that. Unless you want to withdraw the suggestion that I’ve switched my ground, I don’t see any point in engaging further with you.

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dbk 10.07.11 at 6:14 pm

@36 Would a bright young Greek stay in Athens or move to Berlin or Frankfurt where there are industries rewarding skills?

Of course they would, and they are doing it in droves. The 18-30 cohort is departing at the (unofficial, probably low) estimate of 50,000 per year – and nobody plans to return. An entire education section of one of the national newspapers was essentially devoted this past Tuesday to “how to get out for good”.

@38 Depends; is he bright enough to speak German? ISTM that the assertion that there are no borders is somewhat fictional when there are still language barriers.

All Greek students learn at least one major world language (English), in many cases to what is known as “proficiency” level. Many learn a second to “first certificate” level. University students normally have learned two foreign languages (English + French or German) to proficiency level, and know another one-two (Italian/Spanish) sufficiently well to communicate. The language barrier is not an issue here, but it hardly seems a good omen that the country’s best and brightest are flocking to Germany/England (UK)/ Australia (which is announcing a special deal for miners!)/ Canada/ the U.S. and elsewhere when they represent Greece’s best hope for emerging from the euro-debt debacle.

OTOH, on Wednesday the Greek Minister of Finance announced the new payscales for public servants. Grade and high school teachers will start at 660 euros, which puts them well below the poverty level and pretty much on a par with Bulgaria.

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Henri Vieuxtemps 10.07.11 at 6:30 pm

If people are paid 700 euro/month in Greece, why wouldn’t German industrialists move their factories from Germany to Greece, to exploit low labor costs?

I suspect it’s because if they decide to exploit low labor costs, they’ll skip Greece and move straight to China where people are paid 100 euro/month, not to mention much more industry-friendly environmental laws.

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dbk 10.07.11 at 6:43 pm

@52: I suspect it’s because if they decide to exploit low labor costs, they’ll skip Greece and move straight to China where people are paid 100 euro/month, not to mention much more industry-friendly environmental laws.

Well, not necessarily. The recent abolition of collective bargaining agreements in Greece by the Troika has made German investment in Greece far more attractive. We need to remember here that transportation costs for goods produced in SEE for export to SEE will be vastly lower than moving such goods from China; also, of course, “no tariffs” within the EU trading zone. (Also: we recall here that a substantial % of the Greek workforce for German producers will be university grads fluent in two-three EU languages.)

The Greek PM’s latest meetings with German officials were partly devoted to the topic of “German investment” in Greece. It all seems rather similar to a US manufacturer moving from Massachusetts/ Minnesota /Michigan to South (or North) Carolina/Tennessee, etc., and we certainly have plenty examples of this.

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john c. halasz 10.07.11 at 7:17 pm

JQ @46:

“The standard Keynesian story (whether or not it has scriptural authority) is that deficits expand real output in recessions, but not when the economy is at full employment.”

Ah, but the question is what do you mean by “full employment”? It is not something that can be simply assumed, but rather it needs to be defined and demonstrated. Supposedly, it amounts to a state of the full employment of all available resources and factors in an economy, not just labor, in their optimal uses and allocations, which is to be achieved at “general equilibrium”. (That is, of course, a rather metaphysical notion, “the fullness of being”). But I think the point that both L.P. and my own damned self are making is that READ, in both its level and composition, is not independent of the distribution of income, (and thus also of economy-wide debt-loads), and that full employment through sustaining optimal READ qua the optimal distribution of income between labor and productive capital investment is a floating target, (not a given and not to be re-defined downward as “NAIRU”), but as an economy approaches full employment with a level of READ sufficient to absorb invested productive capacity, public deficits will trend downward and disappear into primary surpluses willly-nilly. Provided, of course, that the tax system is not hell-bent on preventing such an outcome through maintaining a suboptimal distribution-of-income and level of READ. (Krugman has explicitly denied that the distribution of income is a factor in determining READ, citing as an example of a viablely prosperous, if highly unequal, economy, Manhattan! I call this the Singapore fallacy, citing the economy of an imperial city-state as an exemplar, without regard for the role it plays in the broader regional and even global economy. And to think he was cited in his Swedish Bank prize partly for his work on economic geography!) So the point remains that you need to provide some sort of “model” of a non-ergodic pathway by which public deficits would fail to “clear” at full employment, (and that requires, at least, considering the total debt balance and not just the public one). (I added on the point that actually achieving a full employment level of READ would likely require both an income compression policy through the tax-and-transfer system and a public investment and publicly-guided industrial policy program, together with a reduced and tightly regulated financial/banking sector).

“The real question is why you are both so keen on deficits. Unless deficits stimulate an increase in real output, they require a reduction in private expenditure, ”

What do you mean by “private expenditure”? Consumption or investment? Because it should be clear that we are so “keen” on public deficits, insofar as they “stimulate an increase in real output” and reduce private debt burdens.

To return to the original topic, it’s fairly clear what need to happen in the Euro-zone. Germany and the other surplus countries need to stimulate their economies through deficit spending (and likely income redistribution), while the ECB needs to buy up the debt of the GIIPS, i.e. monetize it, until such time as a more permanent resolution can be found/negotiated. If that would be inflationary, so be it. In the case of the most severely under-productive economies, such as Greece and probably Portugal, a high VAT could be leveled, counterbalanced by a sharply progressive, mostly negative tax on income and wealth, to generate de facto trade barriers to facilitate much needed reform and restructuring, which would be much better than deflationary “internal devaluation”, which won’t work anyway. (Among the overlooked factors is that Greece is one of the most demographically aged societies in Europe, so it would never recover, since it is also a well-educated society, thanks in part to its bloated public sector, as well as a sea-faring people with a long tradition of emigration, resulting in a collapsed society of impoverished pensioners, who could never be expected to pay off their debt.) That such a policy course won’t be adopted is a political decision, having much to do with the hegemony of the global financial system and its elites, not sheerly a technocratic, purely economic matter.

If then countries are to leave the Euro-zone, as seems likely, as commentators in the FT and elsewhere have convincingly argued, it would be less disruptive and devastating if Germany and the other surplus countries would leave, rather than the GIIPS.

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Lemuel Pitkin 10.07.11 at 8:03 pm

John,

Your original FP piece does not include any reference to the primary balance, nor does the CT comments thread following it. It does, however, explicitly describe hard Keynsianism as a stricter version of the Stability and Growth Pact. Since the SGP is defined in terms of the overall deficit, not the primary deficit, the natural reading of your piece is that you also are talking about overall deficits. But, since I want this debate to continue, I will concede that I’m mistaken and that when you say deficit, you mean primary deficit unless you say otherwise.

That doesn’t help you much.

First of all, as I noted in my previous comment, the vast majority of Euro countries *were* running primary surpluses in the period prior to the crisis. So how is “hard Keynesianism” any change from the status quo?

Second, you explicitly say upthread that in your preferred scenario “standard measures of the budget balance will show a small deficit on average.” Does a good-faith reading require me to take this as referring to primary deficits? In that case, under your preferred assumption of g=i, debt-GDP ratios will still rise without limit in an infinite horizon. (In an infinite horizon, a small deficit is no better than a big one.) That doesn’t bother me — I don’t think infinite horizons are relevant to policy questions — but you’ve previously said such paths are unacceptable. Or does “standard measure” here mean overall deficit? As you know, when the primary balance is zero, the overall deficit will simply be equal to interest payments on the debt. Assuming 5% interest (i=g, where nominal g is generally taken to be 5%), this will imply an overall deficit of 3% when debt-GDP ratios are stable at 60%. This, of course, is what the Maastricht criteria already require. I guess you are proposing a lower target debt-GDP ratio than 60%, then? So what’s your preferred target, and what’s the analysis by which you arrived at it?

Finally, there is the question of the mechanism by which “hard Keynesianism” would have prevented or ameliorated the current crisis. Since most of the crisis countries were on sustainable fiscal paths prior to the crisis, how would “hard Keynesianism” have helped?

On my side, I think governments should set deficits or surpluses equal to the gap between desired saving and desired private investment (plus net exports) at full employment. This is not a radical position, it was the standard view of fiscal policy in the 1960s and 70s. The long-term path of the debt-GDP ratio is not a big concern, first because there is no reason to think the relevant parameters are stable enough for an infinite horizon to be meaningful, and second because, if the ratio does begin imposing costs, there are other tools than the fiscal balance to deal with it, namely holding down interest rates via financial repression or raising nominal growth via higher inflation. In any case, I am not convinced that the historical record gives us any good reason to think debt-GDP ratios are a problem for rich countries borrowing in their own currency.

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Lemuel Pitkin 10.07.11 at 8:11 pm

(For the record, this is a weaker claim than the MMT position — I am not saying that currency-sovereign countries cannot face a financing constraint, just that they don’t seem to in practice, and if they did there are various ways to deal with it.)

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John Quiggin 10.07.11 at 9:34 pm

You’re getting closer to the point now. The Maastricht criteria require 3 per cent standard deficits (that is, zero primary deficit) as a general rule. Assuming that this is adhered to under normal conditions, that entails maintaining the same balance during recessions ie. no discretionary stimulus and austerity to offset the cyclical increase in deficit.

So, to repeat, if you are going to maintain zero primary deficit on average over the cycle, and you want stimulus during recessions you need primary surpluses in non-recession periods. As we’ve already discussed, this was the case during the 50s and 60s (I assume your reference to the 70s was a typo, since Keynesian policy was radically modified in the first half of that decade and abandoned in the second half), with the result that debt/GDP ratios declined steadily. Of course, under those circumstances, no one worried much about the long-term path.

Finally, contra your claim about primary surpluses, debt/GDP levels in the eurozone were broadly stable and near the Maastricht limit over the decade to 2007 which implies that primary deficits were close to zero.

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John Quiggin 10.07.11 at 9:40 pm

“I am not saying that currency-sovereign countries cannot face a financing constraint, just that they don’t seem to in practice,”

Latin America? HIPCs?

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Lemuel Pitkin 10.07.11 at 10:14 pm

Latin America? HIPCs?

Currency-sovereign = borrowing in their own currency. Not the case for either of those.

debt/GDP levels in the eurozone were broadly stable and near the Maastricht limit over the decade to 2007 which implies that primary deficits were close to zero.

It would imply that, if it were true that g=i exactly. But it’s not, so it doesn’t. The IMF’s WEO database gives the following average primary surpluses (+)/deficits (-) as percent of GDP for the decade 1998-2007:

Austria: 0.7
Belgium: 4.7
Estonia: n/a
France: -0.1
Germany: 0.4
Greece: 0.8
Iceland: 2.7
Ireland: 2.7
Italy 2.7
[Yes, they’re all the same.]
Luxembourg: 1.6
Netherlands: 1.9
Portugal: -1.1
Slovakia: -2.8
Slovenia: 0.2
Spain: 2.1

It is very difficult to look at those numbers and conclude that Europe’s problem is that countries were fiscally irresponsible in the boom so lacked fiscal space in the slump. What is “hard Keynesianism” telling European countries (except Portugal) to do that they weren’t doing already?

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Lemuel Pitkin 10.07.11 at 10:40 pm

It’s also not really true that Euro-area “debt/GDP levels in the eurozone were broadly stable and near the Maastricht limit over the decade to 2007.” Many Euro-area countries reduced their debt quite substantially as a share of GDP, including Ireland (53-> 12), Italy (101 -> 87) and Spain (57 -> 27). Of course it is not a coincidence that the countries that were worst hit by the crisis were, in general, those with the largest fiscal surpluses in the preceding period. Both were the result of booms driven by capital inflows.

It’s conventional now to say that those inflows were unsustainable. I’m agnostic on that; to some extent, one could also see them as signs of the very large potential gains from a fiscal union or other mechanism that produced stable North-South capital flows. But what it does make clear is the irrelevance of improved fiscal rules, “hard Keynsian” or otherwise, in preventing crises like this one. It wasn’t a fiscal crisis.

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bh 10.07.11 at 11:23 pm

I’m not saying it’s necessarily the optimal policy, but wouldn’t the ‘hard Keynesian’ scenario, even by the least flattering definition, be a tremendous improvement over current practice?

If we were able to direct stimulus at the levels suggested by research, rather than by the White House political team or some dimwitted ‘centrist’ Senator, I’d be willing to put up with a lot in the good times.

As it stands, on both sides of the Atlantic, we’re struggling mightily to pass bills that provide for even a fraction of what’s needed.

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John Quiggin 10.08.11 at 3:01 am

We seem to have different data sources
http://epp.eurostat.ec.europa.eu/tgm/refreshTableAction.do?tab=table&plugin=1&pcode=tsieb090&language=en

Eurozone debt/GDP ratios barely moved over the relevant period. So, as you say, the g=i simplification doesn’t work in the short run.

It’s true that nothing could have helped Ireland’s fiscal position, given the decision to guarantee the debts of the banks. But I’ve never suggested that the problems of these countries (other than Greece) were due to fiscal profligacy – rather, I’ve repeatedly argued the opposite. That doesn’t change the fact that, the stronger your fiscal position, the better placed you are to respond to shocks, wherever they originate.

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John Quiggin 10.08.11 at 3:03 am

It’s trivially true that a country that can borrow as much as it wants in its own currency can’t have a sovereign debt problem. That is, of course, until it can’t borrow as much as it wants in its own currency.

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bh 10.08.11 at 3:13 am

How’s Chavez’s Bank of the Americas or whatever doing? It seems like Rich Country-Poor Country dynamics are still relevant here.

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bh 10.08.11 at 3:31 am

It’s appealing how the balanced-over-the-business-cycle rules could potentially be written into legislation.

If it’s ok to discuss a how a policy like that might play out in the US…

The bill would be hard to pass in the first place. And I can’t see how you’d avoid having it perennially re-legislated. It’s a little too close for comfort to a Super Committee style setup; trying to tie the hands of future congresses in a way that isn’t really possible.

Stan Collender wrote an interesting piece about the “automatic” triggers that supposedly drop in if the SC can’t agree. As it turns out, they’re really not binding. He had a number of examples of similar rules that had been either modified or just ignored. It sounds ponderous, but really, it’s the constitution; each Congress has the same powers as the last.

(Not meaning any of this as a criticism of the piece; it’s sort of a different topic. I’m just gloomy about ever getting good policy in the US.)

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Barry 10.08.11 at 11:55 am

If there’s any law which would require a balanced budget, there’d be several sh*tstorms awaiting:

1) The US system is clearly in gridlock mode (unless the elites want something, in which case there’s neither a check nor a balance to be seen). Any law which causes automatic cuts adds a new layer of power on those who win by blocking. I assume at some point the current system will collapse due to gridlock, but I’d rather not see it.

2) What gets cut? Again, this would be a massive shift of power within the federal government.

3) Who decides when this is invoked? The SCOTUS?

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Lemuel Pitkin 10.08.11 at 11:10 pm

We seem to have different data sources
http://epp.eurostat.ec.europa.eu/tgm/refreshTableAction.do?tab=table&plugin=1&pcode=tsieb090&language=en

I am using the IMF’s WEO database because it gives net debt (rather than economically less meaningful gross debt) and because it gives primary balances, which Eurostat does not. But even using the Eurostat numbers, it isn’t really true that

Eurozone debt/GDP ratios barely moved over the relevant period.

Not only Ireland but also Belgium, Italy, Spain and several other countries reduced their debt-GDP ratios by 20 points or more.

The IMF numbers are here. If you click on the link, you’ll see that almost all Euro-area countries were running primary surpluses in the decade before 2008. So I ask you again: How would hard Keynesianism have been any different from the fiscal policies that were actually followed?

I’ve never suggested that the problems of these countries (other than Greece) were due to fiscal profligacy

Just so I understand clearly: You are saying that apart from the specific case of Greece, hard Keynesianism would have done nothing to prevent the European crisis. Do you really think that’s what most readers of your FP piece understood you to be saying?

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Lemuel Pitkin 10.08.11 at 11:12 pm

ouldn’t the ‘hard Keynesian’ scenario, even by the least flattering definition, be a tremendous improvement over current practice?

In the Euro area, hard Keynesianism *is* the current practice.

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Lemuel Pitkin 10.08.11 at 11:18 pm

That is, of course, until it can’t borrow as much as it wants in its own currency.

I’m genuinely curious — what are some modern examples of rich countries that found themselves unable to place domestic-currency debt?

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Lemuel Pitkin 10.08.11 at 11:38 pm

Oh, look, Eurostat does have primary balances. (Of course it does.)

Here.

2007 2.29
2006 1.51
2005 0.44
2004 0.15
2003 0.21
2002 0.86
2001 1.90
2000 3.80
1999 2.59
1998 2.24

So we see continuous primary surpluses over the decade, averaging 1.6 percent of GDP. John, are you ready to agree that what you call “hard Keynesianism” is simply a description of actual practice in the Euro area?

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John Quiggin 10.09.11 at 10:27 am

We seem to have been stuck on definitions, and not to be getting much closer to the actual issues.

At 21, starting the debate, you said hard Keynesianism “Implies that the debt-GDP ratio goes to zero in the long run, without any explanation of why this is desirable.”

Now, you’re asserting that hard Keynesianism was in force in a decade during which debt-GDP ratios were stable or rising.

These can’t both be right.

I really don’t think its that complicated to get the point that the policy I’m advocating targets stable debt/GDP ratios over the cycle, and enough fiscal space for a large stimulus in recessions.

And with that, I’m going to leave it to you. Why don’t you state your own view of how a Keynesian fiscal policy should be run over the course of a cycle, with (at least illustrative) numbers, and I’ll tell you whether I agree.

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Lemuel Pitkin 10.09.11 at 12:58 pm

At 21, starting the debate, you said hard Keynesianism “Implies that the debt-GDP ratio goes to zero in the long run, without any explanation of why this is desirable.” Now, you’re asserting that hard Keynesianism was in force in a decade during which debt-GDP ratios were stable or rising. These can’t both be right.

Right. I initially understood you be to calling for overall surpluses in normal times. That would be substantially tighter than existing policy, and would lead to debt-GDP ratios going to zero.

You corrected me that you were referring to primary surpluses, not overall surpluses. That doesn’t lead to debt vanishing. The problem with this version is, it’s the same as actual Euro-area policy.

So yes, I made two different objections to your hard Keynesianism, based on two different understandings of what it meant.

I’m advocating targets stable debt/GDP ratios over the cycle, and enough fiscal space for a large stimulus in recessions.

And I’m saying that governments *took your advice* and yet we have a crisis anyway. I’ve asked repeatedly: how is hard Keynesianism different from actual policy in the Euro area? You’ve never responded.

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John Quiggin 10.09.11 at 2:18 pm

Absolutely last time: If governments had been pursuing hard Keynesianism, then debt/GDP ratios would have been falling over the expansion phase of the cycle, leaving room for fiscal stimulus in the recession.

The policy we advocate implies bigger surpluses (standard or primary) during expansions and bigger deficits during recessions.

I’ve said this at least ten times, including several directed to you before this thread started, and this is the last time. If you want to respond to what I’m actually arguing, I can carry on, but I’m done with defining it for you.

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Andrew F. 10.09.11 at 3:34 pm

As I understand it, your argument is that the specter of catastrophe should be sufficient to prod Europe into a new, grander, political bargain. But then wouldn’t the same specter also be sufficient to prod the core into building the necessary firewall and then allowing the restructuring to occur with limited damage to the rest of Europe without tossing about the political grenade of closer European political union as well?

It may be that undertaking the economic steps you outline and not taking the political steps results, down the road, in another crisis – but the reforms being made by Spain, Italy, Ireland, and Portugal are encouraging, and provide a reason to believe that the additional hurdle of tighter political union may be unnecessary.

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IM 10.09.11 at 3:53 pm

>If governments had been pursuing hard Keynesianism, then debt/GDP ratios would have been falling over the expansion phase of the cycle, leaving room for fiscal stimulus in the recession.<

But it did. You really can't look at the aggregate debt/gdp level. That was stable or somewhat rising. But the indivcidual countries had divergent developments.

Group A: Spain, Belgium and Ireland had strongly dropping debt levels.

Group B: Greece, Portugal and Italy had high and stable levels.

Group C: France and Germany had lower but steadily rising levels.

I think Group C is influencing the aggregate to much.

Now your policy prescription- that I share – seems to be right about Belgium who used it and Greece, Portugal and Italy who should have used it.

But what about Ireland and Spain: They don't fit. I think that is a reasonable objection you haven't answered yet.

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Lemuel Pitkin 10.09.11 at 4:58 pm

If governments had been pursuing hard Keynesianism, then debt/GDP ratios would have been falling over the expansion phase of the cycle, leaving room for fiscal stimulus in the recession.

As IM says, debt-GDP ratios were falling in a number of European countries, including several with the most severe crises today. I have yet to see you acknowledge this fact.

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Lemuel Pitkin 10.09.11 at 5:00 pm

Note that Belgium, while not currently in as much trouble as the PIIGS, is generally considered to be one of the next most vulnerable countries.

The “hard Keynesian” position also lacks any evidence that it is a lack of fiscal space that is constraining the response to the crisis (Greece excepted).

The problem in Europe was current account imbalances, not fiscal policy.

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Lemuel Pitkin 10.09.11 at 5:04 pm

Italy who should have used it.

Italy’s debt-GDO ratio was also falling at a pretty good clip.

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IM 10.09.11 at 5:06 pm

>The problem in Europe was current account imbalances, not fiscal policy.<

Would still leave Ireland as special case.

Belgium is a special case too, all that no government for one and half year business.

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IM 10.09.11 at 5:10 pm

>Italy’s debt-GDO ratio was also falling at a pretty good clip.>

The -gross – debt of Italy seems to hover around 120% of gdp since twenty years. ( I tend to use OECD numbers, but that can’t really matter)

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Lemuel Pitkin 10.09.11 at 5:37 pm

Gross debt isn’t the best measure. But even if you use OECD gross debt numbers, Italy’s debt-GDP ratio fell by 15 points over the decade 1998-2007. I don’t think “barely moved” is a good characterization of that.

Would still leave Ireland as special case.

Not really. Ireland ran a current account deficit from 2001 on. In general, the current account in preceding years is a very strong predictor of whether a Euro-area country would find itself in crisis. The fiscal balance is not.

(This is true for Asian countries as well, incidentally.)

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John Quiggin 10.09.11 at 5:44 pm

As I said before, the problems in Ireland and Spain weren’t the result of fiscal profligacy, although the apparent surpluses were illusory to a significant extent. More importantly, the argument isn’t primarily about what went wrong in the first decade of the euro but what do now.

Coming finally to the actual point, the widespread adoption of austerity policies seems to me to be driven very largely by (the perception of ) a lack of fiscal space. The idea that austerity will promote growth via business confidence is much more an ex post rationalisation.

Fiscal space is a dynamic concept, so a policy framework that gives a credible commitment to future surpluses allows more fiscal space than one that does not. In particular, I don’t think we are likely to get significant steps towards fiscal union if this is advocated along with the view that it’s OK to adopt policies that imply that debt-GDP ratios will rise without limit.

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IM 10.09.11 at 5:50 pm

>Fiscal space is a dynamic concept, <

like regulatory uncertainty? or business confidence?

(Snarky, I know)

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Lemuel Pitkin 10.09.11 at 7:07 pm

the problems in Ireland and Spain weren’t the result of fiscal profligacy, although the apparent surpluses were illusory to a significant extent. More importantly, the argument isn’t primarily about what went wrong in the first decade of the euro but what do now.

OK, if you’re not claiming that hard Keynesianism in the previous decade would have helped avoid the crisis, then that removes the biggest area of disagreement. In the interest of comity, I’ll even stipulate that it was my misunderstanding that the concept was intended to offer a diagnosis, and not just a prescription.

So that ends the debate, as far as I’m concerned, but I do want to respond to a couple other things.

the widespread adoption of austerity policies seems to me to be driven very largely by (the perception of ) a lack of fiscal space. The idea that austerity will promote growth via business confidence is much more an ex post rationalisation.

You and I obviously are on the same page as far as the desirability of more expansionary fiscal policy now, and the thinness of the confidence argument against it. One place we still differ, I think, is on the significance of that parenthetical. You seem to be saying that if expansionary policy today is being limited by a perception of government profligacy, then we have to treat that perception as correct even if it’s wrong, and package our proposals for expansion with promises of tighter borrowing limits in the future. Whereas I think that if false perceptions of fiscal space are constraining policy, the last thing we want to do is reinforce those perceptions by conceding to them. But this is obviously a much fuzzier kind of argument than the one we seemed to be having up til now.

On my side, I’d like to see a fiscal policy that runs deficits when output is below potential and surpluses during inflationary booms. The resulting path of debt-GDP will depend on other macroeconomic variables. It may be that desired saving at full employment will consistently exceed desired investment plus net exports. In that case, I *don’t* think the correct response is to say, well, governments can’t run deficit forever, so we’ll just have to accept less than full employment. Rather, it is a sign that fiscal policy isn’t enough and bigger structural reforms are needed. In particular it means the private financial system probably can’t be relied on as the main site of investment decisions. If you read Keynes’ political writings from the 1930s and 1940s, you’ll see that the bits in the GT about “more or less comprehensive socialization of investment” and “euthanasia of the rentier” weren’t just throwaway lines. He really believed that the only way that mature market economies could remain stable at an acceptable level of activity was if the great bulk of investment was carried out by public or quasi-public bodies.

In the case of the Euro area, the real problem is that persistent divergences in competitiveness mean that when output levels (or growth rates) are at an acceptable level throughout the continent, there are going to be large current account imbalances between center and periphery. As long as those have to be financed by private financial flows, you’re going to get crises. So the possible solutions are (1) limitations on trade and/or financial flows, but that goes against the whole idea of the common market; (2) some type of industrial policy that raises competitiveness in the periphery — maybe the best solution but not possible in the short term; or (3) replacing the private financial flows with public ones, i.e. fiscal union. New fiscal rules for member states won’t help, because a current account imbalance financed by private foreign borrowing is just as vulnerable to a sudden stop as one financed by public foreign borrowing.

Now, I *think* you agree with all that. But you also think that tighter fiscal rules, while irrelevant to the economics of the situation, will help make a fiscal union feasible politically. Is that about right?

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Lemuel Pitkin 10.09.11 at 7:17 pm

a current account imbalance financed by private foreign borrowing is just as vulnerable to a sudden stop as one financed by public foreign borrowing.

Sorry, I mean it doesn’t matter if the borrowers are public or private. It definitely does matter which the lenders are — you’re much better off if they are public entities operating on a rules-based system, rather than private lenders subject to sudden shifts in sentiment. That’s the whole point of fiscal union.

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john c. halasz 10.10.11 at 2:20 am

I’m just surprised that in this discussion there is no mention of inflation, the bug-bear of quasi-monetarist “New Keynesian” macro. Pegging low real interest rates Eccles-style, “financial repression”, is not an option? It seems to me that higher inflation would be at least part of the “solution”, if not a panacea. (Right-wing economists, such as Olivier Blanchard and, I think, Rogoff have mentioned somewhat higher inflation, though likely for different reasons and aims).

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Lemuel Pitkin 10.10.11 at 3:12 am

there is no mention of inflation, the bug-bear of quasi-monetarist “New Keynesian” macro. Pegging low real interest rates Eccles-style, “financial repression”, is not an option?

I mentioned both of these at 55.

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john c. halasz 10.10.11 at 4:24 am

@87:

Yep. So you did make a brief mention. Apologies. Though the main focus has been on debt/GDP ratios, no doubt at Quiggin’s insistence. Even though the Godley-style accounting would set the blame mainly on CA imbalances. (I suspect an out-moded, now irrelevant focus on national economic policy might be at issue). And the Quiggin/Farrell approach assumes a time-frame that is of no avail, as several others of various persuasions have pointed out. So why no discussion of debt monetization to generate inflation, (since clearly QE policies don’t work, as acting through a moribund system of banking/finance), to buy the time for further integration on a “democratic” basis?

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John Quiggin 10.10.11 at 8:40 am

Thanks for the repeated and gratuitous accusations of bad faith, jch. The discussion in this thread has focused on debt/GDP ratios because that was the point introduced by LP in his first comment about hard Keynesianism.

If you could have been bothered clicking on the linked article, you would have read

If this was just an economic problem, the solution would simple. In the short-term, Europe needs to shore up investor confidence, and the European Central Bank could do that by announcing that its top priority is preserving the euro, not price stability. This would allow the ECB to increase the money supply and ease the strain on struggling economies such as Greece and Portugal. In the meantime, the wealthier nations could put together a once-off restructuring of, say, Greek debt, and a recapitalization of the country’s national banks.

But you’re much too superior to bother actually reading anything.

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john c. halasz 10.10.11 at 3:28 pm

JQ:

I did read the article… several days ago. Sorry for not memorizing it. But “Europe needs to shore up investor confidence, and the European Central Bank could do that by announcing that its top priority is preserving the euro, not price stability” doesn’t exactly say debt monetization to generate a higher level of inflation. And, of course, the problem is the ECB, which would never do such a thing, (even though they are, in fact, doing such a thing, though in an ad hoc way and at insufficient levels, though technically they lack the notional capital to do so sufficiently without major re-capitalization).

And I don’t think you’ve really been responsive to the points of criticism raised to the article, (though by all means do as you please). 1) The time-frame for further Euro-zone political integration is completely at odds with the exigency of the financial crisis. And 1b) it’s not clear that forced consolidation would really clear up the “democratic deficit” problems of the EU and really be “democratic” and popularly accepted. (Remember the fate of Giscard D”Estaing’s EU “constitution”?). But, more importantly, 2) the problem isn’t rooted in public deficits and debt, but rather in the total debt situation and in CA imbalances, with only Greece and a bit Portugal a partial exception to that rule. Besides which it was clear to just about everybody and his grandma, since the problem emerged fully in the spring 2010, that Greece was insolvent and would have to default, and that it was not Greece, but rather the foreign banks, which were over-leveraged/under-capitalized anyway, that were being bailed-out, as the Greek people were being squeezed into ever-increasing misery. IOW the fiscal crisis is largely a reflex of the banking/financial crisis. And there is both good theoretical reason and fair empirical/historical evidence that the best way to resolve a major banking/financial crisis is to nationalize and recapitalize insolvent banks and write-down bad debts in a prompt and orderly way. Which has much higher up-front fiscal costs, but much lower long-run aggregate and thus final fiscal costs. But that is precisely what is being tabooed and blocked. Which makes focusing on public debt and fiscal “space” as the core policy issue a bit perverse.

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John Quiggin 10.10.11 at 11:09 pm

@jcw non-apology not accepted. If I haven’t made it clear before, I’d prefer it if you didn’t comment on my posts. I’m not going to ban you, just making my view of your contributions as clear as I can.

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John Quiggin 10.10.11 at 11:11 pm

@LP we seem finally to have come pretty close to agreement. A fair bit of confusion there and some hard words, but I want to make it clear that I do find a lot of benefit in discussions with you (unlike with jch).

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Lemuel Pitkin 10.11.11 at 3:42 am

@LP we seem finally to have come pretty close to agreement. A fair bit of confusion there and some hard words, but I want to make it clear that I do find a lot of benefit in discussions with you

And I find a great deal of benefit in discussions with you. This was a very useful one. I appreciate your willingness to engage critical comments — not everyone does. And, I think now that I properly understand your argument, yes, we are mostly in agreement.

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john c. halasz 10.11.11 at 8:18 pm

“jcw”- typo.

Biting tongue.

Krugman recommends:

http://www.tnr.com/article/economy/95989/eurozone-crisis-debt-dont-blame-greece

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