Two deficits, two austerities, and quantities matter

The excellent Kindred Winecoff considers the troubled periphery of the Eurozone:

[A]usterity must occur. It’s only a matter of how it occurs. The alternative to an internal devaluation through wage cuts, tax increases, and reduction of social services is external devaluation (exit from euro) and default. Call it the Iceland Alternative (Iceland was never in the euro, but it did devalue/default, which is what we’re talking about). In that scenario, the new drachma and Irish pound will collapse in value and the government will be unable to borrow from international capital markets. This is austerity too. The government budget will have to be balanced almost immediately, and unless there’s a full default will likely need to run a primary surplus for many years.

Moreover, small open economies like Greece and Ireland are heavily reliant on imports to maintain standards of living. Ireland imported about 40% of its GDP in 2009; Greece about 1/3. For comparison, the U.S. imported about 14% of its GDP. If the post-euro currencies drop 50% in those countries (as Iceland’s did, and it was never attached to the euro), then those imports become 100% more expensive. That’s a big price increase. True, there will be some substitution into domestically-produced goods, but such a large adjustment will take time and cause pain. These are not large, diversified economies and there’s a reason domestic production wasn’t being consumed before; overall standards of living will have to drop if there’s a currency devaluation. And while exporting industries may benefit from a cheaper currency, boosting employment in those sectors, the importing industries will suffer, contracting employment in those sectors. Even if overall employment goes up, it will be at much lower relative wages. This is why Iceland is applying for EU membership, including adoption of the currency, despite the sacrifice of policymaking autonomy that entails.

In other words, there will be austerity. The only question is how it’s distributed.

Winecoff makes an important point, but I think he needs to cut his analysis a bit more finely. Economies run two very different kinds of deficits, a government fiscal deficit and an international current account deficit. Although the two deficits are related, there is no mechanical connection between the two. They do not reliably move together.

A country that defaults on its international debt will find its paper shunned international capital markets for a while. In countries that have grown accustomed to running current account deficits — that is, countries whose citizens have grown used to consuming more imports than they pay for with exports — a forced return to international balance will undoubtedly be perceived as a form of austerity.

But Winecoff is wrong to claim that “[t]he government budget will have to be balanced almost immediately, and unless there’s a full default will likely need to run a primary surplus for many years”. As long as the country, post-default, issues its own currency, and as long as the country’s citizenry is interested in accumulating domestic currency and debt, the government can run a budget deficit after the restructuring. The capacity of a country to run budget deficits post-crisis will depend largely on the citizenry’s confidence in domestic institutions after the fall. (Countries can also employ controls to prevent capital flight and support domestic currency. But in cosmopolitan, habitually integrated Europe, I suspect that won’t work unless people have some measure of confidence in the project. Wise governments would implement technocratically credible monetary institutions and simultaneously encourage patriotic enthusiasm for the country’s newly independent scrip.)

Winecoff’s example of Iceland is a great case in point. Following its collapse and quasi-default in 2008, the Iceland ran a budget deficit of 9.3% of GDP in 2009 (a primary deficit of 6.6%), and has continued to run deficits since, gently drifting towards balance. Iceland has also been able to sustain large current account deficits as well for a while after the crisis, which helps to cushion the adjustment. Iceland received loans from the IMF and several European countries, which partially financed its continuing international deficit. Also, private citizens of Iceland may have had foreign asset holdings which they could pledge or sell to finance imports while the economy shifted towards international balance.

Iceland’s circumstances were, perhaps, unusually benign. Other crises (Argentina in 2002, Russia in 1998) proceeded much as Winecoff describes, with sharp, simultaneous moves towards fiscal balance and current account surplus. But would crises in the Eurozone look more Argentina or like Iceland? I don’t know, but I can make a strong case for Iceland. Savers in the Eurozone periphery inhabit a world of open financial borders, and have already been diversifying out of home-country bank deposits. (Importantly, this forces governments and the ECB to cover financing gaps left by fleeing depositors.) Argentine savers perceived dedollarization as expropriation, which was corrosive to the legitimacy of domestic institutions. Citizens of the Eurozone periphery, on the other hand, might support their governments’ bid to escape impossible foreign debt. The drawn out, slow motion nature of the Euro crisis has made it easy for private citizens to prepare for Euro exit by sending funds abroad. This practice shifts the costs of default to governments, who in turn can shift costs to external creditors. If domestic publics support the move and believe Euro exit to be a one-off event rather than the start of recurrent devaluation cycles, governments may well be able to run deficits and use Keynesian fiscal policy to smooth the aftershocks of Euro exit.

There may be important differences of institutional credibility between Greece and, say, Ireland or Spain. An Irish exit might be more Icelandic, while a Greek exit might be more Argentine. (It’s worth pointing out that, a decade later, Argentina’s default seems to have worked out very well.) As in Iceland, the (growing) foreign savings of private citizens might cushion the shift from international deficit. (Euro drop-outs could not expect the post-crisis IMF support that Iceland enjoyed, though.) There is a hazard that the furious Eurozone core would try to hold the private wealth of citizens of the periphery as security against the defaulted debt of sovereigns. But that would be a stronger violation of current norms than sovereign default.

Suppose that it will be possible for a drop-out to run a fiscal deficit, but as Winecoff predicts, a sharp shift to international balance proves inescapable. Winecoff is absolutely right to point out that

small open economies… are heavily reliant on imports to maintain standards of living… If the post-euro currencies drop 50% in those countries (as Iceland’s did…), then those imports become 100% more expensive. That’s a big price increase… [S]uch a large adjustment will take time and cause pain. These are not large, diversified economies

Undoubtedly, ending an era of persistent current account deficits will prove painful to consumers accustomed to cheap imports. However, that is not ultimately an incremental cost of leaving the Euro. After all, the purpose of staying and suffering austerity would be to pay down indebtedness, which is more costly than a shift to balance. Contrite borrowers have to pay interest on past debt and run (primary) surpluses. Deadbeats just need to pay for what they buy now. Quantities matter. Staying within the Eurozone offers the palliative of stretching the pain out over time, but increases the ultimate burden of the adjustment. Exiting front-loads costs, but reduces their size, as much of the work is done by the act of default. Undoubtedly, jilted creditors would punish “Euro deadbeats”, and exact non-financial costs, so the benefits of debt write-offs would be counterbalanced, at least in part, by new costs. There’d have to be some cost-benefit analysis. But the options are not, as Winecoff suggests, a zero-sum shift in how countries take their lumps. Countries may find they have a lot fewer lumps to take if they repudiate their debt than if they don’t.

Losing the capacity to run a current account deficit and losing the capacity to run a fiscal deficit have very different implications. Shifting international accounts from deficit to balance harms citizens in their role of consumers, but serves them in their roles as workers and savers. If you view the current crisis as driven by the challenge of maintaining consumers’ standard of living measured in tradable goods, then losing the ability to run current account deficits seems harsh. But if you view the crisis as driven by frustration within countries over insufficient opportunity and employment, then shifting to international balance or even to surplus helps. Losing the capacity to run a fiscal deficit has the opposite effect. Where current account austerity increases labor demand, fiscal austerity reduces it. So if you think that underemployment is the pressing problem in the Europeriphery, current account austerity plus continued fiscal deficit is a golden combination.

Lots of countries, obviously emerging Asia but also Germany, seem to prefer the social goods that come with full employment and financial security to the consumer purchasing power gains that accompany current account deficits. The countries of the Eurozone periphery have so far “chosen” the path of excess consumption, but it’s not clear whether that represents a genuine preference or a historical accident. This isn’t to minimize the pain and disruption that would undoubtedly attend import scarcity. Changing human habits hurts. But, as Joni Mitchell might say, something’s lost but something’s gained. This would not be a novel sort of transition. It would be a reprise of the aftermath of the Asian financial crisis.

Leaving the Euro would not be all bows and flows of angel’s hair. But it would not necessarily be catastrophe, and there is no fixed quantity of austerity that Europeriphery countries have to face one way or some other. These countries have difficult choices before them, and should think carefully about the tradeoffs and just what sort of outcomes they hope to engineer.


Note: I have very mixed feelings about any break-up of the Eurozone. This piece was not intended as advocacy of that. I do think the European core is being foolish and shortsighted in its dealings with the periphery. In a better world, the core countries would equitize their claims against the periphery by, for example, adopting some variation of Warren Mosler’s frequent suggestion that the ECB issue per capita grants to all member states, that surplus nations would use as they see fit but debtor states would use to reduce indebtedness.

 
 

49 Responses to “Two deficits, two austerities, and quantities matter”

  1. JKH writes:

    “In a better world, the core countries would equitize their claims against the periphery … ”

    ?

    Debits, credits, and helicopter drops …

    I really don’t know MMT at all.

  2. Ramanan writes:

    Steve,

    Its great someone is talking of the balance of payments issues of the Euro Zone. Some Post Keynesians recognized this problem early on.

    Here is Wynne Godley writing in Observer – A Commonsense Route To A Common Europe, 1991:
    http://dl.dropbox.com/u/16533182/Commonsense%20Route%20To%20A%20Common%20Europe.mht

    But more disturbing still is the notion that with a common currency the ‘balance or payments problem’ is eliminated and therefore that individual countries are relieved of the need to pay for their imports with exports. Quite the reverse: the existence or a common currency makes a country more directly dependent on its ability to sell exports and import substitutes than it was before, particularly as it will then possess no means whereby it can (in the broadest sense) protect itself against failure….

    If we are to proceed creatively towards EMU, it is essential to break out of the vicious circle of ‘negative integration’— the process by which power is progressively removed from individual governments without there being any positive, organic, all-European alternative to transcend it. The nightmare is that the whole country, not just the countryside becomes at best a prairie, at worst a derelict area.

    A central government which makes fiscal transfers/equalization payments is needed if the Euro Zone is to be protected. A bit like one nation, though in another sense not exactly.

    Simple fiscal expansion worsens the situation as the public debt and the net overseas assets position of import dependent countries keeps deteriorating. i.e., it worsens the already troublesome balance of payments situation and finally the balance of payments situation of the whole Euro Zone will deteriorate unless market forces somehow achieve this trick.

    This is because higher income with lead to higher imports. “They do not reliably move together” is a bit misguiding. There is a complicated causality between the budget and external trade. The accounting identity which relates the two is of course known to you:

    NAFA=PSBR+BP

    The causality between the current balance of payments, BP and PSBR is from BP to PSBR. On the other hand, the causality is from fiscal policy to trade imbalance. Do you think a relaxation of fiscal policy can cause an increase in demand but not an increase in imports ?

  3. Ramanan writes:

    Yes leaving is not so easy. Posted this elsewhere, posting it again:

    Leaving the Euro Zone is not so easy.

    There have been very few analysis on the legal aspects of “thinking the unthinkable”.
    Charles Proctor and Gilles Thieffrey analyzed this in Thinking The Unthinkable – The Breakup Of The Economic And Monetary Union and Thieffrey summarized this in Not So Unthinkable – The Break-Up Of European Monetary Union
    The authors talk of Negotiated Withdrawal, Unilateral Withdrawal and Alternate Scenarios.

    If a negotiated withdrawal remains difficult to contemplate, it is almost impossible to envisage circumstances in which a participating member state could unilaterally withdraw from EMU.
    The Treaty does not provide for unilateral withdrawal or termination by a participant state. The other member states could have claims for compensation against the departing state and could be entitled to take countermeasures, for example by withholding moneys or benefits due to the departing state under other treaties. The consequences of a unilateral withdrawal in the context of monetary instruments or obligations in this context would be:
    – once again, the withdrawal from the eurozone necessarily involves the creation of a new national currency by the departing state, and the introduction of a new monetary law in that state;
    – no doubt the courts of the withdrawing state would give effect to the new, national monetary law in accordance with its terms;
    – but it is probable that courts in the other member states would refuse to give effect to the currency change in the withdrawing state on the grounds that (i) the monetary law would have been enacted in breach of a treaty to which the EU member state is itself a party and (ii) recognition of the monetary law would be manifestly incompatible with the public policy of the EU and (consequently) of the relevant EU member state.
    Quite apart from the financial and political risks which a unilateral withdrawal would provoke, the departing state would have to accept that its new currency may not be recognized in other member states – at least until a settlement of the situation had been negotiated. The departing state – and entities carrying on business within it – would thus be exposed to new exchange risks. These risks would be very difficult to quantify at the point of departure, given the uncertain value of the new national currency and the impact of the departure upon the value of the euro.

    Charles Proctor is the author of Mann On The Legal Aspects Of Money – the book expanding on previous versions by Fritz Alexander Mann.

  4. RSJ writes:

    “The ECB issue per capita grants…”

    Since when do central banks issue grants?

  5. […] “Leaving the Euro would not be all bows and flows of angel’s hair. But it would not necessarily be catastrophe, and […]

  6. Houghtie writes:

    I don’t think people have really thought about what a peripheral country leaving the Euro would really means. Take for example Ireland leaving. How would any contracts previously written in Euros be valued (any contract from loans/bonds through to any commercial agreement)? Surely the aftermath would be pricing chaos. Would a contract be valued in “New Punts” or “Euros”? How would anything be priced? Everything was oh so easy moving into the Euro with everything nice and stable. The reason for leaving would be to devalue the “New Punt”, hardly a recipe for stability. I don’t think this bears thinking about, surely a default whilst remaining in the Euro is much more palatable. In a withdrawal things would be messy and panic in at least the country exiting would ensue. Core country exit could be different (Germany + others able to deal with a strong currency) this could be managed in a stable fashion, with the Euro residue able to devalue to its hearts content.

  7. Steve Randy Waldman writes:

    JKH — By “equitize” claims against the periphery, I mean some solution that combines risk-sharing with upside for core lenders if periphery countries get their acts together.

    Mosler’s proposal works, in that sense. All claims are paid, in Euro terms, and the core lenders enjoy a disproportionate share of the Euro pie thanks to their past lending. Mosler often formulates his proposal, as he has formulated several policy proposals, in a manner that assumes regulatory schemes can largely eliminate risks. I don’t buy that at all, both with respect to his proposals re the banking system in the US and with respect to this proposal (were he claims that stability and growth pact constraints can prevent any risk of inflation). But I don’t see that as a problem here. If lenders are given Euro returns free and clear and borrowers are absolved of their debt (but still trade for Euros), you get increased inflation risk. Germans can spend returns that were supposed to be tethered to real tradables production that has so far failed to materialize in the periphery. That could drive tradables and other prices up, though I don’t see the problem as imminent, as inflation didn’t seem a huge threat when these loans were “money good” and very liquid. But I think its a genuine issue — all else equal, monetizing periphery debt while maintaining distributive fairness by giving money to non-indebted countries will put upward pressure either on prices or interest rates compared to not doing so. (The ECB can of course trade some Eurozone wide austerity for low inflation no matter what.)

    However, on the upside, it also frees the Eurozone periphery to conduct policy with an eye towards maximizing the tradables-producing infinite horizon value of their economies. The issue is one very familiar in bankruptcy law. A reorganization is never a pure thing. Even when a company is not reorganizing but is liquidating, there are creditors whose interest would be most purely served by selling off assets sufficient to extinguish their claims, even though that destroys firm value for other claimants. Bankruptcy judges must navigate these conflicts of interest, and I don’t think there’s a clear legal rule in the US about what they should do. But my favorite bankruptcy law scholar’s view is one I’m sympathetic to — the rule should be to maximize the total value of the reorganizing enterprise, even though that unnecessarily puts senior claims at risk. (I swear I’ve seen him take this position before, though I can’t find a cite.) Note that it doesn’t necessarily harm senior claimants — they get paid in full if the reorganization plan works. It just puts them at risk, with everyone else, gives them skin in the game of making the enterprise succeed when they’d rather take their ball and go home.

    Similarly, a wise policy in Europe would be to choose policies that maximize the tradables-producing value of peripheral enterprises, not to extract returns for bondholders at cost to other stakeholders in peripheral economies. Maximizing peripheral economy value should be the lodestar. Particular claimants’ interest, and especially the interest of external claimants who chose to put funds at risk for yield, should be a distant second. (Note most claimants, say, a Greek young adult of modest means, are involuntary stakeholders who did not affirmatively make a risk for profit choice. I think the interests those claimants should get priority, to the degree that there are conflicts of interest.)

    Mosler’s scheme is not an optimal means of maximizing tradables-economy value, but it is extremely easy to implement and has decent characteristics. It gives peripheral economies freedom to make good policy choices rather than to liquidate. It can involve “conditionality” in the lingo designed to restrict practices that are value destructive in peripheral economies. Outside of Greece’s public sector, though, that’s less of an issue than self-righteous creditors claim. Ireland and Spain both had very strong institutions. There single mistake was joining a policy consensus that their creditors never objected to — that markets are reasonably efficient, that policymakers oughtn’t use repressive tools to counter real-estate booms, that tradables-oriented industrial policy is a German quirk other European economies ought not emulate. So actually, the need for conditionality isn’t that great.

    Anyway, under Mosler’s scheme (absent what I consider counterproductive regulatory straightjackets), lenders have a choice. They can escape their entanglement with the periphery by using the Euros they receive to spend or invest in other economies, which will pressure prices of whatever they are buying, and they’ll take some losses in the form of higher prices. Or they can recycle their cash into periphery equity and enjoy the possibility of high growth that these very depressed economies might present, if they were free to adopt progrowth policy. That is, theu can stay invested in peripheral risk, but capture those economies’ upsides.

    There is a macro constraint we should care about. We don’t want peripheral economies to boom again based on external lending. So a wise policy would include (as I often argue in general) controls on debt flows to prevent consumption-based current account imbalances (which are always prescriptions for disaster). Any good policy regime, for the Eurozone and for the world, will include controls designed to prevent persistent external debt growth not backed by tradables production capacity.

    And there is a political issue, which is that Germany has yet to face up to its role in the Euro crisis and its policy incoherence. On the one hand, the German public and the officials that represent it are outraged that they may be forced to pay the bills for the profligacy of others. On the other hand, they’ve structured their economy in such a way that if others were to be prudent and insist on balanced trade (not at every point in time, but over some production cycle), it would put huge pressure on perceived German prosperity. Fundamentally the German position is analogous to that of a businessman who walks by a homeless man during a depression and says “get a job”. There are no jobs, or really, there is no market for peripheral production if core economies are structured to flood the Eurozone with exports. A good European community will understand nations’ duty to consume as well as produce, in order to allow neighbors to flourish as productive economies. It used to be called “balance of trade” for a reason.

  8. Rider I writes:

    Some analysis that I would have loved to see would have been the idea of service bell curves which create a negative income disparity as compared to production bell curves that allow for a positive creation of wealth storage for smaller countries. The idea that the link between the countries in the example is linked from imports is a good distinguishable factor. However, in the debt area I believe my service bell curve theory along with negative capital inflow disparity theory holds stronger. As that is what all the countries in the first example have in common. The idea that each is not allowed to create their own value via production, as per a Soviet Characteristics explained purely by the fact that the Communist Chinese are following exactly in the Soviets foot steps. From everything from creating a Bloc which is now called the Bric, to trying to implement a single world currency, to literally going on a resource domination campaign.

    n Nomeni Patri Et Fili Spiritus
    http://rideriantieconomicwarfaretrisii.blogspot.com/

    Rider I

  9. Steve Randy Waldman writes:

    Ramanan — I’m having a hard time reading the document you’ve linked, but it doesn’t suprise me that the post-Keynesians have been on top of these issues, as was Keynes himself.

    Re the international accounting identity, I don’t buy any universal story of causality. I can conceive of, and I bet I can unearth historical example of, almost any combination. A public sector deficit can be attached to a current account deficit or to an increase in net domestic financial assets. Policy far from neutral here. We can constrain the external balance, and pin the effect of deficit spending. There are lots of examples (and this I think is counter to Winecoff’s intuition) of countries that run fiscal deficits and external supluses, with domestic absorption of financial assets covering the difference. Look to Asia, and especially Japan, for this combination.

    You might argue that in a particular country context, under its current institutions and politics, that causal arrows can be drawn, and I won’t dispute the possibility. Still, even there, in practice, I think we know less than we think we do. In the US, if we went Moslerian domestically and tried to deficit spend our way out of counterproductive inactivity (without imposing any sort of controls), in the short term, how much of that would support “deleveraging” and how much would go to reinflate the external deficit? I don’t know. In the long run, would external revulsion to US claims reverse causality? If the rest-of-world tires of US claim accumulation, does the US government “accommodate” by reducing a deficit, or are the politics too hard and domestic financial asset positions grow to become inflationary? Again, I think we need a lot more detail to flesh out causal narratives. The accounting identity is just a constraint, and since there are three variables, it’s a loose constraint. Mess with any one, and you still don’t know what happens.

  10. Steve Randy Waldman writes:

    RSJ —

    “Since when do central banks issue grants?”

    They don’t. This would be an innovation in what central banking is, for better or for worse. I’ve proposed something similar here, with more detail about how central bank balance sheets are not a constraint.

    BTW, I’ve really enjoyed your commentary here and over at Worthwhile Canadian Initiative. We have a very similar view of many things.

  11. Steve Randy Waldman writes:

    Houghtie — No question. An abandonment of the Euro would be very, very messy. It would only happen if the alternatives are dire. But then, a couple of generations of counterproductive austerity sounds pretty dire. Some “adjustment costs” — call that austerity — are inevitable, as Winecoff argues. But that’s too broad a brush. Minimizing pain and maximizing value are worth doing. One kind of pain that should be minimized of it can be minimized is the financial ruin and commercial and legal confusions that would come with unilaterally redenominating contracts in some jurisidctions (while they would not be redenominated in others). If that’s avoidable at reasonable cost, it should be avoided. Again, my preference isn’t for Eurozone withdrawals, but for a strategy of accommodation by the Euro core that tolerates and encourages tradables-economy growth in the debted periphery. But if that doesn’t happen, I think it quite likely the costs to these countries will grow so large that tolerating the confusions of de-Eurofication become a least-bad option. That choice externalizes some costs — if Ireland exits the Euro, that creates legal and commercial headaches throughout the Eurozone, for anyone who does business in Ireland or with Irish firms. So it’s in the Eurozone’s interest to prevent this. But there’s only so much sacrifice that Ireland should be asked to bear to protect the rest of the Eurozone from their own poor institutions. And Ireland — and Greece, and certainly Spain should it come to that — can credibly threaten to leave. This has been done before, cf Argentina. The complexities are terrible but not fatal. I think the peripheral economies should openly consider exit as an option, not because they hope it will happen, but because they’ll get accommodations from the core only if lenders perceive risk in their current stance of demanding their claims be prioritized over domestic economies’ present and long-term health.

  12. Steve Randy Waldman writes:

    Rider — I’m intrigued, but I don’t quite get what you mean by debt and service bell curves. I gather you have a concern with cartelized blocks of countries, and there might be lots of reasons one might be concerned about those, but I’m not sure I understand your reasons.

  13. Ramanan writes:

    SRW,

    The proposal to “distribute … per capita” doesn’t work because it doesn’t solve the balance of payments problem and worsens it. So nations which have managed to achieve a deterioration of the net foreign assets position of 90-150% of GDP in all these years will just take a few years to double that and its a recipe to a sensational collapse. Those who use the phrase “throwing money at the problem” (somewhat pejoratively) have a point.

    Fiscal equalization is a subtle thing. A single nation doesn’t have too much balance of payments issues between the states. This is not because the government is “distributes” – it helps structurally weaker regions directly and through subsidies without anyone noticing. In other words, “distribution” is capitalist and what governments do is socialist.

    The causality between the identities is so simple in one sense and so complicated in another, that its the reason Macroeconomics is such a hard science. IMHO, those who have been associated with Nicholas Kaldor know this really well and none from the rest of the world.

    There are various aspects of the causality and one needs to work with variables and decide on what is exogenous and what is endogenous. Of course what these terms mean itself is debatable!

    In general, I’d say that there are zillions of causalities instead of saying there are none. The causalities can be understood by various gedankens. Imports depend on the decision of a citizen to choose a foreign product over a domestic one. This says something about the weakness of the local producers compared to producers in the rest of the world. (Japan runs an external surplus and an fiscal deficit because the they are strong producers and the private sector wants to save, respectively). So something needs to be done for nations which have high import dependence because imports are made on credit.

    I have seen you frequently use the phrase “current account deficit signifies foreigners’ desire to save in your currency”. Unfortunately that statement is misleading to the core. Consider this – Australia’s import bills are invoiced more in USD than AUD.

    Back to the sectoral balances identity, I agree with you that one shouldn’t interpret the identity as a behavioral relationship. The person who made maximum use of the identity, Wynne Godley – from his days in the UK since the 1960s, wrote detailed models to describe the behavior of each sector of the economy to describe how economies move in time.

    Btw, if you find the article I quoted somewhat difficult, here is one more from 1992: Maastricht And All That from the London Review of Books. (Really goes into the heart of the matter)

    http://www.lrb.co.uk/v14/n19/wynne-godley/maastricht-and-all-that
    http://www.google.com/search?q=maastricht+and+all+that (first link, to break the paywall).

    It needs to be emphasised at the start that the establishment of a single currency in the EC would indeed bring to an end the sovereignty of its component nations and their power to take independent action on major issues. As Mr Tim Congdon has argued very cogently, the power to issue its own money, to make drafts on its own central bank, is the main thing which defines national independence. If a country gives up or loses this power, it acquires the status of a local authority or colony. Local authorities and regions obviously cannot devalue. But they also lose the power to finance deficits through money creation while other methods of raising finance are subject to central regulation. Nor can they change interest rates. As local authorities possess none of the instruments of macro-economic policy, their political choice is confined to relatively minor matters of emphasis – a bit more education here, a bit less infrastructure there…

    … Some writers (such as Samuel Brittan and Sir Douglas Hague) have seriously suggested that EMU, by abolishing the balance of payments problem in its present form, would indeed abolish the problem, where it exists, of persistent failure to compete successfully in world markets. But as Professor Martin Feldstein pointed out in a major article in the Economist (13 June), this argument is very dangerously mistaken. If a country or region has no power to devalue, and if it is not the beneficiary of a system of fiscal equalisation, then there is nothing to stop it suffering a process of cumulative and terminal decline leading, in the end, to emigration as the only alternative to poverty or starvation.

  14. Ramanan writes:

    Houghtie,

    Agree with you. See comment #3. My 2¢ is that the IMF’s role in the breakup (say if it happens in few years) will be important. The IMF and other nations can help the indebted nations by helping them keep their currencies devalued for a while, allow them to have some say in putting restrictions on imports and help them reduce their debt levels through marketing their exports.

  15. Steve Randy Waldman writes:

    Ramadan — I agree with your balance of payments critique of Mosler’s plan. I would attach it to capital controls (especially controls on debt finance) to ensure that doesn’t happen. I should have emphasized that point more — it’s buried in the second to last paragraph of my response to JKH above.

    I have seen you frequently use the phrase “current account deficit signifies foreigners’ desire to save in your currency”.

    You have never seen me use that phrase. It is not and has never been my view. It is the view of some MMT-ers who don’t much worry about balance-of-payments issues. I am a longstanding balance-of-payments worrywart. I do think, as an empirical matter, the US’ “reserve currency” status means the rest-of-world is willing to absorb more US paper than it otherwise would, but I wouldn’t give that a positive normative valence or claim that other countries “want” to save in dollars.

    I agree with you that there are zillions of causailities you can find within the sectoral balances accounting identity. At any given time or in any given circumstance, there are, I suspect, valid causal stories. But there is not any universal or simplistic account. It is not correct, as a general matter, to claim that the fiscal deficit drives the current account deficit, as is very frequently claimed. Sometimes and under some circumstances it might, but very often not.

    I think we agree about the conditions under which a common currency works between, for example, US states. It works when there are means of ensuring balance over time, including both overt and subtle means. For example, an important instrument of interstate current account balance in the US is FDIC’s bank resolution process. There are also explicit transfers, transfers via private default engineered by the banking system, etc. Persistent current account imbalances bigger than a growth rate always end; that was the original Stein’s law, and it works within currency unions as much as without. Ideally, such imbalances would only occur when their resolution would be via reversal thanks to returns on productive investments. In practice, within currency unions and across currencies, persistent nonproductive imbalance is a regular and destructive feature of economic life, and any economic system must find some mix of transfers and defaults, overt and covert, to diffuse them when they do occur, or else deal with the very dangerous sort of impasse that we now see in Europe and that is historically associated with international conflict that escalates beyond economics.

    I don’t know whether the article that you previously linked was difficult… The link didn’t work for me (it linked to a file in an odd e-mail format that I couldn’t easily read). the piece you quote above is in-line with MMT-ers views regarding the importance of money to sovereignty, and my own views of the importance of having flexible and nondisruptive means of unwinding persistent current account imbalances when they do occur.

  16. Ramanan writes:

    SRW,

    The world is in trouble due to sectoral imbalances. This includes all kinds of imbalances – in addition to global imbalances. For example there are imbalances between various classes of society.

    Anthony Thirlwall from the UK in fact promoted this to a fundamental principle and wrote a book with John Mccombie called “Economic Growth And The Balance Of Payments Constraint”.

    This comment is intended to be a comment on how imbalances between regions of a nation are less problematic. Its true, Texas has a balance of payments with California. However, the US government makes fiscal transfers without anyone noticing. It does this by say building a bridge in Texas. Lower income due to imbalance with California may reduce income and hence taxes paid. So California is paying higher taxes and the residents do not mind since the quality of life is increasing. Wages in Texas adjust or do not rise as fast at California and it may make residents of Texas more competitive. In general, the US government is involved in fiscal equalization.

    Note however, that the US government does not “distribute .. per capita” as argued by the crowd who think that the government is not revenue constrained and along those lines.

    There are also imbalances between different classes. During the 60s, the working class had much more power and it led to a wage-price spiral and governments had to engineer recessions to prevent this from becoming unsustainable. Monetarism entered in the 1970s and the power shifted back to the capitalist class. This was really a bad way of achieving price stability. Both Keynesians and Monetarists committed their set of mistakes. Monetarists for example didn’t realize (or were blind to the fact) that their policies to control the money supply will bring in a huge recession and unemployment will rise. They assumed that wages would adjust to keep the employment constant and the central bank just had to adjust the money supply – wages will adjust.

    These imbalances look for policy of the right kind.

    I have noticed you writing freely about spending on imports as if its under the control of policy! The free-market/sound money lobbyists have made it difficult to achieve this. The only option left for nations to reduce demand is via deflating demand. There of course exists another “option” – i.e, assuming the foreign exchange markets do the trick for you. Unfortunately they do not do the trick. Hence nations have become obsessed with growing via exports. However I notice a lot of commenters elsewhere (not here) saying “its easy to exports”. In a sense exports are exogenous. Exports depend on income elasticity of demand abroad and also on the demand abroad. The income elasticity is a proxy for how good the producers are and how they manage to sell their products. However in addition to this exports depend on the demand abroad itself. For example, in the recent collapse, demand tanked and the rest of the world’s exports to the US also reduced, even though they wanted more dollar-denominated assets.

    Unlike the case of a closed economy, there is a no government at the world level to address imbalances. This is certainly the problem with the Euro Zone, but is also the problem with the whole world. It can be seen easily in the case of the Euro Zone, because the economic and financial architecture of the Euro Zone was a kind of a wet dream for the laissez-faire economist. The neoclassical economists argue that imbalances take care of themselves by via wage adjustments. For flexible exchange rates, their argument is that it takes care by currency movements.

    Unfortunately market economies do not take care of imbalances themselves. Those who face imbalances continue to suffer.

    PS: The crowd you have interacted with online recently has no notion of a balance of payments constraint. In fact for them, endemic current account deficits are not a problem.

  17. Ramanan writes:

    SRW,

    Didn’t notice your comment at 3:31am before writing my last one.

    Good to see you having some worries on the BoP constraint.

    Have emailed you the file.

    Agree with you about causalities as well. However there is another aspect to this as well. Fiscal Deficit versus Fiscal Policy. We should distinguish the two.

    The causalities are to be presented as stories and agree that at one time, one cannot say A causes B etc.

  18. Steve Randy Waldman writes:

    Ramanan — Oh, as I said, I’m a terrible and longstanding BoP worrywart. I don’t just assume that governments can control BoP — I actively and persistently support the imposition of capital controls to manage BoP imbalance.

    I know the MMT-ers’ general position on BoP issues. I consider it short-sighted and oversimplistic.

    I think we are mostly agreeing furiously, re for example, the ways governments of successful currency unions resolve potential balance of payments issued by effecting countervailing transfers through fiscal policy.

    Your point about inter-class BoP issues is interesting. BoP is a concept that applies to any sort of collective, and I think about it quite generally. But I hadn’t considered it in class terms so directly. Definitely worth thinking about.

    I suspect you and I agree a great deal on these questions. BoP issues were one of the founding concerns of this blog. I started interfluidity as an outgrowth of commenting frequently at Brad Setser’s blog, which was BoP obsessed.

  19. […] Two deficits, two austerities, and quantities matter Steve Waldman […]

  20. Ramanan writes:

    SRW,

    Really nice to know this!

    The BoP is usually between nations. But there are others as well – the inter-class BoP. Its easier to call the whole thing “sectoral imbalances”. One can also simply state the differences in the schools of thoughts by saying that School A says free markets resolve the imbalances and School B says that while capitalism is the best system, only policy can resolve the imbalances. Household sector as a whole (without making any class distinction) can be said to be having an imbalance – atleast before the crisis.

    There is fiscal imbalance as well, but MMTers become offended of the usage of such a language. While it is true that the fiscal imbalance is a result of decisions of the other sector, its an imbalance nonetheless. Most economists tend to push policy into saying that the government should balance its budget and worse, make attempts to achieve primary surplus, they miss the fact that this brings about loss of employment. So the way to resolve this is by doing something about the BoP. Of course not everyone can simultaneously achieve a CA surplus, so a coordinated policy is required.

    Didn’t know before how interfluidity started. Good to know this.

    “I think we are mostly agreeing furiously, re for example, the ways governments of successful currency unions resolve potential balance of payments issued by effecting countervailing transfers through fiscal policy.”

    Yes. However, I’d say that if the European Union Parliament becomes a federal government, the problems can be overcome. But for all practical purposes, this is equivalent to saying that all nations of the union merge to become one country. Another way to state this is that while inside a nation, the government makes fiscal transfers without anyone noticing, in the case of the Euro Zone, everyone has started already noticing, even if its unclear if such a thing (federal government) can be achieved.

  21. a writes:

    “As long as the country, post-default, issues its own currency, and as long as the country’s citizenry is interested in accumulating domestic currency and debt, the government can run a budget deficit after the restructuring.”

    “Winecoff’s example of Iceland is a great case in point. Following its collapse and quasi-default in 2008, the Iceland ran a budget deficit of 9.3% of GDP in 2009 (a primary deficit of 6.6%), and has continued to run deficits since, gently drifting towards balance. Iceland has also been able to sustain large current account deficits as well for a while after the crisis, which helps to cushion the adjustment. Iceland received loans from the IMF and several European countries, which partially financed its continuing international deficit. Also, private citizens of Iceland may have had foreign asset holdings which they could pledge or sell to finance imports while the economy shifted towards international balance.”

    So Iceland did not default. It was therefore not cut off from international capital markets. So, in addition to IMF and European money, it received money from private foreign investors. Could you explain to me again how this is a case for sovereign default by the European periphery? Or how they could avoid austerity by defaulting on their sovereign debt?

    IMHO there is a misunderstanding of the path dependence of the situation. Having your own currency pre- and post-crisis is very different from having your own currrency only post-crisis. Ireland is the best case in point, having made engagements to its European partners which, if it went back on, would justify the rest of Europe to retaliate by forcing it from the EU. This kind of threat doesn’t exist in the case of Iceland. (Ireland made these engagements because it didn’t have its own currency to fall back on. If it had been Denmark, it would have been in much better shape.)

  22. JKH writes:

    SRW,

    Thanks.

    I think you capture it with:

    “Or they can recycle their cash into periphery equity and enjoy the possibility of high growth that these very depressed economies might present.”

    Maybe they should take up low interest periphery debt with warrants indexed on GDP/employment growth.

  23. Jose writes:

    What if Ireland or Greece left the euro for another type of alternative?

    They could adopt the US dollar as their new currency. With an international reserve currency, there be would be no risk of disintegration of the economy for lack of trust in the drachma or the punt. And they would benefit from an immediate depreciation of some 40%, that would quickly raise their exports and reduce their imports in a dramatic measure.

    It seems that the low dollar is in for a long run, so the two countries would likely become competitive again for a long period, with a good chance of rapidly achieving a current account surplus. They would stop accumulating more foreign debt – a key issue that the current EU rescue plans are ignoring – and could start paying it back instead.

    The euro zone seems to be functioning pretty well for net exporters but has been a disaster for net importers. Deprived of the possibility of depreciating, the only way foreign deficit countries will be able to balance their current account again will be through unending years of brutal recessions. This is a terrible option, nay, the worst possible option for their populations. Their economies will be crippled for decades to come.

    Adopting the dollar would provide austerity with lower imports combined with a strong chance of recovery via net exports. Once foreign surpluses are achieved, the private and state sectors will necessarily also tend toward surplus.The debt spiral would be broken once and for all.

    The foreign debt could be restructured through negotiations with creditors, providing lower interest rates and longer maturities coupled with warrants on the new found GDP growth. But the creditors would at least be aware that the countries would have a real ability to pay via their new external surpluses, something that is also missing in the current plans. Let’s not fool ourselves – today everybody knows, but does not want to admit,that the debts of the periphery are simply impossible to pay back under the current circumstances of the euro zone. This is the reason yields are still rising, and will keep rising, even for the countries already under EU assistance. The crisis will tend to become perpetual under the current EMU framework

    So let those countries exchange their current aid packages for a huge dollar loan to start the process now. And let us not forget that Hong Kong, China and many other countries are a living proof that pegging to the dollar may be a realistic basis for export-led growth processes and widespread prosperity.

  24. Ramanan writes:

    “What if Ireland or Greece left the euro for another type of alternative?

    They could adopt the US dollar as their new currency. With an international reserve currency, there be would be no risk of disintegration of the economy for lack of trust in the drachma or the punt. And they would benefit from an immediate depreciation of some 40%, that would quickly raise their exports and reduce their imports in a dramatic measure.”

    What kind of setup are you talking of Jose? Dollarization or a currency board regime ? First these countries may have to borrow heavily to do anything and there is no guarantee that they will be successful in exporting. Borrowing may be highly expensive for them. Currency boards need a good foreign reserve position.

    As far as depreciation is concerned, a 40% depreciation would lead to huge capital losses in their Euro-denominated liabilities.

    Price competitiveness is one thing for exports. “Non-price competitiveness” (measured by income elasticity of imports of foreigners) is equally important.

  25. Jose writes:

    Ramanan,

    Let’s say they adopt a currency board, after arranging for a US dollar loan – from the IMF only. This loan would replace the current aid packages for Greece and Ireland (for Portugal it could be an “ex novo” loan, in dollars).

    These loans would provide the needed foreign reserve position. And remember the IMF has been defending slightly less harsh attached conditions than those proposed by the EU.

    As for those countries’ euro-denominated liabilities, they would have to be restructured anyway. The negative effect of the depreciation could thus be more than compensated by future negotiated haircuts. And if periphery GDP starts growing again as a result of the devaluation, the debt to GDP ratio will improve and this will facilitate the payment of debts.

    And this time, with the export boost resulting from the effective depreciation after adoption of the dollar, the creditors would know that the countries in question would now really be in a condition to pay the debts back, in the long term. Something that is – let’s put it this way – arithmetically impossible if they stay within the euro zone.

    Plus, the countries will at least have a realistic chance to get back to growth. It’s a chance, not a certainty of course. In economic forecasts nothing is certain. But again, under the current EMU aid and austerity plans they have the virtual certainty of being stuck in a recession for a great many years to come. It will be a cruel, long term, unusual and useless punishment on their populations.

    So I think imaginative proposals will have to be sorted out in order for a solution to this terrible crisis in the periphery countries to emerge.

    A dollar currency board would not be perfect. It would carry some risks. But the present situation is simply a zero volatility guarantee for the demise of three economies and the ruining of the lives of 25 million human beings.

    We really have to start thinking out of the box, including the economic experts’ box, otherwise the course to economic disaster for the periphery countries won’t be stopped.

  26. Tom Hickey writes:

    R @20 “But for all practical purposes, this is equivalent to saying that all nations of the union merge to become one country.”

    I believe that this was/is the intention of the Europeanizers who pushed for the EMU. They saw that adoption of a single currency in a currency union was tantamount to abolishing national sovereignty as well as monetary sovereignty, as Godley observed in the article cited above. They probably thought the road would be smoother than it turned out and never dreamed of the GFC. However, neoliberals are generally good at using “the shock doctrine” (Naomi Wolf) to force change that might be politically difficult otherwise. The situation now is either go forward to an increasing more united Europe under a single fiscal authority (European Parliament?) in addition to a single monetary authority (ECB), or else see at least some countries exit the EMU out of political necessity as their populations revolt or emigration rises unacceptably. But could a European parliament function without a federal government as executive branch, too, e.g., under a prime minister to execute policy? Is Europe ready to take that step? If it is not, is any economic fix more than a band-aid?

    The question is whether Europe can develop a mechanism similar to the US which also has an internal BoP problem with the rich and poor states, where the rich states essentially carry the poor states. This also includes Eastern Europe, as more countries are admitted to the EZ.

    I have said from the beginning that I question whether the voters of the rich nations of the core, specifically Germany, are willing to approve this. I have doubts and if the EZ/euro breads down it will be due to German politics. If it doesn’t break down there will be serious political issues in the periphery. at least until the issue of mass unemployment is resolved.

    It would seem that any viable economic solution has to take these political issues into account since economics cannot be divorced from policy considerations. The neoliberal notion that market are self-organizing and self-regulating is not supported empirically.

  27. Ramanan writes:

    “I have said from the beginning that I question whether the voters of the rich nations of the core, specifically Germany, are willing to approve this. I have doubts and if the EZ/euro breads down it will be due to German politics. If it doesn’t break down there will be serious political issues in the periphery. at least until the issue of mass unemployment is resolved.”

    Tom,

    The present debate is about bailout which is far from any kind of fiscal equalization. These are just loans and the it can be considered fiscal to the extent that the interest rate on the loans are kept low.

  28. Merijn Knibbe writes:

    Some points I’m missing in this interesting discussion:

    A. At the moment, Greece is forced to sell government companies and to use the 50 billion Euro this is supposed to deliver to pay back its debts. The country is indeed stripped of its assets.

    B. Wages in Germany are

    (1) more than twice as high as in Greece and
    (2) in contrary to the situation in Greece, industrial wages in Germany are higher than average wages of the entire economy. Wages can indeed be too high to be competitive, but what you really need, in the end, is a modern export oriented industry. If Greece is not competitive it’s not because wages are too high, but because its industry either has the ‘wrong’ specialization – or because Greece did not invest in modern technology, education, networks, modern infrastructure and the like. To me, that seems to be a more basic fact than just ‘too much consumption’.

    C. Present austerity measures do not lead to internal devaluation, but to higher inflation (indirect taxes!). As the most important industry of Greece, tourism, is price sensitive this is austerity at its worst. In fact, its ‘internal revaluation’.

    But there is good news too. The European Court (how do you call this, in english?) has decided that pensionados are allowed to permanently relocate to another EU country while keeping full rights to their pensions. I.e, the German pension funds will buy the privatized Greek government companies and pay for the permanent relocation of German pensionados to splendid villa’s on rustic Greece Islands with the dividends of these companies. Suddenly, leaving the Euro sounds a lot better.

    By the way – when the Euro was introduced, everybody was flabbergasted that Greece was included.

  29. Ramanan writes:

    Jose,

    Yes, Euro Zone arithmetic is unpleasant.

    What I am saying is a depreciation is not guaranteed to achieve exports. Just because foreigners find Greek products cheap doesn’t mean they will buy them. So their export industry needs to be promoted.

    A nation leaving the Euro Zone can do many things such as renegotiating debts with creditors etc, but these are in foreign currency. A depreciated exchange rate means that the burden is higher.

    Also, we haven’t discussed the imports situation. Some strong measures need to be given to the nations which amounts to allowing them some protectionism.

    The situation is really bad. Greece’s net foreign assets position is about minus 150% (?). Unpleasant. Some really solid plans are needed.

  30. Ramanan writes:

    Merijn Knibbe,

    Interesting points. Plus there is this opinion everywhere that Germans work twice as much as the Greeks. Don’t know where such prejudices have come from.

    Yes, agree wages are not the only thing. It just offers price-competitiveness. In Keynesian trade theory, one hears of price elasticity and income elasticity.

    Wage adjustments do not do the trick. Its neoclassical mechanism and bound to fail.

  31. Tom Hickey writes:

    R: The present debate is about bailout which is far from any kind of fiscal equalization. These are just loans and the it can be considered fiscal to the extent that the interest rate on the loans are kept low.

    If you think that these are “just” loans, you are not paying attention to European politics, which is really heating up now. Any economic solution that does not take current political reality into account is impractical.

    How this economic situation is approached is inherently political. There has to be a practical solution that is acceptable to the parties, i.e., whose ox is going to get gored and whose ox is going to be fed.

    That is the advantage of the Mosler plan. It is pretty neutral politically and economically feasible, and it could actually be implemented practically, with fairly minimal disturbance of the system.

  32. Tom Hickey writes:

    “Plus there is this opinion everywhere that Germans work twice as much as the Greeks. Don’t know where such prejudices have come from.”

    The same view was recently surfaced by a US politician about whites v. disadvantaged minorities. This relates to the concept of BoP based on class that Ramanan astutely noticed. This internal BoP is a huge factor in US politics and economic policy depending on which party is in power, as well as which faction of that party. These are not just neutral transfers as reflected on data reports. There is a rationale behind them that that rationale is not entirely rational.

    Another advantage of the Mosler plan politically. It is a per capita distribution.

  33. […] Lump of Austerity Doctrine (Wonkish) Steve Randy Waldman has a good post critiquing the now widespread notion that debt-troubled economies will have to engage in the same […]

  34. Eddy writes:

    Yes, a country could threaten to leave the eurozone…but the rest of the eurozone could counter-threat with trade restrictions if that step is taken.

    This may not be the case with small countries, like Ireland or Greece, but surely with Spain (because ultra cheap spanish goods post-devaluation, like cars or food would surely cause a certain amount of angst in France, for example).

  35. BeatCal writes:

    houghtie asks, “Take for example Ireland leaving. How would any contracts previously written in Euros be valued (any contract from loans/bonds through to any commercial agreement”. By government decree, all contracts in Euros would be converted to the new currency, just as the dollar deposits in Argentina were converted to pesos.

  36. Ramanan writes:

    Tom,

    “That is the advantage of the Mosler plan. It is pretty neutral politically and economically feasible, and it could actually be implemented practically, with fairly minimal disturbance of the system.”

    No, it won’t work. It will create a situation in which the public debt and the negative net foreign assets position of the ones in doldrums rise forever, though increasing their income temporarily.

    So a few years later we may hear that Greece’s net international investment position is -400% of GDP. Not a problem ?

    Its not even close to being neutral politically.

    Its really difficult to explain this. A government doesn’t “distribute xyz per capita” to the states. It tries to achieve a balance between regions, helping out structurally weak regions. In the Mosler plan we are discussing, there is always an external imbalance.

    Minimal disturbance ? And the whole Euro Zone itself with find with problems in its balance of payments problems later.

    “If you think that these are “just” loans, you are not paying attention to European politics, which is really heating up now. ”

    No I have been tracking. By just loans, I meant, there is a burden of servicing this debt.

    “There is a rationale behind them that that rationale is not entirely rational.”

    Yes of course, nobody promised us a rose garden.

  37. Tom Hickey writes:
  38. Ramanan writes:

    “The ECB’s Secret Bailout Strategy by Hans-Werner Sinn”

    Tom,

    Sorry what is that ?

    Its partly correct. The Deutsche Bundesbank balance sheet has claims on the rest of the Euro Zone in assets and is financing the affected countries. One can also see this item in the German international investment position.

    However, this in itself is not sufficient. This is done in an accommodative way by the Bundesbank and offers no relief on the interest rates paid on government debt.

  39. Ramanan writes:

    “has claims on the rest of the Euro Zone” …

    I meant has claims on the rest of the Eurosystem to be precise.

  40. RSJ writes:

    SRW,

    Thanks! Regarding the proposal, transfers from the CB are fiscal policy, not monetary. They must come out of bank capital, and are funding by the fiscal arm of government. Now it doesn’t matter if you allow banks to have negative capital, because the capital is supplied by the member governments and the income the central bank earns on its capital is returned to the member governments. Allowing for negative capital means that the transfers are happening in the other direction — from member governments to the central bank to the public. The loss of seignorage income together with the increase in capital subscriptions is the same as the amount of transfers or grants that would occur.

    It is still fiscal policy.

    Perhaps this is the logical conclusion of monetarism. After realizing that income transfers, and not asset swaps are what is necessary to stimulate demand, they would start having the central bank engage in these transfers even while pretending that they are conducting monetary policy.

    But the EMU does not have a centralized fiscal policy for a reason — the member governments are not willing to give up this power — and the same reason will block the attempts to conduct the transfers under another name.

    Moreover, there is a reason why we do not typically allow banks to engage in fiscal policy. Such transfers should be part of a democratic decision making process, and should not be handed over to the domestic financial sector, to which central banks are beholden.

  41. beowulf writes:

    “A public sector deficit can be attached to a current account deficit or to an increase in net domestic financial assets.”

    Right, so unless we wish to drain private sector assets (and we don’t), the govt deficit must be larger than the current account deficit. That’s what choked out Clinton’s full employment economy in 2000. Running a 2.4% GDP budget surplus (or any surplus at all) at the same there’s a 3.7% GDP trade deficit is a bad idea. This process was explained by Wynne Godley and Randy Wray in, umm, 1999. I’ll leave it to the reader to decide if Wynne Godley understood macroeconomics better than anyone else or if he was, in fact, a time traveler.

    “the notion that a federal budget surplus is sustainable come hell or high water and that it promotes economic growth must be abandoned. Given the realities of the U.S. trade imbalance, public sector surpluses are consistent with economic growth only so long as the private sector’s financial situation deteriorates at an accelerating pace.”
    http://www.epicoalition.org/docs/99-4.htm

  42. beowulf writes:

    “Such transfers should be part of a democratic decision making process, and should not be handed over to the domestic financial sector, to which central banks are beholden.”

    Politically, this could be accomplished by Member parliaments reducing its VAT rate, with the EMU “printing” Euros for transfer to Member treasuries to make up lost revenue. The US doesn’t have a VAT but the current 2% (out of 15.3% FICA) FICA tax holiday works out this way operationally.

    I’m a fan of Larry Seidman’s idea of an “automatic fiscal policy”, Seidman would tie it to GDP growth but, as I’ve mentioned here before, I’d tie to to U3 unemployment. Congress sets a formula,say, reduce FICA rates by 10% for each 1% of U3%. so at 8.8% U3, reduce FICA by 88%, if it drops next month to 7.5% or rises to 9.5%, then standard FICA rate would be cut by 75% or 95% respectively. Bureau of Labor Statistics releases U3 update a few days into a new month (April’s numbers, for example, will drop next Friday) so whenever BLS updates its monthly U3 rate, Tsy could update FICA withholding schedule at the same time. Since U3 will never go to 0, might as well uncap SS FICA at the same time ($900 billion FICA receipts would go to $1.1 trillion).

    Anyway, the EMU could do the same with a VAT holiday pegged to unemployment. I guess the question would be whether it should track Eurozone unemployment rate or pegged it differently for each Member country.

  43. vimothy writes:

    RSJ,

    “It is still fiscal policy.”

    True. And fully agree that we do not want CBs to conduct fiscal policy. Your statement about monetary policy being incapable of stimulating demand is interesting though. How do you resolve this with your belief in the non-neutrality of money? (Incidentally, the vaguely pornographic nature of business cycle language creeps me out at times: “stimulation”, “peak”, etc).

  44. […] Two deficits, two austerities, and quantities matter Steve Waldman […]

  45. RSJ writes:

    Vimothy,

    “Your statement about monetary policy being incapable of stimulating demand is interesting though. ”

    That’s not what I meant. I think the quote was ” income transfers, and not asset swaps are what is necessary to stimulate demand”. If the CB, by lowering interest rates, can spur more investment, then this will create additional savings, and it will be stimulative. The private sector will self-stimulate (to continue with reproductive analogies) and there wont be a need for income transfers. But after relying too much on this self-stimulation, there are repercussions :P

    I don’t see this as relevant to the non-neutrality of money, as I don’t think CB asset swaps are effective at increasing the quantity of money held by the non-financial sector. As far as households are concerned, this is a non-event. Households did not increase their deposit holdings as a result of either round of QE, just as in Japan household money holdings failed to increase as a result of their QE efforts.

    I think this depends very much on the institutional arrangements that are in place. I can imagine some arrangements by which asset swaps succeed at increasing the quantity of money held by households and they might succeed at generating inflation as well. For example, in undeveloped nations in which households don’t have access to deposits and almost all money is held as currency. In that case, the CB can control the quantity of money held by the non-financial sector.

  46. […] Two deficits, two austerities, and quantities matter (Interfluidity) […]

  47. […] Two deficits, two austerities, and quantities matter (Interfluidity) […]

  48. Anonymous writes:

    […] […]

  49. […] (for now) the question of whether, or when, or should the periphery leave the euro, as part of a debt restructuring or a long process of fixing their […]