PK continues to fight the good fight for Keynesian common sense in the face of resurgent austerity. The austerity front, which brings together Tea Partiers and Tories, blue dogs and Bundesministerien, wants to snuff out last year’s stimulus and force the North Atlantic economy to sink or swim. It’s chances of sinking are frighteningly large. Krugman says we should keep applying fiscal CPR until economic growth is in full recovery and unemployment has dropped—and until the zero lower bound on interest rates no longer binds, and normal monetary policy becomes an option.
Yes but.
There is an enormous hole in Krugman’s argument. A chief worry of the austeritarians is that their country—Britain, Germany, even the US—will be the new Greece, abandoned by creditors and teetering on default. These fiscal deficits are unsustainable, they say, and debt-to-GDP ratios are drifting up into the danger zone. The risk is that financial markets will lose confidence in governments with so much red ink, leading to a spike in interest rates, the dumping of bonds, and national humiliation at best, meltdown at worst. Why wait for this moment, the argument goes, when you can prevent it by bringing fiscal deficits down now?
Krugman’s response is that the creditor flight threat is imaginary. Speaking of the new budget cuts and tax increases in Germany, he writes, “Nor can they claim that markets are demanding austerity. On the contrary, the German government remains able to borrow at rock-bottom interest rates.” This has also been his pitch for the US, which also enjoys lowest-ever rates on its long-term bonds. The markets aren’t worried, so why should we be?
Does anyone else notice that this argument rests on the assumption that low interest rates today guarantee low rates tomorrow? Yes, the US, Germany and England can borrow long-term at firesale prices, but old debt keeps coming up for refinancing, and if market sentiment changes, the effects will be felt immediately. Do financial markets ever swing radically from favoring one asset or currency to panic buying of its substitute? Is there unpredictable herd behavior among investors? Do we have to ask?
The issue is not what markets “think” today, but how exposed we are to their gyrations in the coming months and years. This is the strongest argument of the austeritarians, and Krugman can’t see it. It is entirely possible that we could be in for a period of cascading panics, with money surging to one apparent safe haven, and then another, and then somewhere else, wrecking whole economies in the process. In other words, we have to worry not only about 1937, when premature austerity put an end to economic recovery in the US, but also 1931, when the failure of Vienna’s Kreditanstalt led to a period of devastating currency runs. Now, as then, there is no sufficient international lender of last resort, and any defense would have to be improvised on the fly. Back then, defense failed utterly.
The solution, however, is not fiscal tightening; Krugman is right about that. The starting point for any intelligent analysis has to be the basic accounting identity, that the sum of private sector deficits plus fiscal deficits equals the current account balance. Surplus countries that choose austerity are choosing some combination of decreasing private sector savings and increasing trade surpluses, most likely through declines in national income. They are making life even more difficult for their counterparties. Deficit countries, like ours truly, are in an even worse situation. Fiscal retrenchment means even greater private borrowing, with the only difference, in the short to medium run, coming from the effect of falling incomes on imports. We got into this situation because the private sector, especially financial institutions, were over-leveraged and badly invested; with deleveraging the debt burden was shifted onto governments that stepped into the breach. To withdraw the fiscal lifeline before private wealth-holders are prepared to lend would be catastrophic. We would have unavoidable crises, first in the deficit countries, then in the surplus regions exposed to them.
This is Scylla and Charybdis territory, to be sure. We got here by a long sequence of institutional failures and policy errors, and it will not be easy getting out. I remain convinced that the bailouts of 2008 were deeply mistaken, and that we are now paying the price. (At the time I instead favored the use of public money to create “good, new” financial institutions.) Moreover, no action was taken to address global imbalances, and without this it is difficult to see how growth can resume: the US will no longer borrow the vast sums needed to sustain global demand. (Recent labor action in China is a sign that bottom-up rebalancing may be gathering force—I hope so.) The Eurozone crisis is itself a dilemma of rebalancing on a regional scale.
In short, there is no obvious way out. Austerity is a sure-fire loser, but the risk of distended fiscal deficits in a low- or no-growth world is real. Time is running out to deal with the underlying causes.
10 comments:
Peter Dorman said,
"Does anyone else notice that this argument rests on the assumption that low interest rates today guarantee low rates tomorrow?"
It doesn't. As a matter of fact, Brad Delong argues that since interest rate increases are reflective of expanding economies and inflation, borrowing (LONG TERM) at these low interest rates makes perfect sense. And the assumptions are all Keynesian. We BLEEEEEEEEVE that stimulus will result in recovery. That recovery will increase interest rates, and that the real cost of the _CURRENT_ debt burden will have been dramatically reduced by a decent amount of inflation.
And then we have the real champion in Dean Baker who tells us that the FED can monetize the needed stimulus at this point.
"There is a simple way to avoid a sharp rise in the interest burden associated with a higher debt. The Federal Reserve Board can buy and hold the debt that is currently being issued by the Treasury to finance the deficit. The logic of this is straightforward. If the Fed holds the debt, then the interest on the debt is paid to the Fed. The Fed then returns the interest to the Treasury each year, meaning the net cost to the government is zero."
I wonder why Paul Krugman seems to tacitly concede your premise that a run on the US Treasury would be a bad thing. How so? If investors lost their taste for Treasury securities, they would try to shift to some other asset, creating an increased demand for either foreign exchange or domestic private sector assets. Given the deficiencies in both net exports and private investment that the US faces today, the economic benefit of such increases in demand would (up to a point, but a fairly distant point, given the severity of the problems) outweigh the fiscal cost. Alternatively, investors might not lose their appetite for US Treasury securities in general but only increase their preference for shorter maturities. Such a shift could produce a problem if handled badly by the Treasury (and the Fed), but in principle, the Treasury can supply whatever maturities the market demands. I see Scylla, but I still need binoculars to make out Charybdis.
I'd appreciate one of our resident economists responding to this question. Within the argument of how much is too much "stimulus" spending a secondary question comes to mind. So the government popurs money into stimualtion efforts. Jobs may be created. At least that's what I understand to be the primary intent of the spending. Forget for the moment the possible negative effects of the deficits that result from such stimulus spending and concentrate on what happens after the stimulus spending is spent. If income distribution stays at its current shape how is any result of the
stimulus effort going to be sustained? Our economy has had stimulus spending going on for decades in the form of mililtary spending, agricultural price supports and the bridges to no where. The economoy still tanked after one major disruption in confidence. If 95% of the working population doesn't earn more than the proverbial hill of beans and the other 5% (and that split may be less progressive than my estimate) have all the disposable income, what good the stimuluos effort? That's the question. How does the economyu staty stimulated if the vast bulk of the population doesn't enjoy the income benefits of its labor?
I am looking at the two posts from Peter Dorman (this one and the letter to the German dude) and wondering what good it does to be the creator of your own currency. I had thought that competing currencies was to replace trade barriers and it seemed a rational course at first. But we don't have that. Germany and Greece and the rest are on the Euro standard which is just like the gold standard. These nation states are prohibited from using tariffs but at the same time can't use floating exchange rates to balance trade. Then I look at the bigger world and see that oil must be traded in dollars and realize that the American dollar is a competing "standard" with the Euro. If competing currencies is the tune then where are they? The American dollar keeps gaining value against all the other currencies BECAUSE the government refuses to to extend social insurance to the American middle class. There are no import duties and no falling currency values either. And it is just more rape of the middle class as far as the eye can see. All the world's rich want to suck that rent out of the American middle class and our illustrious "government" is assisting them.
Dean Baker has the proper solution to this problem. High time we used our ability to create our own currency. Unlike Dean Baker, I believe that this will cause dollar devaluation (otherwise known as inflation) and interest rates on T-Bills will react immediately sending US borrowing costs much higher. I have no idea where the creation of your own money meets the interest rate monkey; where the equilibrium might be. But it does seem that there is a balance point between monetization and interest rates. The "zero bound" problem appears to be a hoax. Either the Fed is part of the US government, or it must be made so. We have seen that the banks and the financiers can't be trusted to manage the money system.
Blogger Jack said...
"How does the economyu staty stimulated if the vast bulk of the population doesn't enjoy the income benefits of its labor?"
My own take on this is that the United States must join the rest of the civilized world in the provisioning of Social Insurance systems at the expense of the very wealthy. Looking at it in a very pointed way, if the rich must pay people not to work then they will probably find something more profitable for these people to do. And being even more forceful about it, import duties can be used as a means to supplement the progressive income tax revenue steam thus stopping the off shoring of all the jobs.
The result of all of this will be a dramatic increase in the price of imported oil and other imports. But that is not some unwanted side effect. The goal is American Jobs and energy independence. Algae biofules, wind, solar, hybrid autos, and modular nuclear are all a lot more attractive when the oil costs a lot more.
I don't know how to make the political transition to a greater "welfare state" as the proper solution. Such a system is a "continuing stimulus". That spending does not stop and must be supported by taxing the rich. Now is the time.
What say you, any of you, to the idea of taxing income, in all its forms,no exceptions, at a very high rate after it passes the level of obnoxious. Granted that opinions will differ as to the exact amount an obnoxious amount may be, but unless extraordinary levels of income are taxed in a harsh manner they will continue to be a drain, and strain, on the incomes of all others.
The real problem with the austerity argument is that it results in the same policy response no matter the evidence. Thus:
* If interests rates on government debt are high, they respond (rightly) that governments should cut their deficits.
* If interests rates are low (which they are now), they respond that at some point in the future, maybe tomorrow, interest rates will be too high so we should preempt that and government should cut their deficits.
Same conclusion for them every time. If you reach the same conclusion no matter the evidence, as they do, then what you have is not science but ideology, and this is why Krugman's argument is right (though yours works too).
Dear Jack:
The righteousness of your opinions will be seen among the people of testosterone as an estrogen overdose. The joining of hands and the singing of Kombaia will not sell in the land of Davy Crockett and Matt Dillon. So unless you are going to be religious about it, claiming that "compassion" should trump all, you must be a lot more sneaky. You must couch your appeal in terms of "justice" as opposed to "compassion". And even that is a hard sell among the Republicans. I have a friend that truly believes that Republicans get a woody from proferring a successful lie.
But the best approach is to sell "economic growth" couched in terms of wages and middle class prosperity. That is, after all, the true reason for the existence of political economy. The taxation of the rich is actually a recovery of privatized unearned economic rent. It is that higher incomes are composed mostly of economic rent. What is interesting is that the privatization of this rent is made possible by government. Yet the rich will ever try to foist the costs of government onto the middle class.
BY cutting taxes and being dependent upon debt, the rich simply loan money to government instead of paying taxes. Much is made of the fact that the rich are paying a higher percentage of the taxes than ever before. But the fact is that there are not enough taxes being paid to prevent the growing debt. If the total tax bite out of the X trillion economy is $500 and the rich pay 99.99999999% of it, they make out like bandits as they "invest" in T-bills with the money they save from not paying taxes. The hidden tax is the rent flowing into the hands of the rich from their ownership of government backed financial instruments like T-Bills and Fannie bonds.
So just print the money to fund the stimulus and allow the Bush tax cuts to expire and the deal is done. Thank you very much. The problem is that the political success of this depends utterly on an understanding of economic rent in all its forms. The starter course is here.
Trucker: "So unless you are going to be religious about it, claiming that "compassion" should trump all, you must be a lot more sneaky. You must couch your appeal in terms of "justice" as opposed to "compassion"."
I didn't think that compassion was the point of my comments. Fairness is mt usual point and I've been focused on that issue all along. I am continuously perplexed by any mention by others of the income distribution disparity's negative effect on the economy. How else does the economy get a real stimulation without a persistent and large cadre of participants, whether they be buyers, savers, or investors. If the vast bulk of income goes to the tiniest percentile rank then what is left to spend, save, injvest or what ever works best for economic prosperity for the whole of the economy?
This is not an emotional issue. It's a simple fact of life. Unfortunately the political class, in all its varied hues, represents that tiny percentile rather than the bulk of the nation. The Tea Party knuckle heads don't seem to get that point, but nor does the more centrist mass of the people. So here we sit spitting into the wind needing to recognize that we have little impact on the so called debate. The Deficit Commission is the one best example of the stacked deck that our political economy is. Imagine, Alan Simpson and David Walker are going to come up with a balanced plan for stabalizing the economy by resolving the deficit issue. I need to keep ereminding myself that it's all a sad joke.
Trucker: "But the best approach is to sell "economic growth" couched in terms of wages and middle class prosperity."
A good idea, but I'm not very optimistic, as noted above. Possibly someday the press and the general media will take on some aspect of its so called liberal bias and actually communicate the truth of economic issues to the mass of the population. Don't hold your breath.
Bottom line is that there doesn't exist any alternate universes where the US, today, can borrow long-term just fine at 3%, but where another $400 billion stimulus, which would increase the debt burden by only about $200 billion, or 1% of the total debt, would suddenly lead to a default.
Exorbitant privilege, hello?
The situation is different for Ireland, or even the UK, or any smaller countries with worse fiscal situations.
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