Sunday, February 24, 2013
Fiscal Space Cadets
I had intended to write something about the strange empirics in this paper on the supposed dangers of our fiscal path, but then I figured that others, and certainly Paul Krugman, would take up the task, and I was right. So no additional criticisms.
Nevertheless, the issue of US fiscal space is too important to be left to the ideologically blinkered. (There is no other explanation for the crude methods employed in Crunch Time.) No country’s fiscal space is unlimited, not even ours—or Japan’s for that matter. Here are four points to bear in mind.
1. The US borrows in its own currency, so it can’t be compared to countries that don’t. This is the core of the many published critiques of Crunch Time.
2. A second consideration is whether a country is a chronic surplus accumulator or deficit secreter. Japan, for instance, has had decades of surpluses (we are talking current account here), so there is a vast pool of domestic savings to draw on. Taken in isolation, this call would go against the US: we are the biggest deficit country in history.
3. But the third point is that it also matters whether a country issues a reserve currency—and, in the case of the US, the denomination that accounts for about two-thirds of the global total. As long as the US supplies the world’s primary money it has a lot of leeway to borrow. The dollar’s strength is bolstered by the absence, for the time being, of a credible alternative; in particular, it helps the dollar’s cause that the Eurozone has often resembled a suicide cult.
4. Past experience is no guide at all, because there has never been a situation like this in all of human history. We have a country that has run current account deficits ranging from large to mammoth for decades, that has large domestic debts, public and private, it cannot wind down, but also supplies the dominant reserve currency. We are playing it by ear.
People are right to be worried, but this is not about fiscal deficits per se; the entire edifice of public and private debt in the context of continuing external deficits is unsustainable. I can only speculate, but my guess is that it will all end suddenly, unexpectedly and unpleasantly. 2008 didn’t do the job, so we are headed to another seismic event. Alas.
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I guess the message of this paper (based on those blue v. red dots in Krugman's graph) is that if we are dumb enough to have your currency be the Euro (which means the Germans control your monetary policy etc) then a major recession will lead to a fiscal crisis so your interest rate shoots up meaning you're doomed. But if you adopt a floating exchange rate regime (those red dots) none of what these authors note empirically for the Euro nations necessarily applies. Don't get me wrong - this is an interesting paper but their empirical work needs a lot of revisiting.
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