Today’s exam question

In honour of the fine examination weather we are having these days:

According to this morning’s Eurointelligence,

The Eurogroup will analyze to what extent past imbalances contribute to the current low growth, according to an unnamed Eurogroup official, and also whether Spain’s large current account deficit prior to the crisis can be attributed to the housing bubble, inappropriate banking supervision, or lax credit standards.

Does it make sense to attribute Spain’s current account deficit to Spanish policies alone? Be explicit about the theoretical and empirical assumptions you are making.

34 replies on “Today’s exam question”

Has there ever been a post crash deleveraging with credit rationing that had anything other than low or no growth ? And what did you expect to see from a Torquay bedroom window , Mr Osborne and Mr Rehn ? If the goal of policy is the compensation of creditors that is what will happen . But not growth . Asset prices are only kept going via CB money . Much of it is mar dhea . But the traders need to believe it is all real , God love them.

The recent article by Martin Wolf and his blog comments are pertinent.

This extract from his column in particular.

“If one wants to understand how far the folly goes, one must study the European Commission’s work on macroeconomic imbalances. Its features are revealing. Thus, it takes a current account deficit of 4 per cent of GDP as a sign of imbalance. Yet, for surpluses, the criterion is 6 per cent. Is it an accident that this happens to be Germany’s? Above all, no account is taken of a country’s size in assessing its contribution to imbalances. In this way, Germany’s role is brushed out. Yet its surplus savings create huge difficulties when interest rates are close to zero. Its omission makes this analysis of “imbalances” close to indefensible.”

The difficulty is that the analysis, while correct, butters no bread. The burden of adjustment almost invariably, whether in a domestic or an international context, lies with the debtor.

The fact remains, also, that the most egregious errors were made by the latter, especially in the case of the countries excluded from market access.

There is also the point that any criticisms directed at Germany in respect of the country’s insistence on running a large export and current account surplus must be based on considerations that are justified i.e. deliberate administrative action designed to skew the economy to obtain such a result and/or to restrict access to their domestic market.

Unfortunately, this is a game that all countries of the EU attempt to play as this recent study by Open Europe on the failure to establish a single market in services reveals.

Spain did what was perfectly rational given the organisation of its economy (which lends itself to a growth regime based on domestic demand). It entered the EMU to increase capital inflows and that is precisely what happened. If the government were to have used that capital for more productive investment would require a level of state intervention that most economists would be aghast at (not to mention rules of the single market).


It is not unusual for researchers to stack the deck but it is also foolish to ignore the fact that 75% of the 2012 trade surplus was ex-EU27 and that only 4% of the surplus was with the other 16 EMU members.

On other data of interest, the German employment agency (Bundesagentur für Arbeit) says that in 2012 there was a total of 323,000 households in the country receiving top-up benefits despite having a regular gross monthly income of over €800 – – a rise of 20,000 people from the levels recorded back in 2009. Single-person households were affected most, with a 38% rise. The overwhelming proportion of workers affected worked in the retail sector as well as in the health and social services industries.

BA said that a total of half a million adults are less dependent on government transfer payments since 2008.

In March 2013, a total of 41.5m persons resident in Germany were in employment according to provisional calculations of Destatis.

It does not make sense to attribute Spain’s current account deficit to Spanish policies alone.

In a modern closed economy the vast majority of money exists as the banks’ liabilities. And just as every liability has a corresponding asset, every euro has a corresponding debt. In fact banks don’t record any interest agreed on each debt on their balance sheets and so the economy owes more to banks than exists. Such an economy would not run smoothly because mandatory defaults on loans are inevitable no matter how careful the banks are and no matter how wise borrowers are.

Cue the national debt and net exporting. If a government can borrow and perpetually roll over its debt then any money entering the economy through the national debt can feel like debt-free money. Equally a net exporting country can take in money from abroad while the associated debt stays abroad. Since Spain was a net importer for much of the boom the only source of debt-free money was its national debt. The economy would have been completely unfit for purpose if Spain had tried to run a surplus and we can see the evidence of this today. Working within the constraints of the present system, what more could Spain do to achieve common sense goals like low unemployment, good public services etc? Hence because Spain can’t change the global monetary system by itself it’s not it’s fault that it had to run deficits to make the system fit for purpose (temporarily)

@Kevin O’Rourke

Your question is unhelpful at this time when Spain and the other peripherals are on the path to be forced to take the kind of steps that will lead to a rebalancing of the economy at some point in the future.

Let me rephrase your question so as to incorporate the common sense political realities that all serious people acknowledge.

Given that the current economic situation in Europe is not a systemic crisis of EMU but a collection of simultaneous and unrelated individual crises of poor governance in countries not bordering Germany, and given that ECB monetary policy was impeccable up to the crisis, and given the moral and legal superiority of creditors, what are the cultural, racial and political failings in Spain and other peripheral countries that caused the global financial crisis and are these same flaws preventing the necessary fiscal consolidation from having a beneficial effect?

For extra points, given rational expectations and perfect competition, how did governments cause the global financial crisis?


How do you make out that 75% of the surplus was ex-EU?

It is not true that 75% of all German trade is ex-EU. More like the reverse.

How is it possible to pinpoint the fraction of trade that is “surplus” and then divide that between EU and ex-EU? Any such division into “surplus” and non-surplus is arbitrary and mostly meaningless.

@ Kevin O’Rourke

Does it make sense to attribute Spain’s current account deficit to Spanish policies alone?


Even the US economy cannot be viewed as an island and when Ben Bernanke joined the Fed, he gave attention to the impact of what he called the global ‘savings glut’ in pushing down long-term interest rates. He highlighted the policies of Asian countries led by China, post the 1997/98 financial crisis to boost exports and build up protective reserves by keeping the values of their currencies low.

As for Spain and the level of responsibility of the different local and external groups or policies in a rating from 1 to 100, people usually pick what dovetails with an existing position.

The banks supervised by the Bank of Spain survived while the politically controlled cajas have had the most problems.

The central bank insisted on additional provisioning in 2000. However, Jaime Caruana, the governor, who is currently MD of the Bank for International Settlements, gave into pressure from banks and Europe (there was a change in accounting standards) in 2004 to cut the provisions from 30% of loans to 15% and Spanish bank lending, which was expanding at 14% annual rate, rose 27% in 2005 and an additional 25% in 2006 – – similar rises to Ireland’s.

Spain had a budget surplus in 2007 for the third year in a row – – after 30 years of deficits. Spain and Greece were running current account deficits of about 10% of national income in 2006.

Martin Wolfe wrote in 2012: “In 2008, the IMF, among the world’s most independent and respected official institutions, thought that Spain had run a substantial structural – or cyclically-adjusted – fiscal surplus in 2004, 2005, 2006 and 2007. Now it thinks this had in fact been a substantial structural deficit.”

Who’s to blame?

There were many local ingredients that it shared with Ireland including the control of the planning system.

As for a possible economics study, it would likely be a waste of time.

There are always factors that cannot be measured but what non-economists would view as commonsense and arithmetic, would be good starting points.

@ wt

How is it possible to pinpoint the fraction of trade that is “surplus” and then divide that between EU and ex-EU? Any such division into “surplus” and non-surplus is arbitrary and mostly meaningless.

So all trade data is basically meaningless?

Pinpoint precision in a total of €185bn isn’t necessary in custom data of goods exports and imports by country. Germany has a small services deficit. The Netherlands and Belgium trade data is complicated because they are shipping and air freight hubs for other countries.

Eurostat says statistics are published for each declaring country with respect to each partner country, for several product classifications. Data is usually collected by customs. One of the most commonly used product classifications is the Standard international trade classification (SITC Rev. 4) of the United Nations (UN); this allows a comparison of international trade statistics to be made on a worldwide basis.

In extra-EU trade statistics, the data shown for the EU-27 treat this entity as a single trading block. In other words, the data for exports relate only to those exports from the EU-27 that leave the trading block and are destined for the rest of the world, while extra-EU imports relate to imports from the rest of the world (non-member countries) coming into the EU-27.

In contrast, when reporting data for individual Member States, international trade flows are generally presented in terms of world trade flows (including both intra-EU and extra-EU partners).

More on the German trade surplus…

@Kevin O’Rourke

Be explicit about the theoretical and empirical assumptions you are making.

We are using “common sense” and not any of your decadent and unserious economic theorizing but if it has to be spelled out for you:

* National budgets are just like household budgets and need to be balanced in the short term especially when the supply of money is tight.
* The supply of money needs to be kept tight.
* Independent central banks solely focused on price stability are vital to financial stability.
* High unemployment is not a factor in financial instability.
* Sensible fiscal rules are the only way to guarantee economic stability.
* Fiscal rules must be set within the parameters acceptable to the financial markets.
* The parameters acceptable to the financial markets have not been established but we are pretty sure they want a smaller state. Lets go with that.
* Lending money is a selfless activity (and not lazy).
* Borrowing money is greedy (and not productive).
* The existing set of European Union legislation is sufficient except where they cause economic inefficiencies (like preventing downwards wage adjustment)
* The existing set of European Union legislation is sufficient except where damages economic incentives (like rising rewards for investors).

I may have missed a few Eurorules, but I am sure someone can help me out.

Now there are some other minor assumptions (Say’s law, Ricardian equivalence, the policy ineffectiveness theorem, the strong version of the Efficient Markets Hypothesis and the entire body of new classical economics) but these are all also basically just uncontroversial common sense.)

As for evidence, who are you going to believe, my market state intuition or your lying eyes?

@ MH

With all due respect, you continue to insist on missing the point. The imbalances causing the problem with the euro cannot be reduced to the imbalances in exports of goods and services between Germany and the EA. The difficulty arises from the enormous balances i.e. claims that Germany is building up abroad, often at the expense of other European exporters, and which have to find an investment home, often destablising, somewhere.

Indeed, your own data confirm this.

“In 2011 according to the World Bank, Germany’s goods and services exports were at a ratio of 50% of GDP (gross domestic product) and the ratio was 27% in France; in 2000 the ration were 33% and 29% and in 1991, the first year of German reunification, the ratios were 26% and 22%.

€140bn of Germany’s trade surplus was ex-EU27 or 74.5%; €41bn of the surplus was with non-Eurozone EU countries e.g. UK, Sweden, Poland etc; the surplus with the other 16 Eurozone members was only €7bn.”

It is not a normal situation that a country of 88 million should be the world champion exporter in absolute terms. This did not come about by accident and it will not change by accident but by an a change of policy in Germany to promote a greater level of growth across the entire economy, not just the export sector.

I agree that simplistic explanations should be avoided.

One of them is to ignore, as most macro-economists appear to do, assuming that they are aware of it in the first place, the fact that there are two sides to the balances in question, imports and exports. As The Economist sagely remarked some years ago, Germany appears to have forgotten that the purpose of exports is to pay for imports.

The country’s deficit in services would be much higher if the domestic market was not tied up tighter than a drum.

Incidentally, the FT and, indeed, some German papers, have picked up the Open Europe report.

P.S. The pin-headed reaction of the French representative may be noted.

Shea Begorrah
So you finally dragged this site down towards its nadir…”racial failings”.
Worthy of on a bad day. Sir, your a clown. A racist clown at that.

1. The Open Europe report surprisingly avoids the hot-button issue of massive tax avoidance by giant multinationals which is the biggest roadblock to services progress.

Google, Amazon and Apple have been big beneficiaries of the single market and in their biggest European markets, they pay little or no corporate taxes.

2. On the German surplus issue, unless rises in consumer spending and wages were massive or restrictions were imposed on German companies, there would be little benefit for firms elsewhere in the EMU.

Europe would be the loser.

There are reforms that are overdue in the services area but its manufacturing where its strengths lie and German firms provide a huge number of jobs across Europe.

Contrast that with Apple: 47,000 jobs in the US and Foxconn’s 1m+ army in China.

Internationalisation experience; the products and services, firms size, the number of exporting firms, are all crucial.

I would like to get some estimates at least of a credible solution with account taken of some of the following:

a) Germany has a convergence challenge that takes decades to solve.

Economic convergence moves at a snail’s pace, at best. Even if the weakest German regions were to grow a steady 4 percentage points faster than the strongest regions, it would take them almost half century to catch up.

In 2009, Prof. Hans Werner Sinn, president of the Ifo Institute for Economic Research at the University of Munich wrote on almost 20 years of German reunification: “Germany’s political unification has succeeded; its economic unification has not. Twenty years after the fall of the Berlin wall, GDP per capita in the formerly communist area is 69% of that of the former Federal Republic of Germany including West Berlin. This value sounds better than it is, as it is artificially inflated by civil servants’ wages and salaries, which have reached West German levels. East Germany’s privately produced GDP per capita is only about 66% of the West German level. Moreover, a substantial part of the convergence is explained by West Germany’s slow growth and the outmigration from East Germany.”

b) In an age of stateless income and global companies, individual governments have limited influence. Germany is the only large European country that continues to maintain a strong and persistent presence in high- and medium-high-technology manufacturing.

Emerging markets are already getting more investment from European companies than home markets.

c) The IMF forecasts Germany’s gross government debt at 78% in 2014.

d) In Germany, household final consumption expenditure (formerly private consumption) amounted to 57.6% of GDP in 2012. This equals roughly the average of all Eurozone countries (57.5%). In 2011, France was at 58%; Germany was at 57% according to the World Bank.

e) Bruegel economists estimate that if Italy and Spain had the industrial structure of Germany their exports would grow considerably, mostly because of firm-size effects.

About 90% of European exporters sell their products within the EU, a much smaller proportion sell to distant emerging markets. Even more importantly, in all countries the smaller the firms, the more difficult it is to overcome the rising fixed costs of global operations.

European Commission economists say that French exports are characterized by a lower number of exporting firms and a high level of concentration. With 100,000 exporting companies, about 1 in 20, the share of exporting companies is lower in France than in Germany. Moreover, export volumes tend to be concentrated among a relatively small set of exporting companies. In 2007, the top 10% French exporting firms accounted for 94% of export revenues.

Typically, the German economy exports capital goods. By investing in modern machinery and equipment, the production potential abroad can be increased. Vehicles, machines, electronic devices and chemicals account for more than half of Germany’s exports.

@ MH

Much as I admire your tenacity, there are more red herrings in your reply than could be caught in the North Sea.

The issue is one of balanced development across Europe and this cannot be achieved if countries skew their economies in the manner that Germany has done over the past decade. False analysis such as (i) Germany must reduce her competitiveness or (ii) launch a misplaced i.e. ineffective stimulus programme simply plays into the hands of those forces in Germany insistent on maintaining the status quo; and they are considerable.

When the history of the period comes to be written, the failure of the Commission to act in the area of analysis, policing and tabling of single market proposals will be seen as the most egregious failure of the lot. It has taken a eurosceptic UK think tank to bring this home (and, in the process, shine a spotlight on the total contradiction in the UK position; one cannot spend years decrying “over-regulation” from Brussels and at the same time insist on completing the single market in services).

@Frank Galton

You’re the victim of a trend

Not at all Mr Galton.

Like the workshy Greek, the unrealistic Spaniard, the shifty resident of Cyprus, the undeserving poor (who should either show some initiative or have their labour “activated”, Hartz reform style) and, of course, the gullible Paddy, I am the author of my own misfortune.

If only they were more “North European”, eh?

@ All

Another comment by Martin Wolf of more than passing interest i.e. the debate in the UK on EU membership which seems to be going more and more off the rails.

As he points out;

“Since the UK still sends 46 per cent of its exports of goods and services to the EU, exit would surely put a large proportion of its trade at risk. People focus on what they view as costly immigration. But membership also allows British people to travel, live and work in the EU, freely. That is a huge asset.”

It will certainly come as a bit of a shock to the many “Househunters in the Sun” if they suddenly wake up with the status of third-country citizens. Presumably, Boris Johnson is unconcerned.

The link to Eurointelligence does not provide the quote in the post. A quick search on the internet leads back here. Is there a link?

There seems to be a assumptions in the exam question, about which the guy who drafted the exam question has been far from explicit, that if institution A intends to analyze :

“the extent to which past imbalances contribute to the current low growth,”

Then the answer will be “a lot” and that the answer to:

“whether Spain’s large current account deficit prior to the crisis can be attributed to:

a) the housing bubble,
b) inappropriate banking supervision, or
c) lax credit standards.”

…will be both “yes, and the housing bubble was, in our view entirely the result of Spanish policies”,


that institution A will then go further and declare that:

“we have, by the way, even also considered a number of other factors, outside the control of the Spanish (you know, ECB interest rate policy, trade policies etc) and have worked out that none of them could have contributed to the Spanish current account deficit in any way”.

Otherwise the question doesn’t really seem to make sense.

Would a student be more likely to be marked down, or up, for spotting this, and rude enough to point it out?

@ grumpy

The question is largely pointless. These reviews are now part of a routine while the “collectivity” waits for the appropriate moment i.e. after the German elections to tackle the other side of the coin; the German surplus which is now in excess of 6%, the trigger level, if I am not mistaken. (MH can confirm).


Michael White in top form on Ireland’s “English question”.


The answer to the Spanish question is ;

1 A total misallocation of resources by the banks/cajas-monoline property lenders
2 No risk assessment
3 Inappropriate lending incentives
4 No regulation



I accept that your narrative is the conventional wisdom.

The danger is that in the global market, Europe loses and the demise of Nokia, the only significant European company in consumer electronics, shows that it’s not easy to sustain success at this level.

It can take decades for a company to be successful at internationalisation and selling in emerging markets is different to selling in one’s neighbouring country as many French exporters do.

The US has lost more than 5m jobs in manufacturing since 2000 and despite some hopes, they will not return. The UK has lost more than 3m since 1990 and 1.2m since 2000; France has lost 1.4m and 800,000 since 2000. Germany has lost 3m since 1991 and 600,000 since 2000.

General Motors’ worldwide employment in 1979 was 853,000. Today it is about 202,000 with 80,000 employed in the US. Volkswagen employs 400,000 people across Europe.

General Electric employs 133,000 in the US. Siemens, its global rival, employs almost 200,000 people in Europe.

Manufacturing is important as it maintains a lot of services and in the US, the sector is responsible for 70% of business R&D spending. It is estimated that German manufacturers are responsible for 25% of services exports.

Europe has few leaders in high tech and 40% of Airbus’ procurement is done in the US.

Germany after the US has the biggest annual trade in services.

German exporters are not in the same type of low margin cutthroat business as Lidl and Aldi with millions of low-cost unskilled workers just over the border.

About 345,000 Mittelstand firms export and there are an estimated 1,300 that are market leaders in their niche sectors.

Four-fifths of trainees — more than 1.35m were in apprenticeship with Mittelstand firms in 2010.

During the bubble years Spain was building 700,000 residential units per year,which was greater than the combined total of Germany ,France and Italy. Professor Krugman likened it to Florida which also has a large coastline and is a popular holiday destination. Both Spain and Florida had a massive property bubble.

Below is the elementary property valuation error that bankrupted Spain;
Professor Neil Crosby’s online response to this Irish Independent letter
“Bubble values” 29th February 2012

“The analysis may be simplistic but unfortunately it is not flawed.
Banks ask valuers to tell them what the market value/exchange price is
at a point in time and then lend vast amounts over time based on that
simple number. The surveyor gives them that simple number and do not
think it is their job to tell the banks that the question they have been
asked is stupid on its own and what they should have asked for is the
underlying value. It was obvious in 2005 and 2006 that prices in the
property market were higher than could be sustained by any rational cash
flow analysis. But in a culture that rewards individuals for short term
performance rather than longer term perspective, it was in neither the
bankers’ nor the valuers’ interests to stop it. I cannot see anything in
what the UK regulatory authorities have proposed that makes me think
they understand the role of property valuation in driving asset bubbles
and will prevent it all happening again sometime in the 2020s.”

Neil Crosby
Professor of Real Estate and Planning
University of Reading

John Corcoran – Neil Crosby is quite right to point out the critical and corrupting role of valuers and banks in the property bubble. RICS and other property related professionals should hang their heads in shame for not raising the alarm bells and not challenging landowners, banks and homeowners about the outrageous rise in property valuations which had no relationship with reality or ‘underlying value’. Their role is similar to that of ratings agencies which were paid to sign off triple A ratings by their clients for instruments most of which related to property assets..Sadly it does not require a university professor to point this out.

Anyone with a modicum of experience in property and development knew we were headed for trouble and I am sure I was not the only person to flag it up. If these so called professionals had been held to account by their so called professional bodies ( as the General Medical Council regulates doctors) half of them would have been struck off. Their primary responsibilty should have been to the reputation of the valuation profession and not their commission. In many countries property is taxed and valuers are independent or are part of the state.

Radical reform is required or we will surely revisit this crisis again in the near future.


The picture in the US is not very encouraging beneath the spin .

The S&P index broke 1600 last week on non farm payroll numbers .

S&P companies are sitting on record amounts of cash but they are not putting it to work in productive parts of the economy

Median family income decreased from $54,841 in 2000 to $50,054 in 2011

the change in the nature of work is partly responsible

“During the Great Recession when more than 11 million full-time jobs were lost, there was actually a gain in part timers—so that the reported net loss of jobs, 8.7 million, did not give a full picture of what was happening. Many part-time workers are in especially difficult work environments, with new computerized scheduling programs able to tell bosses the number of workers needed during different days of the week—and even at different times during the day. As a result, many part-timers, especially in retail sales, do not have fixed schedules that they can count on. This makes it more difficult to work at a second part-time job. An additional problem for labor in the current environment is that, of the workers hired during the “recovery” from the Great Recession, over 750,000 of these jobs were supplied by temporary help services, leaving these employees with a precarious hold on their jobs.”

Labour is not going to bring the US back to trend growth .Capital doesn’t appear to be interested.

@MH-ff: Thanks for this: “Manufacturing is important as it maintains a lot of services in _________.

Fill in the gap with the name of the relevant country and tattoo it across the knuckles of every politician, economist and economic commentator. Lest they dis-remember, you understand!

Services do not maintain an economy (they are complements, not substitutes). And what is modern finance? – a bog standard service which has morphed into a gigantic gambling enterprise, and multiple dopey persons assert that we need such to provide economic ‘growth’. So if I aggregate all the gambling activities in Ireland I can, by some mysterious multiplier, achieve ‘growth’? And here was I thinking that gambling was simply an income transfer from the many to the few. At least on the racecourse the excrement is collected and composted. Whereas in financial gambling the excrement (debt) endures – and increases. The winners win, the losers lose – and by way of compensation they get to keep the sh*te!

D-land has been an industrial Black Swan since the 1870s. Ireland is a DIY garden shed.

@ MH

If you consider in more detail what I have been writing, it may strike you that it cannot be described as the conventional wisdom. This is rather contained in this recent article by Barry Eichengreen i.e. a German stimulus in return for various actions by other countries.

The conventional wisdom might also be described as continued attempts to make the reality fit the dominant economic model of the day rather than adapt the model to the reality; in this instance, the fact that (i) a stimulus would have little impact (which you have demonstrated) (ii) it would probably be damaging to the Germany economy if not accompanied by the necessary labour and liberalisation measures and (iii) the Germans will not do it.

My focus is elsewhere i.e. in the area of the necessary structural and single market reforms that will bring about a more balanced economic development. This also seems to be the focus of Berlin for the two European Councils prior to the elections (the topics for the next meeting being energy and the fight against tax evasion).


TARGET balances and balance of payments/ current account issues are different kettles of fish.

Spain’s current account balance has fallen, but Banco Santander’s domestic operations may well have increased reliance on ECB funding.

The UK situation shows that in Europe, it’s not a simple issue of Germany cutting its surplus.

Trade in UK goods has not been in surplus for even a month since 1985.

Sterling on a trade-weighted basis is 24% below the 2007 peak – which should make the economic environment more conducive to UK exporters, as well as pricing some foreign goods out of domestic markets.

Britain has been in overall current account deficit – including services and the balance of investment income – since the mid-1980s, despite the benefit of North Sea oil for some of the period. Its deficit in 2012 was one of the worst since 1948.

Even so, exports of goods have performed better than services since 2008. Its exports to BRIC countries combined have overtaken exports to Ireland but it’s not a big gaisce.

Things are bad in the UK. While Gordy was Chancellor and then PM the Private finance Initiative was the spawn of Satan to people like Boy George. No credibility shifting liabilities onto later cohorts at inflated interest rates. But now that Plan A has hit the buffers and the tories are so anti borrowing they turn to their old object of hate and reformulate PFI for a new generation.

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