This FT article reports on two letters it publishes today (the article provides links to the letters) which argue against a more aggressive approach to fiscal consolidation.
Category: Fiscal Policy
In this letter to the Sunday Times, a group of economists call for a credible medium-term fiscal consolidation plan for the UK.
The signatories are listed below:
Tim Besley, Sir Howard Davies, Charles Goodhart, Albert Marcet, Christopher Pissarides and Danny Quah, London School of Economics;
Meghnad Desai and Andrew Turnbull, House of Lords;
Orazio Attanasio and Costas Meghir, University College London;
Sir John Vickers, Oxford University;
John Muellbauer, Nuffield College, Oxford;
David Newbery and Hashem Pesaran, Cambridge University;
Ken Rogoff, Harvard University;
Thomas Sargent, New York University;
Anne Sibert, Birkbeck College, University of London;
Michael Wickens, University of York and Cardiff Business School;
Roger Bootle, Capital Economics;
Bridget Rosewell, GLA and Volterra Consulting
With all the talk about debt crises last weeek, it is easy to forget that there is a real economic crisis afflicting Europe as well. The 4th quarter GDP numbers were disappointing, and the fact that Eurozone industrial output fell 1.7% in December is alarming. Unemployment is still rising, and the real Eurozone economy is not out of the woods yet. A primary focus of economic policy still needs to be the avoidance of a double dip.
The fact that little Ireland is having to cut expenditure and raise taxes at a time like this will further worsen our own economic problems, but is of no broader consequence. How many Irish people have even noticed what is happening in Latvia? The same could be said of Greece. But if the entire periphery found itself having to fight market panic by cutting in an excessive fashion, simultaneously, that could be very dangerous — especially if Spain, or, God forbid, Italy, became involved as well.
Martin Wolf is very good on this, while those of you of a more temperamental disposition may enjoy Simon Johnson’s latest piece, with Peter Boone. The core Eurozone countries don’t just have to ward off self-fulfilling market panics focussed on the PIIGS, but continue to support aggregate demand in the Eurozone. I understand concerns about government debt, but people focussed on that problem should remember three things. First, deficits will continue to rise if the real economy worsens, and a lack of aggregate demand is still a problem for the real economy. Second, the more the ECB does to loosen monetary policy, the less is the burden which fiscal policy has to shoulder. And third, if we experience another year like 2008-2009 any time soon, the probability of a wave of defaults will rise sharply.
There is an extensive interview with Olivier Blanchard on the IMF website, and a link to his recent paper on the future of macroeconomic policy making (co-authored with Giovanni Dell’Ariccia and Paolo Mairo), here. I can see this one ending up on lots of undergraduate reading lists.
Update: Krugman likes the paper, which makes sense. He alo cites a completely different argument in favour of moderate levels of inflation, which made quite a splash a few years ago: given that it is hard to cut nominal wages, inflation can be very useful in lowering real wages, when that is what is required.
Real wage reductions are required in Ireland, but nominal wage reductions remain elusive here, despite the spin. Can anyone doubt that Irish real wage adjustment would be easier if we could rely on higher inflation rates to do the bulk of the work?
I’ve been following the news stories on the proposed potential Greek bailout. However, reading articles like this, I’m struggling to find a good rationale for the agreement that’s been reached. The following questions come to mind:
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Greece needs to address its huge fiscal problems. To do this will require putting through highly unpopular measures. How does the EU’s offer of a potential bailout help get this achieved? How does the Greek government convince its people that harsh measures are required to reduce its deficit and keep open its access to sovereign debt markets when they now know that the EU tooth fairy is waiting by to help?
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Even if the senior figures in the leading EU countries have ultimately decided to intervene to prevent the disruptions associated with a Greek failure to roll over its debt, why not wait until that failure has happened?
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Why would the EU wish to be associated in the Greek public’s minds with the harsh expenditure cuts and tax increases that would still have to follow even after a bailout deal?
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Do those who advocate this policy really believe that the current Greek crisis is sui generis or are they planning to put in place a safety net for the whole Euro zone? If the latter, can such a policy really be credible?
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Is the long-run macroeconomic stability of the Euro area better served by avoiding the dislocations associated with one its constituent members going through a sovereign debt default or should we be more concerned about the problems created by the new bailout mechanism that lets governments know that the EU will intervene if they choose not to tackle their fiscal crises?
I feel that in asking these questions, I’ve clearly been missing something. Hopefully those who thrashed out this deal have thought these issues through. My concern is that in the somewhat fevered quasi-crisis atmosphere of this week, precedents may be getting set that we will live to regret.
Update: To be honest, I probably should have linked to this hand-wringing Times editorial as a better illustration of what I’m confused about. The editorial worries about “depressing the value of the euro” (which would in fact be a good thing for the Euro area economy) and discusses how this “raises major doubts about the future of the single currency” without explaining why this is the case. The piece ends with the dramatic note of “The European Union remains on alert and on financial standby.” It does make one wonder a little whether this issue is being hijacked somewhat by those who see “Europe” as the solution to most ills.