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1. Εθνικό και Καποδιστριακό Πανεπιστήμιο ΑθηνώνΜεταπτυχιακό Πρόγραμμα Σπουδών «Εφαρμοσμένης Οικονομικής και Χρηματοοικονομικής»Μάθημα: Αναπτυξιακά Θέματα Αιχμής της Ελληνικής Οικονομίας Ακαδημαϊκό έτος: 2013-2014 Διδάσκων: Π.Ε. Πετράκης Γραφείο: Σταδίου 5, (Γραφείο 110) Ώρες γραφείου:Τρίτη 16:00-17:00 Τηλέφωνο: 210-3689353 E-mail: ppetrak@econ.uoa.gr

2. Διάλεξη 3η και 4η

   The Developed World’s Great Recession and the Great Depression of the Greek Economy Two Parts: 17-24/2/2014
3. Part A. The Developed World’s Great Recession Overview B. Eichengreen, K. O’Rourke (2010) What do the new data tell us?, 8 March 2010, voxeu.org J. Bradford DeLong (2013) The Great Depression from the perspective of today, NBER N. Crafts (2013) The eurozone: if only it were the 1930s, 13 December 2013, voxeu.org The Great Moderation B. Bernanke (2004) The Great Moderation, Remarks by Governor Ben S. Bernanke At the meetings of the Eastern Economic Association, Washington, DC, February 20, 2004 O. Blanchard, J. Simon (2001) The long and large decline in U.S. output volatility, MIT Department of Economics Working Paper No 01-29 Bubbles A Greenspan (2004) The mortgage market and consumer debt, At America’s Community Bankers Annual Convention, Washington, D.C.October 19, 2004. P McCulley (2009) The shadow banking system and the Hyman’s MnskyEconomic Journey, PIMCO Global Central Banks Focus, May 2009. FCIC Report (2011) The boom and bust, part III.
4. Crisis Models D. Diamond (2007) Banks and Liquidity Creation, Economic Quarterly—Volume 93, Number 2. G. Gorton (2009) Slapped in the Face by the Invisible Hand: Banking and the Panic of 2007, Prepared for the Federal Reserve Bank of Atlanta’s 2009 Financial Markets Conference: Financial Innovation and Crisis, May 11-13, 2009 B. Bernanke (2013) The crisis as a classic financial panic, At the Fourteenth Jacques Polak Annual Research Conference, Washington, D.C. November 8, 2013 The Panic Financial Crisis Inquiry Commission (2011) Causes of the Financial and Economic Crisis in the United States,Crisis and panic, part IV Bailout CONGRESSIONAL OVERSIGHT PANEL (2011) TARP Report The final report of the congressional oversight panel Stimulus C. Romer, J. Bernstein (2009) The job impact of the American recovery and reinvestment plan CBO (2013) Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic Output from October 2012 Through December 2012 War Among the Economists P. Krugman (2009) How Did Economists Get It So Wrong? NYT, September 2, 2009 E. Fama (2009) Bailouts and Stimulus Plans, Fama/French Forum. J. Cochrane (2009) Fiscal Stimulus, Fiscal Inflation, or Fiscal Fallacies?
5. The Euro and the European Crisis European Commission (2008) EMU@10 Successes and challenges after ten years of Economic and Monetary Union, European Economy 2|2008 K. O’ Rourke, A Taylor (2013) Cross of Euros, Journal of Economic Perspectives—Volume 27, Number 3 O. Accominotti, B. Eichengreen (2013) The mother of all sudden stops: Capital flows and reversals in Europe, 1919-1932, voxeu.org, 14 September 2013 Austerity Debates I: Short-run Effects P. Krugman (2010) Myths of Austerity, Opinion, NYT, July 1 2010 A. Alesina, S. Ardagna (2009) Large Changes in Fiscal Policy: Taxes Versus Spending, NBER Working Paper No. 15438 O. Blanchard, D Leigh (2013) Growth Forecast Errors and Fiscal Multipliers, IMF Austerity Debates II: Debt D. Greenlaw, J. Hamilton, P. Hooper, F.Mishkin (2013) Crunch Time: Fiscal Crises and the Role of Monetary Policy, U.S. Monetary Policy Forum, New York City, February 22, 2013 P. De Grauwe (2011) The Governance of a Fragile Eurozone J. Cassidy (2013) The Reinhart and Rogoff Controversy: A Summing Up, The New Yorker, 29 April 2013
6. Monetary Debates M. Feldstein (2009) Feldstein: Inflation is Looming, Economist’s view, 19 April 2009 P. Krugman (2011) This Age of Hicks, The Conscience of a liberal, NYT, 22 July 2011 P. Krugman (2012) Woodford on Monetary Policy, The Conscience of a liberal, NYT, 1 September 2012 Unemployment: Structural or Cyclical? E Lazear, J. Spletzer (2012) The United States Labor Market: Status Quo or A New Normal?, U.S. Census Bureau Hysteresis B. DeLong, L. Summers (2012) Fiscal Policy in a Depressed Economy, Brookings Papers on Economic Activity, Spring 2012 D. Reifschneider, W. Wascher, D. Wilcox (2013) Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy, Paper presented at the 14th Jacques Polak Annual Research Conference Hosted by the International Monetary Fund
7. Part A. The Developed World’s Great Recession
8. What do the new data tell us?Barry Eichengreen, Kevin Hjortshøj O’Rourke, 8 March 2010 Global industrial production continues to recover – something for which policy deserves considerable credit. World trade also continues to recover but remains 8% below its previous peak. The world is currently undergoing an economic shock every bit as big as the Great Depression shock of 1929-30. Looking just at the US leads one to overlook how alarming the current situation is even in comparison with 1929-30.The good news, of course, is that the policy response is very different. The question now is whether that policy response will work.
9. “The Great Depression from the perspective of today”J. Bradford DeLong, September 2013 The past six years have seen an interesting dual shift in economics and economic history. Six years ago economists were a highly confident, aggressive, and arrogant bunch. We believed that we understood how modern market economies worked. We believed that we knew how to keep them running with both low and stable inflation and at fairly high levels of prosperity, relative to their technological productive potential. We were wrong, as we have discovered over the past six years as people attempted to do economic policy, that we had misjudged how to reliably keep economies running at a high level of prosperity. And we had misjudged how to reliably keep economies running at a high level of prosperity because we had misjudged what the Great Depression was. The fact that we had a faulty vision of the Great Depression was a caused of the policy errors and macroeconomic disaster of our day, And the fact that following the policy course that we did not cure the problems of today has led us to revise our view of the Great Depression. Thus we were doubly wrong, but now--we hope--we have it right. So what should be done next time? There certainly will be a next time. The successful examples of rapid recovery from the Great Depression do say that what you need are: expectations of somewhat higher inflation large-scale government deficit spending Perhaps loan guarantees.
10. The Eurozone: If only it were the 1930s Nicholas Crafts, 13 December 2013 The legacy of public debt resulting from the crisis in the Eurozone is a serious threat. Both the size of the problem and the options to address it make life much more difficult for policymakers than was the case in the late 1930s after the collapse of the gold standard. For some countries, a ‘subservient’ central bank might be preferable to the ECB. How can the legacy of high debt-to-GDP ratios be addressed in a less damaging way (Crafts 2013b)? As the interwar experience underlines, a key starting point is for the ECB to ensure there is no price deflation in the Eurozone. Then, the alternatives to fiscal consolidation as a means of reducing public debt ratios are well known, namely, financial repression, debt forgiveness, or debt restructuring/default. Financial repression works on the interest rate/growth rate differential by way of the government being able to borrow at ‘below-market’ rates. Current EU rules severely limit the scope for this. History suggests that a combination of financial regulations designed for the purpose, the re-introduction of capital controls, and a central bank willing to subvert monetary policy in the interests of debt management might be required. Debt forgiveness would be very expensive for the creditors – forgiving a quarter of the debts of Greece, Ireland, Portugal, Italy, and Spain would cost about €1,200 billion – and, in the absence of watertight fiscal rules to prevent a repeat, risks a serious moral hazard problem. Paris and Wyplosz (2013) suggest that forgiveness could, however, play a part if the ECB were to buy up government debt in exchange for perpetual interest-free loans – in effect monetising part of the debt.
11. IS-LMentaryP. Krugman, October 9, 2011 My favorite of these approaches is to think of IS-LM as a way to reconcile two seemingly incompatible views about what determines interest rates. One view says that the interest rate is determined by the supply of and demand for savings – the “loanable funds” approach. The other says that the interest rate is determined by the tradeoff between bonds, which pay interest, and money, which doesn’t, but which you can use for transactions and therefore has special value due to its liquidity – the “liquidity preference” approach. (Yes, some money-like things pay interest, but normally not as much as less liquid assets.) Yes, IS-LM simplifies things a lot, and can’t be taken as the final word. But it has done what good economic models are supposed to do: make sense of what we see, and make highly useful predictions about what would happen in unusual circumstances. Economists who understand IS-LM have done vastly better in tracking our current crisis than people who don’t.
12. 2. The Great Moderation
13. The Great ModerationBen S. Bernanke, February 20 2004 The Great Moderation, the substantial decline in macroeconomic volatility over the past twenty years, is a striking economic development. Whether the dominant cause of the Great Moderation is structural change, improved monetary policy, or simply good luck is an important question about which no consensus has yet formed. I have argued today that improved monetary policy has likely made an important contribution not only to the reduced volatility of inflation (which is not particularly controversial) but to the reduced volatility of output as well. Moreover, because a change in the monetary policy regime has pervasive effects, I have suggested that some of the effects of improved monetary policies may have been misidentified as exogenous changes in economic structure or in the distribution of economic shocks. This conclusion on my part makes me optimistic for the future, because I am confident that monetary policymakers will not forget the lessons of the 1970s.
14. The long and large decline in U.S. output volatilityOlivier Blanchard, John Simon, April 2001 The last two U.S. expansions have been unusually long. One view is that this is the result of luck, of an absence of major adverse shocks over the last twenty years. We argue that more is at work, namely a large underlying decline in output volatility. This decline is not a recent development, but rather a steady one, starting in the 1950s, interrupted in the 1970s and early 1980s, with a return to trend in the late 1980s and the 1990s. The standard deviation of quarterly output growth has declined by a factor of 3 over the period. This is more than enough to account for the increased length of expansions. We reach two other conclusions. First, the trend decrease can be traced to a number of proximate causes, from a decrease in the volatility in government spending early on, to a decrease in consumption and investment volatility throughout the period, to a change in the sign of the correlation between inventory investment and sales in the last decade. Second, there is a strong relation between movements in output volatility and infation volatility. This association accounts for the interruption of the trend decline in output volatility in the 1970s and early 1980s.
15. 3. Bubbles
16. The mortgage market and consumer debtAlan Greenspan, October 19 2004 Housing price bubbles presuppose an ability of market participants to trade properties as they speculate about the future. But upon sale of a house, homeowners must move and live elsewhere. This necessity, as well as large transaction costs, are significant impediments to speculative trading and an important restraint on the development of price bubbles. Although some broader macroeconomic measures of household debt quality do not paint as favorable a picture as do the data on loan delinquencies at commercial banks and thrifts, household finances appears to be in reasonably good shape. There are, however, pockets of severe stress within the household sector that remain a concern and we need to be mindful of the difficulties these households face. In addition, a significant decline in consumer incomes or house prices could quickly alter the outlook; nonetheless, both scenarios appear unlikely in the quarters immediately ahead. If lenders, including community bankers, continue their prudent lending practices, household financial conditions should be all the more likely to weather future challenges.
17. The Shadow banking system and the Hyman’s Minsky Economic JourneyPaul McCulley, May 2009 Minsky moment: a sudden major collapse of asset values. As we look for answers about the current financial crisis, it is clear that creative financing played a massive role in propelling the global financial system to hazy new heights.-before leading the way into the depths of a systematic crisis. Perhaps the most lucid framework for understanding this progression comes from the work of Minsky whose theory on the nature of financial instability proved unnervingly prescient in explaining the rise and the fall of shadow banking. Minsky’s Hypothesis richly explains the endemic boom-bust cycles of capitalism, including the bubbles in property prices, mortgage finances and shadow banking that characterize the current bust. Minsky’s insight that financial capitalism is inherently and endogenously given to bubbles and busts is not just right, but spectacularly right. We have much to learn and relearn from the great man as we collectively restore prudential common sense to bank regulation.
18. The boom and bustFCIC report, part III There was untrammeled growth in risky mortgages. Unsustainable, toxic loans polluted the financial system and fueled the housing bubble. Subprime lending was supported in significant ways by major financial institutions. Some firms, such as Citigroup, Lehman Brothers, and Morgan Stanley, acquired subprime lenders. In addition, major financial institutions facilitated the growth in subprime mortgage–lending companies with lines of credit, securitization, purchase guarantees and other mechanisms. Regulators failed to rein in risky home mortgage lending. In particular, the Federal Reserve failed to meet its statutory obligation to establish and maintain prudent mortgage lending standards and to protect against predatory lending.
19. 4. Crisis Models
20. Banks and Liquidity CreationDouglas W. Diamond, Spring 2007 Investors face an uncertain horizon to hold the asset. A motivation for a large demand for liquid assets comes from an entrepreneur who may have a sudden need to fund a very high return project at date 1 (which cannot be funded elsewhere). When assets are illiquid and risk-averse investors do not know when they will need to liquidate, the bank can create a more liquid asset that allows investors to share the risk of liquidation losses. Banks can create liquidity by offering deposits that are more liquid than their assets. If only the proper depositors withdraw, it works very well. However, creating this liquidity subjects the bank to bank runs. The bank may have liquidity problems. When there is a demand for more liquid assets from investors or entrepreneurs, demand deposit contracts serve as a means for quick access to liquidity. Demand deposits work very well when investors forecast that banks will survive, but can cause severe damage if investors lose faith in banks. There is scope for banks to write more refined contracts, such as deposits with suspension of convertibility of deposits to cash. In addition, there may be a role for government policies to eliminate self-fulfilling runs on banks. The government plays a role because its taxation authority is not available to private firms.
21. Slapped in the Face by the Invisible Hand: Banking and the Panic of 2007Gary Gorton, May 9 2009 The “shadow banking system,” at the heart of the current credit crisis is, in fact, a real banking system – and is vulnerable to a banking panic. Indeed, the events starting in August 2007 are a banking panic. A banking panic is a systemic event because the banking system cannot honor its obligations and is insolvent. Unlike the historical banking panics of the 19th and early 20th centuries, the current banking panic is a wholesale panic, not a retail panic. In the earlier episodes, depositors ran to their banks and demanded cash in exchange for their checking accounts. Unable to meet those demands, the banking system became insolvent. The current panic involved financial firms “running” on other financial firms by not renewing sale and repurchase agreements (repo) or increasing the repo margin (“haircut”), forcing massive deleveraging, and resulting in the banking system being insolvent. The earlier episodes have many features in common with the current crisis, and examination of history can help understand the current situation and guide thoughts about reform of bank regulation. New regulation can facilitate the functioning of the shadow banking system, making it less vulnerable to panic.
22. The Crisis as a Classic Financial PanicBen S. Bernanke, November 8 2013 Like many other financial panics, including the most recent one, the Panic of 1907 took place while the economy was weakening. The recent crisis echoed many aspects of the 1907 panic. Like most crises, the recent episode had an identifiable trigger--in this case, the growing realization by market participants that subprime mortgages and certain other credits were seriously deficient in their underwriting and disclosures. As the economy slowed and housing prices declined, diverse financial institutions, including many of the largest and most internationally active firms, suffered credit losses that were clearly large but also hard for outsiders to assess. Pervasive uncertainty about the size and incidence of losses in turn led to sharp withdrawals of short-term funding from a wide range of institutions; these funding pressures precipitated fire sales, which contributed to sharp declines in asset prices and further losses. Institutional changes over the past century were reflected in differences in the types of funding that ran: In 1907, in the absence of deposit insurance, retail deposits were much more prone to run, whereas in 2008, most withdrawals were of uninsured wholesale funding, in the form of commercial paper, repurchase agreements, and securities lending. Interestingly, a steep decline in interbank lending, a form of wholesale funding, was important in both episodes. Also interesting is that the 1907 panic involved institutions--the trust companies--that faced relatively less regulation, which probably contributed to their rapid growth in the years leading up to the panic. In analogous fashion, in the recent crisis, much of the panic occurred outside the perimeter of traditional bank regulation, in the so-called shadow banking sector.
23. 5. The Panic
24. Crisis and panic FCIC report, part IV As massive losses spread throughout the financial system in the fall of 2008, many institutions failed, or would have failed but for government bailouts. As panic gripped the market, credit markets seized up, trading ground to a halt, and the stock market plunged. Lack of transparency contributed greatly to the crisis: the exposures of financial institutions to risky mortgage assets and other potential losses were unknown to market participants, and indeed many firms did not know their own exposures. The scale and nature of the over-the-counter (OTC) derivatives market created significant systemic risk throughout the financial system and helped fuel the panic in the fall of 2008: millions of contracts in this opaque and deregulated market created interconnections among a vast web of financial institutions through counterparty credit risk, thus exposing the system to a contagion of spreading losses and defaults. Enormous positions concentrated in the hands of systemically significant institutions that were major OTC derivatives dealers added to uncertainty in the market. The “bank runs” on these institutions included runs on their derivatives operations through novations, collateral demands, and refusals to act as counterparties.
25. 6. Bailout
26. TARP reportMarch 2011 On October 3, 2008, in response to rapidly deteriorating financial market conditions, Congress and the President created the Troubled Asset Relief Program (TARP) to ‘‘immediately provide authority and facilities that the Secretary of the Treasury can use to restore liquidity and stability to the financial system of the United States.’’ It is now clear that, although America has endured a wrenching recession, it has not experienced a second Great Depression. The TARP does not deserve full credit for this outcome, but it provided critical support to markets at a moment of profound uncertainty. It achieved this effect in part by providing capital to banks but, more significantly, by demonstrating that the United States would take any action necessary to prevent the collapse of its financial system. By protecting very large banks from insolvency and collapse, the TARP created moral hazard: very large financial institutions may now rationally decide to take inflated risks because they expect that, if their gamble fails, taxpayers will bear the loss. Ironically, these inflated risks may create even greater systemic risk and increase the likelihood of future crises and bailouts.
27. 7. Stimulus
28. The job impact of the American recovery and reinvestment planRomer-Bernstein, January 9 2009 • A package in the range that the President-Elect has discussed is expected to create between three and four million jobs by the end of 2010. • Tax cuts, especially temporary ones, and fiscal relief to the states are likely to create fewer jobs than direct increases in government purchases. However, because there is a limit on how much government investment can be carried out efficiently in a short time frame, and because tax cuts and state relief can be implemented quickly, they are crucial elements of any package aimed at easing economic distress quickly. • Certain industries, such as construction and manufacturing, are likely to experience particularly strong job growth under a recovery package that includes an emphasis on infrastructure, energy, and school repair. But, the more general stimulative measures, such as a middle class tax cut and fiscal relief to the states, as well as the feedback effects of greater employment in key industries, mean that jobs are likely to be created in all sectors of the economy. • More than 90 percent of the jobs created are likely to be in the private sector. Many of the government jobs are likely to be professionals whose jobs are saved from state and local budget cuts by state fiscal relief. • A package is likely to create jobs paying a range of wages. It is also likely to move many workers from part-time to full-time work.
29. Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic Output from October 2012 Through December 2012CBO, February 2013 In total, CBO estimates that ARRA will increase budget deficits by about $830 billion over the 2009–2019 period. By CBO’s estimate, close to half of that impact occurred in fiscal year 2010, and more than 90 percent of ARRA’s budgetary impact was realized by the end of December 2012. CBO estimates that, compared with what would have occurred otherwise, for 2012 as a whole, ARRA: - Raised real GDP by between 0.1 percent and 0.8 percent, - Lowered the unemployment rate by between 0.1 and 0.6 percentage points, - Increased the number of people employed by between 0.2 million and 1.1 million, and - Increased the number of FTE jobs by between 0.2 million and 1.3 million.
30. 8. War Among the Economists
31. How Did Economists Get It So Wrong?P. Krugman, September 2, 2009 It’s hard to believe now, but not long ago economists were congratulating themselves over the success of their field. Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems. More important was the profession’s blindness to the very possibility of catastrophic failures in a market economy. As I see it, the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth. Until the Great Depression, most economists clung to a vision of capitalism as a perfect or nearly perfect system. Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. So here’s what I think economists have to do. First, they have to face up to the inconvenient reality that financial markets fall far short of perfection, that they are subject to extraordinary delusions and the madness of crowds. Second, they have to admit — and this will be very hard for the people who giggled and whispered over Keynes — that Keynesian economics remains the best framework we have for making sense of recessions and depressions. Third, they’ll have to do their best to incorporate the realities of finance into macroeconomics.
32. Bailouts and Stimulus PlansE. Fama, January 2009 Government bailouts and stimulus plans seem attractive when there are idle resources - unemployment. Unfortunately, bailouts and stimulus plans are not a cure. Even when there are lots of idle workers, government bailouts and stimulus plans are not likely to add to employment. The reason is that bailouts and stimulus plans must be financed. The additional government debt means that existing current resources just move from one use to another, from private investment to government investment or from investment to consumption, with no effect on total current resources in the system or on total employment. And stimulus plans only enhance future incomes when they move current resources from less productive private uses to more productive government uses - a daunting challenge, to say the least.
33. Fiscal Stimulus, Fiscal Inflation, or Fiscal Fallacies?John H. Cochrane, February 2009 There is a plausible diagnosis and a logically consistent argument under which fiscal stimulus could help: We are experiencing a strong portfolio, precautionary, and technical demand for government debt, along with a credit crunch. People want to hold less private debt and they want to save, and they want to hold Treasuries, money, or government-guaranteed debt. However, this demand can be satisfied in far greater quantity, much more quickly, much more reversibly, and without the danger of a fiscal collapse and inflation down the road, if the Fed and Treasury were simply to expand their operations of issuing treasury debt and money in exchange for high-quality private debt and especially new securitized debt. Fiscal stimulus can be great politics, at least in the short run. The beneficiaries of government largesse know who wrote them a check. The businesses and consumers who end up getting less credit, and the businesses that can’t sell them products, can only blame “the crisis,” and call up their congressmen to get their own stimulus. Roosevelt understood this, and his biggest stimulus came as political support was flagging. But President Obama has such widespread support, he doesn’t have to buy votes any time soon.
34. 9. The Euro and the European Crisis
35. EMU@10 Successes and challenges after ten years of Economic and Monetary Union EC, EUROPEAN ECONOMY 2|2008 While the euro is a clear success, so far it has fallen short of some initial expectations. Output and particularly productivity growth have been below those of other developed economies and concerns about the fairness of income and wealth distribution have grown. At around 2% per annum, potential growth remains too low. Moreover, there have been substantial and lasting differences across countries in terms of inflation and unit labour costs. As an international currency the euro is a major asset for all euro-area members and for the EU at large. However, the lack of a clear international strategy and the absence of a strong voice in international fora implies costs for the euro-area in an increasingly globalised world. Finally, the public image of the euro does not fully reflect EMU's successful economic performance.
36. Cross of EurosKevin H. O’Rourke and Alan M. Taylor, Summer 2013 The eurozone crisis gives rise to three questions. First what macroeconomic policy mix is consistent with running a diverse monetary union involving 17 independent nation states? More specifically, what policy mix will be required to ensure that the adjustment problems that countries like Greece and Spain now face can be successfully overcome and that the eurozone does not collapse in the short to medium run? Second, what is the minimum institutional framework consistent with the survival of the eurozone in the medium to long run? If macroeconomic adjustment problems cannot be overcome in the shorter run, and if necessary institutional reforms cannot be delivered in the longer run, then a third question becomes potentially relevant: how can the costs of a eurozone break-up be minimized? The fact that the eurozone scores so poorly on optimal currency area grounds suggests a need for mechanisms allowing smoother and more symmetric adjustment between its members. Moves to enhance labor mobility, for example by improving pension or health insurance portability, can help—but, we suspect, only to a limited extent. A stronger fiscal center as in the United States is desirable, but there seems little prospect of this; thus, member states will have to engage in countercyclical fiscal policy, if at all, by themselves. For some countries, the size of their existing debts means that debt restructuring will be required for them to regain the ability to do this (Wyplosz 2012).
37. The mother of all sudden stops: Capital flows and reversals in Europe, 1919-1932 Olivier Accominotti, Barry Eichengreen, 14 September 2013 The parallels between capital flow surges and reversals in Europe in the periods leading up to the two great financial crises of the modern era, the Great Depression and the Global Credit Crisis, are more than skin deep. In both periods there was a flood of capital from one half of Europe to the other, as well as to the continent’s recipient half from the rest of the world. There was neglect by lenders of public debt burdens and their implications for credit worthiness during the boom and then the sudden rediscovery of sovereign risk once capital dried up. In both periods, countries that imported foreign finance most liberally during the boom suffered the largest reversal and most serious dislocations when the surge of capital inflows came to an end. But recipient-country characteristics explain only a part of trends and fluctuations in private long-term capital flows in the 1920s and early 1930s. At least as important were conditions in international capital markets. Among the important factors there was the level of interest rates, as emphasised in a host of earlier studies, but also perceptions of the riskiness of the investment environment, as captured by the volatility of equity prices, the same proxy utilised in studies of the recent period. Interwar experience thus underscores the extent to which global factors largely exogenous to conditions in the borrowing countries shaped the capital inflows and outflows to which European countries were subject. This was a precedent of which European countries in the period leading up to subprime/global credit crisis of 2007-8 could have usefully taken heed.
38. 10. Austerity Debates I: Short-run Effects
39. Liquidity preference, loanable funds, and Niall Ferguson (wonkish)P. Krugman, May 2009 So what determines the level of GDP, and hence also ties down the interest rate? The answer is that you need to add “liquidity preference”, the supply and demand for money. In the modern world, we often take a shortcut and just assume that the central bank adjusts the money supply so as to achieve a target interest rate, in effect choosing a point on the IS curve. Which brings us to the current state of affairs. Right now the interest rate that the Fed can choose is essentially zero, but that’s not enough to achieve full employment. So what does government borrowing do? It gives some of those excess savings a place to go — and in the process expands overall demand, and hence GDP. It does NOT crowd out private spending, at least not until the excess supply of savings has been sopped up, which is the same thing as saying not until the economy has escaped from the liquidity trap. Now, there are real problems with large-scale government borrowing — mainly, the effect on the government debt burden. I don’t want to minimize those problems; some countries, such as Ireland, are being forced into fiscal contraction even in the face of severe recession. But the fact remains that our current problem is, in effect, a problem of excess worldwide savings, looking for someplace to go.
40. Myths of AusterityP. Krugman, July 2010 What’s the evidence for the belief that fiscal contraction is actually expansionary, because it improves confidence? (By the way, this is precisely the doctrine expounded by Herbert Hoover in 1932.) Well, there have been historical cases of spending cuts and tax increases followed by economic growth. But as far as I can tell, every one of those examples proves, on closer examination, to be a case in which the negative effects of austerity were offset by other factors, factors not likely to be relevant today. For example, Ireland’s era of austerity-with-growth in the 1980s depended on a drastic move from trade deficit to trade surplus, which isn’t a strategy everyone can pursue at the same time. And current examples of austerity are anything but encouraging. Ireland has been a good soldier in this crisis, grimly implementing savage spending cuts. Its reward has been a Depression-level slump — and financial markets continue to treat it as a serious default risk. Other good soldiers, like Latvia and Estonia, have done even worse — and all three nations have, believe it or not, had worse slumps in output and employment than Iceland, which was forced by the sheer scale of its financial crisis to adopt less orthodox policies.
41. Large Changes in Fiscal Policy: Taxes Versus SpendingAlberto F. Alesina and Silvia Ardagna October 2009 We examine the evidence on episodes of large stances in fiscal policy, both in cases of fiscal stimuli and in that of fiscal adjustments in OECD countries from 1970 to 2007. Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments, those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions. We confirm these results with simple regression analysis. Rather than reviewing again our result it is worth elaborating, or perhaps speculating on the current and future fiscal stance in the US. As we well know a very large portion of the current astronomical 12 percent of GDP deficit is the result of bailout of various types of the financial sector. After the "perfect storm" of this current crisis the US will emerge with an unprecedented (for peace time) increase in government debt. The analysis of the present paper suggests that unless primary spending is cut, it is difficult to achieve fiscal stability because spending may rise faster than tax revenue.
42. Growth Forecast Errors andFiscal MultipliersOlivier Blanchard and Daniel Leigh, IMF 2013 In advanced economies, stronger planned fiscal consolidation has been associated with lower growth than expected, with the relation being particularly strong, both statistically and economically, early in the crisis. A natural interpretation is that fiscal multipliers were substantially higher than implicitly assumed by forecasters. The weaker relation in more recent years may reflect in part learning by forecasters and in part smaller multipliers than in the early years of the crisis. Finally, it is worth emphasizing that deciding on the appropriate stance of fiscal policy requires much more than an assessment regarding the size of short-term fiscal multipliers. Thus, our results should not be construed as arguing for any specific fiscal policy stance in any specific country. In particular, the results do not imply that fiscal consolidation is undesirable. Virtually all advanced economies face the challenge of fiscal adjustment in response to elevated government debt levels and future pressures on public finances from demographic change. The short-term effects of fiscal policy on economic activity are only one of the many factors that need to be considered in determining the appropriate pace of fiscal consolidation for any single country.
43. 11. Austerity Debates II: Debt
44. Crunch Time: Fiscal Crises and the Role of Monetary PolicyDavid Greenlaw, James D. Hamilton, Peter Hooper, Frederic S. MishkinJuly 2013 In the aftermath of the global financial crisis, concerns about fiscal sustainability have come to the forefront in discussions of monetary policy. In this paper, we examined sovereign debt dynamics and concluded that countries with high debt relative to GDP cannot be complacent, even if they currently face low sovereign interest rates. Such countries are always vulnerable to an adverse feedback loop in which high debt leads to higher interest rates and hence higher debt loads, culminating in a tipping point-- or fiscal crunch -- in which the interest rate shoots up. Our empirical work used both econometric analysis and event studies, and suggests that countries with debt above 80% of GDP and persistent current account deficits are vulnerable to a rapid fiscal deterioration as a result of these tipping point dynamics. If long-run fiscal policy consolidation occurs, consistent with a gradual decline in the debt burden, accommodative monetary policy would help counter any potential weakness in the economy. If long-run fiscal policy were shifting in the right direction, consistent with a gradual decline in the debt burden, accommodative monetary policy would be the appropriate response to a weak economy.
45. The Governance of a Fragile EurozoneDe Grauwe, April 2011 When entering a monetary union, member-countries change the nature of their sovereign debt in a fundamental way, i.e. they cease to have control over the currency in which their debt is issued. As a result, financial markets can force these countries’ sovereigns into default. In this sense member countries of a monetary union are downgraded to the status of emerging economies. This makes the monetary union fragile and vulnerable to changing market sentiments. Is also makes it possible that self-fulfilling multiple equilibria arise. The new governance structure (ESM) does not sufficiently recognize this fragility. Some of the features of the new financial assistance are likely to increase this fragility. In addition it is also likely to rip member-countries of their ability to use the automatic stabilizers during a recession. This is surely a step backward in the long history of social progress in Europe.
46. The Reinhart and Rogoff Controversy: A Summing UpJohn Cassidy, April 2013 There may well be a threshold at which high levels of public debt tend to be associated with very bad growth outcomes (as Reinhart and Rogoff claim) and financial crises, but it isn’t ninety per cent of G.D.P., or even a hundred per cent. Maybe it’s a hundred and twenty per cent, although that figure isn’t a firm one, either. Do high debts cause low growth, or vice versa? Theoretically, it could go either way. High levels of public debt, through their impact on interest rates and business confidence, can crowd out private-sector spending and reduce growth. But low growth depresses tax revenues and forces the government to spend more on things like unemployment insurance and food stamps. That increases the budget deficit, which necessitates the issuance of more debt. Whichever way the causation goes, the issue has always been whether there was room for further fiscal stimulus, or whether debt levels were getting so high that further borrowing and spending was likely to be counter-productive. Back in 2010 and 2011, the Keynesians said there was room; the austerians said there wasn’t. Purely on the basis of the corrected Reinhart and Rogoff figures, there was, and is, room. In the United States, the ratio of net debt-to-G.D.P. is seventy-three per cent. In the United Kingdom, it is about the same. In Germany, it is about eighty per cent. In France, it is about ninety per cent.
47. 12. Monetary Debates
48. Feldstein: Inflation is LoomingMartin Feldstein, April 2009 The unprecedented explosion of the US fiscal deficit raises the spectre of high future inflation. There is ample historic evidence of the link between fiscal profligacy and subsequent inflation. But historic evidence and economic analysis also show that the inflationary effects can be avoided if the fiscal deficits are not accompanied by a sustained increase in the money supply and, more generally, by an easing of monetary conditions. So am I worried about inflation? Somewhat, particularly when I hear that the Fed's independence is likely to come under review by congress. Whatever doubts you have about the Fed's commitment and ability to keep inflation low in the future, I have little doubt that congress would choose to monetize the debt when faced with tough choices about how to solve a deficit problem (would congress have done what Volcker did?). I still have faith in the Fed, but as you can see from the government budget constraint above, what the Fed can do is dependent upon the actions of congress. If deficits persist, it could come down to a choice by the Fed to monetize the deficit - and risk inflation - or allow government debt to pile up and risk high interest rates. Volcker chose low inflation over high interest rates when confronted with a similar choice, but it's not completely clear to me at this point what this Fed will do in the same situation, and how much cooperation they can expect from congress in terms of reducing the deficit.
49. This Age of HicksP. Krugman, July 2011 Hicksian theory makes two assertions that are very much at odds with what conventional wisdom suggests: It says that once adverse demand shocks have pushed the economy into a liquidity trap, even very large increases in the monetary base — the sum of currency and bank reserves, which is what the Fed controls — will be basically sterile, leading neither to a boom nor to inflation. 2. It also says that under these conditions even large government borrowing will not crowd out private investment, and will not drive up interest rates.
50. So here’s a picture to illustrate the first point. It shows monetary base and nominal GDP since the recession began; if any kind of quantity theory applied, these should have gone up in tandem. Not quite: Meanwhile, after several trillion of borrowing, the 10-year bond rate is a low, low 2.97%. I can’t tell you how many times, in late 2008 or early 2009, I ran into people — including economists — who scoffed at the notion that either of the Hicksian predictions could really come true. They *knew* that inflation and sharply rising rates were coming any day now; and kept expecting them month after month. So what we have here is, if anyone were willing to notice, a triumph of economic analysis.
51. Woodford on Monetary PolicyP. Krugman, September 2012 The topic is what, if anything, monetary policy can do when interest rates are up against the zero lower bound (or the near-zero lower bound. Woodford devotes the first half of his paper (Methods of Policy Accommodation at the Interest-Rate Lower Bound) to an extended review of the evidence on “forward guidance”, in which central banks signal their future intentions — and finds strong evidence that such talk matters. So his answer is yes, the Fed could boost the economy by making a commitment to hold off on raising interest rates when recovery finally kicks in. But that isn’t what the Fed has mainly done, at least not explicitly. Instead, it has relied on purchases of nonconventional assets (misleadingly billed as quantitative easing or QE), especially long-term debt. Has this been effective? Woodford parses the evidence, and concludes tentatively that most of the apparent effects of QE actually come through the expectations channel — that is, that QE works, to the extent it does, largely because markets see it as a form of forward guidance. So what should the Fed be doing? Woodford concludes that it needs to make a change in its basic policy pronouncements, so as to make them “history-dependent” — that is, it needs to promulgate a view of its intentions that would lead it to be slower to raise rates following a big slump than it would in other circumstances. And let me repeat the past tense: following a big slump, not just when you’re in it.
52. 13. Unemployment: Structural or Cyclical?
53. The United States Labor Market: Status Quo or A New Normal? Edward P. Lazear, James R. Spletzer , October 2012 The recession of 2007-09 witnessed high rates of unemployment that have been slow to recede. This has led many to conclude that structural changes have occurred in the labor market and that the economy will not return to the low rates of unemployment that prevailed in the recent past. Is this true? The question is important because central banks may be able to reduce unemployment that is cyclic in nature, but not that which is structural. An analysis of labor market data suggests that there are no structural changes that can explain movements in unemployment rates over recent years. Neither industrial nor demographic shifts nor a mismatch of skills with job vacancies is behind the increased rates of unemployment. Although mismatch increased during the recession, it retreated at the same rate. The patterns observed are consistent with unemployment being caused by cyclic phenomena that are more pronounced during the current recession than in prior recessions. The analysis in this paper and in others that we review do not provide any compelling evidence that there have been changes in the structure of the labor market that are capable of explaining the pattern of persistently high unemployment rates. The evidence points to primarily cyclic factors.
54. The Beveridge Curve for US
55. 14. Hysteresis
56. Fiscal Policy in a Depressed EconomyDeLong and Summers, 2012 In a depressed economy, with short-term nominal interest rates at their zero lower bound, ample cyclical unemployment, and excess capacity, increased government purchases would be neither offset by the monetary authority raising interest rates nor neutralized by supply-side bottlenecks. Then even a small amount of hysteresis—even a small shadow cast on future potential output by the cyclical downturn—means, by simple arithmetic, that expansionary fiscal policy is likely to be self-financing. Even if it is not, it is highly likely to pass the sensible benefit-cost test of raising the present value of future potential output. Thus, at the zero bound, where the central bank cannot or will not but in any event does not perform its full role in stabilization policy, fiscal policy has the stabilization policy mission that others have convincingly argued it lacks in normal times. The premise of our analysis is that expansionary fiscal policy can be both timely and temporary. Thus, it makes a case only for as much fiscal stimulus as can be delivered in a timely and temporary way. At the zero bound, monetary policy does not change when fiscal policy is altered. Central banks, however, do have room for maneuver, both in their ability to operate directly on a wider range of financial instruments than they use in normal times, and in their ability to precommit policy.
57. Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary PolicyD. Reifschneider, W. Wascher, D. Wilcox, November 1, 2013 The recent financial crisis and ensuing recession appear to have put the productive capacity of the economy on a lower and shallower trajectory than the one that seemed to be in place prior to 2007. Using a version of an unobserved components model introduced by Fleischman and Roberts (2011), we estimate that potential GDP is currently about 7 percent below the trajectory it appeared to be on prior to 2007. We also examine the recent performance of the labor market. While the available indicators are still inconclusive, some indicators suggest that hysteresis should be a more present concern now than it has been during previous periods of economic recovery in the United States. We go on to argue that a significant portion of the recent damage to the supply side of the economy plausibly was endogenous to the weakness in aggregate demand—contrary to the conventional view that policymakers must simply accommodate themselves to aggregate supply conditions. In the labor market, matching efficiency seems to have been somewhat impaired, the natural rate of unemployment appears to have risen somewhat, and trend labor force participation appears to have moved noticeably lower relative to what would have been expected based on pre-crisis trends. Despite this supply-side damage, our point estimates also suggest that the level of economic slack has been and remains quite high. we have also argued that policymakers may appropriately be restrained from pursuing a highly aggressive response to a deep recession if they fear the attendant risks to financial stability, or are concerned that inflation expectations may become unanchored. More generally, the pervasive uncertainty in which policymakers operate may encourage them to proceed with caution.