My Inet Lecture in Berlin

... due to family reasons, this must have been the shortest trip I ever took, but with 1,600 + hits on youtube on day one, it seems to have hit a nerve:

The whole thing was made more challenging by the (normally highly efficient) INET people not managing to upload my presentation, so that I had to speak without slides or a manuscript. At least, one finds out if one knows one's own stuff...

Austerity and Confidence

Brad Delong has written an excellent VOX piece containing some home truths on austerity, together with a review of the latest writings by Corsetti, Alesina, and Giavazzi:

WILL SPENDING CUTS IMPROVE CONFIDENCE? THE ARITHMETIC PROBABLY GOES THE WRONG WAY
VoxEU: This column is a Lead Commentary on VoxEU's debate on Austerity:In their recent ‘Lead Commentary’, Alesina and Giavazzi (2012) attack Corsetti (2012) for missing the point:
The European debate on fiscal austerity has gone astray – focusing exclusively on the size of deficit reductions. What policy makers should really be focusing on is the budget tightening’s composition (tax versus spending) and on the accompanying policies. Indeed, the title of this Vox debate – “Has austerity gone too far?” – reflects this inappropriate emphasis…
But as I read further, I feel that Alberto Alesina and Francesco Giavazzi immediately proceed to miss an even bigger point. They say:
…spending-based consolidations accompanied by the right polices tend to be less recessionary or even have a positive impact on growth. These accompanying policies include easy money policy…
But right now in Europe we are not going to have easier monetary policies to offset the contractionary effect of fiscal policies, are we?
Indeed, it is not even clear what, in today's context, easier monetary policies would mean.
The ECB could induce banks to make more loans, and fund more investment and consumption spending by credibly promising to raise its permanent inflation target – but it will not so promise, and it would not be believed if it did. The ECB cannot induce banks to make more loans and fund more investment and consumption spending by swapping bonds for reserves as long as the value of pure liquidity is zero and reserves are as good as – nay, better than – short-term bonds. The ECB could induce banks to make more loans and fund more investment and consumption spending by taking risk onto its balance sheet and so freeing-up scarce private risk-bearing capacity – but is that monetary policy? No, that is fiscal policy, albeit non-standard fiscal policy.
Fiscal policy is the only game in town. If austerity is to boost recovery, it must do so because it in itself is good for recovery – not because it is accompanied by monetary policies that speed recovery.
It is certainly the case that a Europe with shaky credit could boost its economy by pursuing a spending-based reduction in its deficit that boosted confidence in public credit. As Karl Smith (2011) of UNC Chapel Hill noted, one way of seeing this is to look at a neo-Wicksellian equilibrium flow-of-funds condition in financial markets. On the left-hand side place the net flow of private savings into a country's financial market: its domestic private savings which depends on the level of economic activity (i.e. Savings[Y]), minus net exports (NX). On the right hand side place the change in the desired bond holdings of banks and other investors, a function of the riskiness of bonds ρ and the real opportunity cost of money to banks, the difference between the nominal interest rate i and the expected inflation rate π, i.e. i.e. ΔB[i - π, ρ]. The resulting neo-Wicksellian equilibrium condition is:
Savings[Y] - NX = Δ Bond_holdings[i - π, ρ]
This equation tells us that the warranted level of domestic private savings – and thus, via savings, the short-term equilibrium level of economic activity Y – can be boosted by: 1) a depreciation that raises NX, 2) monetary policy that reduces i, 3) a commitment to higher future inflation that raises expected inflation π, or 4) policies to reduce the riskiness ρ of the bond stock – by policies like loan guarantees, forced recapitalization of the financial sector, or adoption of a budget strategy that reduces the risk of holding private or public bonds that may be subject to default, less-than-fully-voluntary exchange, or unexpected inflation.
The only stimulus possibleIn a situation where an economy is at the zero lower bound so that i cannot be lowered, a central bank that will not raise π, and a common currency that rules out depreciation to raise NX, reducing the riskiness ρ of the bond stock is the only game in town.
Now a credit-worthy government like the US would have no problem reducing the average riskiness ρ of the bond stock. It would simply issue more bonds and spend the money on projects of social utility. Because its credit is good, its bonds are automatically less risky than the average, and so the average riskiness of the bond stock falls.
And a government with shaky credit that adopts a credible fiscal plan also has no problem reducing the average riskiness ρ of its bond stock. It adopts its plan. Its plan is credible. And, voila, the average riskiness of the bond stock declines – and so the warranted flow of private domestic savings rises, and so the equilibrium level of economic activity rises as well.
What makes a fiscal plan credible?But what is a credible fiscal plan? It certainly involves in the long-run balancing the funding requirements of the promised social insurance system with taxes. But what does a credible fiscal plan require in the short run? Does it require austerity now, and spending cuts now?
The point of Lawrence H. Summers's and my contribution to the spring 2012 Brookings Institution Panel on Economic Activity was that, as a matter of basic arithmetic, if there is any short-term Keynesian multiplier at all – even one as low as 1/2 – and if there is any long-run shadow cast on potential output by a deeper economic downturn at all – even one as low as 1/10 – then for a country like those of western Europe with a marginal tax-and-transfer share 0.4 and an expected long-run growth rate of 2% per year, short-term spending cuts worsen the long-run fiscal picture as long as the government's real long-term borrowing cost is under 5%.[1]
Thus, unless we believe that the long-term real borrowing costs for western Europe as a whole will be more than 5% per year – that nominal borrowing costs will be more than 7% year – spending cuts now to reduce the deficit are likely to erode rather than bolster the overall fiscal situation. They damage rather than restore confidence. They raise rather than lower the riskiness of the outstanding bond stock. And so they reduce rather than raise employment and production in the economy.
Credible plans and programs for long-run fiscal balance, yes.
Structural reforms to free-up enterprise and increase opportunity, yes.
Reworking the social-insurance state to make it cheaper and less wasteful, yes.
But spending cuts now to lay sacrifices on the altar of credibility in the hope of improving confidence and reducing the riskiness of the outstanding bond stock? No. The arithmetic simply goes the wrong way – unless you believe that Eurozone nominal bond yields will soon normalize to levels above 7% per year.

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ReferencesAlesina, Alberto and Francesco Giavazzi (2012). "The austerity question: ‘How’ is as important as ‘how much’", VoxEU.org, 3 April.
Corsetti, G (2012), “Has austerity gone too far? A new Vox Debate”, VoxEU.org, 2 April.
DeLong, Bradford and Lawrence H. Summers (2012). “Fiscal Policy in a Depressed Economy”, paper presented at the Spring 2012 Brookings Panel.
Smith, Karl (2011). “More on BL-MP”, blog post on Modeled Behavior, 8 October 2011.

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What's being cut in Spain?

You may have read about budget cuts in Spain. Where do they fall? Over at nada es gratis, a great econ blog (in Spanish), FLORENTINO FELGUEROSO has a great post on "Bread and Circus". R+D is going down; this matters for the hard sciences. In the humanities and social sciences? Not sure. Research grants from the Research/Education/add renaming exercise here Ministry were always so small you needed a microscope to see them... largely independent of the merit-points in the academic evaluation, or the amount one requested. Apparently, the time-honored distribution rule was "cafe para todos" (coffee for all). You see, discrimination based on quality is inappropriate. So, to be honest, this won't make much of a difference to the quality of research that I see going on here; funding was a joke long before. All the serious money comes from the ERC anyway these days, at least in economics. Job training is also being cut, clearly part of a cunning plan in a country where unemployment is pushing towards 25%. And what's going up by 13.6%? Payments to the state's sports agency. No joke. Apparently, they are taking on some new responsibilities, too, so this is not quite comparing like with like, but it is still... pretty depressing.

All of this reminds me of an old joke by American comedian Evan Esar, who said "America believes in education: the average professor earns more money in a year than a professional athlete earns in a whole week." Let's do the numbers for Spain. The country's soccer clubs dominate the international leagues largely by paying what it takes, and buying the best, like Cristiano Ronaldo (Brazil) - current pay $17.06 million -- and Lionel Messi ($ 16 million). Average pay at Barca and Real Madrid is now $ 7 million p.a. Most professors would be hard-pressed to earn €45,000 a year. So the equivalent calculation to Esar's quip is even worse: "Spain believes in education: It pays the average professor more money in a year than a soccer player earns in three days of hard work." 

Suicide in Athens - Remember what touched off the revolution in Tunisia?

That's right, a very public suicide. Mohamed Bouazizi burned himself in December 2010; less than a month later, President Zine El Abidine Ben Ali had fled the country. The Arab Spring got going in earnest. Now comes the news that a pensioner shot himself in Athens, followed quickly by a wave of rioting (via BBC):

Protesters have clashed with riot police in the Greek capital, Athens, hours after a pensioner shot himself dead outside parliament.

The 77-year-old man killed himself in the city's busy Syntagma Square on Wednesday morning.
Greek media reported he had left a suicide note accusing the government of cutting his pension to nothing.
Flowers have been laid at the spot where he died and tributes have been paid online.
Hundreds of demonstrators gathered in the square outside parliament on Wednesday evening, the scene of many large protests in recent months.
Violence erupted, with petrol bombs hurled at police, who fired tear gas in response.
Depression and suicides are reported to have increased in Greece as the country introduces tough austerity measures to deal with huge debts.

 'Dignified end'

The man has not been officially identified but was named in Greek media as Dimitris Christoulas. He was said to be a retired chemist, with a wife and a daughter, who had sold his pharmacy in 1994.
He shot himself in the central square just before 09:00 (06:00 GMT), Athens News reports.
In the alleged suicide note, found by police and reported by Athens News, he said: "The government has annihilated all traces for my survival, which was based on a very dignified pension that I alone paid for 35 years with no help from the state.
"And since my advanced age does not allow me a way of dynamically reacting... I see no other solution than this dignified end to my life, so I don't find myself fishing through garbage cans for my sustenance."
Dozens of people left handwritten messages and flowers at the spot where Mr Christoulas killed himself.

Of course, there is no guarantee that the same course of events will come to pass in Greece... but when people only see their choices as suicide or living out of garbage cans, after paying into the pension system for 35 years, something is VERY wrong. Apparently, the Greek pharmacists' pension fund held a lot of Greek debt, which now got "voluntarily restructured" to be worth 20 cents on the €. 

The News From Spain

can drive you insane...via BBC:

Spain's jobless level hits record 4.75 millionContinue reading the main story

The number of Spanish jobseekers rose for the eighth month in a row in March to hit a record 4.75 million.The Labour Ministry said the number of people filing for unemployment benefits rose by 38,769 with the services sector seeing the most jobs lost.

The jobless rate in Spain stood at 23.6% in February, according to EU figures released on Monday.
Meanwhile, Spain has said its public debt will leap more than 10 percentage points this year to 79.8% of GDP.

Of course, if you are Eurocrat or a finance ministry official, you will think that austerity isn't failing, it just hasn't been tried long and hard enough.

Blanchard and Delong on the Greek endgame - and implications for Spain and the future of the Euro

After the crisis is before the crisis... Olivier Blanchard (via Brad Delong) has some simple home truths for those who think that Greece has now been "rescued" by cutting its privately-held debt by ~80%, a uniquely savage restructuring for any country except Ecuador and Argentina -- what great company for the Eurozone. It's really a gentle reminder that Merkel, Schäuble, and the rest of the German "Austerity Will Solve Everything" Muppet Show just failed Econ 101. The real underlying issue, as Blanchard points out, is the continued current account deficit - still 10% of GDP. Olivier points out that leaving the Eurozone would give Greece a chance to finally increase competitiveness, but with his IMF hat, seemingly rules this out as impractical. Brad Delong, probably remembering the experience of leaving the gold standard in the 1930s, strikes a different balance -- with quitting the Eurozone looking much better. And everything that we say about Greece also applies to Spain. Here is why "internal devaluation" (ie savage wage cuts), the only alternative route to make countries competitive, will never work in the Club Med:

• strong unions combined with an inclination to strike and raise hell. That will damage growth directly
• high private debt burdens. The average Spanish family carries so much debt thanks to consumer + mortgage lending that even a 10% wage cut translates into a 30% fall in disposable household income
• small export sector -- after years of post-industrial growth, there isn't enough of a manufacturing sector left that could benefit from a major increase in competitiveness

So, overall, I think Brad is right - for many countries in the South of Europe, the costs of staying in the Eurozone far outweigh the benefits. Responsible governments should prepare for the day after.

When you don't want to be this right...

(image via libcom.org)

Last year, Jacopo Ponticelli and I wrote a paper looking at the link between austerity measures and unrest. We found a close one. The dramatic images from yesterday - with wide-spread rioting in Athens, building burning, etc. could not bear out our thesis with more force. And there is no question that this was about austerity, either ... normally a tough nut to crack in this context is the question if the link is really causal. Of course, academics always enjoy being able to say "I told you so", but this time, I would have preferred it if the Greeks had proven us wrong.

While there is a lot of understandable frustration with Greece's unwillingness or inability to implement reforms, the riots illustrate that austerity is reaching its limit. How many more budget bills can the government and the troika push through parliament? And what is the implication for the rest of Europe? For the moment, bond markets are a bit calmer, and equity markets are in party mood. The pictures from Greece tell us that the cheer of markets thanks to more austerity is bought in an unsustainable fashion. It's not the most likely scenario, but we may very well see a rapid deterioration in the growth outlook in Spain and Portugal, thanks to all the cuts and tax hikes being implemented now. If this produces yet more deficits and another round of austerity, the Greek scenario is beginning to look much more likely; somewhere along the way, the bond market will panic, and the mother of all bailouts could be on the agenda by mid-summer. Let's hope I am wrong. Even Wolfgang Schaeuble, whose pleasure in forcing austerity on deadbeat ClubMed countries has a been a constant at EU summits, seemed to hint last week that he is starting to change his mind. 

The Economist

The Economist in its "Economics Focus" column this week features Jacopo Ponticelli's and my work on unrest and austerity... as well as my earlier paper on Latin America, making a related point -- the more you cut, the higher the level of unrest will be. 

The sharp end of history

It's been a pretty exciting week on the beach... my paper with Jacopo Ponticelli about austerity and anarchy in Europe, 1919-20009, got a ton of press, including interviews with the BBC, France24, and Die Welt. The fact that London burned a mere week after we posted the working paper surely helped. Typically, with economic history papers, something that seems topical now, when you start working on it, will barely elicit a yawn when you are done. This time, we got lucky... we started working a year ago on the topic, inspired by the Greek protests and an invitation to do a paper on fiscal policy in historical context, for the Central Bank of Chile (a far-sighted lot, it turns out). I first finished a similar paper on Latin America, and then we got this one out.

I hope the paper doesn't become any more topical...via Haaretz, I found the photo above, of what Israeli protesters installed on Rothschild Boulevard in Tel Aviv.

Austerity and Unrest Over the Long Run

With riots in London last night and the heavy smell of tear gas still lingering over the Acropolis, Jacopo Ponticelli and I thought we'd look at the connection between budget cuts and unrest more systematically. The working paper is now out. We look at the extent to which riots, demonstrations, political assassinations and general strikes increase as governments cut expenditure in Europe, 1919-2009. Here is the abstract:

Does fiscal consolidation lead to social unrest? From the end of the Weimar Republic in Germany in the 1930s to anti-government demonstrations in Greece in 2010-11, austerity has tended to go hand in hand with politically motivated violence and social instability. In this paper, we assemble cross-country evidence for the period 1919 to the present, and examine the extent to which societies become unstable after budget cuts. The results show a clear positive correlation between fiscal retrenchment and instability. We test if the relationship simply reflects economic downturns, and conclude that this is not the key factor. We also analyse interactions with various economic and political variables. While autocracies and democracies show a broadly similar responses to budget cuts, countries with more constraints on the executive are less likely to see unrest as a result of austerity measures. Growing media penetration does not lead to a stronger effect of cut-backs on the level of unrest.

And here is our answer, in one slide:

The bars show the number of incidents - CHAOS aggregates them all, and then you have the components -- demonstrations, riots, assassinations, and general strikes. As the bars get darker, cuts get deeper. Once you cut expenditure by more than 2% of GDP, instability increases rapidly in all dimensions, and especially in terms of riots and demonstrations.

Sure, there are many incidents that can lead to an eruption of violence– from the killing of Mark Duggan in London last Saturday to a high-speed pursuit gone wrong (in the case of the Rodney King riots in LA in 1992). The more interesting question is -- why are cities at some points in time more akin to a tinderbox? Why does it only take one incident for massive violence, riots, or anti-government demonstrations to erupt? Even if there is something else that provides the spark, you want to know why there is so much dry wood around that you get a conflagration. Here, our results suggest that the role of budget measures is important.

We also use some additional, more detailed data on the causes of each demonstration to confirm our hypothesis that the link is causal. Incidentally, the same pattern is apparent in Latin America since 1937.

So, if you ever found yourself reading papers by Alesina and co-authors arguing that i. budget cuts can be good for growth ii. there is no punishment at the polls for governments cutting expenditure, and wondering why governments don't engage in more austerity - maybe here is your answer. Even if (and it's a big if, given the IMF's latest research) Alesina et al. are right, and growth can follow cuts, the pain may be concentrated amongst some groups. If these become massively unhappy... it can start to look pretty ugly out there in the streets, and I doubt that that'll be good for growth. As a matter of fact, Nick Bloom of Stanford has a bunch of fantastic papers showing just how painful uncertainty shocks are in terms of subsequent economic performance.

tear gas and "chicken"

Nathaniel Rothschild allegedly said that one should "buy to the thunder of cannons and sell to the sound of trumpets". I guess, the modern-day version would be to trade to the smell of tear gas, which has been wafting across Athens recently. Closer to home, in the beautiful park next to the university that houses the Catalan parliament, ministers and MPs were surrounded by Spain's own indignados movement... which made it just that touch harder to be in the office on time this morning, with riot police blocking many of the streets leading to the campus. It was pretty calm as things go, with no violent clashes, but the image of ministers being ferried in by helicopter reminded me a bit of President De La Rua's last day in office.

Back to the issue of trading: Even popular financial advice sites like marketwatch are now offering suggestions on how to make $$$ from a coming Greek default. I would say, not so fast... we are mainly witnessing a public game of "chicken" between the German finance ministry and the ECB. Some of this is squarely aimed at the wider public -- "look, we are trying to get tough with private creditors". While the EU has an amazing talent to screw up things, I would say -- uncharacteristically, as those who know my pessimistic side might think -- that this one is too important to go wrong, and that a deal will eventually get done, with no more than a bit of a Vienna-style initiative imposed on the creditors. Now, if only the Greek government will actually stay in office for long enough to see through the implementation of the next round of austerity...

some basic arithmetic for gauging austerity's impact...

Brad DeLong has a beautifully simple back-of-an-envelope calculation on what the deficit implications of austerity are. His figures are for the US, and they are ugly... austerity means higher deficits in the future. Exercise for today: plug a number (any number, really) for Greece, and put them through the same formula. You get the opposite result, big-time. I dare anyone to suggest a multiplier so high that you can undo the effect of interest rates in this case. So, do the German deficit-hawks have a point? Discuss, in no more than 1,500 words!