Financial crises have devastating impacts on the public finances. The impact is also most severe where the pre-crisis excesses were greatest. Among members of the Group of Seven leading high-income countries, this means the bubble-infected US and UK. The question both countries confront is how soon and how far to tighten. Tightening will have to be substantial. But premature action could be a devastating error.

In their work on the history of financial crises, Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard University note that “the real stock of debt nearly doubles” in crisis-hit countries.* This will be true for the US and UK. It is only in small part the result of bail-outs of the financial sector or of stimulus programmes. According to the International Monetary Fund, in the UK none of the 10.6 percentage point rise in the ratio of fiscal deficits to gross domestic product between 2007 and 2010 will be due to crisis-related discretionary measures.** In the case of the US, 1.8 percentage points of a 6.5 percentage point deterioration will be due to such measures. Most of the change is structural: the levels of GDP and fiscal revenue will not return to the previous path.

How, though, does one assess this fiscal slippage? One way is historical (see charts). In the case of the UK, the crisis is forecast by the IMF to raise the ratio of net public debt to GDP by close to 50 percentage points between 2007 and 2014. The only comparable previous episodes are wars. The increase this time is smaller than that in the wars with revolutionary and Napoleonic France or the world wars of the 20th century. But it is as large, or larger, than in other 18th-century wars.

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From the FT:
Goldman Sachs: the case for the defence - William Cohan
Europe needs action, not quiet consensus - Peter Mandelson

From elsewhere:
Elections in developing countries: do they improve economic policy? - VoxEU
Creating new jobs rather than sharing old ones Peterson Institute

From the FT :
Will sovereign debt be the new subprime? - Gillian Tett

From elsewhere:
The thing about the Fed most worth knowing - Economic Principals
The Phantom Menace - NY Times, Paul Krugman
How preferential are preferential trade agreements? - VoxEU

From the FT:
Tackling systemic risk is no job for the status quo - William Donaldson and Arthur Levitt

From elsewhere:
China, the Renminbi, and global imbalances: A quantative View - Econbrowser
The Big Squander - Paul Krugman, NY Times
Forecasting macroeconomic developments - VoxEU

Windfall taxes are a ghastly idea. They are a sop to prejudice, a burden on risk-taking and a form of arbitrary confiscation. No sensible person should support them. So why do I now find the idea of a windfall tax on banks so appealing? Well, this time, it really does look different. Continue reading "Tax the windfall banking bonuses"

From the FT:
Obama seeks change Beijing can believe in - David Pilling
How to reinvent China’s growth - John Gapper
Modesty would become Europe’s new duo - Jacques Delors

From elsewhere:
The effectiveness of fiscal and monetary stimulus in depressions - VoxEU
A Yuan-sided argument - Economist
Balancing fiscal support with fiscal solvency - IMFDirect

From the FT:
America must start treating China as a friend - Bill Owens
How the market proved no panacea for BT - John kay

From elsewhere:
Uncertainty and the tale of two depressions - VoxEU
Lecturing each other on trade - Michael Pettis

Barack Obama, president of the US, met Hu Jintao, president of the People’s Republic of China, for a private meeting on Tuesday. The agenda was long, covering the world economy, climate change and non-proliferation of nuclear weapons. The last two are the most important, over the long run. But the first is the most urgent. If we do not achieve a healthy global economic recovery, hope of a co-operative relationship is likely to prove vain. Yet such a recovery is far from ensured. Worse, some of what is now happening – particularly China’s decision to depreciate the renminbi along with the dollar – makes healthy recovery less likely.

This, then, was an opportunity for Mr Obama to tell some brutal truths. I hope he did, after careful briefing from his staff, on the following lines.

“Mr President, as I said in Japan, ‘the US does not seek to contain China, nor does a deeper relationship with China mean a weakening of our bilateral alliances. On the contrary, the rise of a strong, prosperous China can be a source of strength for the community of nations’. For the foreseeable future, our two countries will be the leading players on the world stage. We must approach our challenges in a spirit of co-operation and accommodation. But that is, alas, not happening over your exchange rate policies.

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