Monthly Archives: March 2012

How rapidly should governments correct their fiscal deficits, which in the long run are unsustainable in the US, UK, Japan and many countries in the eurozone?

That is a question which continues to dominate the policy debate among economists. Rapid correction undoubtedly damages near term economic growth, but is intended to reduce the risk of a sovereign debt crisis coming suddenly out of the blue. Slow correction does the opposite. There is no theoretically “correct” policy on this. The result depends on how the near term loss of output should be weighed against the risk and consequences of a fiscal crisis, which is an empirical matter. (See this earlier blog: Assessing the risk of a financial crisis, which attempts to measure the risk of fiscal crisis.)

It is possible for reasonable economists to disagree about this, and for the “right” policy to be different in different countries. However, occasionally a piece of research comes along which changes the “dial” on the debate, and I believe that applies to the important Brookings Paper published last week by Brad DeLong and Larry Summers. This paper, which is well summarised here and here, essentially implies that the trade-off between near-term GDP growth and the probability of fiscal crisis can be irrelevant, because temporary fiscal expansions, at a time when interest rates are at the zero bound, are eventually self-financing.  Read more

Global equities have enjoyed a very strong start to 2012, rising by about 11 per cent year-to-date. This of course has been driven mostly by the improvements in the eurozone debt crisis and in the US labour market, which have raised hopes of stronger growth in global GDP in coming quarters. But on a longer-term view, equities remain in the doldrums. Relative to government bonds, equities in the developed economies have given negative excess returns for more than a whole decade, which is an extraordinary state of affairs in a free market economic system. Read more

In recent years, UK Budget Day has become the occasion for an outbreak of hand-wringing from the economics profession. Downward revisions to GDP forecasts, and upward revisions to budget deficit projections, have become the norm.  Those who have criticised the chancellor for tightening fiscal policy far too quickly have increasingly felt vindicated. Calls for a Plan B, involving less fiscal stringency in the immediate future, have become deafening.

Today may be rather different. For the first time in quite a while, there is no good reason for the Office for Budget Responsibility to downgrade its previous views on the economy. The underlying improvement in the budget deficit (adjusted for the absorption of the Royal Mail pension fund into the government accounts) will stay much the same as the OBR expected in November. If you believed it then, there is no new reason to doubt it now. That should allow the chancellor to focus on micro-economic issues, such as the tax treatment of higher earners, which will generate enormous political heat, but which will not alter the path for the economy very much in either direction.

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In the past week, government bond markets have finally done what some economists have been predicting for a while. Following a prolonged period of exceptionally low volatility, with US 10 year note yields becalmed at about 1.9 per cent, we have seen a fairly sharp sell-off, taking yields to around 2.3 per cent. Although this is a very minor blip in the large scheme of things, it does raise the question of whether the era of exceptionally low bond yields, or the government bond “bubble” as some analysts call it, may finally be coming to an end. Read more

“You cannot solve a debt crisis by creating more debt.” As Martin Wolf reminds us, this disarmingly simple statement has been of profound importance in shaping public attitudes to the economic crisis. The failure to make a compelling political argument against this proposition has been crucial in limiting the feasible scale of the fiscal response to the crisis.

Whether one looks at the US, the UK or the eurozone, an aversion to “more debt” has become a dominant political theme, as it did in the 1930s. Richard Koo, a leading student of the debt crisis in Japan, has even argued recently that it is impossible to respond adequately to a balance sheet recession in a democracy because the public dislike of “more debt” becomes so profound. Read more

 As they meet today the Federal Reserve’s governors face a dilemma; with unemployment creeping lower while inflation rises, can they justify a third round of stimulative quantitative easing? Gavyn Davies, chairman of Fulcrum Asset Management, explains to Long View columnist John Authers that while the Fed is keen for QE3, it needs to bring inflation more under control first.  (5m 27sec)

The FOMC meets on Tuesday and, for the first time in several years, there is room for a genuine debate about whether the condition of the US labour market justifies the aggressively easy monetary stance which the Fed has adopted.

The February employment report showed strong growth in the number of jobs for the third successive month, taking both the main measures of employment gains into territory which is normally seen only during healthy economic expansions. However, as I commented in this piece for the FT’s A-List on Friday, it is dangerous to conclude that the labour market is now returning rapidly to normal. The Fed is likely to pause, but not to change its basic strategy. Read more

The initials LTRO, barely ever discussed prior to last December, now form the most revered acronym in the financial markets. Before the first of the ECB’s two Longer Term Refinancing Operations in December, global equity markets lived in fear of widespread bankruptcies in the eurozone financial sector. Since LTRO I was completed on December 21, equities have not only become far less volatile, but have also risen by 11 per cent.

With LTRO II completed last week, over €1tn of liquidity has been injected into the eurozone’s financial system. Private banks were permitted to bid for any amount of liquidity they wanted, the collateral required was defined in the most liberal possible way,  and the loans will not fall due for three years. Any bank that might need funds before 2015 should have participated to the hilt, thus eliminating bankruptcy risk fora long time time to come. Read more