Monthly Archives: April 2012

Paul Krugman has an interesting blog on the New York Times website on austerity and growth in the eurozone. I thought it would be interesting to examine the question, using the latest data from the International Monetary Fund’s World Economic Outlook database.

I have defined the fiscal tightening as the percentage point change in the structural (or cyclically-adjusted) general government deficit from 2008, the year of the crisis, to the forecast for 2012. The assumption is that this change represents the results of policy, rather then cyclical effects. I have taken growth as being the proportional change in GDP from 2008 to 2012. Read more

“The share of total income going to the top 1 per cent of income earners has increased dramatically, from 9 per cent in 1970 to 23.5 per cent in 2007, the highest level on record since 1928 and much higher than in European countries or Japan today. Meanwhile, the top tax rate has fallen by half, from 70 per cent to 35 per cent.”

In fact,

“because the top 1 per cent has captured about half of income growth since the 1970s, income growth for the bottom 99 per cent has been only about half of the macroeconomic growth we always hear about in the press.”

The second of the quotations is from an interview with Emmanuel Saez of Berkeley, winner of the John Bates Clark Medal, which goes to an outstanding economist under the age of 40. The first is from an article entitled “Taxing High Earnings” that prof Saez wrote jointly with Peter Diamond of MIT, a winner of the Nobel memorial prize in economics.

"Occupy Wall Street" protests at Zuccotti Park in New York. Getty Images

"Occupy Wall Street" protests at Zuccotti Park in New York. Getty Images

Both come from a collection of essays by well-known commentators and analysts, in response to the Occupy Wall Street movement.* The authors include, among many others, Raghuram Rajan of the University of  Chicago’s Booth School of Business, Daron Acemoglu and James Robinson, of MIT and Harvard, respectively and Michael Lewis, the well-known author. Even Gillian Tett and Martin Wolf of the Financial Times are to be found in this list. Read more

Read part I: Fiscal and monetary policy in a liquidity trap

Part II

Might fiscal expansion be a free lunch? This is the question addressed in a thought-provoking paper “Fiscal Policy in a Depressed Economy”, March 2012, by Brad DeLong and Larry Summers, the most important conclusion of which is obvious, but largely ignored: the impact of fiscal expansion depends on the context. *

In normal times, with resources close to being fully utilised, the multiplier will end up very close to zero; in unusual times, such as the present, it could be large enough and the economic benefits of such expansion significant enough to pay for itself. In a liquidity trap fiscal retrenchment is penny wise, pound foolish. Indeed, relying on monetary policy alone is the foolish policy: if it worked, which it probably will not, it does so largely by expanding stretched private balance sheets even further.

As the authors note: “This paper examines the impact of fiscal policy in the context of a protracted period of high unemployment and output short of potential like that suffered by the United States and many other countries in recent years.  We argue that, while the conventional wisdom rejecting discretionary fiscal policy is appropriate in normal times, discretionary fiscal policy where there is room to pursue it has a major role.”

There are three reasons for this. Read more

Part 1

What is the correct approach to fiscal and monetary policy when an economy is depressed and the central bank’s rate of interest is close to zero? Does the independence of the central bank make it more difficult to reach the right decisions? These are two enormously important questions raised by current circumstances in the US, the eurozone, Japan and the UK.

Broadly speaking, I can identify three macroeconomic viewpoints on these questions: Read more

Part II -The cost of equity

Read Part I: Thoughts on Peter Sands

Now, let me turn to Peter Sands’ second and most important point. He condemns the notion that the cost of equity has fallen or might fall, as a result of lower leverage.

The idea that the correct target for banks is the risk-unadjusted return on equity is as close to a religion as one can find in banking. It is always buttressed by the view, also advanced by Mr Sands, that these returns on equity somehow do not depend on risk.

Yet that is utterly at odds with everything bankers do in their daily lives.

Suppose that Mr Sands’ subordinates suggest that his bank lends $100m to a certain company. He would surely want to know how indebted the company was and where the bank’s lending would be in the order of seniority. If his colleagues responded by telling him that none of this mattered, Mr Sands would surely sack them. The riskiness of lending to a company depends, in part, on the level, cost and structure of its debt.

Now consider the position of an investor in common equity. Such an investor is, by definition, junior to all other claimants. Equity investors must be interested, therefore, in how leveraged the company is: higher leverage does, other things being equal, raise their expected returns and the expected volatility of returns. This is finance 101.

Every banker knows it. Read more

Part I

I admire Peter Sands, the group chief executive of Standard Chartered. Unlike many of his peers, he does not rely on making arguments behind closed doors. He is prepared to make arguments publicly, instead. He did this in a piece he published in the FT last week (“The dangers of our new regulation”).

The fact that I admire Mr Sands, does not mean I agree with him. On the contrary I found this article valuable, not because I thought it right, but because I found it revealingly wrong.

Mr Sands starts by saying that Standard Chartered (a bank that has, by the way, almost no business in the UK) supports the idea of macro-prudential regulation.

Nevertheless, he argues, the approach taken by the Bank of England’s interim Financial Policy Committee to which responsibility for such regulation will be transferred in forthcoming legislation is “extremely interventionist and extraordinarily blinkered”. Read more