Monthly Archives: May 2012

The focus of US economic policy discussion at present is almost entirely on fiscal deficits and the level of taxes. My view is that these are second or even third order issues. What matters far more is the capacity of the economy to offer satisfactory lives for the citizenry. This depends on far more fundamental forces than deficits and taxes, such as innovation, jobs and incomes. Evidently, I am arguing that taxes and deficits do not determine these outcomes. I am suggesting this because they do not.

So I want to address two widely held, but mistaken, views. The first is that lower taxes are the principal route to better economic performance. The second is that the financial crisis is a crisis of western welfare states.

How does one measure economic performance? The most important measure is incomes per head. Employment and the distribution of income matter, too. But incomes per head are the place to start. In the long run, income per head determines the standard of living. So an obvious question is how far tax levels explain growth of income per head. Read more

In the second part (you can read Part 1 here) of this comment on the concluding statement of the International Monetary Fund’s recent mission to the UK, I intend to address one issue:

Is it the case that greater flexibility on fiscal policy, to support demand, might destroy the UK government’s credibility, with disastrous results? Read more

“Fiscal easing and further use of the government’s balance sheet should be considered if downside risks materialize and the recovery fails to take off. In particular, if growth does not build momentum and is significantly below forecasts even after substantial additional monetary stimulus and further credit easing measures, planned fiscal adjustment would need to be reconsidered. Under these circumstances, gains from delaying fiscal consolidation could be larger as multipliers are estimated to move inversely with growth and the effectiveness of monetary policy. To preserve credibility, reconsidering the path of consolidation should be in the context of a multi-year plan focused on further reducing the UK’s large structural fiscal deficit when the economy is stronger and taking into account risks to sovereign borrowing costs. Fiscal easing measures in such a scenario should focus on temporary tax cuts and greater infrastructure spending, as these may be more credibly temporary than increases in current spending.”

The above quote is from the concluding statement of the International Monetary Fund’s mission to the UK for the so-called Article IV Consultation, released on 22 May 2012. Read more

A statue holds up a symbol of the euro in front of the European Parliament building in Brussels. Getty Images

A statue holds up a symbol of the euro in front of the European Parliament building in Brussels. Getty Images

The previous two posts Part 2 and Part 1 tried to explain why the sovereign debt of eurozone countries seem to be far more fragile than that of countries with their own central banks.

This issue is a relatively new one, so far as I know. But it is extremely important.

One of the questions raised in the subsequent discussions is why the possibility of illiquidity-induced default (as in the Spanish sovereign debt market) should be any different in impact from the possibility of a devaluation and inflation (as in the gilt market).

I have three suggested answers. Read more

I have noted in the first part of this blog that the debts of countries in the eurozone have suffered a very different fate from those outside the eurozone during the crisis. This is evident when one compares the yields on sovereign bonds of the UK with those of France, Italy and Spain, countries that on the face of it, have governments at least as solvent, if not more so.

So why has the experience of the eurozone members been so different and so painful and what can be done to remedy the problem?

There are two possible explanations, which are not mutually exclusive. Read more

In my most recent post, The journey towards becoming Japan, I noted the similarities between what has been happening to the US and UK and what happened earlier to Japan. But the question obviously arises: why has eurozone experience been different?

Let us start by looking at what has happened. For this purpose, I compare countries of roughly similar economic size: Germany, France, Italy and Spain, which are, of course, members of the eurozone, and the UK.

The time since the signing of the Maastricht Treaty in 1992 can be divided into three periods: 1992-98, which was when interest rate convergence was achieved among the eurozone members; 1998-2008, when all eurozone bonds were treated as being essentially identical, while UK yields diverged a little, from time to time; and, finally, 2008 to today, which has been a period of growing divergence in the eurozone, with Germany acting as safe haven and revulsion from Italian, Spanish and, more recently, even French debt.

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On May 10 2012, the yield on the German 10-year bund was 1.44 per cent, on the US 10-year Treasury was 1.85 per cent and on the UK 10-year gilt was 1.9 per cent.

These are extraordinary numbers. They are particularly striking in the cases of the US and UK, which unlike Germany, run very large fiscal deficits and are experiencing very rapid increases in public sector indebtedness.

This combination of falling government bond rates with very rapid rises in public sector indebtedness reminds us, of course, of the experience of Japan since 1990. (See charts below)

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How should the European Union regulate its banking system? What discretion should be granted to member states in deciding how safe their banking systems should be?

On these vital issues, the EU is coming to the wrong conclusions. That is the UK’s view. I agree with it. But the UK is, once again, in a minority of one. Read more

In my latest column, I discussed the state of the UK economy. Since the column does not contain charts, I have decided to post a few on the Wolf Exchange.

Let us start with gross domestic product since 1970. The chart shows quarterly GDP at constant prices and the pre-crisis trend in quarterly GDP, extrapolated up to the first quarter of 2012. Over this period the trend rate of annual economic growth was 2.5 per cent a year. It will be seen that we do see a period of above trend levels of activity in the 2000s. It will also be seen that, since the third quarter of 2008, GDP has shown a growing negative deviation from the trend. In the first quarter of 2012, the deviation was 8.9 per cent below the long-term trend.

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In my most recent post, I investigated whether fiscal contractions were expansionary. The answer seemed to be unambiguously negative: eurozone member countries that had undertaken large cyclically adjusted fiscal contractions had also experienced larger declines in gross domestic product. This being so, a question obviously follows:

Does fiscal contraction improve actual fiscal outcomes or are the effects on GDP so dire that outcomes do not improve? Read more