Another report from Paul Mason in Greece where he explains the third bailout package. He also meets a doctor whose hospital has had its budget slashed from €19 million to €7 million and who says the deal is ‘a crime against humanity’.
In the NYT it was stated that Moody’s are predicting that a tighter fiscal policy – cuts in government spending and increased taxation – will slow economic growth for 2013 by about 1.2 percentage points and prevent the unemployment rate from falling to 6.1 percent by the end of the year. Where is the effect of QE on these figures?
Lately there has been a lot of media coverage about an Excel error by academics Ken Rogoff and Carmen Reinhart – co-authors of ‘This Time is Different’ – 2009. A student from University of Massachusetts tried to replicate one their models regarding growth rates when a country has a public debt of greater than 90% of GDP. Rogoff and Carmen stated that with this level of public debt growth in a country falls to a mean of -0.1%. However using the same data the student found that a figure of 2.2% was applicable in this context.
However Rogoff and Reinhart have been cautious about saying that high debt causes slower growth rates but it does highlight the validity of analysis connecting debt and austerity to growth rates. Adam Posen in the FT stated that the claim of a clear tipping point for the ratio of Government Debt to GDP past which an economy starts to collapse doesn’t hold. Following the second world war the US, UK, Belgium, Italy and Japan had public debt greater than 90% of GDP but there was not much of an effect on their economies. In Italy and of late in Japan stagnation in economies led to slowly rising debt levels. In the UK and US in the 1950’s growth returned and debt levels declined. What this is suggesting is
Slow growth is at least as much the cause of high debt as high debt causes growth to slow.
But a certain amount public debt is necessary for future development of any economy especially when you think about the construction of infrastructure and government spending on education. Both of which contribute to future growth and in theoretical terms move the production possibility curve outwards. This in turn creates growth and subsequently income for a government.
USA – Mad Spending v EU – Nervous Austerity
With one side of the Atlantic – USA – involved in quantitive easing (printing money) and the other – EU – with severe austerity, maybe somewhere in between would be a logical way to go about things. But is moderation a choice for policy makers when they have already gone so far down the track of their respective plans?
What can be concluded is that too much debt has costs for growth but the degree of those costs is dependent on the reasons for debt accumulated and what path the economy is actually taking.
If you look at the labour market in Spain you would think that it resembles the German economy 10 years ago when Gerhard Schroder was its leader. Schroder was responsible for labour reforms that ignited the German economy into one of the strongest in Europe.
Spain is relaxing labour laws and cutting public spending and there are some positive signs here in that labour unit costs are falling as result of greater productivity. However German’s vocational education sector was a significant factor in its improved performance as the education and training system is more job orientated. Furthermore, with austerity measures in place and more to follow – pressure from the EU to introduce yet another sales-tax rise – Spain will find it hard to generate any sort of growth. But if it does grow will it generate any reduction in unemployment? Because of labour reforms some economists now believe that only 1.5% growth is required to bring about net job creation rather than 2.5% as previous.
The 10bn-euro (US$13bn) bailout of Cyprus’ economy, agreed by the EU and IMF, demands that all bank customers pay a one-off levy and has led to heavy cash withdrawals.
Under the currently agreed terms, depositors with:
* Less than 100,000 euros in Cyprus accounts would have to pay a one-time tax of 6.75%.
* More than 100,000 euros would pay 9.9%.
The BBC says the president may want to lower the former rate to 3%, while raising the levy on the larger depositors to 12.5%. Some EU source told Agence France-Presse there could be a three-way split on the level of levy, grouped into accounts holding less than 100,000 euros, between 100,000 and 500,000 and more than 500,000. The clip below is from Al Jazeera – it shows at one bank in the Limassol district, a frustrated man parked his bulldozer outside and threatened to break in.
The race for countries to devalue their currency (make their exports more competitive) has led to massive increase in monetary stimulus into the global financial system. We are all aware of the three rounds of Quantitative Easing from the US Fed and the indication that they would keep the Fed Funds Rate at virtually zero until 2015. To add fuel to the ‘dim embers’, in 2013 the US is going to inject US$1 trillion into the circular floe. However in China they have also embarked on some serious stimulus:
* More infrastructure development – US$60bn
* Additional credit – US$14 trillion in extra credit since 2009 (equal to entire US banking system)
Nevertheless even with all this artificial stimulus there might be some short-term growth but I can’t see it being sustainable when you consider the extent of global deleveraging. Also IMF figures show that the world saving rates are on the increase (* forecast):
With increased saving rates accompanied by significant austerity measures in many parts of Europe where is the consumer demand going to come from? Unemployment in Spain is 26% and predicted to hit 30% this year- more worrying is 50% of those under 25 are unemployed. Spanish protesters chanted “We don’t owe, we won’t pay” in a march against austerity. So in the US we have massive fiscal stimulus but across the water in Europe it’s all about “tightening the belt” and cutting government spending. Neither seems to be working and are we just putting off a significant downturn for a later date?
Free Exchange in The Economist debated this topic and went into detail concerning the Fiscal Multiplier. It refers to the change in GDP that is due to a change in government fiscal policy – taxes and spending. They use the following examples
Multiplier = 1.5 Government Spending down $1 = overall spending down = $1.5
Multiplier = 0.5 Government Spending down $1 = overall spending down = $0.5
Therefore the value of the multiplier is the crucial variable and a value that is greater than the level of GDP you maybe able to close the deficit but this results in a higher debt to GDP ratio than it started with. Estimates of the fiscal multiplier have been approximately 1% or below and the IMF have suggested that if you cut deficits by 1% of GDP it will have an impact of 0.5% of GDP – multiplier value of 0.5. What has been suggested is that:
Spending cuts may “crowd in” private-sector activity: if governments are using up scarce capital and labour then austerity creates room for private firms to expand. In open economies, austerity’s bite can be passed on to other countries through reduced imports. Most important of all, monetary policy can act as a counterweight to fiscal policy. Spending cuts that threaten to drag growth below a desired level should prompt monetary easing, limiting the multiplier.
However timing is everything and austerity measures now are not conducive to favourable outcomes for the following reasons:
1. With many economies implementing the same measures the impact can’t be deflected onto others.
2. Austerity measures normally might free up resources for private use but that mattered far less when unemployment and saving were high.
3. With interest rates at near-zero levels there was little scope for any additional monetary stimulus to offset the fiscal tightening. Monetary policy has run out of ammunition.