When fiscal policy lags, the one-two fiscal/monetary punch doesn’t land [feedly]

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When fiscal policy lags, the one-two fiscal/monetary punch doesn't land
// Jared Bernstein | On the Economy

Two recent pieces looked at where we are in this recovery and why, seven years into an expansion, we're still not at full employment. One is by my main man Josh Bivens from the Economic Policy Institute and the other is by David Mericle and Avisha Thakkar from Goldman Sachs (GS) research (sorry; no link to that one).

The figure below–not from either of these pieces–motivates the discussion. It shows three lines of real GDP: an estimate of potential GDP pre-great-recession (2007), the most recent estimate of the same, and actual real GDP (potential GDP is CBO's estimate of what GDP would be with fully utilized resources; it's the value of the economy when it's firing on all cylinders). I–somewhat artfully, you'll surely admit–call this figure: The runner who can't cross a goal line that's moving towards her.



Sources: BEA, CBO

Why is that?

The GS folks take a unique and informative approach: they compare a spate of economic indicators in the US to the "Big Five" advanced economy financial crises (taken from the work of Carmen Reinhart and Kenneth Rogoff) as well as to the 2008 European crisis economies. Basically, GS asks: how has the US recovery gone compared to prior recoveries elsewhere from financial-crisis-induced recessions? (The "Big Five" include Spain in 1978, Norway in 1987, Finland in 1990, Sweden in 1990, and Japan in 1992.)

Josh provides a different but also useful comparison: prior US downturns.

The GS team concludes that the labor market in particular has outperformed their historical comparison groups, as shown through the unemployment rate comparison below. True, our unemployment rate is biased down due to the weak performance of labor force participation and still-elevated underemployment, but as I've extensively documented, the US job market has been tightening up for awhile, driven by solid employment growth, now averaging around 200,000/month. See Bivens' Figure A on this point.



Source: GS Research

Still, as the first figure shows, the output gap is yet to close, even as potential GDP's been downgraded. That reflects both slower labor force growth (some of which is demographics but some of which is weak labor demand) and our most serious outstanding economic problem, very slow productivity growth.

What's most interesting to me about both the Bivens and GS studies is in regard to policy responses. Initially, US policy makers hit back hard with both monetary and fiscal policy. I've argued that the combination is important and complementary: monetary policy lowers the cost of borrowing but if households are both deleveraging and, based on the loss of housing wealth, suffering from lower net worth (i.e., a negative wealth effect), they're less likely to take advantage of those lower rates. That's when you need fiscal policy to put more money in people's pockets such that they'll tap the monetary stimulus. Ergo, the one/two punch.

Both studies show the following: the one/two punch of monetary/fiscal policy weakened when fiscal support for the recovery faded. The GS figure is striking (sticking with my artful theme, let's call it Paul Krugman's nightmare). Fiscal support started strong both here and in Europe, as did (see second figure) monetary policy (the negative numbers reflect the Fed's lowering and holding down the Fed funds rate). But while the monetary authorities kept their stimulus going, austere fiscal policy kicked in with a vengeance.



Source: GS



Source: GS

Bivens austerity figure is also illuminating, and includes all three levels of government spending (fed, state, local).



Source: Bivens

Over to Josh:

[The above figure] shows the growth in per capita spending by federal, state, and local governments following the troughs of the four recessions. Astoundingly, per capita government spending in the first quarter of 2016—27 quarters into the recovery—was nearly 3.5 percent lower than it was at the trough of the Great Recession. By contrast, 27 quarters into the early 1990s recovery, per capita government spending was 3 percent higher than at the trough, 23 quarters following the early 2000s recession (a shorter recovery) it was 10 percent higher, and 27 quarters into the early 1980s recovery it was 17 percent higher.

His judgment is harsh and unequivocal…practically Old Testament:

If government spending following the Great Recession's end tracked spending that followed the recession of the early 1980s for the first 27 quarters, governments in 2015 would have been spending an additional trillion dollars in that year alone, translating into several years of full employment even had the Federal Reserve raised interest rates. In short, the failure to respond to the Great Recession the way we responded to the other postwar recession of similar magnitude entirely explains why the U.S. economy is not fully recovered seven years after the Great Recession ended.

I think that's probably right and I also think it helps to at least partially explain what may be the most negative development in any of the above pictures. I'm gonna let you guess what that is…I'm waiting…hint: it's in the first figure.

It's the sharp decline, from the 2007 to the 2016 vintage, in CBO's estimate of potential real GDP. Hard to believe that downshift is a demographics story, because CBO estimators knew the population's demographics back in 2007, when they had potential growing a lot more quickly. In fact, CBO assigns most of the reduced potential to "reassessed trends:" a more pessimistic outlook re hours worked and productivity than what they believed before the crisis. By taking half the punch out of the one/two fiscal/monetary punch, dysfunctional and mindlessly austere policy makers have contributed to the loss of hundreds of billions in value-added.

Still, sticking with the first figure, soon the aging runner will likely finally cross the goal line, and we're doing better here than most other advanced economies. We're nudging towards full employment and I'm even finally seeing a little pressure on wages. But it would be foolish to ignore the mistakes we've made and what they're actively costing us in lost output, jobs, and living standards.

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Baker: End of Trump

http://cepr.net/publications/op-eds-columns/the-end-of-trump-keep-your-eyes-on-the-prize

The State of Higher Ed Funding [feedly]

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The State of Higher Ed Funding
// Center on Budget: Comprehensive News Feed

With a new academic year approaching, we've updated our major report on state funding trends for public colleges and universities, which shows that 46 states are spending less per student than they did before the recession.  While most states have boosted per-student funding in the last year, 12 states cut it. Overall, funding for public two- and four-year colleges is almost $10 billion below its pre-recession level, after adjusting for inflation.

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Expansionary Fiscal Consolidation Myth [feedly]

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Expansionary Fiscal Consolidation Myth
// TripleCrisis

Anis Chowdhury and Jomo Kwame Sundaram

The debt crisis in Europe continues to drag on. Drastic measures to cut government debts and deficits, including by replacing democratically elected governments with 'technocrats', have only made things worse. The more recent drastic expenditure cuts in Europe to quickly reduce public finance deficits have not only adversely impacted the lives of millions as unemployment soared. The actions also seem to have killed the goose that lay the golden egg of economic growth, resulting in a 'low growth' debt trap.

Government debt in the Euro zone reached nearly 92 per cent of GDP at the end of 2014, the highest level since the single currency was introduced in 1999. It dropped marginally to 90.7 per cent at the end of 2015, but is still about 50 per cent higher than the maximum allowed level of 60 per cent set by the Stability and Growth Pact rules designed to make sure EU members "pursue sound public finances and coordinate their fiscal policies". The debt-GDP ratio was 66 per cent in 2007 before the crisis.

High debt is, of course, of concern. But as the experiences of the Euro zone countries clearly demonstrate, countries cannot come out of debt through drastic cuts in spending, especially when the global economic growth remains tepid, and there is no scope for the rapid rise of export demand. Instead, drastic public expenditure cuts are jeopardizing growth, creating a vicious circle of low growth-high debt, as noted by the IMF in its October 2015 World Economic Outlook.

Deficits, debt and fiscal consolidation

Using historical data, a number of cross-country studies claimed that fiscal consolidation promotes growth and generates employment. Three have been the most influential among policy makers dealing with the economic crisis unleashed by the 2008-2009 global financial meltdown.

First, using data from advanced and emerging economies for 1970-2007, the IMF's May 2010 Fiscal Monitor claimed a negative relationship between initial government debt and subsequent per capita GDP growth as a stylized fact. On average, a 10 percentage point increase in the initial debt-GDP ratio was associated with a drop in annual real per capita GDP growth of around 0.2 percentage points per year. By implication, a reduction in debt-GDP ratio should enhance growth. Released just before the G20 Toronto Summit, it provided the ammunition for fiscal hawks urging immediate fiscal consolidation. The IMF has since admitted that its fiscal consolidation advice in 2010 was based on an ad-hoc exercise.

Using a different methodology, the IMF's 2010 World Economic Outlook reported that reducing fiscal deficits by one per cent of GDP "typically reduces GDP by about 0.5% within two years and raises the unemployment rate by about 0.3 percentage point". Domestic demand—consumption and investment—falls by about 1%". Similarly, a 2015 IMF research paper concluded that "Empirical evidence suggests that the level at which the debt-to-GDP ratio starts to harm long-run growth is likely to vary with the level of economic development and to depend on other factors, such as the investor base".

The second study, of 107 episodes of fiscal consolidation in all OECD countries during 1970-2007 by Alberto Alesina and Silvia Ardagna, found 26 cases (out of 107) of fiscal consolidation associated with resumed growth, probably influenced policy makers most. This happened despite the actual finding that "… sometimes, not always, some fiscal adjustments based upon spending cuts are not associated with economic downturns."

Yet, in Harvard Professor Alesina's public statement, "several" became "many" and "sometimes" became "frequently", and mere "association" implied "causation". In April 2010, Alesina told European Union economic and finance ministers that "large, credible and decisive" spending cuts to rescue budget deficits have frequently been followed by economic growth. Alesina was even cited in the official communiqué of an EU finance ministers' meeting.

Jonathan Portes of the UK Treasury has acknowledged that Alesina was particularly influential when the UK Treasury argued in its 2010 'Emergency Budget' that the wider effects of fiscal consolidation "will tend to boost demand growth, could improve the underlying performance of the economy and could even be sufficiently strong to outweigh the negative effects". Christina Romer, then Chair of the US President's Council of Economic Advisors, also acknowledged that the paper became 'very influential', noting exasperatedly that "everyone has been citing it".

Researchers have found serious methodological and data errors in this work. Historical experience, including that of current Euro zone economies, suggests that the probability of successful fiscal consolidation is low. These successes depended on factors such as global business cycles, monetary policy, exchange rate policy and structural reforms.

Drawing on the IMF's critique of Alesina and his associates, even the influential The Economist (30 September, 2010) dismissed the view that fiscal consolidation today would be "painless" as "wishful thinking". Nevertheless, the IMF's policy advice remained primarily in favour of fiscal consolidation regardless of a country's economic circumstances or development level. There seems to be a clear disconnect between the IMF's research and its operations.

The third study, by Harvard Professors Carmen Reinhart and Kenneth Rogoff on the history of financial crises and their aftermaths, claimed that rising government debt levels are associated with much weaker economic growth, indeed negative rates. According to them, once the debt-to-GDP exceeds the threshold ratio of 90 per cent, average growth dropped from around 3 per cent to -0.1 per cent in the post-World War II sample period. Since then, however, significant data omissions, questionable weighting methods and elementary coding errors in their original work have been uncovered. Nevertheless, the Reinhart-Rogoff findings were seized upon by the media and politicians around the world to justify austerity policies and drastic public spending cuts.

Bill Clinton, fiscal hawk?

Supporters of austerity based fiscal consolidation often cite President Bill Clinton's second term in the late 1990s. However, the data shows that fiscal consolidation was achieved through growth, contrary to the claim that austerity produced growth. Clinton broke with the traditional policy of using the exchange rate to address current account or trade imbalances, opting for a strong dollar. Thus, the US dollar rose against major currencies from less than 80 in January 1995 to over 100 by January 2000.

The strong US dollar lowered imported inflation, allowing the Fed to maintain low interest rates even though unemployment fell markedly. The low interest rate policy not only boosted growth, but also helped keep bond yields close to nominal GDP growth rates. Thus, the interest burden was kept under control, with primary balances stable at close to zero.

Originally published by Inter Press Service.

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Retail Sales Show No Growth for July 2016 [feedly]

Retail Sales Show No Growth for July 2016
http://www.economicpopulist.org/content/retail-sales-show-no-growth-july-2016-6000

July 2016 retail sales were a real Wall Street let down as there was no change from June.  Gasoline sales plunged by -2.7%, yet most retailers had declining sales.  Auto sales and Amazon prime day were not enough to salvage overall retail sales.  Without autos & parts sales, retail sales would have dropped by -0.3% for the month.  Retail sales without gasoline station sales considered would have been a 0.2% monthly increase.  Retail sales overall have increased 2.3% from a year ago.

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Eichengreen: Airing the IMF’s Dirty Laundry [feedly]

Airing the IMF's Dirty Laundry
https://www.project-syndicate.org/commentary/imf-self-assessment-eu-crisis-by-barry-eichengreen-2016-08

Airing the IMF's Dirty Laundry

Barry Eichengreen

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BERKELEY – Following the International Monetary Fund's controversial actions in the Asian financial crisis of 1998, when it conditioned liquidity assistance to distressed countries on government belt-tightening, the IMF established an Independent Evaluation Office (IEO) to undertake arm's-length assessments of its policies and programs. That office has now issued a comprehensive critique of the Fund's role in Europe's post-2008 crisis.

Many of the IEO's conclusions will be familiar. IMF surveillance, intended to detect economic vulnerabilities and imbalances, was inadequate. While staff sometimes pointed to booming credit, gaping current-account deficits, or stagnant productivity, they downplayed the implications.

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This reflected a tendency, conscious or not, to think that Europe was different. Its advanced economies did not display the same vulnerabilities as emerging markets. Strong institutions like the European Commission and the European Central Bank had superior management skills. Monetary union, for some less-than-fully articulated reason, changed the rules of the game.

Such self-serving claims were in the interest of European officials, but why was the IMF prepared to accept them? One answer is that European governments are large shareholders in the Fund. Another is that the IMF is a predominantly European institution, with a European managing director, a heavily European staff, and a European culture.

The report, still on familiar ground, then goes on to criticize the Fund for acquiescing to European resistance to debt restructuring by Greece in 2010. It criticizes the IMF for setting ambitious targets for fiscal consolidation– necessary if debt restructuring was to be avoided – but underestimating austerity's damaging economic effects.

More interestingly, the report then asks how the Fund should coordinate its operations with regional bodies like the European Commission and the ECB, the other members of the so-called Troika of Greece's official creditors. The report rejects claims that the IMF was effectively a junior member of the Troika, insisting that all decisions were made by consensus.

But that is difficult to square with everything we know about the fateful decision not to restructure Greece's debt. IMF staff favored restructuring, but the European Commission and the ECB, which put up two-thirds of the money, ultimately had their way. He who has the largest wallet speaks with the loudest voice. In other words, there are different roads to "consensus."

The Fund encountered the same problem in 2008, when it insisted on currency devaluation as part of an IMF-EU program for Latvia. In the end, the Fund felt compelled to defer to the EU's opposition to devaluation, because it contributed only 20% of the funds.

The implication is that the IMF should not participate in a program to which it contributes only a minority share of the finance. But expecting the IMF to provide majority funding implies the need to expand its financial resources. This is something that the IEO report evidently regarded as beyond its mandate – or too sensitive – to discuss.

And was the ECB even on the right side of the table in these European debt discussions? When negotiating with a country, the IMF ordinarily demands conditions of its government and central bank. In its programs with Greece, Ireland, and Portugal, however, the IMF and the central bank demanded conditions of the government. This struck more than a few people as bizarre.

It would have been better if, in 2010, the IMF had demanded of the ECB a pledge "to do whatever it takes" and a program of "outright monetary transactions," like those ECB President Mario Draghi eventually offered two years later. This would have addressed the contagion problem that was one basis for European officials' resistance to a Greek debt restructuring.

One objection to imposing conditions on the ECB is that the eurozone, as a regional entity, is not an IMF member. Only countries, not regions, are entitled to draw IMF resources. But nothing prevents the IMF from demanding policy commitments from regional bodies when lending to their member governments. This has been done before when African and Caribbean monetary unions and central banks were involved.

Finally, the report criticizes IMF management for failing to ensure adequate involvement by the Executive Board, its oversight committee of 24 national representatives. Board approval was sought, but only after the key decisions were already made. Moreover, the Board was forced to act under intense time pressure and lacked the information needed to challenge management recommendations.

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The IEO's report suggests involving the Board more meaningfully, in order to provide a counterweight to political pressure from regional stakeholders. But this merely threatens to substitute one form of political influence for another.

It would be better to allow an independent management team to make decisions free of political interference, in the manner of a central bank policy committee. But this presupposes freeing the IMF from dependence on financial contributions from its regional stakeholders. And it requires IMF management to demonstrate that it can consistently make decisions based on program countries' economic interest, not on the political preferences of powerful national shareholders.

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