When incomplete ideas get embodied in institutions and the people in them
As I have said before, its too easy to be rude about austerity. It is harder to put yourself in the mindset of reasonable individuals who take a different view, and pinpoint exactly - in ways that they will understand - why their view is wrong. So this paper from Marco Buti and Nicolas Carnot (HT Philip Lane) is useful because it shows us that mindset. [1]
The argument in the paper is essentially this. “We recall that large adjustments are needed
in most economies to restore sustainable fiscal positions, not because of the arbitrary will of the markets or of EU institutions.” So the debate is about the precise speed of adjustment, and the Commission is trying to strike the “right balance”. In particular, it recognises the need for different speeds in different countries. I think this view characterises the position of many international organisations, including the OECD, and many in the IMF.
There is a big mistake being made here. It essentially involves the prioritisation of issues. Fiscal adjustment is seen as the overriding priority. Issues involving the state of the economy are secondary: they are one factor in judging the appropriate speed of adjustment. This is the wrong way around.
The major priority at the moment should be doing something about the demand led recession in the Eurozone (and other countries like the UK). The budgetary position of some countries is a secondary factor that may influence the country by country balance of any fiscal actions required to deal with this priority.
This point about priorities is not an expression of political preferences. It is about what basic macroeconomics tells us. The recession is a problem right now. If it is not dealt with now, the loss of resources is permanent and irretrievable, and in addition there is likely to be a more permanent scarring effect through hysteresis. Given the imbalances within the Eurozone, and the political tensions generated by creditor/debtor relationships, the costs of a recession could be greater still. Budget consolidation is a permanent, long term issue, and there is clearly a right and a wrong time to deal with it. Recessions are the wrong time, not just because it conflicts with other priorities, but because it may not even work, because of hysteresis effects, or political effects, or banking effects.
So why is this obvious to me, but not to those running policy? To repeat, my own view is in no sense about the relative importance, in some abstract sense, of deficit bias versus avoiding recessions. As regular readers will know, on deficit bias and long run goals for debt I am something of a hawk. I just do not see why we cannot avoid recessions and bring down government debt.
In some cases those running policy take a different view because of ulterior political motives, but not in all cases. I’m prepared to give those in the Commission, and other international organisations like the OECD and IMF, the benefit of the doubt on this. I believe an important influence on their mindset is that they are working in a framework in which overall demand stabilisation is not their problem. That is monetary policy, not fiscal policy. It is very revealing that in the Commission paper two phrases do not appear at all: they are ‘zero lower bound’ (ZLB) and ‘liquidity trap’. Too few in government have recognised that when we hit the ZLB, the rules of the macroeconomic game fundamentally change, and the institutions of government - and those in them - have to adapt too.
This is hardly a novel point, but as Paul Krugman keeps stressing, it is absolutely central. It is why I get annoyed by those who insist that, if only we did monetary policy differently, all would be well - what I call ZLB denial. Few (unfortunately not all) deny the central role and importance of monetary policy in getting us out of recessions. When monetary policy fails - which it patently has, mainly [2] because of the ZLB - fiscal policy has to take its place. Countercyclical fiscal policy becomes as important as monetary policy normally is. Institutions, and habits of thinking, that are set up for normal times must adapt. The IMF recognised this in 2009, but I’m not sure the OECD or European Commission ever did.
We can see how this failure to change priorities influences the subsequent discourse by looking at two issues that are covered by the paper: OMT and Germany. The paper recognises the importance of OMT in altering market expectations. But they then say “As is clear as well however, the OMT announcement per se does not address the underlying sustainability concerns.” Of course OMT does not directly change the outlook for future primary balances. However it is a game changer in allowing periphery countries to change priorities. When you cannot sell your debt, this has to take priority over recession concerns (although fiscal consolidation can still be designed to try and avoid recession). What OMT allows countries to do is change priorities. If it had been implemented earlier, priorities could have been changed earlier. The paper does not see this, because for them fiscal consolidation remains the key priority.
The paper says “In Germany, the fiscal stance is now broadly neutral [3], hence consistent with
the call for a differentiated fiscal stance according to the budgetary space”. Which makes perfect sense (albeit using the rather tortured language of international organisation space), except at the ZLB. At the ZLB we need overall fiscal expansion in the Eurozone. The differentiation point still stands, so from an overall Eurozone perspective the Commission (and the OECD, and the IMF) should be arguing for substantial fiscal expansion in Germany. However, if your priority is fiscal consolidation, advocating doing nothing can seem quite radical and brave.
Right at the end there is a hint of recognition, but in a way that reinforces my point. To quote in full:
“A dedicated stabilisation fund could improve the conduct of fiscal policies throughout
the cycle by enforcing tighter policies in good times and providing additional leeway for cushioning downturns. Such a tool could strengthen the existing automatic
stabilisers while maintaining a credible rule-based framework. It would be particularly useful in the current predicament characterised by large cyclical differentials across the zone as well as a not insignificant average output gap. However, according to the Commission blueprint such a tool should only be considered in the longer term in the context of full fiscal and economic union.”
In other words countercyclical policy at the overall Eurozone level would be useful right now, but it needs to wait until we have the institutional change that can accommodate it. [4] Which tells me that those in the Commission think institutions are very important, but it does not tell me why existing institutions (and those within them) have to be behave in such a blinkered way.
[1] This can be seen as a companion piece to two others that looked at the power austerity has over politicians, and why some economists are suspicious of Keynesian fiscal stimulus. This post is about economists working in policy institutions.
[2] Unfortunately the ECB often gives the impression that as long as consumer price inflation is around about 2%, then nothing else (like other measures of inflation, or a recession) has anything to do with them. However I doubt very much that if the ECB had done what the Fed is now doing, a Eurozone recession would have been avoided.
[3] Whether this is true is another matter: see here for example. The latest OECD Economic Outlook has the German debt to GDP ratio falling steadily since 2011, despite a widening output gap.
[4] That institutional change will come too late for the current recession. I take a critical view of whether fiscal union for the Euro is either feasible or desirable here.
0 Comments