News That Scares Me

Well, today I have come across three short news stories, each of which, in its own way, sent some kind of a shiver down my spine.

Iceland’s Interest Hike

First off, we have Iceland, where the central bank has just raised interest rates by a whopping six percentage points:

Crisis-hit Iceland’s central bank boosted interest rates by a massive 6 percentage points to 18 percent on Tuesday, just two weeks after it had eased policy to soften the impact of the country’s financial meltdown.

Now, I know they have to do something like this, but just think about it for a moment. Eighteen precent is a very attractive rate for you if you put your money there (and assume that the banks don’t default) – but how the hell are the Icelanders themselves going to pay all the interest that people will be clocking up?

Bulgaria’s Fiscal Surplus

Then we have Bulgaria, which is probably only days away from visiting the IMF itself at this point (assuming that is that they haven’t been already sounding them out). Now Bulgaria, as we know, has in the past been accused of running profligate government spending policies, even while its economy was booming. Heavy government spending under these circumstances simply makes existing overheating worse, and Bulgaria’s inflation not unsurprisingly went right through the roof. But now the whole process been transformed into its opposite (rather like in one of those scenarios where global warming leads to a new ice age). So I was really shocked to read the following:

Bulgaria plans to keep its tight fiscal policy and run a budget surplus of at least 3 percent of GDP in 2009 to protect the economy from the global financial meltdown, its 2009 draft budget showed on Monday.

This is really getting everything back to front, lax fiscal policy when you are overheating, and fiscal surpluses as you go into a “sudden credit stop” driven deep recession. Bad timing isn’t in it. This is simply madness.

EU Commissioner Almunia

And then there is Almunia – our dear and beloved Economy and Finance Commissioner Joaquin Almunia. I was really astonished – even horrified – to read this:

The European Union’s Economic and Monetary Affairs Commissioner Joaquin Almunia said on Monday that while lower financing costs were needed interest rates should not fall to negative levels in real terms.

“At this moment, it would be good for the cost of financing to go down,” Almunia told a live Internet chat with readers of Spanish newspaper El Pais (www.elpais.com), adding: “We shouldn’t go back to a situation in which real interest rates are negative, as we know from experience that this leads to excess indebtedness, low perception of risk and new bubbles which always end by blowing up in our faces.” Almunia said it was hard to say how long the present bout of financial turbulence would last but he thought the uncertainty plaguing markets should have cleared with a year.

Essentially two things are being confused here. Negative interest rates (such as those Spain had between 2002 and 2006) are highly undesireable during the upswing in a business cycle, since you are simply giving more stimulus to economies which are already stretched to capacity – and may thus produce “bubbles”, as they did in Ireland and Spain – but they are of course highly desireable during the downturn, and especially during recessions. We are currently heading into one of the most important recessions since WWII, or hadn’t our commissioner noticed?

I mean, basically the man is a total economic illiterate. Of course, there is no harm in that you may say, since many people are seriously challenged by the complexity of economic processes. Well quite, but this particular gentleman is supposed to be handling economic policy over at the EU commission, and he seems to have even less idea of how things work than they do in Bulgaria (with no disrespect, or negative stereotyping, intended towards Bulgaria, but simply the EU is supposed to be showing the new members how to do things, and if the Commission itself has no idea, then what chance is there for the rest of them).

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About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".