Putting Out Fires During Noah’s Flood, Or Eyeless In Gaza Part II

Paul Krugman had a short post recently drawing attention to a rather foolish and ill-thought-outstatement originating in the mouth of German Finance Minister Peer Steinbrueck.

Germany’s finance minister told AFP in an interview that cutting interest rates too low in an effort to counter the global recession could create what he called a dangerous “growth bubble.” – “On the one hand we need to boost the economy, on the other hand we must make sure that a policy of cheap money does not lead to a new growth bubble founded on credit, as happened after September 11, 2001,” Steinbrueck said.”It is therefore important that the focus, at least in Germany, be on sustainable investments in infrastructure and less on consumer spending financed by debt,”

Apart from the point Krugman wants to implicitly make about interest rates, the point about consumer debt in a current account surplus economy like Germany is extraordinarily misplaced. You have about as much chance of fuelling up a property boom in Germany as you have of setting up a ski slope in hell (that is, there is a “ski slope in hells” chance of getting this outcome – or put another way the likelihood is infinitely small). In Spain on the other hand, even while the possibilities of fuelling a further property boom right now are about as close to zero as you can get, the country’s leaders waste not a moment in trying to convince people to go out, borrow and buy, even though with a 10% current account deficit to correct, and corporate and household debts which run to over 220% of GDP, what they need to do is start saving, and not borrow more. This very ineptness (and basically I would argue lack of understanding of what monetary policy is all about) was also highlighed recently by statements from the European Union’s Economic and Monetary Affairs Commissioner Joaquin Almunia, who said (in an online chat for the Spanish newspaper El Pais) that whille getting financing costs down was necessary and important, interest rates should not be allowed to fall to negative levels in real terms.

“At this moment, it would be good for the cost of financing to go down……..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.”

Essentially two things are being confused here. Negative interest rates (such as those Spain had between 2002 and 2006 – you know, the ones that lead to the current Spanish crisis, see chart below) are highly undesireable during the upswing in a business cycle, when an economy is “overheating”, since you are simply giving more stimulus to economies which are already stretched to capacity – and negative rates may thus produce “bubbles”, as they obviously did in both Ireland and Spain – but these very same negative rates are obviously highly desireable during a downturn, and especially during recessions of the kind we are seeing at the moment, since they are one of the tools policymakers can use to stimulate slumping economies – all basic Econ 101 really. And of course, we are all currently heading into one of the most important recessions since WWII, or hadn’t our “machine-reader” commissioner noticed?

While I’m on this sort of topic, Krugman has a lot of useful and interesting material on the proposed US stimulus plans. The numbers are truly impressive and awe inspiring, with the fiscal deficit set to rise to close to (or even over) 10 per cent of GDP in 2009 according to initial estimates from the Congressional Budget Office.

But even this kind of aggressive fiscal assault may, as Krugman indicates, fall woefully short of what could be needed to stop the US labour market turning really sour, at least in the short term.

The new CBO budget and economic outlook is out. Above is its forecast for the GDP gap — the hole stimulus has to fill. I’d guess that the CBO estimate, which has unemployment averaging 8.3 percent in 2009 and 9 percent in 2010, is actually too optimistic (see 3, below), but even so it puts the Obama plan in perspective: a 3% of GDP plan, with a significant share going to ineffective tax cuts, to fill an 8% or more gap.

A comment which set me thinking about what is actually happening in Spain right now. Unemployment went over the 3 million mark in December, and is now running at something over 13.5% of the economically active population (according to Eurostat estimates). During 2009 this figure is certain to rise further, possibly to 4.5 million, or 20% of the economically active population (my guess, though it is a guess, since there are so many “unknowns” at this point – but we will surely be over the 4 million mark come next December).

Yet Spain’s Labour Minister Celestino Corbacho proudly points to a 10 billion euro public works and infrastructure programme which is intended to create 300,000 jobs during 2009 – 300,000 new jobs in an economy losing jobs at the rate over over a million a year, again is like trying to light a damp match during Noah’s flood. And obviously Spain’s resources are seriously limited in terms of fiscal resources to fight a problem on this scale. My back of the envelope calculations suggest that a capital injection – Japan style – of between 40% and 50% of GDP may be needed to sort out the accumulating pile of non performing corporate loans and grossly over-valued mortgage backed securities. Evidently Spain cannot handle a problem of this magnitude alone. So would those whose monetary policy helped light this bonfire, now like to step forward with the fiscal policy hose to try to help extinguish it? Are you listening Joaquin Almunia?

This entry was posted in A Fistful Of Euros, Economics and demography by Edward Hugh. Bookmark the permalink.

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".

16 thoughts on “Putting Out Fires During Noah’s Flood, Or Eyeless In Gaza Part II

  1. Pingback: bitsenbloc » Blog Archive » Interessant (2009.01.09)

  2. My view is a bit different. I think the ratio of debt (ie: money) to potential debt (ie: available future work) is critical to credit stability and an imbalance is the cause of this debt deflation. Government ‘stimulus’ merely piles up debt in a different column – it is future taxpayer earnings substituted for future taxpayer earnings, when you analyze it right to the core. In other words, it is neutral and it may be harmful to the degree that it actively prevents necessary debt destruction.

  3. I’m afraid I’m missing basic Econ 101 also.

    …the point about consumer debt in a current account surplus economy like Germany is extraordinarily misplaced. You have about as much chance of fuelling up a property boom in Germany as you have…

    Why?

    Didn’t Japan recently have an interest-rate-fueled property boom whilst running a current account surplus?

    michael

  4. i’ll say it again. krugman is an ego-maniacal sham who can’t grasp basic economic concepts. who endowed him with the mission to save the GDP growth at all costs? we already have a messiah. fighting to keep positive growth by fucking up future generations is not good business. let the generation that spent the money suffer a little. yes, unemployment can go to 20% for a couple of years. so? the way human race eat its young is despicable.

  5. I will put to you the same comment I left on Krugman’s blog: why do you assume that the GDP numbers are even real? If we all agree that we had a credti driven bubble – ? – then how can the GDP as stated be remotely close to reality? Consequently, the idea that we are filling a short term gap is a misnomer. it is a false flag who see the governement and low interest rates as the solution (again). Read PIMCO piece on the p[roblems. Gross obviously gets the problem. he is not stupid. But he is in almost every sense the very embodiement of the problme. He concludes the clincial diagnosis of the world / anglo economic model byu saying well saddly up close the fed and front run them. is that any different than the parasites who issued CDOs?

    Krugman gets it wrong becusue his starting piont is wrong. The gap whatever that means is far greater than 8% per CBO. If we were overlebveraged as an econbomy it has to be – unbles you think the Fed can force stuff to go up and then we just get poverty faster.

    The german Minister is absolutely correct. You argue your point as do all Keynesians with the certitude of knowing what? Where is the dat a to support the idea that low rates are the answer? Where is the evidence that spending money you don’t have and have no hope of repaying other than therough currency perversion is the right solution?

    Oh wait there is no solution, other than driving rates to zero and hoping you can impoverish and create enopugh chaos around the world to make yourself a relative winner. All is fare in love and war I suppose. Hoewever as Iraq shows the conventional tactics have formented. I might sugges you read Boyd.

  6. Hi Michael,

    “Didn’t Japan recently have an interest-rate-fueled property boom whilst running a current account surplus?”

    Not at all, property prices in Japan are still mired somewhere round where they were in 1994. Near zero rates in Japan did fuel a property boom in Iceland and New Zealand though – via the carry trade. There is a big difference between the property boom and the non property boom economies. It is one of the keys to the present situation.

  7. Hi Elto,

    “My view is a bit different. I think the ratio of debt (ie: money) to potential debt (ie: available future work) is critical to credit stability and an imbalance is the cause of this debt deflation. Government ’stimulus’ merely piles up debt in a different column – it is future taxpayer earnings substituted for future taxpayer earnings, when you analyze it right to the core.”

    Well you are certainly entitled to your view, and I basically agree with the above. I disagree with this bit though:

    “In other words, it is neutral”

    Basically it isn’t, because it moves demand around intertemporally. So the final path of GDP growth is higher if you do this sensibly. This is the core of the 1930s argument Krugman is using, and in this I very much agree with him. Some people always did, and still do, take another view.

    Basically, if you move demand around from when an economy is moving close to capacity (some point in the future, the point at which you pay down debt and cool and overheating economy via fiscal surpluses) to when it is operating massively below capacity (now, for example), you can increase total GDP considerably, since you leave less resources idle, and indeed you can produce quite a few things more cheaply (since energy, raw materials, productive capacity and wages are all cheaper now than they are at the height of a boom).

    Basically this was Keynes’s insight. What I think he hadn’t twigged, and that we can now see, is this situation becomes far more complicated under an ageing and declining population scenario (since you have less people working in the future to pay down the debt). Which is why France and the US for example, have a lot more leeway than Germany or Japan do.

  8. Hi S,

    “I will put to you the same comment I left on Krugman’s blog: why do you assume that the GDP numbers are even real?”

    Because I do. I think I have no better answer than that. I think you need to make certain assumptions to get the game started, like in chess or conversation. I look at very large quantities of data every day, and I see lots of problems, but not the ones that worry you. Sorry I can’t be more helpful.

    “Oh wait there is no solution, other than driving rates to zero and hoping you can impoverish and create enopugh chaos around the world to make yourself a relative winner.”

    Well, I may have many ambitions in life, but I must say I never thought of the above as one of them. Chaos, eh?

  9. Hi Andy,

    “krugman is an ego-maniacal sham who can’t grasp basic economic concepts.”

    Well, there’s an interesting idea. I must say I had never considered that possibility. That must make two of us.

  10. What I find very curious in what I am reading is the idea that Paul Krugman’s critics seem to feel modern economies need neither fiscal nor monetary stimulus. Not only that, they normally claim to know more economics than he does. This is certainly a very fresh and original view of the world. Unfortunately I can’t bring myself to share it.

  11. don’t defer to credentials. nobels outside hard sciences mean nothing. literature/econ/peace are all political. in this case the best course of action, like with the cold, is to do nothing. let the system heal itself.

    never heard krugman explain who’s gonna pay for the trillions he’s pushing. or maybe, just maybe he’s hoping his former boss, bernanke will get him a cushy job too if he does a great job? dirty mind i have.

    and to summarize keynesisim is reduced to “in the long run we’re all dead”. he was an old, childless, bitter man when he said that.
    you go figure.

  12. Hi,

    “and to summarize keynesisim is reduced to “in the long run we’re all dead”. he was an old, childless, bitter man when he said that.
    you go figure.”

    Didn’t he write this in the Tract on Monetary Reform (1923), one of his earlier works, and one of my personal favourites. The next sentence is even better (I actually use it as a masthead on my East Europe blog:

    “Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past, the ocean is flat again.”

    Pity you don’t like either Krugman or Bernanke, they are definitely my two favourite macro economists. Still, there are products to suit all tastes.

  13. Maybe if you Anglos hadn’t been so keen on selling your manufacturing bases to the highest (Asian) bidder while building your shopping mall nirvanas with E-Z credit, UK and US economies would still have some chance of avoiding The Collapse. Thanks to Mad Maggie and Ronald Ray-Gun who started this neoliberalism crap.

    The UK has had a peristent current account deficit for the past 17 years. USA is even worse. Now it is all falling down with frightening speed.

  14. “Basically it isn’t, because it moves demand around intertemporally. So the final path of GDP growth is higher if you do this sensibly.”

    Yes, I understand what you are saying. However, I still believe there is an absolute limit to debt (money) based on the realistic capability of a population to produce in the future. You cannot promise more than that or confidence colapses… and it makes no difference who does the promising. Government can no more guarantee 110% of your future capacity than you can.
    If governments would let today’s unsustainable debt collapse and then apply stimuli, I’d swing to your view. But they are not doing that – they are doubling down. They are trying to avoid current debt destruction by promising more future debt to be added to it.

  15. Hi again Elto,

    “If governments would let today’s unsustainable debt collapse and then apply stimuli, I’d swing to your view. But they are not doing that – they are doubling down. They are trying to avoid current debt destruction by promising more future debt to be added to it.”

    I see your view, but I still think the big difference is between those who have done their homework on immigration and fertility and those who haven’t.

    Those who will have larger and younger workforces in 2020 can afford to take on more debt now than those who won’t, and its as simple as that I think. Those who only have ageing and declining populations in front of them really are in a very tight fix, since they really can’t switch that much debt around inter-temporally. At least not without placing an intolerable burden on future cohorts of young people, and possibly risking that they leave en masse, they can’t.

  16. Pingback: “There Is No Deflation Threat In Europe” - Jean Claude Trichet - Oh Really! | afoe | A Fistful of Euros | European Opinion

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