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Archive for the ‘History’ Category

Several colleagues recently suggested that now is a propitious time to read (or re-read) Paul Blustein’s “The Chastening.” The book recounts how the International Monetary Fund (IMF) and the G-7 nations struggled to combat the Asian, Russian, and Latin American economic crises of the late 1990s.

Having read the book while flying back and forth across the nation, I heartily agree. The Chastening is a great read if you want to get up to speed on many of the issues now posed by the “PIIGS” (Portugal, Ireland, Italy, Greece, and Spain).

I particularly enjoyed (if that’s the right word) the number of characters, familiar from today’s Greece debacle, that appear in the book. For example:

* The government that used derivatives to hide its perilous financial situation (Thailand)

* The German leaders who denounced the moral hazard created by sovereign bailouts (most notably Hans Tietmeyer)

* The policymakers facing doubts (often well-founded) about whether assistance packages could really help or were just postponing the inevitable (and, in the meantime, bailing out some unsympathetic creditors).

With the benefit of ten years more hindsight, readers can also enjoy a certain “you ain’t seen nothing yet” thrill from passages about how scary the financial world looked during the crises of the late 1990s.

[Alan Greenspan the] Fed chief told the G-7 that in almost 50 years of watching the U.S. economy, he had never witnessed anything like the drying up of markets in the previous days and weeks. (p. 334)

Unfortunately, we were all in for even worse in less than a decade. And now Greece is following in many of the steps of Korea, Thailand, Indonesia, Russia, and Brazil.

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A couple weeks ago, I highlighted an IMF report that compared the fiscal challenges facing developed economies. Not surprisingly, the IMF concludes that the United States has one of the largest structural deficits. To get our national debt back down to 2007 levels (relative to the economy), the IMF believes that we need to undertake a major fiscal adjustment–equivalent to a whopping 8.8% of GDP.

I have some quibbles about that figure, not least because the United States could avoid a fiscal crisis without getting the gross government debt all the way back to 2007 levels. But the basic message is sound: we face an enormous fiscal challenge.

However, we should not give up hope. As I discuss in a new piece over at e21, the IMF report also provides some reason for optimism: history provides numerous examples of developed economies that have successfully undertaken major fiscal adjustments. Indeed, the IMF finds 30 instances during the past three decades in which countries made adjustments of at least 5% of GDP, and nine cases in which the adjustments were even larger than the IMF currently prescribes for the United States:

The United States itself makes the list, with a fiscal adjustment (i.e., reduction in the cyclically-adjusted primary budget deficit) of 5.7% back in the 1990s.

Looking through the list, you will notice that many of these large adjustments occurred, at least in part, during the economic boom of the late 1990s. That isn’t surprising: fiscal adjustment is much easier if strong economic growth reinforces responsible fiscal policies.

P.S. For related posts, see this and this.

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The fiscal outlook for the United States is grim. This year’s deficit will be around $1.4 trillion, about 10% of GDP, and the Obama Administration projects that deficits in the next ten years will total about $9 billion. Under those projections, the ratio of publicly held debt to GDP will be approaching 77% by the end of 2019, up from 41% just a year ago.

Those figures are daunting. We are in a deep fiscal hole. But we shouldn’t give up hope just yet.

As the Committee for a Responsible Federal Budget notes in a new report, numerous countries have faced gigantic deficits and found the political will to change course. A few examples:

Finland (1992–2000): Following a major banking crisis, Finland faced large deficits (around 8 percent of GDP) and a rapidly rising debt (58 percent of GDP). Prior to the crisis, Finland was running surpluses of around 6 percent of GDP. Motivated by strong political support to get its house in order to qualify for eurozone participation and by the need to address external financing concerns, the government pursued a fiscal consolidation program. A medium-term budget framework, entitlement reforms, spending cuts and tax reform were part of the program. By 2000, the debt/GDP ratio was under 45 percent. The cyclically adjusted primary fiscal balance improved cumulatively by 10 percent of GDP from 1992.

Spain (1993–97): Spain’s fiscal position had been deteriorating since the late 1980s. By 1995, its fiscal deficit exceeded 7 percent of GDP. Its public debt exceeded 70 percent of GDP. Facing external financing concerns and strong public support to adopt fiscal disciplinary measures to prepare for euro area membership, the government adopted a fiscal consolidation plan that emphasized spending (including cuts in social transfers, government wages and health care spending) but also included tax reform. Fiscal balances improved, cumulatively by around 4 percent of GDP since 1993.

Sweden (1994–2000): Sweden’s fiscal situation deteriorated severely in the early 1990s as a result of a banking and economic crisis. In the midst of a recession, the government adopted a fiscal consolidation program to achieve fiscal balance through a tightening up on household transfer payments and an increase in various taxes. As a result of its fiscal consolidation efforts, the fiscal position shifted from a deficit of over 11 percent of GDP to a surplus of 5 percent of GDP and the debt/GDP ratio was reduced from 72 percent to 55 percent in 2000.

The CRFB report draws some interesting lessons from these episodes (e.g., Lesson 6: “It is preferable to make fiscal adjustments on your own terms before they are forced upon you by creditors.”)

But my point today is much simpler: Just as we were hardly the first developed economy to face a major financial crisis, we also are not the first to face a looming fiscal crisis. Indeed, as the examples of Finland and Sweden show, we aren’t even the first developed economy to face a potential fiscal crisis in the aftermath of a financial crisis.

As we prepare (I hope) to address our looming deficits, we can take heart from the fact that some other nations have successfully faced similar challenges.

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One of my first posts cautioned against comparing the current economic downturn to the Great Depression. Our economy is certainly in terrible shape, as Friday’s GDP data confirmed. Indeed, it’s the worst downturn since World War II. But it still pales in comparison to the horror of the Great Depression.

Since we received fresh data on Friday, it seems like an auspicious time to present a new version of my chart making this point:

Seven of the Eight

The green bar is the current recession. Most forecasters expect the economy to grow, albeit tepidly, in coming quarters. If they are right, the estimated peak-to-trough GDP decline in this downturn is 3.9%. (If you believe that forecasters are too rosy, feel free to add on your own estimate of further declines in the quarters ahead.)

The chart has three main messages:

(more…)

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Yesterday’s GDP report confirmed what many had already suspected: the current economic downturn is the worst since World War II.

According to the advance estimate, GDP fell at a 1.0% annualized pace in the second quarter, somewhat better than consensus estimates (which were looking for a decline in the 1.5% range). Revisions to last year, however, revealed than earlier parts of the recession were more severe than originally estimated.

Putting it all together, GDP has declined by an estimated 3.9% over the past four quarters. That edges out the recession of 1957-58, when GDP fell by 3.7% in just two quarters, as the deepest contraction in GDP since World War II.

To put this in context, the following chart shows the magnitude of all GDP declines since 1947:

Worst Downturn Since WWII (August 1)

There have been 25 such declines, ranging in length from one to four quarters. The current downturn beats all the others.

There wasn’t room to include the dates of the downturns in that chart, so here’s one that shows just the top five declines:

(more…)

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I’m not usually one to sign public petitions, but I made an exception today for a key issue: defending the independence of the Federal Reserve.

Like many other economists (here’s the list of signatories, with a day’s lag), I am troubled by the anti-Fed rhetoric emanating from some parts of the Congress. The Fed has taken a remarkable series of actions that deserve close congressional oversight. But that oversight should not endanger the Fed’s fundamental independence in executing monetary policy.

The petition therefore makes three important points about Fed independence:

First, central bank independence has been shown to be essential for controlling inflation. Sooner or later, the Fed will have to scale back its current unprecedented monetary accommodation. When the Federal Reserve judges it time to begin tightening monetary conditions, it must be allowed to do so without interference.

Second, lender of last resort decisions should not be politicized.

Finally, calls to alter the structure or personnel selection of the Federal Reserve System easily could backfire by raising inflation expectations and borrowing costs and dimming prospects for recovery. The democratic legitimacy of the Federal Reserve System is well established by its legal mandate and by the existing appointments process. Frequent communication with the public and testimony before Congress ensure Fed accountability.

Over at the WSJ, David Wessel has a nice piece on the petition.

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Today, the Washington Post has a letter to the editor about counting stimulus efforts. I think the letter is pithy and on-point, but that might be because I wrote it. Anyway, my conclusion is:

[T]here have already been two rounds of stimulus since the recession started in December 2007. The first, enacted in February 2008 (when I served at the President’s Council of Economic Advisers), provided $168 billion in tax cuts for families and businesses. The second, enacted in February of this year, provided $787 billion in various spending programs and tax cuts. The question we face today is whether to enact a third stimulus, not a second one.

The letter was a response to an editorial the Post ran last Friday.

Stimulus aficionados will recognize that, in the interest of brevity, I used dollar amounts that aren’t completely apples-to-oranges. As noted in my previous post on this topic, the $168 billion amount for the first stimulus reflects the gross amount of stimulus in the first couple of years; the long-run, net cost budget cost of the bill is lower. The $787 billion amount for the second stimulus is the ten-year net cost; the initial stimulus is a bit larger. I think the gross impact is a better way to characterize the stimulus effort, but I didn’t want to confuse anyone by referring to an $800+ billion stimulus, when everyone knows it as $787 billion.

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