I’ve been browsing through the collected speeches of Olli Rehn, the vice-president of the European Commission, who has emerged as the face of denialism when it comes to the effects of austerity. What I wanted to do is pinpoint what, exactly, he and those who share his position see as the evidence that their view is right. And I think it’s two things.
First, they look at the decline in interest spreads against Germany for troubled countries:
I see these moves as indicators of the effects of ECB policies — the LTRO program at the end of 2011, and the signaled willingness to buy sovereign debt beginning last summer. But they see it as proof that the confidence fairy has arrived.
Second, they see adjustment in unit labor costs:
I see that too — but it looks as if only a fraction of the needed adjustment has taken place, with years to go.
So basically they have seized on the ECB’s success at stabilizing debt markets — which from the De Grauwe point of view, which I share, is a demonstration that extreme austerity was unnecessary and unwise — as a vindication of austerity; and they have taken the slow progress of grinding deflation as a sign that all will be well.
Oh, by the way — for those following it, De Grauwe got his austerity measures here.
Binyamin Applebaum reports on a new paper by Greenlaw et al alleging that bad things will happen to America, because debt over 80 percent of GDP leads to high interest rates, and is skeptical – but not skeptical enough. I found the paper amazing, and not in a good way.
As Applebaum says, Japan poses a big problem for this kind of analysis. So the question is whether Japan is a special case. The argument that it isn’t revolves around the suggestion that what really matters is borrowing in your own currency – in which case the US and the UK are, in terms of borrowing costs, like Japan rather than Greece. That’s certainly what the De Grauwe (pdf) analysis suggests.
Even the quickest look at the data suggests that there’s something to this argument; for example, taking data from the paper itself, and dividing the countries into euro and non-euro, we get a scatterplot like this:
It’s not just Japan, off at the far right, that looks different; Canada, the UK and the US, the three red squares along the middle bottom, also seem to have borrowing costs well below what euro-area experience might have suggested.
Furthermore, the experience since mid-2012, in which the ECB drove spreads down sharply after it signaled its willingness to head off self-fulfilling liquidity crises — which can’t happen to countries with their own currencies – also suggests that the own-currency issue is crucial.
So how do Greenlaw et al respond to this issue? Well, they don’t – not at all. They don’t even cite De Grauwe. So as far as I can tell this paper isn’t helpful at all; it ignores the key question in the whole debate.
So, people want me to comment on the Moody’s downgrade of Britain. No real news there. As a guide to the future, ratings agency judgments are literally worse than useless; remember, US bond yields actually fell after the 2011 S&P downgrade. Still, it’s kind of a poke in the eye for Cameron/Osborne, who are subjecting their country to pointless austerity because confidence!
But they won’t change course; basically, they can’t, for careerist reasons. And that’s the story of a lot of what’s going on now.
Ralph Waldo Emerson understood this. The original version of his famous quote — I had forgotten this — reads:
A foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines.
I don’t know about the divines bit, but the little statesmen thing is completely accurate. Suppose George Osborne were to admit that austerity isn’t working. What, then, would be left of his claim to be qualified to do, well, anything? He has to stick it out until something turns up,no matter how many lives it destroys.
Pretty much the same thing is going on among pundits now stuck in what Jonathan Chait memorably calls the “fever swamp of the center”. Suppose that some pundit who has spent his whole career calling for bipartisanship, a compromise between the extremes of left and right, were to admit the plain fact that Obama is very much a centrist, who is in particular proposing deficit reduction through exactly the kind of mix of tax hikes and spending cuts “centrist” pundits demand — and that the GOP, by contrast, is an extremist organization whose extremism is almost solely responsible for the bitterness of the partisan divide. A pundit making that admission would in effect be saying that everything he has said and done for the past several years was not just useless but harmful, actively misleading readers about the state of the debate. He just can’t do it.
The point is that a large part of the reason we’re locked into such a mess is careerism. And yes, that’s quite vile, if you think about it: politicians and pundits alike letting the world burn — probably unconsciously, but still — because their personal position would be hurt if they admitted to past mistakes.
Some readers have been asking me for the data source for Paul De Grauwe’s measure of austerity. I’m working on it. Meanwhile, however — and partly for my own reference — I discovered that I can do a similar exercise over a somewhat longer time horizon, which I’m posting in large part as a note to myself.
Now, measuring austerity is tricky. You can’t just use budget surpluses or deficits, because these are affected by the state of the economy. You can — and I often have — use “cyclically adjusted” budget balances, which are supposed to take account of this effect. This is better; however, these numbers depend on estimates of potential output, which themselves seem to be affected by business cycle developments.
So the best measure, arguably, would look directly at policy changes. And it turns out that the IMF Fiscal Monitor provides us with those estimates, as a share of potential GDP, for selected countries from 2009 to 2012 (Table 15). What I’ve done is to plot those estimates (horizontal axis) against changes in real GDP from 2008 to 2012 (vertical axis). Here it is:
The implied multiplier is 1.2; the R-squared is 0.84.
In normal life, a result like this would be considered overwhelming confirmation of the proposition that austerity has large negative impacts. Yes, you can concoct elaborate stories about how it could be wrong; but it’s really reaching. It seems safe to say that what we have here is a case in which rival theories made different predictions, the predictions of one theory proved completely wrong while those of the other were totally vindicated — but in which adherents of the failed theory, for political and ideological reasons, refuse to accept the facts.
Nobody has taught me as much about the euro crisis as Paul De Grauwe, who brought to the fore a crucial point almost everyone was overlooking: the importance of self-fulfilling debt panics in countries that no longer have their own currencies. Now he has a new paper with Yuemei Ji following up on that insight, and offering yet more evidence of the incredible unwisdom of European economic policy.
What De Grauwe and Ji show is that the rush to austerity in Europe largely reflected the surge in sovereign debt spreads after Greece got in trouble; the bigger the spread, the harsher the austerity. But it turned out that the spreads didn’t reflect underlying fiscal fundamentals. De Grauwe had already made that point by comparing the UK with Spain; similar fiscal outlooks, wildly different borrowing costs. Now he has another piece of evidence, the spectacular decline in spreads once the ECB signaled its willingness to buy sovereign debt if necessary, thereby removing fears of a self-fulfilling liquidity crisis.
Meanwhile, all that austerity has taken a terrible toll. De Grauwe and Ji offer us yet another revealing scatterplot, using announced austerity measures in 2011:
But hey, Keynesian economics can’t be right, can it?
And they also show that countries pursuing austerity have by and large seen their debt positions worsen:
But take heart. Olli Rehn of the European Commission, last heard declaring that the big problem with austerity isn’t that it doesn’t work, it’s the fact that economists keep publishing studies showing that it doesn’t work, says that the only thing we have to fear is fear itself:
Mr. Rehn insisted that Europe’s belt-tightening policies were working and would lay the groundwork for a recovery. He said the European economy should expand in 2014, with growth reaching 1.6 percent across the Union and 1.4 percent in the euro area.
“We must stay the course of reform and avoid any loss of momentum, which could undermine the turnaround in confidence that is underway, delaying the needed upswing in growth and job creation,” he said in the statement.
Well, that’s all right, then.
While most Americans view their healthcare system as “free-market,” Switzerland actually has the most market-oriented healthcare system in the West. It translates into universal coverage and low entitlement costs. Swiss government entities spent about 3.5 percent of gross domestic product on healthcare in 2010, compared to 8.5 percent in the United States. That’s a difference of more than $5 trillion over 10 years: real money, especially relative to our $16 trillion debt.
OK, I don’t know what spending by “government entities” means — but the OECD offers standard data on public and private health care expenditure; according to these data, America does indeed have public spending of 8.5 percent of GDP — but the Swiss number is 7.4 percent. This isn’t an obscure source, it’s where everyone goes for the numbers. Something is very wrong here.
More generally, comparing public spending and calling lower public spending a “saving” is deeply wrong when it comes to health care, where some countries simply pay for health care out of public funds, while others use a combination of regulation and subsidies to achieve similar result, but with lower on-budget outlays. Here’s how I do the comparison when I teach it. First, a single payer system:
Here all of the spending shows up in the government budget.
Next, ObamaRomneycare (or, actually, the Swiss system), in which everyone is obliged to buy insurance, but the government subsidizes premiums for lower-income families:
Here only the subsidy component shows up in the government’s budget — but the two systems produce pretty much the same results. Oh, and ObamaRomneycare doesn’t save money relative to single payer — it just arranges that much of the cost takes the form of premiums rather than taxes.
Look, I know that we’re supposed to be celebrating people like Holtz-Eakin and Roy for showing more intellectual flexibility than the rest of their party. But I guess I find it hard to be encouraged when the supposed show of flexibility leads with grossly false and/or misleading numbers.
Oh, my. Aaron Carroll is rightly very, very annoyed at Douglas Holtz-Eakin and Arik Roy for saying that Obamacare should be replaced with a free-market system, like Switzerland’s. As he points out, the Swiss system is nothing like their description. In particular, they denounce community rating — but Switzerland has community rating!
Actually, though, it’s even worse than Carroll lets on, for two reasons.
One is that Obamacare in fact looks a lot like, you guessed it, the Swiss system — so much so that back in 2009 I described it as a plan to Swissfy America. After all the screaming about the awfulness of Obamacare, it’s pretty rich to hold up as a role model a very similar system.
But wait, there’s more: the Swiss system is more privatized than other European systems — and guess what, it has higher costs, indeed second only to America’s:
Maybe Holtz-Eakin doesn’t know anything about this — but wasn’t Roy supposed to be a conservative expert in this field? Are they really unaware of the basics here? Or do they just expect their readers to be easily fooled?
As I’ve written on previous occasions, the Bernie Madoff phenomenon helped me understand a lot about the persistence of bad economics. Madoff flourished through “affinity fraud”; his investors thought he was their kind of guy, so they didn’t look hard at how he was allegedly making money. And I realized that a similar phenomenon explains the enduring popularity of goldbugs and fiscal doomsayers — including, say, the Wall Street Journal editorial page — despite years of being wrong about everything; their devotees, who consist in large part of cranky old white men, see kindred spirits and can’t see past that to the consistently terrible analysis.
But it’s not just the goldbugs who benefit from affinity fraud, a point driven home by Ezra Klein’s piece on Alan Simpson. Simpson is, demonstrably, grossly ignorant on precisely the subjects on which he is treated as a guru, not understanding the finances of Social Security, the truth about life expectancy, and much more. He is also a reliably terrible forecaster, having predicted an imminent fiscal crisis — within two years — um, two years ago. Yet he remains not only respectable among the Beltway crowd; as Ezra says, he’s lionized in a way that looks from the outside like a clear violation of journalistic norms:
For reasons I’ve never quite understood, the rules of reportorial neutrality don’t apply when it comes to the deficit. On this one issue, reporters are permitted to openly cheer a particular set of highly controversial policy solutions. At Tuesday’s Playbook breakfast, for instance, Mike Allen, as a straightforward and fair a reporter as you’ll find, asked Simpson and Bowles whether they believed Obama would do “the right thing” on entitlements — with “the right thing” clearly meaning “cut entitlements.”
So what is it that makes Simpson the figure he is? Clearly, it’s an affinity thing: never mind his obvious lack of knowledge, his ludicrous track record, reporters trust and idolize Simpson because he’s their kind of guy.
And think about what it says about them that their kind of guy is this cantankerous, potty-mouthed individual, who evidently feels not a bit of empathy for those less fortunate.
There’s a lockdown on the Wikipedia page for Austrian economics and wouldn’t you know it, one or way or another, it all seems to be Paul Krugman’s fault.
For more detail, you can go, of course, to the Wikipedia page for Austrian economics. But until at least Feb. 28, if you do so, you will find that the page “is currently protected from editing.” An “edit war” has been raging behind the scenes. Two factions were repeatedly deleting and replacing a section of text that had to do with a description of a critique of Austrian economics made by economist Paul Krugman.
Substance aside — not that substance isn’t important — Austrian economics very much has the psychology of a cult. Its devotees believe that they have access to a truth that generations of mainstream economists have somehow failed to discern; they go wild at any suggestion that maybe they’re the ones who have an intellectual blind spot. And as with all cults, the failure of prophecy — in this case, the prophecy of soaring inflation from deficits and monetary expansion — only strengthens the determination of the faithful to uphold the faith.
It would be sort of funny if it weren’t for the fact that this cult has large influence within the GOP.
The interwar trade collapse (pdf).
Erskine Bowles tells a Politico event — now that’s a match made in heaven — that
The idea of a grand bargain is at best on life support.
OK, is there anyone whose immediate reaction isn’t, “Let’s convene a death panel!”
Look, a grand bargain right now is a terrible idea. The simple fact is that our political system isn’t ready. Washington is divided between parties with utterly different visions of what our society should look like; Republicans, in particular, would wait maybe a minute before trying to renege on any bargain that raises rather than cuts taxes on the wealthy, and that leaves the basic structure of Medicare and Social Security intact. So grand-bargain negotiations are, in practice, just an attempt to create facts on the ground for future confrontations, not a good-faith effort to secure the nation’s fiscal future.
Meanwhile, the Kabuki of grand bargain negotiations absorbs all of DC’s political energy, making it impossible to talk seriously about the economic problems we have right now. And while it may be possible in principle to support stimulus now even while talking long-run austerity, as a practical matter all the debt rhetoric leads to short-run austerity too.
So let’s disconnect that respirator, and let Bowles and Simpson spend more time with their families.
So, several people, including NF himself, have written in to say that Ferguson actually did concede that I was right about deficits and interest rates. Indeed he did; I missed it.
Unfortunately, there’s a very disturbing aspect to this sort-of concession; even while admitting that he had been wrong, Ferguson completely misrepresented his own earlier position, in an attempt to make it sound more defensible. Here’s his 2012 version:
FERGUSON: I think the issue here got a little confused, because Krugman wanted to portray me as a proponent of instant austerity, which I never was. My argument was that over ten years you have to have some credible plan to get back to fiscal balance because at some point you lose your credibility because on the present path, Congressional Budget Office figures make it clear, with every year the share of Federal tax revenues going to interest payments rises, there is a point after which it’s no longer credible. But I didn’t think that point was going to be this year or next year.
But here’s what he actually said in our original 2009 debate:
You can’t be a monetarist and a Keynesian simultaneously—at least I can’t see how you can, because if the aim of the monetarist policy is to keep interest rates down, to keep liquidity high, the effect of the Keynesian policy must be to drive interest rates up.
After all, $1.75 trillion is an awful lot of freshly minted treasuries to land on the bond market at a time of recession, and I still don’t quite know who is going to buy them. It’s certainly not going to be the Chinese. That worked fine in the good times, but what I call “Chimerica,” the marriage between China and America, is coming to an end. Maybe it’s going to end in a messy divorce.
No, the problem is that only the Fed can buy these freshly minted treasuries, and there is going to be, I predict, in the weeks and months ahead, a very painful tug-of-war between our monetary policy and our fiscal policy as the markets realize just what a vast quantity of bonds are going to have to be absorbed by the financial system this year. That will tend to drive the price of the bonds down, and drive up interest rates, which will also have an effect on mortgage rates—the precise opposite of what Ben Bernanke is trying to achieve at the Fed.
Points, then, for intellectual flexibility — but major demerits for trying to flush one’s own past statements down the memory hole.
David Brooks writes about the limitations of Big Data, and makes some good points. But he goes astray, I think, when he touches on a subject near and dear to my own data-driven heart:
For example, we’ve had huge debates over the best economic stimulus, with mountains of data, and as far as I know not a single major player in this debate has been persuaded by data to switch sides.
Actually, he’s not quite right there, as I’ll explain in a minute. But it’s certainly true that neither stimulus advocates nor hard-line stimulus opponents have changed their positions. The question is, does this say something about the limits of data — or is it just a commentary on human nature, especially in a highly politicized environment?
For the truth is that there were some clear and very different predictions from each side of the debate — not about the success of the Obama stimulus, which even advocates like yours truly warned would fall far short, but about interest rates, inflation, and the effects of austerity policies. On these predictions, the data have spoken clearly; the problem is that people don’t want to hear.
And really, would you have expected otherwise? It would be lovely to live in a world in which the failure of interest rates to soar as predicted would lead Brian Riedl of Heritage and Niall Ferguson to concede that their anti-stimulus critiques of 2009 were based on a completely wrong model; in which the economic downturns that have followed austerity policies almost everywhere they have been applied would lead Alberto Alesina to concede that his work on expansionary austerity was probably flawed, and lead George Osborne to proclaim publicly that he led Britain down the wrong path. But such things very rarely happen, and the fact that they don’t happen has nothing to do with the limitations of data.
Indeed, such things rarely happen even in fields of endeavor that are largely insulated from politics, and in which the ethos is supposed to reward objectivity over ego. Science, Max Planck declared, progresses funeral by funeral. If quantum mechanics needs to rely on mortality to prevail, how much more so must this be true of Keynesian macroeconomics?
That said, if you look at players in the macro debate who would not face huge personal and/or political penalties for admitting that they were wrong, you actually do see data having a considerable impact. Most notably, the IMF has responded to the actual experience of austerity by conceding that it was probably underestimating fiscal multipliers by a factor of about 3.
So yes, it has been disappointing to see so many people sticking to their positions on fiscal policy despite overwhelming evidence that those positions are wrong. But the fault lies not in our data, but in ourselves.