Dear Friends
This is to share with you critical work on "macroeconomic confidence"
Best
Anisuzzaman Chowdhury
Professor of Economics
University of Western Sydney, Australia
Chasing the confidence fairy
When the financial crisis first hit, world leaders, including those in the largest economies in the G-20, acted decisively with large fiscal stimulus packages, totalling about $2.6 trillion during 2008-2010.
But with the emergence of supposed ‘green shoots’ of recovery from mid-2009, financial markets and media shifted attention to the ballooning public debt, especially in the Eurozone, where countries borrow in Euros, rather than in national currencies. Governments have been successfully pressured to take drastic measures to cut government debt and deficits.
Such drastic actions, it is claimed, would engender investor confidence and hence stimulate recovery. However, market confidence has not been restored. As the austerity measures adversely affect growth, jobs, incomes, and tax revenue, they reduce rather than raise market confidence. This is evident from recent downgrading of UK’s credit rating by Moody’s, saying that sluggish economic growth would hinder the government's ability to control rising debt levels and deal with any new financial shocks.
Yet, instead of abandoning or at least re-evaluating the austerity-based policies, the cuts are now said by some to have been insufficiently deep. Thus, more cuts are being proposed, further choking their ability to grow.
As a result, more than four years into the Great Recession, most industrialized countries continue to face growing unemployment and public debt. Average unemployment in industrialized countries rose from around 5% in 2007 to 8% in 2012. The Eurozone is faring worse, with unemployment over 11%, and still rising in some countries. The unemployment rate in Spain rose to 26% in 2012, with youth unemployment surging to 55%. In Greece, it stood at 26.8%, the highest in the European Union with youth unemployment edging towards 60%.
At the same time, the average public debt in industrialized economies increased from 70% of GDP in 2007 to about 110% in 2012 – its highest level in half a century. Government debt in the 17-nation euro zone rose to around 90% in the 3rd quarter of 2012 and is expected to peak at 94.5% in 2013, according to European Commission forecasts.
Thus, fiscal austerity – seeking to cut budgetary deficits, curb public debt and thus “regain the confidence of the financial markets” – has been self defeating, as it reduces economic growth as well as fiscal revenue and capacity.
The work of Alesina and his associates that influenced the European leaders of investors’ confidence and the need for big bang fiscal consolidation has been found fraught with methodological shortcomings and factual errors. Nonetheless, in his presentation at the European Cen! tral Bank, Alesina asserted very strongly that “Many even sharp reductions of budget deficits have been accompanied and immediately followed by sustained growth rather than recessions even in the very short run”.However, his findings were more modest: “...in several episodes spending cuts adopted to reduce deficits have been associated with economic expansions rather than recessions”. In his presentation, ‘several’ became ‘many’ and ‘associated’ became ‘immediately followed by’! Alesina’s study with Ardagna of 107 episodes of fiscal consolidation in all OECD countries during 1970-2007 found only 27 cases – about a quarter – of fiscal consolidation with growth.[1]
A recent IMF study notes that confidence effects have never been strong enough during downturn to make the consolidations expansionary at least in the short run.[2] It also finds that “Frontloaded consolidations tend to be more cont! ractionary and, hence, delay the reduction in the debt-to-GDP ratio relative to smoother consolidations.” Another IMF study shows that when fiscal consolidation leads to growth contractions they reduce rather than raise market confidence.[3]
Research at the IMF, using data from the past 30 years, indicates that very little long-term gains can be expected from fiscal consolidation which raises both short-term and long-term unemployment. It finds much greater impact of fiscal consolidation on long-term unemployment, and wage-earners are hurt disproportionately more than profit- and rent- earners. Thus, it concludes, “slamming on the brakes [fiscal consolidation] too quickly will hurt the recovery and worsen job prospects. Hence the potential longer-run benefits of fiscal consolidation must be balanced against the short- and medium-run adverse impacts on growth and jobs”. [4]
An earlier IMF study of 74 cases of fiscal consolidation in 20 industrialized countries during 1970-1995 found only 14 cases – less than a fifth – which were ‘successful’ in reducing (by about three percentage points over a period of three years) the debt-to-GDP ratio as the growth rate increased. [5] These successes were also due to factors such as the global business cycle, monetary policy, exchange rate policy, and structural reforms. It also found that “strong global economic growth helps to achieve a successful consolidation, and weak global growth reduces the chances that consolidation will cut the debt-to-GDP ratio”.[6]
The IMF has finally admitted that there was a serious miscalculation of multipliers with respect to the depth of resulting negative impact on growth during the design phase of austerity policies.[7] Is this admission enough for accountability when policy advice based on such erroneous research has brought miseries to millions of people and policy advisors comfortably hold on to their own jobs?
One wonders why the IMF with around 1,000 professional economists, many with Ph.Ds from top schools, had to use “informal evidence” to suggest a low multiplier. It is also not clear why the IMF advised fiscal consolidation so early in the
recovery when its past study was not so sanguine about the outcome. More puzzling is the little influence IMF research seems to have on its operations and policy advice and conditionalities.
So, it is not surprising that policymakers are still refusing to
reconsider their approach to dealing with unemployment and debt. Instead, they are still seeing signs of progress and ready to slam more cuts.
They are also hoping that growth will come from a major expansion of export demand, but obviously, global economic recovery cannot be based on all countries finding external markets for their output. Hence, the response to growing unemployment and public debt has to primarily involve reinvigorating domestic demand.
This would entail both immediate policy actions to expand domestic demand as well as medium-term policies to address structural issues, and longer-term challenges such as climate change. This requires national consensus among stakeholders, particularly government, business and workers.
The immediate task is to restore consumer and business confidence which depends on sales and profits prospects. This would require boosting spending. This can be quickly achieved by reversing social protection and public employment cuts.
Governments should expand public services including active labour market programs, subsidized childcare, universal healthcare and education. Such public provisioning enhances ‘social wages’, taking pressure off wage demands as businesses strive to recover. These measures help mitigate inequalities and enhance the welfare of all, thus ensuring social and political stability.
Moreover, well designed unemployment benefits and active labour market programs not only provide much-needed income support, but also prevent skill erosion by keeping workers employed and providing training.
Almost eight decades ago, President Franklin Roosevelt introduced the New Deal for a strong and sustained economic recovery. Not only did it pull the United States out of the Great Depression, but it also addressed unsustainable agricultural practices that had caused widespread environmental, economic and social distress, and helped usher in a new era of economic growth and prosperity, especially in some poorer regions.
The current crisis also needs a New Deal type response, but after decades of globalization and environmental deterioration, it must also involve international cooperation and coordination as well as a collective global commitment to sustainable development.The current crises are global
in nature and responses are needed in all countries.
The GGND will inevitably increase public debt in the near term; but this should not pose a longer-term problem as it will engender sustained economic growth and employment recovery, as the New Deal did almost eight decades ago.
Many countries had huge public debts when WW II ended. Despite similar calls then for drastic expenditure cuts, governments spent a great deal more on economic
reconstruction and social protection measures As a result, economies grew all over the world, and debt burdens diminished quickly with rapid economic growth and fast growing tax revenues. These experiences show that deficits and surpluses should be adjusted counter-cyclically over
the course of business cycles.
There is, of cou! rse, one big difference between then and now. The financial sector is much more powerful now, with governments often held hostage by financial markets and the whims of rating agencies. This continues, despite rating agencies abysmal performance before the crisis, with even the US Congress seriously debating whether they should be
prosecuted.
To make matters worse, there is still no orderly and fair mechanism for sovereign debt work-outs. The protracted
difficulties in resolving the Greek crisis underscore the urgent need for a fair and orderly sovereign debt work-out mechanism for all countries.
Harsh fiscal measures, without offsetting efforts to foster growth and job creation, typically fail to induce growth, create jobs, raise incomes and restore investor confidence. Instead, they exacerbate unemployment and social unrest, and are politically unsustainable.
A better way out is by deepening social dialogue among investors/employers, employees and governments. Only genuine social dialogues can reconcile competing demands on meagre resources as all parties can clearly see and address the costs and benefits as well as trade-offs among various difficult policy options.
[1] Alesina, Alberto, and Silvia Ardagna (2009). ‘Large Changes in Fiscal Policy: Taxes vs Spending’. NBER Working Paper 15438, National Bureau of Economic Research, Cambridge, MA; Alesina, Alberto (2010). ‘Fiscal adjustments: lessons from history’. Economics Department, Harvard University, prepared for the Ecofin meeting in Madrid, April 15.
[2] Batini, Nicoletta, Giovanni Callegari and Giovanni Melina (2012). ‘Successful Austerity in the United States, Europe and Japan’. IMF Working Paper, WP/12/190, p. 7.
[3] See, Cottarelli, Carlo and Laura Jaramillo (2012) “Walking Hand in Hand: Fiscal Policy and Growth in Advanced Economies”, IMF working paper, WP/12/137.
[4] Ball, Laurence, Daniel Leigh, and Prakash Loungani (2011). ‘Painful medicine’. Finance & Development, September, p. 20.
[5] Dermott, C. John, and Robert F. Wescott (1996). ‘Fiscal Reforms That Work’. Economic Issues, 4, November.
[6] Dermott and Wescott, op. cit, p.10.
[7] IMF (2012), World Economic Outlook 2012, October
This is to share with you critical work on "macroeconomic confidence"
Best
Anisuzzaman Chowdhury
Professor of Economics
University of Western Sydney, Australia
Chasing the confidence fairy
When the financial crisis first hit, world leaders, including those in the largest economies in the G-20, acted decisively with large fiscal stimulus packages, totalling about $2.6 trillion during 2008-2010.
But with the emergence of supposed ‘green shoots’ of recovery from mid-2009, financial markets and media shifted attention to the ballooning public debt, especially in the Eurozone, where countries borrow in Euros, rather than in national currencies. Governments have been successfully pressured to take drastic measures to cut government debt and deficits.
Such drastic actions, it is claimed, would engender investor confidence and hence stimulate recovery. However, market confidence has not been restored. As the austerity measures adversely affect growth, jobs, incomes, and tax revenue, they reduce rather than raise market confidence. This is evident from recent downgrading of UK’s credit rating by Moody’s, saying that sluggish economic growth would hinder the government's ability to control rising debt levels and deal with any new financial shocks.
Yet, instead of abandoning or at least re-evaluating the austerity-based policies, the cuts are now said by some to have been insufficiently deep. Thus, more cuts are being proposed, further choking their ability to grow.
As a result, more than four years into the Great Recession, most industrialized countries continue to face growing unemployment and public debt. Average unemployment in industrialized countries rose from around 5% in 2007 to 8% in 2012. The Eurozone is faring worse, with unemployment over 11%, and still rising in some countries. The unemployment rate in Spain rose to 26% in 2012, with youth unemployment surging to 55%. In Greece, it stood at 26.8%, the highest in the European Union with youth unemployment edging towards 60%.
At the same time, the average public debt in industrialized economies increased from 70% of GDP in 2007 to about 110% in 2012 – its highest level in half a century. Government debt in the 17-nation euro zone rose to around 90% in the 3rd quarter of 2012 and is expected to peak at 94.5% in 2013, according to European Commission forecasts.
Thus, fiscal austerity – seeking to cut budgetary deficits, curb public debt and thus “regain the confidence of the financial markets” – has been self defeating, as it reduces economic growth as well as fiscal revenue and capacity.
The work of Alesina and his associates that influenced the European leaders of investors’ confidence and the need for big bang fiscal consolidation has been found fraught with methodological shortcomings and factual errors. Nonetheless, in his presentation at the European Cen! tral Bank, Alesina asserted very strongly that “Many even sharp reductions of budget deficits have been accompanied and immediately followed by sustained growth rather than recessions even in the very short run”.However, his findings were more modest: “...in several episodes spending cuts adopted to reduce deficits have been associated with economic expansions rather than recessions”. In his presentation, ‘several’ became ‘many’ and ‘associated’ became ‘immediately followed by’! Alesina’s study with Ardagna of 107 episodes of fiscal consolidation in all OECD countries during 1970-2007 found only 27 cases – about a quarter – of fiscal consolidation with growth.[1]
A recent IMF study notes that confidence effects have never been strong enough during downturn to make the consolidations expansionary at least in the short run.[2] It also finds that “Frontloaded consolidations tend to be more cont! ractionary and, hence, delay the reduction in the debt-to-GDP ratio relative to smoother consolidations.” Another IMF study shows that when fiscal consolidation leads to growth contractions they reduce rather than raise market confidence.[3]
Research at the IMF, using data from the past 30 years, indicates that very little long-term gains can be expected from fiscal consolidation which raises both short-term and long-term unemployment. It finds much greater impact of fiscal consolidation on long-term unemployment, and wage-earners are hurt disproportionately more than profit- and rent- earners. Thus, it concludes, “slamming on the brakes [fiscal consolidation] too quickly will hurt the recovery and worsen job prospects. Hence the potential longer-run benefits of fiscal consolidation must be balanced against the short- and medium-run adverse impacts on growth and jobs”. [4]
An earlier IMF study of 74 cases of fiscal consolidation in 20 industrialized countries during 1970-1995 found only 14 cases – less than a fifth – which were ‘successful’ in reducing (by about three percentage points over a period of three years) the debt-to-GDP ratio as the growth rate increased. [5] These successes were also due to factors such as the global business cycle, monetary policy, exchange rate policy, and structural reforms. It also found that “strong global economic growth helps to achieve a successful consolidation, and weak global growth reduces the chances that consolidation will cut the debt-to-GDP ratio”.[6]
The IMF has finally admitted that there was a serious miscalculation of multipliers with respect to the depth of resulting negative impact on growth during the design phase of austerity policies.[7] Is this admission enough for accountability when policy advice based on such erroneous research has brought miseries to millions of people and policy advisors comfortably hold on to their own jobs?
One wonders why the IMF with around 1,000 professional economists, many with Ph.Ds from top schools, had to use “informal evidence” to suggest a low multiplier. It is also not clear why the IMF advised fiscal consolidation so early in the
recovery when its past study was not so sanguine about the outcome. More puzzling is the little influence IMF research seems to have on its operations and policy advice and conditionalities.
So, it is not surprising that policymakers are still refusing to
reconsider their approach to dealing with unemployment and debt. Instead, they are still seeing signs of progress and ready to slam more cuts.
They are also hoping that growth will come from a major expansion of export demand, but obviously, global economic recovery cannot be based on all countries finding external markets for their output. Hence, the response to growing unemployment and public debt has to primarily involve reinvigorating domestic demand.
This would entail both immediate policy actions to expand domestic demand as well as medium-term policies to address structural issues, and longer-term challenges such as climate change. This requires national consensus among stakeholders, particularly government, business and workers.
The immediate task is to restore consumer and business confidence which depends on sales and profits prospects. This would require boosting spending. This can be quickly achieved by reversing social protection and public employment cuts.
Governments should expand public services including active labour market programs, subsidized childcare, universal healthcare and education. Such public provisioning enhances ‘social wages’, taking pressure off wage demands as businesses strive to recover. These measures help mitigate inequalities and enhance the welfare of all, thus ensuring social and political stability.
Moreover, well designed unemployment benefits and active labour market programs not only provide much-needed income support, but also prevent skill erosion by keeping workers employed and providing training.
Almost eight decades ago, President Franklin Roosevelt introduced the New Deal for a strong and sustained economic recovery. Not only did it pull the United States out of the Great Depression, but it also addressed unsustainable agricultural practices that had caused widespread environmental, economic and social distress, and helped usher in a new era of economic growth and prosperity, especially in some poorer regions.
The current crisis also needs a New Deal type response, but after decades of globalization and environmental deterioration, it must also involve international cooperation and coordination as well as a collective global commitment to sustainable development.The current crises are global
in nature and responses are needed in all countries.
The GGND will inevitably increase public debt in the near term; but this should not pose a longer-term problem as it will engender sustained economic growth and employment recovery, as the New Deal did almost eight decades ago.
Many countries had huge public debts when WW II ended. Despite similar calls then for drastic expenditure cuts, governments spent a great deal more on economic
reconstruction and social protection measures As a result, economies grew all over the world, and debt burdens diminished quickly with rapid economic growth and fast growing tax revenues. These experiences show that deficits and surpluses should be adjusted counter-cyclically over
the course of business cycles.
There is, of cou! rse, one big difference between then and now. The financial sector is much more powerful now, with governments often held hostage by financial markets and the whims of rating agencies. This continues, despite rating agencies abysmal performance before the crisis, with even the US Congress seriously debating whether they should be
prosecuted.
To make matters worse, there is still no orderly and fair mechanism for sovereign debt work-outs. The protracted
difficulties in resolving the Greek crisis underscore the urgent need for a fair and orderly sovereign debt work-out mechanism for all countries.
Harsh fiscal measures, without offsetting efforts to foster growth and job creation, typically fail to induce growth, create jobs, raise incomes and restore investor confidence. Instead, they exacerbate unemployment and social unrest, and are politically unsustainable.
A better way out is by deepening social dialogue among investors/employers, employees and governments. Only genuine social dialogues can reconcile competing demands on meagre resources as all parties can clearly see and address the costs and benefits as well as trade-offs among various difficult policy options.
[1] Alesina, Alberto, and Silvia Ardagna (2009). ‘Large Changes in Fiscal Policy: Taxes vs Spending’. NBER Working Paper 15438, National Bureau of Economic Research, Cambridge, MA; Alesina, Alberto (2010). ‘Fiscal adjustments: lessons from history’. Economics Department, Harvard University, prepared for the Ecofin meeting in Madrid, April 15.
[2] Batini, Nicoletta, Giovanni Callegari and Giovanni Melina (2012). ‘Successful Austerity in the United States, Europe and Japan’. IMF Working Paper, WP/12/190, p. 7.
[3] See, Cottarelli, Carlo and Laura Jaramillo (2012) “Walking Hand in Hand: Fiscal Policy and Growth in Advanced Economies”, IMF working paper, WP/12/137.
[4] Ball, Laurence, Daniel Leigh, and Prakash Loungani (2011). ‘Painful medicine’. Finance & Development, September, p. 20.
[5] Dermott, C. John, and Robert F. Wescott (1996). ‘Fiscal Reforms That Work’. Economic Issues, 4, November.
[6] Dermott and Wescott, op. cit, p.10.
[7] IMF (2012), World Economic Outlook 2012, October
