This short document (2 pages) is a synthesis of my macroeconomic views. One page of explanation and one page of graphs – The 2 pages Macro – 15 March 2019
Donald Trump hit out again recently at the Federal Reserve for its monetary policy management, taking it to task for hiking interest rates, which he claims would hamper US growth. But this is something of a bold statement given the White House’s fiscal policy.
The chart below depicts US unemployment and the government balance as a percentage of GDP, revealing that the two indicators have trended in a similar way over almost 60 years, each reflecting the US cycle. When economic activity is robust, jobless numbers decrease, while at the same time, tax income increases and spending to support the economy is lower, thereby improving the budget balance. This twofold trend has always worked well, even when Ronald Reagan embarked on economic stimulus at the start of the 1980s. Meanwhile, the budget surplus at the end of the 1990s is also an illustration of this trend, with Bill Clinton’s – fairly smart – moves to implement austerity policies to gain leeway in the event of a downturn in the cycle.
But the current period marks an exception. The cycle is robust, as reflected by the drop in unemployment to 3.7% in September 2018, hitting its lowest since 1969, yet the government balance is not improving, but rather it is deteriorating under the influence of Donald Trump’s policies. The public deficit stands at close to 5%, yet it should have fallen significantly on the back of the economic cycle. The government is driving economic stimulus at a time when the economy is running on full employment.
So it is reasonable for the Fed to take action to counter these excesses and avoid the emergence of persistent imbalances. We cannot rule out the possibility that fiscal policy will bolster domestic demand, triggering a significant surge in inflation and a larger external imbalance despite the White House’s protectionist measures (demand is rising sharply – due to tax cuts and increased spending – and supply does not have time to adjust, which leads to a swell in imports).
The Fed, as embodied by Chair Jay Powell, has clearly indicated that this policy is not sustainable in the medium term and that it must be offset, which is why the Fed is hiking interest rates – and it is right to do so – thereby setting the US economy on a more sustainable path for the medium term.
However, the risk lies in the event of a severe negative economic shock, as there would be no leeway for fiscal policy to adjust, and there would be no scope for raising the budget deficit or implementing a stimulus plan like Obama did in 2009, as the budget deficit is already extensive before a potential shock: the US economy would therefore be hampered over the long term. Trump’s policies will only help the better-off in society, who benefit from lower taxes, while the cost of this policy is spread out across the population via the ensuing increase in the public deficit. And this approach will create even more inequality in the longer term as some Republicans are alarmed at the extent of public debt and are arguing for a reduction in social spending to make this debt sustainable in the medium term. For now, America seems to have lost sight of the meaning of the words equality and fairness.
This post is available in pdf format My Tuesday Column – 1 October 2018
French public debt stands at close to 100% of GDP, but is this really a cause for concern?
No – it is important not to overstate the importance of this figure. French statistics body INSEE made the news as it measured public debt at over 100% of GDP for 2017, when it included railway operator SNCF’s debt. However, this is no longer the case, with debt accounting for 99% of GDP in the second quarter of 2018.
The chart shows two phases in French public debt trends – before and after the 2008 financial crisis. The State increased its debt issues and thereby smoothed the way for macroeconomic adjustment to the crisis by spreading out the shock that hit the French economy over the longer term.
We can see that the figure then rises again after 2010, but this is not a specific feature to France. It reflects slower growth in the French economy over the longer term, and a welfare set-up that failed to change to adapt to this new trend: so soaring public debt denotes a sluggish adjustment from French institutions.
In other words, the primary role of public debt is to help spread the load at times of economic shocks, but it skyrockets when the economy is slow to adjust to new economic conditions.
Is the 100% of GDP threshold a problem or not?
The figure itself is impressive and somewhat symbolic, but it is not necessarily damaging for economic momentum per se. Japanese public debt stands at 240% of GDP, yet the country has come through the financial crisis better than others judging by per-capita GDP: the country does not seem to be in danger of default.
The real problem is that we do not know just when public debt can actually become detrimental. Rogoff and Reinhart indicated in their research that public debt begins to dent growth when it moves beyond 90% of GDP, and this rule at least partly spurred on the European Commission’s austerity policy in 2011 and 2012. However, this argument does not hold water: R&R’s calculations were wrong and there is no rule on excessive public debt. Continue reading
Here is the frightening part of the Italian budget: growth figures. In an interview Giovanni Tria said that growth forecasts for 2019 and 2020 were 1.6% and 1.7% respectively.
These are unbelievable expectations. Such numbers were attained only in period of global euphoria (2006) or of global recovery (2010). This will not be the case in 2019 or 2020. The Italian GDP growth trend is just 1.1%. That’s why budget numbers are at risks.
We cannot bet on a 2.4% budget deficit in 2019, 2020 and 2021. We must have lower growth figures in mind and probably higher expenditures. The situation is at risk in Italy In other words, the reduction of the public debt (reduction of the public debt to GDP ratio by 1% every year ) will not be achieved.
The Italian budget program, which sets out a budget deficit of 2.4% of GDP for 2019, 2020 and 2021, did not go down very well with investors. Uncertainty on Italy is making a comeback and the yield on the 10-year government bond rose sharply as shown by the chart below (as at 15.00pm CET today).
So just what are investors worried about? Continue reading
“The biggest policy mistake of the last decade” is the title of an article by Ryan Cooper, and the mistake is of course austerity. (It is a very US focused piece, so Brexit is not on the map.) Cooper goes through all the academics who gave reasons why austerity was necessary and how their analysis later fell to bits. (How much they fell to bits is still a matter of dispute as far as these authors are concerned.)
Here is his concluding paragraph:
“As we have seen, the evidence for the Keynesian position is overwhelming. And that means the decade of pointless austerity has severely harmed the American economy — leaving us perhaps $3 trillion below the previous growth trend. Through a combination of bad faith, motivated reasoning, and sheer incompetence, austerians have directly created the problem their entire program was supposed to avoid. Good riddance.”
To read this article by Simon Wren-Lewis click on the link
The Italian question remains a concern for Europe, even after the nomination of a prime minister (to be confirmed by the Italian president), who is something of a lowest common denominator between the Five Star Movement and the League. Investors are breathing a sigh of relief, with the yield spread with Germany widening at a comparable pace than last week, as shown in the chart. However, many questions remain.
A number of points are worth raising:
1 – Italian malaise