The Crisis in the EU

by Jerry O’Driscoll

I addressed the Greek situation and the wider EU debt crisis in an op ed in The Wall Street Journal on Wednesday, November 2^nd (“Why We Can’t Escape the Eurocrisis”). It is also posted today on the Cato homepage. I explain the linkages between the US and the EU, particularly among financial institutions.

Banks within the EU finance the deficits of their governments. It is not just that Greek banks buy Greek sovereign debt, but French banks lend to Greek banks. And French banks buy the bonds of the Italian government. US banks lend to EU banks. Less well known, US money market funds hold a good amount of debt issued by EU banks. And the Fed is backstopping dollar funding of EU banks.

Sovereign defaults over there will have a big impact over here. And, then, there is our own public debt problem. And it is not just public-sector debt that afflicts both economies, but, to varying degrees, excessive leverage in the household and nonfinancial corporate sectors.

Last night, Judge Napolitano interviewed me for a segment on “Freedom Watch.”

The Judge was interested in not only the economic issues, but also political issues.

The lead segment was with John Allison, former CEO of BB&T, who decried the crony capitalism that is at the root of the crisis here and there. It was enjoyable to hear a former banker denounce rent seeking by banks. He even used the word “rents.”

No Way to Escape for the Swiss National Bank

by Andreas Hoffmann and Gunther Schnabl

It came as a surprise to many: the Swiss National Bank announced an exchange rate target. Accordingly, the Swiss franc will be held above the level of 1.20 francs per euro. Switzerland gives up a part of its sovereignty, when the ECB makes bad press in buying trash-rated euro area government bonds to support unsustainable national budgets.

But, particularly in an environment of global excess liquidity originating in too-easy monetary policies in major advanced economies, small open economies have incentives to stabilize exchange rates.

“A Divine Miracle”

by Jerry O’Driscoll  

In the August 24^th Wall Street Journal, Harvard Professor Robert Barro penned a hard-hitting op ed: “Keynesian Economics vs. Regular Economics.” He contrasts the lessons of standard economics with some of the unsubstantiated claims of Keynesian economics. He zeroes in on the idea that transfer payments provide economic stimulus.

Transfer payments in the guise of food stamps, unemployment benefits, and income redistribution generally have been the centerpiece of this administration’s policy to stimulate the economy. Barro quotes Agriculture Secretary Vilsack’s claim that the multiplier effect of food stamps is close to 2.

Trouble is, as Barro notes, “there is zero evidence that deficit-financed transfers raise GDP and employment – not to mention evidence for a multiplier of two.”

A Moment of Truth in the Debt-Ceiling Impasse?

by Mario Rizzo

The difference between a conservative and a classical liberal/libertarian once again is manifest.

The conservative wants to get the debt crisis over with even at the cost of some tax increases and not so reliable budget cuts. He thinks that, in the end, there will be some budget cuts, the deficit will be lowered and we can go on to real reform some way down the road.

The radical classical liberal realizes that the government keeps expanding over the long run and that the ordinary politics of compromise has not changed the fundamental course. We now have a moment of truth or perhaps simply of anxiety. This can be used to “force” the system toward real change. The danger, of course, is that the debt ceiling won’t rise in time. In time for what?

Where is the Bubble?

by Jerry O’Driscoll  

The monetary analysis of the housing bubble focuses on the impact of low – even negative – real rates of interest on housing demand.  That theory suggests the Fed must be inflating new bubbles with its continued policy of a near-zero federal funds rate. Skeptics ask where are the bubbles?

In today’s Wall Street Journal Business World column, Holman Jenkins answers with “Plane Crazy.” He specifically points to the recently announced deal in which debt-burdened and unprofitable American Airlines will take delivery of 460 new planes.  How did American pull this off?

Boeing and Airbus will share the order and each will finance a substantial portion of the purchase. “Think about it this way: Two rival banks get together and offer you a ‘no-doc’ mortgage for 115% of the value of your home,” writes Jenkins. He characterizes this as an opportunity for a “go-for-broke shot at a turnaround” for American. It’s an offer the airline could not refuse.

There are an ample number of other candidates for a bubble: gold, oil, farmland in the Midwest and perhaps the S&P. The entire world is awash in cheap dollars and much of the impact of the Fed’s policy has been to inflate bubbles overseas. That can be seen directly with the AA deal. More than half the order is going to Airbus, a European company.

The Fed’s easy-money policy was supposed to stimulate the U.S. economy and produce jobs for Americans. Fed policy has produced prosperity and jobs, just not in the United States.

Resource Allocation Distortions in the Great Recession: Empirical Evidence

by Mario Rizzo

The recent annual report of the Bank for International Settlements (BIS) has focused attention on the sectoral imbalances in the previous boom that resulted in the Great Recession. This is a refreshing change from the excessively aggregative analyses of the Keynesian-stimulus crowd.  

We Told You So

by Mario Rizzo  

In recent months – or has it been years? – Paul Krugman and Brad DeLong have been saying, in effect, “We told you so – the stimulus was not enough. Look at the sluggish economy and high unemployment rate.”

They are arguing that the problem with the fiscal stimulus is that it was not enough. The idea was right but the quantity was wrong.

Let it pass that at ThinkMarkets it was predicted that this is what the stimulus advocates would say in the event that the economy did not improve as much as they wanted.   

The basic problem with the quantitative claim is that it skirts some real problems in the analysis.

1. What was supposed to happen when the lines of spending actualized by the stimulus were exhausted?
2. How was the stimulus supposed to jump start private spending? Even the advocates of fiscal stimulus were not saying that the government stimulus had to be permanent .

What Peter Diamond Doesn’t Understand

by Mario Rizzo

I read with interest Peter A. Diamond’s opinion piece in The New York Times, “When a Nobel Prize Isn’t Enough.” Professor Diamond, by all accounts a very competent economist at MIT, is complaining that he really IS qualified to be a member of the Board of Governors of the Federal Reserve System. He really IS qualified to make decisions about monetary policy. He really IS qualified because he is an expert on labor markets. He really IS qualified because a top priority must be to lower the unemployment rate. And he IS qualified because he knows how to do this. 

I might have been forgiven if I had called this blog post, “Peter Diamond is a Crybaby.”

The Role of the Perverse Elasticity of Credit Money

by Andreas Hoffmann

I want to bring a recent comment by Sornette and von der Backe to the attention of the reader (in Nature 471, p. 166, May 2011). Sornette and von der Backe remind us to pay more attention to disequilibria caused by the fractional reserve banking system to explain the emergence of crises. They particularly recommend a reconsideration of the Austrian School of Economics to derive short-term policy solutions. “We should relearn and expand some of the old economic wisdom about the specific role of banks.”

Krugman’s No April Fool’s Joke — Unfortunately

by Mario Rizzo

I have been on an enforced vacation by the failure of my previous laptop. Now that I have access to my old files, permit me to begin where I left off at the beginning of April. The topic is of “eternal” significance.

In an April 1^st (print edition) opinion article Paul Krugman complained about the revival of so-called Mellonism. This is the idea that liquidation of over-expanded industry and a fall in prices and wages will somehow re-generate economic activity after a recession has begun.As Krugman duly notes, it is unclear that President Herbert Hoover’s Secretary of the Treasury Andrew Mellon had anything to do with this vague idea and even what his putative rationale was. Nevertheless, Krugman believes that Mellonism is still with us, some eighty years later.

But one thing is clear to any informed economist. The issue in pre-Keynesian economics was not whether prices and wages in general should fall or whether a large number of enterprises should fail. Keynes liked to summarize the “classical” position as allowing (encouraging?) the general fall in wages and prices to revive economic activity. While there was a basis for the view in the work of A.C. Pigou and some others, this was not representative of the major tradition.