How Europe’s Double Dip Could Become America’s

ROBERT B. REICH

Wednesday, April 25, 2012




Europe is in recession.



Britain’s Office for National Statistics confirmed today (Wednesday) that in the first quarter of this year Britain’s economy shrank .2 percent, after having contracted .3 percent in the fourth quarter of 2011. (Officially, two quarters of shrinkage make a recession). On Monday Spain officially fell into recession, for the second time in three years. Portugal, Italy, and Greece are already basket cases. It seems highly likely France and Germany are also contracting.



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Why should we care? Because a recession in the world’s third-largest economy, combined with the current slowdown in the world’s second-largest (China), spells trouble for the world’s largest.



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Remember – it’s a global economy. Money moves across borders at the speed of an electronic impulse. Wall Street banks are enmeshed into a global capital network extending from Frankfurt to Beijing. That means that notwithstanding their efforts to dress up balance sheets, the biggest U.S. banks are more fragile than they’ve been at any time since 2007.



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Meanwhile, goods and services slosh across the globe. If there’s not enough demand for them coming from the second and third-largest economies in the world, demand in the U.S. can’t possibly make up the difference. That could mean higher unemployment here as well as elsewhere.



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What’s the problem with Europe? Don’t blame it on the so-calleddebt crisis.” There was no debt crisis in Britain, for example, which is now experiencing its first double-dip recession since the 1970s.



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Blame it on austerity economics – the bizarre view that economic slowdowns are the products of excessive debt, so government should cut spending. Germany’s insistence on cutting public budgets has led Europe into a recession swamp.


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German Chancellor Angela Merkel, who has led the austerity charge, and other European policy makers who have followed her, have forgotten two critical lessons.


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First, that the real issue isn’t debt per se but the ratio of the debt to the size of the economy.In their haste to cut the public debt, Europeans have overlooked the denominator of the equation. By reducing public budgets they’ve removed a critical source of demandat a time when consumers and the private sector are still in the gravitational pull of the Great Recession and can’t make up the difference. The obvious result is a massive slowdown that has worsened the ratio of Europe’s debt to its total GDP, and is plunging the continent into recession.



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A large debt with faster growth is preferable to a smaller debt sitting atop no growth at all. And it’s infinitely better than a smaller debt on top of a contracting economy.



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The second lesson Merkel and others have overlooked is that the social costs of austerity economics can be huge. It’s one thing to cut a government budget when unemployment is low and wages are rising. But if you cut spending during a time of high unemployment and stagnant or declining wages, you’re not only causing unemployment to rise even further. You’re also removing the public services and safety nets people depend on, especially when times are tough.




And with high social costs comes political upheaval. On Monday, Netherlands Prime Minister Mark Rutte was forced to resign. U.K. Prime Minister David Cameron is on the ropes. The upcoming election in France is now a tossupincumbent Nicolas Sarkozy might well be unseated by Francois Hollande, a Socialist. European fringe parties on the left and the right are gaining ground. Across Europe, record numbers of young people are unemployed – including many recent college graduates – and their anger and frustration is adding to the upheaval.



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Social and political instability is itself a drag on growth, generating even more uncertainty about the future.



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What European policy makers should do is set a target for growth and unemployment — and continue to increase government spending until those targets are met. Only then should they adopt austerity. What are the chances that Merkel et al will see the light before Europe plunges into an even deeper recession? Approximately zero.



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The danger here for the United States is clear, but there’s also a clear lesson. Republicans have become the U.S. party of Angela Merkel, demanding and getting spending cuts at the worst possible time – and ignoring the economic and social consequences.



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Even if the U.S. economy (as well as President Obama’s reelection campaign) survives the global slowdown, we’re heading for a big dose of austerity economics next January – when drastic spending cuts are scheduled to kick in, as well as tax increases on the middle class. But the U.S. economy isn’t nearly healthy enough to bear this burden.



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If nothing is done to reverse course in the interim, we’ll be following Europe into a double dip.



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ROBERT B. REICH, Chancellor’s Professor of Public Policy at the University of California at Berkeley, was Secretary of Labor in the Clinton administration. Time Magazine named him one of the ten most effective cabinet secretaries of the last century. He has written thirteen books, including the best sellers “Aftershock" and “The Work of Nations." His latest is an e-book, “Beyond Outrage.” He is also a founding editor of the American Prospect magazine and chairman of Common Cause.               


Spain will get worse without reform and European help
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Mohamed El-Erian

April 30, 2012



 
Standard and Poor’s' multi-notch downgrade of Spain’s sovereign credit rating was largely shrugged off by markets. That is the good news. The bad news is that S&P’s reasoning speaks to dynamics on the ground that are likely to worsen if a more balanced Spanish policy mix is not accompanied by targeted external support.


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In slashing Spain’s credit rating to BBB+ and retaining a negative outlook, S&P cited its forecast that the Spanish economy would contract by 1.5 per cent in 2012 (rather than expand as previously anticipated), the budget deficit would exceed 6 per cent of gross domestic product (compared to a government deficit target of 5.3 per cent), and the country’s debt-to GDP would rise steadily to almost 90 per cent by 2015. And all this in the context of recent government data that show that one in every four Spaniards is unemployed (with the youth unemployment rate alarmingly exceeding 50 per cent).


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This difficult reality explains why Spain is experiencing the worrisome combination of high borrowing costs, a slowly shrinking bank deposit base, capital outflows, and an increasingly binding internal credit crunch. This is a scary combination. It systematically withdraws oxygen from a real economy that is already struggling mightily; and it worsens in to a vicious cycle unless pronounced progress is made in three critical areas.



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First, Spanish policy needs to do a better job in convincing citizens that medium-term economic stability is both feasible and probable. To do so, it must act through both the numerator and denominator of debt sustainability; and, in particular, by striking a better balance between deficit containment (numerator) and growth (denominator).



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Too much of the burden is being placed on budget austerity and not enough on structural reforms that enhance Spain’s growth and job creation in a sustainable manner. As such, there are doubts about the durability and effectiveness of Spain’s adjustment efforts.


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Second, Spain needs to reduce worries about the potential impact on government finances of contingent liabilities that reside in its banks and on account of its real estate bubble. At a minimum, this requires further progress in consolidating the banking system, in allocating loan losses, and in convincing institutions to be much more aggressive in raising new capital from the private sector.



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The greater the timidity of these actions, the larger the concerns that Spain’s funding needs will overwhelm the markets’ appetite to provide voluntary financing at reasonable terms. It is thus paramount for Spain to do more to reassure the world that its budgetary financing gap will not be crushed by the assumption of liabilities from other sectors of the economy.


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Third, Europe needs to be more willing and able to support Spanish adjustment efforts. As currently set up, European mechanisms for exceptional financing assistance are overly binaryeither way too little assistance or, at the other end, a full blown rescue package that brings with it the risks of collateral damage and unintended consequences.



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Existing procedures make it difficult for Spain, if not impossible, to receive targeted official financing without also signaling that it is becoming a ward of the European state. As such, rather than complement a market-financed adjustment program, recourse to European emergency funding could result in Spain foregoing virtually all access to private financing (as is the case today for Greece, Ireland and Portugal).




What is at stake here goes well beyond the wellbeing of 46m Spanish citizens. The country’s health is also central to the proper functioning of a vital European unity project that is already under pressure due to economic and financial dislocations elsewhere, as well as political uncertainties that are sure to continue increasing.



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Spain does not have the public debt problems of Greece, nor its administrative dysfunction. Moreover, its government has not followed Ireland in assuming on its balance sheet the liabilities of an irresponsible segment of the private sector. But all this could prove irrelevant in avoiding a full-blown crisis if the country’s mounting difficulties are not tackled in a more balanced fashion by the government and, at the same time, supported by European partners in a more targeted fashion.



Re-Capturing the Friedmans
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J. Bradford DeLong

30 April 2012

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BERKELEYOn my desk right now are reporter Timothy Noah’s new book The Great Divergence: America’s Growing Inequality Crisis and What We Can Do about It and Milton and Rose Director Friedman’s classic Free to Choose: A Personal Statement. Considering them together, my overwhelming thought is that the Friedmans would find their task of justifying and advocating small-government libertarianism much harder today than they did in 1979.


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Back then, the Friedmans made three powerful factual claims about how the world worksclaims that seemed true or maybe true or at least arguably true at the time, but that now seem to be pretty clearly false. Their case for small-government libertarianism rested largely on those claims, and has now largely crumbled, because the world, it turned out, disagreed with them about how it works.


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The first claim was that macroeconomic distress is caused by the government, not by the unstable private market, or, rather, that the form of macroeconomic regulation required to produce economic stability is straightforward and easily achieved.


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The Friedmans almost always made the claim in its first form: they said that the government had “caused” the Great Depression. But when you dug into their argument, it turned out that what they really meant was the second: whenever private-market instability threatened to cause a depression, the government could avert it or produce a rapid recovery simply by purchasing enough bonds for cash to flood the economy with liquidity.


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In other words, the strategic government intervention needed to ensure macroeconomic stability was not only straightforward, but also minimal: the authorities need only manage a steady rate of money-supply growth. The aggressive and comprehensive intervention that Keynesians claimed was needed to manage aggregate demand, and that Minskyites claimed was needed to manage financial risk, was entirely unwarranted.

.Real libertarians never bought the Friedmans’ claim that they were as advocating a free-market, “neutralmonetary regime: Ludwig von Mises famously called Milton Friedman and his monetarist followers a bunch of socialists. But, whatever its packaging, the belief that macroeconomic stability requires only minimal government intervention is simply wrong. In the United States, Federal Reserve Chairman Ben Bernanke has executed the Friedmanite playbook flawlessly in the current downturn, and it has not been enough to preserve or rapidly restore full employment.


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The second claim was that externalities were relatively small, or at least that they were better dealt with via contract and tort law than through government regulation, because the disadvantages of government regulation outweighed the harm done by those externalities that the legal system could not properly address. Here, too, reality does not seem to have endorsed Free to Choose. In the US, this is most apparent in changing attitudes toward medical-malpractice lawsuits, with libertarians no longer viewing the court system as the preferred arena to deal with medical risk and error.

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The third, and most important, claim is the subject of Noah’s The Great Divergence. In 1979, the Friedmans could confidently claim that, in the absence of government-mandated discrimination (for example, the South’s segregationist Jim Crow laws), the market economy would produce a sufficiently egalitarian distribution of income. After all, it had appeared to do soat least for those who did not suffer from legal discrimination or its legacies – for the entire post-WWII era.


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So the Friedmans argued that a minimal safety net for those whom bad luck or a lack of prudence had rendered destitute, and elimination of all legal barriers to equality of opportunity, would lead to the most equitable outcomes possible. Profit-seeking employers, using and promoting human talents, would bring us as close to a free society of associated producers as is attainable in this fallen sublunary sphere.


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Here, too, the Friedmans’ hopes have been disappointed. The end of American preeminence in education, the collapse of private-sector unions, the emergence of a winner-take-all information-age economy, and the return of Gilded Age-style high finance have produced an extraordinarily unequal pre-tax distribution of income, which will burden the next generation and make a mockery of equality of opportunity.


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It would have been nice if the political program laid out a generation ago in Free to Choose had lived up to the Friedmans’ billing. It would have been nice if a relatively equal and prosperous society with full employment and equal opportunity had followed from a government that stood back from the economy and provided nothing but a minimal safety net, courts, and a constantly growing money supply.


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Alas, that did not happen. And it did not happen because the world described by the Friedmans is not the world in which we live.



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J. Bradford DeLong is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau for Economic Research. He was Assistant US Treasury Secretary during the Clinton Administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies, and cemented his stature as a leading voice in economic-policy debates.


The Case for Queasiness on the Economy
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Noam Scheiber
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April 27, 2012 | 2:53 pm