06/05/2012 03:17 PM
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Euro Troubles
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The End of Germany's Illusions
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by Stefan Kaiser





Germany's booming economy and plummeting unemployment has long insulated the country from the euro crisis on Europe's periphery. Those times, however, are coming to an end. The German economy is now showing it is vulnerable after all, and Chancellor Merkel will now be forced to make sacrifices.


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There they are again: the traders with sad eyes and the stock price displays showing jagged lines sloping downward. In the last 10 days, the DAX, Germany's blue-chip stock index, has fallen by 16 percent. On Monday it fell below the 6,000 point benchmark for the first time since January and has continued its plunge on Tuesday. Has the crisis, which for so long seemed to leave Germany untouched, finally reached Europe's largest economy?



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The stock slump is a warning signal, just as it was last summer, when the DAX lost 30 percent within just a few weeks, sparking a wave of politicking. One euro summit followed the next, resulting in ever larger bailout funds. Meanwhile, the German government tried to battle the problem by simply banning certain bets on sinking share prices. The widespread belief in Germany was that only the financial markets were acting up.



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That is probably the biggest problem the Germans have in the now two-year-old euro crisis. For Germans, it was always a crisis that belonged to others -- the Greeks, Portuguese, Spanish and Italians. That is, those who didn't have their finances in control and were expected to kindly atone for it by adopting the German model. Back home in Germany, by contrast, the economy was booming and people had work. In a sea of misery, Germany was an island of bliss.


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Fears Justified



But now, though, even its most stubborn adherents have begun realizing that this concept cannot work. The falling stock prices are just one of many indicators.
Corporate purchasing managers have been reporting unfavorable outlooks for months in surveys, and in May the Ifo business climate index, one of the country's leading economic pulse checks, fell for the first time in half a year.



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Even Germany's export-driven auto industry, typically spoiled by success, registered some major setbacks in May. Compared to the same month last year, domestic production dropped by 17 percent, while exports were down 13 percent. Though May 2011 was a record year for the industry, it still looks as though the European auto sales crisis has finally reached Germany too. Across the EU auto sales went down by 7 percent in April, year on year.



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German companies fear that the crisis, which began on the outskirts of Europe only to edge ever closer to the center, will reach them too. The fear is justified. A national economy cannot remain separate from these developments in the long term. The business world recognizes that demand from the countries in crisis is collapsing, and they realize that this could be just the beginning.


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Is the Party Over?



The fact that Germany has felt so little of the crisis so far is due largely to emerging markets like China, India, Brazil and Russia. Their economies booming, companies and consumers in developing economies were eagerly buying German products. In 2011, for example, China bought a record number of German cars.



But things are cooling off here too. The Chinese economy has long since ceased to grow as quickly as it did a year ago, while Russia feels the effects of the crisis in the form of currency turbulence. Not to mention that the United States, the biggest economy in the world, is also suffering major problems. The party in Germany could be over soon.



This makes it all the more important to finally grasp just how deeply mired in the crisis we are. Staying out of it is no longer an option. As far as Asia or the US are concerned, the differences have long since blurred. When investors lose their trust in the euro zone and take their money out of Europe, Germany too will feel the effects.



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Letting Go of Power



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Thus it is in Germany's interest to solve the life-threatening problems within the currency union both swiftly and sustainably. But steps more radical than Germany has been willing to take will be necessary to achieve this -- and that goes for both Chancellor Angela Merkel's government and the German people at large, who have vehemently rejected the prospect of their country having to give up any power or money to save the euro.



But that's what it must come down to in the end. Without an economic government and a true fiscal union, the euro won't survive.


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Some elements have already been established. European leaders already have significant influence on the budgets of those countries in crisis. Furthermore, the planned fiscal pact, agreed on by 25 of the EU's 27 member states at a summit in January, also requires signatories to pursue fiscal responsibility. But these measures are both incomplete and provisional.



Saving the euro requires European countries, including Germany, to give up more sovereignty and to accept more joint decisions. Ultimately, it also requires euro-zone countries to be collectively liable for their debts.

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© SPIEGEL ONLINE 2012


The many things that prey on our minds
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A big hairball of risk
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Jun 4th 2012, 3:09
by G.I. | WASHINGTON





PERHAPS the most disconcerting aspect of the world’s current flight to safety is the lack of a single overriding threat to justify it. China is slowing, but hardly in recession. Europe is in crisis—but when has it not been in the last three years? And Americawell, there’s that fiscal cliff later this year but it’s hard to find any investor thinking that far ahead.




The puzzle was underlined by May’s weak jobless report in America. What fundamental factors could explain it? Consider the usual suspects:



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1. Petrol prices rose much less this year than a year ago, and peaked in the first half of April. Retail sales, the most obvious place where petrol prices would be felt, didn't signal distress.




2. The current episode of European stress can be traced to Spain’s announcement in early March that it would miss its deficit targets, but equity markets in America didn’t take notice until the Greek elections in the first week of May. That’s too late to explain a slowdown that began in April.



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3. Emerging markets are slowing sharply. But even after extraordinary growth, exports to China, Brazil, India and Russia only equal 1.3% of American GDP. And a slowdown in emerging markets would be ambiguous for America by both hurting exports and pulling down oil prices.



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It’s tempting to chalk it up to technicalities. Consider the following contrast. GDP grew 2.2% annualised in the first quarter and Macroeconomic Advisers thinks it’s growing 2.4% in the current quarter. But employment growth shows a completely different picture: it plummeted from 225,000 per month in the first quarter to 73,000 so far in the second.


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Perhaps in reality employment grew 165,000 every month from January to May but warm winter and off-kilter seasonal adjustment telescoped most of it into the first three months at the expense of the next two. However, I have learned over the years that blaming bad data on seasonalities or technicalities usually reflects wishful thinking. Better to take it at face value.






What I think preys on the minds of financial and business-world risk takers is not a single threat but a multitude of them, regurgitated in one big hairball of risk. And all are about policy.



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1. The easiest to understand is China. The fall in credit, property prices and industrial activity are the result of a deliberate government effort to corral inflation and rebalance from investment towards consumption. The downsides of China's tiáo kòng (”macro control”) are well known: state-directed allocation of credit and investment is wasteful and distortionary. But the upside is that when the taps are opened, the effect is almost immediate. For example, businesses routinely pay their bills with bank drafts. When the authorities increase bank reserve ratios, those drafts immediately become harder to come by. Investors have learned to put enormous faith in tiáo kòng: as quickly as the authorities put the brakes on, they can release them. “Weak data to prompt effective support,” is how Barclays headlined a typical report Friday.






There are two problems with this optimistic take. The first is about will: authorities may be more willing to tolerate a slowdown and less enthusiastic about stimulus of the kind used in 2008 since it would delay rebalancing away from investment. 


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The second is about ability. China’s record of managing growth is not to be taken lightly but the policy that guarantees 8% growth with no booms or busts has yet to be invented. If China suffers a hard landing this year, it will only prove its leaders are human. Odds of a good outcome: 80%.




2. The most insoluble is Europe. It has faithfully followed Robert Feldman’s CRIC cycle: crisis, response, improvement, complacency. The European Central Bank bought the euro zone valuable time with its long-term loans to banks earlier this year; that time has been wasted. This is hardly a novel observation, but Greece isn’t about Greece; the euro zone can survive without it (the reverse is not necessarily true). 


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Whether it can survive a sudden and disorderly departure that precipitates runs on banks throughout the periphery is another matter. To fireproof the euro zone, most everyone outside Germany thinks euro members should share responsibility for each other’s banks (via common deposit insurance) and sovereign debt (via Eurobonds). Germany has refused to countenance this, and presumably won’t until Greece is in the process of leaving the euro. The optimists are convinced that Germany will bend if that’s the price of saving the euro. What they may not appreciate is that there is no singleGermany” to nod his head when some line is crossed; the country is a mosaic of competing power bases who may not coalesce around a solution in time to save the region. Odds of a good outcome: 60%.



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3. The most perplexing is America. The fiscal cliff at the end of the year is a problem in itself, and symptom of a larger problem. If all the tax increases and spending cuts programmed to take effect at year-end do so, GDP will suffer a 5% hit. Neither party wants this to happen. The larger problem this symptomises is the parties' inability to agree on any sort of stable fiscal policy that would take the place of the cliff. If they could, there wouldn't be a cliff in the first place.


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Optimists love to quote Winston Churchill’s line about Americans always doing the right thing after exhausting all other possibilities. Yet Congress and the administration have precious little time and incentive to do the right thing. Countless things could happen: Republicans who thought their leaders gave away too much before could force the government to shut down or default on the debt; a lame duck Barack Obama could refuse to override the fiscal cliff and bail out president-elect Mitt Romney; and who knows what the campaign may bring. Odds of a good outcome: 70%.



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The key takeaway is that while a good outcome is the likeliest scenario for each, the combined probability of all three turning out well is only one-third. And by the way, that’s without throwing in all sorts of other risks such as: Israeli attack on Iran; civil war in Syria; a victory by the populist Lopez Obrador in Mexico; and so on. Is it any wonder that the marginal investor or business would prefer to hold Treasury bonds or sit on cash? And that sort of disengagement can make economic pessimism self-fulfilling.



June 3, 2012
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This Republican Economy
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By PAUL KRUGMAN




What should be done about the economy? Republicans claim to have the answer: slash spending and cut taxes. What they hope voters won’t notice is that that’s precisely the policy we’ve been following the past couple of years. Never mind the Democrat in the White House; for all practical purposes, this is already the economic policy of Republican dreams.       



.So the Republican electoral strategy is, in effect, a gigantic con game: it depends on convincing voters that the bad economy is the result of big-spending policies that President Obama hasn’t followed (in large part because the G.O.P. wouldn’t let him), and that our woes can be cured by pursuing more of the same policies that have already failed.


.For some reason, however, neither the press nor Mr. Obama’s political team has done a very good job of exposing the con.


.What do I mean by saying that this is already a Republican economy? Look first at total government spendingfederal, state and local. Adjusted for population growth and inflation, such spending has recently been falling at a rate not seen since the demobilization that followed the Korean War.


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How is that possible? Isn’t Mr. Obama a big spender? Actually, no; there was a brief burst of spending in late 2009 and early 2010 as the stimulus kicked in, but that boost is long behind us.


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Since then it has been all downhill. Cash-strapped state and local governments have laid off teachers, firefighters and police officers; meanwhile, unemployment benefits have been trailing off even though unemployment remains extremely high.


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Over all, the picture for America in 2012 bears a stunning resemblance to the great mistake of 1937, when F.D.R. prematurely slashed spending, sending the U.S. economy — which had actually been recovering fairly fast until that point — into the second leg of the Great Depression. In F.D.R.’s case, however, this was an unforced error, since he had a solidly Democratic Congress. In President Obama’s case, much though not all of the responsibility for the policy wrong turn lies with a completely obstructionist Republican majority in the House.


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That same obstructionist House majority effectively blackmailed the president into continuing all the Bush tax cuts for the wealthy, so that federal taxes as a share of G.D.P. are near historic lowsmuch lower, in particular, than at any point during Ronald Reagan’s presidency.


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As I said, for all practical purposes this is already a Republican economy.


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As an aside, I think it’s worth pointing out that although the economy’s performance has been disappointing, to say the least, none of the disasters Republicans predicted have come to pass. Remember all those assertions that budget deficits would lead to soaring interest rates? Well, U.S. borrowing costs have just hit a record low. And remember those dire warnings about inflation and the “debasement” of the dollar? Well, inflation remains low, and the dollar has been stronger than it was in the Bush years.


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Put it this way: Republicans have been warning that we were about to turn into Greece because President Obama was doing too much to boost the economy; Keynesian economists like myself warned that we were, on the contrary, at risk of turning into Japan because he was doing too little. And Japanification it is, except with a level of misery the Japanese never had to endure.

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So why don’t voters know any of this?


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Part of the answer is that far too much economic reporting is still of the he-said, she-said variety, with dueling quotes from hired guns on either side. But it’s also true that the Obama team has consistently failed to highlight Republican obstruction, perhaps out of a fear of seeming weak.


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Instead, the president’s advisers keep turning to happy talk, seizing on a few months’ good economic news as proof that their policies are working — and then ending up looking foolish when the numbers turn down again. Remarkably, they’ve made this mistake three times in a row: in 2010, 2011 and now once again.


.At this point, however, Mr. Obama and his political team don’t seem to have much choice. They can point with pride to some big economic achievements, above all the successful rescue of the auto industry, which is responsible for a large part of whatever job growth we are managing to get. But they’re not going to be able to sell a narrative of overall economic success. Their best bet, surely, is to do a Harry Truman, to run against the “do-nothingRepublican Congress that has, in reality, blocked proposals — for tax cuts as well as more spending — that would have made 2012 a much better year than it’s turning out to be.


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For that, in the end, is the best argument against Republicans’ claims that they can fix the economy. The fact is that we have already seen the Republican economic future — and it doesn’t work.   


06/04/2012 12:16 PM
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Rising Currency Concerns
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Berlin Wants Spain to Accept Bailout Money

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With Madrid struggling to recapitalize its struggling banking sector, Chancellor Angela Merkel is pressuring Spain to accept bailout money. Spanish premier Rajoy has thus far resisted the move, but with central banks in developing countries now rapidly reducing their euro holdings, the situation is becoming dire.





Spain insists that it can recapitalize its banks by itself. The problem, as has become increasingly apparent in recent weeks, is that neither the markets nor Madrid's euro-zone partners believe it.


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SPIEGEL has learned that German Chancellor Angela Merkel and Finance Minister Wolfgang Schäuble agree that Spain should be forced to accept bailout money from the European Financial Stability Facility (EFSF), the temporary euro bailout fund, to inject liquidity into the country's struggling banks. The two settled on the strategy last week. Last Wednesday, Schäuble pressured his Spanish counterpart, Luis de Guindos, to accept the outside funding.
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Government experts in Berlin estimate that Spanish banks need between €50 billion and €90 billion in fresh capital. Madrid, however, has so far resisted applying to the EFSF for funding.


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Concern over Spain's ability to shoulder the burden has driven up the country's borrowing rates significantly. Last week, Madrid was forced to offer 6.7 percent interest rates on 10-year bonds, perilously close to the 7 percent rate that forced Portugal and Ireland to accept bailout funds from the EFSF in 2010 and 2011 respectively.




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The situation in Spain is causing significant unrest in euro-zone capitals and on the markets. The euro lost close to 7 percent of its value against the dollar in May while the German blue-chip stock index, the DAX, likewise plunged 7 percent in May, its largest drop in that month since its founding in 1988. On Monday, the DAX fell below 6,000 points for the first time since January.




Concern in Europe's common currency zone is not just limited to Spain, however. The possibility that Greece might ultimately be forced to give up the euro remains real as that country prepares for parliamentary elections on June 17. The far-left party Syriza, leading in some polls, remains insistent that it would seek to abandon many of the austerity measures imposed upon the country by Europe in exchange for bailout money. Europe could withhold funding in response, which would push Greece into bankruptcy. Both Portugal and Ireland likewise remain sources of worry.
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.Developing Countries Shedding the Euro


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An additional country has recently been added to the watch list. Cyprus has until the end of this month to come up with €1.8 billion to recapitalize Cyprus Popular Bank, the country's second largest, according to the Financial Times. The country's central bank head Panicos Demetriades told the paper that Cyprus was facing "crunch time" and allowed that applying for European funds was becoming "less unlikely."




.Cyprus has been hit hard by the troubles in neighboring Greece, with more than €3 billion having evaporated when Athens wrote down its sovereign debt. Loans to the Greek private sector that have so far gone unpaid are responsible for a sum many times that amount.




.More concerning, however, are reports that central banks of developing countries are turning their backs on the euro, a trend which has played a large part in the European currency's recent plunge against the dollar. Citing currency traders, the Financial Times on Monday reported that central banks have been among the largest sellers of the euro.



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The paper reports that the trend marks a reversal of buying patterns last year which saw developing countries, in an attempt to diversify their currency holdings, continue to buy euros despite debt troubles in the common currency zone.



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On Monday, European Commission head Jose Manuel Barroso will travel to Berlin for an evening meeting with Merkel to discuss the current situation in the euro zone. The talks are in preparation for a European Union summit scheduled for June 28-29 in Brussels. The common currency promises to be agenda item number one.


OPINION

Updated June 4, 2012, 7:13 p.m. ET
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Why This Slow Recovery Is Like No Recovery
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The U.S. economy lost about 10% relative to trendline growth. To make up the shortfall, we need to average more than 3% growth a year for several years.
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By ROBERT J. BARRO
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Last week's dismal jobs report showed little change in payroll employment for May and a slight rise in the unemployment rate to 8.2%, thereby underscoring the weakness of the economic recovery. Although changes in payroll employment and the unemployment rate are important, the key gauge of recession and recovery is the growth rate of real gross domestic product, and that is where our core problems lie.



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The average annual growth rate of U.S. GDP since 1948 has been 3.1%. In the recession starting in the third quarter of 2007 and ending in the second quarter of 2009, GDP fell by nearly 5%. But this decline is 10% when gauged relative to trend—that is, after factoring in normal growth. To make up for this shortfall, the subsequent recovery has to attain growth rates averaging above 3% for several years.




This is not an unreasonable expectation. For instance, the GDP growth rate averaged 4.3% per year from 1982 to 1989 following the deep recession of the early 1980s.



Yet in the current "recovery," beginning in the second quarter of 2009, growth has averaged only 2.4% per year, and just 1.8% for the first quarter of 2012. This low growth means that the U.S. economy has actually been falling further and further behind the normal trend. Therefore, it is not a recovery at all.




The Obama administration likes to blame the country's weak economic performance on the Bush administration, Europe's debt crisis, Japan's tsunami and so on. President Obama's advisers are now saying they learned only gradually that the economy was in even worse shape than they had imagined in 2009. But even if this is so, it gets the signals backwards: A bigger recession predicts a stronger recovery (as has to be true for the economy to return to its trend line).



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The pattern of strong recoveries following sharp downturns is clear when one examines the history of economic disasters. The worst depressions relate to wartime destruction, and the subsequent peacetime periods typically exhibit strong growth. Examples include the high post-World War II growth rates in Japan, Germany and much of Western Europe.





The pattern applies also to non-war depressions, including the Great Depression of the 1930s. U.S. GDP growth from 1933 to 1940starting from the trough of the Depression and ending before the economy was heavily influenced by World War II—was a remarkable 7% per year, despite the 1937-38 recession.



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A better argument can be made that recoveries are typically sluggish following a real-estate crash and prolonged declines in housing prices, as the U.S. has recently experienced. In a study of international housing crises published May 2 by Global Economics Weekly, Jose Ursua examines long-term house-price data for 11 countries, including the U.S. His sample included 65 housing busts, defined as falls in average house prices by at least 15%. The bottom line is that housing crises do impede subsequent recoveries.





However, the average GDP growth rate during the U.S. recovery since 2009 remains nearly 2% per year lower than would be expected, according to the Ursua study. That is, after factoring in the estimated impact of the typical housing bust, Mr. Ursua found that the U.S. growth rate since 2009 should have averaged a little over 4%, rather than the 2.4% we've experienced.




What's interfering with a real recovery? Perhaps the Obama administration should stop casting blame elsewhere and examine the policies it has implemented to ease the pain of recession and falling housing prices. (Some of those, to be fair, were initiated under the Bush administration.)



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Consider the expansion of social-safety-net programs, including food stamps, unemployment insurance, Medicaid (prospectively) and housing and mortgage programs. In a study published last month by the National Bureau of Economic Research, University of Chicago economist Casey Mulligan observed that, because these programs were means-tested (falling or ending as income rises), expanding them raised the effective marginal tax rate on labor income.





Specifically, Mr. Mulligan estimates that the effective marginal tax rate for low-income households went from around 40% in 2007, before the recession started, to about 48% in 2009, at the start of the recovery. Thus, while these programs may be attractive from the standpoint of assisting poor families, they dilute incentives to work.




.To achieve a real recovery, government policy should focus on individual incentives to work, produce and invest. Central here are tax rates and regulations, including especially clarity about future policies. In a successful policy package, the government would get its fiscal house in order and make meaningful long-term reforms to entitlement programs and the tax structure.




The Obama administration seems to think that individual incentives and serious fiscal reforms are of no great importance and policy should emphasize Keynesian-style demand stimulus (public works, prolonged benefits) along with bits of industrial policy (loans and grants to "green" energy companies). This approach has failed for three years.






Mr. Barro is a professor of economics at Harvard and a senior fellow of Stanford University's Hoover Institution.


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