Two posts yesterday. First was “Debt, Spreads, and Mysterious Omissions:”
Binyamin Applebaum reports on a new paper by Greenlaw et al alleging that bad things will happen to America, because debt over 80 percent of GDP leads to high interest rates, and is skeptical – but not skeptical enough. I found the paper amazing, and not in a good way.
As Applebaum says, Japan poses a big problem for this kind of analysis. So the question is whether Japan is a special case. The argument that it isn’t revolves around the suggestion that what really matters is borrowing in your own currency – in which case the US and the UK are, in terms of borrowing costs, like Japan rather than Greece. That’s certainly what the De Grauwe (pdf) analysis suggests.
Even the quickest look at the data suggests that there’s something to this argument; for example, taking data from the paper itself, and dividing the countries into euro and non-euro, we get a scatterplot like this:
It’s not just Japan, off at the far right, that looks different; Canada, the UK and the US, the three red squares along the middle bottom, also seem to have borrowing costs well below what euro-area experience might have suggested.
Furthermore, the experience since mid-2012, in which the ECB drove spreads down sharply after it signaled its willingness to head off self-fulfilling liquidity crises — which can’t happen to countries with their own currencies – also suggests that the own-currency issue is crucial.
So how do Greenlaw et al respond to this issue? Well, they don’t – not at all. They don’t even cite De Grauwe. So as far as I can tell this paper isn’t helpful at all; it ignores the key question in the whole debate.
The second post of the day was “Euro Delusions:”
I’ve been browsing through the collected speeches of Olli Rehn, the vice-president of the European Commission, who has emerged as the face of denialism when it comes to the effects of austerity. What I wanted to do is pinpoint what, exactly, he and those who share his position see as the evidence that their view is right. And I think it’s two things.
First, they look at the decline in interest spreads against Germany for troubled countries:
I see these moves as indicators of the effects of ECB policies — the LTRO program at the end of 2011, and the signaled willingness to buy sovereign debt beginning last summer. But they see it as proof that the confidence fairy has arrived.
Second, they see adjustment in unit labor costs:
I see that too — but it looks as if only a fraction of the needed adjustment has taken place, with years to go.
So basically they have seized on the ECB’s success at stabilizing debt markets — which from the De Grauwe point of view, which I share, is a demonstration that extreme austerity was unnecessary and unwise — as a vindication of austerity; and they have taken the slow progress of grinding deflation as a sign that all will be well.
Oh, by the way — for those following it, De Grauwe got his austerity measures here.