Krugman’s blog, 4/19/15

There were two posts on 4/19.  The first was “Notes on Greece:”

OK, that was intense. I’ll write more about my visit, but right now (from Frankfurt, where I’m laying over for a couple of hours) I want to make a data point. about just how much adjustment Greece has done.

First, on the fiscal side, Greece has made an incredible adjustment — close to 20 percent of potential GDP, or the U.S. equivalent of about $3 trillion per year (not our usual 10-year calculation) in spending cuts and tax hikes:


Second, Greece has accepted roughly a 25 percent cut in nominal private-sector labor costs, or more than 30 percent relative to the euro average, far more than anyone else:


You can make a pretty good case that the costs of this adjustment were so large that Greece would have been better off exiting the euro in 2010. You can make an even better case that Greece would have been much better off if it had never joined in the first place. But at this point these are sunk costs. If Greece can negotiate a halfway reasonable compromise, one that more or less pauses further austerity, it’s hard to see that the risks of exit would be worth it.

And the creditors would be equally well served by such a compromise.

So is it going to happen? Well, it’s the right thing to do — which tells you nothing.

The second post on 4/19 was “Crowding In and the Paradox of Thrift:”

As Francesco Saraceno notes, the IMF’s research department, which was always excellent, has become an extraordinary source of information and ideas in this Age of Blanchard. In particular, these days you can pretty much count on the semiannual World Economic Outlook to offer some dramatic new insight into how the world works. And the latest edition is no exception.

The big intellectual news here is Chapter 4, on business investment. As the report notes, weak business investment has been a major reason for global economic weakness. But why is business investment weak?

Broadly speaking, there are two views out there. One is that we have a special problem of lack of business confidence, driven by fiscal worries, failure to make needed structural reforms, and maybe even careless rhetoric. The U.S. right, in particular, is fond of the “Ma! He’s looking at me funny!” hypothesis – the claim that President Obama, by occasionally suggesting that some businessmen have behaved badly, has hurt their feelings and perpetuated the slump.

The other view is that business investment is weak because the economy is weak. Specifically, it is that the effects of household deleveraging and fiscal consolidation have produced slow growth, which has reduced the incentive to add capacity – the “accelerator” effect – leading to low investment that further reduces growth.

The IMF comes down strongly for the second view. In fact, if anything it finds that business investment has held up a bit better than one might have expected in the face of economic weakness:

This is, interestingly, something I concluded a while back looking at U.S. data, during the height of the he’s-looking-at-me-funny era.

But wait, there’s more.

In order to deal with the problem of reverse causation – weak investment can cause weak growth as well as vice versa – the IMF adopts an “instrumental variables” approach. Loosely speaking, it looks for episodes of weak growth that are clearly caused by other factors, so that it can be sure that falling investment is an effect rather than a cause. And the instrument it uses is fiscal consolidation. That is, it finds cases where spending cuts and/or tax hikes depress demand and hence investment.

What it doesn’t say explicitly is that in using this procedure, it manages in passing both to refute a very widely held but false belief about deficits and to confirm a highly controversial Keynesian proposition.

The false belief is that government deficits necessarily “crowd out” investment, so that reducing deficits should free up funds that lead to higher investment. Not so, says the IMF: when governments introduce deficit-reduction measures, investment falls instead of rising. This says that the deficits were crowding investment in, not out.

And there’s another way to look at it: when governments introduce austerity measures, they are trying to reduce their net borrowing – in effect, they are raising their savings rate. What the IMF tells us is that such attempts to increase saving actually lead to lower, not higher, investment – and since saving equals investment, actual savings fall. So what we have here is an empirical confirmation of the existence of the paradox of thrift!

Remarkable stuff. Someone tell Wolfgang Schäuble.



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