Autor: Steve Keen

University of Western Sydney

Deficits And Deleveraging

My focus is and will remain on explaining how the crisis came about, but in the middle of the crisis, government policies have the potential to either lessen the crisis or make it more extreme. Two of the best commentators on sensible policies to lessen the crisis are Yanis Varoufakis and Richard Koo.

Yanis (together with Stuart Holland) has authored the “Modest Proposal” to overcome the European crisis (the latest version is here in PDF: “The Modest Proposal“). Richard Koo recounts the Japanese experience with the bursting of its Bubble Economy and the many policy twists and turns afterwards in the Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession.

Richard argues this case with the empirical data provided by the unfortunate experiment that Japan has run in macroeconomics since its Bubble Economy burst back in 1990. Richard gave a keynote presentation at the Central Bank of Argentina conference last week, which I have posted on YouTube and reproduce below.

Both Yanis and Richard argue that government austerity at a time when the private sector is in a debt crisis is counterproductive. If the private sector is reducing its expenditure by deleveraging, then the same behavior by a government intent on “balancing the budget” will amplify the depressing impact of reduced private expenditure, thus deepening the crisis. Unfortunately this is precisely what the EU proposals for the PIGS are likely to do. Richard’s historically based analysis predicts that these austerity measures will deepen the crisis, and quite possibly result in increased rather than reduced government deficits, on the experience of Japan.

Yanis’s alternative Modest Proposal is to effectively have the European Central Bank behave as a true Central Bank. At present the ECB acts more like a financial disciplinarian than a Central Bank, since the only debt it directly funds is that of the EU itself–which is at the trivial level of about 1% of European GDP–while it imposes strict standards on how much public debt member states can carry on their own books (no more than 60% of their GDP) and how fast that debt can grow (budget deficits cannot exceed 3% of GDP). Member states are responsible for issuing and financing any debt they issue themselves.

In practice, these standards have been imposed very laxly, but in the current crisis they are being imposed with a vengeance on the PIGS, with Greece the country most in the firing line right now. Since it is almost universally acknowledged that Greece can’t meet these terms, the cost of Greek debt has blown out dramatically–further guaranteeing that it will fail to meet the conditions of the EU “bailout”–which of course is a means of paying Greek’s creditors, rather than Greece itself.

This is very different to the situation in the USA. If the European situation were imposed on the US, then each State in the USA would have to issue and fund its own debt for any budget deficit greater than 3% of GDP: there would be Californian bonds, Florida bonds, etc. You can imagine what the ratings agencies would do to those bonds, which would in turn guarantee that California and Florida would go bankrupt. Though the US States are in a parlous position, they are not formally bankrupt, while the US Federal Government is able to raise debt finance for itself and its States at near zero rates.

Yanis’s proposal is for the ECB to adopt the debt of its member states up to the 60% ceiling allowed by the Maastricht Treaty, and then to issue bonds to finance this debt which would then be serviced by the relevant member states. On the precedent of the US itself, this would result in highly rated bonds that would need very low interest rates, resulting in servicing costs that could be met by the PIGS–even by Greece (Greece would need special further arrangements since its public debt, when the last version of the Modest Proposal was published, was 87% of its GDP).

The Modest Proposal goes well beyond this single detail, and I suggest reading the full document since I don’t have the time to outline it in full here. It includes provisions to properly stress test the commercial banks that caused this crisis in the first place, to impose the pain of adjustment on the banks and their shareholders via equity transfers for any recapitalization needed to maintain solvency in the face of their toxic debts, and to finance infrastructure investment in Europe so that it can grow its way out of this crisis rather than deepening it by misplaced austerity.

Anyone who thinks that austerity is the way to go, on the basis of simplistic analogies to the situation of a household having to balance its budget or the like, should watch the presentation by Richard Koo.


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