Thought du Jour

The most important hole in the plans for economic co-ordination is the unwillingness to recognise the link between the external surpluses of core countries and the financial fragility in the periphery. The focus remains overwhelmingly on fiscal indiscipline, which was not the cause of the crises in Ireland or Spain. ….

An admission that mistakes have been made by both the virtuous and the sinners may be a necessary condition for sustaining the political will to strengthen the system. Huge challenges remain ahead. It would be easier to believe they will be overcome if everybody confessed to their part in the mess. Those who lent so foolishly and those who borrowed so foolishly are implicated.

As Christine Lagarde, the French finance minister, has remarked, “it takes two to tango”. So it does. The eurozone’s tango is fiendishly complicated. But the dance goes on. It will continue to do so, provided the will to remain entwined survives.

Martin Wolf, “The ‘grand bargain’ is just a start“, Financial Times, 30 March 2011.

There is much more in the full column. Non-subscribers: this is an excellent choice for one of your ten monthly downloads from the Financial Times (registration required).

Cuban American economist Carmen Reinhart and her husband, American economist Vincent Reinhart, think that it is time for Japan to draw on its large stockpile of foreign exchange reserves. “Japan wisely built up a stock of foreign reserves for a rainy day. That rainy day is here ….”

Japan’s economic and financial system had never really recovered from the bursting of the equity and real estate bubbles (and the attendant systemic financial crisis) in 1992. ….

Japan’s fiscal position is no less dismal. Government debt is 226 per cent of GDP, by far the highest of advanced economies. Even with low interest rates, such levels constrain the state’s ability to respond to shocks. ….

Rebuilding is not Japan’s only problem however: it must also avoid a recession. In a recent study, we examined how 15 economies had responded to recent financial crises. The bad news is that large-scale banking crises, such as that recently suffered by Japan, leave a long trail of destruction – with real GDP growth about 1-1.5 percentage points slower in the decade after a financial fall. Worse, seven out of those 15 suffered a second recession during the post-crisis decade. In all seven it was possible to point to an external force – such as a natural disaster – that pushed an already sluggish economy back into a slump. Japan is similarly vulnerable now.

So what should be done? Thankfully, Japan has a war chest of liquid assets at its disposal: its authorities have been carefully stockpiling foreign exchange reserves (mostly US Treasuries) for years. At present, this stock is worth more than $1,000bn, or slightly below 20 per cent of GDP. To rebuild, the logical thing is to cash in some of this horde.

Carmen Reinhart and Vincent Reinhart, “Japan must dip into its rainy day fund“, Financial Times, 25 March 2011.

The writers are with the Peterson Institute for International Economics and the American Enterprise Institute, respectively. The study of 15 economies they refer to is “After the Fall“, Federal Reserve Bank of Kansas City, Jackson Hole Economic Policy Symposium, August 2010.

Via Mark Thoma, an old but still relevant post of Berkeley economist Brad DeLong.

Back in 2000, the U.S. government’s long-term budget was out of balance–although not by all that much. The government had, you see, made promises–very popular promises–for Medicare, Medicaid, and Social Security without proposing sufficient funding streams to pay for those promises. So back in 2000, looking forward, we had a choice: raise taxes, or “bend the curve” by cutting the growth of spending.

Instead of doing either of these, we elected George W. Bush. Two wars. A big (and ill-advised) defense buildup that is very unsuited to protecting us from Al Qaeda and company. A huge unfunded expansion of Medicare. Plans for the unfunded expansion of Social Security that came to nothing. However, instead of raising taxes George W. Bush reduced them.

This simply does not work. As Milton Friedman liked to say, to spend is to tax. If the government spends somebody will pay for it. And if you don’t levy the taxes to pay for it now all that means is that the person who owes the taxes does not know it yet. …

Taxes are going up over the next decade–barring cuts of 1/3 to Medicare, etc. They can either go up smartly or we can pretend they don’t have to go up, in which case they go up stupidly. The argument for small government was lost long ago, and was lost again and anew in the past decade with Medicare Part D and the wars of George W. Bush.

Brad DeLong, “In Which Mr. Deling Responds to Someone Who Might Be Professor Xxxx Xxxxxxxxx“, 18 September 2010.