While there is talk in some euro area countries, most notably Italy, about exiting the euro, Latvia remains determined to join in 2014. Since Latvia has for a long time pegged its currency, the lat, to the euro this wouldn't mean any loss in monetary policy independence, only that the transaction costs associated with a separate unit would disappear.
However, unlike those who have already joined, Latvia is forced to meet certain criteria. It has no problem meeting the criteria of exchange rate stability, or the fiscal criterias, but it does face the potential problem of having too high inflation. Since it can't have inflation more than 1.5 percentage points above the average of the lowest three EU-countries (including those with independent floating currencies) and since Latvia has the fastest growth in the EU (more than 5% at a time when most other countries have negative growth), and since given a fixed exchange rate higher growth tends to be associated with higher inflation (because of for example the Balassa-Samuelsson effect), this raises a potential obstacle to euro entry.
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However, it would seem that there is in fact no problem. Latvia's inflation was only 0.3% in February, the second lowest (after Greece). But how could inflation have fallen so much even as growth was high? Simple, they decided to do the opposite of what the Southern European countries have done and lowered taxes, especially the VAT. A lower VAT will provide a positive supply shock and lower prices while also boosting real income.
That the purpose of this VAT cut was to lower price inflation just in time for when it will be decided if Latvia meets the criteria is evident by the fact that it was implemented in July 2012, just in time for the annual average inflation rate to be lowered when the meeting about Latvia's entry will be held during the early summer. And indeed, Latvian officials are admitting that a key purpose of the VAT cut was to qualify Latvia for the euro.
The U.S. savings rate fell dramatically in January, from 6.4% to 2.4%. This mostly reflected the fact that income and savings was temporarily boosted in December by advance salary and dividend payments in anticipation of higher tax rates, but it also seems that for January, Ricardian equivalence was mostly confirmed.
Indeed, one could argue that it was entirely confirmed as spending didn't fall at all, while the savings rate fell sharply not only from the December level but also from the levels earlier in 2012. However, as some of the salary and dividend payments that were made in advance in December would have normally been made in January, it would seem that underlying income (and therefore also savings) was probably somewhat higher than formal income. We will have to wait a few more months to see if the savings rate recovers.
If it doesn't, then it is at a ominously low level, as the household savings rate was 2-2.5% during the housing bubble, the same level as in January.
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Since President Obama proposed an increase in the federal minimum wage in the U.S., from $7.25 per hour to $9 per hour and then index it to inflation, the debate has been raging about whether or not this would make low wage workers better paid or not paid at all (or in other words if they would get unemployed).
The short answer is that it would be a little bit of both, but with emphasis on little. To understand why we must first examine the issue theoretically and then look at current U.S. conditions.
Starting with theory, when a worker's pay is set on the free market, it will be no higher than the worker's (expected) marginal productivity and no lower than what the worker could get paid elsewhere or what the worker would feel is so low that not having any job is better (the latter is of course influenced by the extent to which the workers could live on for example unemployment benefits or welfare). The latter could be referred to as a worker's personal minimum wage.
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For unemployed workers their personal minimum wage is higher than the marginal productivity employers think they might have for them, while for employed workers, the marginal productivity is equal to or higher. ( Continue… )
According to the first preliminary U.S. GDP report, nominal GDP increased at an annualized rate of just 0.5%-yet nominal disposable personal income rose at an annualized rate of 8.1%.
How is that possible? Well, in part it probably reflects so-called statistical discrepancy. Production- and income numbers are based on different data sources and this quarter, unlike previous quarters, the production numbers are probably weaker than the income numbers.
The second, and likely far more important, explanation is that companies made large advance payments of salaries and dividends because they expected a big increase in tax rates. The fact that dividend income jumped an annualized $268 billion in December compared to November, and by $302 billion compared to October illustrates the importance of this factor.
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This will with near certainty be more or less entirely reversed during this quarter.
One of the lessons of this is that people do respond to incentives. If they hadn't, we wouldn't have seen these large advance payments of salaries to high income earners, and above all, dividends.
It has become an annual tradition here to summarize yearly exchange rate movements for some selected major currencies.
In 2012, the U.S. dollar fell against most other currencies, with only the Indian rupee, the Brazilian real and the Japanese yen falling in value against it. The yen's big drop was the by far most dramatic change, followed interestingly by the big increase for the South Korean won. Since Japan's and South Korea's economies are specialiced on very similar things, like electronics, ships, and cars, and because they therefore are direct competitors to each other, this will create some problems for South Korean companies.
It should however be noted that the won's big increase in value relative to the yen comes after several years of big drops, and compared to a few years ago, the won is despite the big rebound in 2012, significantly weaker compared to the yen. ( Continue… )
Now that the U.S. debt limit has been reached again depite being raised by $2.1 trillion (to $16.4 trillion) less than 1½ years ago, the limit and possible ways for Obama to evade it if House Republicans refuse to raise it have been debated, so I will offer some thoughts on the issue here.
On the one hand, I sort of agree with those liberal critics who argue that it makes no sense for Congress to on the hand make certain taxation and spending decisions and then to make a decision about debt unrelated to that. Since the change in debt is an arithmetic result of the difference between spending and revenue, making two decisions could be seen as a denial of the laws of arithmetic.
However, this doesn't necessarily mean that the debt limit is illegitimate, it could just as well imply that the decisions authorizing unlimited deficit spending are illegitimate. After all, most people have actual or potential debt limits in terms of how much creditors are willing to lend them. This means that one has to try to increase one's incomes or reduce spending once one comes near the limit. Regardless of whether one thinks that would be a good policy for the government or not, it is certainly consistent with the laws of arithmetic to adjust revenue and spending policies instead of doing away with the debt limit.
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And as it happens, the debt limit represents the best chance of achieving what the talks of the "fiscal cliff" utterly failed to achieve (indeed, they in fact quite to the contrary resulted in higher spending): namely lower spending in exchange for a higher debt limit. That was in fact what happened at the latest drama over the debt limit in 2011, though none of the cuts have actually been implemented yet. ( Continue… )
Apparently, a French court has struck down Socialist President Francois Hollande's new 75% tax rate on income above €1 million, something that some think means that there won't be punitive taxation of the richest in France. However, what the court actually objects to isn't the high tax rate, but that it will be applied to individuals, instead of households as has been the rule in France. By applying it to individuals while continuing to otherwise tax households, two households with the same total income could end up paying different rates depending on how incomes are divided among members of those households, something that the court finds violates the equal treatment rule in the French constitution.
This means that the Socialists are free to come up with a new tax proposal that applies a 75% tax on household income above €1 million, and the government has indeed already that it plans to quickly introduce a new proposal that doesn't violate the equal treatment rule.
It is a shame for France that the court in fact didn't strike down the punitive taxation, and only objected to some technical details in the enacted proposal. Even using unrealistic static analysis, where behavior isn't affected, the tax would have only brought in €210 million, a neglible sum (about 0.01% of GDP) in France's €2 trillion economy And considering how it has driven away hundreds of rich Frenchman, including famous actor Gerard Depardieu to Belgium and other countries, and created negative PR for the French business climate, the tax is in fact a lot more likely to lower tax revenue rather than increase it.
Veronique de Rugy makes the case for "going over the cliff". As she correctly points, that has its negative side in the form of higher marginal tax rates, something that is bad for growth, but nevertheless, it is long overdue for Americans to decide whether they want big government or not, instead of continuing the current policy of small government when it comes to taxation and big government when it comes to spending. In the long run, the current deficits that the combination of low taxes and high spending means is both unsound, harmful and unsustainable.
So ultimately, they 'll have to choose between either raising taxes (and that means higher taxes not just for the rich, but for the middle class as well) or cutting popular spending programmes or do a combination of these two. What the so-called "fiscal cliff" means is in fact doing that third option of both raising taxes and cutting spending to cut the current deficit of more than $1 trillion a year by half.
Not stopping it would therefore represent a great leap toward ending the current unsustainable and unsound build up of debt. The fact that the so-called debt ceiling (currently at $16.4 trillion, more than $2 trillion higher than 16 months ago) will be reached on the last day before "the cliff" could be viewed as a sign that the massive deficit reduction it means should be implemented, even though parts of it (the marginal tax rate increases) are bad for growth.
Japan has during the latest decade lagged most countries in GDP growth and it has also had low but relatively persistent price deflation. This has by some been interpreted as evidence that even low levels of deflation is harmful to the economy.
However, if you adjust for population growth, Japanese growth has actually been in line with U.S. growth and somewhat higher than the average for Western Europe. And if you further adjust for the fact that Japan's population is aging much faster than elsewhere, growth has actually been higher. Total GDP may have grown slower, but GDP relative to its working age population has been growing somewhat faster than the average for rich countries.
As a result, unlike both the U.S. and Western Europe it has a higher employment to population (in the 15 to 64 year age span) than a decade ago, and a lower unemployment rate. This clearly indicates that the source of Japan's economic stagnation is demographic, not monetary.
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This didn't stop Japanese voters from electing a new government that promised to create at least 2% in yearly inflation and has threatened to remove the Bank of Japan's formal independence unless it does a lot more to inflate. Since an "independence" that depends on it following orders isn't really independence, this means that the Bank of Japan's independence has in effect already been abolished. ( Continue… )
Ireland is often lumped together with the Southern European crisis countries. That was until recently justifiable since it too is a euro area country that has had a very weak economy and received a bailout due to soaring yields on its government bonds.
Yet Ireland has the recent year come to diverge in a positive way from Portugal, Spain, Italy and Greexe. Its borrowing costs have dropped dramatically so that they now potentially could return to the bond market. True, yields have dropped dramatically in Greece, Portugal and Italy too, but in Greece and Portugal they are still at punitive levels and Italy never saw yields rise high enough to force them to leave the bond market.
And though current account deficits in Southern Europe has dropped dramatically in the latest year, particularly in Greece and Portugal, they still have external deficits. By contrast, Ireland now has a large and rapidly rising current account surplus, €6.9 billion, or more than 5% of GNP, up from a surplus of just about €1.5 billion a year earlier and a deficit of more than €10 billion at the height of its housing bubble in 2007.
Though domestic demand is still falling somewhat, the increase in its external surplus was big enough for GNP to increase 3.7%. Contrast this with the significant declines in economic activity in Southern Europe in general and Greece in particular. It is also in fact stronger than in all non-Baltic EU countries. ( Continue… )