Stefan Karlsson
One of many new houses empty and unsold around Ballymahon. Ireland's difficult but healthy deflation is allowing it to restructure faster than many other European nations. (Don Duncan/File)
Deflation is pushing Ireland to restructure faster
In March 2009, the Irish inflation rate fell below zero for the first time in decades. It was -0.7%, compared to 0.1% in February 2009.
Given this, one would have expected the inflation rate to pick up (or perhaps more accurately deflation rate to drop) now because of base effects.
The increase in the overall euro area inflation rate from 0.9% to a preliminary 1.5% reflected this. But it held firm at -2.4%.
The gap to the euro area average thus widened to a record high 3.9 percentage points. During the last two years, consumer prices are down a cumulative 3.1% in Ireland, compared to a cumulative 2.1% increase in the overall euro area (While the U.K. number is not yet available, it was almost certainly a lot higher than the euro area, probably around 6%).
Ireland is thus further down the path of a painful but healthy deflationary restructuring of its economy than other crisis hit European economies.
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Abigail Clark waits for her fiance at Whittier Street Health Center in Roxbury, Mass. The state's health plan, similar to the new federal health plan, is causing costs to rise, which has forced Massachusetts to put price controls on insurers. (Sarah Beth Glicksteen/The Christian Science Monitor/File)
Massachusetts' health plan is failing
James Capretta has an interesting column on the failure of Mitt Romney's health care scheme in Massachusetts (which is nearly identical to Obama's scheme, except that Obama's is on a federal level).
The subsidies it provides has - surprise, surprise - led to increased demand, which in turn has caused health care costs to increase even faster.
This has created big fiscal problems for the Massachusetts state government, which is now responding by price controls on insurers to limit cost increases. The insurers in turn respond by restricting access. Meaning that Massachusetts is rapidly moving towards the kind of "cost control by government rationing of health care" that the health care systems in Europe and Canada have used.
And since Obamacare will create similar problems once it is implemented on a federal level, so will the rest of the United States later.
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Krugman on Austrian Business Cycle Theory
I hate to discuss Krugman for a second day in a row, but I can't help myself after seeing this post attacking the Austrian Business Cycle Theory (ABCT). After referencing an article by Martin Wolf that mentions Austrian theory, yet contains no real arguments, he himself advances arguments against Austrian theory:
"My view is that the fatal flaw in Austrian economics is that it can’t explain unemployment — or, worse, that it thinks that it can explain unemployment, but is deluding itself. The Austrian view is that unemployment in a slump results from the difficulty of “adaptation of the structure of production” — workers are unemployed as resources are painfully transferred out of an overblown investment-goods sector back into production of consumption goods.
But this immediately raises the question, why isn’t there similar unemployment during the boom, as workers are transferred into investment goods production?"
The answer to that is of course that during the boom phase no businessman is suffering from lack of demand, and so no one needs to lay off workers, quite to the contrary, those in the investment sectors are seeing increased demand.
The problem is that this new source of demand is unsustainable, which means that these new businesses will eventually see a shortfall in demand, something which will cause them to lay off workers.
Krugman continues:
"I’ve asked this question repeatedly over the years, and all I get is one of two things: gobbledygook, or “but during the phase of rising investment, the economy is booming!”, which is of course circular. In practice, Austrians seem to be Keynesians during booms without knowing it; they realize that high demand produces a boom, but don’t realize that this contradicts their own theory of slumps."
What Krugman seems to think that anyone who even mentions demand in any way is a Keynesian-and furthermore that if you mention demand you must think it is the only factor. Both assertions are wrong, of course.
Yes, if some businesses are seeing increased demand while others don't, then this will produce booms. There is nothing necessarily Keynesian about recognizing that. He furthermore fails to mention how this is supposed to contradict the theory of slumps, which is that the end of this unsustainable source of demand is causing the slump. It seems perfectly consistent to me.
Perhaps Krugman believes that this contradicts the theory because the end of this source of demand supposedly means that there is a drop in "aggregate demand", and Austrians supposedly can't believe in declines in "aggregate demand". If you define aggregate demand as simply the quantitative sum of all purchases, then Austrians can believe in it since it is an accounting identity at that point. But the question is just how meaningful that accounting identity is.
The reason why Austrians don't think that the accounting identity "aggregate demand" is what we should focus on is because it misses the key causal factors at work. Since "aggregate demand" is equal to "aggregate supply" which in turn is equal to output, saying that slumps are associated with falling aggregate demand is really like saying that slumps are caused by slumps, meaning that it is in fact Keynesians which use a circular explanation of the boom and bust.
While Austrian theory agrees with Keynesian theory that some form of demand is driving the boom and that the destruction of that demand is driving the slump, what Austrian theory correctly describes unlike Keynesian theory is that 1) The boom is driven not just any form of demand, but by an unsustainable source of demand in the form of newly created money and by demand for capital goods industries (including the construction and consumer durable goods sectors) and that 2) When that demand disappears, the factors of production can move to other sectors only slowly or not at all, causing a decline in real output.
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Paul Krugman on 'Meet the Press' on March 6, 2005 before he won the Nobel economics prize. (Alex Wong/Meet The Press/AP/File)
Keynesian monetary policy needs bubbles to 'work'
If someone told you that he planned to buy a lot of fat food because he thinks they taste so good and he wants to experience those positive taste sensations, yet he wasn't going to actually eat them because he wants to avoid the weight gains associated with it, wouldn't you believe that he was delusional?
Yet an equivalent delusion can be found in Paul Krugman's writings about monetary policy and asset bubbles. In his latest post, he comments on his old call for bubbles. Let's start by reiterating what Krugman wrote then.
"The basic point is that the recession of 2001 wasn't a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble."
Krugman now claims that he wasn't advocating a bubble, he was simply neutrally stating the alleged fact that in order to end the recession, a new bubble was needed.
"If you read it in context, you’ll see that I wasn’t calling for a bubble — I was talking about the limits to the Fed’s powers, saying that the only way Greenspan could achieve recovery would be if he were able to create a new bubble, which is NOT the same thing as saying that this was a good idea. Of course, I know that this explanation won’t keep the haters from pulling up the same quote out of context, over and over."
I have read that whole article repeatedly, yet I can't find anything in the rest of it (you can try to find it yourself here) which provides a different context from what is in the above 2002 paragraph. Still, his explanation might have been plausible if Krugman had been a well-known "liquidationist" Austrian. But of course, we all know he isn't, and we all know that he instead advocates the use of government actions to close the "output gap" as soon as possible, at basically all costs. Indeed, in the next paragraph in his latest post, he writes this:
"But did I call for low interest rates? Yes. In my view, that’s not what the Fed did wrong. We needed better regulation to curb the bubble — not a policy that sacrificed output and employment in order to limit irrational exuberance. You can disagree if you like, but that doesn’t make me someone who deliberately sought a bubble."
So let's restate what Krugman argued:
1) He argued that the only way to end the recession or in other words to "not sacrifice output and employment" was to create a bubble.
2) He argues that he believed and still believe that it would be wrong to "not sacrifice output and employment".
3) Yet he still claims that he didn't endorse a bubble.
You simply can't believe in all of these things at once. You can believe in 1) and 3) at the same time if you at the same time didn't believe in 2), and you can believe in 1) and 2) at the same time as long as you don't endorse 3) and you can believe in 2) and 3) at the same time as long as you don't endorse 1). But you simply can't believe that in the absence of a bubble we would "sacrifice output and employment", argue that it is wrong to "sacrifice output and employment" and still argue that you're not for a bubble.
But aside from Krugman specifically wrote about bubbles in 2002, his current argument that you can use interest rate policy to revive an economy without creating bubbles reveals a lack of understanding (or perhaps honesty) about how a Keynesian monetary policy temporarily boosts an economy.
By lowering interest rates, a Keynesian central banker wants people to borrow money and start spending. If they don't do that for whatever reason, then monetary policy will have no effect on the economy. Thus, a necessary (but not sufficient) condition for Keynesian monetary policy to work is if it causes credit expansion (or possibly lower savings). Yet an expansion based on central bank inflation is an expansion based on an unsustainable factor, meaning in short that it is creating a bubble in the parts of the economy where the newly created money is spent. Thus, in order to work Keynesian monetary policy needs bubbles (not necessarily big ones, but it needs to be some form of bubble(s)).
Suppose then however, we got Krugman's current stated wish of "better regulation to curb bubbles". Assuming they were effective, this means that monetary policy would also become less effective, meaning that the regulations would "sacrifice output and employment".
There is really no escape: either you get a bubble type boom with a temporary boost to some forms of output and employment-or you don't get it. If you get it, it might shorten a recession but create a bubble which will create future problems. If you don't get it you will avoid bubbles, but you won't get the temporary boom in some sectors that Keynesian monetary policy is aimed at achieving. The view of Krugman and other Keynesian that we need Keynesian monetary policy to create a temporary boom and regulation to prevent bubbles is as confused like the view of the guy that bought fat food to enjoy the taste sensations they create while refusing to actually eat it because he doesn't want to gain weight.
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n front of a portrait of the late Iranian spiritual leader Ayatollah Khomeini, President Mahmoud Ahmadinejad flashes a victory sign to the crowd in a public gathering at the city of Oroumiyeh on April 7. (Hamed Malekpour/Fars News Agency/AP)
China may avoid 'currency manipulator' label under conditions
There are reports that the U.S. government will postpone and perhaps cancel a planned classification of China as "currency manipulator" (Which China is of course, but not more than other governments, including the U.S.) in exchange for Chinese support for tougher sanctions on Iran. Britain, France and Russia already agree, so if the Chinese too agree to it, it can pass the UN Security Council.
Meanwhile, Iran's President Mahmoud Ahmadinejad tries to pretend that Iran won't be affected by sanctions:
"Faced with the prospect of new sanctions because of Iran’s nuclear defiance, Ahmadinejad said that such penalties would only strengthen his country’s technological advancement and help it to become more self-sufficient.
"Don’t imagine that you can stop Iran’s progress," Ahmadinejad said in remarks broadcast live on state television. "The more you reveal your animosity, the more it will increase our people’s motivation to double efforts for construction and progress of Iran.""
But if "self-sufficiency" would be so good, why not impose it yourself? Why not double those "efforts for construction and progress for Iran" without foreign inducement? After all, you can always copy the successful implementation of "self-sufficiency" of fellow pariah state North Korea.....
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People wait in line to enter a job fair in New York on March 2. (Shannon Stapleton/Reuters)
U.S. employment report observations
Because it was Good Friday, not much happened in the economic world last Friday-Except for, of course, the U.S. employment report.
As expected, it was overall relatively strong with significant gains in jobs and even greater gains in hours worked. However, this was largely related to the reversal of the weather factor that had depressed the February number, and also to Census 2010 hirings by the government.
The one really weak item was average hourly earnings, which fell by 0.1%, the first drop in several years. As it is difficult to see how the weather factor could have affected this, this was clearly a sign of weakness. It could however be a sign that the weak labor market are making workers more willing to accept lower pay, something which will depress the average hourly earnings number, but boost the number of employed people and hours worked. '
Another interesting factor is that the number of people unemployed for a long period of time (27 weeks or more( has risen significantly while the number of people unemployed for a shorter period of time (26 weeks or less) is falling significantly. Compared to the previous month, the seasonally adjusted number of long-term unemployed is up by 414,000, from 6.133 million to 6.547 million. Compared to 12 months earlier, the number of long-term unemployed has doubled, from 3.241 million to 6.547 million.
Meanwhile, the number of short-term unemployed has dropped to 8,31 million, down from 8,856 million the previous month and 9.92 million 12 months earlier.
Why has short-term unemployment dropped while long-term unemployment continues to soar. While there are probably several explanations for this, the likely most important one is the fact that the U.S. Congress has significantly expanded the duration of unemployment benefits. In the past, you could only get it for 26 weeks, but now you can get it up to 99 weeks (or in other words, nearly 2 years). This has significantly reduced the incentive for the long-term unemployed to accept jobs whose pay level or tasks they don't like, and as a result, they choose to stay unemployed rather than take jobs they don't like.
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A monorail travels past the Sydney, Australia, skyline March 15. The country's population is growing faster than most other developed nations, which is contributing to its housing shortage. (Daniel Munoz/Reuters)
Australia's housing boom driven in part by population growth
I have frequently discussed how growth in the Australian economy is driven by rising commodity prices. There is however another factor driving growth, namely high population growth.
Australia's population grew by 2.1% in the year ending September 2009, a lot higher than in most other advanced economies (typically population growth is less than 1%, and even negative in for example Germany and Japan). This has a particularly positive effect on the housing sector, which continues its long boom, despite high prices and interest rates that are higher than in most other countries.
As this article points out, the rapid population growth has contributed to a housing shortage, something which implies that both construction activity and house prices will continue to increase.
More rate hikes by the Reserve Bank of Australia will have a cooling effect, but as long as population growth remains high, the Australian housing sector will likely remain strong, or it will at the very least not see a significant crash, as a growing population implies growing demand for housing.
However, this doesn't mean that Australian housing will necessarily boom forever. Ireland and Spain both had high immigration driven population growth during the peaks of their housing booms, but when their economies started to cool, the flow of migrants turned, and they were left with a huge surplus of housing, a huge debt burden and many unemployed construction workers. If the Australian economy weakens because of renewed declines in commodity prices, this could happen to Australia too.
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Obama's strategy: 'Addict the people'
Some have accused opponents of big government of favoring (In some cases this accusation has been true. In other cases it hasn’t been true) a "starve the beast"-strategy: first you pass popular tax cuts and temporarily "forget" about the unpopular offsetting spending cuts. Then a deficit will become a big problem, something which will enable people to say that spending cuts are necessary.
As Charles Krauthammer points out, Obama may have what one could call a "addict the people" strategy: first you pass big spending increases, and argues that the deficits are necessary for Keynesian reasons, and that the long term fiscal problems can be solved simply by "soaking the rich". In the long run, the deficits will prove to be unsustainable. As people have become dependent on the new spending programs, spending cuts might not be so easy to push through, while it becomes apparent that raising taxes for the rich won't be sufficient to reduce the deficit. At that point, it will be seen as necessary to raise taxes for the middle class and the poor as well, by for example introducing a Value Added Tax (VAT).
Krauthammer is probably right that this is Obama's strategy. Obama wants government to become a lot bigger, but he and his advisors realize that tax increases for the middle class is political suicide at this point (at least if it is honestly labeled as tax increases), which is why they are now only pushing through spending increases. Only later when a fiscal crisis will be obvious will they be able to push through a VAT or other middle class tax increases.
It remains to be seen whether the "addict the people strategy will work or not, though. The "starve the beast" strategy have generally not been so effective. As a VAT will be broadly unpopular (with conservatives hating it because it constitutes tax increases, and leftists opposing it because it is regressive), pushing through it will probably not be so much easier than reversing the Obama spending increases.
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Greece's Prime Minister Georgios Papandreou arrives at the European Council building ahead of a European Union leaders summit in Brussels March 25. European Union leaders are "inching forward" in talks on Greece's debt crisis and a special meeting of euro zone leaders is still possible late on Thursday after the first day of an EU summit, European diplomats said. (Eric Vidal/REUTERS)
Ignoring Greece's borrowing problems won't make them go away
Despite the relatively radical austerity measures Greece have undertaken, the yield spread remains stubbornly high against German bonds. The Greek government understandably doesn't want to pay such high interest rates, but as they need to refinance loans and borrow for the continuing deficit and as previous austerity measures haven't achieved much in terms of lowering interest rates, what is there to do?
Trying to exit the euro area, or defaulting on its debt payments aren't realistic options, for reasons that I've already explained (follow the links if you don't remember).
One option would be to borrow from fiscally stronger EU governments, such as Germany and Holland. But as that is perceived as a bailout, and as that is very unpopular in Germany and Holland, the chances of that seems slim. The one remaining option would be to borrow from the IMF, like several other EU countries (Including Latvia, Romania and Hungary) have in fact already done recently.
It seems increasingly likely that Greece will in fact like Latvia, Romania and Hungary borrow from the IMF, but some in the ECB and other institutions oppose this because, to quote ECB executive board member Lorenzo Bini Smaghi "The image of the euro would be that of a currency that is able to survive only with the external support of an international organization"
I find it this argument to be completely absurd, as such a move really would have no link to the survival of the euro (because first of all ditching it was never an option for aforementioned reasons and secondly even in the extremely unlikely scenario that Greece and a few other countries would ditch it, it would still remain in more than 10 countries), and would instead simply be a way to lower Greek borrowing costs.
While it could perhaps be argued that the existence of the IMF is bad for sounder nations and should therefore be abolished, there is no economic reason for any country that could lower its borrowing cost by using it to abstain from doing so. And that is true whether or not it has an independent currency. And to abstain from doing so just to deny the obvious reality that Greece has a high cost of borrowing is just silly and absurd.
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UK government spending rise above 50% of GDP
For the first time ever, at least during the absence of a major war, U.K. government spending rose above 50% of GDP in 2009. During the reign of so-called "New Labour" since 1997, government spending is up from 40% of GDP to 52% in 2009, and a projected 53% in 2010. This means that the ratio has on average risen by one percentage point per year during "New Labour". The increase has been fastest during the last two years, but it has risen ever since 2001.
The increase has in part been financed by tax increases, but mostly through a soaring budget deficit.
Though most other countries have seen their burden of government increase during the recent slump (Israel is one of very fex exceptions), the U.K. has seen a bigger increase than elsewhere, and unlike most others (the U.S. being and additional example) the burden of government spending was rising even during the boom.
As a result, government spending is now higher than in Germany and most other continental European countries, after previously having been much lower.
While I can't say I trust David Cameron, these numbers provides a very strong case for voting Gordon Brown out of office during the election that will come later this year.
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The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link above.
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