High public debt impedes recovery

This graph from a FRBSF paper Private Credit and Public Debt in Financial Crises, by Òscar Jordà, Moritz Schularick, and Alan M. Taylor, perfectly illustrates how high public debt levels impede the ability of an economy to recover from a financial crisis:

Figure 3……. shows that high levels of public debt can be a considerable drag on the recovery. The figure displays the path of per capita GDP in a typical recession compared with the paths under three scenarios following a financial crisis resulting from excess growth of private credit. Each of the three scenarios corresponds to a specified level of public debt at the start of the recession. The dotted line represents a low level of debt of about 15% as a ratio to GDP; the solid line represents a medium level of debt of about 50% of GDP, which is the historical average; and the dashed line represents a high level of debt of about 85% of GDP.

Recessions and Public Debt Levels

Read more at Federal Reserve Bank San Francisco | Private Credit and Public Debt in Financial Crises.

Hat tip to Barry Ritholz

High credit growth prolongs recessions

Research by the Federal Reserve Board of San Francisco shows how high credit growth prior to a financial crisis can prolong the recession by three or more years. The graph below compares the average recovery time for a normal recession to recessions preceded by low credit growth [blue or red] and recessions preceded by high credit growth [green or orange].

Recession Recovery Time

Differences in public debt growth appear to have little impact, but public debt levels are another matter.

Read more at Federal Reserve Bank San Francisco | Private Credit and Public Debt in Financial Crises.

Hat tip to Barry Ritholz

How a private credit boom can lead to a sovereign debt crises | FRBSF

From a FRBSF paper Private Credit and Public Debt in Financial Crises by Òscar Jordà, Moritz Schularick, and Alan M. Taylor:

Recovery from a recession triggered by a financial crisis is greatly influenced by the government’s fiscal position. A financial crisis puts considerable stress on the government’s budget, sometimes triggering attacks on public debt. Historical analysis shows that a private credit boom raises the odds of a financial crisis. Entering such a crisis with a swollen public debt may limit the government’s ability to respond and can result in a considerably slower recovery.

In financial crises, steep declines in output worsen the ratio of public debt to gross domestic product (GDP) even if the nominal amount of debt remains unchanged. Progressive tax systems cause government revenues to decline at a faster rate than output. Meanwhile, other automatic stabilizers, such as unemployment insurance programs, quickly swell public expenditures. The public sector often assumes private-sector debts to prevent a domino effect of defaults from toppling the financial system. Programs to stimulate the economy put further stress on public finances. As budget deficits balloon, deep economic downturns resulting from a private credit crunch often turn into sovereign debt crises.

Read more at Federal Reserve Bank San Francisco | Private Credit and Public Debt in Financial Crises.

Hat tip to Barry Ritholz

Income inequality: Ask the wrong question, get the wrong answer

John Mauldin writes

That income inequality stifles growth is not simply the idea of two economists in St. Louis. It is a widely held view that pervades almost the entire academic economics establishment. Nobel prize-winning economist Joseph Stiglitz has been pushing such an idea for some time (along with Paul Krugman, et al.); and a recent IMF paper suggests that slow growth is a direct result of income inequality, simply dismissing any so-called “right-wing” ideas that call into question the authors’ logic or methodology.

The suggestion that income inequality stifles growth is a fraud, designed to promote a socialist agenda of redistributing wealth to the poor. We are currently experiencing slow growth because of the GFC, not because of rising income inequality.

The real question that needs to be answered is: which system best promotes growth and improves the living standards of the broad population? Evidence of the last 100 years is difficult to dispute. Socialism has an abysmal track record in uplifting the poor, while capitalism has fueled a massive upliftment in living standards over more than a century. High rates of tax on top income earners kills growth and redistribution to the impoverished does little to improve their living standards, whereas low tax rates encourage growth and raise living standards.

To recover from the GFC we need to allow capitalism to flourish instead of impeding it at every turn.

Read more at The Problem with Keynesianism | John Mauldin.

Mass Privatization, State Capacity and Economic Growth in Post-Communist Countries | Hamm, King & Stuckler (2012)

From the abstract of a paper by Hamm, King and Stuckler:

We perform cross-national panel regressions for a sample of 30 post-communist countries between 1990 and 2000, and find that mass privatization programs negatively affected economic growth, state capacity, and property rights protection.

Read more at Hamm, King, Stuckler (2012) – Mass privatization (submitted manuscript).pdf.

The importance of regulation

Capitalism without regulation is prone to excesses, driven by individuals pursuing their own self-interest. Price-gouging and provision of inferior quality goods and services are held in check by competition, but there are other aberrations against public morals, or not in the public interest, that require regulation. Historical examples would be the use of slaves, the opium trade, usury, prostitution, child labor, conquest and exploitation of primitive cultures, and sale of weapons or related technology to a nation’s enemies.

Regulation is also required to curb monopolistic practices, where competition is ineffective. There is much talk of the importance of free markets, but unregulated markets are not free. They are prone to cheating, corruption and abuse of market power. What is needed are efficient markets, where there are:

  • low barriers to entry for new participants
  • low transaction costs
  • equal access to information, at the same time

Stock markets are often quoted as an example of an efficient market. Regulation has contributed to this over the years by policing illegal activities such as insider trading, front-running, wash sales, pump and dump, price manipulation, squeezes, and disseminating false or misleading information. But lately the prevalence of high-speed trading has eroded investor confidence, as most market participants no longer have access to price information at the same time. If this continues, the onus is on regulators to allow competitors to set up efficient markets for investors.

In the Real World the Trade Deficit Is More Important Than the Budget Deficit | CEPR

Dean Baker writes:

….the trade deficit is a direct measure of the amount of demand that is going overseas rather than being spent here. This represents income generated in the United States that is not creating demand in the United States. By definition, this lost demand must be made up by other borrowing, either by the public sector (i.e. budget deficits) or the private sector. Currently the trade deficit is running at an annual rate of around $480 billion (@ 3.0 percent of GDP), which means that the sum of net borrowing in the public and private sector must be equal to $480 billion.

Read more at In the Real World the Trade Deficit Is More Important Than the Budget Deficit | Beat the Press.

Recession time for Russia | The Market Monetarist

Lars Christensen at The Market Monetarist writes:

….. sharply increased geo-political tensions in relationship to Putin’s military intervention on the peninsula of Crimea has clearly shocked foreign investors who are now dumping Russian assets on large scale. Just Monday this week the Russian stock market fell in excess of 10% and some of the major bank stocks lost 20% of their value on a single day.

In response to this massive outflow the Russian central bank – foolishly in my view – hiked its key policy rate by 150bp and intervened heavily in the currency market to prop up the rouble on Monday. Some commentators have suggested that the CBR might have spent more than USD 10bn of the foreign currency reserve just on Monday. Thereby inflicting greater harm to the Russian economy than any of the planned sanctions by EU and the US against Russia.

By definition a drop in foreign currency reserve translates directly into a contraction in the money base combined with the CBR’s rate hike we this week has seen a very significant tightening of monetary conditions in Russia – something which is likely to send the Russian economy into recession (understood as one or two quarters of negative real GDP growth).

Read more at Recession time for Russia – the ultra wonkish version | The Market Monetarist.

A Century of Policy Mistakes | Niels Jensen

In A Century of Policy Mistakes Neils Jensen describes the demise of Argentina over the last 100 years.

A century ago Argentina ranked as one of the wealthiest countries in world, behind the United States, the United Kingdom and Australia but ahead of countries such as France, Germany and Italy. Its per capita income was 92% of the G16 average; it is 43% today. Life in Argentina was good. It enjoyed the benefits of one of the highest growth rates in the world and attracted immigrants left, right and centre. Boom times galore.

Argentina’s wealth was based on agriculture, but also on its strong ties with the UK, the pre-World War I global powerhouse. Equally importantly, it understood the importance of free trade and took advantage of the relatively open markets which prevailed in the years leading to the Great War. Most importantly, though, it benefitted from, but also relied upon, enormous inflows of capital from the rest of the world. All of this is well documented in a recent piece in The Economist which you can find here.

Neils identifies three main causes:

  1. An over-reliance on commodities;
  2. Failure to invest in education; and
  3. An increasingly closed, inward-looking economy.
  4. It occurred to me that, apart from education, Australia has made the same mistakes.

    Read more at A Century of Policy Mistakes | Niels Jensen – Absolute Return Partners | PRAGMATIC CAPITALISM.