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The Economist’s obituary for the late Wynne Godley generated a couple of worthwhile letters. A key passage: Your obituary of Wynne Godley (May 29th) did an injustice to his considerable intellectual achievements in macroeconomics and his courage in going against the orthodoxy that has ruled the economics profession for the past three decades. You can read the rest here.

The Squam Lake Report (Princeton University Press) is a set of recommendations by 15 leading economists on reforming the financial system. Considering the magnitude of the recent financial crisis, it is surprising how little change the book proposes. Certainly, the first step in devising a set of recommendations for reform is to understand what went wrong, something the authors set out to do in their first chapter. They list a number of factors that may have contributed to the crisis but take no stand on their relative importance. They believe that their recommendations will help make the system more stable, although not crisis-proof, even if they don’t completely understand the origins of the current crisis. While a few of the recommendations are intended for guiding the financial system towards stability, most are only useful for when a financial crisis has already erupted. Perhaps the best recommendation is for a systemic regulator with an explicit mandate of maintaining financial stability. As financial institutions are increasingly involved in activities outside their traditional domain, having a systemic regulator makes sense. But the report recommends that the central bank be that regulator—which is logical, since the Fed’s discount window gives it a good view of financial institution balance sheets. The problem, at least in case of the U.S., is that the Federal Reserve had the authority… Read More

Bloomberg polled international subscribers to its Bloomberg Professional Service and found that 73 percent expect a Greek default. These subscribers are described as decision-makers in finance, economics etc. The full story is here. You can also read the poll and results for yourself by clicking on the “attachment” tab at the top of the window. This will take you a pdf that is unfortunately missing the file extension. Just rename it to add .pdf to the end and it will open normally.

In a sobering column in the Financial Times, Edward Chancellor reminds us that the late Wynne Godley was right in predicting that large private deficits in the U.S. would lead to trouble–and that the Eurozone, when it was formed, might become a tragic disinflationary trap. The end of the column is particularly noteworthy: He went on to caution that without a common European budget, there was a danger that “the budgetary restraint to which governments are individually committed will impart a disinflationary bias that locks Europe as a whole into a depression that it is powerless to lift”. Rob Parenteau, a fellow Levy Institute scholar, has recently applied Prof Godley’s analysis to the eurozone periphery. Germany wants countries, such as Spain, to get their public finances in order. Yet if Spain is to reduce its fiscal deficit without too much pain, two conditions are necessary. First, the country’s trade position must shift into surplus. This is problematic since labour costs are high relative to Germany and Spain cannot devalue its currency. Second, the private sector must move back into deficit. Yet it is difficult to see Spanish households and companies wanting to borrow more given the ongoing problems caused by the collapse of the property bubble. There is a danger the proposed fiscal tightening in the eurozone will lead to… Read More

Nervous financial markets and waves of fiscal austerity spreading across Europe raise an important question: when does a country’s budget deficit become a problem? The easy answer, of course, is that a deficit is too large when it can no longer be financed. But by that time it’s too late, so it’s important to ask if there is a good way to tell before things get that bad. Carmen Reinhart and Kenneth Rogoff, in a recent paper called Growth in a Time of Debt, found that when government debt reaches 90 percent of GDP, economic growth is seriously retarded. But rules of thumb are by their nature imperfect, and it’s difficult to apply the 90 percent formula across the board. The U.S., for example, is not Greece—it’s closer to being the anti-Greece, in fact. Greece is a tiny, uncompetitive country that does not control its own currency. The business climate there is terrible. America is a vast, competitive, adaptable nation that not only controls its own monetary policy, but is blessed with the world’s reserve currency. The climate for business is favorable, abetted by large reserves of cultural and intellectual capital. So we shouldn’t conclude that just because the Europeans are suddenly cutting public spending, we ought to as well. Since deflation looks more threatening than inflation, it seems sensible,… Read More

The Germans too are embarking on a fiscal austerity program, and consumers aren’t spending there either.

David Cameron, the new PM, warns that the nation’s fiscal hole is even deeper than it seemed, and that savage spending cuts will be required. An important union leader calls Cameron’s speech “a chilling attack on the public sector, public sector workers, the poor, the sick and the vulnerable.” The full (and sobering) story is here.

The Bureau of Labor Statistics released its May employment situation report today and the news was mostly grim. Sure, unemployment dropped to 9.7 percent from 9.9 percent. But don’t get too excited, because almost all the new jobs created in May were for census-takers, and these folks will be unemployed again soon. In more bad news masquerading as good, the so-called mancession appears to be easing. Most developed countries are beset by one of these male recessions, with men suffering the brunt of job losses due to their much greater representation in construction and manufacturing—both of which are hard-hit almost everywhere. In this country, at least, the mancession looks like it’s easing—until you look a little closer and realize that this is only the case because men leaving the labor force increased by 4.7 percent over last year, an increase twice that of women. In other words, men aren’t gaining jobs. They’re giving up. What shall we do with the horrendous number of idle men? Their skills may not be valued in industries that have done better than traditional men-industries. Training for new kinds of work is one possibility, but demand for new workers may not be there yet; relocation to other states may be out of the question if your mortgage is underwater; and the Euro crisis is a… Read More

The world has its usual cornucopia of troubles, but if you were worried about federal deficits, you can at least set those aside and focus on unemployment, oil spills and other here-and-now concerns. That’s the message of Levy Senior Scholar James K. Galbraith in this lively interview with Ezra Klein. Galbraith offers this historical perspective: Since the 1790s, how often has the federal government not run a deficit? Six short periods, all leading to recession. Why? Because the government needs to run a deficit, it’s the only way to inject financial resources into the economy. If you’re not running a deficit, it’s draining the pockets of the private sector.

As the European financial crisis continues to percolate, by now a few irreducible facts are distressingly clear: First, Greece has no hope of repaying its debts as they are now constituted. Thus, the much-contested 110 billion euro bailout plan and the wider subsequent trillion-dollar bailout proferred by the Eurozone countries and the IMF are doomed to fail for the simple reason that they offer only more lending to countries already drowning in debt. Greece has a primary deficit (meaning one that would persist for a number of years unless the country experiences spectacular economic growth) exceeding 6% of GDP and a budget deficit due to financing of the accumulated debt of at least another 4%, in addition to which it faces a GDP contraction for at least three years. Simple math shows that to have a stable debt/GDP ratio Greece must generate a budget surplus of at least 10%, which is basically impossible. A rising debt/GDP ratio together with contracting economy will make financing from private investors very doubtful. Second, although Greece can default on most of its public debt with a unilateral act of parliament—and the political and economic realities to do this may yet prove irresistible—it would be much better for Greece, the IMF and the rest of the Eurozone if it avoided this. For Greece to give… Read More

The Financial Times reports that the European Central Bank (ECB) has warned of a “financial contagion” risk from concerns about the debt of some European governments. Many readers of this blog will recall that a similar concern was important in the late 1990s, when debt and currency problems seemed to spread among Asian and Latin American countries. Financial contagion can occur in many ways. A modern financial system is highly interdependent, with financial corporations holding the liabilities of other financial corporations, often in foreign countries. Also, perceptions that a particular debtor might default on some of its debt can quickly lead to worries about similar debtors and financial instruments. For example, after the Penn Central Railroad went bankrupt in 1970, there was panic selling of commercial paper, leading to a near-collapse of the commercial paper market. There are grounds for fears that the crisis that began in Greece could grow much further through some such contagion effect.  Indeed, another article in today’s FT describes how spreads between interest rates on the debt of financial and nonfinancial corporations and rates for government debt have generally widened in the past month in the United States and Europe. Draconian measures aimed at closing budget gaps could exacerbate the contagion effect, since they increase fears of sharply reduced growth around the world.

The Economist has published this obituary of the late economist, whose career included a lengthy stint as head of the Levy Institute’s Macro-Modeling Team. In the small world dept.: After a spell in business and a few years at the Treasury, he was enticed to King’s College, Cambridge, which 61 years earlier another economist-aesthete, John Maynard Keynes, had joined as a lecturer, writing (with his mother’s help) a letter of resignation from the civil service to his boss, a Sir Arthur Godley. This man was to become the first Lord Kilbracken and eventually grandfather of Wynne.