Posted by: Dirk | May 18, 2012

Who pays for the crisis?

Ursula Engelen-Kefer and Hans-Werner Sinn discussed the above question at the Berlin School of Economics. It turned out that Hans-Werner Sinn opposes austerity and calls for Greek exit, although he was shy to discuss what Germany could do to help. Anyway, his main argument was that you can move the price level some way, but those countries that are too far away from the price level that they should have to repay their debts should exit. For their benefit, he stressed. Mrs Engelen-Kefer stressed the point that politics in Europe and European nations is driven by powerful interests. Mr Sinn disagreed somehow, claiming it was the markets doing. I don’t think that these position are incompatible, once you recognize that the rich have more influence on the market than the poor.

The whole episode shows once again how far removed from reality the European Commission is. Consider this bit from President of the Commission José Manuel Barroso on Europe Day:

But from the very beginning the Commission has kept saying that apart from fiscal consolidation it is important to create conditions for enhanced growth. The reality is that to regain competitiveness several Member States need to reform their labour markets, create better conditions for business and adapt their tax law to make them more employment friendly.

This means that the choice should not be austerity versus growth. The choice is unsustainable short term stimulus that will lead to a short-living relaunch of growth versus sustainable long term reforms that will make a difference over time. And our choice is very clear. It is about investing in lasting sustainable growth while immediately addressing the most urgent issues and first of all unemployment that has reached intolerable rates.

I cannot see any respected economist suggesting that today’s problems in the euro zone can be solved by more flexibility of workers and lower taxes for business. I wonder who advises the European Commission.

Taking a look at their homepage of DG ECFIN (Directorate-General for Economic and Financial Affairs), there is a list of papers on macroeconomic modelling. One of the papers is Effects of Fiscal Stimulus in Structural Models. The abstract reads like this:

The paper subjects seven structural DSGE models, all used heavily by policymaking institutions, to discretionary fiscal stimulus shocks using seven different fiscal instruments, and compares the results to those of two prominent academic DSGE models. There is considerable agreement across models on both the absolute and relative sizes of different types of fiscal multipliers. The size of many multipliers is large, particularly for spending and targeted transfers. Fiscal policy is most effective if it has moderate persistence and if monetary policy is accommodative. Permanently higher spending or deficits imply significantly lower initial multipliers.

These policy advisors would have been fired twenty years ago in Japan, which after a financial crisis coupled with a real estate bust only managed to stabilize by increasing government demand. OK, they had low growth rates, which averaged about one percent. But this is exactly the average growth rate of Germany 2000-2009, which is supposed to do relatively well!

Apart from that, we have a natural experiment in Japan. After the tragedy of Fukushima, the Japanese government decided to spend a lot of government money to repair the damage. Here is what CNN reported yesterday about the situation:

Japan’s gross domestic product grew at nearly double the U.S. rate for the first quarter, an unexpectedly strong sign of recovery in the wake of last year’s devastating earthquake and tsunami.

The Japanese government said that its GDP grew 1% in the first quarter, or an annualized rate of 4.1% for 2012. The GDP was driven by strong domestic demand, particularly by government expenditures.

Feel free to draw your own conclusion on the question of why these economists are still around.

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