Greek and US great depressions compared

https://twitter.com/ianbremmer/status/620570062538309632/photo/1

Financial crises surprisingly common, but few countries close their banks

The left-wing solution to Greek bankruptcy

Why Greece joined the Euro

The roots of Greece’s crisis are simple. Before Greece joined the Eurozone, investors treated it as a middle-income country with poor governance — which is to say, a credit risk.

After Greece joined the Eurozone, investors thought that Greece was no longer a credit risk — they figured, if push came to shove, other Eurozone members like Germany would bail Greece out. They were wrong.

Michael Dooley put forward a theory of speculative attacks on currencies as insurance attacks on currencies for emerging markets after the East Asian financial crisis:

First generation models of speculative attacks show that apparently random speculative attacks on policy regimes can be fully consistent with rational and well-informed speculative behaviour.

Unfortunately, models driven by a conflict between exchange rate policy and other macroeconomic objectives do not seem consistent with important empirical regularities surrounding recent crises in emerging markets. This has generated considerable interest in models that associate crises with self-fulfilling shifts in private expectations.

In this paper we develop a first generation model based on an alternative policy conflict. Credit constrained governments accumulate reserve assets in order to self-insure against shocks to national consumption. Governments also insure poorly regulated domestic financial markets.

Given this policy regime, a variety of internal and external shocks generate capital inflows to emerging markets followed by successful and anticipated speculative attacks.

We argue that a common external shock generated capital inflows to emerging markets in Asia and Latin America after 1989. Country specific factors determined the timing of speculative attacks. Lending policies of industrial country governments and international organizations account for contagion, that is, a bunching of attacks over time.

His model was not within the context of a currency union but his basic theory is correct.

There are speculative attacks on a currency or a bank run after foreign markets revises their estimates of the available central bank reserves and international lines of credit to bail out the banking systems and/or foreign debt.

Michael Dooley was dealing with the emerging economies of Southeast Asia and their official lines of credit that insure their foreign exchange liabilities and domestic banking system. Greece is about lines of credit for similar purposes to other European union member states.

via 12 charts and maps that explain the Greek crisis – Vox and The Most Important Graphs of 2011 – The Atlantic.

The reason why New Zealand should rule out helping Greece!

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Greece is a tiny part of the European economies so it doesn’t matter that much to the rest of the European Union what happens to Greece. The only people will notice the sovereign default of Greece once the breathless journalism has died down are Greeks themselves as they rebuild their banking and monetary system against a background of a government run by coffee shop Marxists.

Gambling for Redemption and Self-fulfilling Debt Crises in the Eurozone

Sir Humphrey was right on why Britain entered the common market in 1973? Real GDP growth per working age British and French, PPP, detrended, 1950 – 2013

Figure 1: Real GDP per British and French aged 15-64, converted to 2013 price level with updated 2005 EKS purchasing power parities, 1.9 per cent detrended, 1950-2013

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Source: Computed from OECD Stat Extract and The Conference Board, Total Database, January 2014, http://www.conference-board.org/economics

Figure 2: Real GDP per British and French aged 15-64, converted to 2013 price level with updated 2005 EKS purchasing power parities, 1.9 per cent detrended, base 100 = 1974, 1950-2013

image

Source: Computed from OECD Stat Extract and The Conference Board, Total Database, January 2014, http://www.conference-board.org/economics

In figure 2, a flat line represents annual real GDP growth at a rate of 1.9%, which is the trend rate of annual growth of the USA in the 20th century. A rising line means annual growth at above that trend rate; a falling line means annual growth at below that trend rate of 1.9% per year.

The Spanish economic recovery compared

Where has all the productivity gone?

Maybe joining Euroland isn’t that bad after all

Two booms, two depressions: British and Irish real GDP detrended, 1955–2013

Figure 1: Real GDP per British and Irish aged 15-64, converted to 2013 price level with updated 2005 EKS purchasing power parities, 1955-2013

image

Source: Computed from OECD Stat Extract and The Conference Board, Total Database, January 2014, http://www.conference-board.org/economics

Figure 2 detrends British real GDP growth since 1955 by 1.9% and Irish real GDP growth  by 3.6%. The US  real GDP growth in the 20th century is used as the measure of the global technological frontier growing at trend rate of 1.9% in the 20th century. The Irish economy is more complicated story because its growth rate in figure 2 was detrended at a rate of 3.6% because it was catching up from a very low base. Trend GDP growth per working age Irish for 1960-73 was 3.6 per cent (Ahearne et al. 2006).

Figure 2: Real GDP per British and Irish aged 15-64, converted to 2013 price level with updated 2005 EKS purchasing power parities, 1.9 per cent detrended UK, 3.6% detrended Ireland, 1955-2013

image

Source: Computed from OECD Stat Extract and The Conference Board, Total Database, January 2014, http://www.conference-board.org/economics

A flat line in figure 2 indicates growth at 1.9% for that year. A rising line in figure 2 means above-trend growth; a falling line means below trend growth for that year.

In the 1950s, Britain was growing quickly that the Prime Minister of the time campaigned on the slogan you never had it so good.

By the 1970s, and two spells of labour governments, Britain was the sick man of Europe culminating with the Winter of Discontent of 1978–1979. What happened? The British disease resulted in a 10% drop in output relative to trend in the 1970s, which counts as a depression – see figure 2 .

Prescott’s definition of a depression is when the economy is significantly below trend, the economy is in a depression. A great depression is a depression that is deep, rapid and enduring:

  1. There is at least one year in which output per working age person is at least 20 percent below trend; and
  2. there is at least one year in the first decade of the great depression in which output per working age person is at least 15 percent below trend; and
  3. There is no significant recovery during the period in the sense that there is no subperiod of a decade or longer in which the growth of output per working age person returns to rates of 2 percent or better.

The British disease in the 1970s bordered on a depression. There was then a strong recovery through the early-1980s with above trend growth from the early 1980s until 2006 with one recession in between in  1990. So much for the curse of Thatchernomics?

Figure 1 suggests a steady economic course in Ireland until the 1990s with a growth explosion growth with the Irish converged on British living standards up until the global financial crisis.

Figure 2 shows the power of detrending GDP growth and why Ireland was known as the sick man of Europe in the 1970s and 1980s with unemployment as high as 18% and mass migration again. The Irish population did not grow for about 60 years from 1926 because of mass migration.

Figure 2 shows that real GDP growth per working age Irish dropped below its 3.6 per cent trend for nearly 20 years from 1974 , but more than bounced back after 1992. The deepest trough was 18 per cent below trend and the final trough was in 1992  –  see Figure 2.

The deviation from trend economic growth made the Irish depression from 1973 to 1992 comparable in depth and length to the 1930s depressions (Ahearne et al. 2006).

The Irish depression of 1973 to 1992 can be attributed to large increases in taxes and government expenditure and reduced productivity (Ahearne et al. 2006). There were two oil price shocks in the 1970s and many suspect Irish policy choices from 1973 to 1987.

There were three fiscal approaches: an aggressive fiscal expansion from 1977; tax-and-spend from 1981; and aggressive fiscal cuts from 1987 onwards. In the early 1980s, Irish CPI inflation at 21 per cent, public sector borrowing reached 20 per cent of GNP.

To rein in budget deficits, taxes as a share of GNP rose by 10 percentage points in seven years. The unemployment rate reached 17 per cent despite a surge in emigration. The rising tax burden raised wage demands, worsening unemployment. Government debt grew on some measures to 130 per cent of GNP in 1986 (Honohan and Walsh 2002).

From 1992, Ireland rebounded to resume catching-up with the USA. The Celtic Tiger was a recovery from a depression that was preceded by large cuts in taxes and government spending from the late 1980s (Ahearne et al. 2006). Others reach similar conclusions but avoid the depression word. Fortin (2002, p. 13) labelled Irish public finances in the 1970s and to the mid-1980s as a ‘black hole’.

Fortin (2002) and Honohan and Walsh (2002) disentangle the Irish recovery into a long-term productivity boom that had dated from the 1950s and 1960s, and a sudden short-term output and employment boom since 1993 following the late 1980s fiscal and monetary reforms.

Honohan and Walsh (2002) wrote of belated income and productivity convergence. The delay in income and productivity convergence came from poor Irish economic and fiscal policies in the 1970s and 1980s.

This was after economic reforms in the late 1950s and the 1960s that started a process of rapid productivity convergence after decades of stagnation and mass emigration; Ireland’s population was the same in 1926 and 1971. During the 1950s, up to 10 per cent of the Irish population migrated in 10 years.

In the 1990s, many foreign investors started invested in Ireland as an export platform into the EU to take advantage of a 12.5 per cent company tax rate on trading profits. Between 1985 and 2001, the top Irish income tax rate fell from 65 to 42 per cent, the standard company tax from 50 to 16 per cent and the capital gains tax rate from 60 to 20 per cent (Honohan and Walsh 2002).

What happened after the onset of the global financial crisis in Ireland  and the UK are for a future blog posts.

British economic recoveries compared

Recoveries from recessions across the G-7

The looming fiscal crisis in the USA

Has New Zealand been in deflation since 2012?

All agree that the consumer price index (CPI) is biased and overstates inflation. In 1996, economists hired by the Senate Finance Committee estimated that the U.S. CPI overstates annual inflation by 1.1% (Boskin et al. 1996). That estimated CPI bias has not gotten smaller with time. It is now up to 1.5%, even 2%.

One of the rationales for the inflation target of the Reserve Bank of New Zealand of 0-2% was the 2% was to account for the consumer price index was biased upwards. Targeting 0% would lead to mild deflation when inflation was properly measured.

The main biases in the consumer price index everywhere come from how to handle changes in the quality of goods and services and how to deal with completely new goods and services.

I thought I might see what happened if I took this one and a half percentage point annual bias in the CPI estimated for the USA and adjusted the New Zealand CPI inflation rates available at the Reserve Bank of New Zealand’s website over the last 20 years or so with this number.

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If these consumer price index bias adjustments are correct, and they are roughly correct, inflation came to a dead stop  in New Zealand after the global financial crisis in 2008, spiked again, and then moved into deflation in 2012. If anything, there’s been a mixture of price stability and the deflation since 2012.

People get quite hot and bothered with deflation. The New Zealand economy has been in a deflationary phase since the beginning of 2012  but it is recently grown so quickly that  it is referred to in the media as the rock-star economy.

Breathless journalism aside , fears of inflation are just a legacy of the great depression in the 1930s. The only depression where deflation was accompanied by mass unemployment was the Great Depression. Mild deflation with good growth is a common phenomena as Atkinson and Kehoe found:

Are deflation and depression empirically linked? No, concludes a broad historical study of inflation and real output growth rates.

Deflation and depression do seem to have been linked during the 1930s. But in the rest of the data for 17 countries and more than 100 years, there is virtually no evidence of such a link.

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