Costs and Consequences of Austerity (Panel discussion)

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ASSA/AEA Annual Meetings 2014:
Panel Discussion:

Costs and Consequences of Austerity

Philadelphia Marriott Downtown
Philadelphia, PA
January, 4 2014


Session 2:  Costs and Consequences of Austerity

Allen Sinai:
            Good morning everyone. Thanks for coming. You are asked just to be sure you’re on the right plane because the planes have been a little difficult the last couple of days for a lot of people.
            This session is titled Costs and Consequences of Austerity. It’s an Economists for Peace & Security, EPS, session motivated by the recent but long—it’s the last three to four years’ policies of Austerity, capital ‘A’, used by or imposed on heavily indebted, in some cases insolvent, countries, mostly in the Eurozone, but also Ireland and the UK, lately Cyprus, but not the sovereign debt-ridden US or Japan. Austerity has been the generic policy used in the sovereign debt crises of a number of countries whose insolvency or near-insolvency led to requests, or potential requests, for financial support from the “center,” in this case, the latest case, essentially the Troika--the European Union, the ECB, and IMF. And the lender conditionality, austerity in one form or another, that was part of the bargain, the conditionality in return for the help.
These countries principally were Ireland, Greece, Portugal, and lately Cyprus.
            Other countries of sovereign debt and potential insolvency problems also undertook programs of austerity as a preventive set of measures. Such countries as Spain, Italy, the UK, and other Eurozone countries’ ability to handle the crises, of course, [was] impeded by the single currency, single interest rate, and monetary policy of the Eurozone community, immobilizing two important mechanisms of equilibration for open economy macroeconomics of countries: exchange and interest rates. With austerity where applied, those countries impacted lost control to some extent or totally of another potential mechanism for equilibriation: fiscal policy.
            A really interesting laboratory experiment in the real world for this kind of arrangement, the Eurozone arrangement, with the rigidity of the equilibrating mechanisms set into place by the arrangement, the question being--and it’s still evolving—how would that all work out.
            The shocks, the economic and financial crises for the countries of the Eurozone, the problem of the one-size-fits-all Eurozone economic and political arrangement, financial markets’ reactions, interactions of the world economy with Europe and vice versa through trade and finance and the inevitable political instability of these kinds of situations revealed in the history of crises like this, was a global economy event of monumental impact, negatively shocking.
            The economic and financial systems of countries around the globe, austerity and its use in this kind of episode, going back to the Latin American debt crises of the 1970s and 1980s, the Mexican crisis of the early 1990s, the Russian debt crisis, the Asian crisis in the late ‘90s, more exchange rate-motivated than debt-motivated, and the costs and consequences, including potential benefits, not in the title of this session--maybe somebody will talk about the benefits of austerity—is a general issue and question of major economic and policy significance. Is austerity the way to go? What is the evidence pro and con? Is there a better way, or is austerity the only way, or some combination of policies? What is the role of the center, the policymakers in these situations? How much attention should be given to political side-effects which inevitably have occurred throughout history? What about the interaction of policies and politics? What is the role that that plays? What are the particulars of the recent use of austerity in the Eurozone-UK context? What in retrospect would be the advice and views? I’m going to repeat this: What in retrospect would be the advice and views of our panelists in the use of austerity? In retrospect, has it failed? Has it succeeded or been partially successful in its costs and consequences?
            After all, most forecasts now are showing a recovery of some sort in the countries in 2014 that have been impacted by austerity, and maybe that is good. It’s taken a long time. Many of the signs are tentative so that, thanks to a growing GDP and the measures taken that the GDP ratio should be coming down, and in most forecasts it looks like the crises are abating.
            Well anyway, we have five—These are far too many questions for the panelists. Don’t worry, you don’t have to answer all of them. I know you panelists have prepared remarks. They will tell you the titles of their remarks. And I think they will touch on many of the issues that I have mentioned.
            We have five distinguished panelists to deal with the costs and consequences of austerity, some intimately involved in the practice and implementation of Austerity. Bob Zoellick—he’s on his way from the airport. He is last, going by alphabetical order, so Bob will be cleanup. So he’ll get here in time, not to have heard what anybody else has said, and then we’ll see what he says. But Bob and Olivier Blanchard—Bob now is Peterson Institute, ex-head of the World Bank, at times one of the policymakers involved in these types of situations. Olivier, chief economist at the IMF. Then we have the keeper of the chronicles and bible—no religious connotations here—on debt, its role in financial crises in numerous countries; that’s Carmen Reinhart of the Kennedy School at Harvard. We have Bob Pollin, professor and researcher at University of Massachusetts, analyst of these kinds of situations. And a distinguished dean and international economics expert, Dean Susan Collins of the Ford School of Public Policy of the University of Michigan. So it’s a great panel.
            The ground rules are ten to twelve minutes. We might stretch the twelve to thirteen or fourteen. We have till, I was told, 12:15, so let’s say 12:10 to give you time to go to wherever you’re going to go next—lunch, for example. So that would be 75 minutes, an hour-and-a-quarter. We’ll then give time for the panelists to have some back-and-forth. We then will have lots of time for the audience to ask questions briefly, make comments briefly, and I from now on, my role is strictly as moderator. You will not hear much from me except to remind you that you’re running out of time.
            So why don’t we go alphabetically, if that’s all right with the panel. That means Oliver first, then Susan Collins, Bob Pollin, Carmen Reinhart, and then Bob Zoellick. I should mention that Carmen is a co-keeper of what I call the Chronicle and Bible of these kinds of episodes across a number of countries. Ted Rogoff is her distinguished co-author on many of the works that they have been involved in. Olivier. Here’s Bob. Welcome Bob. I said a lot of bad things about you.

Olivier Blanchard:
            Good morning. I’m in three sessions on fiscal policy today, and so I had to decide what I would say where, try not to contradict myself too much across sessions.
            In this one I decided, rather than be unsympathetic, to try to focus on one issue, which is, I think, we’re still very much in search of a good fiscal [rule?]; and I just want to say a few things about that.
            What is it that a good fiscal rule should do? It should be flexible. It should lead to countercyclical fiscal policy for aggregate demand reasons. It should be credible. Basically people should think that whatever you’re doing, there is a plan, maybe a contingent plan, in order to stabilize the debt and repay it; that the debt will be honored. That’s clearly one of the major issues on the minds of investors at this point.
            And so we take this as the goal, what has struck me and the motivation for this presentation is what has happened to monetary policy. This is going to be about the lessons of monetary policy for fiscal policy. Because a caricature of what has happened with monetary policy is central bankers have done crazy stuff over the last four years; yet they haven’t lost credibility. And basically if you look at inflation expectations and whatever signals we have of credibility, they have remained anchored. And I think the answer is that monetary policy has acted within a set of rules that people believe, which make them think that whatever is done today will basically in time be adjusted, and that there is no reason to worry. [So in general a?] notion of inflation targeting, but with, again, a lot of creativity in the crisis. So what I want to do is spend a few slides on monetary policy, and then try to take it to fiscal, and see whether this is a lead that we should explore at more length.
            So the first slide shows some aspect of the “craziness,” quote-unquote, which is the increase in the size of the central bank’s balance sheets. There have been increases—you have it for a number of central banks here—there have been increases of the order of 20, 25 percent of GDP, which is very large. In terms of [their] own rate of growth, some of these countries have had rates of growth since 2008 of 300 percent, 400 percent; so clearly something completely out of the norm.
            Something else has happened which could have been very worrisome, which is that, although there was no direct purchases of government bonds, of new government bonds, on the primary market by the central bank, which would be explicit monetary financing, there [were] a lot of purchases in the secondary market of government bonds which can be seen as an indirect form of money financing. That is shown in this figure. So what you have on the left is the deficit in red since 2007, and then you have the Fed purchases of government bonds year by year with two QE episodes in 2011 and then more recently. And you see that at some point actually the Fed was in effect buying an amount of bonds. It was not buying the new bonds, but it was buying an amount of bonds equal to the new bonds issued by the government. The whole deficit was in that sense money financed. You have the integral on the right, and you can see that, although this is less impressive, some proportion of the cumulative deficit was financed in effect by the central bank.
            Now, in a different environment this might have led people to think, well, we have now gone back to the bad old days in which we have money financing, and we’ve seen hyper-inflation in the past, and so on. But as we know, this discussion didn’t take place. Now again, it was not the […?] money financing; but it could have been seen as actual money financing with implications.
            So this is the part about credibility. How do you judge credibility of monetary policy? Well, you look at the anchoring of inflation expectations. The central banks had spent a large amount of time, a large amount of capital to actually establish something like the two percent inflation target, and this gives you the evolution of inflation expectations, I think, for twelve advanced countries, starting in 1990. And the kind of blue cloud shows you that basically nobody—some people we know believe that there would be hyperinflation; but in effect the people who matter, the people from the consensus forecast basically […?]. I plotted with different colors the two countries where inflation went clearly outside the range that the central bank had indicated. So on the upper side the yellow is the UK, where they systematically had high inflation than what they had said they would. There was some increase, as we can see, in inflation expectations, but a very moderate one. On the downside, the red dots are Japan, where they had less inflation than the central bank said it wanted, and yet basically the inflation expectations have remained around 1.5, 2 percent. So it’s clear that the markets, the investors, basically saw enormous movements in monetary policy, but didn’t worry very much about this.
            My sense is that it came from a fairly clear set of feedback [rules?]. So until 2007, a lot was invested in interest rate rules, a feedback rule in which, when you see inflation go up, you basically increase the nominal rate more. You may also react to activity. […?], but the general principle is a feedback rule. This was replaced in the last few years by [?] guidance, which I think of—I’m not sure the Fed would agree, but I see this as an extension of a [?] rule, when the interest rate is underwater. You would like an interest rate below zero. You can’t achieve it, but you want to give an indication of when it’s going to emerge again and crosses the zero line. That’s what [?] guidance is.
            And I think that these rules convince markets that, indeed, if inflation were going to pick up, the central bank would do something. If activity became too strong, the central bank would do something. And again, the proof of the pudding is in the eating, these inflation expectations.
            So it’s not as if people are sure that everything will be fine. There are discussions about what’s going to happen if the US economy starts heating up. Will the central bank be willing to increase rates? How will it be able to do this? So, again, there are some caveats, and that’s the line of this slide. But in general I think the conclusion is that credibility, the feedback rule, gave them a lot of flexibility in what they did.
            So the question is, can we think of a rule on the fiscal side which would have the same nature [as the?] feedback rule which says, well, when things get worse, we’re going to do more to counteract it. An what I want to push is an old idea which dates back to—probably dates back to earlier, but formally to papers by [?] in the 1990s, in which he showed that, if you have a rule in which the primary balance excluding interest payment reacts positively to the level of debt, that’s basically enough to stabilize the debt. If you commit to say, when debt goes up I will increase my primary balance by some amount--and it doesn’t actually matter what the amount is, it just has to be a positive parameter--this will be enough to actually stabilize the debt.
            And in practice this may be a bit strong, and so this is a modified [?] rule which says, you look at the primary balance last year. So for example you had the primary deficit of 10 percent, you start from there. You have the level of debt where you’re going to decrease your primary deficit—this is the [?] you’re going to basically—the [?] is less than one. So all things equal, to reduce your primary deficit by some. And also if debt is higher, you’re going to have a slightly larger primary surplus, or a better primary balance. That rule implies that if it is […?], debt will stabilize. And so he argued that was a good rule.
            But what he did also, and that’s interesting, he actually showed that the rule was a very good description of what had happened in the US. And what we have done since at the Fund is show that it is actually a rule which describes well what countries have done since basically the 1800s, that that describes the behavior of countries in a very good way. So if you look at—you’ll remember the equation. So if [?] is equal to zero, then you have a primary balance just responding to debt, and the coefficient is better. But if there is a slow adjustment, then the rule tells you basically the speed at which these things happen.
            And so this gives you the estimates for a very long period of time on […?] from 1800 to now; and then a more recent one, 1950 to now gives it to you for advanced economies, [?], and emerging markets. And you can see that the rule fits well in the sense of having a very significant coefficient. And the conclusion is that beta, which is the strength of the response of the primary balance to debt, is—you can see it in the second set of lines—is about .04, which is if debt goes up by 10 percent, then you increase your primary balance by .4 percent of GDP, right? In addition, the fact that that [rule?] is about .8 says that you do this, but you do this slowly. So as a description of history, that actually works well.
            It seems to me that that rule is conceptually different from some of the advice and some of the rules that have been adopted, or some of the policies which have been adopted, by countries in this crisis. The first thing it says is it says, there is no magic debt or deficit ceiling. Basically debt could be very high, but as long as you stick to that rule, you will actually get it down. So it takes away the focus on numbers like 60 percent, or 3 percent for deficit, and says, look at the primary deficit. Say that whenever debt is higher, you will increase your primary surplus a bit, or you will improve your primary balance. The second is the […?] says, well, don’t do it overnight; just do it slowly. And historically it has been done at a reasonable rate.
            So one interesting thing is, once you have these estimates you say, well, how has fiscal policy behaved in the crisis relative to this rule? And what you find, that in effect outside of the southern periphery Euro countries the adjustment, not year by year, but over the last four years, has been very consistent with this rule. You use the rule, you basically predict what would have happened, and the fiscal conciliations happen roughly at that pace. But there [are] a number of countries where clearly it went much much much faster. Greece, Portugal, Spain are countries where the adjustments went much faster than predicted by this rule. Now we have some of the explanations for it, which is that they need money, and the people that were lending were not very open to doing it unless they went very fast; but the fact is that it went more slowly.
            Now, the last point of this slide is, is this a completely new idea? No, it’s not. Some of the rules which are introduced and are used have some of this element of feedback. So, for example, in Switzerland and Germany you have debt break rules, which is when debt gets too high, then the automatic effect on spending, even the incredibly complex procedure that the EU is using, has some of this element in it. But it has many more things which I think are counterproductive.
            When you propose a rule, people can think of ten reasons why it’s not going to work; and indeed, the simple rule faces a number of challenges. So I’ve listed here a few. The first one is, there is no reason to think that the historical behavior is the optimal behavior. What has happened has worked, but clearly we should sit down and think about what are the optimal values of […?], these two barometers, rather than take them as given. I think we can make some progress. It’s exactly the same thing as for the Taylor rule. Taylor said, well, these coefficients look reasonable; but a lot of work was done in trying to think about what the right coefficients could be.
            Another big issue is cyclical adjustment. If you want to avoid procyclical fiscal policy, namely having fiscal contraction when there is a recession, this rule has to apply to the cyclically adjusted primary balance. And there what we have learned from the crisis is it’s awfully hard to do the cyclical adjustment, awfully hard to know what is a permanent decrease in output or a cyclical decrease in output. And historically there has been a lot of cheating.
            That leads to the next point, which is the only way you do this is you need some institution which is apolitical which basically tell you, or tells the policymakers, what they think the output gap is, or what potential output is. You don’t let the policymakers decide what the cyclical adjustment is, because otherwise they cheat.
            The last point, which is very well relevant, is this rule for the primary balance says, if debt is really high, you actually have to have a fairly high primary balance. And the question is, why isn’t there a limit to how high the primary surplus is for political reasons? And [these are] my last two slides.        
            I think there is a limit. You cannot basically run very large primary surpluses forever. So the debt-to-GDP ratio of 600 percent, for example, just to take a crazy number, would imply that you’d have to run a primary surplus which would be orders of magnitude bigger than realistic. So this gives you the maximum primary surpluses which have been run on a ten-year average basis for various countries. And you can see basically that, except in very special cases, running a primary surplus of more than five percent for ten years hasn’t happened very often. You have to assume that if you try, you’re going to get into political trouble. So that puts a limit, I think, on the level of debt in the end. If you have a level of debt which is very high, you’re going to be in trouble.
            The last slide is trying to get at that, which is to say, well, could it be that when the level of debt is very high, the strength, the political strength, to actually the primary balance is there? So this set of points [comes] from looking at the large number of countries of about two centuries and about 25 emerging and 25 advanced. And that’s the [?] of points you get when you plot the primary balance as a ratio to GDP against the debt to GDP.
            Now, while I’ve talked about this positive relation that came from the [?] estimation, goes basically, you can see, up to about 150 percent—this is a regression line—is very significant. Clearly there’s an enormous amount of dispersion, but the slope is very significant, which means until then governments on average are able to increase the primary balance.  If you look at levels of debt above 150 percent, you see that there’s enormous uncertainty about this happening, and not too many points; but the estimate is basically that it goes the other way, which is, when you get to this very high level of debt, there’s just no way you basically just are able to generate the primary surplus you’d need; and then you’re in trouble, and presumably there is debt restructuring.
            So it’s clear that the argument is not, you can carry any level of debt; but up to very high levels of debt it seems to me that a rule like this would actually dominate the way we’re doing fiscal policy. Thank you.

            Save your applause till the end. We’ll wait till everybody--

Susan Collins:
            Thank you. Why don’t I get started while—Perfect, thank you very much.
            So as you heard at the beginning, there’s a long list of questions on the table, issues for us to address; and like Olivier, I’m going to be selective and actually think that what I have to say complements the comments that he just made.
            It seemed to me that a very helpful starting point in terms of this topic was to really clarify what we mean by this term austerity. What I mean is the definition that I’ve put here. Now clearly different people might define austerity in somewhat different ways; but I think of austerity as being an intentional government set of policies intended to reduce the fiscal balance, in particular reduce deficits either through expenditure cuts or enough increases in the revenue. And in particular when we call a program an austerity program, we’re talking about a program that is almost invariably taken in the midst of adverse [?] conditions. We don’t think that a kind of sustainable, long-term, well thought through fiscal rule that Olivier was just talking through in I think a very thoughtful, convincing way—that’s not the type of program that is typically labeled as austerity. And so a lot of the kinds of situations I’m going to talk about are the ones in which the kinds of rules he was discussing are not being followed.
            So what I’d like to do is to make three points, as follows. Let me just say my punch line up front, and then if I’m cut off because I’m elaborating too much then you’ll know what my main takeaways are. The first one essentially is that there’s a really important political context to the kinds of fiscal policy changes that we call austerity. That has a variety of implications. I want to spend a little bit of time talking about that because I think it’s very hard to understand what the costs and consequences are without really taking account of that context. These are not policies that are undertaken in a vacuum.  And that’s also really important in terms of the empirics, and we see that extensively with a lot of the research that has been done recently and that is still underway.
            I also then want to spend a little bit of time talking about what some of the estimates have been for what the fiscal drag, the costs of austerity, have been in economies that have arguably had significant fiscal [space?], and I will give two sets of estimates there. And again, others have other estimates as well.
            And then I want to highlight a number of areas where I don’t have any precise estimates to suggest; but I will point to some literature that [argues] that there’s a much broader context in which the kinds of adjustments that we’ve seen recently are likely to have broader consequences than the estimates that I’ve just talked about […?].
            So those are my broad points.
            So first in terms of the political context—and I think that the recent book by Lorenzo [?] makes this point extensively in the European context very well—but the point is really a much broader one. And that is a point that essentially when countries and in a scenario in which they are making often radical changes in policies in a political context that’s typically because there’s been a failure to confront and to actually tackle the longer-term challenges that they’re facing. And so it’s a scenario in which the choices are difficult. There’s often very complicated contexts politically in terms of who should or is willing to bear the costs that often are different estimates being floated out there with the different factions; and so the political context is really quite charged in these scenarios, and it’s also a situation that countries get into over time. And so these are not scenarios that simply are ones that could be described as random, that could happen to economies in a variety of cases. They’re often what happens at the aftermath of a series of delayed decisions or failure to actually undertake adjustments.
            And I think that’s important for a variety of reasons. One of them is that it makes it all the more challenging to be credible to announce that one is going to [do?] a phase program going forward that will undertake the kinds of fiscal rules that Olivier was talking about, that might be back-loaded, for example, that will address the current situation that is slow growth, because these are often taken in the context of adverse economic situations, and will address the longer-term very real high debt and large deficits over time. That credibility has often been squandered away, which is exactly the opposite of what Olivier talked about in terms of the monetary policy situation that we had in which central banks had already accumulated a significant amount of credibility, which provided them with the flexibility to do some of the crazy kinds of policies that we all know they have undertaken, and I would argue, very successfully.
            That also highlights that the empirics are—It’s very important for them to take the selection issues into consideration. And there has been a very large explosion of empirical research, and certainly we have now a lot of new episodes, which give us many more data points to try to understand these issues. That’s the silver lining, I suppose, is that we have much better estimates. And I think that we are getting some very strong evidence that really reflects a lot of these selection issues and gives us better guidance going forward.
            So in terms of those kinds of estimates—and here I think one of the nicest summaries is a recent IMF paper; there are other summaries as well--and my strong read of that evidence is that the fiscal policy can be countercyclical and have powerful effects. And in particular those effects are likely to be stronger in the kind of contexts that we’ve seen recently, in particular with the zero lower bound and monetary policy that therefore has a variety of constraints in which the economy is in a slump with high rates of underused labor and physical capital.
            So there are a couple of reasons why the recent evidence suggests that likely fiscal multipliers are likely to be particularly high in the recent contexts. Those include that the type of crowding out that would come as interest rates are increased as a result of the fiscal expansion are unlikely to happen with the zero lower bound and the kind of monetary policy accommodation that we’ve seen. It’s also the case that the financial crisis, to the extent that parts of the private sector are kind of constrained, that they are likely to have more sensitivity of consumption investment to current income than to anticipated future income; and that’s again likely to have the same implication. And it’s also the case that in a scenario in which the risk [premiums], already relatively low and are unlikely to be as responsive, that the idea that the austerity program, the fiscal consolidation, by increasing credibility that debts will be lowered in the future will bring those risk [premiums] down further is likely to be less relevant for helping to spur private sector growth. And so the goals of the austerity program in terms of boosting the private sector are less likely to be in play, and therefore those offsets are less likely to be important.
            So there are other rationales or reasons as well, but those are some of the key highlights, as well as the issues related to the added uncertainty that’s typically associated, or often associated, with various kinds of radical types of consolidation programs.
            And there’s also strong evidence that during a slump in which typically the economy grows relatively rapidly as it comes out of a recession, that taking that into account has caused conclusions that during slumps those multipliers are likely to be somewhat higher still. So of course all of that is particularly relevant in the current context.
            Well, it’s also clear from the recent crisis and from the recent episodes that we’ve seen that the kinds of risks that we, I think, had become quite comfortable thinking were only valid for emerging markets and developing economies are also relevant for advanced economies. And so it’s certainly important that we take into consideration the broader implications of those very high debt levels that many countries had accumulated and some of the challenges associated with very large deficits.
            At the same time, the context really does matter, and in particular in countries which are able to borrow in their own currency, [what?] those limits might look like—and actually I shouldn’t use the word limit --but what the associations are between accumulation of debt and the various kinds of risks are likely to be somewhat different. And so these are complicated and more nuanced; but the history and the context and the particular situation of the country in question certainly matter.
            In that context, of course, it’s very important to say that not all countries have fiscal space. There are some countries— And at the end of my comments I’m going to say a little bit about just the breadth and extent of fiscal consolidation measures which could be classified as austerity that are underway around the world. Many of the countries that have taken those policy decisions actually did not have a lot of fiscal space and did not have a lot of alternatives; however, there are certainly some economies in which that is not the case.
            So let me just mention two estimates of what some of the costs of the fiscal policies that were implemented since 2010 in the United States and in the UK have been. In both cases those have—the estimates that I am presenting here, and there are other estimates as well which a number of them are in similar ballparks, suggest that there has been an accumulated reduction in GDP associated with those fiscal policy decisions relative an alternative that might have taken place--and of course there are a lot of assumptions that are required in order to make those kinds of estimates—[that] might be in the order of 3 percent cumulatively in the UK and in the order 2, 2.5 percent in the US. And so those are clearly significant and have many implications in terms of the unemployment that is associated with it and the distribution costs which I will come back to in just a moment. So those are short-run and talking about what the implications have been over a particular recent time period.
            I want to end by just highlighting that I think there are a number of broader consequences that are also important to have on the table, and estimates are still in process; and so these are not ones that I’m going to offer particular numbers for. One is that—and a lot of my work is focused on longer-term growth issues, and certainly the underlying accumulation of both physical and human capital is important. And certainly in the United States this is true, and in a number of other countries as well. There are longstanding concerns of the depreciation of both infrastructure, public capital; and there are significant concerns I think that we should have about the longer-term implications for potential GDP growth as a result of what’s happened to both public investments and also the fact that private investment has been much more sluggish. Although it has recovered to some degree, much less than what many might have anticipated.
            I’ve also mentioned the distribution costs as well. There is a recent paper that is a comprehensive look at the variety of different types of consolidations; and essentially what it argues is that there’s a significant impact on inequality measured through the Gini indicator that’s associated with fiscal consolidations, and in particular that association is much stronger when the consolidations are associated with spending cuts than when those consolidations are associated with tax revenue increases. At the same time, that work really does highlight that a well-designed program that focuses on a composition can offset and mitigate those distribution costs; and so that the burden of the adjustments are not concentrated so heavily on some of the most vulnerable populations. And also they’re likely to be more sustainable because, to the extent that the adjustments are viewed as being fair and equitable, the politics, political issues that I started with, are much more likely to suggest that the programs will be sustained going forward.
            Then, finally, just to close, while many of us have focused on the austerity kinds of programs in the US and in Europe, I think it’s also to highlight that there has been a much more broad shift towards fiscal consolidation globally. And I cite here a recent paper that looks at a large number, 181 countries. In the initial phase, right after the crisis, there was some 90 percent of the countries in that sample under some type of expansion of varying degrees. Then a second phase: about 40 percent of those countries began to retrench and the fiscal consolidations have actually expanded, and they’ve expanded more extensively in the developing country world than they have among the industrial countries. And I think that graph is really important to note. There are a number of studies, case studies, that focused on fiscal consolidations that are associated with growth recoveries that are generated by increased exports. To the extent that this is much more of a global phenomenon, I think the linkages and the externalities that are associated with that in terms of reviving the global growth engines are also a great concern and suggest some additional consequences associated with a widespread austerity, especially in an environment with a zero lower bound, where it’s much more difficult for an individual economy, through depreciations or other kinds of adjustments, to offset some of the lack of export opportunities when trading partners are undertaking austerity programs.
            And so essentially what I have done is to try to highlight some of the challenges and considerations that make me conclude that the kinds of fiscal rules that Olivier was talking about are much much more sensible ways to be thoughtful and to adjust fiscal policies over time. The challenge, of course, is having avoided those adjustments, one can get into very very challenging situations. And it’s unfortunate to see such a large percentage of economies appearing to be in the midst of those austerity situations at the moment.
            So let me stop there. Thank you.

Robert Pollin:
            Thank you. Thank you, Jamie Galbraith, for inviting me to be on this.
            I am going to focus on the US, and in that context will get into some of the recent debate that my coauthors and I have had with professors Reinhart and Rogoff.
            So the US logic of austerity economics is still very ascendant. We can see that in the budget agreement that President Obama signed the day after Christmas, which entailed cutting benefits, pensions for federal employees, including military personnel. It included failing to extend unemployment insurance for 1.3 million long-term unemployed. It didn’t address tax loopholes for the wealthy at all; no spending on priority programs in the Obama administration on infrastructure or the green economy; cut food stamps November 1st for 47 million people, including 22 million children; and last year, in 2012, we saw Indiana and Michigan become right-to-work states--Michigan really being the home of the development of unionism in the United States is now a right-to-work state. So rather than giving a broad definition, I think these pieces of evidence characterize austerity as practiced today in the United States.
            Now of course the most dramatic effect of the great recession, the financial crisis and the great recession, has been on mass unemployment; so what we see here—well known data, but I want to highlight not just the fact of the spike of unemployment-- So you have the spike of unemployment here, which is only matched in the early 1980s recession in the post-World War II. This is [U6?]; this is the broader measure of unemployment. But in 1982 we saw that unemployment comes down very very quickly; in the most recent recession, unemployment is coming down much more slowly. And by the U6 measure of unemployment, we’re still—I checked this morning—[at] 13.2 percent; so that’s 21 million people are unemployed or underemployed by that measure.
            So a simple extrapolation, if you take from the month that the NBER says the recession officially ended, and then you just trace out the rate of reduction in unemployment, to get to a 5 percent unemployment rate would be June 2017; to get to a 4 percent unemployment rate would be March 2019. And of course the fiscal policy has not been addressing mass unemployment, despite this.
            Now the fiscal deficit, which is of course what the austerity agenda is about: We see here—These are the deficits as a percentage of GDP. This part, which gives us the average fiscal deficit as a share of GDP from 1950 to 2012; so the average is 2.2 percent.
            Now in 2007, before the crisis, the fiscal deficit as a share of GDP was 1.2 percent; so whatever else one might say about Bush’s economic policies, the tax cuts, the wars, not paying for the wars, there was no fiscal crisis by any measure here in 2007. So obviously what generated the large expansion in the fiscal deficit was the Great Recession. The fiscal deficit spiking at 10.1 percent in 2009 and staying very high at least through these three years, and then slightly coming down, was the consequence of the financial crisis and the subsequent Great Recession.  But we see here that, at least according to the most recent projections as of December 20, the CDO is saying the fiscal deficit in 2012 was 7 percent; this year it’s coming down to 4.1 percent; and their prediction is 3.3 percent and 2.1 percent, 2014 and 2015.
            Okay, as a consequence of the spike and the fiscal deficits, the austerity hawks argued that the most serious problem at the time was not mass unemployment, but was the fiscal deficit itself; so that the priority had to shift away from addressing unemployment to controlling the deficit. And there are three basic arguments made about this: that the large increase in the fiscal deficits would generate inflation; they would generate rising interest rates; and they would generate major declines in GDP growth. So that the whole point of expanding fiscal deficits in order to fight unemployment would in any case be self-defeating because of inflation interest rates and declining GDP growth.
            Now the inflation, rising inflation in interest rates didn’t happen. This shows us average inflation rates from 1953 to 2008: 3.8 percent. 2009 to 2012 was 1.6 percent. I just checked this morning for the first eleven months of 2013: 1.4 percent inflation. […?] treasuries average from 1953 to 2008, 6.2 percent. From 2009 to 2012, 1.6 percent. Then I just checked this morning for 2013: 1.4 percent. So the inflation effects didn’t happen.
            So the government debt did of course grow as a consequence, but what also happened was that the interest burden on the debt actually is at a historic low, not at an historic high. So if we say that we define a fiscal crisis according to the capacity to cover your obligations next month, two months, four months, actually the US is in better shape than it’s ever been since the 1950s, because the average interest burden since 2009 is 6.4 percent.
            Okay. Those arguments then don’t hold, and then the question is-- and the debate of course with Reinhart and Rogoff is relevant to what I’m talking about; that’s why I’m bringing it up—

            Actually we really don’t want to go there, especially—

            Well, that’ why I was invited to be on the panel.

            No, I don’t think so.

            What’s that?

            No, no, that’s not the case. That’s not the case. So please finish up because you’re running out of time anyway. We’re not going there. You have something you want people to pick up at the end of the session, a paper, fine; but we’re getting into that debate in this session. It is not the subject of this session.


            This is a professional discussion. It’s not personal.

            Let’s be brief then, please.

            Now, okay, so here’s the forbidden fruit that I’m not supposed to talk about. So the 2010 Reinhart & Rogoff papers, the recorded GDP growth according to their debt-to-GDP [categories?] shows that you have an average annual GDP growth rate with 20 advanced economies, 1946 to 2009, 4.1 percent less than 30 percent, 30 to 60 percent, 2.8, 2.8; and then you get this [?]. And that certainly was the thing, whether or not it was Reinhart and Rogoff’s intention, this was the thing that garnered so much attention, that when you get this threshold you’re going to experience a GDP growth decline.
            Okay, so myself along with my graduate student, Thomas Herndon, and colleague, Michael Ash produced the working paper, and posted on April 15, said that there are three basic problems with the paper: One, was a spreadsheet error, which they acknowledged; two was the selective exclusion of available data—and I should say the reason that we’re able to do this replication was because Professor Reinhart was nice enough to send us her Excel spreadsheet; and then three, the weighting scheme that was used, without getting into the details, according to the weighting scheme one year, for example, in New Zealand, 1951, was weighted equally with seventeen years of UK in which the UK was in the highest debt-to-GDP category.
            Okay. So quickly, we then did our [replication] and we found that GDP growth rate for the above-90 percent category was not -1.1, but 2.2 percent.
            Now, Reinhart and Rogoff have responded in various places, and they said the following: that we should focus on medians, not means; we should focus on the full 1790 to 2009 data set, as opposed to just the 1946 to 2009. And then when we do that is a consistent result that on average GDP growth for the above-90 percent category will be about 1 percentage point lower than in the lower public debt-to-GDP categories. But in our subsequent—

            That being the opening sentence of our paper.

            Yes, so in expanding on our original working paper, the result of which is in The Cambridge Journal of Economics, just published, here’s what we show. Now Reinhart and Rogoff themselves show in their errata that they put out in May that actually with the median 1946-2009, the difference using the full sample is not a difference of 1 percentage point, but a difference of 2.9 to 2.5, 0.4 percentage points. –You interrupted me, so—

            No, I’ve been pretty generous here. We have two more panelists so—

            Okay, okay. So—

            If you want to litigate this in court, be my guest, but you don’t want to do it here.

            Okay. Just let me finish and then we’ll get there. Okay, so 1790 to 2009, we also see a 0.4 percent difference, not a full percentage point. And then when we do this robustness check by adding a 120 percent, adding another debt-to-GDP category, actually the difference of GDP growth between the 60 to 90 percent, and the 90 to 120 percent evaporates entirely. So it’s 2.5 percent.
            And then finally when you look at the 2000 to 2009 data by itself, the most recent data that I would argue would be most interesting for trying to understand the world today, the most recent data, actually the above-90 percent category has somewhat higher growth and basically comparable to the 30 to 60 and 60 to 90 categories.
            So Rinehart and Rogoff said that this is an academic kerfuffle, a minor debate about nothing of great significance; but in fact what I would conclude, and my coauthors, is it actually is quite relevant for understanding the capacity of governments to undertake fiscal stimulus to fight mass unemployment; that we have more flexibility. The flexibility needs to be understood also within a range of complementary policies for expansion and inclusive growth, and I would very very quickly just mention two: which is addressing the excess reserves that the banking system now holds, which is $2.2 trillion, 14 percent of GDP; taxing those excess reserves; and taxing financial market transactions. This picture just shows the cash reserves—$2.2 trillion—now held by US commercial banks. And at the same time, the lending to non-financial businesses is actually, since the recession on net been zero. Like zero-zero. Nothing. So arguing—and Alan Blinder has made this point many times; I agree with Professor Blinder—to tax the excess reserves. I would also argue that impose not just a stick, but a carrot, the carrot being to expand loan guarantees for small businesses.
            And finally, a financial transaction tax. There is a bill—there [are] two bills now in Congress, one by Representative [Ellison?] called the Inclusive Prosperity Act, which is basically based on the UK stamp tax, which taxes stocks at 50 basis points. This proposal also imposes lower tax rates on bonds and derivatives. And here’s a simple calculation I did. If you take the Ellison bill and you just look at the level of trading as of 2011, and you impose the tax rate, and just the last column here, and we divide—Let’s assume that trading declines by 50 percent; as a consequence we generate $300 billion a year just from that.

            Time’s up.

Bob, Bob, Bob, I think we’ve been pretty generous in time, but you’ve been finally for the last 5 minutes, so that I’m really running out of patience. In one sentence finish it up please.

            I am, okay? So that’s $300 billion which by itself is 78 percent of the CDO’s projected 2015 fiscal deficit. So there are ways to address the long-term fiscal issues in an inclusive way. Thank you.

Carmen Reinhart:
            Well, let me begin by thanking Jamie for inviting me to this panel. What I would like to do is start out with the heart of the session which is to talk about austerity, talk about also how austerity is a very encompassing term. Austerity in Greece is not the same as austerity in Italy, is not the same as austerity in the US. –Is there a clicker here? There we are.
            So here’s my roadmap: I’m going to talk a little bit about what is meant by austerity, what shape it has taken. I’m going to talk about debt reduction. What are the many new policy options? Importantly I’m going to focus on the things we don't talk about: Austerity is a way of reducing deficit. Growth is the great way of reducing deficit, but that is an elusive—But what about debt relief? What about write-offs? What about financial repression? These are topics than Ken Rogoff and I have been writing about for year. In effect, if you go back to our 2003 work on debt intolerance, it makes the point that—that paper was focused on emerging markets—but that most of the reductions in debt post-World War II involved a combination of policies in which part and parcel were debt restructurings, if in some cases outright default. I’m not suggesting any of this is [costless?]; but I will go through that menu. I’m going to talk about debt and growth, and then I’m going to talk about policy lessons. So that’s what is on the agenda.
            Susan already covered this, so it’s really redundant: I think when we conceptualize austerity, I think it’s meaning very different things. But essentially let me start with the origins of austerity. I am a firm believer, based on the empirical work that I’ve done over the course of the years, that austerity has its roots during boons because in boons, as Ken Rogoff and I have talked about, when this time is different and when everybody is a genius, everybody takes the growth and the income aspects for granted, spends accordingly, and in the end, when things turn bad, the adjustment falls on the bad times—and that is the essence of austerity. So one way of avoiding austerity is actually is what you do in boom times; but that’s too late for this crisis.
            So what has austerity looked like? In Greece, the most extreme case, austerity has meant a decline in per capita terms of real spending per capita of 26 percent between the start of the crises in 2008 and 2012. That is austerity. Let me point out that in recent work that we’ve presented in other sessions Greece has been in contraction all this time. The trough in economic activity in Greece, if we’re lucky, was in 2013. And so this is austerity in its most extreme form.
            In Italy the decline has been about 7 percent. In the US—in the US—we are still at levels of per capita government spending that are above what they were in pre-crisis. This does not belittle the fiscal drag we’ve had in the last few years, the fiscal correction. This chart, this data, which comes from [The Economic Reporter?], […?] in no way is comparable to what I’ve shown on Greece, on Italy, and in Europe. So austerity means different things for different countries. This is, however, the big picture for the advanced economies. This is where, you know—I think a lot of the debate that we’re having is not so much about, is high debt a desirable thing. I think countries aspire to high per capita income, to high levels of education, to high standards for health. Few countries—none that I’ve heard of—aspire to have high debt; so I don’t think high debt is desirable. The question is, how do you bring it down?
            And what I’d like to focus on is, what are the things we don’t talk about? What are the things that we should have been doing that haven’t been doing or that are really part of the history lesson that Ken and I have written about?
            Throughout history, debt ratios, debt-to-GDP ratios, have been sometimes, in periods like after World War II, growth was an important factor in reducing debt levels. Fiscal adjustment and austerity sometimes also [have] played a critical role. But let me say that three, four, and five—namely, debt restructuring, outright defaults, or debt conversions—have also played a critical role, and not just in emerging markets. In effect, one of the themes that I’d like to leave with you—please let me know how much time I have—one of the themes I’d like to leave with you is that when you look at the contraction in fiscal spending in much of periphery Europe, you have to ask yourself the obvious question: From here on out, what is sustainable? And I’m going to divide my remarks [into] what is sustainable, what is advisable for Greece is not the same as for the UK or the US, where they do have a lot of scope on monetary policy, where fiscal thresholds are different, and so on. But let me take it one step at a time.
            In he 1930s—it may sound like an ancient history, but it’s very pertinent to today—in the 1930s the advanced economies on the whole defaulted. This is something we forget about. So part of the debt reduction in the 1930s involved the abrogation of the gold clause, which in the US meant a debt reduction of about 16 percent, and World War II debts were not repaid to the US. This was about 22 percent of GDP for the UK, about 24 percent for France—these are big debt reduction numbers. Anyone who’s interested, I’m doing a session and a paper on this later this afternoon.
            In the US, in the UK, the concept of [deeding?] debt restructuring a la Greece or a la Ireland or a la Italy in terms of some kind of arrangement in official debt is not the issue. So what are some of the other ways? Bob talked about some ways. The financial repression tax is part of what one would call financial repression. I’ve been writing on financial repression for the last three years. And what about financial repression? Financial repression—it sounds really sinister—but I didn’t create that name; that dates back to the 1960s, to the 1970s, and work by McKinnen and […?]—is basically a way of you have heavy-handed regulation, you maintain real interest rates, negative, and essential that liquidates your debt, or it’s part of debt liquidation. Negative real interest rates [are?] a tax on the [?]. These are not your sort of run-of-the-mill policies that one goes out and advertises, but they have been part and parcel, an integral part of debt reduction in the advanced economies. The concept that this is stuff that emerging markets do, but that advanced economies have never done, is just not fact. And I think we should look at debt restructuring in the context of official debts in Europe and what we have de facto been doing, which is a lot like financial repression, as ways of debt reduction that, at least in history, have contributed. I am not suggesting that these are panaceas. There are no panaceas. When one gets into a high-debt, low-growth environment, high-unemployment environment, there are no easy ways out.
            Let me say something about Robert’s remarks. This idea that Ken Rogoff and I went out and said, Oh, 90 percent, the world falls apart. We do not pretend to argue that growth will be normal at 89 percent, and sub-par about one percent lower at 91 percent anymore than a car crash is unlikely at 54 miles an hour and near-certain at 56. What we’re trying to do is map the theoretical notion of vulnerability regions to [bad?] outcomes and [the necessity?] involves defining thresholds. So US traffic signs don’t say, just drive slower. They actually have a limit.
            Now what we wanted to put out there—and we wrote this, by the way, on August 11, 2010, not as a response to Pollin et al—what we wanted to put out there is the notion that there are vulnerability regions. And there is a huge number of papers, really a burst in literature, that we hope will start dealing with all the deficiencies of our studies, because our study was very preliminary, very first-pass. We put it out there; we didn’t put it out there with any policy prescriptions. We just put it out there, and in the past, if you look at the methodology issues that are discussed in Kaminsky and Reinhart, 1999, Kaminsky and Reinhart put out notions also that, look, if real exchange rates get above a certain threshold, there’s an overvaluation problem; you’re less competitive. There’s nothing special about debt per se; but the idea of identifying vulnerability regions, I think when we are where we are in the advanced economies, is pretty fundamental.
            Let me conclude by saying that I think one of the lessons that I take from history is that we’ve been straight-jacketed in how we have approached this crisis; and we are in the sixth year of the crisis, in the sixth year of an economic contraction in periphery Europe. The US is one of the two countries—Germany and the US are the only ones—that have regained their previous level of income prior to the crisis. I would add that in a paper that I did in 2010 with Vincent Reinhart for the Kansas City Fed, Jackson Hole said, Look, unemployment in the decade after the crisis normally is about 5 percentage points higher for the full decade. And in 10 of the 15 crises we looked at, unemployment didn’t return to pre-crisis levels for 10 years. This is not to belittle the unemployment problem; it’s not to belittle the absence of growth problem; it’s not to belittle the income distribution problems. But let’s face it, high debt is an issue that is going to be with us for some time, especially in light of the fact that it’s not just high public debt, it’s high private debt. And we know that private debt becomes public debt also.
            Let me conclude by saying that I’m really delighted to have this opportunity to engage in what I think is a meaningful discussion of some of the issues at hand. But let me leave you with a message--I’m not an uplifting person: I think silver bullets in terms of policies are not to be found. The idea that there’s something easy, relatively easy, including debt restructuring—debt restructuring has costs, it has stigma issues, it creates uncertainty. There are no silver bullets. But I do think we have to amplify the menu beyond austerity and not keep praying for growth.

            Okay, Bob, you’re cleanup. We’re running a little short of time. We want to have some discussion. Clearly I have been [?] by this finally finally finally—[…?]; but it’s all a very good discussion.

Robert Zoellick:
            I’ll try to move this quickly. It’s a privilege to take part with a group of scholars, which I’m not, although I try to consume their work. In his invitation, Allen, I think, posed a very important question, which is, what have we learned from the recovery strategies after the Great Recession? On the way here—and I apologize for being a little late; my Amtrak train was late—I read Allen’s paper that he wrote actually in March of 2013, which is a pretty good way of answering the question.
            But my sense—and perhaps this discussion here elucidates it—is a lot of scholarship that I’ve tried to read suggests varying conclusions. So I’d like to add to the mix today by just adding some impressions of a policymaker.
            And to start let me suggest, I’m very skeptical of the austerity versus growth dichotomy. Of course at the policy extremes, one can see the risks of, or the role of fiscal policy when demand collapses; although, at least again from the work I’ve seen there are some very good questions about the effectiveness of the US fiscal stimulus. And of course monetary policy plays a role in terms of lessening tail risks and assisting deleveraging. And you’ve got a little flavor of this here. At least what I’ve seen, the policy mix itself depends heavily on national, regional, global circumstances; it depends on the policy flexibility that makers have as they come into the situation; it depends very heavily on the type of the downturn. So Marty Feldstein has a paper here that’s very useful in looking at some of the failings of the fiscal stimulus program because of the nature of the downturn.
            And so, for example, I believe that, looking at the situation that the UK was in at the start of the crisis, that if they did not convey through plans and actions that the government would gradually establish fiscal discipline, this could have slipped out of control for them. Now, […?] always a very difficult thing to prove; frankly, I think the talk of austerity was greater than the actual numbers.
            But my principal concern in the binary austerity debate is that it seems to assume—and of course this is the very nature of the GDP equation—that government and private spending and investment are the same. And I would suggest—and I know this may be a little heresy—is we sometimes start to think about perhaps a different framework. And in my framework I think, and in the nature of recovery, the policies also have to point to the need for a handoff to the private sector in employment, investment, and overall demand. At some point, over some time period, I do think it matter whether the public sector perceives itself as the ongoing driver of growth. Then you notice in these discussions there’s never any distinction between where the sources of demand come from. I believe that part of the challenge is creating the conditions for this handoff, which effects psychology, behavior, and recovery often from the nature of structural blows.
            Now I suppose it’s very difficult to quantify the effects of government policy on certainties, on private sector expectations; although I’ve seen some studies start to try to do this. And we have seen that expectations of future public spending, and debt, and taxes can cut the [multipliers’ analytical?] work on that. And the reality that I’ll share with you is that it’s natural that policymakers focus on the short term, because if they don’t get through the short term, they never get to the long term as a matter of politics.
            But I personally am increasingly of the view that if one develops stimulus policies, they need to be accompanied by structural growth policies. And the structural reforms will create the environment for the private sector investment, employment, innovation, and productivity growth. For example, one of the challenges of the United States is we’ve seen very strong corporate cash flows, low costs of capital; yet until perhaps very recently, very weak total investment.
            So how does a country point the economy back to stronger trend growth? What are the policy challenges to do that? And we’ve seen this being debated in developing countries, particularly middle-income countries all around the world, just as you see it in developed countries. And indeed, take the case of China, a wonderful example, where they’re in the midst of a great experiment of a structural shift of their growth approach at the same time as you see they’re trying to learn how to deal the credit expansion that they used for the stimulus.
            So in the case of the United States, somebody just closed with [?] six ideas that I would focus on to boost confidence, psychology, and growth. First, I think a broad-based tax reform with lower rates, equalizing tax treatment across all types of capital, eliminating distortions in tax subsidies, would go a long way toward building increasing confidence and psychology. Second, just look at the cities and states around the world, and see the painful effects on benefits and pensions of the public employees. You talk about debt numbers; at some point that should be a warning that we’re not going to be able to continue the federal benefit programs if we don’t at least start to think of modest steps. So frankly, as a policy official who’s been doing this for a number of years, I think if you had those two steps, just modest dealings with entitlement programs and a tax reform, you’d see a big takeoff in confidence and growth--and I spend a lot of my time dealing with private executives that make these decisions. Third, as a lot of people have stressed, I think human capital has to be given a lot more critical attention. Today private sector employment is still less than it was six years ago. My view is the way you do this is you have more flexible labor markets, which I don’t think the NLRB has at the heart of its design. And the simple policy goal should be get people into private sector jobs. So I would not suggest the government is very good at setting the prices for labor. If we want more returns to labor, especially for low-wage workers, why don’t we consider a permanent reduction in the payroll tax? Why are we taxing labor, particularly for low-wage people in a regressive fashion? And also, if you want to increase income for people in a redistributive sense—it’s a legitimate choice—for low-wage workers why not do it through things like the earned income tax credit, as opposed to trying to have the government set a wage in the minimum wage process?
            Now there’s much more that we can also learn about having people gain or regain the skills, including the use of the private sector. I hope this is actually a field that the economics profession helps policymakers learn more about. Let me just give you a reference point: The United States government spends about $18 billion a year on worker and job training, about 50 separate programs run by nine agencies; and they’re almost never evaluated. That’s a good place to start to try to figure out how we can use that money better. If you think about it in the broader sense, our unemployment insurance program, our trade assistance program, our job retraining program, are basically 30 years old, 40 years or 70 years old, 40 years old, 30 years old. What else in the economy hasn’t been reassessed and evaluated, given what’s going on? We’ve got to be able to do that better.
            Fourth, US immigration policy should focus on welcoming people that the American economy needs to boost growth and skill levels. Over 50 percent of the startups in Silicon Valley were created by immigrants.
            Fifth, we’ve got a great opportunity with energy innovation if we don’t choke it off.
            And sixth, I continue to believe in an activist trade agenda with global competition would not only boost productivity, but it’s a great way of forcing governments to face up to their failures.
            So in sum, even as we study the effectiveness of the macroeconomic tools, I would urge attention to policies that drive the microeconomic fundamentals not out of some policy purism, but because those are the policies that I suspect will create the private sector opportunities and confidence that will enable the recovery to be handed off to the private sector. Thank you.

            Let’s give all the panelists a round of applause. […?] questions from the audience. We’ll try to group them into—We’ll take four or five, and then let the panelists have at these questions.

            […?] I have a question for Professors Reinhart and Blanchard. My question is, would you say the debt is in effect a very arbitrary […?] fiscal obligation […?]. First […….... ? can only catch phrases here and there]

            Let’s take three or four more questions and then we’ll go to the panel.



            […?], University of Delaware. Susan Collins pointed out that there’s been a recent study suggesting that fiscal stimulus really did help, does help in reducing unemployment in a severe recession. But of course what holds it back is the worry about debt. Now there’s a big debate about whether the debt should be worried about or not […?]. But you wouldn’t even have to have that problem if the Federal Reserve, central banks and central banks in general were able to give cash transfers […?] recession to the treasuries of the country so they could continue fiscal stimulus without borrowing. And would that be a good reform for us in the US and possibly in Europe and other places?

            Okay, one more, and then we’ll have the panelists come back.


            That’s an interesting practical real-world question rather than theory. One more. Jamie, did you have a question?

            […?] thank the panel for an exceptionally crisp discussion, and I want especially to thank Carmen Reinhart for having phrased an issue in a very clear-cut way with one slide, which simply placed five alternative policies in a list to deal with a debt problem where it exists. They were growth, austerity, restructuring, inflation, financial [reflection?], plus […?]. Numbers four and five, as she said correctly, are not available if you owe debt in somebody else’s currency. Numbers one and two have been tried in Southern Europe and have plainly failed over five years, leaving one alternative. And I’m wondering whether anybody on the panel has any disagreement with that conclusion.

            Okay, that’s general. Now let’s go back to the panel here and start with Olivier and start with those that pertain to you.

            […?] Let me actually take, make two points on the interventions themselves and then—
            So, Susan said, quoting her paper, that austerity is expected to increase over 2013-2015. This is not the case. Basically we’ve seen the worst or the strongest part of austerity, of fiscal consolidation; and looking forward basically fiscal consolidation should be much more limited than it has been in the past. I think these are the facts.
            On austerity, I like very much the point I think that Carmen made. Austerity is a different debate in different countries. So I just want ot make the point that for the US, the US adjustment, the US fiscal consolidation, is very consistent with the estimated bond [?]; namely, we basically have behaved the way the US has behaved for the last 200 years. Now not every year. In 2013, it was stronger than most of us would have liked, but over the last four years. So we basically have done it the way we usually do it.
            Now, have we done it right in terms of spending and taxes, in terms of sequester? No, surely not. But at least what we have done in the US is not unusual from an historical point of view. What has been done in other countries, in the south of Europe clearly has been unusual.
            Now on the questions which have been asked:
            I fully agree that the definition of debt as we take it is not the right one, and I think one of the main lessons of the crisis is the role of contingent liabilities. This is the case for Iceland, this is the case for Ireland. Ireland suddenly found itself with 60 percent more debt to GDP as a result of contingent liabilities. So I think we have to probably construct not one measure […?] one measure, but broader measures. And I think the separate issue [are] the trends in entitlement programs, which I think have to be fought separately. But you’re completely right that the kind of formula I wrote down is not where you start. So I take your point completely.
            On the multipliers being self-defeating as a matter of arithmetic, actually this is an important point. That’s not true. What is true is that fiscal consolidation, if you assume that fiscal consolidation affects output in the year in which it happens, then it is true that a fiscal consolidation with large multipliers will actually increase the debt-to-GDP ratio in that year. But if you can work out the dynamics, then eventually it decreases the debt-to-GDP ratio. But it is absolutely true that with high multipliers fiscal consolidation will initially lead to an increase in the debt-to-GDP ratio. What is not correct that it will lead permanently to a higher debt-to-GDP ratio. So this is just a matter of arithmetic, but I think it’s important to clarify.
            On fiscal austerity and growth, I think none of us would argue that fiscal austerity does not negatively affect growth. I think we all take this as a given, and the question is what is the pace. I think most of us would also think that there was a need for some fiscal consolidation in some countries, and probably more so in Europe, in Southern Europe and elsewhere. Now I think the issue is a question of pace. Now did we do it too fast in Southern Europe? Remember that one of the constraints was the need for external financing. And although the amount of external financing which went to Greece was extremely large, the Europeans in particular were not willing lend much more, and that determined the size of fiscal consolidation. If the world had been more generous, it would have gone more slowly, but that’s basically what happened. So again, here I think the reality is a bit more complex. Maybe I’ll leave the other questions […?].

            I think in terms of the focus of the questions that probably Carmen next. If you stay there be loud, because you have no mike. If you want to come up to the mike you can.

            [?] that’s absolutely right. One cannot be married to a particular measure of debt. In the work that Ken and I have done, the big emphasis has been on the public debt numbers because essentially they’re the most complete of historical [?] series. But wherever possible we’ve looked at private debt. We’ve referenced not just the work of [Jordat and Taylor?], which [looks] at private credit; this is private bank credit. Because also there’s the issue that Olivier raised of contingent liabilities.
            Now the issue that you raised on assets is a very big issue, and I think anything where we can get better balance sheet assessments is very important. The problem with some of the assets is that they become highly liquid during crisis periods. And I’m not talking about the US; I’m talking about in Greece, or in Italy, assets owned by the government can loose liquidity in a crisis; that is, you still have to pay your debts, but nobody wants to buy your assets. We also saw this on the households. Whoever tried—and I did—tried to sell a house during this recession knows very well that your house may be an asset, but it’s a highly liquid one, especially in bad times.
            I like the question on the [counterfactual, …?]. Do we know which path is better? Is it better to try to make extreme efforts at austerity and try to continue to repay; or default on your debt and risk losing access to credit markets? Now, let me say the following: I do not take default lightly. I do not take restructuring lightly. But there are conditions where you see debt-GDP ratios in which you have to ask yourself, is Greece really going to become Singapore and grow their way out of debt? And under most plausible scenarios the answer is no. And in those cases it is really simply not credible to continue to expect that you can generate surpluses indefinitely.
            But getting back to your counterfactual question, what I’d like to add is that one of the big fears of default is that you lose access to credit markets forever, or for a very long period of time. And that was true in the old days, meaning, if you look at the 1800s, a country would go in default and would stay in default 25 years. By the way, Greece has been in a state of default since 1830 50 percent of the time.
            But in the modern era, that’s shortened considerably. So in effect—I have a paper this afternoon presenting on that—that highlights that countries that do restructure, especially if it is a restructuring that is in conjunction with the IMF, with the markets, and so on, that they regain access; so that the penalty for default is not as onerous as it once was.
            Now, the gentleman here—this is my last [?]—the gentleman here said the obsession with austerity. There are two parts that I would answer to that. One is a cheap shot, which is lack of imagination. You do austerity without thinking about the other debt reduction; and the other one, which is a very real one, is [?]. What politician in their right mind wants to go out and do 26 percent reduction in fiscal spending as it was in Greece, or 8 percent as it was in Italy voluntarily? I think one of the areas that there needs to be more study—this is not a copout; this is a real research area—is decoupling to what extent the austerity is driven by external procyclicality, meaning you lose access to borrowing at that time, so that your recourse, particularly if you can’t print money, your recourse to alternatives—they dry up. This, I think, has been a big issue in periphery. Do not underestimate that this wasn’t so much also an austerity obsession only, although there was certainly that; but also a complete, what Guillermo […?] called a sudden stop, that all of the markets that were willing to lend to you in 2007 don’t want to lend you a dime in 2009.

            I think Susan and then the two Bobs were very much US-focused; then try and get another round of questions. So Susan, if you’d respond. Carmen, by the way, I just might say that some people think the obsession with austerity came from the politicians, not from the economists; so you might want to comment on that at some point. But Susan—

            So just to pick up actually on both Allen’s point and what Carmen was just saying, I do think it’s important to have the political economy context and the history of how one got there not just within the individual country, but as Carmen was talking about, in terms of the linkages and what the broader financial access looks like. The bad luck of getting into a problem with one’s deficit and debt at a time at which there is a broader financial crisis really exacerbates the situation and restricts the options. And again, as I talked about at the beginning, you get there to a process. No one chooses to make the kinds of cuts that happened in Greece and a number of other European countries. And so I’m just reiterating, I think, the response there that Carmen made.
            I also wanted to just say a little bit about some of the—Olivier Blanchard talked about the fiscal rules and the kind of longer-term adjustment that recognizes a sustainable system. I also did not discuss the need for structural focus and longer-term adjustments that Bob Zoellick talked about, which I also agree in terms of the kind of more sustainable normal situation need to be part of the mix, and often are thrown out of the window in these political economy situations in which countries are facing a sudden stop financially. The politics are at the situation where people are making decisions that really are not long-term in structure. And so I don’t think that there is a dichotomy between austerity and growth; I think it’s really important to see these decisions as part of a broader context [of] the longer-term adjustment mechanisms which have to include things like tax reform and other types of structural adjustment with a focus on human capital interventions, as well as some of the longer-term investments which have to involve the private sector.  So I didn’t talk as much about some of the issues that Bob Zoellick talked about. I think that many of those are also important to keep on the table in these contexts too.

            We have 10 minutes left. Let’s take a quick, very quick round of questions. I have questions for the two Bobs if people don’t. We have to be very brief here and very brief in the answers. Again, we’ll categorize them, so--

            Thank you very much. [….?] Wikipedia School of Economics. But I wonder whether that word austerity is not completely mislabeled. I would say, example, Europe showed that part of the problem of fiscal consolidation was linked to corruption, inefficiency, state capture, and so on and so on. That’s[…?] or educational for kids and children […?] were not affected […?] by good management. I think that maybe you can make a difference between what is reduction of predicted expenditures by better management, efficient management, and respect of the rule of the law, and so on, and […?] expenditures […?] austerity.

            I think that a lot of this instruction is avoiding any acknowledgment of the […?] and we actually looked […?]. I don’t think there’s a very convincing argument that the private sector has been growing, and I think that there’s a clear role for the government to step in […….?].

            So far those questions are for all the panelists.

            Just two quick things: First I wonder if people in their final round could get back to Jamie’s question. And then, in terms of […?] your suggested rule, could we think of adding some kind of emergency political-economic intervention such as even youth unemployment or something else to add into that mix as look toward the longer run?

            I’d like to say I don’t think it’s just bad luck that you happen to have austerity pushed on you. […..?]. I think it more relates to what Carmen was saying about you didn’t prepare for it during the boon. And so I think what we need to work on or what policy research is being worked on is cyclically adjusted deficits, as difficult as it is to do, to try to look at when things are good to try to work in the opposite direction.
            The second thing I’d like to throw out is the consensus economists […?] missing the financial crisis, but in looking for the return to average growth next year. And doesn’t that also influence the policymakers thinking, oh, things are going to get better next year, when they aren’t going to get that much better next year.

            Okay, I think these are all questions each panelist can answer. I would throw into it the question of politics and economists. The perception I have is the economists have a lot of good ideas. We’ve heard many of them, including the rule that Olivier talked about. But they’re dealing with politicians who have a different agenda, a different set of objective functions; and to what extent from the point of view of economists and prescriptions in looking at austerity does that muck it up? That will not be for quotation, by the way, for anybody here in terms of what you say.
            So let’s start with, be very brief, left to right, starting with Carmen, Olivier, Bob, Susan, and Bob.

            I think the reluctance to move toward faster debt write-offs and talk about debt reduction and talk about higher inflation targets in the context of the ECB has been very much subject to the political obstacles so you really can’t separate them. It’s also, let me say, a classic creditor-debtor clash, right, the creditor trying to minimize the haircut and obviously the interests of the debtors and the creditors don’t align.
            I want to take the question here on the deficiency of aggregate demand. Debt is a huge issue. In the initial stages of the crisis I think the arguments for countercyclical fiscal policy and countercyclical monetary policy are fundamental, and I have argued repeatedly that, in the case of the United States at least, raised the bottom. If you look at the decline and compare our crisis now to historic crises, our bottom was raised, that floor was higher, and fiscal and monetary countercyclical policies had a huge impact.
            Now the kind of debt reduction that I’m also discussing is not limited to the public sector. In Spain, Italy, Portugal—you can go down the list—credit crunches are a massive problem. There is no working capital. And part of that is that banks are engaged in two activities: One is rolling over loans that are dead because they haven’t been written off and by government debt that pretty much […?] so there is a write-off of some of the private debts, as has happened in earlier banking crises does help restore credit [channel?]. Credit channel is also a fundamental way of getting to aggregate demand. Without credit it is very difficult to restart recovery.

            I will gladly accept the point that Allen made about the difference between economists and politicians … But I think it’s true that the great majority of economists actually gave reasonable advice, which is that when debt is really high, you have to stop thinking about […?] much more, but try to do it at a reasonable rate. That has been the message in various forms, and indeed politicians have gone beyond that message in a couple of cases.
            So this actually relates to the answer to the previous question, which is how do you decide about the speed of fiscal consolidation? I think on the one hand, [from the point of view of?] of aggregate demand you clearly want to go very slow, and maybe even have a fiscal stimulus. But we know is that when you get to very high levels of debt, you really have this danger of multiple equilibria, of investors deciding that you’re not going to repay asking for a high interest rate […?]. So you’re trading these two risks. The first one you can assess; the second is very hard. You have to make a choice. That’s why I think [……?].
            Should you think about aggregate demand? Yes, you should. This is the main issue. You want to maintain output, you want to limit unemployment. Again, I think the [room?] with fiscal is limited in a context like this one; but there is still monetary policy, there is still financial policy to decrease the spreads. And all these margins, governments, central banks have to do what they can. But one also has to be realistic. They’re not going to make things just nice. They’re going to improve things a bit, but not much.
            On the last point, which was the first question asked on the quality of adjustment. I’m in complete agreement that what’s important is how you reduce the deficit. That relates to the discussion between do you cut spending, [?] spending, or do you increase taxes […?] a big issue in France. I think many of us would think that there are many countries where rationalization of spending is probably the way to go rather than further increases in taxes. So I think yes, the quality of adjustment is essential.

            I’m going to make four quick points: One, on the question about the Eurozone and Allen’s point […?], I’d be wary of letting your community of economists off the hook a little too easily because you have to work with the institutions and framework we have. As valuable as microeconomics is, we have democracy, too; that’s very valuable. We have institutional structures. So the honest answer to the Eurozone question is, look, that would have to pay—for example, particularly the Germans—don’t want to have open-ended subsidies to Eurozone partners whose policies they distrust, whether […?] for corruption, or inefficiency. Or to leave you with a very pointed explanation, Mario Monte once said to me, Bob, you have to understand, in Germany economics is a branch of moral philosophy. So when you’re discussing monetary policy, fiscal policy, they’re thinking rectitude, hard work, discipline. Now it sounds funny, but in reality the challenge for policymakers, international ones, is how do you put the mix together to deal with those attitudes while trying to learn from the economic research.
            So second point: Here’s the real challenge for Greece now and the question about the debt. Look, I personally think Greece’s debt is unsustainable. But who holds the debt now? They’re primarily official creditors, okay? So here’s the real challenge: How do you have an official creditor take the hit--including the IMF I might add—while maintaining the institutional support we’ve built up over 50 years.
            So over the past weekend I’ve been trying to get votes in Congress to support the IMF quota. It appears the IMF will have to take a hit on Greece’s debt. That will be gone, and then you lose the IMF as an institution. Those are the real issues you face.
            And the third one—[Dean?] I think raised a very good point talking about assets in a way; he was talking about [?] with debt. But here’s where you get to the real crunch on political economy issues: First there’s the point that Olivier mentioned, is you have to consider the full range of liabilities like entitlements. But be wary, Dean, of paper assets. In other words, I may support a carbon tax—I’d like perhaps to have it reduced to something else—but if I don’t believe that tax is ever going to happen, at least in a reasonable time frame, but I still have to pay the debt, I still have to roll over the debt, I still have to worry about those entitlements, then I have to make the numbers add up. Now maybe the political debate will change, so that’s a reasonable point; but in the meantime that’s the reality you have.
            And the fourth and the last point is the question about aggregate demand. I don’t want to be misunderstood. I obviously believe, as Carmen said, there’s a role for the government to step in if the private sector aggregate demand collapses, as I think it did. But what I was trying to add to it is to urge a recognition that, first off, how it doesn’t matter, and I think we’re going to learn in the case of the US stimulus we could have designed a better one. But my key point is, while we’re thinking of the immediate policy mix, please also be thinking beyond aggregate demand to the fundamentals of the growth, because I think it’s a way of building the political support across a broader constituency, and I also think it gives you what I think is the ultimate handoff to the private sector. So don’t mistake me as saying the private sector will always do it. But I do think you need to think about the policy mix that will bring the private sector in—unless you believe, and some people might, that the government spending versus private sector spending [?] are totally equal over time. [recording ends here]

Economists for Peace and Security