Brad DeLong

No, Austerity Is Not Contractionary

Anthony Faiola:

In Greece, fears that austerity is killing the economy: ATHENS — Deeply indebted and nearly bankrupt, this Mediterranean nation was forced to adopt tough austerity measures to slash its deficit and secure an international bailout. But as the Greek economy slides into free fall, critics are scanning the devastated landscape here and asking a probing question: Does austerity really work?

Unemployment has surged to 18.8 percent from 13.3 percent only a year ago. Overburdened public hospitals are facing acute shortages of everything from syringes to bandages because of budget cuts, with hiring freezes forcing the mothballing of operating rooms even as more unemployed are relying on the public health system. Rates of homelessness, suicide, crime and HIV cases from intravenous drug use are jumping.

Greece has been forced to cut spending and raise taxes in the middle of a severe downturn, slashing pensions as well as state salaries, jobs and services. As public confidence has evaporated, consumer spending — the biggest driver of the economy — has plunged, generating cascading losses at private firms. The result is a dizzying economic plummet and social crisis that is bringing the cradle of Western civilization to its knees…. On Monday, German Chancellor Angela Merkel and French President Nicolas Sarkozy turned up the heat on Greece, suggesting that its bailout deal is in danger of unraveling if Athens does not press ahead quicker with pledged budget reforms and seal a deal with bondholders to voluntarily restructure its massive debt. But they also acknowledged that new steps are needed to combat slowing growth in the euro zone….

Leon Hannen, 64, a fluent English speaker and a maker of sacred icons for the Greek Orthodox faithful. When Greece’s economy went from bad to worse in 2011, squeezing wallets here, religious shops rapidly stopped purchasing his wares. He said he went from a monthly income of roughly $2,600 as recently as 2009, to just about $260 a month by last summer. “Before I knew it, rent was six months overdue and I was asked to leave,” he said. “I had nowhere to go. I slept under the stars, on park benches, at first. I chose the ones by street lamps to be careful. Frankly, I feel as if I’ve had an easy life up until now. But none of us do anymore”…

Matthew Yglesias and Paul Krugman Read John Cochrane...

Paul Krugman:

New Frontiers in Economic Barbarism: I’ve written quite a lot about the way much of the macroeconomics community has descended into a Dark Age, forgetting the things they used to know. I was originally set off by the way some economists were propounding Say’s Law — the idea, refuted 75 years ago, that all income must be spent and hence that supply creates its own demand — as a profound insight, somehow missed by three generations of economists.

Well, new forms of acquired ignorance keep surfacing.

Matthew Yglesias finds John Cochrane ridiculing the notion that devaluation makes it easier to bring a country’s relative wages down, whereas the empirical evidence is overwhelming that devaluation does, in fact, do just that.

Now, Yglesias has some fun with Cochrane’s violation of the extended version of Godwin’s Law, which says that the first person to mention either Weimar or Zimbabwe in a discussion of current issues loses. But Matt’s main point is that there are very good reasons why changing relative currency values is a lot easier than changing the whole structure of nominal wages and prices:

Depreciation makes vacations in Spain cheap, it makes Spanish exports cheap, and it makes it attractive for rich foreigners to actually go buy up excess Spanish housing stock to use as vacation homes and such. Everyone’s taken a hit, but they’re back on the path to growth.

The other alternative — the road we’re actually traveling down — is one in which all of these adjustments need to happen piecemeal. To make the same adjustment happen, every single contract in the country needs to be piecemeal renegotiated. That’s every town budget, every cell phone plan, every commercial lease, every salary, etc. It’s not “impossible” but it’s a logistical and political nightmare. And it takes time. During that time instead of everyone working harder because they’re poorer and more indebted than they realized and need to raise their incomes what happens is that 10-20 percent of the population does nothing because they can’t find jobs.

Quite. What Matt may not know, however, is that this is a classic argument in international macro, and the person who made it best was …. drumroll … Milton Friedman. Here’s a snip from Friedman’s 1953 essay “The case for flexible exchange rates”:

The argument for flexible exchange rates is, strange to say, try nearly identical with the argument for daylight saving time. Isn't it absurd to change the clock in summer when exactly the same result could be achieved by having each individual change his habits? All that is required is that everyone decide to come to his office an hour earlier, have lunch an hour earlier, etc. But obviously it is much simpler to change the clock that guides all than to have each individual separately change his pattern of reaction to the clock, even though all want to do so. The situation is exactly the same in the exchange market. It is far simpler to allow one price to change, namely, the price of foreign exchange, than to rely upon changes in the multitude of prices that together constitute the internal price structure.

Is it really possible that people at the University of Chicago have unlearned not only Keynes but Friedman? Alas, yes.

Indeed. Cochrane:

How Bad Ideas Worsen Europe’s Debt Meltdown: John H. Cochrane: Defenders think that devaluing would fool workers into a bout of “competitiveness,” as if people wouldn’t realize they were being paid in Monopoly money. If devaluing the currency made countries competitive, Zimbabwe would be the richest country on Earth…

Matthew Yglesias snarks:

Let's Play Analogies With John Cochrane: Try this mode of argument on for size. If water made agriculture possible, then the Pacific Ocean would be the breadbasket of the earth. Or: If flooding is a problem, then the Sahara Desert would be the best place to live. Right?

I just want to point out that Cochrane's claim that devaluation won't help reduce unemployment--even when unemployment is as high as it is in southern Europe today--entails a more general claim that not just fiscal policy but monetary policy has no effect on employment or production. For, after all, one would say:

Advocates of monetary expansion think that increasing liquidity would fool workers into working more and longer, as if people wouldn’t realize they were being paid in Monopoly money. If expanding the money supply made countries prosperous, Zimbabwe would be the richest country on Earth…"

What is the difference? None.

Yes, Virginia, the Yen Is Overvalued

Paul Krugman:

A Yen For Yenm: Japan has expected inflation that is around 2 points less than in other safe haven countries, but it has long interest rates that are only about 1 percentage point lower; Japan is a high real rate country. And this pushes up the value of the yen.

Just to be clear, this is a bad thing from Japan’s point of view; the country really needs more exports, and the high yen prevents that.

Another reason why you really, really don’t want to get into a deflation trap.

Investors Are More Confident in Countries That Can Devalue and Inflate

Joe Weisenthal:

CHART OF THE DAY: This Is Our Vote For CHART OF THE YEAR: A phrase you sometimes hear in financial markets is 'punish the printer.' The idea is that countries that are printing a lot of money will see their currencies dive. But a defining characteristic of 2011 was that markets loved printers. Specifically, countries that were able to print their own money saw their borrowing costs plunge, while countries (even fiscally responsible ones) that didn't have this ability saw their borrowing costs jump. (Our) favorite example of this is Sweden vs. Finland. The former is outside of the euro zone and can print its own money; the latter uses the Euro and can't. Historically, the two countries have borrowed money at roughly the same rate. Both are considered to be stable and fiscally disciplined.

In this chart, the green line is the yield on the Finnish 10-year bond. The orange is the Swedish 10-year bond. Starting in the Spring, Finland began to pay a penalty, but still, the two roughly moved in the same direction. It was in late November, when the European crisis got to its hairiest point (even Germany had a failed auction) that you really saw the difference. Finnish yields spiked at the same time Swedish yields plunged. Investors flocked to the country that could print its own money. This defining idea of 2011 also resulted in ultra-cheap rates in the UK, Japan, and of course the U.S.

Paul Krugman: Exchange Rates and Wages

PK:

Exchange Rates and Wages: Exchange Rates and Wages A followup to my post about modern Chicago economists forgetting what Milton Friedman knew: recent events have actually given us a dramatic demonstration of the reality of nominal wage stickiness…. [D]espite crushing unemployment, wages in Ireland and Latvia have come down only slightly — but Iceland, by letting its currency devalue, achieved a quick 30 percent fall in wages relative to the euro zone. And international macroeconomists know that the behavior of real exchange rates — exchange rates adjusted for relative inflation — is a prime piece of evidence for price stickiness. Not only do real rates move very closely with nominal rates, but the behavior of real rates changes dramatically when you move from floating to fixed rates or vice versa.

It would be one thing if people like [John] Cochrane had a serious critique of all this evidence, and of the decades-long research agenda that has confirmed the importance of price stickiness. But what’s clear in this discussion is that these guys are simply unaware of all this work, and feel entitled to make proclamations a priori.

What went wrong with the economics profession?

Interest Rates: The U.S. Is Not Just the "Tallest Midget", But One of a Number of "Safety" Countries

Paul Krugman:

America Is Not Exceptional: Ezra Klein points out… the big economic story of 2011 was that the conventional wisdom of Washington about the urgency of deficit reduction was totally contradicted by the bond market. But Ezra makes at least a slight nod in the direction of a new conventional wisdom, which says that it’s about the unique safe haven status of the United States:

This is not, to be fair, a bet on America’s economic strength. It’s a judgment about the rest of the world’s economic weakness. U.S. Treasuries are what savvy investors buy when they’re in a canned-goods-and-ammunition sort of mood and they think gold is overvalued. But though that makes the demand we’re seeing more depressing, it doesn’t make it any less real.

What such stories miss is the fact that interest rates have dropped sharply for every [major, credit-worthy] country that borrows in its own currency…. Note to British readers: every time Cameron takes credit for low British rates, he’s hoping you don’t know that the same thing has been happening in every non-euro advanced country.

What we’re looking at is a world of depressed demand, where government securities look like a good buy everywhere except in countries that either don’t have their own currency or have large debts in foreign currency, making them vulnerable to self-fulfilling panic. It’s a world in which deficit obsession is mad, bad, and dangerous.

David Beckworth: Macro and Other Market Musings: Why the Global Shortage of Safe Assets Matters

And I should have linked to this already. Very worth reading:

Macro and Other Market Musings: Why the Global Shortage of Safe Assets Matters

Why the U.S. Treasury, the Bundesrepublik Treasury, the Japanese Treasury, the Fed, the ECB, and the BoJ Need to Be Pumping Out Safe Assets at a Much Faster Pace...

Full-employment equilibrium in the demand and supply of currently-produced goods and services requires that there be enough cash to grease all the transactions so that sellers are happy selling to would-be buyers. If not--if there is a liquidity squeeze--we see a downturn and the shortage of cash reflected in low asset prices of (and high interest rates on) pretty much all other financial assets as people scramble to dump other assets for cash and do so until they can no longer bear the cost of letting value go at fire-sale prices.

Full-employment equilibrium in the flow of funds through financial markets requires that businesses (and governments) issue enough liquid savings vehicles to absorb all the planned full-employment saving in financial assets. If not--if there is a savings vehicle shortage--we see a downturn and not low but high prices of financial assets and we see what should be the transactions balances of the economy diverted as cash is transformed into a savings vehicle.

Right now, however, it is not the case that we are in a liquidity squeeze: the debts of credit-worthy governments are not at a discount but at a premium. Right now, however, it is not the case that we have a shortage of liquid savings vehicles: equities and corporate and junk bonds--and the bonds of non-credit worthy governments--are selling not for high prices but for low ones.

There is, however, a third market equilibrium condition: a credit-channel equilibrium condition. The economy must possess enough AAA-rated assets suitable to serve as collateral to keep the moral hazard associated with lending your wealth to somebody who knows more about the deal than you do from causing a Minsky meltdown. If not we see a downturn and what we see now: relatively low asset prices for risky assets and assets perceived as safe selling at values far above any reasonable estimate of long-run fundamentals that does not take account of their value as collateral for greasing financial-intermediation transactions.

It is in that context that we need to look at what has happened to the global supply of suitable AAA assets as shown in Cardiff Garcia's unwanted mutant offspring of the most important chart in the world:

Olivier Blanchard on Why 2011 Turned Out So Much Worse than Expected

To the extent that people think that I am smart--to the extent that I have been smart at analyzing what has been going on over the past five years--it is because a have a functional OBEM, a functional Olivier Blanchard Emulation Module, operating in my neocortex:

Olivier:

2011 In Review: Four Hard Truths: What a difference a year makes…

We started 2011 in recovery mode.... The issues appeared more tractable: how to deal with excessive housing debt in the United States, how to deal with adjustment in countries at the periphery of the Euro area, how to handle volatile capital inflows to emerging economies, and how to improve financial sector regulation. It was a long agenda, but one that appeared within reach.

Yet, as the year draws to a close, the recovery in many advanced economies is at a standstill…. I draw four main lessons from what has happened.

• First, post the 2008-09 crisis, the world economy is pregnant with multiple equilibria—self-fulfilling outcomes of pessimism or optimism, with major macroeconomic implications. Multiple equilibria are not new…. What has become clearer this year is that liquidity problems, and associated runs, can also affect governments. Like banks, government liabilities are much more liquid than their assets—largely future tax receipts….

• Second, incomplete or partial policy measures can make things worse….

• Third, financial investors are schizophrenic about fiscal consolidation and growth. They react positively to news of fiscal consolidation, but then react negatively later, when consolidation leads to lower growth—which it often does. Some preliminary estimates that the IMF is working on suggest that it does not take large multipliers for the joint effects of fiscal consolidation and the implied lower growth to lead in the end to an increase, not a decrease, in risk spreads on government bonds…. I should be clear here. Substantial fiscal consolidation is needed, and debt levels must decrease. But it should be, in the words of Angela Merkel, a marathon rather than a sprint. It will take more than two decades to return to prudent levels of debt.  There is a proverb that actually applies here too: “slow and steady wins the race.”

• Fourth, perception molds reality…. [N]ot much happened to change the economic situation in the Euro zone in the second half of the year. But once markets and commentators started to mention the possible breakup of Euro, the perception remained and it also will not easily go away.  Many financial investors are busy constructing strategies in case it happens….

Is all hope lost? No, but putting the recovery back on track will be harder than it was a year ago. It will take credible but realistic fiscal consolidation plans. It will take liquidity provision to avoid multiple equilibria. It will take plans that are not only announced, but implemented. And it will take much more effective collaboration among all involved. I am hopeful it will happen. The alternative is just too unattractive.

: http://blog-imfdirect.imf.org/2011/12/21/2011-in-review-four-hard-truths/

Look for LTRO at 2:15 AM PST

Adam Button:

Look for LTRO at 5:15 am ET | ForexLive: Several inquiries about this one. That’s nine hours from now, 7:15 p.m. in Tokyo, 10:15 am GMT. It may be out a few minutes early or late. Jamie’s "guess the LTRO" contest is a hit so far. Reuters has surveyed 23 monkeys economists and the range is € 50-€450B with the median at €250B. I suspect the market is priced for at least €300B. Mark me down at the high end of the range or higher. A strong, carry-trade-driven bid makes perfect sense to me.

It's Maynard Keynes's World...

Paul Krugman:

Keynesophobia:

1. There has been no crowding out; interest rates outside the euro area have remained low despite massive government borrowing, which is what you’d expect in a liquidity trap.

2. Inflation has been quiescent despite huge increases in the monetary base, again what you’d expect in a liquidity trap.

3. Fiscal austerity has deepened the economic downturn everywhere it has been put in place.

Were these predictions different from what non-Keynesians were saying? And how. Go back to Niall Ferguson, or Brian Riedl, etc., and you’ll find confident assertions that all that government borrowing would send interest rates soaring. Go back to the likes of Allan Meltzer or the Austrians, and you’ll find confident predictions that all that money printing would cause an explosion of inflation. And just about everyone on the right bought into some version of the doctrine of expansionary austerity.

But, but, the Obama stimulus didn’t bring unemployment way down! Indeed — and those of us who took our Keynes seriously warned of just that.

So what the anti-Keynesians are left with are the sovereign debt troubles in the euro area. But as many of us have tried to explain, these are really balance of payments crises exacerbated by the refusal of the ECB to act as lender of last resort.

And bear this in mind: no country has driven itself into a debt crisis with stimulus — nor has any country with significant debt regained investor confidence through austerity.

Look, I know that many people can’t bring themselves to even consider the possibility that Keynes was right — or, for that matter, that I personally might have gotten anything right. But reality has been really clear here.

http://krugman.blogs.nytimes.com/2011/12/19/keynesophobia/?pagewanted=all#

The truly puzzling questions are: Why is the world right now so "Keynesian"? And what might make it stop being so Keynesian?

A "Keynesian" world is a world in which three things are true:

1. Spending is held down not because of a shortage of liquidity but because people's portfolios don't have enough or the right kind of savings vehicles to make them happy.

2. Investors are eager to hold the nominal liabilities of governments that can print money at will and so turn those liabilities into cash with certainty--never mind any long-term political-economic inconsistency between spending plans and tax rates.

3. Private-sector leverage is sufficiently high that adjustments to reduced spending via lowering the path of the price level are perverse--that they create enough bankruptcies and moral-hazard credit-channel problems that they such adjustments push the pace of production not up but down.

That these things are true right now seems to me to be indisputable. I think I understand why (1) and (3) are true. But I don't think I have a good understanding of why (2) is true. The Princes of Canary Wharf and Midtown I talk to say that at this conjuncture they think that if they take on risk and then have a bad year that they are then out of the game--lose their existing clients whose money they manage and cannot attract new ones. Thus, they say, their only option is to hunker down and try to hold as low risk a portfolio as possible so that they will still be in the game when the return to normalcy comes about.

I then say: I understand that in that case you would like to be holding cash. But why the #$$&*@^! would you be eager to hold 30-Year U.S. Treasuries at a nominal yield of 2.79%/year? 30-Year TIPS at a real yield of 0.68%/year? Houses in Elmwood are selling at a price-annual rental ratio of 12, for Jeebus' sake! The earnings yield on the S&P Composite is 6%/year. Those are extraordinary return gaps in expected returns. Why not sell some of your long-duration U.S. Treasury and Agency assets and try to take advantage of them?

And the answer to that is: we will, but we won't start selling our long-duration Treasury and Agency assets until the market turns and Treasury bonds start to fall in price.

And I say: What if you are not first? At the moment, you are earning 2%/year on your 10-Year Treasuries relative to zero on your cash, but if the 10-Year interest rate normalized to its 2007 level tonight you would have lost 23% of your principal... by dawn

Nouriel Roubini: Stimulative Action Now!

Nouriel Roubini:

A plea to policymakers: we can’t risk another year of delay: For the last three years the world’s biggest economies - the US, eurozone and China - have been living up to the infuriating euphemism so beloved of policymakers: ”kicking the can down the road”…. [P]olitical constraints - the approaching elections in the US and leadership transition in China at the end of 2012, and the inability of the eurozone’s 17 governments and coalitions to coordinate policies coherently while staggered elections and changes of government take place – have led leaders to avoid the short-term pain and political costs of tough decisions that will yield benefits only over the medium term. 

It will become clear in 2012 that this game of “kicking the can down the road” is a zero-sum game…. If the world’s biggest economies continue to play the same game and try to kick the cans further down the road for another year, the cans will become bigger and heavier and eventually hit a brick wall. By 2013 at the latest, but possibly already in 2012, a perfect storm of a double-dip recession in the US, a disorderly scenario in the eurozone and a hard landing in China could materialise.

"The Fault, Dear Brutus, Lies Not in the Stars But in Ourselves…" Inadequate Fiscal, Monetary, and Banking Policy Response to the Lesser Depression

Mark Thoma sends us to Christy Romer:

A Financial Crisis Needn’t Be a Noose: RECESSIONS after financial crises are long and severe, and the subsequent recoveries are protracted…. But while there are strong patterns in the authors’ mountains of data, this simple summary misses an important fact: There’s dramatic variation in the aftermaths of crises, and much of it is caused by how policy makers respond….

Reinhart-Rogoff… emphasizes common patterns across crises…. [T]he averages are stunning. For 14 major crises since 1929, the associated decline in real per capita gross domestic product averaged 9.3 percent….

But… Norway had only a slight decline in per capita G.D.P. — around 1 percent — after its 1987 crisis…. The Depression… G.D.P. fell nearly 30 percent in the United States, and didn’t return to its pre-crisis level for a decade. But in Spain, it fell only 9 percent in the Depression as a whole, and actually rose in the year after its 1931 banking crisis….

What explains the variations?… [C]rises that happen along with currency crises tend to be followed by much more severe recessions…. [B]ig declines in house and stock prices… have damaging effects on their own…. BUT an even larger determining factor is the policy response. Why was the Great Depression so much worse here than in Spain?… Spain benefited from not being on the gold standard. Its central bank was able to lend freely and increase the money supply after the panic. By contrast, in 1931 the Federal Reserve in the United States raised interest rates to defend its gold reserves and stay on the gold standard…. [P]olicy response largely explains why output fell after the American banking panics in 1930 and 1931, but rose after the final wave in early 1933. After the first waves, the Fed did little, and President Herbert Hoover signed a big tax increase to replenish revenue. After the final wave, President Franklin D. Roosevelt abandoned the gold standard, increased the money supply and began a program of New Deal spending….

The Reinhart-Rogoff study points out that policy makers’ ability to take strong fiscal action depends on whether they start with high levels of debt. In the current episode, China and South Korea have recovered faster, partly because they have taken more aggressive fiscal stimulus measures. They could do that because they entered the crisis in good fiscal health…. After its banking panic in 1991, Sweden aggressively restored its banks to health. They were nationalized, recapitalized with public funds, and then returned to private control. After three rough years, Sweden grew rapidly, soon returning to its pre-crisis trend. Japan, by contrast, put off cleaning up its banks after its 1992 crisis….

[W]here does this… leave us?… [P]olicy makers need to make the financial system less prone to crises, and to fight panics aggressively when they arise…. A country as creditworthy as the United States can continue to use fiscal stimulus to help return the economy to full employment. And… there’s much more the Fed could be doing. Whether we continue to fester or finally embark on a robust recovery depends on whether we choose to use the tools available.

Finally, governments around the world, including our own, should remember that it helps to be in sound fiscal shape before a crisis hits…. Being careful in good times gives policy makers the ability to fight crises in bad ones.

Paul Krugman: They Have Made a Desert, and Called it Successful Austerity

Ireland Edition. Paul Krugman:

They Have Made A Desert, Ireland Edition: And called it a successful example of austerity…. Like that other implausible candidate for role model, Latvia, Ireland has been hailed as a success story — and a challenge to Keynesians like me — when there was never anything that looked like real success and nothing that posed any sort of puzzle. (Even in a Keynesian world, internal devaluation will work in the long run if you can stick to it — but in the long run, well, you know the rest.)

The sad thing here is that textbook Keynesian macro has been a very good guide all through this crisis — but nobody will believe it.

The Speed with which International Economic Imbalances Can Mount...

Karl Smith sends us to Kate Mackenzie quoting a chart from Bank of Canada Mark Carney:

Kate Mackenzie:

Structure of a Recession: Europe Edition: Carney points out that it doesn’t matter whether the debt is initially public or private, because private debts inevitably become public.

And of course, Europe is a microcosm (or, whatever a big microcosm is called) for the whole world. As Carney says, “Accumulating the mountain of debt now weighing on advanced economies has been the work of a generation.

And Karl Smith:

This in itself, however, is not enough.

Lets imagine that Portugal received massive inflows of foreign capital from 2002 to 2010. Then it used that capital to stockpile massive quantities of gold. Where would they be today? Chances are living the high life…. The point is… that there is something magical about the ability to send back whatever you borrowed. One of the things about Europe’s situation and that in America as well is that what was borrowed was structures…. Portugal can’t just ship Villas back to Germany or China to make good on its debts. What it could do is ship Germans or Chinese to Portugal to stay in the Villas. That would require, however, increased expenditures on vacations in Germany or a falling Euro to make it more affordable for the rising Chinese middle class to visit Portugal.

Daniel Kuehn: Maynard & Fred & Gus & Ralph on the History of Macroeconomics

Definitely not your father's Bob & Carol & Ted & Alice…

Daniel Kuehn:

Facts & other stubborn things: David Glasner on Keynes, Hayek, Cassel, and Hawtrey: [David Glasner's] is one of the best blog posts I've read in a while - one of those posts that really drives home the value-added of the blogosphere…. [T]wo points: that the Keynes v. Hayek mania is ridiculous, and that Cassel and Hawtrey deserve more credit than Keynes and Hayek.

Keynes v. Hayek:

I strongly agree with Glasner here. I consider this blog (and myself) pro-Keynes and pro-Hayek. I like them both a lot…. Keynes has always been a pariah in Austrian circles, and Hayek (before Friedman took his place) has always been a sort of short-hand for reactionary economics among left-wingers…. But I'm not sure that ever defined the men for people like it has in the last couple years…. [W]e really have two people to "thank" for this development: Russ Roberts and John Papola…. Roberts and Papola will often protest that there's nothing "wrong" with what they had Keynes say…. It's not that any of Keynes's words were "wrong" (although I would have written it differently), it's that he was advocating top-down solutions, he was getting special favors from government, he was acting like he could (and he wanted to) plan people's lives, he was a jerk to Hayek, he was on the side of the cronies and crooks, he was irresponsible, he was indifferent about war, etc…. There wasn't a whole lot of economics in the videos (particularly the second one). It was that Roberts and Papola are pounding the story that Keynesianism is the anti-bottom up, illiberal, cronyist, cheating side. Papola continues to protest to me in correspodence that he's presenting an entirely legitimate view of Keynes, but Russ Roberts has come out and said it's all about ideology for him…. [I]t's doing far more harm than good.

Indeed. Keynes was not a top-down special-favors irresponsible jerk indifferent about war. Far from it. For example:

John Maynard Keynes: The General Theory of Employment, Interest, and Money: If the State is able to determine the aggregate amount of resources devoted to augmenting the instruments and the basic rate of reward to those who own them, it will have accomplished all that is necessary…. Our criticism of the accepted classical theory of economics has consisted not so much in finding logical flaws in its analysis as in pointing out that its tacit assumptions are seldom or never satisfied, with the result that it cannot solve the economic problems of the actual world. But if our central controls succeed in establishing an aggregate volume of output corresponding to full employment as nearly as is practicable, the classical theory comes into its own again from this point onwards…. Thus I agree with Gesell that the result of filling in the gaps in the classical theory is not to dispose of the 'Manchester System', but to indicate the nature of the environment which the free play of economic forces requires if it is to realise the full potentialities of production…. Within this field the traditional advantages of individualism will still hold good. Let us stop for a moment to remind ourselves what these advantages are. They are partly advantages of efficiency--the advantages of decentralisation and of the play of self-interest. The advantage to efficiency of the decentralisation of decisions and of individual responsibility is even greater, perhaps, than the nineteenth century supposed; and the reaction against the appeal to self-interest may have gone too far. But, above all, individualism, if it can be purged of its defects and its abuses, is the best safeguard of personal liberty… the best safeguard of the variety of life… the loss of which is the greatest of all the losses of the homogeneous or totalitarian state…. Whilst, therefore, the enlargement of the functions of government, involved in the task of adjusting to one another the propensitv to consume and the inducement to invest, would seem to a nineteenth-century publicist or to a contemporary American financier to be a terrific encroachment on individualism, I defend it, on the contrary, both as the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative…

And

John Maynard Keynes: If we take the view that for at least a generation to come Germany cannot be trusted with even a modicum of prosperity, that while all our recent Allies are angels of light, all our recent enemies, Germans, Austrians, Hungarians, and the rest, are children of the devil, that year by year Germany must be kept impoverished and her children starved and crippled, and that she must be ringed round by enemies; then we shall reject all the proposals of this chapter.... But if this view of nations and of their relation to one another is adopted... heaven help us all. If we aim deliberately at the impoverishment of Central Europe, vengeance, I dare predict, will not limp. Nothing can then delay for very long that final civil war between the forces of Reaction and the despairing convulsions of Revolution, before which the horrors of the late German war will fade into nothing, and which will destroy, whoever is victor, the civilization and the progress of our generation. Even though the result disappoint us, must we not base our actions on better expectations, and believe that the prosperity and happiness of one country promotes that of others, that the solidarity of man is not a fiction, and that nations can still afford to treat other nations as fellow-creatures?...

Daniel goes on:

Cassel and Hawtrey:

Glasner goes on to talk about who he thinks really ought to be recognized instead of Keynes and Hayek: Gustav Cassel and Ralph Hawtrey. I found this discussion interesting, in part because I know Keynes was so influenced by Cassel and I think considered himself on the same page…. I don't think it's quite right to draw this sharp line that Glasner does. Keynes's point on the gold standard was that money was a "limiting factor" rather than an "operative factor" (this comes out in his letter to Roosevelt, but also more clearly on pages 230-236 of the General Theory). Tight money could drive economies into depression for all the reasons that Keynes and many other economists at the time laid out, and that money would have to be loosened to enable a recovery. But Keynes's broader point was that the level of output and employment is a function of investment demand, which itself is function of entrepreneur's expectation of future yields…. There's discussion in it of the problems associated with golden fetters, but that alone doesn't give you a theory of output and employment, which is the book's object.

I've never personally seen any substantial disagreement between Keynesianism and market monetarism. I think there's something to be said for monetary policy becoming relatively less effective in a liquidity trap (something Glasner isn't entirely in disagreement with himself), but that hasn't lead any prominent Keynesians to disagree with market monetarists, just as Keynes was right there with Cassel and Hawtrey advocating and then praising the exits from the gold standard in the 1930s.

I would put it this way: Contrary to Say's Law, money opens the door to general gluts, and general gluts can cause depressions…. Keynes rejected Say on a more fundamental level, pointing out that even when purchases and sales were balanced, the balance might not be struck at a full employment level. Was he right? That's a tough call. The Depression didn't end in 1933, and there's pretty strong reason to believe increased (public) investment demand in the early 1940s determinantly put an end to it. That seems to be a mark in Keynes's favor (although, of course, not a mark against Cassel and Hawtrey…. Does comparing today to the 1930s offer a good test of whether the Cassel-Hawtrey strategy alone could have addressed the problem?

btw - anyone not following Glasner's blog should be.

With that I agree. You need not just Fisher-Cassel-Hawtrey-Friedman, but also Wicksell-Kahn-Hicks and Bagehot-Minsky-Kindleberger-Koo. And anybody not following Glasner's weblog should be.

On Hayek… in my view, there are four Hayeks, one good, and three of varying degrees of badness:

1. The good Hayek of the price system as a discovery and information transmission mechanism, of the importance of entrepreneurship, and of private property and the rechstaat as guarantees of individual liberty.

2. The bad Hayek who prefers Augusto Pinochet to Helmut Schmidt.

3. The worse Hayek who had his head completely up his posterior on economic policy during the Great Depression.

4. The worst-of-all Hayek. The one who when Keynes praises the Road to Serfdom and pronounces himself in "not just agreement, but deeply moved agreement with it" responds "no you are not!"

No. The Irish Economy Is Not Recovering

Yet more "Cuir Siao Ar Ghabhar Agus Is Ghabhar" blogging, via Paul Krugman:

Kevin O'Rourke:

The Irish Economy: The latest employment figures: “So, we hear Ireland is recovering”, a French friend said to me last night. (Mind you, they said something similar in the summer of 2010. Our government has an incentive to sell the Irish good news story, and “Europe” has an incentive to buy it.) So, here http://cso.ie/en/media/csoie/releasespublications/documents/labourmarket/2011/qnhs_q32011.pdf are the latest employment data, reporting the largest seasonally adjusted quarterly fall in employment in two years, and which surely deserve a thread of their own.

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• Google
• Tyler Cowen
• Tim Cavanaugh
• Megan McArdle

James Saft, Fifteen Months Ago, on Ireland

The Great Debate:

Ireland and its economic unraveling is not simply a test case of the stimulus versus austerity dispute, it is an illustration of the limits and pitfalls of the very popular strategy of keeping the banks ticking over, hiding under a desk and hoping for a strong recovery…

DeLong Smackdown Watch: Jim Henley Provides a Materialist Interpretation of Nick Clegg

Jim Henley thinks that Nick Clegg drew the wrong conclusions from his time spent as an intern at the Nation:

Oh Right – Needs a Title § Unqualified Offerings: Brad DeLong was implicitly puzzled last week why British Lib-Dem leader Nick Clegg sticks in coalition with the Tories, ensuring the continuation of “expansionary austerity” policies that are delivering 100% of the austerity and 0% of the expansion. Brad:

Note that Nick Clegg and the Liberal Democrats in Britain could end this farce tomorrow, and give their country a chance. It would be the end of Nick Clegg’s political career, of course–but his career is over already. It may be the end of the Liberal Democrats–but they have a much better chance if they admit they made a big mistake in selling their soul to the Conservatives for a mess of pottage than if they try to brazen it out and support the current government.

I suggest that Professor DeLong has already explained Clegg’s behavior…. Nick Clegg is going to need a new job. Who can give an ex-national politician the really good ones – the ones that require two commas in the annual salary? The people who can give Nick Clegg that kind of job are the people who favor “austerity” (for the littles) and even profit by it (in the short term).

This relates to the cleverness behind the term-limits movement in the US…. [T]erm limits does produce a regular crop of ex-Senators and turfed-out Representatives… [who] don’t really want to go back to their Tennessee mountain homes. They’ll want the sorts of incomes you can only get from – interests who can afford to pay you those incomes. And that’s what you’re auditioning for as your legislative career draws to a close. The system already works this way. But under term limits, the extra volume of job-seekers makes it even more of a buyer’s market…

Lessons From Europe for Economic Theorists

Paul Krugman:

Lessons From Europe: Let me return for a minute to Kevin O’Rourke’s recent piece on the European summit. Aside from pointing out just how bad an idea the new super-stability pact is, O’Rourke makes an important observation about what the European experience teaches us about macroeconomics:

One lesson that the world has learned since the financial crisis of 2008 is that a contractionary fiscal policy means what it says: contraction. Since 2010, a Europe-wide experiment has conclusively falsified the idea that fiscal contractions are expansionary. August 2011 saw the largest monthly decrease in eurozone industrial production since September 2009, German exports fell sharply in October, and now-casting.com is predicting declines in eurozone GDP for late 2011 and early 2012.

A second, related lesson is that it is difficult to cut nominal wages, and that they are certainly not flexible enough to eliminate unemployment. That is true even in a country as flexible, small, and open as Ireland, where unemployment increased last month to 14.5%, emigration notwithstanding, and where tax revenues in November ran 1.6% below target as a result. If the nineteenth-century “internal devaluation” strategy to promote growth by cutting domestic wages and prices is proving so difficult in Ireland, how does the EU expect it to work across the entire eurozone periphery?

The world nowadays looks very much like the theoretical world that economists have traditionally used to examine the costs and benefits of monetary unions. The eurozone members’ loss of ability to devalue their exchange rates is a major cost. Governments’ efforts to promote wage cuts, or to engineer them by driving their countries into recession, cannot substitute for exchange-rate devaluation. Placing the entire burden of adjustment on deficit countries is a recipe for disaster.

Basically, European experience is very consistent with a Keynesian view of the world, and radically inconsistent with various anti-Keynesian notions of expansionary austerity and flexible prices.

The point about nominal wages is especially telling. Ireland has clearly — clearly — faced a massive demand shock; maybe Casey Mulligan will find some way to insist that 14.5 percent of the Irish work force has voluntarily decided to refuse employment, but it’s just not true. And Ireland is supposed to have flexible markets — remember, before the crisis it was hailed as an example of successful structural reform…. It is really, really hard to cut nominal wages, which is why reliance on “internal devaluation” is a recipe for stagnation and disaster.

The crisis really has settled some major issues in economics. Unfortunately, too many people — including many economists — won’t accept the answers.

We Are Trapped in a Nightmare from Which We Struggle to Awake...

Paul Krugman:

Slow Learners: The WSJ has an article today [by Thomas Caton] pointing out that the euro crisis isn’t really about fiscal irresponsibility:

So if public debt is your yardstick, then the Spaniards were paragons of virtue. They borrowed lightly despite the fact that their euro-zone membership gave them an all-you-can-eat buffet of financing at bargain-basement rates.

As Europe scrambles to find a solution to a debt crisis that’s threatening the world economy, it’s crucial to understand what actually happened in countries like Spain. Otherwise, policymakers will end up prescribing the wrong medicine, with disastrous results.

That’s all true, and I’m glad to see it in the WSJ. But it’s presented as a startling insight, one that runs contrary to what everyone thinks. And that’s amazing and depressing.

I mean, this was obvious from the very beginning. Here’s what I wrote in February 2010:

The biggest trouble spot isn’t Greece, it’s Spain — which was running budget surpluses just a few years ago. True, Spain is running big deficits now — but that’s because of its economic collapse. And underlying that collapse is the real problem with the euro: one-size-fits-all monetary policy, which offers no relief to countries that suffer adverse shocks.

There are two things that are frustrating about the fiscalization of our discourse. First, it’s taking place even though many, probably most good economists have been arguing strenuously for a more sophisticated view. Second, many of the people insisting that deficits are the big issue probably don’t even realize that they’re taking a questionable position — it’s just part of what everyone thinks they know.

Against conventional wisdom, the gods themselves…

Sometimes (actually, often) it feels like I’m in one of those nightmares where you’re shouting, but nobody can hear you. And you wouldn’t really expect that to happen when you’re doing your shouting from a pretty prominent platform.

Paul Krugman: They Have Made A Desert, And Called It Adjustment

PK:

They Have Made A Desert, And Called It Adjustment: It continues to be a source of amazement to see what passes for a success story among austerity advocates. Ireland is proclaimed a huge success despite 14 percent unemployment and a very slow recovery in incomes. And then there’s Latvia…. GDP down 24 percent, recovered to being down only 18, is a triumph?

Interestingly, people who trumpet small bounces off a very low floor as successes for austerity tend to describe the New Deal as a failure because the fairly rapid growth after 1933 wasn’t enough to fully restore prosperity until the war. Funny how that works.

Where Are the Institutions of Global Economic Governance?

John Maynard Keynes and Harry Dexter White built the IMF to handle situations like this...

Ed Luce:

Now on Broadway! Waiting for Euro: Last week Mr Obama told a gathering of donors that he spends “an awful lot of time making transatlantic phone calls.” It is time understandably spent. The Republicans could nominate a loose cannon for the White House and leopards could lie down with baby goats in the Middle East. But if Europe fails to stave off a collapse, Mr Obama’s re-election prospects would be downgraded to junk….

The US model no longer looks exceptional. Last week’s welcome fall in the US jobless rate – from 9 per cent to 8.6 per cent – illustrates why. On the surface, it looked like a big drop in unemployment. But more than half the fall was due to the number of people dropping out of the labour market, which exceeded the number of new jobs created.

US employment as a proportion of the population now stands at 58.5 per cent – the same level as in Europe. In the 1990s, America stood out as having both the highest proportion of employed workers and the most dynamic jobs turnover rate. Nowadays it is average….

[D]awning recognition of America’s inability to stop a faraway event with the potential to plunge the country back into recession may help explain why Newt Gingrich is surging in the Republican polls. The first response to loss is denial. Next comes anger. The Tea Party, whose enthusiasm has assisted the former Speaker’s surge, is nothing if not angry….

[W]e have no idea what is going to happen. The flawed Mr Gingrich could yet emerge with the nomination – it is hard not to believe Mr Obama would be happy with that. The US economy could keep adding jobs at a modest rate. Ditto. And Ms Merkel could empower the ECB to act more like the Fed. Or vice versa…

Unvirtuous Germany

Alex Harrowell:

Chart of the week, IMF edition: [Y]es, Virginia, the Germans bailed out the banks… carried out the biggest discretionary fiscal stimulus in Europe at 5% of GDP… German public debt increased as a percentage of GDP by more than Italy or France’s and second only to the UK’s…. Italy’s problems are entirely to do with growth or else with interest rates. And it looks like the political ability to pull in taxes is pretty important…

Department of Citations...

Twitter / Home:

@mattyglesias: mattyglesias Another day, another @tylercowen post on Germany that doesn't link to our quote who he's disagreeing with: http://t.co/gaQRqFSg

Heh, Indeed...

Twitter / @TheStalwart:

Joseph Weisenthal: Heh, understatement of the day. Mankiw on Europe:

There are bigger risks than inflation just now.

http://bit.ly/tKB1L2

Obama Administration Response to Eurocrisis: Doesn't Anybody Know How to Play This Game?

The United States does not share a currency with any European country. The United States can thus decouple itself from the European business cycle, if it so wishes and whenever it so wishes. When demand falls in Europe that does not mean that demand has to fall in the United States. When spreads rise in Europe that does not mean that spreads have to rise in the United States.

The Federal Reserve and the Treasury simply have to take appropriate action to make sure that any holes in aggregate demand that emerge from a European recession are filled by other means.

If Obama thinks that the European situation means that the U.S. will grow too slowly over, say, the next eleven months, he can convene a meeting with himself, Tim Geither, and Ben Bernanke and ask for a plan to ensure that the U.S. is decoupled from the European recession.

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Duncan Black watches the Obama Administration miss this very basic point:

Eschaton: Operation Blame Yurp: No it isn't. It really isn't.

He is referring to Richard McGregor:

Obama’s morbid fear of EU meltdown: [W]within both the administration and Mr Obama’s campaign team in Chicago, there is a morbid fear about a eurozone meltdown and its flow-on impact on the US economy and the president’s re-election chances. “The thing that matters the most in determining the health of the US economy and job creation is what happens in Europe,” says a senior administration official….

Like the eurozone itself, the administration is captive of German domestic politics and Chancellor Angela Merkel’s juggling act balancing support for European unity with local taxpayer discontent about ever rising demands for funds to bail out its neighbours…

Mark Thoma on Coordinated Central Bank Intervention

Mark Thoma:

WCBS News: Central banks in the U.S., England, Canada, Japan and Switzerland along with the European Central Bank announced on Wednesday that they are taking steps to make dollars readily available to troubled banks in Europe. The plan is to reduce the cost of loans between central banks -- these are known as liquidity swaps -- so that dollars are cheaper to obtain.

What are the central banks doing?

The worry is that the financial troubles in Europe will cause problems similar to when Lehman failed in the U.S. An event such as a default on government loans, a bank failure or even just the fear that such events are just around the corner can cause short-term money markets to tighten up. If this happens, then it will be harder for banks to obtain the money they need to fund their operations. Many banks make money by borrowing short and lending long, and make a profit on the spread between short and long interest rates. When the short-term money markets dry up, these banks lose the ability to obtain the money they need to stay liquid and that puts them in danger of failing.

Why are the central banks taking this step?

One reason is to make sure that the banks have the liquidity they need to stay afloat. A widespread domino-like cascade of bank failures would be disastrous and this provides insurance against that possibility. In addition, even without bank failures a loss of liquidity is troublesome. As liquidity dries up, interest rates rise and the loans that businesses and consumers need become harder or impossible to get. That can have a large negative impact on economic activity.

How does the plan work?

These swaps are loans between central banks. For example, the Federal Reserve in the U.S. might swap dollars for euros with the European Central Bank, and then the European Central Bank can lend those dollars to banks that are in trouble….

[N]ote that while this move can ease financial market conditions, it does nothing to address the underlying problems creating those conditions. So this is no substitute for the difficult decisions that Europe must make to overcome its troubles.

The World's Central Banks Do Something

It is not clear what, however.

Joe Wiesenthal:

MARKETS SURGE AS FED/ECB/BOJ/BOE/SNB/BOC ANNOUNCE COORDINATED INTERVENTION: The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve and the Swiss National Bank are today announcing coordinated actions to enhance their capacity to provide liquidity support to the global financial system. The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity.

These central banks have agreed to lower the pricing on the existing temporary US dollar liquidity swap arrangements by 50 basis points so that the new rate will be the US dollar Overnight Index Swap (OIS) rate plus 50 basis points. This pricing will be applied to all operations conducted from 5 December 2011. The authorisation of these swap arrangements has been extended to 1 February 2013. In addition, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank will continue to offer three-month tenders until further notice.

As a contingency measure, these central banks have also agreed to establish temporary bilateral liquidity swap arrangements so that liquidity can be provided in each jurisdiction in any of their currencies should market conditions so warrant. At present, there is no need to offer liquidity in non-domestic currencies other than the US dollar, but the central banks judge it prudent to make the necessary arrangements so that liquidity support operations could be put into place quickly should the need arise. These swap lines are authorised through 1 February 2013.

European Central Bank Decision

The Governing Council of the European Central Bank (ECB) decided in co-operation with other central banks the establishment of a temporary network of reciprocal swap lines.  This action will enable the Eurosystem to provide euro to those central banks when required, as well as enabling the Eurosystem to provide liquidity operations, should they be needed, in Japanese yen, sterling, Swiss francs and Canadian dollars (in addition to the existing operations in US dollars).

The ECB will regularly conduct US dollar liquidity-providing operations with a maturity of approximately one week and three months at the new pricing. The schedule for these operations, which will take the form of repurchase operations against eligible collateral and will be carried out as fixed-rate tender procedures with full allotment, will be published today on the ECB’s website. In addition, the initial margin for three-month US dollar operations will be reduced from currently 20% to 12% and weekly updates of the EUR/USD exchange rate will be introduced in order to carry out margin calls. Those changes will be effective as of the operations to be conducted on 7 December 2011. Further details about the operations will be made available in the respective modified tender procedure via the ECB’s Website.

Information on the actions to be taken by other central banks is available...

How Does the Economy Choose Which Equilibrium to Settle at?: Praying for the Confidence Fairy to Rescue Italy Edition

Martin Feldstein claims that Italy does not need anybody else's help:

Italy can save itself and the euro: The euro currency may soon collapse even though there is no fundamental reason for it to fail. Everything depends on Italy, because financial markets now fear that it may be insolvent. If the Italian government has to continue paying a seven or even eight per cent interest rate to finance its debt, the country’s total debt will grow faster than its annual output and therefore faster than its ability to service that debt. If investors expect that to persist, they will stop lending to Italy. At that point, it will be forced to leave the euro. And if it does, the value of the “new lira” will reduce the price of Italian goods in general and Italian exports in particular. The resulting competitive pressure could then force France to leave the euro as well, bringing the monetary union to an end.

But this need not happen. Italy can save both its own economic sovereignty and the euro if it acts decisively and quickly to convince the financial markets that it will balance its budget and increase its rate of economic growth…. It already has a “primary budget surplus”…. [I]f it cuts spending and raises revenue by a total of just three per cent of its GDP…. If reforms to strengthen incentives and reduce regulatory impediments raise [its economic] growth rate to two per cent, that together with a long-term balanced budget would cause Italy’s public debt to decline from today’s 120 per cent of GDP to about 65 per cent over the next 15 years [if Italy can borrow at the 4% it borrowed at before the crisis began]….

Italy’s situation is totally different from Greece’s. The latter has a budget deficit of nine per cent of GDP and its real GDP is declining at seven per cent [per year]…. The over-valued exchange rate results in a current account deficit of ten per cent of its GDP. Greece would be better off if it abandons the euro, devalues its new currency, and defaults on its debt.

A decision by Athens to leave the euro and default could cause a run on the euro and on Italian debt in particular. That’s why it is so important for Italy to stress that its conditions are totally different….

Italy can do all of this itself. It does not need assistance from Frankfurt, Brussels, or Washington. The proposed policies for help from the European Central Bank, the European Commission, and the International Monetary Fund would ultimately weaken Italy and undermine its economic independence….

Any of these proposed programmes would create new conflicts within Europe as borrower governments are forced to relinquish their ability to set their own national tax and spending policies…. The riots and political upheavals in Greece are a symptom of what would happen more generally if the Brussels bureaucracy and the German Chancellor came to dominate national economic policies.

Fortunately, none of this is necessary if Italy now acts forcefully to create budget and growth conditions that imply sustainable debt outcomes. But impatience and scepticism in financial markets may cause a deeper financial crisis before Italy has time to prove itself.

Yes, if Italy cuts spending by 1% of GDP, improves tax compliance by 2% of GDP, and manages to boost its economic growth rate from 1% per year to 2% per year, then if it can borrow at 4% per year then its debt is sustainable--and if you bet in financial markets that Italy will default, you will lose your money.

But even if Italy cuts spending by 1% of GDP, improves tax compliance by 2% of GDP, and manages to boost its economic growth rate from 1% per year to 2% per year, if it nevertheless finds that it can only borrow at 8% per year then its debt is unsustainable--and if you bet in financial markets that Italy will default, you will lose your money.

There are two equilibria out there if Italy reforms its policies: There is one in which investors lose money if they bet Italy will default even if Italy undertakes minor policy reforms--and if investors believe that we are in this equilibrium we will indeed be in this equilibrium and investors who bet Italy will default will lose their money. There is another equilibrium in which investors lose money if they bet Italy will not default if Italy undertakes minor policy reforms--and if investors believe that we are in that equilibrium we will indeed be in that equilibrium, and investors who bet Italy will not default will lose their money, and all the policy adjustments Italy can undertake by itself will not help.

What can the world do to make financial markets--and Italy, and the eurozone--settle at the first equilibrium?

Martin Feldstein appears to argue that the world should let Italy undertake its economic policy reforms by itself, and otherwise it should stand back and pray for the appearance of the Confidence Fairy.

I don't think that the Confidence Fairy is guaranteed to show up.

I think that if the assembled credit-worthy sovereigns of the globe--the money-printers: the BOJ, the ECB, the FRB, the BoE, and the IMF--show up and say that if you bet on the bad equilibrium we will ruin you, because we will buy up as many Italian government bonds as needed to cut Italy to the good equilibrium, and if they then start buying, then we do not need to pray for the Confidence Fairy because we are in the good equilibrium whether the Confidence Fairy shows up or not.

And by one of the arcana imperii of monetary and financial policy, the best way to guarantee that the Confidence Fairy will show up is not to need to pray for it--and so if the money-printers show up, they probably won't have to buy Italian government bonds because everybody will see that holding Italian government bonds is a way to profit and selling Italian government bonds short is a way to bankruptcy.

The problem, of course, is what if the money-printers show up but Italy does not undertake its structural adjustment...

Eurocrisis: When the Going Gets Weird, the Weird Turn Pro...

Seeking Alpha:

More Imaginative And Weird Solutions To The Euro Zone Crisis.

Econ 24-1: Readings for Final Week's Meeting

• James Surowiecki: An Avoidable Crisis.

• Christina Romer: What Do We Know About Fiscal Policy?

• John McDermott: British Economic Policy: Less Plan B, More Plan A+1.

• Tim Duy: Can the US Decouple From the Eurozone?

• Izabella Kaminska: The German Bond Market Is All About ‘Buy and Hold’.

• Joe Weisenthal: UPDATED: Wall Street Analysts Everywhere Are In Agreement: THE WORLD IS ENDING

Paul Krugman: Sweden Is Not in the Eurozone and Is Fine; Finland Is in the Eurozone and Is Not

PK:

The Euro Curse: Joe Weisenthal has a smart post comparing Sweden and Finland… solid… fiscally are in good shape. But where Swedish bond yields have been plummeting, Finnish yields have risen… the penalty Finland is paying for being part of the euro and lacking a lender of last resort….

I think it’s interesting that Finland and Sweden started to diverge back in April. What happened then? Ah, yes — the ECB started raising rates. And as Rebecca Wilder points out, that’s precisely when euro bond spreads began their upward march, culminating in the current crisis. By itself, that rate hike — although it was obviously, obviously a big mistake — should not have mattered that much. But maybe it acted as a signal of the ECB’s bloody-mindedness, and that’s what set off the panic.

If that’s what happened, then the ECB’s hard-money madness may have destroyed the euro.

Ten Days to Save the Eurozone?

Or so Wolfgang Münchau says:

The eurozone really has only days to avoid collapse: In virtually all the debates about the eurozone I have been engaged in, someone usually makes the point that it is only when things get bad enough, the politicians finally act – eurobond, debt monetisation, quantitative easing, whatever. I am not so sure. The argument ignores the problem of acute collective action. Last week, the crisis reached a new qualitative stage. With the spectacular flop of the German bond auction and the alarming rise in short-term rates in Spain and Italy, the government bond market across the eurozone has ceased to function.

The banking sector, too, is broken. Important parts of the eurozone economy are cut off from credit. The eurozone is now subject to a run by global investors, and a quiet bank run among its citizens. This massive erosion of trust has also destroyed the main plank of the rescue strategy. The European Financial Stability Facility derives its firepower from the guarantees of its shareholders. As the crisis has spread to France, Belgium, the Netherlands and Austria, the EFSF itself is affected by the contagious spread of the disease. Unless something very drastic happens, the eurozone could break up very soon.

Technically, one can solve the problem even now, but the options are becoming more limited. The eurozone needs to take three decisions very shortly, with very little potential for the usual fudges. First, the European Central Bank must agree a backstop of some kind…. The second measure is a firm timetable for a eurozone bond…. The third decision is a fiscal union. This would involve a partial loss of national sovereignty, and the creation of a credible institutional framework to deal with fiscal policy….

I am hearing that there are exploratory talks about a compromise package comprising those three elements. If the European summit could reach a deal on December 9, its next scheduled meeting, the eurozone will survive. If not, it risks a violent collapse. Even then, there is still a risk of a long recession, possibly a depression….

I cannot quite see how the German chancellor is going to extricate herself from these self-inflicted constraints….

I have yet to be convinced that the European Council is capable of reaching such a substantive agreement given its past record. Of course, it will agree on something and sell it as a comprehensive package. It always does. But the halt-life of these fake packages has been getting shorter. After the last summit, the financial markets’ enthusiasm over the ludicrous idea of a leveraged EFSF evaporated after less than 48 hours. Italy’s disastrous bond auction on Friday tells us time is running out. The eurozone has 10 days at most.

Karl Smith Wants to Bankrupt the Gnomes of Zurich

Karl Smith:

Europe: What Is To Be Done: Halt the Crisis: The ECB should announce that it will become Lender of Last Resort for all Eurozone Countries. If I were running the show I would lead this off with a particular show of force. A short term bond issue for which there is heavy short interest I would have the ECB buy into specifically and dramatically to drag bond yields to 1.25%, in an effort to cause the shorts to miss their margin calls and take heavy losses on the issue.

This is not because I have anything against shorts, think they are acting irresponsibly or even initiating some type of implicit attack. Instead, its because I don’t need to waste the rest of the afternoon or god-forbid the better part of a week with markets wondering whether or not I am serious. It will become abundantly clear within the first 10 mins of trading that I am quite serious and prices need to adjust, lest there be more losses of this type.

Replace Individual Sovereign Debt with Eurobonds…. Independent Issues of Sovereign Debt are Banned…. Sliding Scale on New Issues…. Issue Holds For Violation of EC Rules: A violation of European Commission rules can result in a increase in the penalty rate for new issues or a hold on the funding on new issues…. The Single List is Replaced By Eurobonds…. Super-Sovereignty for Eurosystem Banks….

Right now, the EC is attempting to use “market discipline” to impose reforms on peripheral countries. As I pointed out from the beginning this is a dangerous game. It only works if you are actually willing to drive the bond markets over a cliff and if you are actually willing to do this and the markets believe you then you go over the cliff automatically…. [F]or this to fail all you need is incompetence, not intransigence, on the part of your counterparties. This is the problem with doomsday devices or credible commitments to be irrational, generally.

To solve this the EC should just abandon attempts at market discipline – which are unserious or in any case should not be used by serious people – and replace that with administrative discipline…. This is the power it really wants. It wants the power to say that Greek retirees will not get their pension checks unless Greece shapes up. It does not want the power to say Greek bondholders will not get paid. You see where that leads…

Would That the Executive of the Modern State Were Such a Committee!

Karl Marx and Friedrich Engels:

The Communist Manifesto: Each step in the development of the bourgeoisie was accompanied by a corresponding political advance of that class. An oppressed class under the sway of the feudal nobility, it became an armed and self-governing association in the medieval commune; here independent urban republic (as in Italy and Germany), there taxable "third estate" of the monarchy (as in France); afterwards, in the period of manufacture proper, serving either the semi-feudal or the absolute monarchy as a counterpoise against the nobility, and, in fact, cornerstone of the great monarchies in general--the bourgeoisie has at last, since the establishment of modern industry and of the world market conquered for itself, in the modern representative state, exclusive political sway. The executive of the modern state is but a committee for managing the common affairs of the whole bourgeoisie…

Marx and Engels were wrong.

The executive of the modern state is not a committee for managing the common affairs of the bourgeoisie.

Would a competent committee allow the reduction of the value of the bourgeoisie's equity investments by 30% for no fundamental reason at all save for a desire to appeal superior to feckless, spendthrift, corrupt, bunga-bunga Italians and Greeks?

No, it would not.

Would that the executive of the modern state was a committee for managing the common affairs of the bourgeoisie!

Karl Smith: We Could Put the Global Economy on the Road to Recovery Today, Costlessly

Karl Smith:

Tyler Cowen on Europe: I pick on Tyler because he is probably one the sharpest voices for what I see as a deep misunderstanding…. Germany doesn’t need to experience any [negative consequences]. Germany only needs to agree to letting the ECB stand as Lender of Last Resort…. [P]art of the reforms which Mario Monti is putting in place are to decrease tax evasion. Yet, taxes are simply the forcible extraction of private resources by the government. Its not as if taxes represent the government producing something or even government officials or government pensioners consuming less. Taxes represent the transfer of resources under the threat of imprisonment. Now, if this could possibly solve your problem then you know that at root the problem has to be about who holds private claims over resources.

You can attack the problem in another way by seeing that Italy is roughly in primary budget balance. This means current borrowing exists only to repay past lenders. Again, this is an issue over the distribution of private claims.

To make the point more clear – this is explicitly not the case for Greece. From a budget standpoint Greece faces a more fundamental issue. It is currently in primary deficit. It would have shift resources from private control to public control in order to balance the budget given the current economic environment. It is true that Greece’s economic environment is primarily the result of a fundamental mismatch in monetary policy between it and the core countries and so could be solved if Germany were to endure more inflation. However, Greece does face an immediate adding up constraint that Italy does not face. A third way to see this is to imagine what would happen if Italy repudiated its debt vs. Greece. Italy would then be able to support itself on tax revenue. Greece would not. Greece would have to go back into the bond markets somehow and get more money.

Why is all of this important?

Its important because it means Italy doesn’t actually need anyone to transfer real resources to it. It simply needs someone to manage resource distribution among bondholders. The ECB can do this at virtually no direct cost. Again that is because nothing actually has to be produced or transferred. Debt just has to be managed.

Perhaps, a fourth way to see this is by noting that you only need new savers to agree to step in where old savers were. This is ultimately a co-ordination issue between groups of savers. Its breaking down because there is a musical chairs issue. No one wants to be the last saver who can’t find someone to whom to transfer his savings. The ECB can assure this doesn’t happen because the ECB controls the total amount of borrowing from European banks. It can constrict the amount of borrowing to make sure that someone steps up to take the transfer of Italian debt.

All of this is to say that Germany doesn’t have to suffer any near term economic bad effects…

Nick Rowe: Magneto Trouble

Nick Rowe:

Worthwhile Canadian Initiative: Darwin Awards, and other random thoughts on the Euro: At root, the coming Eurozone crash, like the 2008 crash, are not caused by a failure of governments, or of finance, but by a failure of monetary systems. Yes, people and governments borrowed more than they should have, and other people lent them more than they should have. But people make mistakes, and do stupid things, and loans go bad. A good monetary system should have the ability to keep the economy functioning even if loans go bad. Nowhere is it written in stone that if a lot of borrowers can't pay a lot of lenders that there has to be a recession and we all stop working and producing and buying and selling and just sit and watch while those borrowers and lenders sort themselves out.

We need a monetary system that keeps on functioning despite human mistakes, stupidity, or asteroid strikes.

The tragedy is that we have such a monetary system--or could have one, if the ECB and the Fed would do what they ought to be doing.

The "Failure" of the German Ten-Year Bond Auction

Greg Ip:

German bunds: Fun with bunds: NEWS that a German auction of government bonds ("bunds") flopped rattled markets today. Since bloggers don't spend a lot of time immersed in the mechanics of European bond auctions, I asked Lorenzo Pagani, of Pimco's European government bond team, to explain how Germany's auction process works and what the Bundesbank's role is. He replied:

In Germany the debt auction process is similar to other countries'.  Dealers can bid with size and price. The difference is that in Germany, the Debt Agency (Finanzagentur) will retain part of the new issuance all the time, usually 15-20%, so they do not need full demand to issue. Also, the requirement to be a dealer in Germany means making sure of a minimum allocation across auctions that is relatively low (0.05%), while in other countries this requirement is higher (3% for example in Italy). Germany doesn’t grant greenshoe options to its dealers. Other countries do. A Greenshoe option gives the dealer the right to buy the bonds for a few day after the auction at the same price of the auction.

Overall this means that demand for German auctions will tend to be lower—all else equal—than for other countries’ auctions. Since 2008, Germany has seen uncovered auctions 1 out of 5 times.

Today's retention amount was large, 39% of the 6bln target.The Finanzagentur issued only 3.9bln cash. They gave 3.9bln bunds to the market and kept 2.1bln bonds on their books. In the future they can sell this retention amount into the secondary market, raising cash. You may have read that the Bundesbank bought the unfilled part of the auction; this is not correct. The Bundesbank is not financing Germany; it just operates as an agency for Finanzagentur.

It is worth repeating that Finanzagentur always retains part of the bonds, so this part of the process is normal. Today the retention was larger than usual. This is probably due to low liquidity across market, lower incentive to place certain minimum size bids by dealers, and richness of bunds in general.

"Low liquidity across market" means "right now people in Europe don't want to trade away their cash for anything--not even bunds". "Lower incentive to place certain minimum size bids" I do not understand. "Richness of bunds" means "they are expensive creatures that pay low interest rates".

The ten-year German government bond right now has a yield of 2.268%, which is extraordinarily low. If Germany's financial position were "in doubt" in any way, it would be yielding a lot more than 2.268%.

What has happened over the past week is that markets have started demanding a 30 basis point premium for holding bunds over US 10-Yr Treasuries--a thing that they weren't demanding before. Is this because the market fears that in the chaos of a eurozone breakup it might not be able to turn bunds into cash just when it needed to, and so is now demanding a 30 basis point premium yield to compensate for the possibility of that eventuality? Is this because the market now fears (or hopes) that changes in eurozone fiscal or monetary governance will in the future give the eurozone not a slightly lower but a slightly higher inflation rate than the US, and so is now demanding a 30 basis point premium yield to compensate for the possibility of that eventuality? I don't know--and I don't think anybody else knows either.

UPDATE: in my email:

People are selling Bunds because they need the cash. That's the definition of a liquidity crisis - it's not when people are selling poor-quality assets because they want to, it's when people sell everything, because they have to…. If you have to raise cash in a hurry, you sell high-quality assets, not low-quality ones. Soros has made a ton of money out of understanding this, and he even gives away the advice for free in one of his books.

Resolving the Eurocrisis: Department of "Huh?!"

Tyler Cowen:

Is the end near?: There is so much talk about what the Germans should do, but I don’t see the viable options.  With Germany’s own credit status now in doubt…

Why does he say this?

At a current ten-year nominal interest rate of 2.268%, Germany's own credit status is not in doubt. Countries whose credit status is in doubt do not have their ten-year bonds selling at a yield-to-maturity of 2.268%.

What has shifted over the past week is that U.S. ten-year Treasury bonds at a yield of 1.95% are now significantly stronger than German ten-year Treasury bonds at a yield of 2.268%. We can hope that this is because the market sees good news: perhaps it expects the ECB to raise short-term interest rates more and sooner because European growth will be faster than was anticipated (but that is extremely unlikely). This may be bad news: perhaps the market expects the ECB to raise short-term interest rates more and sooner to demonstrate that it is tough. Or perhaps the market fears some future chaos event involving the breakup of the euro will make its German bund holdings illiquid just when it would want to sell them to raise cash. This may simply be a recognition, finally, that there are about to be shifts in eurozone political economy and governance that are likely to give the eurozone a slightly higher inflation rate than the U.S. over the next generation.

We don't know.

But a country whose ten-year bonds carry a market yield of 2.268% is not a country whose credit status is in doubt.

The key, I think, is that in a world in which investors are desperate for safe assets--which is our world--then any sovereign which has the political support to run a persistent primary surplus is credit-worthy either if it is believed to be credit-worthy or if a credit-worthy sovereign is willing to guarantee it. Italy is running a primary surplus right now. Portugal, Spain, and Ireland could run primary surpluses with no change in policy if we had a half-recovery to 2007 business cycle conditions. (Greece could not: Greece needs big policy changes.) Nobody I know is doubting that Germany and France can run primary surpluses if they so choose.

But Tyler does not seem to see any of this:

[Germany with an] eighty percent debt to gdp ratio, massive welfare state, and unfavorable demographics, are they supposed to endorse — going to endorse — ten or fifteen percent price inflation for a few years’ time, all with no guarantee of reforms in the economically weaker countries?…

We don't need ten or fifteen percent price inflation. (Although three or four percent price inflation would make things a lot easier.) And we don't need big reforms in the economically-weaker countries--or, rather, even a half-hearted recovery does more good.

At the Very Least, the Fed and the Treasury Need to Flood the RIsk-Tolerance Zone to Decouple America from the Looming Eurocrisis Now

It's no longer "eurotail risk" that we are worried about.

Ryan Avent:

The euro crisis: Faster toward the end: THE bad news out of Europe is coming fast and thick now. Markets were still digesting news of Spain's terrible bond auction yesterday, in which the yield on its 3-month debt more than doubled, from 2.3% to over 5%. That was but an appetizer, however; in an auction of 10-year debt today, Germany failed to place some 40% of the issuance. The lack of appetite for German debt has come as a shock to many, and the language being used to describe matters is increasingly apocalyptic. "It is a complete and utter disaster", Reuters has one strategist saying. On the secondary market, German bond yields have finally joined those of its neighbours on their upward march. The German 10-year yield is up over 7 percentage points today, and back above 2%. It still has a ways to go to catch France and Austria (approaching 4%), Belgium (over 5%), and Spain and Italy (back near 7%).

Trouble at big European banks is growing; the euro-zone banking system is increasingly reliant on the European Central Bank for funding. The prospect of bank failures is a troubling one given the fiscal strain on European sovereigns; no one wants to find itself in Ireland's position, squarely in bond vigilantes' crosshairs having assumed the obligations of sinking banks. Uncontrolled collapses are too awful to contemplate, however, and so the pressure on the ECB will grow. Meanwhile, trouble is growing around the eastern periphery of the euro zone. Poland's zloty is under pressure, and there are signs of bank runs in the Baltics.

Perhaps worst of all, the financial strain in the euro zone is increasingly apparent in the real economy. New data indicate that euro-zone industrial orders plummeted in September, falling 6.4%. Orders dropped 4.4% in Germany, 6.2% in France, and 9.2% in Italy. Predictions that the euro zone will face little more than a shallow recession oin 2012 increasingly seem to be wildly optimistic….

The good news, such as it is, is that the stunning German bond-market failure may shock leaders their into recognising their own great vulnerability and pushing for bold initiatives to slow the crisis…. It will take the power of the printing press to stop the panic. But the ECB seems if anything more reluctant to save the situation than the German government. As Martin Wolf quips today, "the ECB risks being remembered by historians as the magnificently orthodox central bank of a failed currency union".

The world can give thanks that a new Depression is not yet upon it. Enjoy the sentiment now, while it lasts.

The Austerity Play: Euronomics of Speculative Attacks

Karl Smith:

On Bank Runs and Fighting the Folks Who Own a Printing Press « Modeled Behavior: Ultimately bond traders are looking to make money. In the short term you might be looking to support a liquidity position or something, but at the end of the day everyone is looking to increase profitability. If the ECB stands ready to buy bonds at par for example, then how can it possibly be profit maximizing to sell bonds at below par? It doesn’t matter what the fundamentals are or what the long run is or any of that. So long as you are fully confident that tomorrow you can sell your bond to the ECB at par, it is not sensible to sell it below par today.

This means interest rates on Sovereign Debt collapse if the ECB stands ready to trade.

Now, someone could come in and attempt to break the ECB. That is you could say to yourself: I don’t think the ECB really means it. They will fold if they are required to buy more than X bonds.

Then you attempt to short sell them X+1 bonds so that they will break, the price of the bonds will collapse and you can rake in a ton of money. This is a fairly high stakes game and the ECB is very large, so its not clear who will play it.

More importantly, while I definitely see the ECB as the type of institution that would dither while Europe burned and don’t at all see them as the type of institution that would give in to a speculative attack.

I feel pretty confident that they would double down against the speculator and ruin him or her as a matter of principle. Moreover, anyone who is going to loan you the bonds for this attack has got to be worried that the ECB is going to ruin you.

So, I find it unlikely that an attack will be successful.

It used to be that speculative attacks against the currencies of sovereigns were successful in two cases:

1. When the central bank is trying to keep its currency above its real fundamental value, and is intervening by buying its currency and selling its (limited) supply of harder assets. Then you can break a central bank.

2. When the central bank is trying to keep its currency above its real fundamental value, and is intervening by selling domestic bonds for cash and so pushing up interest rates to make its currency attractive to hold. Then it is defending the dollar by attacking the economy--creating a recession and boosting unemployment. The central bank's ability to do this is determined by its (limited) politicians' willingness to make their voters poor and unemployed. Then you can break a central bank.

Now we have a third case. Note that it is not a speculative attack on a currency: core eurobond interest rates are very very low. And within the current eurozone, the ECB can print enough euros to peg the europrices of the eurobonds of peripheral eurosovereigns wherever it wants to. Given this power, under what circumstances can a speculative attack succeed?

It's not that the ECB is unwilling to buy bonds for cash because it then creates inflationary pressure. The cash it prints goes straight into the speculative balances of the investors who sold the bonds, not into the transactions balances of the economy as a whole. And when the speculative attack passes, the positions are unwound with a profit to the ECB.

Thus the marginal velocity of money created by eurointervention is highly likely to be very small. It's not as though Italy is running a primary deficit or anything.

I don't understand it. It is, it seems to me, an episode of euri sacri fames: the accursed love for the euro as a--well, not a hard currency, exactly, because a currency that collapses and destroys itself is not "hard". Rather, I would say, it is a love of austerity and unemployment for its own sake.

So those who are betting on the collapse of the euro and the exist of Greece, Spain, Portugal, Ireland, Italy, and now France to a weaker currency are making a very big austerity play. They may be correct to make such a play. But it is not a scenario we have ever seen before...

Robert Skidelsky: "The Wages of Economic Ignorance"

Robert Skidelsky:

The Wages of Economic Ignorance: Three years after the global economy’s near-collapse, the feeble recovery has already petered out in most developed countries…. Pundits decry a “double-dip” recession, but in some countries the first dip never ended: Greek GDP has been dipping for three years. When we ask politicians to explain these deplorable results, they reply in unison: “It’s not our fault.” Recovery, goes the refrain, has been “derailed” by the eurozone crisis. But this is to turn the matter on its head. The eurozone crisis did not derail recovery; it is the result of a lack of recovery. It is the natural, predictable, and (by many) predicted result of the main European countries’ deliberate policy of repressing aggregate demand. That policy was destined to produce a financial crisis, because it was bound to leave governments and banks with depleted assets and larger debts….

Depressions, recessions, contractions – call them what you will – occur because the private-sector spends less than it did previously. This means that its income falls, because spending by one firm or household is income for another. In this situation, government deficits rise naturally…. But if the government starts reducing its own deficit before private-sector spending recovers, the net result will be a further decline in total spending, and hence in total income, causing the government’s deficit to widen, rather than narrow….

That is the crazy logic of current economic policy in much of Europe (and elsewhere). Of course, it will not be carried through to the bitter end….

The best option of all is for the government to spend the money itself. Governments can do this consistently with a medium-term deficit-reduction plan by making a crucial distinction between their budgets’ current and capital accounts….

If nothing works, it will be time to sprinkle the country with what Milton Friedman called “helicopter money” – that is, put purchasing power directly into people’s pockets, by giving every household a spending voucher with an expiration date….

It would be better if such schemes could be agreed upon by all by G-20 countries, as was briefly the case in the coordinated stimulus of April 2009. If not, groups of countries should pursue them on their own…

The Eurocrisis: Will Somebody Please Push the Big Red Button?

This morning a lot of people are not happy campers:

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I confess that last August I thought that Ms. Market had overreacted.

I thought that the political costs to being the people on whose watch the Euro had crashed were so great that the administrators of Europe would take steps to make sure that it did not happen on their watch. I thought that Germany would guarantee a facility which would then borrow at 2.5% and buy peripheral eurobonds yielding 5%. I thought the facility would then make a ton of money as the ECB reflated the continent, and changed its inflation target from 1% for the eurozone as a whole to 2% for Germany (which means 3% or more for the eurozone as a whole).

Silly me.

And I confess that last August I was focused on risks to the U.S. recovery from domestic sources.

It seemed to me very clear that the Fed and the Treasury would announce that they would take steps and would in fact take steps to neutralize and offset any effects of the eurocrisis on aggregate demand in the U.S. That seemed a much smaller danger than that right-wing political pressure interested in choking off recovery would push the Fed into a much-too-austere monetary posture.

Silly me.

I do not (yet) know how much eurorisk is on the balance sheets of U.S.-relevant banks and shadow banks. I do not know what the tail of the distribution looks like. I do not know if we wind up in the tail how much of their eurorisk banks and shadow banks will be able to dump onto new entrants to the market who see a long-term bullish bet on Europe as an attractive one. I do not know if we wind up in the tail how much of American business will not be financed over the next year as banks feel constrained by their eurorisk.

I do not know what facilities the Fed and the Treasury have planned and have started setting up to deal with getting eurorisk off of Ms. Market's diminished risk-bearing capacity if we wind up in the tail. And I really ought to know this by now. In fact, everybody should know this by now: the argument that the Treasury and the Fed should not reveal their contingency plans because it would spook the markets is at least two-months past its sell-by date.

Hyun Song Shin: "The Global Banking Glut and the Loan Risk Premium" http://goo.gl/OBj44

Yet Another New York Times Fail: Ross Douthat Department

Why oh why can't we have a better press corps?

Ross Douthat:

Conspiracies, Coups and Currencies: [F]or the inhabitants of Italy and Greece, who have just watched democratically elected governments toppled by pressure from financiers, European Union bureaucrats and foreign heads of state, it evokes the cold reality of 21st-century politics. Democracy may be nice in theory, but in a time of crisis it’s the technocrats who really get to call the shots. National sovereignty is a pretty concept, but the survival of the European common currency comes first…

(1) The democratically-elected representatives of the Greek and the Italian people voted to change the prime minister. They can do that. That is part of their democratic process. They voted to change the prime minister because they wanted their countries to borrow money--and the people who they wanted to borrow money from were very unwilling to lend it to governments headed by Papandreou and Berlusconi but willing to lend it to governments headed by Papademos and Monti.

Does Ross Douthat really believe that there ought to be a law saying that lenders must lend to a country's government whenever that country wants to borrow on terms that the country's government sets? He simply has not thought any of this through.

(2) Those who are calling the shots in Europe right now are in no wise "technocrats": technocrats would raise the target inflation rate in the eurozone and buy up huge amounts of Greek and Italian (and other) debt conditional on the enactment of special euro-wide long-run Fiscal Stabilization Repayment Fund taxes. These aren't technocrats: they are ideologues--and rather blinders-wearing ideologues at that.

The Downward Spiral of Europe Continues: What Is to Be Done? Department

Paul Krugman:

Incredible Europeans: Right now, the ECB has too much credibility on the inflation front; the spread between German nominal and real interest rates, which is an implicit forecast of the inflation rate, is pointing to disastrously low medium-term inflation:

I.e., inflation of 1.24%/year in the eurozone.

And:

On the other hand, there has been a severe loss of credibility in the promises of European governments other than Germany to repay their debts. There are strong self-fulfilling aspects to this crisis of confidence — which is why Europe desperately needs the ECB to act as lender of last resort, and short-circuit the vicious circles.

The spread between German and Spanish 10-year bonds is now 4.41%/year--which if you expect a 40% depreciation from Spain in the event of a Euro breakup, gives you a 110% risk-neutral measure of a Euro breakup. (Yes, I know: risk-neutral measures aren't probabilities: they are probabilities of different states of the world multiplied by marginal utilities of wealth in those states normalized to add up to 100%. They are still useful things to calculate.)

Paul concludes:

[T]he ECB will defend its credibility. And it will end up as the highly credible defender of the value of a currency that no longer exists.

At this stage, it really does seem to me that the best thing the United States could do for Europe--and also for itself--would be for Tim Geithner to announce that a weak dollar is in America's interest.

The hope is that would change the European Oligarchs from focusing on how credibility requires monetary and financial austerity to focusing on how competitiveness requires monetary and financial expansion. I would give it a 50%-50% chance of working.

Paul Krugman: "Incredible Europeans: I had some hopes for Mario Draghi; he has just done his best to kill those hopes." http://goo.gl/vIQ2b

Henry Farrell: "The ECB and the Davies Folk Theorem" http://goo.gl/6pnd8

Econ 24-1: The European Financial Crisis: Readings for November 18, 2011

• Edward Carr: Staring into the abyss | The Economist; plus the additional pages in his special report: A very short history of the crisis, Destructive creation, In theory, Beyond the fringe, The Nico and Angela show, Look at it this way, Making do.

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• October 21: The euro-zone crisis: If it wasn’t so serious | The Economist
• October 21: Italy's central bank: The Italian job | The Economist
• October 24: The euro crisis: The exception that proves the rule | The Economist
• October 26: The euro-zone crisis: The long shadow of Greece | The Economist
• October 27: The euro crisis: A (big?) deal | The Economist
• October 27: Euro bonds: The tricky path toward greater fiscal integration | The Economist
• October 31: The euro crisis: Italy on the brink | The Economist
• October 31: Monetary policy: Work with me here | The Economist
• October 31: The euro crisis: Chicken caesar | The Economist
• November 1: The euro crisis: Eurodoom | The Economist
• November 3: The euro crisis: The Greeks will vote on something, and other euro news | The Economist
• November 3: European monetary policy: “Super Mario” takes charge | The Economist
• November 7: The euro crisis: A fatal recession? | The Economist
• November 8: The euro crisis: Tightening the purse strings | The Economist
• November 8: The euro crisis: Catching a falling knife | The Economist
• November 8: The euro crisis: Germany suffered for its surplus | The Economist
• November 10: Breaking up the euro: How it could happen; why it would be horrible | The Economist
• November 11: Understanding the euro crisis: It's not about Berlusconi | The Economist
• November 14: The euro crisis: New faces, same problems | The Economist
• November 14: European bond markets: Super Mario vs the Bond Vigilantes | The Economist
• November 14: Currency unions: Sell your bourbon you bankrupt Kentuckians! | The Economist
• November 14: Financial markets: No such thing as risk free | The Economist