Paul Krugman: Currency Regimes, Capital Flows, and Crises: Noted

Paul Krugman: Currency Regimes, Capital Flows, and Crises:

In the immediate aftermath of the 2008 financial crisis and the global recession that followed, most economic policy debate focused on the downturn and how to stop it. In late 2009 and early 2010, however, a sea-change came.... I like to say that the discourse was “Hellenized”--suddenly, the paramount concern of many policymakers was no longer mass unemployment, but fear of triggering a Greek-style crisis of confidence in government solvency. In the euro area aggregate fiscal policy turned sharply contractionary, as debtor countries turned to harsh austerity and even creditor countries began cutting back as a precautionary measure. In the UK a new government turned to austerity policies justified explicitly by the alleged need to reassure markets about solvency. In the United States, while there was no comparable explicit shift in policy, warnings of a possible Greek-type crisis became a staple of political rhetoric, and may have played a role in a de facto turn to austerity not too far short of what was happening in Europe. There was, as one might have expected, substantial pushback....

One debate involved the notion of “expansionary austerity,” the idea that cutting government spending could actually have positive effects on growth, even in the short term, by raising confidence. Another debate concerned possible negative effects of high sovereign debt levels on growth that did not involve a Greek-style crisis of soaring interest rates, with many policymakers seizing on preliminary results that seemed to suggest a “cliff” in which growth drops sharply if debt exceeds 90 percent of GDP. At this point I think it’s safe to say that both the expansionary austerity hypothesis and the proposition that there is a debt cliff have been strongly rejected by the data....

[The third and] what I want to talk about instead is a question that some of us have been asking with growing frequency over the last couple of years: Are Greek-type crises likely or even possible for countries that, unlike Greece and other European debtors, retain their own currencies, borrow in those currencies, and let their exchange rates float? What I will argue is that the answer is “no”.... First, countries that retain their own currencies are less vulnerable to sudden losses of confidence than members of a monetary union--a point effectively made by Paul De Grauwe (2011). Beyond that... even if a sudden loss of confidence does take place, countries that have their own currencies and borrow in those currencies are simply not vulnerable to the kind of crisis so widely envisaged.... Mobody seems to have laid out exactly how a Greek-style crisis is supposed to happen in a country like Britain, the United States, or Japan--and I don’t believe that there is any plausible mechanism for such a crisis.

Alan Greenspan in the Wall Street Journal, June 10, 2010:

Don't be fooled by today's low interest rates. The government could very quickly discover the limits of its borrowing capacity: An urgency to rein in budget deficits seems to be gaining some traction among American lawmakers. If so, it is none too soon. Perceptions of a large U.S. borrowing capacity are misleading. Despite the surge in federal debt to the public during the past 18 months—to $8.6 trillion from$5.5 trillion—inflation and long-term interest rates, the typical symptoms of fiscal excess, have remained remarkably subdued. This is regrettable, because it is fostering a sense of complacency that can have dire consequences.... Fortunately, the very severity of the pending crisis and growing analogies to Greece set the stage for a serious response.

Erskine Bowles, co-chairman of President Obama’s debt commission, in testimony to the Senate Budget Committee, March 8, 2011:

[T]his is a problem we're going to have to face up to. It may be two years, you know, maybe a little less, maybe a little more. But if our bankers over there in Asia begin to believe that we're not going to be solid on our debt, that we're not going to be able to meet our obligations, just stop and think for a minute what happens if they just stop buying our debt.