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Saturday, December 31, 2011

Argentina in December 2001 versus Europe in December 2011

This month marks the ten-year anniversary of Argentina’s massive sovereign debt default, an event with many lessons for the European sovereign debt crisis of today, though analogies are far from perfect.

First, as has been discussed and debated on planet money and naked capitalism, the Argentine economy actually recovered quickly from the painful default and crisis of 2001 after it negotiated a substantial write-down of its sovereign debt.

Second, the experience of Argentine’s neighbor Uruguay shows that the economic pain of such crisis is less severe if a more orderly restructuring is employed from the start rather than a chaotic default. Such an orderly restructuring could have taken place in Greece two years ago as it did in Uruguay ten years ago as veteran debt expert Carlos Steneri and I discuss with Juan Forero in this NPR price "What Greece Can Learn from South America" which aired last week. (I worked closely with Steneri during the Uruguayan crisis when I was US Treasury Under Secretary).

Third, and most important, despite the immediate and sharp impact of the default in Argentina, there was very little international contagion at the time of the default. This outcome was contrary to many warnings at the time that such a default would have large contagion effects much as the Russian default three years earlier in 1998. The first chart shows the contagion following the Russian default in terms of emerging market bond spreads in Asia. The second chart shows, using the same measure, that there was virtually no contagion following the Argentine default.

In my view the reason for this remarkable difference is that the IMF and the international policy community was clear (at least following an increase in loans in August 2001) that the bailouts of Argentina would stop, making a debt restructuring inevitable or at least more predictable than the surprise withdrawal of support for Russia in 1998 which caused the contagion then. Contagion is not automatic if the policy is clear and predictable.

As the investigative reports in the Wall Street Journal this week make clear, this same type of fear of contagion (expressed, according the the WSJ story, very strongly by Jean-Claude Trichet during the past two years) is why a restructuring of Greek sovereign debt has been kicked down the road so many of times. Instead of reducing the role of bailouts as occurred for emerging markets around the time of Argentina, the role of bailouts in European policy has increased and this has made policy even less predictable. As the prospects of bailout increased, the political incentives to take action to reduce deficits and debt decreased as evidence in Italy over the past year and made the crisis much worse.

Tuesday, December 20, 2011

The Return of the Best Economics 1 Lecturer Ever -- Plus One

This fall was a great quarter to teach the introductory course (Economics 1 at Stanford) with plenty of good examples from Occupy Wall Street, the crisis in Europe, the continuing debate in Washington over economic policy, and the rising federal debt. Unfortunately nothing much has changed about the debt as I tried to illustrated with the return of a guest lecturer.  

In 2009 I invited this guest lecturer to my Economics 1 class to illustrate the burdens of the debt on future generations.  Though only a few months old, the guest lecturer turned out to be the best ever (here is a  video excerpt). Students in that class still remember her message as she looked up at the exploding debt chart on the big screen, and said "fix it."

So this fall I invited her back to this year’s Economics 1 class , and her brother joined her, as seen in this second video excerpt (click on the closed caption option as the audio is weak).  Again she looked up at the chart on the big screen in the lecture hall , and again it was "scary." In fact, it was even worse! Unfortunately, no one has fixed it, either in 2009,  2010, or 2011. I said I'd like to keep bringing them back as guest lecturers until it is fixed. 

(The chart in the first video was developed from Congressional Budget Office data from the long term projection made in 2009; the chart in the second video is from the CBO long-term projection made in 2011.)

Monday, December 19, 2011

Economic Freedom in the News

People are writing about economic freedom a lot these days. George Will’s recent Washington Post column Testing the Waters of Economic Liberty focusses on a big deviation from economic freedom in the State of Washington with implications for America. Jeb Bush’s recent Wall Street Journal article Capitalism and the Right to Rise summarizes the great benefits of economic freedom to improve people's lives.  My new book, First Principles, out in January, shows that America has deviated from the principles of economic freedom in recent years, and proposes ways to get back to them.  

Of course the concept of economc freedom has been a pillar of basic economics courses for years. When I lecture about economic freedom to Stanford students  I like to build on the Stanford motto which translates from the German words on the Stanford seal as “Let the Winds of Freedom Blow” 

Wednesday, December 7, 2011

Krugman is Wrong

Paul Krugman is wrong in his criticism of my brief summary of last week’s economic policy conference at Stanford’s Hoover Institution. Krugman was not at the conference, which lasted a full day and went well beyond previous research by the participants.  In general people focused on policies to restore strong economic growth and reduce unemployment in the United States.

First, Krugman incorrectly claims that I mischaracterized the research of my Stanford colleague Nick Bloom and his coauthors Scott Baker and Steve Davis presented at the conference. Krugman says my conference summary suggested that “Bloom, Baker and Davis had showed that fear of Obama was holding the economy down.” No, my summary said or implied no such thing; there is no mention of Obama, Bush, or any politician in my summary. It simply says that these authors “presented their empirical measures of policy uncertainty and showed that they were negatively correlated with economic growth.” And that is what they did at the conference. Second, Krugman claims that my summary mischaracterized the presentation of my Stanford colleague Bob Hall, making it look like something it wasn't. My summary referred to Bob’s interesting presentation at the conference. As part of his presentation Bob said that now and going forward we should assume “no chance of conventional fiscal expansion; rather, possible cutbacks motivated by excessive federal debt.” That is why Bob focused his paper at the conference on monetary policy and the problem of the zero lower bound, and that was what all the discussion of his paper was about, rather than on his earlier work on the multiplier, which is now part of a huge literature recently nicely reviwed by Valerie Ramey.

I stand by my brief summary of the conference as a being accurate. Lee Ohanian and I, as co-organizers of the conference, hope that we can soon get a book published containing the full proceedings (written versions of the individual presentations and many comments by participants), as has been done with other recent Hoover economic policy conferences: The Road Ahead for the Fed and Ending Government Bailouts As We Know Them. We hope the results of each author will be read carefully by policy makers and other researchers.

Monday, December 5, 2011

Restoring Robust Growth in America

Why has the recovery been so slow? What can we do about it? Alan Greenspan, George Shultz, Ed Prescott, Steve Davis, Nick Bloom, John Cochrane, Bob Hall, Lee Ohanian, John Cogan and I recently met at the Hoover Institution at Stanford to present papers and discuss the issue with other economists and policy makers including Myron Scholes, Michael Boskin, Ron McKinnon and many others. Here is the agenda.

We plan to publish a book on the conclusions, but here is a very brief summary of the presentations. George Shultz led off by arguing that diagnosing the problem and thus finding a solution was extraordinarily important now, not only for the future of the United States but also for its leadership around world. Tax reform, entitlement reform, monetary reform, and K-12 education reform were at the top of his pro-growth policy list. Alan Greenspan presented empirical evidence that policy uncertainty caused by government activism was a major problem holding back growth, and that the first priority should be to start reducing the deficit immediately; investment is being crowded out now. He also recommended starting financial reform all over again because of the near impossibility of implementing Dodd Frank. Nick Bloom, Steve Davis and Scott Baker then presented their empirical measures of policy uncertainty and showed that they were negatively correlated with economic growth.

Ed Prescott had the most dramatic policy proposal which he argued would cause a major boom and restore strong growth. He would simultaneously reform the tax code and entitlement programs by slashing marginal tax rates which would increase employment and productivity. John Cochrane focused on the bailout problems in the European and American financial sectors, arguing that they would continue to be a drag on growth until policy makers stopped kicking the can down the road.

Bob Hall argued that fiscal policy was not working, and focused on alleviating the zero lower bound constraint on monetary policy. One of his proposals was a gradual phase-in of a tax reform in the form of a consumption tax, which would make consumption today relatively cheap and thereby increase aggregate demand. I presented research with John Cogan on fiscal policy showing that it had not been successful in raising government purchases and was ineffective regardless of the size of the multiplier. Finally Lee Ohanian showed that unemployment remained high in part because of restrictions on foreclosure proceedings which increased search unemployment by allowing people to stay in their homes for longer periods of time.

In sum there was considerable agreement that (1) policy uncertainty was a major problem in the slow recovery, (2) short run stimulus packages were not the answer going forward, and (3) policy reforms that would normally be considered helpful in the long run would actually be very helpful right now in the short run.