The fear of 'turning-Greek', which is now apparently worse than 'turning-Japanese', is the anchoring bias that seems to be driving more and more countries to dramatically adjust their fiscal affairs. However, Nomura's Richard Koo (whose blood pressure was already elevated last week [14] at the ignorance of many nations to his balance sheet recession diagnosis and treatment protocol) points out in a note this week that Greece's problems stem from fiscal profligacy, a lack of domestic savings, and dishonest reporting by the government (it does kind of ring a bell). His point being that the rest of the eurozone - not to mention Japan, US, and the UK - are suffering balance sheet recessions (unlike Greece), which occur when the collapse of an asset price bubble drives sharp increases in private savings. His problem is that traditional economists are not taught of a situation in which private sector deleveraging (which we discussed last week also [15]) leaves fiscal stimulus as the only way to stabilize an economy and in the currrent environment of deficits being watched and denigrated by any and all politician, market participant, and talking head, Koo's borrow-and-spend 'all deficits are good deficits' medicine is hard to swallow. Koo believes that the post-Lehman world was saved by fiscal stimulus, that Greece is different, and that the anti-Koo austerity actions have 'thrown a large wrench into the works of many world economies' and while the UK is coming around to the notion that austerity is not working, he worries on recent actions in the US and Japan at a time of excess private saving. It seems to us that his argument boils down to - given the system's fragility - an Austrian solution to the broken Keynesian problem is unworkable (without depression), and he hopes that the growing doubts (recessions popping up left, right, and center) about an overriding focus on fiscal consolidation will bring people back to Keynesian (Kooian) fold. He concludes with a worrying reflection on his countrymen in the MoF that seem to have learnt none of his lessons as they look to raise the consumption tax and Japan's rising sun sets.
[16]
Austerity Is Not The Correct Medicine
Greek Tragedy should not set fiscal agenda for rest of world
Richard Koo, Nomura
Can Greek "spell" be broken?
News of a reopening of debt negotiations between the Greek government and private banks—which were supposed to have been settled last October— rocked financial circles last week. I expect the two sides will eventually come to an agreement. Nevertheless, I find it disturbing that a problem that started with the Greek debt crisis, which is insignificant in the larger scheme of things, has now grown to deliver a severe shock to the global economy.
It has prompted countries throughout the eurozone—not to mention Japan, the US, and the UK—to dramatically alter their approach to fiscal affairs lest they become another Greece.
Greece's problems, however, stem from fiscal profligacy, a lack of domestic savings, and dishonest reporting by the government.
[17]
The rest of these countries are suffering from balance sheet recessions, which occur when the collapse of an asset price bubble drives a sharp increase in private savings. A world of difference exists between the two.
Countries embrace austerity in misguided bid to avoid Greece's fate
Traditional economists are not taught of a situation in which private sector deleveraging leaves fiscal stimulus as the only way to stabilize the economy. Policymakers, believing all fiscal problems are the same, seem transfixed by the fact that their own fiscal deficits are as large as Greece's and have therefore embraced fiscal consolidation as the core of their macroeconomic policies.
By trying to administer the same treatment as Greece even though their fiscal deficits have entirely different causes, they have—not surprisingly— thrown a large wrench into the works of their economies.
Fiscal stimulus contributed greatly to post-Lehman recovery...
Fiscal deficits rose around the world because the Lehman crisis sent the global economy into free fall, causing industrial output to drop to 1997 levels in the US and the eurozone and to the level of 1983—fully a quarter of a century earlier—in Japan.
Faced with this unprecedented decline in economic activity, many of the world's leading economies administered a heavy dose of fiscal stimulus in 2009. Their spending revived the global economy and restored output to 2005 levels in the eurozone and the US and to 2004 levels in Japan (since the 11 March earthquake Japanese output has fallen back to the level of 2002).
In addition to fiscal stimulus such as public works investment and Japan's "eco-point" program of government subsidies for the purchase of energy- efficient appliances, automatic stabilizers—including the lower tax take and increased benefits for the unemployed that typically accompany a recession— contributed greatly to the ensuing recovery.
And summarising the body of his article:
- While monetary policy has lost its effectiveness
- Focus on austerity has triggered sharp slowdowns in eurozone
- UK slowly realizing that austerity isn’t working
- Japan and US have also fallen under Greece’s spell…
- But US economy likely to be quite stable
- Austerity at time of excess private savings will slow the economy
- Hashimoto government’s austerity attempt failed in 1997
- As did Koizumi administration’s efforts in 2001
- DPJ and MOF officials unaware of past failures
- Proper indicator for fiscal consolidation is private loan demand, not GDP growth
- Shifting funding for social security from bonds to taxes would cut disposable income
- Private loan demand a precondition for fiscal consolidation
- Debate should first ask whether tax hike is appropriate for Japan
- With both DPJ and LDP behind tax hike, voters have no choice
- Both politicians and public starting to question notion of tax hike as foregone conclusion
- Doubts about overriding focus on fiscal consolidation are growing…
Still, those calling for fiscal stimulus and not fiscal consolidation remain in the minority.
When future historians write about this era, will they say that governments implemented mistaken policies that crushed their economies out of a fear of following in Greece’s footsteps, when in fact their circumstances were entirely different from those of Greece? The answer depends on whether we can free ourselves from the power of the Greek spell.