MacroScope

Spend more now, save more later. It may sound somewhat counterintuitive, but it’s the best prescription for getting out of deep economic ruts, according to a new paper from Bradford DeLong and Lawrence Summers, former economic policymakers now in academia.

In particular, the economists focus on the notion of hysteresis, which is a state where a prolonged period of economic retrenchment and high long-term unemployment creates new types of structural barriers to reintegrating the jobless back into the labor market. It thereby does lasting damage to the economy’s potential rate of growth.

Against this backdrop, DeLong and Summers argue a highly stimulative fiscal policy can actually reduce the long-term debt burden. They argue vigorously against policies of austerity, saying they are self-defeating and ultimately may actually worsen a country’s debt profile.

Our analysis simply demonstrates that additional fiscal stimulus, maintained during a period when economic circumstances are such that multiplier and hysteresis effects are significant and then removed, will ease rather than exacerbate the government’s long run budget constraint. […]

While our analysis underscores the importance of governments pursuing sustainable long run fiscal policies, it suggests the need for considerable caution regarding the pace of fiscal consolidation in depressed economies where interest rates are constrained by a zero lower bound.

The first quarter winds to a close and, for most investors, it must have been a profitable one with stocks climbing and peripheral euro zone bond yields falling largely on the back of the European Central Bank’s efforts to pump prime the financial sector with a trillion new euros. Reuters’ asset allocation polls on Tuesday will look at whether there has been a significant pull-back from core government debt and the “risk on” trend can continue.

The second quarter may be much less straightforward (though let’s not forget at the turn of the year, no one thought the first quarter would be either) but let’s not get too far ahead of ourselves.

The coming week provides a number of chances to take the temperature of the euro zone debt saga. Spain, having ripped up its 2012 deficit target, will present its full budget a day after a general strike and EU finance ministers gather in Copenhagen where the still unresolved issue of how to structure the euro zone’s permanent rescue fund will be structured.

Today we get the what could possibly be the most pre-spun British budget ever, though don’t rule out the traditional “rabbit from the hat” surprise so beloved of British finance ministers.

The important stuff for the markets is that with ratings agencies still threatening to rob Britain of its AAA status, it will be pretty much fiscally neutral – i.e. no serious economic stimulus on offer – borrowing will have come in  a little lower than expected this year and the government’s independent forecasting body will predict the economy will eke out just enough growth this year to avoid a new recession.

In other words, don’t expect much market reaction, though the fact the slightly lower borrowing may allow slightly lower debt issuance in the coming year could give gilts a small fillip.

By Robert H. Frank
The opinions expressed are his own.

Reuters invited leading economists to reply to Lawrence Summers’ op-ed on his reaction to the debt ceiling deal. We will be publishing the responses here. Below is Franks’s reply. Here are responses from Laura Tyson, Benn Steil, Russ Roberts, Donald Boudreaux and James Pethokoukis as well.

I'm in general agreement with Larry Summers' piece. If it had been my column to write, I'd have been more emphatic about how much more important the unemployment problem is than the deficit problem. Deficits need to be reduced, yes, but not in the midst of a deep downturn. If we could put just half of the people who are either unemployed or underemployed back to work, for example, national income would be larger by more than ten times the interest we're paying on the 2011 deficit. The extra income tax revenue alone would be enough to cover the interest on last year's debt.

I'd also have hit harder on the claim by ostensible deficit hawks that extra spending right now would impoverish our grandchildren. Some of the most vivid and easily understood counterexamples involve infrastructure maintenance. According to the Nevada Department of Transportation, repairing a damaged 10-mile stretch of Interstate 80 would cost $6 million if we did the work today. But if we postpone repairs, weather and traffic will continue to damage the roadbed. If we wait just two years, the cost of bringing that same stretch of road up to par rises to $30 million. There are thousands of similar projects crying out to be done.

George Osborne has delivered his budget speech for the 2011/12 fiscal year to parliament.

The Chancellor said corporation tax would be cut by two percentage points to 26 percent from April, rather than by just the one point originally planned. A levy on banks would be increased to help pay for it.

Osborne also announced a surprise cut in fuel duty, while slapping higher charges on oil and gas production which he said would raise 2 billion pounds. Meanwhile, the government will offer loans to help first-time buyers get on the property ladder.

The White House budget proposal released on Monday assumes the U.S. economy is heading for a six-year run of above-average economic growth with no sign of a worrisome spike in inflation or interest rates.
The forecasts underlying President Barack Obama’s budget plan show real gross domestic product rising 2.7 percent this year, which is largely in line with private forecasts.
Beginning in 2011, the White House’s projections diverge. It expects six consecutive years of strong growth ranging from 3.2 percent to 4.3 percent — well above what most economists consider the longer-term trend of around 2.6 percent.
The last time the economy saw a similar streak of strong growth was in the late 1990s, during the dot-com boom.
The missing link is still jobs. Despite the rosy economic forecast, the White House sees the jobless rate only slowly declining from the current 10 percent level. In fact, the forecast shows the unemployment rate won’t dip below 6 percent until 2015.
Strong growth. Weak labor market. Can we really have both for six years?

The possible need for a second economic stimulus seems to be on everyone’s mind these days, but skeptics worry about the possible cost given that the country’s budget deficit is already at a record. On this week’s edition of MacroScope TV, Randall Wray, professor of economics at the University of Missouri, Kansas City, and Lawrence Mishel, president of the Economic Policy Institute, argued that the cost of inaction could be even higher — an anemic recovery with no end in sight for the labor market’s troubles.

It may not be legislation, but a recently passed “pension guarantee” has re-kindled debate over a pillar of Germany’s welfare state – the notion of “inter-generational justice”.

The agreement, which basically calls for nationally funded retirement benefits to be locked in at current levels for all eternity, has not gone down as smoothly as its sponsors would have liked, since many nowadays see the country’s sagging birth rate as a sign coming generations will struggle to support their predecessors in old age. Two years ago when elections were far off, the government headed in a different direction, deciding to gradually expand the retirement age to 67 from 65 in order to offset both the birth rate and rising life expectancy.

While the agreement had already been supported by both parties in the awkward left/right governing coalition, some policymakers cried hypocrisy last week when it passed a final hurdle in parliament.

Eighteen months into the worst recession in decades, and the pain of the downturn is reaching into nearly every U.S. state, city and municipality.

With ever more people out of work, consumer spending has dried up, depriving local government of sales tax revenue. The continued housing slump has wiped out real estate transfer taxes, while declining corporate profits have eroded business tax revenue.

From Maine to California, the slump has drained coffers at the very time that the cost of providing jobless benefits and healthcare has risen, straining public finances.

Five things to think about this week:

EARNINGS DELUGE
-- A heavy U.S. earnings week looms and the European reporting calendar is picking up. While more banks and financials will be reporting (e.g. Bank of America, Bank of New York Mellon, Credit Suisse and a trading update due from Barclays), results will start flowing from a wider range of sectors in both the U.S. and Europe (ranging from Apple and IBM to Glaxo SmithKline, Du Pont, Coca Cola). Health of the broader economy on display.

MACRO SIGNALS
-- The more mixed signals that earnings send, the more investors are likely to look to macro and other indicators as a cross-check of whether the stock market rebound is sustainable and whether the economy is anywhere near an inflexion point. Flash PMIs and Ifo for April will give an early indication of how economic activity was faring as Q2 got underway. Trade data from Japan is also due for release.

FISCAL HELP
 -- The UK budget on April 22 is expected to issue grim forecasts and extend a helping hand to some sectors, such as autos. The fiscal presentation will keep the spotlight on the limited room for budgetary manoeuvre in Britain and elsewhere with past bailouts and support measures leaving tough decisions to be made on public spending, taxes, etc.