By Jordan Eizenga

Some economists have become concerned about the unforeseen effect of very low interest rates.  The Bank for International Settlements notes that prolonged low interest rates result in a mis-allocation of capital and labor, excessive risk-taking, and volatile capital flows.  Closer inspection shows that some of these concerns are overblown.

Low interest rates can stimulate certain parts of the economy.  This was particularly true in the United States between 2002-04 when low interest rates allowed for cheap borrowing that pushed up home prices and allocated labor and capital into housing related activities, such as construction. 

Read More

by Jordan Eizenga

A standard argument offered by fiscal conservatives is that government stimulus “crowds out” private investment.   That is, public spending causes a reduction in private consumption and investment.  The reason for this, it is argued, is that stimulus spending is financed either by future tax increases or increased borrowing.  Both of these financing options cause a net reduction in household consumption and private investment; increased taxes mean less after tax income to spend and invest; increased government borrowing leads to higher interest rates, reducing the return of private investment activity.

Read More

by Jordan Eizenga

Despite the US recovery standing on very shaky legs, Republican policymakers are calling for deep and immediate cuts to government spending.  And the thought of an additional round of stimulus spending causes them to ring the alarm bells with fury.  The bond market vigilantes, they claim, will punish the United States just as they did to the Greek bond market earlier this year. That is, unless the country makes significant cuts to shore up its fiscal position, bond investors, en masse, will begin to sell Treasury bonds. The massive sell-off of American debt will depress Treasury prices and push up interest rates, making US government debt a much costlier burden.

Read More

Alberto Alesina, a Harvard economics professor, has been making the case that spending cuts and tax increases generate economic growth.  In a paper presented to the European Union’s economic and finance ministers in April of this year, Alesina made the argument that large spending cuts, sufficient to reduce budget deficits, have often been followed by economic growth.  He writes:

Current increases in taxes and/or spending cuts perceived as permanent, by removing the danger of sharper and more costly fiscal adjustments in the future, generate a positive wealth effect.

Read More

by Jordan Eizenga

The paradox of thrift seems relevant to the current economic moment.  The concept, first introduced by John Maynard Keynes, goes as follows.  Households decide to save more at each level of income and consumption drops.  One might conclude that households’ decision to save more has resulted in a net increase in savings.  However, despite a conscious effort to reduce spending, the effect of all these thrifty households is that their savings levels have actually decreased or stayed the same.  The reason for this is that decreased spending can depress economic activity and thus, push down equilibrium incomes (all other things being equal).  Thus, the paradox of thrift is that increased saving can ultimately result in decreased saving.  Given that basic economics tells us that savings equals investment, stagnant savings also means stagnant investment. 

Read More

Much has been said about the lack of monetary tools available to the Greeks in their fight to remain a solvent sovereign. While not entirely similar to the Greek situation, Argentina’s currency board regime in the 1990s is a good example of the importance of independent monetary policy. This cautionary tale goes as follows:

After an inflationary period in the late 1980s, Argentina created a currency board arrangement in which the Argentinean peso was pegged to the U.S. dollar. During the peak periods of hyperinflation, Argentineans had begun to reject the peso and demand the U.S. dollar instead.

Read More

by Jordan Eizenga

Given yesterday’s post and the recent creation of a 720 billion Euro rescue fund, I thought it would be prudent to spell out in more detail my contention that the Greek problem is not simply fiscal, but also monetary. 

The basic point is that the Greek debt crisis is a function of an institutional arrangement it has with other countries in the Eurozone whereby it shares a single currency (the Euro) and has no control over monetary policy, as such matters are decided by the European Central Bank.  The logic behind creating the Eurozone is that its members would collectively form what is referred to as an “optimum currency area.”

Read More

by Jordan Eizenga

George Will asserts that the Greek debt crisis demonstrates an inherent problem with the welfare state.  However, his assertion neglects the fact that other nations with strong welfare support systems, such as Canada and the Scandinavian countries, have had strong, vital economies.  The real source of Greece’s problems is that it does not have control over its own monetary policy.  Instead, the European Central Bank controls European Union interest rates and money supply.  As a result, Greece is unable to devalue its currency (indeed, it does not have its own currency), which would allow it to create economic growth through a more competitive export sector.

Note: for the relevant part of the video, scan ahead 7-8 minutes or so.

by Jordan Eizenga

Many on both sides of the Atlantic breathed a sight of relief when the International Monetary Fund and certain EU member countries stepped in to offer a lifeline to the debt ridden country of Greece.  The term sheet presented by the IMF basically provided relatively low cost financing to Greece in order for it to meet its existing short term obligations, which begin to come due on May 19^th (of this year).  As part of the agreement, the Greek Government will be required to impose austerity measures.  (This is simply a crude way of describing measures that require significant cuts in public spending).

Read More