The Unassuming Economist

In an article for the Peterson Institute for International Economics, economist Olivier Blanchard discusses 45 takeaways on the changing scope of fiscal policy and debt sustainability, in the light of consistently low interest rates. He also discusses three applications of the same- in the US, Japan, and Europe. Excerpts from the article:

• “A case of too little? The shift from output stabilization to debt reduction in the wake of the global financial crisis in Europe was too strong and too costly, reflecting an excessive weight on the costs of debt and an insufficient belief in the adverse effects of contractionary fiscal policy on demand and output.
• A case of just right? Faced with a strong case of secular stagnation, Japan has run large deficits for three decades and debt ratios have increased to very high levels, while the Bank of Japan remained at the effective lower bound. Was it the right strategy (if indeed it was a strategy)? The answer is a qualified yes, but, looking forward, the high debt ratios raise issues of debt sustainability. Alternative ways of boosting demand should be a high priority.
• A case of too much? To boost the US recovery from the initial COVID-19 shocks, the Biden administration embarked in 2021 on a major fiscal expansion. The strategy (again, if indeed it was a strategy) was for fiscal policy to increase demand and thus increase the neutral rate, and for monetary policy to delay the adjustment of the policy rate to the neutral rate, and in the process generate temporary inflation. Inflation has turned out to be much higher than expected. Was the fiscal expansion too strong? Was the strategy a mistake?”

Click here to read the full article.

While the Covid-19 pandemic hit the world very hard, it is particularly well known that developing economies took the largest hit. In that, Latin America’s “long-standing fiscal and social deficits” have compounded the problem for policymakers, as discussed in a recent blog for VoxEU CEPR by Ilan Goldfajn (Chairman of the Board, Credit Suisse) and Eduardo Levy Yeyati (Dean, School of Government, Universidad Torcuato Di Tella).

“The pandemic also flagged two long-standing but often overlooked regional deficits: poor state capacity, and labour exclusion and informality. This explains the region’s worse performance during the pandemic: larger welfare costs and meager relative recovery. Not surprisingly, societies face growing indifference with political regimes (Latinobarómetro 2021), and social outbursts in several countries, such as Chile or Colombia, reveal dissatisfaction which will likely limit economic policy looking forward. On the one hand, many countries came from a period of increased civil unrest that reduced the government’s ability to restrict mobility. On the other hand, lack of political cohesion made it more difficult to implement restrictions, which inevitably led to lockdown fatigue and declining compliance. On top of that, a background of discontent and/or ongoing recessions clouded any perception of effective pandemic response.”

The article then moves on to discuss some areas that may possibly restrain constructive policy solutions, such as the limited size of the public sector given the already mounting primary deficit, populist policy temptations clashing with economically robust policies, etc.

Read the full blog here.

The National Council of Applied Economic Research (NCAER) recently hosted Dr. Gita Gopinath, currently serving as the Chief Economist at the IMF for a discussion on the outlook for global growth in 2022. Among other things, the discussion touched upon topics like vaccination for protection against Covid-19, inflationary pressures in several countries, and the unique set of challenges before policymakers.

Watch the full video here.

In a recent working paper of the Bank of England (2021), authors Jonathan Bridges, Georgina Green, and Mark Joy evaluate a panel dataset of 26 developed nations over 5 decades preceding the Covid-19 pandemic to show that inequality rises following recessions, and rapid credit growth in the time until downturn exacerbates that effect. This growth, whether financial or normal in nature, increases unemployment and inequality effects. They observe that “one standard deviation credit boom leads to a 40% amplification of the distributional fallout in the bust that follows”.

Moreover, “low bank capital ahead of a downturn amplifies the inequality increase that follows. These insights add a new dimension to policy cost-benefit analysis, at the distributional level.” The paper’s results indicate that a 55% amplification in the cyclical response of income inequality to a recession if a country enters the recession with bank capital ratios one standard deviation lower than average. The authors note that using the tools established in new macroprudential norms empower economies to safeguard their financial stability using both borrower and lender resilience, but can also lead to distributional costs in the event of an untamed crisis.

“Taken together, these results suggest an important link between credit, crises, and inequality. They demonstrate that tail events for the macroeconomy also represent distributional shocks.” Vulnerabilities like the rapid accumulation of debt, weakening of bank capital, and an increased risk of recession transforming into a full-fledged financial crisis can all contribute to distributional effects and rising inequalities when a crisis actually strikes. While the use of macroprudential policies to address these vulnerabilities has both, associated costs and benefits, entirely avoiding the usage of these policies entirely can lead to severe macroeconomic and distributional ill effects.

Click here to read the full paper.

From a VOX post by Jesper Lindé and Mathias Trabandt:

“The alleged breakdown of the Phillips curve has left monetary policy researchers and central bankers wondering if we need to develop completely new models for price and wage determination. This column argues that a relatively small alteration of the standard New Keynesian model, combined with using the nonlinear instead of the linearised solution, is sufficient to resolve the two puzzles – the ‘missing deflation’ during the recession and the ‘missing inflation’ during the recovery – underlying the supposed breakdown.

The Great Recession has left macroeconomists with many puzzles. One such puzzle is the alleged breakdown of the relationship between inflation and the output gap – also known as the Phillips curve.

There are two main arguments underlying the hypothesis of a breakdown of the Phillips curve.

The first is the ‘missing deflation puzzle’. The Great Recession generated an extraordinary decline in US GDP of about 10% relative to its pre-crisis trend, while inflation dropped only by about 1.5% (see Figure 1).¹ The modest decline in inflation was surprising to many macroeconomists. For instance, New York Fed President John C. Williams (2010: 8) wrote: “The surprise [about inflation] is that it’s fallen so little, given the depth and duration of the recent downturn. Based on the experience of past severe recessions, I would have expected inflation to fall by twice as much as it has.”

Continue reading here.