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Policy Hub: Macroblog provides concise commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues for a broad audience.

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November 4, 2010

Some in Europe lag behind

Since around June, news of European fiscal deficits, financial markets stresses, potential sovereign debt defaults, or even a breakup of the euro zone has faded. The focal points of global economic policy have shifted to the sluggish recovery in developed countries and potential for further unconventional monetary stimulus.

A cursory look at a few key data reflects an improved European economic outlook from this summer. The simple dollar/euro exchange rate (see chart 1) shows that since June 1 the euro has appreciated nearly 15 percent against the dollar. While many different factors affect exchange rates—and increasing expectation of further monetary stimulus in the United States has helped the euro appreciate against the dollar—some of the appreciation seems to reasonably reflect the relative improvement of market sentiment about the fiscal situation in several European countries. Similarly, looking at the major stock indexes (mostly in Western European nations) shows a steady improvement from the lows of this summer, with the Euro Stoxx 50 index rising nearly 11 percent since June 1 (see chart 2). Thus, looking at most aggregate European data paints a picture of relative improvement, though most forecasters expect sluggish growth going forward. It's when one examines individual countries that it becomes clear some are lagging behind.

Chart 1
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Chart 2
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While the early stages of the European sovereign debt crisis centered on the fiscal scenario in Greece, market stress eventually spread to all the so-called PIIGS (Portugal, Ireland, Italy, Greece, and Spain) and even appeared to threaten the wider euro zone. Following an assortment of unprecedented interventions—highlighted by the 750 billion euro (approximately $1.05 trillion) rescue package from the European Union (through the European Financial Stability Facility) and support from the International Monetary Fund—market confidence slowly grew, and since this summer, various measures of financial market functioning have stabilized.

But while the threat of wider European contagion appears contained, fragilities remain. As has been documented in a variety of media reports, the recent improvement masks the individual euro zone peripheral countries' struggles with implementing fiscal consolidation, improving labor competiveness, resolving fragile banking systems, and staving off a crisis of confidence in sovereign debt markets.

Both bond spreads of individual European sovereign debt (over German sovereign debt) and credit default swap spreads show some stabilization for a few of the euro zone countries, but spreads in three countries—Greece, Ireland, and Portugal—are distinctly more elevated than the others (see charts 3 and 4).

Chart 3
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Chart 4
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The reasons for rising financing costs in these countries vary. In Ireland, for example, concerns about the Irish banking system (and the resolution of Anglo Irish Bank, in particular) were initially the driving cause. In Portugal, it was doubt over the implementation of necessary economic reforms that drove investor reluctance to provide financing; the recent adoption of austerity measures into the 2011 budget should alleviate some worry. But now much of the market action in both Irish and Portuguese bonds is focused on tough new bailout rules being implemented by the European Union.

On one hand, the renewed financing pressure brought upon these countries is less worrisome because of the backstop of the European Financial Stabilization Facility (EFSF). In fact, Moody's thinks it is unlikely there will be a euro zone default. Should market financing become too expensive for Greece, Ireland, or Portugal, the special purpose vehicle (SPV) imbedded within the EFSF could help by providing financing up to 440 billion euros ($616 billion).

But on the other hand, as part of the wider crisis prevention following the introduction of the EFSF, most European governments are implementing some level of fiscal austerity measures. From a political perspective, the implementation of these austerity measures varies widely, as demonstrated recently by the strikes in France over legislation trying to raise the retirement age. In addition to the uncertainty of implementing fiscal consolidation, there is pressure from the administrators of the EFSF to enforce burden-sharing on private bondholders in the event of any future bailout. This pressure is the primary impetus causing investors to shun the weaker peripheral countries.

One important player in this saga is the European Central Bank, which began buying European bonds for Greece, Ireland, and Portugal (among others) in conjunction with the EFSF announcement. Yet in recent weeks this bond buying has abated, and with money market pressures remaining in Europe, "something clearly has to give way," as Free Exchange wrote recently.

While aggregate market measures (exchange rates, stock indices, etc.) from Europe appear to be improving, a few specific countries face some hard challenges ahead.

By Andrew Flowers, senior economic research analyst in the Atlanta Fed's research department

 

December 8, 2009

Another rescue plan comes in below the original price tag

Though the tab to taxpayers could still be substantial when all is said and done, it now appears the taxpayer cost of the Troubled Asset Relief Program (TARP) will be substantially lower than was thought not too long ago:

"The Obama administration expects the cost of the Troubled Asset Relief Program to be $200 billion less than projected, helping to reduce the size of the budget deficit, a Treasury Department official said yesterday.

"The administration forecast in August that the TARP would ultimately cost $341 billion, once banks had repaid the government for capital injections and other investments. Congress authorized $700 billion for the program in October 2008."

There is precedent for such good news. Travel back for a moment to the formation and operation of the Resolution Trust Corporation (RTC), the agency formed to purchase and sell the "toxic assets" of failed financial institutions following the savings and loan crisis of the 1980s. As noted in a postmortem by Timothy Curry and Lynn Shibut of the Federal Deposit Insurance Corporation (FDIC), the cost projections for the RTC ballooned in the early days of its operations:

"Reflecting the increased number of failures and costs per failure, the official Treasury and RTC projections of the cost of the RTC resolutions rose from $50 billion in August 1989 to a range of $100 billion to $160 billion at the height of the crisis peak in June 1991..."

In the end, however, the outcome, though higher than the very first projections, came in well below the figures suggested by the worst case scenario:

"As of December 31, 1999, the RTC losses for resolving the 747 failed thrifts taken over between January 1, 1989, and June 30, 1995, amounted to an estimated $82.7 billion, of which the public sector accounted for $75.6 billion, or 91 percent, and the private sector accounted for $7.1 billion, or 9 percent."

While people may debate the approaches taken, it is heartening to see evidence that TARP, like the RTC before it, is ultimately costing considerably less than estimated.

By David Altig, senior vice president and research director of the Atlanta Fed

July 26, 2007

Why Central Bankers Worry About Fiscal Policy

Today I again hand the keys to Mike Bryan -- now a fellow adjunct faculty member in the University of Chicago's Graduate School of Business -- who provides us with a contemporary example of why it behooves central bankers to speak out when a nation's fiscal situtation gets out of whack:

The reports from Zimbabweover the past year and a half are the stuff that makes for good Money and Banking lectures. It seems that inflation in that country, as officially reported, topped 1,300 percent last year and may now exceed 3,700 percent, with some unofficial reports putting the country’s inflation rate even higher.  Let’s put this inflation in perspective.  If the last reported inflation number can be believed (the country’s Central Statistical Office recently stopped reporting the inflation numbers as it reviews its methodology), prices in Zimbabwe are doubling every month. Inflation of this magnitude renders the government-issued money virtually worthless, wrecking trade and financial institutions in the process.   

While the rate of inflation in the African nation isn’t known for certain, there is little doubt it is extraordinarily high.  Also not in doubt is its cause.  All inflations originate from the same phenomenon—too much money chasing too few goods.  In this case the Reserve Bank of Zimbabwe is rapidly printing Zimbabwe dollars in order to “pay” for a large fiscal shortfall. 

In a recent IMF paper on the Zimbabwe situation the author argues that the Reserve Bank of Zimbabwe’s (RBZ) inflation problems stem not from the usual monetary or fiscal laxness that has triggered other “hyperinflations,” but rather “quasi-fiscal” losses incurred by the central bank itself.  Still, the report concludes that these losses, which stem from some combination of credit subsidies, realized and unrealized exchange losses, and losses from open market operations, were nevertheless incurred to support government policies, and the failure to address these losses has interfered with the monetary management, independence, and credibility of the RBZ.

The immediate “solution” to the Zimbabwe inflation has been the imposition of price controls, an approach that has been attempted by governments ancient and modern, including our own.  I can think of no better source on this topic than economist Hugh Rockoff of RutgersZimbabwe’s controls are actually retroactive, in the sense that merchants have been asked to reduce prices to earlier levels.  Predictably, the problem seems to have gotten worse—now there are even fewer goods for the Zimbabwe dollar to chase.  When and where will the Zimbabweinflation end?  I certainly don’t know.  But I’ve got a pretty good idea how it will end, by a sharp curtailment of their currency expansion.  And that’s the Money and Banking lesson.  If a central bank wants to end inflation, either they better start producing goods, or stop producing money. 

And that, I would add, will be a hard row to hoe unless the fiscal house is put in order.

June 21, 2006

What Is The Right Road To Budget Discipline?

New Hampshire Senator Judd Gregg (in the words of Brad DeLong) is suggesting a return to something like the Gramm-Rudman-Hollings Act of the 1980s. From the WCAX-TV (Vermont) website:

Senator Judd Gregg is leading a move to force cuts in the spiraling growth of federal benefit programs.By twelve to ten vote yesterday, the Senate Budget committee approved a bill written by Gregg, the committee's chairman. It would force mandatory cuts to the deficit, enforced by across-the-board cuts to programs like Medicare, Medicaid and unemployment insurance if Congress can't meet deficit targets on its own.

The bill also revives the idea of the line-item veto which would allow the president to single out wasteful items contained in bills he signs into law, and it would require Congress to vote on those items again.

Says Brad:

The problem with Judd Gregg's proposal is that Gramm-Rudman didn't work when we tried it in the 1980s. It, I think, made matters worse--members of congress became more eager to vote for budget-busting measures when they could claim that Gramm-Rudman placed a cap on the total deficit, and then the congress was unwilling to apply the cap medicine when the dose turned out to be unexpectedly high, and so the process died.

The Budget Enforcement Act framework seemed to work much better in the 1990s than Gramm-Rudman worked in the 1980s.

To be fair to the proponents of Senator Gregg's proposal (who may not be legion), the new variant of GRH seems to address some of the perceived weaknesses of GRH itself -- specifically the inclusion of a presidential line-item veto and the removal of shelter for entitlement expenditures.  And at least in implicit in the Gregg plan is a pay-as-you go feature that was central to the Budget Enforcement Act (as enacted under G.H.W. Bush and extended during the Clinton administration). 

The editorial writers at the Wall Street Journal are skeptical:

Democrats in Congress unveiled their 2006 campaign agenda last week, laying claim to the mantle of "fiscal responsibility." The GOP's spendthrifts have handed them this political opening, which makes it all the more disappointing that Democrats are falling back on an old confidence trick.

Their ruse goes by the name of "pay-as-you-go" budgeting, which has the political virtue of sounding as if spending won't be able to exceed revenue...

That's because paygo rules apply only to new or expanded entitlement programs, not to those that already exist and grow automatically with user demand. Thus spending for Medicare, growing this year at an astounding 15% annual rate, would continue to run on autopilot. Ditto for Medicaid. So-called "discretionary" programs (education, Defense) that Congress approves each year are also exempt. Democrats somehow forget to disclose that those notorious "earmarks" stuffed into spending bills are also exempt from paygo.

Well, OK, but I'm with Brad, on the paygo issue and his broader support for the mechanisms of the Budget Enforcement Act.  In my opinion, the fundamental problem with the GRH approach to budget arose from its focus on the deficit per se.  To me, fiscal policy boils down to answering a few simple questions.  How much do we want to spend, and what do we want to spend it on?  Having answered that question, it is beyond obvious that revenues have to pay for that spending in the long run.  The only remaining question, then, is how those revenues should be raised (that is, who and what do we want to tax).

I am not presuming to answer these questions.  In particular, I am not suggesting that correct answer is to raise revenues to match projected spending, anymore than I am suggesting the correct answer is to lower projected spending to match revenues.  What I am suggesting is that an institutional process that puts the focus squarely on the trade-off between a dollar spent on one type of government spending versus another, a dollar spent in the public sector versus one spent in the private sector, and one type of taxation versus another, is the right way to go.  The Budget Enforcement Act had the great virtue of requiring explicit decisions about new spending (for the discretionary part of the budget and new entitlement programs) and forcing explicit consideration of the inevitable trade-offs when anyone wanted to deviate from the program.    

I'll close with an appeal to higher authority:

... For about a decade, the rules laid out in the Budget Enforcement Act of 1990 and in the later modifications and extensions of the act helped the Congress establish a better fiscal balance...

Reinstating a structure like the one formerly provided by the Budget Enforcement Act of 1990 would signal a renewed commitment to fiscal restraint and help restore discipline to the annual budgeting process. Such a step would be even more meaningful if it were coupled with the adoption of provisions for dealing with unanticipated budget outcomes. As you are well aware, budget outcomes have often deviated from projections--in some cases, significantly--and they will continue to do so. Accordingly, well-designed mechanisms that facilitate midcourse corrections would ease the task of bringing the budget back into line when it goes awry. In particular, the Congress might want to require that existing programs be assessed regularly to verify that they continue to meet their stated purposes and cost projections. Measures that automatically take effect when a particular spending program or tax provision exceeds a specified threshold may prove useful as well. The original design of the Budget Enforcement Act could also be enhanced by addressing how the strictures might evolve if and when reasonable fiscal balance came into view.

I do not mean to suggest that the nation's budget problems will be solved simply by adopting a new set of budgeting rules. The fundamental fiscal issue is the need to make difficult choices among budget priorities, and this need is becoming ever more pressing in light of the unprecedented number of individuals approaching retirement age.

Right.