Canada is not the model
Tim Duy has an interesting piece out that dovetails with something I had been saying in the comments here just yesterday. It has to do with austerity as an economic policy response in this post-crisis world. According to Bloomberg News, German Chancellor Angela Merkel used a trip to Canada as a venue to push for more austerity. As Tim notes, Bloomberg writes:
German Chancellor Angela Merkel renewed her call for austerity as crucial to tackling financial turmoil in the euro area, praising Canada’s economic example as she returned to the crisis fight after her summer vacation.
Merkel, facing European pressure to ease bailout terms and allow shared debt, and from global partners to do more to stop contagion, used a visit to Canada as the stage for her first public comments in a month on the crisis. She hailed Canada’s budget discipline, promotion of economic growth and “not living on borrowed money” as models for the 17-nation euro region.
“This is also the right solution for Europe,” Merkel said at a reception in Ottawa late yesterday before talks with Prime Minister Stephen Harper, according to a transcript posted on the German government’s website. “I will report on our political will to overcome the euro crisis and on our determination in Europe to band together for a common currency.
This is all wrong. Tim notes this as well citing Bloomberg again from a March piece by Peter Coy that got it right in quoting Neil Dutta, an economist at BofA, on whether Canada’s model could be exported to the US:
Canada’s impressive achievement is not necessarily a good example for the U.S., where premature austerity is likely to harm growth. Canada benefited from special circumstances that don’t apply south of the border. A report today by economist Neil Dutta of Bank of America Merrill Lynch concludes that “Canada’s experience is more the exception than the rule.”
Key points from Dutta:
• In Canada, austerity helped lower interest rates. Rates are already super-low in the U.S., so there’s no room to improve.
• In Canada, austerity lowered the value of the Canadian dollar, which made Canadian goods more competitive on world markets. The U.S. is a relatively self-sufficient economy, so it would benefit less from a depreciation, even if one occurred.
• Canada benefited from growing demand for its products from the U.S. and China, which compensated for the chilling affect of deficit reduction. No countries today are eager to soak up more imports from the U.S.
• Canada is indeed an exception. An International Monetary Fund study looked at 172 fiscal policy changes in rich countries and found that on average, reducing the budget deficit by 1 percent of GDP reduced output by two-thirds of a percent and boosted the unemployment rate by one-third of a percent.
Bottom line: If an economy is already suffering from a shortfall in demand, as the U.S. is today, cutting demand further through fiscal austerity can make matters worse, not better.
That’s how I put it in the comments yesterday on my post on public deficits and private savings in the euro zone when a commenter protested that Canada was a model for the euro zone.
"Sorry Edward, however I totally disagree with your logic. As a Canadian, our Federal government we went through this process – of paying down debt in 1995 to 2002. As Canadians, we had a housing bubble bust in 1988, recession from 1990 to 1991 and Federal government debt of 100% of GDP with weak economic performance. In 1994, we were broke! The Liberal government, at the time, did the hard work of paying down our national debt. Taxes increased significantly (including a national sales tax), inflation was mandated at 2%, and our currency fell to $0.61 cents to the US dollar.
With an export led economy and private sector spending (yes, demand picked up as the federal government debt decreased). As a small businessman I can tell you these were hard times however, look at us now. I believe you will find many other countries did the same thing. Australia and Sweden (which had a banking crises) come to mind in the late 1990’s.
UK is following this example – I believe correctly, however Europe is “gumming up” the process. Like your post I had to simplify my response,
however you and your readers would do well by talking to people who have lived and experienced austerity and ultimately its benefits."
I have seen how austerity works in Canada and elsewhere. To be clear, I never said austerity won’t eliminate the deficit. It will that’s why people do it. But it will work in a deflationary way. It "doesn’t work" if the goal is avoiding recession.
"People like Hugh Hendry get it. He is not advocating fiscal contraction because he believes it will immediately be expansionary. Instead, he argues there is no policy remedy for debt deflation. Rather than allow the government’s debt levels to climb and fill in the missing private sector demand as Richard Koo advocates, Hendry recommends just letting aggregate demand fall and starting anew. That leads to Depression of course. "
But more importantly, your example is too simplistic because the macro environment is different today than in 1990. The UK, Sweden and Finland also experienced the same housing bust and recovery that Canada did. The recovery that Canada and these other nations experienced was aided greatly by a number of factors including a benign global economic backdrop, lower interest rates and in some cases exchange rate depreciation.
In today’s environment, with rates already at record lows and the global macro picture very cloudy indeed, austerity can lead to debt deflation. Will it work? It might do in Britain but at great cost.
P.S. In 1994, Canada was not broke. the government prints money. It can never run out:
For reference, see my post on Ireland’s bank debt problem versus Sweden’s. I give a brief synopsis of the difference in macro environment. I view Sweden’s bank debt workout solution as a good model, one that the U.S. should have followed but that Ireland should not have given the magnitude of losses in the Irish banking system, something that was evident from the NPL charts I showed in the Gold-level member post earlier today. For the Swedish banking crisis history, see my 2008 post "The Swedish banking crisis response – a model for the future?" and my 2009 post "Did Sweden really nationalize its banks?"
The bottom line: Yes, austerity will cut deficits over the longer-term. After all, you are spending less and/or increasing tax rates. But in the short-term, if an economy suffers a shortfall of demand from high private debt, austerity will cause that shortfall to become worse. The pain could be so overwhelming in getting to the longer-term that austerity does more harm than good. You have to look at it case by case. And clearly, the euro zone is the worst example for austerity since it is a large economy in a fixed rate regime without implicit central bank backstops. Spain can’t depreciate the currency against Germany but the euro can depreciate overall. However, the game of competitive currency depreciation would end in an ugly trade war if major currency areas started to try this.
A small country like Australia might be a better example for austerity. Latvia and Ireland have been touted in the past by those who want to use austerity as a policy tool as examples of how austerity can succeed. I think there has been some success, but at great cost. Even so, in this macro environment, the results are always going to disappoint. And the story isn’t even over yet.
When You Only Have a Hammer – Tim Duy’s Fed Watch
Tim Duy makes some good points about Canada, namely that Canada benefited from some great global macro fundamentals that made austerity a lot easier than it is for Europe.
Merkel Cites Canada as Debt-Deficit Model in Europe’s Crisis – Bloomberg
Canada is not the model because they faced different constraints. It is yet another example of the search for a nation that can demonstrate why austerity works when it hasn’t thus far in Europe. Insanity.
George Osborne no longer enjoys faith of former prominent economist backers over deficit – Telegraph
"Only one of the 20 economists who put their names to the letter in February 2010 backing Mr Osborne’s deficit reduction plan said he continued to have faith in the Chancellor."
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"Our objection to purchases of Italian or Spanish debt by their own state-backed lenders isn’t necessarily because of the ESM similiarity. Though we think either scheme is ultimately beside the point in the eurozone crisis. What ails the bond markets, and makes them unable to do their job of price-clearing in the present moment, is now beyond any fiscal backstop’s ability to fix – even one monetarily enhanced. The fix, like the problem, either reaches monetary-scale or there will eventually be a sequence of painful write-downs as the fiscal transfer of choice. All this sovereign-state-backed-lender-loop stuff would do is concentrate the pain of write-downs in the countries most likely to restructure their debt, if it comes to restructuring"
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Belgium will need to cut another 500 million euros from its budget to meet its 2.8% deficit target for 2012 after relatively mild cuts of 78 million euros so far. In particular, problems with bailed out bank Dexia have caused Belgium to need to re-double budget cutting efforts. Debt to GDP stands at 101.8%.
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The well-known story of municipal bond defaults « self-evident
Steve Randy Waldman: "they are simply getting a government subsidy for economic development or other purposes." @munilass https://t.co/LXViczxv ht @cate_long
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Along with July retail sales, this is telling us there is no recession.
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" I don’t know what the technical definition of a “recovery” is in economics, but this is not a “recovery”. It might be a “stabilization”, but let’s not go all crazy abusing the english language here. I was a housing bear for years and years and I am infinitely more optimistic about the state of US housing here. But let’s be honest here. This is no “housing recovery”."
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"Insiders can now sell Facebook stock and the reaction so far hasn’t been pretty. Here’s a quick look at what the financial press is saying."
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Research from the British company Strategy Analytics shows that online streaming services for music like Spotify and Pandora are doing much better than traditional purchase applications like iTunes this past year. Growth of 40% for streaming compares favourably to 8.5% growth for downloads. Still 80% of digital music consumption is downloads, making the music industry 3.2 billion euros, so Spotify and Pandora do have a long way to go.
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Adobe Pulls Flash Player From Google Store – John Paczkowski – Mobile – AllThingsD
Flash is history now.
Taking the High Out of High Yield – MarketBeat – WSJ
This is exactly the issue I rant about with regard to zero rates. Investors are starved for yield so they are willing to get 8-year BB-rated paper at 5 3/8% yield. The average in the last ten years is 9.55%. That’s what financial repression is all about. Are investors being adequately compensated for the risk? Heck no.
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Brazil unveils $66bn stimulus plan – FT.com
"Brazil’s president Dilma Rousseff has launched a R$133bn ($65.6bn) stimulus package to spur investment in the country’s creaking infrastructure and shore up ailing investor confidence in the world’s second-largest emerging market economy"
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