The changing face of the IMF

For decades the IMF has been synonymous with the failed policies of a neo-liberal agenda pushed upon developing countries. Set up with the mandate of fostering global growth and economic security successive interventions into crisis proved counterproductive notably in the 90s East Asia Crisis, for which they were widely criticised. The reason for the controversy is the fact that while the Fund does not require collateral for its loans, they are instead conditional on the imposition of policies that have proved exceedingly unpopular. These policies were aptly described by economist Jeffry Sachs as 'belt tightening to countries who are much too poor to own belts'. Further distrust of the Fund has been caused by the influence held by the US, who receives the greatest share of votes, with ‘Special Drawing Rights’ giving undue weight of voice to the larger economies.  As the fund seemingly moved further and further from its mandate, set out as part of the now extinct Breton-Woods system, questions over its legitimacy were raised, characterised by the former chief economist at the World Bank stating that while the Fund was set up to provide Keynesians reflations it was instead ‘reflecting the interests and ideology of the Western financial community.’

This time around things didn’t look like they would be any different. As the fall-out from the 2008 financial crisis took hold of Governments balance sheets the IMF was one of the first and strongest supporters of the austerity measures pushed forward by many governments in the developed world. In 2010, here in the UK, the Fund praised Chancellor George Osborn’s ‘essential’ deficit reduction plan describing it as ‘strong and credible’ and stating that the plan ‘supports a balanced recovery.” Words described by chief economics commentator at the Financial Times Martin Wolf as ‘a love letter’.

Since then however there has been a change of heart within the IMF, its growth forecasts for the UK have been consistently downgraded as the economy slipped back into recession in 2012 and has just narrowly escaped a ‘triple-dip’, according to the most recent figures. Early signs of this shift in consensus came in the October 2012 World Economic outlook which stated that austerity has caused far more damage than IMF experts had assumed. This was shown by the fact that countries implementing austerity underperformed their growth forecasts while those providing fiscal stimulus grew by more than the Fund had anticipated. As has been well documented this was due to the under-estimation of the multiplier effect. In certain situations, especially in downturns, the multiplier effect is high enough that cutting growth leads to a higher deficit because of the negative effect it has on growth. In a meeting last week between the IMF, World Bank and G20 the Funds managing director Christine Lagarde emphasised this new approach saying "We need growth, first and foremost" and stressing the dangers of overemphasizing deficit reduction with growth still fragile. The IMF's economic report called on both the United States and Britain to scale back there deficit reduction plans in the near-term, calling on both nations as well as Europe, China and Japan to adjust their policies in order to boost struggling global growth.

So as the IMF plans its up-coming visit to the UK its Chancellor may well be apprehensive, once among his strongest allies they now join those calling for plan B, their chief economist saying "it may be time to consider adjustment to the original fiscal plans" and warning that the UK was “playing with fire”.  With the IMF jumping the sinking ship austerities intellectual foundations were eroded further by a student in Massachusetts who discovered ‘miscalculation, data errors and unsupportable statistical techniques’ in a paper by two Harvard economists linking debt and growth rates that was previously praised by George Osborne as well as fellow fiscal conservative Paul Ryan.

With these recent events in mind it may be that austerity has reached the beginning of its end - ‘Austerity has reached its limit’ recently declared the European Commission President. However it is clear that the policy many fought so hard to implement will not go down without a fight, according to an aid of Mr.Osborne “If they recommend we loosen fiscal policy, we won’t do it. We think they are wrong.” However with UK unemployment and growth proving as stubborn as its Chancellor, pressure may grow to heed the Funds advice.    

(Central Bank) Independence Day

Stagnant growth, painfully high unemployment levels, depleted consumer confidence, substantial deleveraging and reduced investment by businesses are all documented effects that have lingered from The Great Recession and have been witnessed to varied degrees throughout the global economy. However there is one consequence of the financial crisis that is now only becoming apparent, this being the undermining of central bank independence. With fiscal consolidation being the dominant (albeit tremendously wrong) policy prescription of the day, greater onus has been put on central banks by their respective governments to revive growth and return to the path of prosperity. This has forced central bankers to become more innovative with regards to monetary policy creation and challenged the long established view of the importance of an independent central bank.

But let’s first look at how this independence came about and why it is was widely employed. Economies in the 1970s were characterised by a unique problem: contractions in growth coupled with increasing inflation. A problem, that according to Walter Phillips’ famous original analysis in a 1958 ‘The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957’ , could not exist. The one country who managed to achieve relatively low inflation levels in this harsh economic environment was West Germany, where inflation averaged around 5% during the decade while comparably US inflation rate reached highs of 13% and averaged at around 7%.

Policy makers put the country’s success down to the fact that the Bundesbank was independent from the German government. This, coupled with the rise of Monetarism led by Milton Friedman, triggered a global movement in which countries increasingly adopted legislation to increase the independence of their monetary authority. The main argument put forward for independence is that a central bank would be free from political pressure and the numerous difficulties arising from the dual-mandate that a government had of sustaining high output (resulting in low unemployment levels) while also keep the price level relatively low and stable. It was shown by the use of game theory that with both policy goals, the government would have the incentive to ‘cheat’ the public into believing that the inflation would be a certain level and change it to increase their own pay-off . Thus by giving central bank independence and assigning them to oversee one of the policy goals, sustained output or low inflation, then their actions would be deemed credible by the public thus allowing policy to work effectively.

So what policy goal to give an independent central bank? Inflation or employment targeting? Well Friedman in his famous 1968 paper ‘The Role of Monetary Policy’ claimed that monetary policy could not successfully target employment as a criterion of policy , it could not peg real quantities but only nominal ones and that by following a steady course of action, a monetary authority could promote economic stability. Thus the prospect of unemployment levels being the mandate of monetary policy was ended and instead the rules-based inflation targeting became the economic norm. First initiated by the Reserve Bank of New Zealand in 1988 and now currently used by a number of central banks including those in  Australia, Brazil, Canada, India, South Africa and the United Kingdom.

However due mainly to The Great Recession, this established view is being fiercely challenged across the developed world. With interest rates at the zero-lower bound and no help (with regards to expenditure) from the state forthcoming, monetary policy is being pushed to its limits when trying to accommodate other goals than just price stability. For example in the US, the Federal Reserve is buying $85bn of bonds a month until the US jobs market sees a substantial improvement and plans to keep interest rates at close to zero at least until the US unemployment rate falls below 6.5%. While in the UK, incoming governor of the Bank of England, Mark Carney, has already sparked debate by suggesting that economic output could be targeted instead of inflation and it appears that Chancellor or the Exchequer, George Osborne, plans to grant Carney greater powers to revive growth in the Budget later this month.

The most vigorous attack on Central bank independence however is occurring in in the Land of the Rising Sun, Japan. Newly elected Prime Minster, Shinzo Abe, has pledged to use both fiscal and monetary expansion to stimulate growth and defeat the persistent deflationary problem the country has faced for years. When running for office, Abe said he would set a ‘policy accord’ with the Bank of Japan for a mandatory inflation target of 2%, backed by unlimited monetary stimulus. So far he has got he wish, under increasing political pressure the Bank of Japan changed its inflation target from 1 to 2% and nominated Haruhiko Kuroda, a fierce advocate of past BoJ policy, to be the next head of Japan's central bank. Kuroda has since promised aggressive steps to raise inflation to 2%, which has only reinforced the Yen’s continued rapid decline. Focus on this radical shift in policy has only increased with the Yen’s decline in value and the riskiness of this policy shift has already been discussed at great length. The Bundesbank President Jens Weidmann has claimed that the BoJ's independence is under threat and warned against government interference in monetary policy.

Some may ask so what? So what if the central bank is being forced under political pressure to focus on output and inflation too, surely that is a good thing? In some sense yes. There is a case that monetary policy should focus more on output, as unemployment is not just a problem that has economic consequences but also massive social implications as well (as is being seen in Spain and Greece). Furthermore there is the argument that greater flexibility and openness in monetary policy circles, along with greater debate into monetary tools and their effects can only be beneficial for the improvement of our knowledge on both central banking and monetary policy.

In other ways however caution must duly be applied. Greater burden on Central Banks for creating growth reduces the responsibility on governments. Especially on those already pursuing destructive austerity measures which have increasingly being proven to be doing much more economic and social harm than good. With most noticeably an article, written by IMF chief economist Olivier Blanchard and Daniel Leigh, stating that fiscal multipliers in the advanced economies are considerably larger than had been previously assumed and thus austerity is much more damaging to output in the near term than was anticipated. Furthermore the lack of effectiveness of monetary policy in certain economic times, such as the liquidity trap situation that most developed countries are currently in, means that greater responsibility on central banks will not necessarily lead to the desired outcome to revive growth. As John Maynard Keynes proclaimed to President Roosevelt, using monetary expansion to create growth is “like trying to get fat by buying a larger belt”.

One thing seems certain for the independence of central banks, it is being severely challenged. It remains to be seen whether the long-established central bankers will coordinate a counterattack to save central bank independence and policy as we know it.

What I Learnt From The Coin.

Last month saw Congress pass yet another measure to raise the debt ceiling, the latest measure delays the date the debt will reach its limit until May the 19th. This sets up another round of political wrangling and drawn out negotiations over deep cuts in social spending and defence. As the debt level approaches the level raised by Congress, Republicans will dig their heels in, holding both the US and global economy to ransom by using the threat of economic crisis as leverage in their quest to reduce Government spending and re-establish an America with a small state . On one hand President Obama has previously said he will refuse to play games with regards to the debt ceiling, however Republicans have stated in response that these negotiations are ‘necessary’ for the country. So as agonising as it is, the games will go on.

The reason that the debt ceiling puts the President in such a predicament is the confusing way in which power is divided between Congress and the President. Congress sets the budget, if this involves a shortfall of tax revenue relative to public expenditure, then the President is forced to borrow the difference. What makes this situation different from other countries is that Congress also has the power to limit the amount of debt the country can have. As this level approaches, they put pressure on the President to halt the levels of borrowing, created by their budgets. The President could stop borrowing past the amount Congress needs to implement its budget, but this would result in the Government spending money which it has not been financed. This would have dramatic consequences for the US and global economy, especially with regards to confidence in the dollar as a means of payment, which would be extremely dangerous for global stability and consequently has never been allowed to occur. This raises the question - for what reason does the Debt Ceiling actually exist? Part of the reason is that Congress benefits from creating a problem that only it can solve, allowing it to use the threat of economic destabilisation as leverage to fight against any changes in Government spending or taxation that it opposes.

As for the so called deficit hawks in Congress Obama may reason that they are not in fact deficit hawks at all. Many of the Republicans demanding that the Government deficit be reduced were supportive of the previous President quickly turning large surpluses into deficits with tax cuts to the wealthy and massive military outlay, which together, according to estimates from the Congressional Budget Office, account for a staggering $600 billion of the current deficit today. To put this in perspective according the Office’s estimates by 2019, if current policies are sustained, almost 50% of the total government debt will be accounted for by these two Republican policies. The economic downturn instigated by the burst of the housing bubble along with the failure of adequate recovery measures that attempted to fill the substantial hole in total spending left by the private sector, account for the majority of the current deficit. Clearly in principle therefore Republicans have no problem with sustained deficits. A more appropriate term for them would perhaps be Spending hawks or Welfare hawks, who use self-created deficits to demand the current President cut programs they deem to have no value, these being mainly welfare and health provision which the GOP have wrongly claimed are the main reason for the current deficit.

Because of these frustrations, discussion in some quarters has turned to how the President could get around the obstacles set before him by Congress. One idea was to use the constitution that protects US debt to simply ignore the deficit limit - wanting to avoid all the legal entanglements that this would involve Obama has refuted this option. Next was the infamous “trillion dollar coin” suggestion. Queue the right-wing comedy. ‘How about a twenty trillion dollar coin or even a 100 trillion dollar coin?’ was a common question amongst critics. Stephen Colbert provided probably the wittiest gag: "we should have known a coin was Obama's solution to everything - it was right there in his slogan: CHANGE”. Meanwhile news stations have kept themselves equally amused with clips Dr. Evil and Homer Simpson with a trillion dollar note.

Moving onto the serious discussion of the logistics of the plan Fox News reported that the amount of platinum needed would sink any boat used to transport it as it would weigh 17,774 tons or using their alternative unit of measurement - 89 blue whales! This clearly ignores the simple fact that there is no more reason for the coin to actually be worth one trillion dollars than the paper used to make a $20 note actually be worth $20. Meanwhile those who tried to sound more serious stated that the coin would create massive levels of inflation and destroy the value of the dollar, comparisons with the hyperinflation of Zimbabwe Dollars were especially popular. All this served to prove the point that those hired to inform the rest of us have little understanding of money creation or even basic economics. Economic theory states that in certain conditions, i.e. with depressed demand and interest rates unable to fall any lower, an increase in the money supply does not lead to inflation. Banks today create trillions of dollars by the simple act of lending, which has had very little inflationary effect, as evidenced by the rates of inflation in the US as well as other advanced nations with a highly developed banking industry. In fact in the UK, around 97% of the total money supply has been created by the financial sector and not the Bank of England.

Putting it simply, the creation of more money is not the alien concept it has been made to seem and is only inflationary under certain conditions. But even this misunderstands the central concept of the coin. The one trillion dollars credited to the treasury would be offset by selling assets or borrowing from banks so that borrowing would continue as normal. In other words this is just an accounting trick. This is not an economic solution to the debt in the longer term. Instead it is aimed to get around the political problem of the debt limit set by Congress. As the fiscal cliff showed us by claiming several points of GDP growth, political problems have economic consequences which explains the enthusiasm of some to avoid yet another messy and costly round of negotiations.

Therefore what has been revealed by this round of debt ceiling talks is that the majority of people influencing the debate in Washington either do not understand the concepts discussed or do not want to engage in serious debate about the role of money and debt in the economy. Perhaps before the next round of negotiations begins, this issue should be addressed.

The European Integration Question: Economical or Political?

 Author: Thomas Viegas

With European nations struggling at present with the Sovereign Debt Crisis, which has engulfed the region, intense debate over the progress, desirability and future of both economic and political integration within the single market area has amplified. Originating in the aftermath of the Second World War, the creation of the European Coal and Steel Community (ECSC) in 1951 was declared by Robert Schuman, then French Foreign Minister, to be "a first step in the federation of Europe". Since then the Treaty of Rome, the Single European Act and the Maastricht Treaty have all contributed to furthering of economic and political integration between the nations of Europe. However the extensive economic problems that several countries in the Eurozone now face can only be solved with collective action and further integration. This has led to questioning whether it is possible to do this without deepening political integration within Europe as well. 

Economic integration is defined as “the elimination of economic frontiers between two or more economies’ with a frontier being any ‘differentiation over which actual and potential motilities of goods, services and production factors are relatively low”. Furthermore this type of integration refers to both market and economic policy integration, with the former however remaining the essence of economic integration. The fundamental motives for economic integration between economies are that, in theory, it will lead to increases in overall trade, actual or potential competition and growth rates within the integrated area. Moreover consumers in the area should experience lower prices, greater quality variation and choice as integration forces the allocation of resources to be more efficient.

Political integration has been defined as “the process whereby nations forego the desire and ability to conduct foreign and key domestic policies independently of each other, seeking instead to make joint decisions or to delegate the decision-making process to new central organs”. The keys features of this type of integration are its implications on sharing and delegating amongst member nations, the transfer of national sovereignty to pooled sovereignty and the creation of supranational institutions. Empirical studies have shown the consequences of increased integration include increases innovation and economic growth and the level of competition within both economic and political markets. There has been continual debate over whether political integration is a condition or a process and whether it has an ‘end point’, this is particularly important when considering the long term objectives the European ‘project’.

The current Crisis has exposed severe flaws in the economic integration process between Eurozone members, whilst also showing that political integration affects the optimality of the monetary union. The major flaw is the failure of a federal system in the zone to assist convergence in growth, as funds would be able to be allocated where they were needed in the case of asymmetric shocks (shocks to individual states). The crisis has resulted in the massive divergence of growth between ‘core’ states (Germany, France and Austria) and the ‘periphery’ (Spain, Portugal, Ireland and Greece). The argument for such a system uses the example of the US in which the federal budget redistributes income across regions, thus offsetting parts of the interregional differences in income.  

The cry for common bonds, or ‘Eurobonds’, to be issued has also been mentioned to allow troubled countries to borrow at a lower rate then they currently do from international markets. Not only would this consolidation of national budgets and debt would create a common fiscal authority which would protect member states from the prospect of defaulting, it would also be a very visible and constraining commitment that should ‘convince’ markets of the long term future of the union. In addition  the call for a ‘banking union’ between member states , to guarantee deposits of any individual in the zone, was strengthened when Ireland guaranteed all deposits for customers while others nations did not. In addition the necessity of a distinct eurozone budget has become apparent to allow the union to function much better because it would smooth the impact of asymmetric shocks too.

However these potential economic policies have encountered large political difficulties. The idea of a Federal system within Europe is one with extreme complications. The main one being that the policy would result in national governments surrendering the only available economic instrument left, Fiscal policy. Furthermore it would not only mean substantial changes in individual nation’s constitutions (assuming it would get past a referendum) but it would also have to be sold to the taxpayers of the zone that they would be financially assisting their ‘fellow European citizens’. At present these drawbacks appear unlikely to overcome due to upcoming national elections and the vocalness of citizens in core countries, which have already had to subsidise large bailout packages. The call for ‘Eurobonds’ has been met with strong resistance from nations, especially Germany, who enjoy negative real rates to borrow currently, who feel that this would increase the moral hazard risk. The risk being that, now with implicit insurance, members would issue too much debt.

Discussions over a joint ‘banking union’ have begun between the zone’s finance ministers but have already run into problems. The degree to which the ECB would have supervisory control has caused divisions, with Germany claiming that the supranational body should only monitor the 60 largest banks in the area while France believing  that the  Bank should be responsible for monitoring of all such institutions. The prospect of a distinct eurozone budget looks extremely bleak due to the inability of all EU members to agree on a collective budget for 2014-2020 and agreement looks increasingly unlikely. Moreover the current 2012 budget for the EU totals 0.98% of the regions Gross National Income and an effective budget for the eurozone would need to be considerably larger.

The drive for increased economic and political integration would involve the evolution of supranational institutions in the region. As mentioned before further economic integration would mean further powers being transferred to the European Central Bank, an organisation that was built to be completely independent from national governments. The loss of financial policy, already with the monetary type, to a body that is not accountable does not appear politically desirable. The prospect of the European Commission and Parliament to have greater influence in the management of regional policy is also small. Much debate already ensues over the usefulness of the Common Agricultural Policy (CAP) and with these institutions already heavily involved in competition, trade and industrial policy making; the giving up of more powers to Brussels would question the requirement of national governments.

The process of both economic and political integration between European economies has been largely interdependent and the deepening of the former type requires an increase in the latter. The economic situation that the continent was in after 1945 forced collective political action, which resulted in furthering economic ties between nations to improve prosperity in the region. The continuing removal of economic barriers between European economies led to successful economic growth in the latter half of the twentieth century, thus reinforcing the need for the former to induce the latter. The current Sovereign Debt Crisis however threatens the continuation of both types of integration. It has become obvious that the longevity of the integration process relies on furthering economic ties between economies but whether the political integration process has reached its ‘end point’ remains to be seen.

Iceland: Coming in from the cold

Authors: Andrew Whitehead and Thomas Viegas

In 2008 Iceland became the first country to be hit by the ugly aftermath of the global financial crisis; the now infamous sovereign debt crisis that has now engulfed the rest of Europe. In the now familiar story the years prior to this were characterised by the embracement of unfettered capitalism and financial liberalisation that lead the newly privatised Icelandic banking industry to grow to a monstrous 1000% of GDP, economic policy described by the Chief Economist at Citigroup as “collective madness”. Although, by no means alone in the pursuit of such policies, the relative size the banking industry to a country of only 300,000 people made it unique.    

When the crash did happen it was spectacular: the stock market plummeted 90%, unemployment shot up to an all-time high and inflation rose to 18%. All the ingredients for at best, a prolonged depression and at worst the complete collapse of the economy. The situation was so dire that around 2-3% of the population immediately fled the country! This remarkable implosion not only left their economy in tatters but also resulted in the country being widely mocked. In particular the SNP leader Alex Salmond was roundly sniggered at for his previous quote that an independent Scotland could join some small nations such as Iceland to form an “arc of prosperity”, while across the water with the Irish banking system collapsing the Irish media consoled themselves by joking “at least we’re not Iceland!”

However the mockery has now quickly receded. Employment levels in Iceland have fared far better than in many other European nations, even in the depths of the crisis unemployment never reached double figures while in Greece and Spain it remains above 20%. While their employment rate is the second highest in Europe, in the latest figures (78.5%) this compares favourably against economic powerhouses Germany (72.5%) and the UK (69.5%) and even more so when compared with other small nations hit by the crisis such as Latvia (61.5%) and Ireland (59.2%)

But how has Iceland fared so well despite such an economic catastrophe? The reason is part dumb-luck and part excellent management from the Icelandic Government and, for once, the International Monetary Fund (IMF). I say dumb luck because it is the very nature of the “collective madness” described earlier that makes Iceland such an excellent test of economic doctrine accepted (or forced) on the rest of us. Due to the huge magnitude of their banking crisis (the largest ever relative to GDP), they were forced to use unorthodox measures to save their economy. In the words of economist Paul Krugman “Iceland zigged when all the conventional wisdom was that it should zag”. The rest of the developed world has followed the path of huge bailouts, resulting in the shift of private debt to public balance sheets, and the slashing of public sector spending with the hope that this would restore the much needed confidence in markets to stimulate private sector spending.

These hugely unpopular policies were sold to the public on the basis that there was no other alternative. The case of Iceland however proves that this is not true. While everyone else rushed to give taxpayers money to the banks, Iceland let them fail. While the bankers at the heart of the crisis were protected and in some cases rewarded in the US and Europe, in Iceland they were jailed and while the rest of Europe embarked on a social spending slashing binge, Iceland expanded its social safety net.  At the time, the consequences of these unconventional policies were warned against by many economists, who predicted punishment from global credit markets leading to bankruptcy and economic Armageddon. This has not been the case. Compared to Ireland, which took full responsibility for its banks debt, both suffered similar drops in GDP (14 and 15% respectively from peak to trough) but credit default swaps in Iceland are now much lower than in Ireland, indicating increased confidence in the ability of the Icelandic government to service its debt. Furthermore this year has seen the Iceland successfully return to the international credit markets for the first time in five year.

A crucial part of the recovery was the relationship between the country’s government and the International Monetary Fund, who provided a $2.1 billion loan package. Just as Iceland’s economic catastrophe and road to recovery has been unique so has its co-operation with the IMF. While in the past the IMF has been severely criticised for its role in worsening crisis, most notably in Asia in the 90’s (in South Korea what we know as the “Asian Financial Crisis” they know as the “IMF crisis”), the IMF’s response in Iceland was different. They allowed the Government freedom to maintain fiscal control, altering spending and revenues how they saw fit. More surprisingly they allowed capital controls, a move normally regarded as heresy by the Fund’s free market priests. These capital controls, although controversial, prevented the collapse of the Icelandic currency as it prevented large amounts of funds leaving the country. The measures are still in place and are based not on time but on prevailing economic conditions (a lesson the US may which to observe as they approach their fiscal cliff). Another different approach used by the IMF was allowing the maintenance and even strengthening of the Icelandic welfare system. They allowed automatic stabilisers to do their job in protecting the citizens of the country from the depths of the crisis, as inflation rose and wages fell, delaying fiscal adjustment for a more stable time. A key factor in this economic salvation was the helping out of heavily indebted households, a policy recently recommended to the US by the former chair of the Federal Deposit Insurance Corporation. This freed up consumers to spend their money on other things, no surprise then that domestic demand has been a powerful aspect in the recovery. The extension of social security resulted in inequality actually falling during the crisis as the bond and shareholders as well as foreign creditors bore the brunt of the fallout from the banking collapse.

So although Iceland did experience severe economic damage and a substantial drop in living standards, the effects on its people were contained and the economy has been able to launch its own moderate recovery.  Although comparisons between a small island of 300,000 people and large dynamic economies such as the UK may seem far-fetched it is clear lessons can be learnt from the country that ‘zigged’. The case has clearly taught the IMF a lesson, explicitly shown in the recent conference set up by the fund “Iceland’s Recovery: Lessons and Challenges” in the countries capital Reykjavik. One such noteworthy lesson , outlined by the Funds managing director, is the importance of a wide range of tools for dealing with the crisis, even if such tools go against what is being practiced elsewhere. Another is the importance of the role of the welfare system in any economy’s recovery. It has long been an accepted view that more equal societies perform better on a variety of social indicators from crime to mental health but it has been extensively believed that a trade-off exists between equity and growth. But this conception is being gradually eroded and recent research undertaken by the IMF has shown that countries grow faster and more consistently when income is shared more equally. This coupled with their recent paper stepping away from the use of austerity shows a clear change of direction for the IMF, one that will hopefully see them become an increasing effective in achieving their main goal: the safeguarding of the global economy.

The message to take from Iceland’s experience is that contrary to what the majority of policy makers keep preaching to the public about austerity being the only way forward, there is a clear and credible alternative. While Iceland’s road to recovery will not necessarily be repeated to the same extent in other economies, due to the uniqueness of its crisis, its stance on several key policy decisions can be adhered to. Iceland’s policies centred on protecting its people, assisting indebted households and holding those responsible for the crisis to account and this has rescued its country from economic disaster. Hopefully Europe’s leaders will sit up and take notice of what has been achieved in the country that zigged as currently zagging has not only resulted in increased social unrests but also shows no clear signs of short to medium term improvement in growth.

Election Stick Or Twist

As the general election draws ever closer in the US, It is evident that economics will dominate. The stance of both candidates on this issue will be vital in deciding who will be become the President for the 57^th term in its history. But what is the actual state of the world’s largest economy? Growth had been on an upward trend in 2011, peaking at 3% in the fourth quarter. However with the worsening of the Eurozone debt crisis, coupled with the slowdown of the emerging economies across the world, growth slowed to 1.5% in the second quarter of 2012 with now signs of improvement in the short term. Vast amounts of deleveraging by both firms and consumers have also contributed greatly to lacklustre growth. While Keynesian theory would promote the government stepping in to replace the spending that is not forthcoming from the private sector, gridlock in congress and the upcoming elections have made further fiscal stimulus close to impossible.

Unemployment had been falling at a more than expected rate throughout 2011, a sign some believed signalled a quick recovery for the economy. Yet 2012 has brought about increased difficulty for a large proportion of economically active Americans. With the joblessness rate hovering above the 8% mark, the latest figure being 8.3% in July, and increased problems the creation of new jobs throughout the country, the sign of a quick recovery has all but evaporated.

Despite countless forecasts of high and dangerous inflation from some commentators, who Paul Krugman refers to as ‘Very Serious People’, as a result of large amounts of bond buying from the Fed. The rise in the general price level in the US has slowed greatly over the past year, falling below the target of 2% set in early 2012. This has led to increased calls for the Fed to do more in order to revive growth given it has larger scope in which to do this.

Several economists though have advocated for a long time that US economy is in a position (i.e. a ‘liquidity trap’) in which monetary policy is, to a large extent, an ineffective tool to boost growth Despite an all-time low interest rate of 0.25% for over a year and several rounds of Quantitative Easing (QE) implemented by the Federal Reserve, substantial and sustainable growth has not materialised. With the Fed also seeming to rule out any new action to kick start the economy until after election and Congress not blinking, the short term health and future direction of the US economy increasingly hinges on the outcome on November the 6th.

Running for a second consecutive term in office is President Barack Obama. He will be campaigning partly on the basis that while in office his economic policies prevented a repeat of the type of financial conditions seen in The Great Depression and now under his guidance the US is on a path to recovery, all be it a very slow one . Many would claim that the incumbent has not gone far enough with his economic policies to restore the US to the growth it saw before the financial crisis hit.

An example being his largest economic policy to date, the $787 billion 2009 ‘American Recovery and Reinvestment’ stimulus package. While the total size of the package might sound like a lot, when comparing it to the size of the US economy at the time, it is minuscule. The package only accounted for around 2.6% of total GDP over the period of 2009/2010. Furthermore the central problem of a total loss of spending in the economy (estimated at around $2.9 trillion) was not properly addressed as the stimulus plan consisted of only about $600 billion of actual spending. This was clearly not enough to deal with the dramatic slump of consumption as it didn’t even cover over a third of the total spending lost.

The overall failure to restore substantial growth was clear to see. Despite the package pumping $241.9 billion into the economy, stirring growth to a robust 3.9% by early 2010. Growth, consumption and investment fell thereafter, resulting in the unemployment rate rising to 9%, as it became obvious that the package had not been large enough. Moreover the ineffectiveness of the package gave ammunition to the Republicans, who were reluctant in ratifying the plan in the first place, to prevent any additional spending by the government to help support the economy.

In the aftermath of the crisis Obama has attempted, the degree to which can be debated, to try and prevent another repeat of the implosion of the financial system. The most significant being the Dodd-Frank Wall Street Reform Act, which is the most comprehensive financial reform since the Glass-Steagall Act of 1933, with the intention to improve the overall regulation of the banking sector. But the way in which his administration approached reform in the financial sector drew anger from sections who claimed that it didn’t go far enough in reining in and punishing those responsible for the crisis in the first place.

Another major policy implementation by the President has been the Patient Protection and Affordable Care Act (PPACA) of 2010, referred to generally as Obamacare. The act, which has provoked much controversy in the county and had substantial opposition from the GOP, is aimed at decreasing the number of uninsured Americans and reducing the overall costs of the healthcare system (the US has the most expensive but inefficient system in the western world). The impact of this act is still to be seen due to the constant Republican opposition which has led it to be referred to the Supreme Court in 2012 (the court upheld the constitutionality of most of PPACA). Further improvement of the US healthcare system is one of the main pledges given by Obama should he be re-elected.

Some of the other economic policies that have been instigated by Obama include: The raising of the federal minimum wage from $5.15 an hour to $7.25, favouring an increase in capital gains tax above the present 15% rate to 20% for families whose income is above $250,000 and attempts to implement the so called ‘Buffet Rule’ which would apply a minimum tax rate of 30% on individuals making more than a million dollars a year. No doubt the biggest challenge facing Obama in his campaign will  be re-elected is to regain the trust and confidence of the American people that he is the man that can once again restore growth in the US to the level it once was, despite failing to do so first time around. It remains to be seen whether the electorate are willing to give the man, who campaigned firmly behind the slogan ‘Yes We Can!’ in 2008, another chance to revive the country’s economic fortunes or whether the US people have finally decided that ‘No He Can’t!’.

Opposing him will be Republican Mitt Romney, who recently compounded the shift to the right in US politics by appointing uber conservative Paul Ryan as his running mate. Much of the media has focused on Ryan’s and not Romney plan for the economy, perhaps a sign of the lack of direction the formers campaign is at risk of being characterised by. Romney endorses the so called Ryan Budget, the now well-known and controversial deficit reduction plan. The main victims of the cuts will be the poorest Americans, 62% of cuts are aimed at programs targeted at aiding those on low or moderately low incomes. Medicaid, a program that provides health care to those on low incomes or with disabilities, will be hit with $1.4 trillion cuts thus withdrawing health care from 11 million people. A voucher system is planned to be introduced alongside Medicaid, in the name of increasing consumer choice and competition. These buzz words translate to giving more power to insurance companies, who have it in their interests to try and reduce care and shift the focus away from pre-emptive care.

Even with these harsh cuts to social programs the budget will (if the numbers add up, and many believe they do not) take 18 years to balance. This is because of the plans to further increase military spending, which under Obama has increased to its highest level since World War II. This illustrates the hypocrisy that lies within the Republican Party’s ideology. While championing freer markets with minimal government intervention, they virulently defend an increased military budget which is ironically the least competitive US industry. 

The main reason for the focus on the Ryan Budget is that there is no clear path being proposed by Romney himself. He has released his own 59 point plan for the economy, described by some as “50 shades of Grey without the sex”, light on detail and avoiding difficult or interesting questions. This non-committal stance may be tactical, it is easy to see his opponent struggling with a weak economy while not offering an alternative that may itself be criticised, but with so much focus this election on the economy it will be risky to give it the silent treatment for too long.

A key component of the plan is Romney’s commitment to lowering taxes. With this he seeks to be seen as the candidate for the middle class. His tax cuts would represent roughly a $1000 saving for the moderately well-off family, while those earning over $1m will benefit by $250,000. The tax cuts will be paid for by making the system simpler, first by the notoriously hard task of removing  loop-holes and secondly by reducing tax breaks. These breaks include mortgage reductions, local tax deductions and pension and tax benefits, measures that all aid the middle class. Give with one hand, take away with the other.

While tax remains a divisive issue, the economic impact of Romney’s foreign policy is often forgot about amidst his pandering to Israel and approaching on racist rhetoric towards Arabs. Perhaps the most important relationship America now has is with China. Relations between the world’s two biggest economies have long been strained by the latter’s trade practises and Romney has already ruffled feathers in the Far East by labelling the Chinese “currency manipulators” and describing their currency policy as “cheating”, as well as criticising Obama’s supposed weak stance with the Chinese. What these statements will lead to if he becomes President is unclear but any trade war and rush to protectionism will be disastrous for the recovering US economy.
  
So while Mr Romney describes the levels of poverty in America as “tragic” it is undoubted that his policies will further increase inequality in the most unequal advanced economy. Even ignoring the social context of this shift, it has a wider toxic impact for the economy as a whole. With the population desperate for the economy to accelerate forward all growth is being made at the very top of the pyramid (in 2009-2010 the top 1% captured 93% of the income growth). While the majority of income growth for those at lower incomes is immediately spent, going back into economy, those at the top have a much lower propensity to spend. More importantly the richest, who have sought to buy political influence, do not require as many public services as the 99% and make a habit of avoiding taxes, so use this influence to block any attempt by Government to tax them and invest in infrastructure, education and technology. This means that many potential innovators and entrepreneurs coming from lower incomes may never have the opportunities afforded to their wealthy peers.

What must be remembered is that this is not only a divisive election for the US economy but globally. The time in which it takes for the World’s richest nation to find its feet again, will significantly impact on the prosperity of the rest of us. For the electorate it is a choice between the man that has prevented a repeat of the harsh conditions of 1930’s but has failed on his promise to return America to the path of sound and sustainable growth. While on the other side is a Republican who seeks to return the nation to its Conservative roots both fiscally and socially. Though many believe his ideal America is based on fantasy and that his policies will drive it further away from a return to prosperity.

Authors: Thomas Viegas and Andrew Whitehead

The Inevitable Option

With the people of Greece going to the polls for a second time, after pro-austerity parties were not supported as much as needed (Funny that!), the possibility of a Greek exit from the Eurozone has become increasingly real. The The fall out this could have for the rest of the zone and the world would be massive. However a state in which Greece would keep the single currency could potentially do even more damage in the longer term. Let’s have a look at what could happen next if Greece decided to leave the zone and return to the Drachma.

First off the Drachma would plummet in value against all other currencies, and fast. This would then make imports, which include a lot of food and medicine for Greece, much more expensive and exports extremely cheap. There would almost certainly be a run on Greek Banks which would leave them on the brink of collapse. Greeks would not be able to easily access their own savings, many businesses would go bust due to lack of funds. This would also impact on other European Banks, particularly French ones, which have lent heavily to southern Europe. These banks would become nervous and slash their lending. Thus forcing many firms and consumers to cut back on their own spending. Events that all strongly point to a potential Eurozone recession. Furthermore all this would increase investor’s nervousness across the world, thus leading to the value of stocks falling and the selling off of many risk assets while the fight over safe assets would begin. Moreover let us not forget the immediate impact this would have on other zone states such as Spain especially and Italy. Access to market funds will become even harder as bond yields rise, leaving bailouts as the most viable option. In all, the worst case scenario is that the global economy falls to its knees once more.

However if Greece decided to keep the euro, which basically depends on the results of the second election in June, what would happen then? Well first off it would have to devalue to become more competitive in order to reduce its debt in the long term. The only way it could do this is through internal devaluation, reducing the unit costs of the goods and services it produces to increase its total exports. However with the unions in uproar already due to the savage public sector reductions already in force, anymore action towards reducing the public sector and its costs in further will face increased opposition. Secondly it is likely that the Greek Government would have receive further funds into to keep up with its debt repayments, something that seems increasingly unlikely due to both increased resistance by the German taxpayers and the lack of belief from other zone countries that Greece can actually pay back its debts. The pressure by investors on other southern states such as Spain and Italy would also mean that more bailout funds could be needed. In all it would be a costly and painful process for not only the Greek people but the majority of Europe.

Regarding the longer term existence of the euro, two main ideas have been put forward by both politicians and commentators. The first, which is being advocated by the new French government and is supported by Greece, is the creation of Eurobonds. These are bonds, probably 10 year bonds, which would be released by the zone states together which would allow them all to borrow money from the markets, in all it would be collective debt for the Eurozone. With Greece, Spain, Italy and Portugal facing increasing difficulties and costs from borrow money by releasing separate bonds; Eurobonds would allow these countries to borrow at a cheaper rate thus increasing the possibility of these countries repaying their debts. The main opposition to this is from Germany, who argues that it goes against the EU treaty and could lead to a large increase in costs for their country who can currently borrow around zero, or even negative, rates.

The other suggestion is increased integration of the Eurozone countries, both politically and economically. Some analysts have stated, rightly in my opinion, that creation of the euro was flawed from the beginning due to its failure to have both fiscal and monetary integration of member states. A need for a ‘United States of Europe’ or something to that effect would be needed for the zone such that if problems, like that in Greece, arose again then a transfer union and central fiscal authority would greatly help troubled zone states. This is similar to the way some poorer states, such as New Mexico and Mississippi, in the US are compensated by richer states, such as New Jersey and New York. While the future of the Eurozone and its type of existence still has some time to be decided, the current existence of Greece in the zone has not got time and even multiple options. The inevitable has finally come. The Greek exit will, for the sake of its people and the future of the euro project, and needs to happen.

Author: Thomas Viegas