Tag: fiscal policy

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Economics

[2670] Be careful with the no-default narrative

There is a narrative going around in Malaysia that a government which has a majority of its debts denominated in a local currency can never default on its borrowings. For the purpose of clarity, it is the case where a national government has control over both its fiscal and monetary policy.

I have trouble with that narrative. In case of locally-denominated government bonds, it does certainly make default less likely than the case of foreign-denominated borrowings. But, that is of no guarantee of no-default.

A government for instance can certainly refuse to service its debts even if it is more than capable of fulfilling its obligation. Outright refusal happens very rarely and this is world, it is probably an absolutely disastrously crazy thing to do but I only highlight it to show that a government can default at any time and in this case, voluntarily. The debate about the debt ceiling the United States is an example of voluntary default; without further borrowings, the United States may have to default on its loans payment although it definitely can close down some of its government services before having to resort to defaulting.

Notwithstanding voluntary default, in the case of locally denominated government bonds as a sufficient condition for the outcome of no-default is dependent on the ability of the government to raise more debts to service its preexisting financial obligation when there is revenue shortfall. It depends on several matters. That includes the willingness of the central bank to monetize government debts, its willingness to commit seigniorage or the willingness of the private sector or anybody else which includes foreigners to purchase the government debts.

The most relevant factors to consider are the willingness of the central bank to monetize government debt or to commit seigniorage (money printing).

A fiercely independent central bank can easily refuse to do both, especially when the central bank has a commitment to price stability. In normal times, debt monetization and seigniorage do contribute to inflation in a big way. Without the central bank and without the power of a monetary authority, the government will default.

So, the truth is that a government cannot default of its locally-denominated debts if the central bank cooperates with the government. And if the central bank does decide to cooperate, there is cost to that cooperation.

In talking about that no-default guarantee especially within Malaysian context which both sides of the political divide do misrepresent and wrongly contextualize economic issues in supporting convenient political positions, the cost of the no-default scenario is not discussed.

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Economics

[2657] Fiscal devaluation mimics currency devaluation

I am a supporter of regionalism. Despite whatever jokes I may have about the euro, I do not want to see its disintegration.

While I have refined my opinion by stressing on the importance of having similar economies coming into a union instead of having a disparate set of economies with wildly different setups and cycles coming together, I do still pretty much in favor of monetary union. I may be in the minority now but I do advocate a single currency for Southeast Asia. Not for all countries in the region but maybe just between Malaysia, Singapore and Brunei. These countries were in a union before while Singapore and Brunei are effectively already in a currency union. Furthermore, Malaysian and Singaporean economies are similar in many ways – both are trade-dependent though more so for Singapore. A combination of Indochinese countries can form another separate union. So, I envision at least two monetary unions within Asean (or three with Indonesia and Timor Leste together).

I am still amazed by the fact my trade professor at Michigan showed me. During one winter morning, he showed that trade between New York and Seattle was many times higher than between Seattle and Vancouver, despite the fact that Seattle is much closer to Vancouver than New York. “It appears Canada is located on the moon!” he stressed.

He was demonstrating that monetary union increased trade. As a strong believer of the net benefit of free trade, I was hooked by it. Even now.

And Europe has benefited from its monetary union, even as it is hobbled by troubles right now.

One painful but the obvious solution to the ongoing European problem is for countries in economic recession, indeed, depression, to leave the Eurozone and devalue their currencies. That would have happened in a typical country during a recession. Currency devaluation helps a country regains its competitiveness by making its exports cheaper to the rest of the world. That what happened in Malaysia in the periods after the worst recession the country has ever experienced yet. That was what happened in Asia. It was an export-driven recovery.

For the 17 members of the Eurozone, devaluation is not an option if the integrity of the euro is cherished.

There are alternatives to exit from the Eurozone.

The first was internal devaluation. This pretty much refers to austerity measures. Wages are cut down to make a crisis country more competitive, among others. This a painful because while it does aid competitiveness, it does create a downward spiral that is associated with deflation. People will not spend before they expect prices tomorrow will be cheaper than today. People will not spend because they have less money. While real prices will adjust in the long run, the short term can be really painful.

There is an interesting article on Bloomberg today about fiscal devaluation as proposed by economist Gita Gopinath (of Harvard “Call Me Maybe” recruitment video fame, anybody?).[1] It tries to mimic the effect of currency devaluation, which makes it very appealing. It includes a hike in value-added tax along with the provision of tax credit. The arrangement discourages imports and support exports. The VAT is imposed on all domestically consumed or used goods but the tax credits are granted to all domestic producers that eliminate the effect of VAT. Exporters benefit from this setup. Importers suffer. The great part is that it is no clear link to price deflation, which makes this arrangement usable in time of recession.

That however does raise the alarm of protectionism. In times like this in Europe, it is tolerable. In normal times, this can be a barrier to free trade. It can give unfair advantages to the home countries that may later mimic the ugliness of currency wars.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
[1] — When French President Francois Hollande unveiled a plan in November for a business tax credit and higher sales taxes as a way to revive the economy, he was implementing an idea championed by economist Gita Gopinath.

Gopinath, 41, a professor at Harvard University in Cambridge, Massachusetts, has pushed for tax intervention as a way forward for euro-area countries that cannot devalue their exchange rates. ”Fiscal devaluation” is helping France turn the corner during a period of extreme budget constraints, former Airbus SAS chief Louis Gallois said in a business- competitiveness report Hollande commissioned. [Rina Chandran. Harvard’s Gopinath Helps France Beat Euro Straitjacket. Bloomberg. February 7 2013]

Categories
Economics Politics & government

[2640] Welcome back, LDP

I do not understand the intricacies of Japanese politics. I simply do not follow it closely. But I do know that Japan can play a significant role in Asia, if it finally decides to take up that role, which it has not under the uncertain leadership of the Democratic Party of Japan.

The DPJ wanted a closer relationship with Asia and less of the US. Contrary to what it hoped to achieve, a DPJ-led Japan has not successfully engage China and Japan now needs to forge a strong relationship with the United States in time when China is rising and growing more assertive against its neighbors. DPJ’s economic management itself has not been stellar but I think there it is unfair to blame to DPJ for that.

Unhappy with China, I welcome the reelection of the more conservative Liberal Democratic Party and a Japan with a backbone. That is so because it is almost certain that the LDP will strengthen its relationship with the US. With a stronger relationship with the US and a strong US presence in East Asia (and Southeast Asia), hopefully China will think twice in asserting its weight around the region. China has been an irresponsible giant so far, escalating crisis when a mature power would have handled it with care instead. For instance, is it really necessary to send a plane over the Senkaku islands?

A more hawkish (not too much I hope) Japan will tell China that it cannot bully its way through the region any longer. Rather than a hawk-dove strategy, now China faces a hawk-hawk scenario, which is more complicated and may force China to rethink its assertive, bullying regional policy into something more cooperative and amiable.

A hawkish Japan does have its own problem but at the moment, I do want a Japan that is willing to stand up in the region. China needs to learn that its bully tactics does have consequences and an LDP Japan can push back and say, no, play nice.

One big issue with LDP is its economic policy of Japan. First is the government interference in monetary policy. The Bank of Japan is losing its independence with the government trying to force the central bank to target for higher inflation rate. While I do think Japan needs a bit of more inflation, I am unsure how the interference will pan out. Lack of independence can be a recipe for too much inflation. There is some nuance in the interference in the sense that LDP government wants a stricter (but higher inflation) rule for the BOJ to follow but it does create a precedent of interference nonetheless.

On the same track, the LDP government will embark on a massive stimulus program to revive the economy. I prefer monetary to fiscal stimulus. The preference presents me with a problem: BOJ itself is too conservative to my liking and that probably makes the executive infringement into monetary policy somewhat palatable. Nevertheless, with expansive and coordinated fiscal and monetary policies, I suppose you will get inflation.

Finally, while I welcome the return of the LDP, I do not think the election of DPJ was a mistake. The Japanese system needs a shake-up and the DPJ did just that, even if it did not fulfill its promise. Being in power for too long can be dangerous to a political culture because it implants the party into the state apparatus. For a healthy democracy to prevail, the state has to be ultimately separate from the party. In the case of Japan, there is an additional dimension: the civil service is too influential. From my readings, the DPJ did have some successes in reigning the influence of the Japanese civil service, and that is good.

Categories
Economics

[2637] The necessity of fiscal austerity, sometimes

This is an excerpt from an old article by Raghuram Rajan. The excerpt is a point on the necessity of having a fiscal austerity program during crisis times even when it is ideal to have it spread over time. It is not a new point, but it is worth to be highlighted as a reminder on why some things are as they are right now.

…Fiscal austerity is not painless and will probably subtract from growth in the short run. It would be far better to phase reforms in over time, yet it is precisely because governments did not act in good times that they are forced to do so, and quickly, in bad times. Indeed, there is a case to be made for doing what is necessary quickly and across the board so that everyone feels that the pain is shared, rather than spreading it over time and risking dissipating the political will. Governments should, however, underestimate the pain that these measure will cause to the elderly, the youth, and the poor, and where possible, they should enact targeted legislation to alleviate the measures’ impact. [The True Lessons of the Recession. Raghuram Rajan. Foreign Policy. May 2012]

Categories
Economics

[2633] What is the benchmark of failure for austerity?

Has austerity failed?

In the sense of expansionary fiscal contraction, it has. Expansionary fiscal contraction, in short, suggests that government contraction will immediately expand the private sector. That particular interpretation of fiscal austerity has clearly failed to bear out in countries under crisis. It is like the argument that says reducing taxes will increase government revenue, which is untrue if the economy is on the left side of the Laffer curve.

I do not believe in expansionary fiscal contraction. Other parts of the economy have to grow more than the fiscal contraction caused by austerity if the economy is to expand. In times when taxes go up and public spending goes down, especially in an economy dominated by the public sector, an immediate expansion will be impossible.

But the hypothesized result of expansionary fiscal contraction is a narrow benchmark to measure austerity on. Maybe it is a poetic justice to measure harsh policy harshly.

But the success of austerity can be measured against future growth instead of current growth (or rather current contraction). The idea of austerity is to swallow the bitter pill and get well after that. The point of putting government finance in order is to ensure that the government will not go bankrupt or unable to finance its operations.

Swallowing the bitter pill means the same operations that the government would be unable to finance if it had not switched gears would be cut down to a more reasonable level given the condition of public finance. What makes the cut down bearable is that it usually comes with aids: money for government under severe financial pressure. It means instead of cutting down services drastically under no austerity-no aids condition, the austerity scenario with aids prevents the bankruptcy scenario from happening altogether, with less severe cut.

The cut in public spending in times of recession will be painful and that much is clear. Yet, pointing out that austerity is painful is not enough as a benchmark to say that austerity has failed. There has to be a comparison and the comparison is, how more painful austerity is compared to a scenario of bankruptcy?

There is every reason to believe that the latter scenario (the bankruptcy scenario) will be more painful than the former (austerity). If cutting a significant level of services under the austerity program is painful, imagine a complete collapse of services when the government goes bankrupt. Austerity is the bitter pill to avoid a worse fate.

It is worth stating that austerity is the last option. It is required when countries run out of its economic wits. Despite criticism macroeconomics has suffered in the past few years, I think we still know enough that there are wide options of tools (monetary policy anyone?) before we will be left with severe austerity program.

So, how much pain avoided then should be the benchmark of success for any austerity program. The avoidance of government collapse is another benchmark of success because a collapse is exactly what austerity should aim to prevent.

So, has austerity failed?

When somebody pronounces the failure of austerity, I am almost always wanted to raise my hand and ask, “what is the benchmark of failure?” I suspect those who pronounce the failure believe that pain itself is a failure. If that is the benchmark, then I will disagree with it as I have explained earlier: pain alone is not enough; we need to ask if austerity is more painful than no austerity.

This however does not mean austerity should be done in one shot. There is only so much pain anybody can bear before a society collapses or like in the case of Germany, turns to fascist and other extremists for cure. The point of austerity is to prevent that collapse.

That does not mean austerity should be done in one shot. I prefer an austerity program distributed over time, with a combination of aids, debt relief, low interest rate, long repayment and fiscal reform of government under austerity program.

The alternative to austerity is expanded government spending but in many countries under pressure, they do not have the financial resources to do just that. And there are few countries that are willing to throw money into a blackhole called “helping others” without any fiscal reform associated with a typical austerity program.