Archive for the ‘Economic Policy’ Category

Credit Rating Agencies and Brazil: Why the S&P’s Rating of Brazil’s Sovereign Debt Is Nonsense

Michael Stephens | September 13, 2015

by Felipe Rezende

So S&P has downgraded Brazil’s rating on long-term foreign currency debt to junk and lowered its long-term local currency sovereign credit rating to ‘BBB-‘ from ‘BBB+’.

First, what are sovereign debt ratings? Standard & Poor’s sovereign rating is defined as follows:

A current opinion of the creditworthiness of a sovereign government, where creditworthiness encompasses likelihood of default and credit stability (and in some cases recovery).

So the ratings are related to “a sovereign’s ability and willingness to service financial obligations to nonofficial (commercial) creditors.”

What does this tell us? To begin with, credit rating agencies have repeatedly been wrong. The same agencies that rated Enron investment grade just weeks before it went bust, the same people that assigned triple-A rating to toxic subprime mortgage-backed securities are now downgrading Brazil’s sovereign debt. As the FCIC report pointed out, “The three credit rating agencies were key enablers of the financial meltdown. The mortgage-related securities at the heart of the crisis could not have been marketed and sold without their seal of approval.” (FCIC 2011)

After all, should you take the credit rating agencies seriously? The answer is no. Brazil is a net external creditor, that is, though the federal government has debt denominated in foreign currency, it holds more foreign currency assets (figure 1) than it owes in foreign currency debt (figure 2). Brazil’s public sector can pay all of its long-term financial obligations denominated in foreign currency. Moreover, Brazil’s federal government can never become insolvent on obligations denominated in its own currency (note that since 1999 Brazil maintains a floating exchange rate regime, which increases domestic policy space). continue reading…


Binzagr Institute Inaugural Conference: Sustainable Full Employment and Transformational Technologies

Michael Stephens | September 9, 2015

The Binzagr Institute for Sustainable Prosperity is holding its inaugural conference — Provisioning and Prosperity: Sustainable Full Employment and Transformational Technologies  — October 2nd-3rd at Denison University. For those who cannot attend, the event will be livestreamed (and questions can be posed via Facebook and Twitter @BinzagrInfo).

More information on registration and conference themes can be found here. See below for the list of speakers:

Jan Kregel*, Advisory Board Member, Binzagr Institute
William A. Darity, Jr.*, Professor of Economics, Duke University
Stephanie Kelton*, Chief Economist, U.S. Senate Budget Committee
Julianne Malveaux*, Advisory Board Member, Binzagr Institute
L. Randall Wray, Professor of Economics, University of Missouri – Kansas City
Mathew Forstater, Research Director, Binzagr Institute
Fadhel Kaboub, President, Binzagr Institute
Ahmed Soliman, Research Scholar, Binzagr Institute
Scott Fullwiler, Research Scholar, Binzagr Institute
Pavlina Tcherneva, Research Scholar, Binzagr Institute
Ellen Brown, Research Scholar, Binzagr Institute
R. Paul Herman, Founder and CEO, HIP Investor
Robert W. Parenteau, Research Fellow, Binzagr Institute
Elsadig Elsheikh, Director, Global Justice Program: Haas Institute (UC-Berkeley)
Marco Vangelisti, Research Fellow, Binzagr Institute
Raúl Carrillo, Research Fellow, Binzagr Institute
Shama Azad, Research Fellow, Binzagr Institute
Natalie Brown, Research Assistant, Binzagr Institute
Aqdas Afzal, Research Assistant, Binzagr Institute

* invited (to be confirmed)


S&P Threatens to Downgrade Brazil to Junk

Michael Stephens | July 30, 2015

by Felipe Rezende

S&P has issued a negative outlook regarding Brazilian sovereign debt. The S&P’s announcement stated that

Over the coming year, failure to advance with (on- and off-budget) fiscal and other policy adjustments could result in a greater-than-expected erosion of Brazil’s financial profile and further erosion of confidence and growth prospects, which could lead to a downgrade. The ratings could stabilize if Brazil’s political certainties and conditions for consistent policy execution–across branches of government to staunch fiscal deterioration–improved. It is our view that these improvements would support a quicker turnaround and could help Brazil exit from the current recession, facilitating improved fiscal out-turn and provide more room to maneuver in the face of economic shocks consistent with a low-investment-grade rating.

This warning has been echoed by other credit rating agencies threatening to downgrade Brazilian sovereign debt to junk. But, should anyone trust credit rating agencies? Once more, credit rating agencies are clueless in their assessments. They have specialized in making the wrong assessments regarding sovereign governments’ capacity to pay local-currency debts. They have downgraded sovereign governments like the US, UK, Japan, and now Brazil. Paradoxically, credit rating agencies, which have a track record ranging from arbitrary and imprecise to clueless (here, here, here, here), can still dictate the outcomes of the fiscal policies of sovereign governments.

Recent downgrade warnings by CRAs and market pundits have triggered discussions inside the Brazilian government to implement austerity measures, including welfare programmes and public investment initiatives.

President Dilma Rousseff won’t change course. She has reiterated that “[It] will last as long as necessary to rebalance our economy.” She has invoked the government-as-household analogy, stating that: “You who are a housewife or the father of a family know what this is … Sometimes we have to rein in expenses to keep our budget from going out of control … to ensure our future.” Rousseff is under pressure to impose a fiscal austerity agenda to avoid a downgrade by credit agencies.

The current direction of Rousseff’s policies has exposed its contradictory tendencies in combining austerity policies while trying to maintain or reclaim the pre-crisis progress. This combination leads to incoherent policy formulations and more drift, rather than embracing a demand-led strategy. continue reading…


Not All Macro Models Failed to Predict the Crisis

Michalis Nikiforos | April 16, 2015

Noah Smith has a post on the failure of macro theory to predict the crisis. He concedes that DSGE models did very badly on this score, but, he continues, “There are no other models out there that did forecast the crisis” and there is no better alternative.

The word “better” is important here because some “angry heterodox” people have pointed Smith to at least one alternative—Wynne Godley’s Seven Unsustainable Processes—that had in fact predicted the crisis. However, Smith rejects this as “basically just chartblogging” [emphasis added]. He writes that

Yeah, sure, if you put out hand-wavey reports saying “capitalism sux, there’s gonna be a crash!” every year or two, you’re eventually going to be able to say “see, I told you so”. But that’s no replacement for real modeling.[sic]

First of all, there is nothing wrong with chartblogging. In fact, Noah Smith is a chartblogger—an excellent one.

Having said that, is Godley’s argument just hand-wavey-capitalism-sux-chartblogging or is there something more to it (perhaps even some real modeling)?

To begin with, Godley’s argument in the Seven Unsustainable Processes (which is a policy paper) is based on his theoretical work. Godley was one of the major proponents of what is today called Stock-Flow Consistent methodology. Some of his books and his writings (with real models and everything) are here, here, and here.

(The other major proponent of this methodology was James Tobin. His lecture when he was awarded the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel was a manifesto of this methodology.)

Based on this theoretical work, in the 1990s Godley built a more policy-oriented macroeconomic model at the Levy Economics Institute. The simulations in the Seven Unsustainable Processes were produced with this model (and are thus far from chartblogging).

To understand the argument of the Seven Unsustainable Processes we need to keep two things in mind. First of all, the analysis is Keynesian, so it is aggregate demand that drives output, employment, and growth. These Keynesian results do not stem from imposing rigidities on an otherwise supply-side neoclassical model.

A second important piece of the analysis is a simple macroeconomic identity that comes straight from the National Accounts:

(Private Expenditure – Income) + (Government Expenditure – Income) = Current Account Deficit

In other words, the sum of the private sector and government sector deficit is always equal to the current account deficit. Accounting consistency requires that the flows expressed in the three balances accumulate into related stocks. For example, if the private sector is running a deficit, that will (ceteris paribus) tend to decrease its net worth and increase its debt and debt-to-income ratio.

The examination of these financial balances in relation to income (or GDP) is important because it gives clues about (i) central structural characteristics of an economy, (ii) which component of demand is driving growth, and finally (iii) what net assets/income ratio for each sector is implied from the current situation.

Having said this, we can now go to the crisis and the question of whether Godley actually predicted it or not. continue reading…


How Do We End the Inequality Feedback Loop?

Michael Stephens | April 7, 2015

“As Hyman Minsky argued, there are many varieties of capitalism, some more stable than others—and, we can add, some more equitable than others.” — Pavlina Tcherneva

Pavlina Tcherneva has revisited her (in)famous inequality chart, which showed an ever-rising majority of the income growth during post-1970s economic expansions being captured by the wealthy (specifically the top 10 percent of income earners). In a recently released policy note, “When a Rising Tide Sinks Most Boats: Trends in US Income Inequality,” she has updated the numbers through 2013 and broken down the top decile further (top 1 percent and 0.01 percent), compared the results of including or excluding capital gains, and looked at what happens to the distribution of income growth when we expand our scope to the entire business cycle (Tcherneva looks at NBER-dated GDP cycles as well as “income cycles” based on real income data from Piketty and Saez).

Here are some of the results:

  • The capital gains discussion yields a somewhat counterintuitive result: when you exclude capital gains, the distribution of income growth between the top 1 percent and bottom 99 percent appears more unequal. Tcherneva explains that this is because even though the bottom 99 percent have barely any capital gains income to speak of (2 percent of their income), their shrinking wage incomes meant that, from 2009-13, these meager capital gains were making the difference between declining (excl. cap gains) and merely stagnating (incl. cap gains) incomes for the bottom 99 percent.
  • When we look at entire economic cycles (peak-to-peak GDP or peak-to-peak income) rather than just the expansion periods, the picture doesn’t look any better. In fact, it’s worse. As Tcherneva notes, although the wealthy tend to lose disproportionately more of their income very early on during downturns, they recover faster and stronger than the bottom 90 percent: “Since the ’70s, when we look at the period beginning only one year after a downturn [and ending at the subsequent peak of the income cycle], the cycle delivers between 78 percent and 107 percent of the income growth to the wealthiest 10 percent of families.” In other words, she writes, “the way we grow recovers the incomes of the top 10 percent first.”
  • She also includes the chart below, which, though not quite as striking at first glance, becomes even more galling as you let it sink in. The chart shows the shares of income growth captured by the bottom 99.99 percent and the top 0.01 percent. By contrast with the other charts (90 percent vs. 10 percent and 99 percent vs. 1 percent), the blue bar is still bigger than the red, but keep in mind we’re talking about a tiny fraction of a fraction of the population in that red bar — around 16,000 families — and as you can see, they gobbled up practically one-third of all the income growth in the last full expansion period (2001-07), with the same worrying trend suggesting itself.

Tcherneva_Levy Institute_When a Rising Tide Sinks Most Boats_Fig3

Tcherneva also comments on the need to reorient our broader policy approach (such that it exists) to combating inequality. One of the points she makes is that we give up too much terrain when we focus disproportionately on raising top marginal income tax rates. continue reading…


Berlin Wall

Jörg Bibow | November 12, 2014

Germany is celebrating: it is 25 years ago that the Berlin Wall came down, marking the end of Stasi tyranny, and much more than that. No doubt that is reason to celebrate, for Germany, Europe, and the world. As a German and European, I am celebrating too.

Alas, this is also an occasion for hearing that tiresome story again about how costly and burdensome it was for Germany to reunite. For instance, Terence Roth writes a piece in the WSJ titled “After Fall of Berlin Wall, German Unification Came With a Big Price Tag.” Now, this kind of statement really needs to be qualified, especially as the myth about the “burden of unification” paved the way for yet another German myth a few years later that has proven rather catastrophic for Europe: namely, the myth that Germany had to “restore its competitiveness,” which it apparently had lost in the context of reuniting. Undisturbed by any doubt or reason, the German authorities live in their mythical world of economic virtue and vice, famously referred to by finance minister Wolfgang Schäuble as his “parallel universe.” Let’s try to get the matter straight then.

To begin with, it is unquestionably true that German unification came along with a big price tag. But the price Germany ended up paying was only partly due to the wreckage that communism had produced in the east. The macroeconomic policy response, featuring ultra-tight money and mindless fiscal austerity, proved far more costly. In 1991, both Germany’s consumer price inflation and budget deficit as a share of GDP were about 3 percent. Imagine the Federal Reserve responding to the historical challenge and responsibility of national reunification by monetary overkill—which is exactly what the Bundesbank chose to do, hiking rates to 10 percent and pressuring fiscal policy into sharp tightening too. Ironically, this counterproductive macro policy mix pushed headline inflation up, apart from crushing growth. As a consequence, on top of the legacy of wreckage in East Germany, unemployment in former West Germany doubled as 1.5 million jobs (5 percent of the labor force) were destroyed. Unsurprisingly, Germany struggled until 1998 to get the budget deficit back to just below 3 percent. Only the smaller part of the rise in Germany’s debt ratio from 40 to 60 percent of GDP over the 1990s owed to East German legacies (see here and here).

This is not where the story ends though. continue reading…


Did Ms. Rousseff’s Epiphany Come Too Late?

Michael Stephens | October 15, 2014

by Felipe Rezende

If you’ve been tracking the news on Brazil’s presidential election, you already knew that incumbent Rousseff will face Neves in a runoff election for Brazil’s presidency on October 26th. The tight election reflects the perception of a downward trend of the nation’s economic outlook augmented by news that Brazil’s economy has fallen into recession in the first and second quarters of 2014. This really isn’t looking like the election the Workers’ Party expected. Brazil’s unemployment rate has hit record lows, real incomes have increased, bank credit has roughly doubled since 2002, it has accumulated US$ 376 billion of reserves as of October 2014 and it has lifted the external constraint. The poverty rate and income inequality have sharply declined due to government policy and social inclusion programs, it has lifted 36 million out of extreme poverty since 2002. Moreover, the resilience and stability of Brazil’s economic and financial systems have received attention as they navigated relatively smoothly through the 2007-2008 global financial crisis. Brazil’s response to the largest failure of capitalism since the Great Depression included a series of measures to boost domestic demand.

So, what happened? The reason is fairly obvious, in the aftermath of the global financial meltdown, policy makers misdiagnosed the magnitude of the crisis, the changing circumstances because of it, and ended up withdrawing stimulus policies too early. The premature withdrawal of stimulus measures opened up space for critics, such as the main centre-right opposition party, to blame Ms. Rousseff’s administration as being excessively interventionist leading the Brazilian economy to perform poorly during the past four years. It fueled Mr. Neves’s campaign to convince anti-Rousseff voters he can get Brazil’s economy back on track.

Five years after the crisis where do we stand?

The Brazilian economy in the New Millennium experienced extremely favorable external conditions such as increasing global demand for emerging market exports and rising financial flows to emerging markets (Kregel 2009). Some critics of the Brazilian government argue that the positive economic performance during the past decade was solely due to external tailwinds fueled by the boom in commodity prices, buoyant external demand, and massive foreign flows into Brazil’s economy. This group tends to overlook domestic policies designed to foster private demand. Brazilian economic policymakers, by contrast, proudly point to government policies designed to boost growth. continue reading…


Can Fiscal Policy Stabilize the Economy?

Greg Hannsgen | September 10, 2014

[WolframCDF source=”” width=”397″ height=”448″ altimage=”” altimagewidth=”397″ altimageheight=”448″]
Here is a new Wolfram CDF, which I have constructed based on a macro model. The assumptions behind the model–other than the exact parameter values–are loosely stated in this list:

1) industries dominated by a handful of firms, rather than perfect competition
2) production technology that requires capital and labor inputs
3) chronic underemployment and less-than-full capacity utilization (percent of capital stock in use at a given time)
4) sovereign money and a policy-determined interest rate
5) two groups of households, only one of which has money to save
6) net investment a function of the profit and capacity utilization rates
7) budget deficits offset by the issuance of treasury bills and sovereign money
8) a government that employs workers to produce free public services
9) a fiscal policy rule with (a) a balanced budget target (labeled “0” in the CDF above) or (b) public production and capacity utilization targets (labeled “1” in the CDF above)
10) nonlinear functions that result in endogenous cycles in this figure for some parameter values and policy functions (try different parameter values with policy rule “1” for example)
11) gradual adjustment of public and private-sector output toward levels indicated by one of the two fiscal policy rules and output demand, respectively.

The arrows in the CDF show directions of movement in 2D space, where the two axes represent public production (horizontal) and capacity utilization (vertical). We got a different look at the same model in this previous post. In this new CDF, I have tried to improve on the realism of the parameter values. Here is a link to the download site at Wolfram for the needed CDFPlayer software.

The most serious omissions in the model above, by the way, are a foreign sector, a mechanism by which the broad price level can change over time, and commercial bank deposits and loans. As mentioned before, I am working on adding these and other new features to a larger version of the model depicted above for the upcoming International Post Keynesian Conference in Kansas City later this month. Any macroeconomic model, of course, is only an abstract and simplified version of a real economy. But the bottom line is that (1) guiding fiscal policy with a balanced-budget target leads to instability in all cases, while (2) the output-stabilizing fiscal rule generates a business cycle of varying size or convergence to a point.


Is Inequality Holding Back the Recovery?

Michael Stephens | May 21, 2014

“The biggest obstacle to a sustainable recovery,” according to the Levy Institute’s newest strategic analysis of the US economy, “is the inequality in the distribution of income.”

In their latest, Dimitri Papadimitriou, Michalis Nikiforos, Gennaro Zezza, and Greg Hannsgen begin with a familiar point: the Congressional Budget Office has been predicting fairly rosy economic growth rates for the coming years (rising to 3.4 percent in 2015 and ‘16)—rosy, that is, given the CBO’s expectation that government budgets will remain tight, and get even tighter, over this period (with the federal budget deficit shrinking to 2.6 percent of GDP by 2015).

As Papadimitriou et al. point out, the only way to make these growth and budget forecasts both come true, assuming there are no significant changes in net exports (a safe assumption), is if the private sector substantially increases its indebtedness. There really isn’t any other option. If we don’t see a return to ballooning private debt-to-income ratios, then either government budgets will have to be loosened or we won’t get the growth rates the CBO is telling us to expect.

Now, there are reasons to think that the reappearance of accelerated growth in private debt is unlikely (a theme the authors dealt with in their last US strategic analysis), but if it does happen, rising private debt ratios—which played the starring role in the financial crisis from which we’re still recovering—might destabilize the financial system. This is one sense in which maintaining tight government budgets over the next several years should not be portrayed, as it all-too-often is, as the “prudent” course of action.

And the widening of income inequality over the last few decades makes these dynamics even more problematic. As the authors point out, the trend of rising inequality has gone hand-in-hand with mounting indebtedness among households in the bottom 90 percent of the income distribution:

[O]ver the last 30 years not only was there a sharp increase in the level of household debt but a disproportionate share of this debt was incurred by the middle class and the poorest American households. Moreover, there seems to be a strong correlation between the two variables: as the disposable income of the top 10 percent of the population increased relative to the disposable income of the bottom 90 percent, the gross debt of the latter rose relative to the debt of the former.

Fig 10_Ratios of Disposable Income and Gross Debt_Levy Institute Strategic Analysis

Going forward, the current stance of public policy (including, but not limited to, tight fiscal policy) de facto requires a rise in household debt—borne entirely by the bottom 90 percent of households—as the only path to modest economic growth rates (in the range of CBO’s 3.1–3.4 percent). If, on the other hand, the bottom 90 percent of US households continue to “deleverage,” lowering their debt loads, then the authors show that we’re more likely to see economic growth fall to a piddling 1.7 percent by 2017, with unemployment rising to 7.6 percent.

In other words, absent a change in policy aimed at loosening the government budget or increasing net exports (perhaps through targeted R&D investment), the US economy is facing one of two outcomes: “a prolonged period of low growth—secular stagnation—or a bubble-fueled expansion that will end with a serious financial and economic crisis.”

“The only way out of this dilemma,” they conclude, “is a reversal of the trend toward greater income inequality. A change in the income distribution is a necessary condition for sustainable growth in the future.”

Read the report: Is Rising Inequality a Hindrance to the US Economic Recovery?


Can R&D Help Get Us Out of this Mess? A New Stock-Flow Analysis

Michael Stephens | October 23, 2013

Dimitri Papadimitriou, Greg Hannsgen, Michalis Nikiforos, and Gennaro Zezza have just published a new strategic analysis for the US economy, with a baseline projection and alternative policy simulations through the end of 2016. The report takes a closer look at the potential payoff of R&D investment in the context of a US export strategy.

As Papadimitriou et al. point out, fiscal policy at the federal level is simply stuck on a self-defeating course, with nothing but further growth-killing contraction on the horizon. Their baseline projection shows that if we stay on the current fiscal path, in which the deficit continues to shrink rapidly, growth won’t be high enough to appreciably bring down the unemployment rate — as far out as 2016 unemployment would be just below 7 percent.

The significant increases in federal spending that would be needed to accelerate the recovery and quickly bring down the unemployment rate don’t seem to be politically viable, to put it gently. So the authors turn to the external sector; more precisely, to an export-oriented strategy driven by innovation.

Research and development may be an area in which a proposed increase in government investment would attract less rabid congressional opposition. And from the authors’ perspective, recent revisions to the National Income and Product Accounts (NIPA) now allow us to get a better handle on what to expect from this sort of strategy: “we now enjoy an improved ability to conduct an inquiry in this area: R&D activity is the largest change to measured US GDP, with the recently revised NIPA concepts treating this sort of spending as a form of investment.”

They examine the effects of an increase in R&D spending of $160 billion per year (around 1 percent of GDP) through the end of 2016. This would be R&D expenditure focused on fields with applications in the tradable goods and service sector. In addition to the fiscal stimulus effects, part of the mechanism here is that innovation would increase average productivity in these export sectors, reduce unit costs and relative prices, and thereby boost export volume (“We assume that this spending is aimed exclusively at reducing domestic costs of production, although in reality the effects might also include bringing novel products to market overseas”).

The results of the R&D simulation show that unemployment would drop below 5 percent by the end of the projection period (2016Q4), with economic growth nearing 5.5 percent. Their simulations also suggest that R&D investment would be slightly more potent than the same amount invested in infrastructure, though the authors don’t present this as an either/or policy choice.

The result is particularly noteworthy, given that the meat-axe approach to federal budgeting over the last couple of years has meant that government investment in R&D has been stagnating — and is scheduled for big cuts (from ITIF, via Brad Plumer):

R&D Sequester Cuts

Papadimitriou et al. also introduce a note of caution in their new report. Many economic forecasts assume that the post-financial-crisis deleveraging process — the reduction of the private sector’s debt-to-GDP ratio — will end shortly. In other words, a lot of growth projections for the next few years assume renewed household and business borrowing.

The authors run a simulation in which deleveraging continues for households in particular. Why should we consider this possibility? “Following the work of Wynne Godley, we think it reasonable to argue that historical norms are relevant as benchmarks for household indebtedness ratios.” In this instance, taking that approach would mean treating the private sector’s negative net saving from the 1990s through the 2000s as an exception.

This is what household indebtedness would look like in this scenario (“scenario 3” in the figure, which includes the R&D investment of 1 percent of GDP per year. “Scenario 1” and “scenario 2” correspond to the infrastructure and R&D investment scenarios, respectively, but with the CBO’s more optimistic assumptions about the path of household debt):

Continued Household Deleveraging

If households continue to reduce their debt levels, the positive effects of the R&D investment would be somewhat blunted: growth would just fail to reach 5 percent by the end of 2016 and the unemployment rate would be about 5.5 percent (compared to sub-5 percent unemployment for the R&D scenario in which the household deleveraging process ends).

The upshot is that policymakers need to be prepared for the possibility that the deleveraging process is not finished. If households continue to reduce their debts, there will be even more drag on the economy — and an even more urgent need for ambitious thinking about policies to boost growth and employment.

You can read the report here (pdf).