Archive for the ‘Fiscal Policy’ Category

The Crisis in Brazil and the “Narrow Path” for Economic Policy

Michael Stephens | April 22, 2016

The big political story in Brazil is the potential impeachment of President Dilma Rousseff (Brazil’s lower house of congress voted in favor of impeachment; the motion now moves to the senate for consideration). To get an idea of how messy this situation is, note that the man leading the impeachment attempt, Speaker of the House Eduardo Cunha, is facing 184 years in prison for his role in the Petrobras corruption scandal. (In the NYTimes‘ Room for Debate series, Laura Carvalho describes the impeachment process as a parliamentary coup. See also Felipe Rezende’s critical take on the charges for which Rousseff is ostensibly being impeached: violation of the Fiscal Responsibility Law.)

All of this is happening against the backdrop of a multi-faceted economic crisis. Here’s Fernando Cardim de Carvalho’s summary of the situation from his latest policy note:

Brazilian real GDP is estimated to have contracted 3.8 percent in 2015. Meanwhile, annual inflation reached 10.7 percent in 2015 … The overnight cost of bank reserves in the interbank market (SELIC) is currently 14.25 percent. The exchange rate to the US dollar is around R$4, a 50 percent increase over a year ago. Fiscal space for implementing recovery policies is practically nonexistent, with fiscal deficits reaching 10.3 percent of GDP … Unemployment has been growing rapidly and the outlook for 2016 is not promising, to say the least, with the International Monetary Fund (IMF 2016) projecting a further contraction in GDP of 3.5 percent. Concerns about the solvency of large firms that have sharply increased their foreign indebtedness in recent years intensified with the steep devaluation of the real in 2015.

Cardim de Carvalho recently presented his analysis of Brazil’s political and economic challenges at the 25th Minsky Conference. He observed that for once the balance of payments has not played a key role in this economic crisis; nor are there any easily identifiable “external villains” this time around: “this … is an entirely domestically generated crisis.” (Here are the slides from his presentation; video is embedded below the fold.)

As he points out in the policy note (pdf), even a fully functioning, stable government would have a hard time addressing this mix of economic problems, but as it stands, it isn’t even clear who will be running the country in the near future. Cardim de Carvalho pins Brazil’s hopes[1] partially on maintaining the devaluation of the Brazilian real and advocates a change up in fiscal policy. But even here, there’s not much room for policy maneuvering: “For all practical political purposes, Brazil is stuck with fiscal austerity,” he laments.

Under the circumstances, policymakers might be able to do less damage by turning to what Cardim de Carvalho calls “smarter austerity”:  “an increase in public investment paired with less damaging spending cuts and revenue increases, could limit the negative impact on aggregate demand.” The problem, as he explains, is that implementing this kind of budgetary shift would require managing some complicated political trade-offs. Reading the headlines this week, it’s hard to imagine the political system pulling this off, no matter who ends up running the country until the 2018 elections. He’s not optimistic:

Only skillful negotiation led by a trusted political leadership could obtain current sacrifices from participants with a view to achieving better results in the future. Unfortunately, there does not seem to be the slightest possibility that such a negotiation could happen in the near future. The government does not seem capable of doing it. All initiative was lost when avoiding or beating an impeachment process became its first and practically only priority. On the other hand, no legitimate organized opposition exists to present demands and lead a negotiation on behalf of the people. The country has no “elders” to appeal to, no statesmen of recognized stature who deserve the trust of the nation.

Under such circumstances, until Brazil gets closer to the presidential elections scheduled for 2018, there seems to be no plausible alternative to the continuation of the recession and political uncertainty.

You can read the policy note here. See also Cardim de Carvalho’s working paper for more detailed data on how the Brazilian economy got to this point.

[1] “Hope” being the operative word: “While the extent to which the recent devaluation will help to engineer a sustained recovery is unclear, there is little doubt that a return to the overvaluation characteristic of the post-1994 period would kill any such possibility.” He expresses concern that Brazil’s deindustrialization may limit any potential expansionary effect from devaluation.

continue reading…


Is There a Solution to Brazil’s Crises?

Michael Stephens | April 5, 2016

This is the first of a series of blog posts on the Brazilian crisis by Felipe Rezende.


There are two major crises Brazil’s President Dilma Rousseff is facing: one is a political crisis and the other is Brazil’s sharpest recession in 25 years.

Brazil’s Political Crisis

The political crisis has two main pillars: a) a vast corruption scandal (with evidence of a kickback scheme funneling billions of dollars from state-run firms and, more recently, in a massive data leak over possible tax evasion, Brazilian politicians linked to offshore companies in the Panama Papers); and b) impeachment proceedings to move forward against President Dilma Rousseff.

The Federal Court of Accounts (TCU) announced in 2015 that it had rejected the accounts of Rousseff’s administration for the year 2014. In a unanimous vote, the TCU ruled Dilma Rousseff’s government manipulated its accounts in 2014 to “disguise fiscal deficits” as she campaigned for re-election. The allegation is that Ms. Rousseff manipulated Brazil’s account books to hide a growing fiscal deficit.

The argument is that the federal government borrowed money from public banks (which is forbidden by the Fiscal Responsibility Law) to pay for social programs. So, they argued she allegedly committed an administrative crime.

Once we understand how the government spends and what bonds are for, then we can analyze TCU’s decision. The Treasury has an account—known as Treasury Single Account—with the central bank. When the Treasury spends, its account with the central bank is debited and the bank’s account with the central bank is credited. This is followed by a credit to the beneficiary’s bank account. That is, the public bank then makes payments to the social program beneficiary by issuing deposits (Case 1).

Case 1. The Treasury spends using its account with the central bank

Case 1_Rezende_Brazil

The issue at hand is that the federal government made payments for social programs using its public banks but it delayed payment to the same banks. That is, the federal government did not use its account at the central bank to credit the public banks’ account with the central bank while public banks made those social benefits payments. So, public banks made the payment (by creating demand deposits) and on the asset side there was an increase in credits (“loans”) to the Treasury (Case 2), which is forbidden by the fiscal responsibility law. In a “normal” transaction banks’ reserve balances (that is, government IOUs) with the central bank would go up, but because the Treasury delayed payments to banks there was in increase in balances owed by the Treasury to the public banks. This led the TCU to conclude that this was a “financing” operation. continue reading…


Auerback on Debt and the US Economy

Michael Stephens | February 8, 2016


Reactions to S&P Downgrade: S&P Analyst Confirms There Is No Solvency Issue

Michael Stephens | September 17, 2015

by Felipe Rezende

In previous posts (see here and here), I discussed Standard & Poor’s (S&P) downgrade of Brazil’s long-term foreign currency sovereign credit rating to junk status, that is, to ‘BB+’ from ‘BBB-‘, and its decision to downgrade Brazil’s local currency debt to a single notch above “junk” status.

S&P hosted a conference call on Monday morning to explain its downgrade of Brazil’s credit rating (you can view the video webcast replay here). During the conference call I had the opportunity to ask a couple of questions.  My first question, to S&P analyst Lisa Schineller, at around the 41:53 minute mark, was the following:

Question: “Are there solvency risks associated with Brazil’s local currency debt? Brazil issues its own currency.”

[Lisa Schineller]: “We would not say there are solvency risks, we rate, for both local currency and foreign currency, our ratings are continuum. Yes, we lowered both ratings, we are by no means thinking about a solvency issue here and risks there. There is less policy flexibility at hand, these ratings for the local currency BBB- is still in the investment grade category and the foreign currency is at the high end of the speculative grade category. I think this is an important point to highlight. There is this increase in the stress in the economy, in the policy execution, but it is very different than talking a solvency issue.”

That is, as the S&P analyst confirmed, there are no solvency risks. In its sovereign ratings methodology S&P looks at “sovereign government’s willingness and ability to service its debt on time and in full.” Standard & Poor’s sovereign rating is:

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

As I explained in my previous posts (see here and here), there is no credit risk in obligations denominated in the domestic currency, that is, the risk of payments not being made on government debt denominated in Reais is zero. Why? Because Brazil’s local currency debt outstanding promise to pay Reais and the federal government is the monopoly issuer of currency (Rezende 2009).

My second question to Lisa Schineller, at around the 52:05 minute mark, was the following:

Question: What is the sovereign’s ability and willingness to its service financial obligations to nonofficial (commercial) creditors for a country that has more assets denominated in foreign currency than debt? The government can pay all of its obligations in foreign currency. continue reading…


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…


Martin Wolf on the UK’s Sectoral Balances

Michael Stephens | June 23, 2015

In this video segment, Martin Wolf briefly illustrates the UK’s “severe sectoral imbalances” and the dangers of the current government’s budget policy:



Below is what Wolf describes as his favourite chart (discussed at 48:40), which puts the UK’s public debt situation — the ostensible justification for the above-mentioned budget policy — in historical context: “the idea we were in a public debt crisis was a fantasy.”

Martin Wolf_Public Debt Since 1692


Fed Fiscal Policy, Treasury Monetary Policy

Michael Stephens | June 4, 2015

Don’t miss this post by Scott Fullwiler at New Economic Perspectives.

Fullwiler is reacting to Clive Crook’s Bloomberg column advocating “helicopter drops” (having the Fed simply send checks to households). Helicopter drops or “helicopter money” proposals are widely cast as monetary policy operations (Crook describes helicopter money as a monetary-fiscal “hybrid”) and defended as either preferable to fiscal stimulus or as the only remaining option in light of political obstacles to increasing government spending (to wit, the GOP Congress/Dem White House combination).

For Fullwiler, this way of framing helicopter money is problematic — and relies on a skewed understanding of our policy options:

I find it completely counterproductive to have a theory of macroeconomics in which we define fiscal policy and monetary policy based on who is acting. If the US Congress and Treasury choose to send $1 trillion to households without raising taxes, it’s called fiscal policy. But if the Fed does the exact same thing, it’s apparently called monetary policy. I think this only confuses our understanding of the macroeconomic policy mix and makes it more difficult to have an economics profession that can give good policy advice.


It seems much clearer to simply say that (a) the act of creating a deficit—raising the net financial wealth of the non-government sector—is fiscal policy, and (b) the act of announcing and then supporting an interest rate target with security sales (or purchases, or interest on reserves)—which has no effect on the net financial wealth of the non-government sector—is monetary policy. In the case of (a), whether the Treasury or the Fed cuts the checks, it’s fiscal policy, and with (b), whether the Treasury or the Fed sells securities, it’s monetary policy.

In other words, fiscal policy is about managing the net financial assets of the non-government sector relative to the state of the economy, and monetary policy is about managing interest rates (and through it, to the best of its abilities, bank lending and deposit creation) relative to the state of the economy. This is in fact how Randy Wray explained both in his 1998 book; it’s also how Warren Mosler explained them in his 1996 paper. That is, from the beginning, MMT has labeled monetary and fiscal policies by their functions, not by who was doing what.

I think this is a much more useful taxonomy because it makes clear from the start that (1) the currency-issuing government isn’t constrained while (2) the interest rate on the national debt is a policy variable. All kinds of human suffering the past 6+ years may have been avoided if those two basic points were widely understood.

Read it.

Fullwiler spoke at the last Minsky conference on issues related to central bank operations (actual, vs. textbook): you can hear his remarks here; slides here.


A Cycle of Financial Fragility?

Greg Hannsgen | June 3, 2015


(click image above to enlarge)

Can a bull market founded largely on credit survive? A forthcoming Levy Institute working paper I wrote with Tai Young-Taft of Bard College at Simon’s Rock (link for those interested) represents an attempt to deal with the role of financial instability—along with other sources of economic fluctuations—in the dynamics of the economy. Here, I’ll focus mostly on the role of margin loans that are used by many investors and traders to leverage positions in stock. The model developed in the paper includes a role for several policy tools that might be used in attempts to stabilize the economy: a fiscal-policy rule with public production and unemployment rate targets, along with public-sector R&D, financial supervision and regulation, and a target for the inflation-adjusted interest rate on government debt.

Now, for the current situation. The figure above highlights one potential threat to stability designed to arise spontaneously in runs of the model: surges in the use of margin debt to finance investments in stock. The chart shows that the amount of such debt outstanding in the US relative to GDP rose sharply during the tech bubble and the period leading up to the financial crisis and recession of 2007–09, achieving a new peak each time. Subsequent financial market collapses led to cyclical declines in the use of this form of leverage. On average, for the first quarter of 2015, this ratio stood at more than .028, suggesting that the stock market’s vigor again rests to a great extent on heavy borrowing (see figure). (Moreover, some different but closely related uses of credit, such as bond issues that wind up financing stock buybacks, have also contributed to the post-recession bull market.) This column from the New York Times’s Floyd Norris from a couple of years back discussed evidence that margin-credit cycles helped fuel cyclical movements in stock prices and the economy. His column displayed a longer but now outdated margin loan series.

In the model, margin loans can generate positive feedback effects: a cycle of increasing margin loan balances and rising stock prices, or vice-versa.  The story is similar to that of the “levered losses” in housing that took place in a number of countries earlier in this decade (see the recent book House of Debt for one account of the story, although even in this version of the story, I am inclined to see excessive optimism about the usual cure by wage and price adjustments); indeed, big, unsustainable run-ups in asset prices tend to be driven at least in part by credit booms. The situation shown in the figure is only one of many somewhat worrisome signs of market fragility. At the moment, fragility generally seems to be manifested most clearly in big increases in the quantities of various assets and liabilities relative to flow variables such as income and GDP, rather than in yield data.

More on the new paper and the model in it, for those inclined to look into it: continue reading…


Austerity and Growth: Missing the Point

Michael Stephens | May 22, 2015

The pseudo-debate about whether Keynesians and other fellow travellers ought to be embarrassed when governments that engage in fiscal austerity nevertheless experience positive economic growth rates has become a distraction.

For countries like the US and the UK, it is possible under current circumstances for governments to implement budget cuts and still see their economies grow. But the truth of that statement is not fatal to the Keynesian-inspired critique of austerity policies; it is not by any means the end of the story. The more meaningful question is this: What would have to happen in these economies for significant growth to occur in the midst of budget tightening?

Finding an answer to that last question is one of the strengths of the approach to thinking about the economy pioneered by Wynne Godley, and fleshed out further in the Levy Institute’s strategic analysis series. This approach also provides a clear understanding of how deeply irresponsible it is to cut government spending under present economic conditions: because the danger, given the state of the US and UK economies, is not just that budget cuts might slow down the economy, but that they might not.

Let’s look at the United States in particular. In their just-released report, Dimitri Papadimitriou, Greg Hannsgen, Michalis Nikiforos, and Gennaro Zezza point out that, with the exception of a short cycle in the ’70s, “there has been no other recovery in the modern history of the US economy in which government spending decreased in real terms.”

Exceptional Austerity_Levy Institute Strategic Analysis_May 2015

The Congressional Budget Office is predicting that the budget deficit will continue to shrink over the next few years, from 2.8 percent of GDP in 2014 to 2.4 percent in 2018. At the same time, the authors note, the CBO is telling us that GDP will grow at 2.8 percent, 3 percent, 2.7 percent, and 2.1 percent in 2015, ’16, ’17, and ’18, respectively. If we assume that both of those forecasts (for the budget deficit and GDP growth) come true, what would the rest of the economy need to look like?

The United States has run current account deficits, which act as a drag on economic growth, for decades. And despite the recent increase in net exports of petroleum products, which has helped keep the US trade deficit from returning to its sky-high precrisis levels, there is little reason to think that the external deficit will substantially improve over the next few years (if anything, the authors argue, it is likely to get worse. There’s more on recent developments in the foreign sector beginning on p. 6 of the report).

That being the case, GDP growth rates of the sort projected by the CBO can only come to pass on the basis of a rise in private sector spending. In fact, Papadimitriou et al. show that private sector spending would have to expand so much that it would exceed private sector income for the first time since the crisis. In other words, growth would depend on rising private indebtedness.

If the dollar continues to appreciate further and the economies of US trading partners end up performing worse than the IMF expects (a very real possibility, the authors point out, given the optimism of IMF forecasts), this increase in private sector spending over income — and thus the increase in the private debt-to-income ratio — would have to be even larger. Here’s what that would look like (in the chart below, “Scenario 1” corresponds to slower growth among US trading partners [by 1 percent of GDP annually], “Scenario 2” to a 25 percent appreciation of the dollar over the next four years, and “Scenario 3” to a combination of the two):

Austerity and Private Debt_Levy Institute Strategic Analysis_May 2015

If private spending doesn’t blow up in this way, the CBO’s optimistic growth projections won’t come about. But if growth does occur, it can only do so (given the external deficit) through a process that raises the debt-to-income ratio of the private sector. As the authors point out, this is precisely the same process that led to the Great Recession and its aftermath.

What’s worse, the state of income inequality in the United States is such that this increase in private debt will be borne disproportionately by households in the bottom 90 percent of the income distribution. Unlike the federal government, which can service its debt through mere keystrokes, US households cannot sustain rising debt ratios of the sort portrayed in the chart above (though the amount of public hand-wringing spent on the debt of the former, as compared to the latter, would suggest the opposite). As Papadimitriou et al. write:

“Increased borrowing of one kind or another can often be sustained for a long time … but eventually, retrenchment takes place relative to incomes. The consequences of any further retrenchment in debt-financed consumer spending would be felt throughout industries that produce for the US consumer, and again, as we noted above, the recovery in real private domestic consumption is already weak relative to any previous recovery.”

To bring this back to the tired discussions surrounding austerity policies: yes, it is possible for the United States to have both tight budgets and rising GDP over the next few years. Fiscal conservatism doesn’t make economic growth impossible in the near term — it makes it impossible to grow without increasing financial fragility. In the absence of a significant increase in net exports, keeping the government budget on its current track will lead to either stagnation or an acute crisis.

Austerians in the United States and elsewhere have been allowed to portray themselves as the champions of steely-eyed realism and prudence. In reality, unless their budget proposals come attached with some workable plan to substantially reduce trade deficits, they are courting private-debt-driven financial crises. In any meaningful sense, they are the true practitioners of fiscal irresponsibility.


Needed Macro Policies: Targeted, Broad, and Universal

Greg Hannsgen | January 30, 2015

The recent 40 percent jump in the value of the Swiss Franc will have some effects similar to those of deflation where it seems to be taking hold, including Japan and much of Europe. When a currency increases in value, foreign debts in those currencies become more of a burden. The New York Times brings it home with the story of households in Poland and other European countries who have some foreign debt of their own—mortgages whose payments are suddenly much higher in their own currency, after the Swiss National Bank (the Swiss counterpart to the ECB and the Fed) stopped using foreign-currency operations to peg its currency against the Euro. In fact, the FT reports that mortgages in the Swiss currency make up 37 percent of Polish home loans. The Swiss decision was encouraged by a European Central Bank that is getting ready to push long-term interest rates down further through its own program of quantitative easing (QE). Instead of printing more Francs to buy Euro and other currency, the Swiss National Bank (SNB) allowed the Franc to rise in one big move, abandoning its peg to the depreciating Euro. This move will increase import demand in Switzerland from Poland and other European producers. But as always with a sudden devaluation, foreign-currency debtors suffer from a so-called currency mismatch problem as the amount of debt rises in terms of the things that they sell to make a living, including hours of labor.

Exchange rate pegs are difficult to maintain for an extended period, especially in relatively poor countries, as changing economic conditions cause misalignments in exchange rates. One reason not to institute a peg is the instability that can ensue when it is abandoned, and this instability can cause penury for debtors, including governments. A second bad policy is interest rates that that need to be reduced generally by the monetary policy authorities where possible. One policy approach is to target help at the debtors themselves, particularly households and countries that must be helped up to maintain autonomy. The latter include Greece, for which our Greek macro team recently suggested an interest-payment moratorium. Sometimes, a reduction in the amount owed, or principal, is in order, as it was —and probably still is—for many subprime and Alt-A (mid-range credit rating) borrowers affected by the US mortgage crisis. Eastern European countries debated converting Swiss mortgages into domestic-currency debts at a higher-than-market domestic exchange rate. A slightly less-targeted form of help is to implement jobs programs of various types and to hold the line on public-sector wages. But when unemployment and other economic indicators suggest stagnation if anything, such targeted policy stimulus helps, yet it has only an indirect impact on private investment, overall economic growth, and unmet infrastructure, poverty-reduction, and pension needs.

The ECB is smart to implement QE, given high rates of unemployment in almost every country in the Eurozone. The SNB may even be smart to allow its currency to rise, given strong economic performance. And by the same token, if the Polish government can broadly raise spending, increasing resources for budget items that encourage economic growth and inflation is under control (2 percent—one common benchmark—is rather low for a target, especially given high unemployment), it should do so. Monetary stimulus might also form part of the picture. With such a move, the government would take steps in the same direction as the ECB and the Japanese government, recognizing the threat of  debt deflation.

Generally, the a combination of the three types of policy outlined here would work effectively in many countries with high unemployment, weak growth, and large amounts of bad private-sector debt. Targeted help for borrowers can take many forms, but writing off a portion of the principal, with the central bank’s help, if necessary, is often the only way to avert widespread private-sector bankruptcies. In contrast, broad measures might include, for example, devaluations of the domestic currency, investments in infrastructure and R&D, wide-ranging open-market purchases, tax cuts, and other available measures to spur all sectors of the economy. Third, universal measures—programs available to all who meet eligibility criteria—would include Social Security and its counterparts in affected countries. (An employer-of-last resort, or ELR, program would fit within both universal and targeted categories.) It is more risky rather than less not to maintain such programs during a crisis.