Economic Argument for Austerity Based on Excel Error?

[Admiral Yi]

I don't think rates are generally reflecting risk.

I don't know what you mean.

There's no relationship between risk and return?

[DGuller]

I find it very hard to believe that austerity drive was pushed by an Excel error.  There are two possibilities:  either the error is blown all out of proportion, or that the paper is of such low quality that it couldn't be legitimately used as justification.  If someone uses a very crappy paper to support their point, they are looking for a pretext, not a justification.

[Sheilbh]

Not no relation but that's not all rates reflect. As the IMF put it 'fiscal indicators such as deficit and debt levels appear to be weakly related to government bond yields for advanced economies with monetary independence.' I think that growth and inflation expectations matter far more, at least in countries with independent, national central banks.

In my view I think that if austerity was to be eased any increase of interest rates would reflect either expected growth or the fear of tighter monetary policy. So if you've got a change in the pace of austerity with a stated monetary position - like Carney or Bernanke have set out - then yields should rise because of higher short-term growth expectations. But they won't rise because of risk and they won't rise in a mad, damaging way as you'd expect if market's genuinely thought there wasn't a medium term the US or the UK wouldn't pay their debts.

Low interest rates isn't a good thing, so we can spend like mad. Low interest rates are a bad thing because they suggest the markets expect depressed growth for some time and we should work to address that because unemployment and subdued growth have long-term consequences.

I mean I can't think of a downgrade that's had any effect on those countries, which doesn't make sense if you think it's about risk.

[Admiral Yi]

And once again I ask you to take a look at yield on Greek, Spanish, and Italian debt before the crisis began.  One could have drawn the exact same conclusion about a weak relationship between fiscal situations and yields.

[DGuller]

And once again I ask you to take a look at yield on Greek, Spanish, and Italian debt before the crisis began.  One could have drawn the exact same conclusion about a weak relationship between fiscal situations and yields.

This time it's different.

[Sheilbh]

Spain shouldn't be on that list.

Aside from that I said I think things are different for countries without a national central bank, especially when their currency union central bank is so suspicious of extraordinary measures. In addition I'd add that the cause for increased sovereign risks there - as in the US during the debt ceiling fights - is fundamentally political. I think before the crisis the markets believed European rhetoric, now they don't.

[Admiral Yi]

Spain shouldn't be on that list.

Aside from that I said I think things are different for countries without a national central bank, especially when their currency union central bank is so suspicious of extraordinary measures. In addition I'd add that the cause for increased sovereign risks there - as in the US during the debt ceiling fights - is fundamentally political. I think before the crisis the markets believed European rhetoric, now they don't.

Default risk is *always* political.  Countries default when they don't want to pay, not when their debt service surpasses their GDP.

And technically you're right, a sovereign that controls its own central bank and issues debt denominated in domestic currency can always inflate away its debt.  But has also been pointed out before, a country that does this will be in much the same position as a country that defaults: neither are able to borrow further at reasonable rates.

[Ideologue]

If that's the argument, why are people arguing for austerity given the record low levels of interest right now? Should we wait until rates start moving up a bit first?

People are arguing for austerity now because of very high debt/GDP ratios.  And because of the moral argument of spending money that someone else will have to pay off in the future.

It's called investment.  As long as growth outpaces the interest paid on the debt, it doesn't matter.

And since austerity causes the exact opposite of growth, the debt/GDP ratio just gets worse, along with a lot of human suffering that will severely damage future generations--since future generations depend desperately upon the generation being devastated by austerity measures.  Or is it actually old people taking the pain in Spain, Greece, Europe in general and even America, sacrificing bravely for their children and grandchildren?  If so, why is it their children and grandchildren don't have jobs, will never buy houses, and will either choose not to have children of their own or raise them in squalor?

If austerians were honest it would be about greed and dismantling all but the parts of the welfare state that benefit the Olds.

Rates don't move up a bit.  Investor perception of credit worthiness is flat until it reaches a tipping point, when things go all to shit.

Except when aggregate demand is so depressed so that it is literally better to hoard money than to invest, what do you do?  Shoot the fucking hostage and use Keynesian stimulus.  NOT HARD.  Just politically unpopular with the rich and the new anarchists, and supported by their foolish fellow travelers by false moral arguments such as advanced above.

[Sheilbh]

Well that's why you need a credible central bank. I think the IMF bit on the UK addresses this:

Though such simple relationships are only suggestive, they indicate that a moderate increase in the UK's debt-to-GDP ratio may have small effects on UK sovereign risk premia (though a slower pace of fiscal tightening may increase yields through expectations of higher near-term growth and tighter monetary policy).  This conclusion is further supported by the absence of a market response to the easing of the pace of structural adjustment in the 2011 Autumn Statement. Bond yields in the US and UK during the Great  Recession have also correlated positively with equity price movements, indicating that bond yields have been driven more by growth expectations than fears of a sovereign crisis.

If there is a trend towards higher inflation (as opposed to what we have in the UK which is higher than expected inflation, but everyone believing it should fall) then it's right for the central bank to act.

Given that that's not currently a credible worry or policy for the US and UK, I think the Bernanke-Carney approach is more helpful.

Edit:

People are arguing for austerity now because of very high debt/GDP ratios.  And because of the moral argument of spending money that someone else will have to pay off in the future.

But that can be flipped on its head. A prolonged slump and high unemployment - such as in the Eurozone - will cause permanent damage to an economy. It will increase the output gap and can knock an economy off the sort of growth they should be achieving. Surely it's as morally troublesome to make the future poorer as it is to make them pay more?

Though I don't think that's how the debt situation will play out. I'm confident we'll end up stabilising and reducing debt over the next decade - assuming there's no more shocks and, again, the Eurozone may be an exception.

[Ideologue]

Disclaimer: I'd love a year or so 10,000% inflation.  I don't think any reasonable moneyprinting scenario right now would actually do that, but I would literally win either way.

[Admiral Yi]

It's called investment.  As long as growth outpaces the interest paid on the debt, it doesn't matter.

What do you mean by the interest paid?  The rate?  The dollar amount.

The formula is that you're OK as long as the growth rate is higher than the deficit as a % of GDP.  Then the denominator in debt/GDP is growing faster than the numerator.

And since austerity causes the exact opposite of growth, the debt/GDP ratio just gets worse, along with a lot of human suffering that will severely damage future generations--since future generations depend desperately upon the generation being devastated by austerity measures.  Or is it actually old people taking the pain in Spain, Greece, Europe in general and even America, sacrificing bravely for their children and grandchildren?  If so, why is it their children and grandchildren don't have jobs, will never buy houses, and will either choose not to have children of their own or raise them in squalor?

Very stirring.  Now who's going to lend Greece money?

[Admiral Yi]

But that can be flipped on its head. A prolonged slump and high unemployment - such as in the Eurozone - will cause permanent damage to an economy. It will increase the output gap and can knock an economy off the sort of growth they should be achieving.

Neither of those things are permanent damage.

[Sheilbh]

Neither of those things are permanent damage.

In the long-term we're all dead. I think an economy growing at a lower rate than they otherwise would have for a prolonged period of time then that is as permanent and morally problematic as passing on debt.

[Admiral Yi]

In the long-term we're all dead. I think an economy growing at a lower rate than they otherwise would have for a prolonged period of time then that is as permanent and morally problematic as passing on debt.

As permanent?  What?

[Neil]

Disclaimer: I'd love a year or so 10,000% inflation.  I don't think any reasonable moneyprinting scenario right now would actually do that, but I would literally win either way.

Why?  You're a lawyer.  We'd kill you.

At any rate, why is austerity capitalized in the thread title?  I keep reading it as either Auschwitz or Austerlitz.