Worthwhile Canadian Initiative

Greece, the Eurozone, and Canada

I have been following the story about Greece. Like some other Eurozone countries, Greece has high deficit/GDP and debt/GDP ratios. Unlike Canada, but like Canadian provinces, Greece cannot print money. Eurozone countries are like Canadian provinces, as I argued in here back in January. But the Eurozone, unlike Canada, lacks a federal fiscal authority. The Eurozone is what Canada would be if we abolished the federal government, except for the Bank of Canada.

I rather stuck my neck out in that January post. I had "poster's regret" soon after. But now I'm looking a lot more prescient than I felt at the time. (Which proves it would be sheer luck, even if I do turn out to be right).

In praise of (a little bit of) fiscal dominance

Who makes sure the long run consolidated government-central bank budget constraint balances? Is it the government? Or is it the central bank? The former gives us a Ricardian regime; the latter gives us fiscal dominance.

Most macroeconomists take a Ricardian regime as their unspoken assumption; and, if pressed, would recommend a Ricardian regime, as is required, in the long run, by central bank independence. If the central bank is to have the independence to pursue its own objectives (be it inflation targeting or whatever), the government must take long run responsibility for its own deficits, grateful for whatever profits from seigniorage revenues the central bank deigns to hand over. Worries about the "coordination of monetary and fiscal policies", heard often in Canada until the mid-1990's, were code for the desire for a Ricardian regime.

Yes, the federal government has a structural deficit. But let's keep it in perspective, shall we?

Don Martin loses it in today's National Post:

Clock tallies IOU to next generation: Stephen Harper will join Jean Chretien as only the second prime minister in history to enroll Canada in the half-trillion-dollar national debt club.

This is silly. Nominal debt figures from 1995 - when the federal debt first went above $500b - should not be directly compared to current nominal debt figures; you have to take into account inflation (a dollar in 1995 was worth more) and economic growth (our ability to pay debts has increased). Here is a graph of the federal debt, expressed as a percentage of GDP and in terms of per capita 2009 dollars:

When the nominal federal debt hit $500b in 1995, that was the equivalent of 59% of GDP. Fourteen years later, $500b works out to about to something like 39% of GDP. In order to reach debt levels that are truly comparable to 1995, the federal government would have to run $50b deficits for at least six years in a row. And no-one is forecasting that.

Yes, the federal government has a structural deficit, and something will have to be done. Panicking isn't it.

On the federal government's structural deficit

The Department of Finance publishes monthly data for expenditures, revenues and the deficit. These numbers don't necessarily correspond to the annual numbers (for example, various items are sometimes booked to a fiscal year after it's over), but it gives us a good idea of where the government's finances are going. The monthly numbers are pretty choppy and have some significant seasonal factors, so I'm going to work with 12-month moving sums.

We all know that the federal government will be running a deficit this year, but it's still pretty impressive just how fast the situation has deteriorated. Here is a plot of the 12-month moving sum of monthly deficits through to August, 2009:

 

Towards a Monetarist theory of Neo-Chartalism

I am going to start with an orthodox monetarist approach, make one trivial semantic change, and see how far I can get in deriving Neo-Chartalist results. The semantic change is to change what I mean by "fiscal policy". It's an unconventional definition of fiscal policy, from a monetarist perspective, but I don't think a monetarist could otherwise object.

The federal deficit is small, manageable problem with a simple solution. So why are politicians being so boneheaded?

The editorial cartoon in yesterday's Le Soleil has the best take I've seen yet on the issue of how to deal with the federal deficit. The target is Michael Ignatieff, but it could just have well have been Stephen Harper, because their positions on this issue are identical. Here is my approximate translation of the dialogue:

Ignatieff: I've promised to eliminate the deficit of $56b without increasing taxes and without cutting services. Any suggestions?
Aide: How about you stop talking crap?

And crap it is, because the deficit will not go away without tax increases or cuts in services.

Pre- Darwinian Macroeconomics

There are signs of economic recovery. Suppose a year from now it is clear that the economy has indeed recovered. What caused it? Was it: monetary policy; fiscal policy; or did the economy recover by itself?

I don't know the answer to that question; nor does anyone else. If you have one world recovery, and three competing hypotheses to explain that single data point, you don't know the answer. So we resort to theory, and see if theory, backed by multiple data points from past recoveries, can help us answer the question.

Macroeconomic theory tells us how monetary policy is supposed to work; and it tells us how fiscal policy is supposed to work. But macroeconomic theory (at least, the modern, canonical, neo-Wicksellian model) does not tell us how economies are supposed to recover by themselves. Like pre-Darwinian biology, it only works if there is some sort of designer or creator to make it work: in this case the monetary and/or fiscal authorities, rather than a divine being.

Economic policy advice for the NDP, Part II: Defending big government

A while ago, there was a spurt of articles bemoaning the 'out-of-control' spending of the federal government, making the point that federal spending has been outpacing the rate of growth of GDP over the past five years. We are presumably expected to believe that future federal governments will be obliged by the inexorable logic of budgetary arithmetic to reduce spending.

This reasoning is wrong on many, many levels. Below the fold, I'll develop the arguments that can (and should!) be used to to explain why spending should not only not be cut, but can be significantly expanded without harming the economy.

Weird Fiscal multipliers in New Keynesian models under ZIRP

Paul Krugman has bravely and commendably been trying to understand intuitively the underlying reasons for the big differences between fiscal policy multipliers in a couple of New Keynesian models. Someone needs to do this job. (Take as read a general rant against economists who write down fancy mathematical models without understanding or explaining the results intuitively.)

A fiscal multiplier is the model's predicted change in output per dollar change in government spending (or taxes), other things equal. My guess is that the differences in multipliers has little to do with the models, and has a lot to do with the other things assumed equal. By messing with the other assumptions, it's easy to get fiscal multipliers ranging between plus and minus infinity, even in the same, standard model.

Rambling thoughts on Canadian house prices and global savings gluts

This isn't a very focused post. There are two sets of thoughts bubbling through my mind this morning. The first is about Canadian house prices; the second is about global savings gluts. But the two topics are very definitely related.

There is a lot of anecdotal evidence of a pick-up in at least some Canadian housing markets over the last month or two. Like this story in today's Globe and Mail for example, about record sales, bidding wars, and rising prices in Toronto. I won't fully believe that these stories are real and representative of the whole housing market until I see it confirmed by a rise in the Teranet-National Bank price index, but the most recent Teranet numbers are for April, and show no rebound yet. (You can have accurate data or quick data: pick one.)