Let Greece Go to the IMF

Europeans are saying that the members of the eurozone or the EU have to bail out Greece, that this is better than having the IMF do it. Senior figures in Brussels apparently feel that the latter alternative is unthinkable. I am a little confused about why. Martin Wolf writes in the Financial Times this week that to bring in the Fund “would demonstrate that this is not a true union at all.” But the EU and EMU and not true fiscal unions. If the citizens of Germany and other more successful countries were willing to bail out the Greeks, then fine; the EMU would be ready to be a fiscal union. But they are not; so it is not.

The Maastricht treaty and the Stability and Growth Pact put fiscal constraints front and center on the list of country requirements for euro membership. Why? The same reason that the European Union has an explicit “no bailout” clause. Precisely to avoid the situation that seems to be facing German taxpayers today. What has changed since the euro’s birth? Only one (predictable) development: the realization that huffing and puffing from Brussels and Frankfurt are wholly inadequate to prevent members large and small from breaching the 3% deficit rule. Greece leads the pack, with a deficit last year of 12.7% of GDP. The fears of German taxpayers are more well-grounded today than they were at Maastricht, not less. (And disguising these transfers as loan guarantees is only a futile effort to perpetuate the denial.)

I am not even sure why it is considered anathema to run up default risk a little more, to help force Greek citizens to see the need for painful reform, including fiscal retrenchment at least as severe as what Ireland has recently done. If a presumption is now established that default risk is not to be allowed, moral hazard will wipe out all pressure on future eurozone governments to keep their finances in order. Indeed, some of us were puzzled why, for most of the years since 1999, the financial markets had failed to distinguish among euro members by creditworthiness: until recently the spreads of the Mediterranean countries over the German bond rate had been close to zero. This began to change in late 2008. Then, in 2009, the sovereign spreads in Ireland and Greece shot up, reflecting investor perceptions of these countries’ debt problems. This put pressure on them to adjust. The Irish responded like adults, undertaking stronger budget measures than Greece. Partly as a result, Irish government bond rates have declined over the last year and are now substantially below Greek rates, which have now risen almost to 400 basis points. Is Greece now to be rewarded?

Things aren’t yet bad enough to require a Greek default. Quite likely, by now, they are bad enough to require outside intervention. But shouldn’t Greece have to draw on the IMF first, rather than drawing on Germany and France? The IMF could impose conditionality, thereby helping the current Greek government make the necessary measures stick. There is no use in pretending that any promises that the government makes to Frankfurt or Brussels as conditions for a loan would credibly be enforced in the future, given the politics and given what was come before. But conditionality is what the IMF does for a living, and for all the criticism it sustains, it is better at it than any other institution.

Perhaps it is easier for an American, on the other side of the Atlantic, to discount glibly the financial strains that Greece is placing on Europe, including contagion to other countries such as Portugal, Spain and Italy, loss of prestige of European institutions, and the decline of the euro. But in fact it is the northern Europeans who should be most anxious for the IMF to come in, and who should be most worried what they are going to say to Portugal, Spain, Italy and Ireland if they have just bailed out Greece. It is generally good policy in such episodes to let at least one debtor fail, preferably the one most deserving of such a fate, thereby preserving a foothold in the long-term fight against moral hazard. That guideline may sound cavalier and arbitrary, but better that than letting everyone fail (as the noisy moral hazard police on the right would have it) or to let nobody fail (as the equally noisy social workers on the left would have it). Even if it proves necessary for the northern Europeans to rescue the next-worst debtors in line, after a Greek failure, I don’t see that they would be better off by starting now with Greece.

Limit Tax Expenditures

The National Tax Journal asks for views on a recent proposal from Len Burman . I couldn’t agree more with the idea: we need to limit tax expenditures.

With regard to the politics, one would have to see whether the phrase “cut tax expenditures” polls more like the phrase “cut expenditures,” which I assume polls well, or like the phrase “raise taxes,” which of course polls horribly. I have no idea. But at least there is a hope of breaking through the mindless artificial “Taxes versus Spending” rhetoric that dominates Washington.

With regard to the merits of the idea as economic policy — in a context where strong measures to reduce the budget deficit will be necessary in coming years — Burman is completely right. Most tax expenditures tend by nature to be distortionary. Many of them are convoluted ways of making what would otherwise be a subsidy look like a tax deduction.

Agreeing to the general principle of limiting tax expenditures is easier than agreeing to all the detailed implications. Looking at the list of the actual 12 largest tax expenditures would give most people pause. But much less so for economists. The only one on the list that gives me serious pause, personally, is #7: the “charitable deduction (other than education and health).” But the top two deserve to be cut, as part of a larger fiscal package, not just because they would save a lot of money, but also to get economic incentives right. Those top two are the exclusion for employer-sponsored health insurance and the mortgage interest deduction.

A proposal to eliminate the mortgage interest deduction would of course get zero support in Congress, because it is political suicide with middle class voters. A more moderate proposal to freeze the amount of the deduction would also be unpopular. The same with four other pro-housing tax expenditures out of Len’s list of 12: deduction for property taxes, exclusion of net imputed rental income, capital gains exclusion on home sales, and property tax deduction. All politicians and voters (excluding economists) continue to believe that public policy should tilt in favor of home ownership. Notwithstanding the recession that began with the sub-prime mortgage crisis of 2007, economists have not made even a dent in popular perceptions, with our arguments against artificially tilting the field away from rental housing and the rest of the capital stock, which is what you do when you tilt toward owner-occupied housing. That the bias is toward high leverage in home ownership makes it worse. To take another example, whatever happens ultimately to Fannie Mae and Freddie Mac, they certainly won’t be abolished. Americans believe too strongly in the dream of home ownership to absorb fully the point that you are not doing a family a favor if getting them into their own house means burdening them with debt that they will probably not be able to repay.

“Political impossibility” is not a reason not to try. After all, our country will not get through the next few decades, fiscally, unless we make some “politically impossible” changes. But I emphasized the housing issue in the preceding paragraph to make a different point. Almost all commentators on the financial crisis, whether from the left or right, talk as if the causes of the crisis are obvious and our leaders are idiots for not having acted to fix the problem ahead of time. Needless to say, those on the left blame the right, for deregulation, and those on the right blame the left, for moral hazard. And yet there is still zero support for fixing the housing policy parts of the problem, on which economists have almost unanimous agreement (and did ahead of the crisis).

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Lag in Job Numbers Behind GDP Growth is No Worse than in Past Recoveries

At first glance, the job numbers of the last week seem to offer a mixed and confusing picture. On the one hand, today’s headline from the Bureau of Labor Statistics certainly sounds like good news: the unemployment rate finally dropped below 10.0% — to 9.7%. On the other hand, today’s establishment survey of employment, which most of the time is a more reliable measure than the unemployment rate, still shows job change numbers that are negative. Furthermore, recent numbers on claims for unemployment benefits have been discouraging.

To reach an overall evaluation, one must take a longer-term perspective. Even the job loss reported in the establishment survey for January can be interpreted more positively: it is less than 1/30th of the rate at which job losses were running one year ago, in January 2009. The best way to sum up all the labor market numbers in recent months, both positive and negative, is they have been within measurement-error-distance of zero, roughly flat. That may not sound great, but it is a big improvement relative to what came before.

It is inconvenient, but common, that the labor market and the rest of the economy send conflicting signals.

As a member of the NBER Business Cycle Dating Committee, I get asked whether we are ready to call officially an end to the recession. Although the Committee looks at many indicators in reaching its decisions, the most important overall are measures of output, particularly quarterly GDP. GDP shows growth turning from negative in the first half of 2009 to positive in the 3rd quarter of the year, and now strongly positive in the 4th quarter. That suggests that the trough will probably turn out to have been in the middle of last year.

Beyond output, the monthly indicators that are most important to the Committee are probably those that come from the labor market. Here is how I personally read the overall picture of the labor market that has emerged recently:

  • the employment loss was especially bad in this recession, whether viewed in absolute terms or relative to the output decline (8 million jobs lost, in the BLS revisions that are probably the most important news in today’s report); but
  • the recovery time in jobs does not appear to be lagging behind output any more than was the case in the preceding two recessions — and perhaps less. The worst job loss this time occurred around the time of the worst negative GDP numbers — the very beginning of 2009, as opposed to waiting until GDP growth actually turned positive, as in the preceding two recessions. Yes, it is painful that labor market losses have, at best, not ended until a half-year after the end of output losses. Nevertheless, as I count, that still appears to be a shorter lag than in the famous “jobless recoveries” following the recessions of 1990-91 (job losses ended 11 months after the trough) or 2001 (they did not end until 21 months after the trough).

The bottom line is to reinforce the verdict of most economists: that the recession very likely ended sometime in 2009. At this point the main thing that the NBER Committee must watch out for is the small risk that the economy could be hit in 2010 by a sudden new downturn, as the changes start to diminish; but a real double dip recession (which might in theory count as a continuation of the same recession as 2007-09), seems increasingly unlikely.