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The Bank for International Settlements has released its quarterly review (hat tip EconBrowser). In it, you will find an interesting graph on page 19 (or page 23 including cover pages), titled “Exposures to Greece, Ireland, Portugal, and Spain by nationality of banks”. It’s reproduced here on the left (click on it for a larger view). I am puzzled by the relatively small size of public sector debt compared to the quite significant contribution of private sector debt in the countries discussed. Is fiscal austerity really going to be a solution? I wonder how in the world cautious German and smart French banks ended up with so much exposure to private debt in Spain. Of course, ingenious American banks are disproportionately exposed to financial products rather than straightforward debt. It seems financial reforms of different kinds are required in different places.

The Economist takes a look at European austerity plans and finds…not much. Substantial cuts are happening mainly in the smallest Eurozone countries. Overall the impact is slight, although of course cutting anything at all is still the opposite of stimulus.

Levy public policy scholar Daniel Akst argues in this op-ed that the rise of unpaid internships is exacerbating income inequality. These internships are perceived to offer important professional experience and contacts. Yet young people without money can’t afford to take them, which means kids without money are at a further disadvantage in applying later for desirable paid work.

About a year ago, supply-side economist Arthur Laffer (known for the “Laffer curve,” a graph that depicted tax revenue first rising, then falling as tax rates increased) published an op-ed piece in the Wall Street Journal predicting sharply higher inflation and nominal interest rates over the next four to five years. The justification given for this claim was the rapid growth of the money supply, as measured by the Fed’s monetary base statistic, since the fall of 2008. One year later, inflation has not taken off. Meanwhile, the stock of currency and bank reserve deposits at the Fed has continued to grow rapidly, though growth has slowed markedly over the past year. The chart to the left (click on it for a better look) shows that Laffer’s preferred measure of money-supply growth has trended downward recently. It remained at about 100 percent, year-on-year, in the three months immediately following the op-ed piece. Since then, money-supply growth has remained in the double-digit range. However, there has been no discernible and sustained upward trend in nominal interest rates or inflation. Many recent events have conspired to keep these numbers at low levels. On the other hand, an argument can be made that the money supply itself is mostly a somewhat unreliable indicator of what is happening, rather than a crucial mover of… Read More

Levy research scholar Thomas Masterson has co-edited a new book about the Solidarity Economy, a form of economic organization that emphasizes cooperation over competition and communal well-being over individual gain. From the back cover: “So many of us wish for something more, something different—an economy that we can feel a part of, not that makes us feel like a disposable cog in a mindless, heartless, soulless machine. That something exists and it’s called the Solidarity Economy. It represents new ways of living, of working, of consuming, of banking, of doing business. It represents different ways of doing trade, aid and development between nations. This kind of economy starts from entirely different premises than those of the ruling model of neoliberal capitalism which enshrines individualism, competition, materialism, accumulation, and the maximization of profits and growth. The solidarity economy by contrast seeks the well being of people and planet. It holds at its core these principles: solidarity, equity in all dimensions, sustainability, participatory democracy, and pluralism (meaning that this is not a one-size-fits-all model).”

This posting is by Levy senior scholar Philip Arestis, University of Cambridge and University of the Basque Country, and Theodore Pelagidis, European Institute, London School of Economics and University of Piraeus. A spectre is haunting Europe—the spectre of austerity. All the powers of old Europe have entered into an unholy alliance to exercise this spectre, about which all of us should be depressed. Europe probably will be soon enough. Why this sudden emphasis on austerity, when the well-known lessons of history are that in times of recession fiscal stimulus is the best medicine? Some European countries are chronic over-spenders of course, but others with strong balance sheets have announced austerity programs as well. Why? The short answer is that it is all about the banks. Europe’s financial institutions are loaded with potentially toxic sovereign debt issued by Greece and other shaky countries around the European periphery. French banks are said to be loaded with 75 billion euros of toxic Greek bonds; one can now understand President Sarkozy’s furious campaign to rescue Greece. Taken together, Spain, Greece and Portugal are believed to have planted a 2.2 trillion euro time bomb on the balance sheets of European banks. The value of these assets has already plunged, threatening bank solvency, choking off lending and leaving the taxpayers of such solvent nations as Germany… Read More

Levy senior scholar James K. Galbraith argues in the Los Angeles Times this morning that deficit hawks are pursuing the wrong prey. In a nutshell: The real cause of our deficits and rising public debt is our broken banking system. The debts our economic leaders deplore were largely due to the collapse of private credit, and to the vast giveaways the federal government made to banks to prevent their failure when credit collapsed. Yet those rescues have failed to reanimate private credit markets and job creation, as the latest employment reports show. And so long as that failure persists, public deficits and rising public debt must remain facts of life. Are broken banks a national security threat? Let’s avoid going that far. But the only way to reduce public deficits eventually is to revive private credit, and the only way to do that is build a new financial system to replace the one that has failed. The “national security” case for cutting Social Security and Medicare is bogus. In economic terms, it’s just a smokescreen for those who would like to transfer the cost of all those bank failures onto the elderly and the sick.

The Economist’s obituary for the late Wynne Godley generated a couple of worthwhile letters. A key passage: Your obituary of Wynne Godley (May 29th) did an injustice to his considerable intellectual achievements in macroeconomics and his courage in going against the orthodoxy that has ruled the economics profession for the past three decades. You can read the rest here.

The Squam Lake Report (Princeton University Press) is a set of recommendations by 15 leading economists on reforming the financial system. Considering the magnitude of the recent financial crisis, it is surprising how little change the book proposes. Certainly, the first step in devising a set of recommendations for reform is to understand what went wrong, something the authors set out to do in their first chapter. They list a number of factors that may have contributed to the crisis but take no stand on their relative importance. They believe that their recommendations will help make the system more stable, although not crisis-proof, even if they don’t completely understand the origins of the current crisis. While a few of the recommendations are intended for guiding the financial system towards stability, most are only useful for when a financial crisis has already erupted. Perhaps the best recommendation is for a systemic regulator with an explicit mandate of maintaining financial stability. As financial institutions are increasingly involved in activities outside their traditional domain, having a systemic regulator makes sense. But the report recommends that the central bank be that regulator—which is logical, since the Fed’s discount window gives it a good view of financial institution balance sheets. The problem, at least in case of the U.S., is that the Federal Reserve had the authority… Read More

Bloomberg polled international subscribers to its Bloomberg Professional Service and found that 73 percent expect a Greek default. These subscribers are described as decision-makers in finance, economics etc. The full story is here. You can also read the poll and results for yourself by clicking on the “attachment” tab at the top of the window. This will take you a pdf that is unfortunately missing the file extension. Just rename it to add .pdf to the end and it will open normally.

In a sobering column in the Financial Times, Edward Chancellor reminds us that the late Wynne Godley was right in predicting that large private deficits in the U.S. would lead to trouble–and that the Eurozone, when it was formed, might become a tragic disinflationary trap. The end of the column is particularly noteworthy: He went on to caution that without a common European budget, there was a danger that “the budgetary restraint to which governments are individually committed will impart a disinflationary bias that locks Europe as a whole into a depression that it is powerless to lift”. Rob Parenteau, a fellow Levy Institute scholar, has recently applied Prof Godley’s analysis to the eurozone periphery. Germany wants countries, such as Spain, to get their public finances in order. Yet if Spain is to reduce its fiscal deficit without too much pain, two conditions are necessary. First, the country’s trade position must shift into surplus. This is problematic since labour costs are high relative to Germany and Spain cannot devalue its currency. Second, the private sector must move back into deficit. Yet it is difficult to see Spanish households and companies wanting to borrow more given the ongoing problems caused by the collapse of the property bubble. There is a danger the proposed fiscal tightening in the eurozone will lead to… Read More

Nervous financial markets and waves of fiscal austerity spreading across Europe raise an important question: when does a country’s budget deficit become a problem? The easy answer, of course, is that a deficit is too large when it can no longer be financed. But by that time it’s too late, so it’s important to ask if there is a good way to tell before things get that bad. Carmen Reinhart and Kenneth Rogoff, in a recent paper called Growth in a Time of Debt, found that when government debt reaches 90 percent of GDP, economic growth is seriously retarded. But rules of thumb are by their nature imperfect, and it’s difficult to apply the 90 percent formula across the board. The U.S., for example, is not Greece—it’s closer to being the anti-Greece, in fact. Greece is a tiny, uncompetitive country that does not control its own currency. The business climate there is terrible. America is a vast, competitive, adaptable nation that not only controls its own monetary policy, but is blessed with the world’s reserve currency. The climate for business is favorable, abetted by large reserves of cultural and intellectual capital. So we shouldn’t conclude that just because the Europeans are suddenly cutting public spending, we ought to as well. Since deflation looks more threatening than inflation, it seems sensible,… Read More