AUGUST 12 2011

Paul Krugman, NYT: Credibility, Chutzpah And Debt. To understand the furor over the decision by Standard & Poor’s, the rating agency, to downgrade U.S. government debt, you have to hold in your mind two seemingly (but not actually) contradictory ideas. The first is that America is indeed no longer the stable, reliable country it once was. The second is that S.& P. itself has even lower credibility; it’s the last place anyone should turn for judgments about our nation’s prospects. If there’s a single word that best describes the rating agency’s decision to downgrade America, it’s chutzpah — traditionally defined by the example of the young man who kills his parents, then pleads for mercy because he’s an orphan.

Menzie D. Chinn And Jeffry A. Frieden, NYT: The Downgrading of a Debtor Nation. The Treasury can cry foul all it wants, but the decision by Standard & Poor’s to downgrade America’s credit rating by one notch last Friday, and the subsequent plunge in the stock market, are serious symptoms of a loss of confidence — an assessment that is fundamentally political, not economic. There is little question about the technical ability of America to make good on its debts — but there are grave questions about the political system’s ability to resolve our nation’s financial problems.

Kenneth Rogoff, Spiegel: Some European Countries Are Fundamentally Bankrupt. It is not easy for a politician to do what needs to be done if it is unpopular. Greece needs a massive restructuring plan, Portugal as well, probably Ireland, too. Ultimately, Germany has to guarantee all the central government debt in Spain and Italy, and that will be very painful. If Italy and Spain are to be kept in the euro area, then unfortunately the Germans will have to acknowledge that Europe is going to be a transfer union for some time to come.

Nicholas Bloom, VoxEU: The uncertainty shock from the debt disaster will cause a double-dip recession. The potentially explosive combination of Eurozone debt contagion, vulnerable banking systems, and European and American political paralysis has pushed stock-market volatility to levels nearly as bad as the days following the 11 September 2001 terrorist attacks. Nobody knows what happens next. This column reviews research on 16 previous shocks and concludes that today’s uncertainty shock will create a short, sharp contraction in late 2011 of about 1% with a rebound coming in spring 2012.

Jeffrey A. Frankel, NBER:  Over-optimism in Forecasts by Official Budget Agencies and Its Implications.   The paper studies forecasts of real growth rates and budget balances made by official government agencies among 33 countries.  In general, the forecasts are found:  (i) to have a positive average bias, (ii) to be more biased in booms, (iii) to be even more biased at the 3-year horizon than at shorter horizons. This over-optimism in official forecasts can help explain excessive budget deficits, especially the failure to run surpluses during periods of high output:  if a boom is forecasted to last indefinitely, retrenchment is treated as unnecessary. Many believe that better fiscal policy can be obtained by means of rules such as ceilings for the deficit or, better yet, the structural deficit.  But we also find:  (iv) countries subject to a budget rule, in the form of euroland's Stability and Growth Path, make official forecasts of growth and budget deficits that are even more biased and more correlated with booms than do other countries. This effect may help explain frequent violations of the SGP. 

Christophe Chamley, Bloomberg: The Default More Than 400 Years Ago Leaves Scars. House Republicans, many of them opposed to raising the federal government’s borrowing ceiling, might take a lesson from the first sovereign debt crisis: Spain’s default in 1575. What events more than 400 years ago suggest is that it’s easy to ignite a dangerous chain reaction in financial and credit markets and inflict lasting damage on the economy. Republicans today are playing the part of the cities of Castile, whose delegates to the Cortes (the Spanish parliament) opposed raising taxes to service King Philip II’s long-term bonds.

Denise DiPasquale, Edward L. Glaeser, Chicago/Harvard: The Los Angeles Riot and the Economics of Urban Unrest. We examine the causes of rioting using international data, evidence from the race riots of the 1960s in the U.S., and Census data on Los Angeles, 1990. We find some support for the notions that the opportunity cost of time and the potential costs of punishment influence the incidence and intensity of riots. Beyond these individual costs and benefits, community structure matters. In our results, ethnic diversity seems a significant determinant of rioting, while we find little evidence that poverty in the community matters.

Jacopo Ponticelli, Hans-Joachim Voth, CEPR: Austerity and Anarchy: Budget Cuts and Social Unrest in Europe, 1919-2009. The results show a clear

positive correlation between fiscal retrenchment and instability. We test if the relationship simply reflects economic downturns, and conclude that this is not the key factor. We also analyse interactions with various economic and political variables. While autocracies and democracies show a broadly similar responses to budget cuts, countries with more constraints on the executive are less likely to see unrest as a result of austerity measures. Growing media penetration does not lead to a stronger effect of cut-backs on the level of unrest.

Chris Dillow, Stumbling and Mumbling Blog:  Riots, sell-offs & cascades. There’s a parallel between the riots and the stock market sell-off. Both are examples of how social behaviour can shift from stability to instability. There’s always some doom-monger trader who’s keen to sell.  Usually, though, his selling readily finds a buyer, so prices don’t move much. Analogously, there’s always some nutter who wants to rob and trash places. But normally, his friends don’t go along with him, so he suppresses his tendencies. In other words, when behaviour is uncorrelated - when sellers find buyers or when the lawless are surrounded by the lawful - we get stability. What we’re seeing now, though, is a higher correlation of behaviour. When sellers have tried to sell, they’ve run into other sellers - so prices have tanked low enough to lure out the buyers. And the lawless have found themselves accompanied by other criminals, so their behaviour has been encouraged rather than suppressed. But what explains this? A big part of the story must be information cascades. These happen when people base their behaviour not upon their private information, but rather upon what others are doing.

Mark A. Wynne, Dallas Fed: Will China Ever Become as Rich as the U.S.? Many countries have expanded at a rapid pace for long periods. But as they get richer, their growth rates tend to slow and they can’t attain the U.S. standard of living. For most of the 20th century, the U.S. defined the technological frontier to which other countries could aspire. That remains the case today, and absent any major policy errors in the U.S., it should continue. In 1820, China was responsible for about one-third of global GDP, while the U.S. accounted for just 1.8 percent. So, the likely shift in relative size in the next decade is in some ways simply a return to what we previously experienced.6 Even then, U.S. living standards were twice those of China. If China were to become the first country to completely close the gap with the U.S., it would mark a significant break with development patterns observed over the past half-century.