SEPTEMBER 2 2011

James Surowiecki, The New Yorker: Europe’s Big Mistake: One might have thought that the E.C.B. would learn from the experience. No such luck. This year, Europe has been wrestling with high unemployment, slow growth, and a continuing debt crisis, with the economies of Portugal, Ireland, Italy, Greece, and Spain (the so-called PIIGS) struggling to avoid default. Given the situation, Trichet could have decided to keep interest rates where they were, as both the Federal Reserve and the Bank of England have done. Instead, the E.C.B. raised interest rates in April and, once more, in July. Again, as if on cue, European economic growth stalled and the continent’s debt crisis deepened, which has created problems for markets around the world. Policymakers make bad decisions all the time, of course. The E.C.B.’s failures, however, are the result not of mere bad judgment but of obsession

Leon Neyfakh, Boston Globe: The I-word. Harvard economist Kenneth Rogoff has spent his career fighting inflation. Now he thinks it might just save the economy. Rogoff has emerged as one of the world’s leading experts on the history of financial crises and how they work, a unique perch that has given him a long view on what is happening to our economy and what lies ahead. What we’ve been going through ever since the subprime mortgage crisis - has not been just a typical recession, as our leaders have been treating it, but something much worse, something that demands altogether different tools to stop it. One of these tools, Rogoff believes, is a temporary burst of inflation. And for the past several weeks, as the stock market has convulsed and debate raged over the Fed’s next move, he has been making his case publicly, through syndicated opinion columns, high-profile TV appearances, and numerous interviews.

Michael Schuman, Time Blog: Is the Greek bailout falling apart? The Finland debacle exposes the fundamental flaws in the management of the monetary union. What it reveals is how the domestic politics of any one euro member, no matter how small, can have ripple effects through all of Europe and, in fact, threaten the survival of the euro itself. The Finns insistence on collateral could tank the entire rescue package. Under euro zone rules, the governments of all 17 members have to approve the details of the bailout before funds can be released. That means tiny Finland, which would be contributing a mere 2% of the guarantees for the rescue, could block the entire arrangement. How this gets resolved is a complete unknown. Can Finland be allowed to opt out of the bailout? Will other euro zone countries also insist on receiving collateral, defeating the purpose of the entire bailout?

Kash, The Street Light Blog: Europe's Banking System: A Slow-Motion Bank Run in Progress? The truly troubling thing to note in the table, however, is the rate at which financial institutions have been withdrawing money from European banks. This has particularly affected those countries that have traditionally been large international money centers, such as Germany, the UK, and to a lesser degree, Ireland, but it has affected all of the major European economies to some extent. To varying degrees these withdrawals by financial institutions have been offset in the large euro-zone countries by steady increases in the deposits made by domestic residents and corporations (i.e. non-MFI deposits), leaving the overall level of deposits in the euro-zone roughly unchanged. But it seems very clear that the world's big banks and other financial institutions are indeed moving their funds out of Europe at a significant rate.

Stephen G Cecchetti, M S Mohanty, Fabrizio Zampolli, BIS: The real effects of debt. Our results support the view that, beyond a certain level, debt is bad for growth. For government debt, the threshold is in the range of 80 to 100% of GDP. The immediate implication is that countries with high debt must act quickly and decisively to address their fiscal problems. The longer-term lesson is that, to build the fiscal buffer required to address extraordinary events, governments should keep debt well below the estimated thresholds. Up to a point, corporate and household debt can be good for growth. But when corporate debt goes beyond 90% of GDP, our results suggest that it becomes a drag on growth. And for household debt, we report a threshold around 85% of GDP, although the impact is very imprecisely estimated.

Ahmed Al-Darwish et al, IMF: Possible Unintended Consequences of Basel III and Solvency II. In today’s financial system, complex financial institutions are connected through an opaque network of financial exposures. These connections contribute to financial deepening and greater savings allocation efficiency, but are also unstable channels of contagion. Basel III and Solvency II should improve the stability of these connections, but could have unintended consequences for cost of capital, funding patterns, interconnectedness, and risk migration.

Mark Thoma, The Fiscal Times: What Caused the Financial Crisis? Don’t Ask An Economist. Macroeconomic models have not fared well in recent years – the models didn’t predict the financial crisis and gave little guidance to policymakers, and I was anxious to hear the laureates discuss what macroeconomists need to do to fix them. So I found the lack of consensus on what caused the crisis distressing. If the very best economists in the profession cannot come to anything close to agreement about why the crisis happened almost four years after the recession began, how can we possibly address the problems?

Charles A.E. Goodhart, VoxEU: If banks should act as utilities, why not treat them as such? The calls for better bank regulation are many. This column argues that regulators have the concepts right, but the mechanisms are in need of repair. What needs to be done is bring intervention by the authorities forward in time: prompt corrective action, well before the bank’s managers can really drive it into the ground. A problem is that the available signals for doing so are quite faulty. The accounting value of equity capital is only available after a lag that can be far too long for comfort in fast-moving markets, and can be subject to all kinds of accounting tricks. On the other hand, the market value of equity can be subject to (temporary) manipulation, or to market over-reactions or flash crashes.

Michael Pettis, China Financial Markets: Some predictions for the rest of the decade. Since most global consumption comes from the US, Europe and Japan, the collapse in their demand will ultimately be very painful for the BRICs and the rest of the developing world. The latter have postponed the impact of contracting consumption by increasing domestic investment, in some cases very sharply, but the purpose of higher current investment is to serve higher future consumption. In many countries, most notably China, the higher investment will itself limit future consumption growth, and so with weak consumption growth in the developed world, and no relief from the developing world, today’s higher investment will actually exacerbate the impact of the current contraction in consumption.

Avraham Ebenstein, Ann Harrison, Margaret McMillan, Shannon Phillips, World Bank: Estimating the impact of trade and offshoring on American workers. The authors link industry-level data on trade and offshoring with individual-level worker data from the Current Population Surveys. They find that occupational exposure to globalization is associated with larger wage effects than industry exposure. This effect has been overlooked because it operates between rather than within sectors of the economy. The authors also find that globalization is associated with a reallocation of workers across sectors and occupations. They estimate wage losses of 2 to 4 percent among workers leaving manufacturing and 4 to 11 percent among workers who also switch occupations. These effects are most pronounced for workers who perform routine tasks.

Alastair Muriel, Jeffrey Smith, IZA: On Educational Performance Measures. Quantitative school performance measures (QPMs) are playing an ever larger role in education systems on both sides of the Atlantic. In this paper we outline the rationale for the use of such measures in education, review the literature relating to several important problems associated with their use, and argue that they nonetheless have a positive role to play in improving the educational quality. We delineate several institutional reforms which would help schools to respond “positively” to QPMs, emphasizing the importance of agents’ flexibility to change the way they work, and the importance of a sound knowledge base regarding “what works” in raising attainment. We suggest that the present institutional setups in both England and the US too often hold schools accountable for outcomes over which they have little control – but that such problems are far from insurmountable.

Olivier Bargain, Mathias Dolls, Herwig Immervoll, Dirk Neumann, Andreas Peichl, Nico Pestel, Sebastian Siegloch, IZA: Tax Policy and Income Inequality in the U.S., 1978-2009: A Decomposition Approach. We assess the effects of U.S. tax policy reforms on inequality by applying a new decomposition method that allows us to disentangle mechanical effects due to changes in pre-tax incomes from direct effects of policy reforms. While tax reforms implemented under Democrat administrations, in particular the EITC reforms in the 1990s and the ARRA in 2009, had an equalizing effect at the lower half of the distribution, the disequalizing effects of Republican reforms are due to tax cuts for high-income families. As a consequence of partisan politics, overall policy effects almost cancel out over the whole time period.