The witch called ‘confidence fairy’25 May, 2016 at 16:26 | Posted in Economics | 1 Comment
“We encourage all countries to be absolutely determined to go back to a sustainable mode for their fiscal policies,” Trichet said, speaking after the ECB rate decision on Thursday. “Our message is the same for all, and we trust that it is absolutely decisive not only for each country individually, but for prosperity of all.”
“Not because it is an elementary recommendation to care for your sons and daughter and not overburden them, but because it is good for confidence, consumption and investment today”.
Well, think again. Here is the abstract of ECB Working Paper no 1770, March 2015:
“We explore how fiscal consolidations affect private sector confidence, a possible channel for the fiscal transmission that has received particular attention recently as a result of governments embarking on austerity trajectories in the aftermath of the crisis … The effects are stronger for revenue-based measures and when institutional arrangements, such as fiscal rules, are weak … Consumer confidence falls around announcements of consolidation measures, an effect driven by revenue-based measures. Moreover, the effects are most relevant for European countries with weak institutional arrangements, as measured by the tightness of fiscal rules or budgetary transparency.”
The confidence fairy seems to have turned into a confidence witch. One more victim of the crisis. But this one will not be missed.
Sad to say, Trichet isn’t the only one who has got things wrong. Leading mainstream economists in my own country — Sweden — have even made the same flimflamming confidence reasoning into some kind of national pride issue (emphasis added):
The current monetary policy framework in Sweden … was a response to an earlier malfunctioning system, which motivated a number of academic proposals on reforms, to a large extent inspired by international resarch developments in the monetary policy area … The final transition to the current regime was triggered by two developments: Swedish EU membership, which imposed requirements to do central bank reform, and the Swedish decision to stay outside the monetary union, which made it clear that credibility for low–inflation policy had to be built at home … The current monetary policy framework has been successful in achieving low inflation, in fact too successful as average CPI inflation 1997-2014 was 1 percentage point below the 2 per cent target … An issue raised by these experiences is … whether the objective of stabilising unemployment around its equilibrium level should be stated explicitly in the Riksbank Act. It has also been claimed that a somewhat higher inflation target might be desirable, as this would likely imply higher inflation, and hence a lower real interest rate that would stimulate the economy in a deep recession when the repo rate approaches zero. However, both the politicians and the Riksbank have been reluctant to contemplate such changes because of a worry that they could undermine the credibility of low-inflation policies.
Lars Calmfors (president of the Swedish Fiscal Policy Council)
How hard it seems to be for mainstream economists to grasp the simple fact that no matter how much confidence you have in the policies pursued by authorities nowadays, it cannot turn bad austerity policies into good job creating policies. Austerity measures and overzealous and simple-minded fixation on monetary measures and inflation, are not what it takes to get our limping economies out of their present day limbo. They simply do not get us out of the ‘magneto trouble’ — and neither does budget deficit discussions where economists and politicians seem to think that cutting government budgets would help us out of recessions and slumps. Although the ‘credibility’ that Calmfors talks about arguably has some impact on the economy, the confidence fairy does not create recovery or offset the negative effects of Alessina-like ‘expansionary fiscal austerity.’ In a situation where monetary policies has become more and more decrepit, the solution is not fiscal austerity, but fiscal expansion!