Research Topics

Publications on Eurozone debt crisis

There are 55 publications for Eurozone debt crisis.
  • The Greek Public Debt Problem


    Working Paper No. 867 | May 2016

    This paper examines the issue of the Greek public debt from different perspectives. We provide a historical discussion of the accumulation of Greece’s public debt since the 1960s and the role of public debt in the recent crisis. We show that the austerity imposed since 2010 has been unsuccessful in stabilizing the debt while at the same time taking a heavy toll on the Greek economy and society. The experience of the last six years shows that the country’s public debt is clearly unsustainable, and therefore a bold restructuring is needed. An insistence on the current policies is not justifiable either on pragmatic or on moral or any other grounds. The experience of Germany in the early post–World War II period provides some useful hints for the way forward. A solution to the Greek public debt problem is a necessary but not sufficient condition for the solution of the Greek and wider European crisis. A broader agenda that deals with the malaises of the Greek economy and the structural imbalances of the eurozone is of vital importance.

  • The Two Approaches to Money


    Working Paper No. 855 | November 2015
    Debt, Central Banks, and Functional Finance

    The scientific reassessment of the economic role of the state after the crisis has renewed interest in Abba Lerner’s theory of functional finance (FF). A thorough discussion of this concept is helpful in reconsidering the debate on the nature of money and the origin of the business cycle and crises. It also allows a reevaluation of many policy issues, such as the Barro–Ricardo equivalence, the cause of inflation, and the role of monetary policy.

    FF, throwing a different light on these issues, can provide a sound foundation for discussing income, fiscal, and monetary policy rules in the right context of flexibility in the management of national budgets, assessing what kind of policies should be awarded priority, and the effectiveness of tackling the crisis with the different part of public budget. It also allows us to understand ways of increasing efficiency through public investment while reducing the total operational costs of firms. In the specific context of the eurozone, FF is useful for assessing the institutional framework of the euro and how to improve it in the face of protracted low growth, deflation, and weak public finances.

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    Author(s):
    Giuseppe Mastromatteo Lorenzo Esposito

  • Responding to the Unemployment Challenge: A Job Guarantee Proposal for Greece—An Addendum


    Research Project Report, May 2015 | May 2015
    This addendum to our June 2014 report, “Responding to the Unemployment Challenge: A Job Guarantee Proposal for Greece,” updates labor market data through 2014Q3 and identifies emerging employment and unemployment trends. The overarching aim of the report, the outcome of a study undertaken in 2013 by the Levy Institute in collaboration with the Observatory of Economic and Social Developments of the Labour Institute of the Greek General Confederation of Labour, is to provide policymakers and the general public research-based evidence of the macroeconomic and employment effects of a large-scale direct job creation program in Greece, and to invite critical rethinking of the austerity-driven macro policy instituted in 2010 as a condition of the loans made to Greece by its eurozone partners. 

  • After Austerity: Measuring the Impact of a Job Guarantee Policy for Greece


    Public Policy Brief No. 138, 2014 | October 2014
    To mobilize Greece’s severely underemployed labor potential and confront the social and economic dangers of persistent unemployment, we propose the immediate implementation of a direct public benefit job creation program—a Greek “New Deal.” The Job Guarantee (JG) program would offer the unemployed jobs, at a minimum wage, on work projects providing public goods and services. This policy would have substantial positive economic impacts in terms of output and employment, and when newly accrued tax revenue is taken into account, which substantially reduces the net cost of the program, it makes for a comparatively modest fiscal stimulus. At a net cost of roughly 1 percent to 1.2 percent of GDP (depending on the wage level offered), a midrange JG program featuring the direct creation of 300,000 jobs has the potential to reduce the unemployed population by a third or more, once indirect employment effects are taken into account. And our research indicates that the policy would do all this while reducing Greece’s debt-to-GDP ratio—which leaves little room for excuses.

  • Co-operative Banking in Greece


    Research Project Report, April 2014 | July 2014
    A Proposal for Rural Reinvestment and Urban Entrepreneurship
    The crisis in Greece is persistent and ongoing. After six years of deepening recession, real GDP has shrunk by more than 25 percent, with total unemployment now standing at 27.2 percent. Clearly, reviving growth and creating jobs should be at the top of the policy agenda.

    But banks remain undercapitalized, and lending has been restricted to only the most creditworthy businesses and households. Many start-ups and small- and medium-size enterprises (SMEs) have almost no access to development loans, and for those to whom credit can be extended, it is at disproportionally high interest rates.

    The success of micro-lending institutions in developing nations (such as the Grameen Bank in Bangladesh) has highlighted the positive economic performance of community-based credit, and such lending models have proven to be an important poverty policy alternative in areas where transfer payments are limited. Community or co-operative financial institutions (CFIs) can fill the gap when existing institutions cannot adequately perform critical functions of the financial system for SMEs, entrepreneurs, and low-income residents seeking modest financing and other banking services.

    We propose expanding the reach and services of CFIs within Greece, drawing upon lessons from the US experience of community development banking and various co-operative banking models in Europe. The primary goals of this nationwide system would be to make credit available, process payments, and offer savings opportunities to communities not well served by the major commercial Greek banks.

    Our blueprint includes suggestions on the banks’ organization and a framework within which they would be chartered, regulated, and supervised by a newly created central co-operative bank. It also looks at the possible impact that such a network could have, especially in terms of start-ups, SMEs, and rural redevelopment (agrotourism)—all of which are critical to Greece’s exit from recession. 

  • Responding to the Unemployment Challenge: A Job Guarantee Proposal for Greece


    Research Project Report, April 2014 | June 2014

    This report presents the findings from a study undertaken by the Levy Institute in 2013 in collaboration with the Observatory of Economic and Social Developments of the Labour Institute of the Greek General Confederation of Labour. It uses as background the 2011 Levy Institute study “Direct Job Creation for Turbulent Times in Greece,” which focused on the need for direct job creation to address rising unemployment. The focus in this report, however, is different. Here, the aim is to make available to policymakers and the broader public research-based evidence of the macroeconomic and employment effects of a large-scale program of direct job creation program—a cost-effective and proven policy response. The ultimate goal of this undertaking is to draw urgently needed attention to the worsening levels of unemployment in Greece, and to invite critical rethinking of the austerity-driven macro policy instituted in 2010.

  • The Myth of the Greek Economic “Success Story”


    Policy Note 2014/3 | February 2014
    In 2001, a three-year, multicountry study by the Structural Adjustment Participatory Review International Network (SAPRIN), prepared in cooperation with the World Bank, national governments, and civil society organizations, offered a damning indictment of the policies of structural adjustment reform pursued by the IMF and the World Bank in third world countries. The structural adjustment programs in Greece, combined with the policies of austerity, are producing results that fit the patterns outlined in the SAPRIN study like a glove.   This policy note rejects the myth of Greece as an economic success story and argues that current trends and developments in the country make for a bleak economic future. The experiment under way in Greece will produce an economy resembling, not the Celtic Tiger of the mid-1990s to early 2000s, as the current government envisions, but an underdeveloped Latin America country of the 1980s.
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    Author(s):
    C. J. Polychroniou

  • Prospects and Policies for the Greek Economy


    Strategic Analysis, February 2014 | February 2014
    In this report, we discuss alternative scenarios for restoring growth and increasing employment in the Greek economy, evaluating alternative policy options through our specially constructed macroeconometric model (LIMG). After reviewing recent events in 2013 that confirm our previous projections for an increase in the unemployment rate, we examine the likely impact of four policy options: (1) external help through Marshall Plan–type capital transfers to the government; (2) suspension of interest payments on public debt, instead using these resources for increasing demand and employment; (3) introduction of a parallel financial system that uses new government bonds; and (4) adoption of an employer-of-last-resort (ELR) program financed through the parallel financial system. We argue that the effectiveness of the different plans crucially depends on the price elasticity of the Greek trade sector. Since our analysis shows that such elasticity is low, our ELR policy option seems to provide the best strategy for a recovery, having immediate effects on the Greek population's standard of living while containing the effects on foreign debt.

  • The Continued Relevance of Tax-backed Bonds in a Post-OMT Eurozone


    Policy Note 2013/10 | December 2013

    In a policy note published last year by the Levy Institute, Philip Pilkington and Warren Mosler argued that the eurozone sovereign debt crisis could be solved by national governments without the assistance of the European Central Bank (ECB) and without their leaving the currency union, through the issuance of a proposed financial innovation called “tax-backed bonds.” These bonds would be similar to standard government bonds except that, should the country issuing the bonds not make its payments, the tax-backed bonds would be acceptable to make tax payments within the country in question, and would continue to earn interest.

    In the current policy note, Pilkington examines the continued relevance of the bond proposal in light of changes that have taken place with respect to ECB policy since the original proposal was made, as well as the case made by Ireland’s finance minister that tax-backed bonds would violate current Irish law (and, by implication, the law in other eurozone countries). He also outlines some changes made to the initial proposal in response to constructive criticisms received since its publication, and briefly notes another area in which the proposal might be utilized—outside the eurozone. His conclusion? That tax-backed bonds remain a valid policy tool, one that can be implemented at the national rather than at the federal level, and a stepping stone to solving the eurozone’s economic problems.

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    Author(s):
    Philip Pilkington

  • Fiscal Sadism and the Farce of Deficit Reduction in Greece


    One-Pager No. 43 | September 2013

    Unemployment in Greece has climbed to a new record of 27.9 percent and the country is headed toward a third bailout. The obsession with reducing the budget deficit is crippling the Greek economy. Extreme fiscal consolidation in the midst of a major depression can only have extreme effects on output, leading to greater unemployment, widening poverty, massive loss of faith in political and social institutions, and the potential for political violence. This is precisely what has been taking place in Greece since 2010, as fiscal brutality intensifies from one year to the next. Offering Greece yet another bailout package is not the answer.

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    Author(s):
    C. J. Polychroniou

  • Waiting for Export-led Growth


    One-Pager No. 41 | September 2013
    Why the Troika’s Greek Strategy Is Failing

    Greece’s unemployment rate just hit 27.6 percent. That wasn’t supposed to happen. Why has the troika—the European Commission, International Monetary Fund (IMF), and European Central Bank—been so consistently wrong about the effects of its handpicked policies? The strategy being imposed on Greece depends in large part on the idea of “internal devaluation”: that reducing wages will make its products more attractive, thus spurring a return to economic growth powered by rising exports. Our research, based on a macroeconomic model specifically constructed for Greece, indicates that this strategy is not working. Achieving significant growth in net exports through internal devaluation would, at best, take a very long time—and a great deal of immiseration and social disintegration would take place while we waited for this theory to bear fruit. Despite some recent admissions of error along these lines by the IMF, the troika still relies on a theory of how the economy works that badly underestimates the negative effects of austerity.

  • The Greek Economic Crisis and the Experience of Austerity


    Strategic Analysis, July 2013 | July 2013
    A Strategic Analysis
    Employment in Greece is in free fall, with more than one million jobs lost since October 2008—a drop of more than 28 percent. In March, the “official” unemployment rate was 27.4 percent, the highest level seen in any industrialized country in the free world during the last 30 years.

    In this report, Levy Institute President Dimitri B. Papadimitriou and Research Scholars Michalis Nikiforos and Gennaro Zezza present their analysis of Greece’s economic crisis and offer policy recommendations to restore growth and increase employment. This analysis relies on the Levy Institute’s macroeconomic model for the Greek economy (LIMG), a stock-flow consistent model similar to the Institute’s model of the US economy. Based on the LIMG simulations, the authors find that a continuation of “expansionary austerity” policies will actually increase unemployment, since GDP will not grow quickly enough to arrest, much less reverse, the decline in employment. They critically evaluate recent International Monetary Fund and European Commission projections for the Greek economy, and find these projections overly optimistic. They recommend a recovery plan, similar to the Marshall Plan, to increase public consumption and investment. Toward this end, the authors call for an expanded direct public-service job creation program.

  • The New Rome


    Policy Note 2013/5 | May 2013
    The EU and the Pillage of the Indebted Countries
    The European Union (EU) is a treaty-based organization that was set up after World War II as a means of putting an end to a favorite practice of the Europeans: sorting out their national differences by engaging in bloody warfare. The European experiment—the formation of a Common Market, which led eventually to economic and monetary union—has been linked to some remarkable outcomes: Europe has experienced its longest period of peace since the end of World War II, and war among European member-states now seems highly unlikely. Naturally, senior EU officials never miss an opportunity to remind the public of this achievement whenever the policies of the “new Rome” are questioned by a European citizenship fed up with authoritarian decision-making processes by the EU core, bank bailouts masquerading as national bailouts, austerity policies—and what amounts to the pillaging of the debtor countries by the center.
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    Author(s):
    C. J. Polychroniou

  • On the Franco-German Euro Contradiction and Ultimate Euro Battleground


    Working Paper No. 762 | April 2013

    Highlighting that France and Germany held largely contradicting hopes and aspirations for Europe’s common currency, this paper analyzes how the resulting euro contradiction conditioned the ongoing euro crisis as well as current strategies to resolve it. While Germany generally prevailed in hammering out the design of the euro policy regime, the German authorities have failed to see the inconsistency in their policy endeavors: the creation of a model whose workability presupposes that others behave differently cannot be made to work by forcing everyone to behave like Germany. This fundamental misunderstanding has made Germany the main culprit in the euro crisis, but it has yet to face the full consequences of its actions. Germany had sought every protection against the much-dreaded euro “transfer union,” but its own conduct has made that very outcome inevitable. Conversely, having been disappointed in its own hopes for the euro, France is now facing the prospect of a lost generation—a prospect, shared with other debtor nations in the union, that has undermined the Franco-German alliance and may soon turn it into the ultimate euro battleground.

     

  • The Tragedy of Greece


    Policy Note 2013/1 | March 2013
    A Case against Neoliberal Economics, the Domestic Political Elite, and the EU/IMF Duo
    The crisis in Greece reflects the deep structural problems of the country’s economy, its bureaucratic inefficiency, and a pervasive culture of corruption. But it also reflects the deadly failure of the neoliberal project, which has become institutionalized throughout the European Union’s operational framework—with the International Monetary Fund the world’s single most powerful enforcer of market fundamentalism.
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    Author(s):
    C. J. Polychroniou

  • Greece: Caught Fast in the Troika's Austerity Trap


    Policy Note 2012/12 | December 2012
    On November 27, 2012, the Eurogroup reached a new “Greek deal” that once more discloses that there is no political will to address Greece’s debt crisis—or the country’s economic and social catastrophe.

  • ECB Worries / European Woes


    Working Paper No. 742 | December 2012
    The Economic Consequences of Parochial Policy

    Financial market crises with the threat of a subsequent debt-deflation depression have occurred with increasing regularity in the United States from 1980 through the present. Almost reflexively, when confronted with such circumstances, US institutions and the policymakers that run them have responded in a fashion that has consistently thwarted debt-deflation-depression dynamics. It is true that these “remedies,” as they succeeded, increasingly contributed to a moral hazard in US and global financial markets that culminated with the crisis that began in 2007. Nonetheless, the straightforward steps taken by established institutions enabled the United States to derail depression dynamics, while European 1930s-style austerity proved as ineffective as it was almost a century ago. Europe’s, and specifically Germany’s, steadfast refusal to embrace the US recipe has fostered mushrooming economic hardship on the continent. The situation is gruesome, and any serious student of economic history had to have known, given European policy commitments, that it was destined to turn out this way.

    It is easy to understand why misguided policies drove initial European responses. Economic theory has frowned on Keynes. Economic successes, especially in Germany, offered up the wrong lessons, and enduring angst about inflation was a major distraction. At the outset, the wrong medicine for the wrong disease was to be expected.

    What is much harder to fathom is why such a poisonous elixir continues to be proffered amid widespread evidence that the patient is dying. Deconstructing cognitive dissonance in other spheres provides an explanation. Not surprisingly, knowing what one wants to happen at home completely informs one’s claims concerning what will be good for one’s neighbors. In such a construct, the last best hope for Europe is ECB President Mario Draghi. He seems to be able to speak German and yet act European.

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    Author(s):
    Robert J. Barbera Gerald Holtham

  • Conflicting Claims in the Eurozone?


    Working Paper No. 740 | December 2012
    Austerity’s Myopic Logic and the Need for a European Federal Union in a Post-Keynesian Eurozone Center–Periphery Model

    In this paper, we analyze the role of the current institutional setup of the eurozone in fostering the ongoing peripheral euro countries’ sovereign debt crisis. In line with Modern Money Theory, we stress that the lack of a federal European government running anticyclical fiscal policy, the loss of euro member-states’ monetary sovereignty, and the lack of a lender-of-last-resort central bank have significantly contributed to the generation, amplification, and protraction of the present crisis. In particular, we present a Post-Keynesian eurozone center–periphery model through which we show how, due to the incomplete nature of eurozone institutions with respect to a full-fledged federal union, diverging trends and conflicting claims have emerged between central and peripheral euro countries in the aftermath of the 2007–08 financial meltdown. We emphasize two points. (1) Diverging trends and conflicting claims among euro countries may represent decisive obstacles to the reform of the eurozone toward a complete federal entity. However, they may prove to be self-defeating in the long run should financial turbulences seriously deepen in large peripheral countries. (2) Austerity packages alone do not address the core problems of the eurozone. These packages would make sense only if they were included in a much wider reform agenda whose final purpose was the creation of a government banker and a federal European government that could run expansionary fiscal stances. In this sense, the unlimited bond-buying program recently launched by the European Central Bank is interpreted as a positive, albeit mild step in the right direction out of the extreme monetarism that has thus far shaped eurozone institutions.

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    Author(s):
    Alberto Botta

  • Fiscal Traps and Macro Policy after the Eurozone Crisis


    Public Policy Brief No. 127, 2012 | November 2012
    The United States must make a fundamental choice in its economic policy in the next few months, a choice that will shape the US economy for years to come. Pundits and policymakers are divided over how to address what is widely referred to as the “fiscal cliff,” a combination of tax increases and spending cuts that will further weaken the domestic economy. Will the United States continue its current, misguided, policy of implementing European-style austerity measures, and the economic contraction that is the inevitable consequence of such policies? Or will it turn aside from the fiscal cliff, using a combination of its sovereign currency system and Keynesian fiscal policy to strengthen aggregate demand?

    Our analysis presents a model of what we call the “fiscal trap”—a self-imposed spiral of economic contraction resulting from a fundamental misunderstanding of the role and function of fiscal policy in times of economic weakness. Within this framework, we begin our analysis with the disastrous results of austerity policies in the European Union (EU) and the UK. Our account of these policies and their results is meant as a cautionary tale for the United States, not as a model.

  • Current Prospects for the Greek Economy


    Research Project Report, October 18, 2012 | October 2012
    Interim Report
    In this interim report, we discuss the evolution of major macroeconomic variables for the Greek economy, focusing in particular on the sources of growth before and after the euro era, the causes and consequences of the continuing recession, and the likely results of the policies currently being implemented. Some preliminary suggestions for alternative policies are included. These alternatives will be tested in a more robust econometric framework in a subsequent report.

  • The Collapse of a Nation


    One-Pager No. 33 | September 2012
    Who’s Afraid of Greece?

    As the Greek summer comes to an end, the predatory austerity policies of the second bailout plan are in full swing, while the fiscal consolidation program continues to run its wayward course. Overall, what was once a modern democratic polity is beginning to resemble a feudal state. As the government seeks a broad agreement on its latest spending cuts, the Greek labor movement is set to embark on a new round of paralyzing strikes and demonstrations. This year, the truly hot season in Greece is only just beginning.

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    Author(s):
    C. J. Polychroniou

  • Greece’s Bailouts and the Economics of Social Disaster


    Policy Note 2012/11 | September 2012
    As the decline in Greek GDP should indicate—a contraction of more than 20 percent since the onset of the sovereign debt crisis in late 2009—the economic situation in Greece today is catastrophic. The economy is in freefall, and the social consequences are being widely felt. The main reason for this awful situation is that the country has suffered for more than two years under a harsh austerity regime imposed by the European Union and the International Monetary Fund. The bailouts have proven to be a curse. The nation is literally under economic occupation and sinking deeper into the abyss—and there is very little reason to expect a turnaround in the foreseeable future.
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    Author(s):
    C. J. Polychroniou

  • Euroland's Original Sin


    Policy Note 2012/8 | July 2012
    From the very start, the European Monetary Union (EMU) was set up to fail. The host of problems we are now witnessing, from the solvency crises on the periphery to the bank runs in Spain, Greece, and Italy, were built into the very structure of the EMU and its banking system. Policymakers have admittedly responded to these various emergencies with an uninspiring mix of delaying tactics and self-destructive policy blunders, but the most fundamental mistake of all occurred well before the buildup to the current crisis. What we are witnessing today are the results of a design flaw. When individual nations like Greece or Italy joined the EMU, they essentially adopted a foreign currency—the euro—but retained responsibility for their nation’s fiscal policy. This attempted separation of fiscal policy from a sovereign currency is the fatal defect that is tearing the eurozone apart.

  • The Greek Crisis


    Policy Note 2012/7 | June 2012
    Possible Costs and Likely Outcomes of a Grexit
    The European Union’s (EU) handling of the Greek crisis has been an unmitigated disaster. In fact, EU political leadership has been a failure of historic proportions, as its myopic, neoliberal bent and fear-driven policies have brought the eurozone to the brink of collapse. After more than two years of a “kicking the can down the road” policy response, it’s a do-or-die situation for Euroland. Greece has reached the point where an exit looks rather imminent (it’s really a matter of time, regardless of the June 17 election outcome), Portugal is bleeding heavily, Spain is about to go under, and Italy is in a state of despair. This Policy Note examines why the bailout policies failed to rescue Greece and boost the eurozone, and what effects a “Grexit” might possibly have—on Greece and the rest of Euroland.
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    Author(s):
    C. J. Polychroniou

  • The Mediterranean Conundrum


    Public Policy Brief No. 124, 2012 | May 2012
    The Link between the State and the Macroeconomy, and the Disastrous Effects of the European Policy of Austerity

    Conventional wisdom has calcified around the belief that the countries in the eurozone periphery are in trouble primarily because of their governments’ allegedly profligate ways. For most of these nations, however, the facts suggest otherwise. Apart from the case of Greece, the outbreak of the eurozone crisis largely preceded dramatic increases in public debt ratios, and as has been emphasized in previous Levy Institute publications, the roots of the crisis lie far more in the flawed design of the European Monetary Union and the imbalances it has generated.

    But as Research Associate and Policy Fellow C. J. Polychroniou demonstrates in this policy brief, domestic political developments should not be written out of the recent history of the eurozone’s stumbles toward crisis and possible dissolution. However, the part in this tale played by southern European political regimes is quite the opposite of that which is commonly claimed or implied in the press. Instead of out-of-control, overly generous progressive agendas, the countries at the core of the crisis in southern Europe—Greece, Spain, and Portugal—have seen their macroeconomic environments shaped by the dominance of regressive political regimes and an embrace of neoliberal policies; an embrace, says Polychroniou, that helped contribute to the unenviable position their economies find themselves in today.

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    Author(s):
    C. J. Polychroniou

  • Is an Austerity-induced Depression about to Bring Down the Final Curtain on the Greek Drama?


    One-Pager No. 31 | May 2012

    On June 17, Greece will hold a second round of elections, the outcome of which might force the European Union to halt all financial assistance to the debt-strapped country. What Greece desperately needs is a leadership with the ability to explore all possible options and to prepare the nation for the tough challenges that may lie ahead—and to make them aware of the opportunities available to a government in charge of its own currency.

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    Author(s):
    C. J. Polychroniou

  • The Euro Debt Crisis and Germany’s Euro Trilemma


    Working Paper No. 721 | May 2012

    This paper investigates the causes behind the euro debt crisis, particularly Germany’s role in it. It is argued that the crisis is not primarily a “sovereign debt crisis” but rather a (twin) banking and balance of payments crisis. Intra-area competitiveness and current account imbalances, and the corresponding debt flows that such imbalances give rise to, are at the heart of the matter, and they ultimately go back to competitive wage deflation on Germany’s part since the late 1990s. Germany broke the golden rule of a monetary union: commitment to a common inflation rate. As a result, the country faces a trilemma of its own making and must make a critical choice, since it cannot have it all —perpetual export surpluses, a no transfer / no bailout monetary union, and a “clean,” independent central bank. Misdiagnosis and the wrongly prescribed medication of austerity have made the situation worse by adding a growth crisis to the potpourri of internal stresses that threaten the euro’s survival. The crisis in Euroland poses a global “too big to fail” threat, and presents a moral hazard of perhaps unprecedented scale to the global community.

  • What Are the Driving Factors behind the Rise of Spreads and CDSs of Euro-area Sovereign Bonds?


    Working Paper No. 720 | May 2012
    A FAVAR Model for Greece and Ireland

    This paper examines the underlying dynamics of selected euro-area sovereign bonds by employing a factor-augmenting vector autoregressive (FAVAR) model for the first time in the literature. This methodology allows for identifying the underlying transmission mechanisms of several factors; in particular, market liquidity and credit risk. Departing from the classical structural vector autoregressive (VAR) models, it allows us to relax limitations regarding the choice of variables that could drive spreads and credit default swaps (CDSs) of euro-area sovereign debts. The results show that liquidity, credit risk, and flight to quality drive both spreads and CDSs of five years’ maturity over swaps for Greece and Ireland in recent years. Greece, in particular, is facing an elastic demand for its sovereign bonds that further stretches liquidity. Moreover, in current illiquid market conditions spreads will continue to follow a steep upward trend, with certain adverse financial stability implications. In addition, we observe a negative feedback effect from counterparty credit risk.

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    Author(s):
    Nicholas Apergis Emmanuel Mamatzakis

  • Tax-backed Bonds—A National Solution to the European Debt Crisis


    Policy Note 2012/4 | March 2012
    The root of Europe’s sovereign debt crisis can be found in the fact that investors are concerned that countries in the periphery might default, causing them to demand a higher yield on government bonds. What’s needed is a way of giving peripheral debt a high degree of safety while allowing peripheral countries to remain users of the euro.   A simple solution to this problem would be for peripheral countries to begin issuing a new type of government debt: the “tax-backed bond.” Tax-backed bonds would be similar to current government bonds except that they would contain a clause stating that if the country failed to make its payments when due—and only if this happens—the bonds would be acceptable to make tax payments within the country in question. This tax backing would set an absolute floor below which the value of the asset could not fall, assuring investors that the bond is always “money good,” leading to lower bond rates and thus ensuring that peripheral countries would not be driven to default.
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    Author(s):
    Philip Pilkington Warren Mosler

  • Reconceiving Change in the Age of Parasitic Capitalism


    Policy Note 2012/3 | March 2012
    Writing Down Debt, Returning to Democratic Governance, and Setting Up Alternative Financial Systems—Now

    The five-year-long crisis of Western finance capitalism is pushing advanced liberal societies to a breaking point. If governments continue to be proxies of finance capital and aspiring political leaders cheerleaders for their financial backers, a catastrophic economic scenario is not really as far-fetched as some might like to think. Governments, industries, and households are under debt bondage, with the result that revenues from every sector of the economy are being diverted toward interest payments and late fees for various loans taken out on largely exploitative, even fraudulent terms. Now, after years of building up a Ponzi financial regime, Western capitalism faces its ultimate test. Will it collapse, giving rise to long-term economic instability and authoritarian political regimes? Or will it find the strength and the wisdom to make a comeback?

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    Author(s):
    C. J. Polychroniou

  • Neo-Hooverian Policies Threaten to Turn Europe into an Economic Wasteland


    Policy Note 2012/1 | March 2012

    We live in a terrifying world of policymaking—an age of free-market dogmatism where the economic ideology is fundamentally flawed. Europe’s political leadership has applied neo-Hooverian (scorched-earth) policies that are shrinking economies and producing social misery as a result of massive unemployment.

    Large-scale government intervention is critical in reviving an economy, but the current public-policy mania, which imposes fiscal tightening in the midst of recession, can only lead to catastrophic failure. The bailouts, for example, do not solve Greece’s debt crisis but simply postpone an official default. What is needed is a political and economic revolution that includes a return to Keynesian measures and a new institutional architecture—a United States of Europe.

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    Author(s):
    C. J. Polychroniou

  • The European Central Bank and Why Things Are the Way They Are


    Working Paper No. 710 | March 2012
    A Historic Monetary Policy Pivot Point and Moment of (Relative) Clarity

    Not since the Great Depression have monetary policy matters and institutions weighed so heavily in commercial, financial, and political arenas. Apart from the eurozone crisis and global monetary policy issues, for nearly two years all else has counted for little more than noise on a relative risk basis.

    In major developed economies, a hypermature secular decline in interest rates is pancaking against a hard, roughly zero lower-rate bound (i.e., barring imposition of rather extreme policies such as a tax on cash holdings, which could conceivably drive rates deeply negative). Relentlessly mounting aggregate debt loads are rendering monetary- and fiscal policy–impaired governments and segments of society insolvent and struggling to escape liquidity quicksands and stubbornly low or negative growth and employment trends.

    At the center of the current crisis is the European Monetary Union (EMU)—a monetary union lacking fiscal and political integration. Such partial integration limits policy alternatives relative to either full federal integration of member-states or no integration at all. As we have witnessed since spring 2008, this operationally constrained middle ground progressively magnifies economic divergence and political and social discord across member-states.

    Given the scale and scope of the eurozone crisis, policy and actions taken (or not taken) by the European Central Bank (ECB) meaningfully impact markets large and small, and ripple with force through every major monetary policy domain. History, for the moment, has rendered the ECB the world’s most important monetary policy pivot point.

    Since November 2011, the ECB has taken on an arguably activist liquidity-provider role relative to private banks (and, in some important measure, indirectly to sovereigns) while maintaining its long-held post as rhetorical promoter of staunch fiscal discipline relative to sovereignty-encased “peripheral” states lacking full monetary and fiscal integration. In December 2011, the ECB made clear its intention to inject massive liquidity when faced with crises of scale in future. Already demonstratively disposed toward easing due to conditions on their respective domestic fronts, other major central banks have mobilized since the third quarter of 2011. The collective global central banking policy posture has thus become more homogenized, synchronized, and directionally clear than at any time since early 2009.

  • EU’s Anorexic Mindset Drives the Region’s Economies into Depression


    One-Pager No. 27 | February 2012
    The coordinated contractionary policy on the part of the European Union is inspired by its belief that this is the most effective way to tackle the eurozone’s “debt crisis.” However, by ignoring the endemic problems of unemployment, poverty, and homelessness—all of which have as their underlying cause the contraction of economic activity—European economic policy reveals a growing gap with the real world.
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    Author(s):
    C. J. Polychroniou

  • Fiddling in Euroland as the Global Meltdown Nears


    Public Policy Brief No. 122, 2012 | February 2012
    President Dimitri B. Papadimitriou and Senior Scholar L. Randall Wray argue that the common diagnosis of a “sovereign debt crisis” ignores the crucial role of rising private debt loads and the significance of current account imbalances within the eurozone. Profligate spending in the periphery is not at the root of the problem. Moreover, pushing austerity in the periphery while ignoring the imbalances within the eurozone is a recipe for deflationary disaster.
     
    The various rescue packages on offer for Greece will not ultimately solve the problem, say the authors, and a default is a very real possibility. If a new approach is not embraced, we are likely seeing the end of the European Monetary Union (EMU) as it currently stands. The consequences of a breakup would ripple throughout the EMU as well as the shaky US financial system, and could ultimately trigger the next global financial crisis.

  • The New European Economic Dogma


    One-Pager No. 26 | February 2012
    Improving Competitiveness by Reducing Living Standards and Increasing Poverty
    Greece’s new EU/IMF bailout package is all about private sector wage cuts and an overhaul of labor rights. In short, it will do absolutely nothing to address the nation’s economic crisis because it is not designed to rescue Greece’s embattled economy. In fact, it will have the unwanted effect of keeping the nation locked in a vicious cycle of debt—and leading, finally, to its exit from the eurozone.  
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    Author(s):
    C. J. Polychroniou

  • The Euro Crisis and the Job Guarantee


    Working Paper No. 707 | February 2012
    A Proposal for Ireland

    Euroland is in a crisis that is slowly but surely spreading from one periphery country to another; it will eventually reach the center. The blame is mostly heaped upon supposedly profligate consumption by Mediterraneans. But that surely cannot apply to Ireland and Iceland. In both cases, these nations adopted the neoliberal attitude toward banks that was pushed by policymakers in Europe and America, with disastrous results. The banks blew up in a speculative fever and then expected their governments to absorb all the losses. The situation was similar in the United States, but in our case the debts were in dollars and our sovereign currency issuer simply spent, lent, and guaranteed 29 trillion dollars’ worth of bad bank decisions. Even in our case it was a huge mistake—but it was “affordable.” Ireland and Iceland were not so lucky, as their bank debts were in “foreign” currencies. By this I mean that even though Irish bank debt was in euros, the Government of Ireland had given up its own currency in favor of what is essentially a foreign currency—the euro, which is issued by the European Central Bank (ECB). Every euro issued in Ireland is ultimately convertible, one to one, to an ECB euro. There is neither the possibility of depreciating the Irish euro nor the possibility of creating ECB euros as necessary to meet demands for clearing. Ireland is in a situation similar to that of Argentina a decade ago, when it adopted a currency board based on the US dollar. And yet the authorities demand more austerity, to further reduce growth rates. As both Ireland and Greece have found out, austerity does not mean reduced budget deficits, because tax revenues fall faster than spending can be cut. Indeed, as I write this, Athens has exploded in riots. Is there an alternative path?

    In this piece I argue that there is. First, I quickly summarize the financial foibles of Iceland and Ireland. I will then—also quickly—summarize the case for debt relief or default. Then I will present a program of direct job creation that could put Ireland on the path to recovery. Understanding the financial problems and solutions puts the jobs program proposal in the proper perspective: a full implementation of a job guarantee cannot occur within the current financial arrangements. Still, something can be done.

  • Put an End to the Farce That’s Turned Into a Tragedy


    One-Pager No. 25 | February 2012
    The 2007–08 global financial crisis was the second most disastrous global economic event of the last 80 years. Thanks to severe austerity measures and a fanatical commitment to fiscal consolidation, Europe’s overall economy is now close to stagnation and extremely high levels of unemployment prevail in many countries, especially in the eurozone periphery. In Greece, the situation is completely out of control, with the standard of living rapidly declining to 1960s levels and the number of unemployed having reached one in five. The second bailout plan will do nothing more than buy extra time for the European Union to build firewalls to prevent the spread of Greek contagion—and prepare the ground for Greece’s exit from the euro.  
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    Author(s):
    C. J. Polychroniou

  • Delaying the Next Global Meltdown


    One-Pager No. 24 | February 2012

    It’s a mistake to interpret the unfolding disaster in Europe as primarily a “sovereign debt crisis.” The underlying problem is not periphery profligacy, but rather the very setup of the European Monetary Union (EMU)—a setup that even now prevents a satisfactory resolution to this crisis. The central weakness of the EMU is that it separates nations from their currencies without providing them with adequate overarching fiscal or monetary policy structures—it’s like a United States without a Treasury or a fully functioning Federal Reserve. Without addressing this basic structural weakness, Euroland will continue to stumble toward the cliff—and threaten to pull a tottering US financial system over the edge with it.

  • What Do Poor Women Want? Public Employment or Cash Transfers?


    Working Paper No. 705 | February 2012
    Lessons from Argentina

    The literature on public employment policies such as the job guarantee (JG) and the employer of last resort (ELR) often emphasizes their macroeconomic stabilization effects. But carefully designed and implemented policies like these can also have profound social transformative effects. In particular, they can help address enduring economic problems such as poverty and gender disparity. To examine how, this paper will look at the reform of Argentina’s Plan Jefes into Plan Familias. Plan Jefes was the hallmark stabilization policy of the Argentine government after the 2001 crisis. It guaranteed a public sector job in a community project to unemployed male and female heads of households. The vast majority of beneficiaries, however, turned out to be poor women. For a number of reasons that are explored below, the program was later reformed into a cash transfer policy, known as Plan Familias, that still exists today. The paper examines this reform in order to evaluate the relative impact of such policies on some of the most vulnerable members of society; namely, poor women. An examination of the Argentine experience based on survey evidence and fieldwork reveals that poor women overwhelmingly want paid work opportunities, and that a policy such as the JG or the ELR cannot only guarantees full employment and macroeconomic stabilization, but it can also serve as an institutional vehicle that begins to transform some of the structures and norms that produce and reproduce gender disparities. These transformative features of public employment policies are elucidated by turning to the capabilities approach developed by Amartya Sen and elaborated by Martha Nussbaum—an approach commonly invoked in the feminist literature. This paper examines how the access to paid employment can enhance what Sen defines as an individual’s “substantive freedom.” Any policy that fosters genuine freedom begins with an understanding of what the targeted population (in this case, poor women) wants. It then devises a strategy that guarantees that such opportunities exist and removes the obstacles to accessing these opportunities.

  • Imbalances? What Imbalances?


    Working Paper No. 704 | January 2012
    A Dissenting View

    It is commonplace to link neoclassical economics to 18th- or 19th-century physics and its notion of equilibrium, of a pendulum once disturbed eventually coming to rest. Likewise, an economy subjected to an exogenous shock seeks equilibrium through the stabilizing market forces unleashed by the invisible hand. The metaphor can be applied to virtually every sphere of economics: from micro markets for fish that are traded spot, to macro markets for something called labor, and on to complex financial markets in synthetic collateralized debt obligations—CDOs. Guided by invisible hands, supplies balance demands and markets clear. Armed with metaphors from physics, the economist has no problem at all extending the analysis across international borders to traded commodities, to what are euphemistically called capital flows, and on to currencies themselves. Certainly there is a price, somewhere, somehow, that will balance supply and demand. The orthodox economist is sure that if we just get the government out of the way, the market will do the dirty work. The heterodox economist? Well, she is less sure. The market might not work. It needs a bit of coaxing. Imbalances can persist. Market forces can be rather impotent. The visible hand of government can hasten the move toward balance.

    Orthodox economists as well as most heterodox economists see the Global Financial Crisis as a consequence of domestic and global imbalances. The most common story blames the US Federal Reserve for excessive monetary ease that spurred borrowing, and the US fiscal and trade imbalances for a surplus of liquidity sloshing around global financial markets. Looking to the specific problems in Euroland, the imbalances are attributed to profligate Mediterraneans. The solution is to restore global balance, which requires some combination of higher exchange rates for the Chinese, reduction of US trade deficits, and Teutonic fiscal discipline in the United States, the UK, and Japan, as well as on the periphery of Europe.

    This paper takes an alternative view, following the sectoral balances approach of Wynne Godley, combined with the modern money theory (MMT) approach derived from the work of Innes, Knapp, Keynes, Lerner, and Minsky. The problem is not one of financial imbalance, but rather one of an imbalance of power. There is too much power in the hands of the financial sector, money managers, the predator state, and Europe’s center. There is too much privatization and pursuit of the private purpose, and too little use of government to serve the public interest. In short, there is too much neoliberalism and too little democracy, transparency, and accountability of government.

  • Direct Job Creation for Turbulent Times in Greece


    Research Project Report, November 30, 2011 | November 2011

    Countries in crisis round the world face the daunting task of dealing with abrupt increases in unemployment and associated deepening poverty. Greece, in the face of her sovereign debt crisis, has been hit the hardest. Remediating employment policies, including workweek reductions and employment subsidies, abound but have failed to answer the call satisfactorily. Direct public-service job creation, instead, enables communities to mitigate risks and vulnerabilities that rise especially in turbulent times by actively transforming their own economic and social environment.

    With underwriting from the Labour Institute of the Greek General Confederation of Workers, the Levy Economics Institute was instrumental in the design and implementation of a social works program of direct job creation throughout Greece. Two-year projects, funded from European Structural Funds, have begun.

    This report traces the economic trends preceding and surrounding the economic crisis in Greece, with particular emphasis on recent labor market trends and emerging gaps in social safety net coverage. While its primary focus is identifying the needs in Greece, broader lessons for direct job creation are highlighted, and could be applied to countries entertaining targeted employment creation as a means to alleviate social strains during crisis periods.

  • Biopolitics and Neoliberalism


    One-Pager No. 21 | November 2011
    The Future of the Eurozone

    With the crisis in the eurozone threatening the integrity of the European Union itself. German Chancellor Angela Merkel continues to brush aside calls to permit the European Central Bank to act as lender of last resort, and she remains steadfast against suggestions for the issuing of a eurobond. Yet Germany does have a plan for the eurozone, even if many prefer not to see it—a plan centered on Darwinian biopolitics and neoliberal economics.

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    Author(s):
    C. J. Polychroniou

  • Confusion in Euroland


    One-Pager No. 20 | November 2011
    As the crisis in Europe spreads, policymakers trot out one inadequate proposal after another, all failing to address the core problem. The possibility of dissolution, whether complete or partial, is looking less and less farfetched. Alongside political obstacles to reform, there is a widespread failure to understand the nature of this crisis. And without seeing clearly, policymakers will continue to focus on the wrong solutions.

  • Toward a Workable Solution for the Eurozone


    Policy Note 2011/6 | November 2011
    Although it didn't originate with an economist, the malaprop “It’s déjà vu all over again” is invariably what springs to mind in the aftermath of virtually any euro summit of the past few years, all of which seem to end with the requisite promise of a so-called “final solution” to the problems posed by the increasingly problematic currency union. But it’s hard to get excited about any of the “solutions” on offer, since they steadfastly refuse to acknowledge that the eurozone’s problem is fundamentally one of flawed financial architecture. Today’s crisis has arisen because the creation of the euro has robbed nations of their sovereign ability to engage in a fiscal counterresponse against sudden external demand shocks of the kind we experienced in 2008. And it is being exacerbated by the ongoing reluctance of the European Union, European Central Bank, and International Monetary Fund—the “troika”—to abandon fiscal austerity as a quid pro quo for backstopping these nations’ bonds.

  • The Future of the Eurozone Does Not Lie with Enlargement


    One-Pager No. 19 | November 2011
    The European Union’s survival depends on its ability to reform, either through enlargement—greater economic and fiscal coordination in the direction of some sort of federal state—or by getting smaller, with the eurozone becoming a true optimum currency area. Most analysts support the former proposition. But the rush to strengthen and expand the Union is precisely what led to the current crisis in the eurozone.
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    Author(s):
    C. J. Polychroniou

  • Resolving the Eurozone Crisis—without Debt Buyouts, National Guarantees, Mutual Insurance, or Fiscal Transfers


    Policy Note 2011/5 | November 2011

    One of the reasons for the failure of Europe’s governing bodies to resolve the eurozone crisis is resistance to debt buyouts, national guarantees, mutual insurance, and fiscal transfers between member-states. Stuart Holland argues that none of these are necessary to convert a share of national bonds to Union bonds or for net issues of eurobonds—two alternative approaches to the debt crisis that would offset default risk and, by securing the euro as a reserve currency, contribute to more balanced global growth.

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    Author(s):
    Stuart Holland

  • Twin Strategies to Resolve the Eurozone Crisis—without Debt Buyouts, Sovereign Guarantees, Insurance Schemes, or Fiscal Transfers


    One-Pager No. 18 | November 2011

    The cancellation of the October 26 meeting of the European Union’s council of finance ministers, or Ecofin, has further eroded confidence in its ability to solve the burgeoning sovereign debt crisis in the eurozone. A viable strategy is needed now—and as Stuart Holland illustrates, two viable strategies are even better than one.

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    Author(s):
    Stuart Holland

  • Debtors’ Crisis or Creditors’ Crisis?


    Public Policy Brief No. 121, 2011 | November 2011
    Who Pays for the European Sovereign and Subprime Mortgage Losses?

    In the context of the eurozone’s sovereign debt crisis and the US subprime mortgage crisis, Senior Scholar Jan Kregel looks at the question of how we ought to distribute losses between borrowers and lenders in cases of debt resolution. Kregel tackles a prominent approach to this question that is grounded in an analysis of individual action and behavioral characteristics, an approach that tends toward the conclusion that the borrower should be responsible for making creditors whole. The presumption behind this style of analysis is that the borrower—the purportedly deceitful subprime mortgagee or supposedly profligate Greek—is the cause of the loss, and therefore should bear the entire burden.

  • Euroland in Crisis as the Global Meltdown Picks Up Speed


    Working Paper No. 693 | October 2011
    Yet another rescue plan for the European Monetary Union (EMU) is making its way through central Europe, but no one is foolish enough to believe that it will be enough. Greece’s finance minister reportedly said that his nation cannot continue to service its debt, and hinted that a 50 percent write-down is likely. That would be just the beginning, however, as other highly indebted periphery nations will follow suit. All the major European banks will be hit—and so will the $3 trillion US market for money market mutual funds, which have about half their funds invested in European banks. Add in other US bank exposure to Europe and you are up to a potential $3 trillion hit to US finance. Another global financial crisis is looking increasingly likely.

    We first summarize the situation in Euroland. Our main argument will be that the problem is not due to profligate spending by some nations but rather the setup of the EMU itself. We then turn to US problems, assessing the probability of a return to financial crisis and recession. We conclude that difficult times lie ahead, with a high probability that another collapse will be triggered by events in Euroland or in the United States. We conclude with an assessment of possible ways out. It is not hard to formulate economically and technically simple policy solutions for both the United States and Euroland. The real barrier in each case is political—and, unfortunately, the situation is worsening quickly in Europe. It may be too late already.

  • Dawn of a New Day for Europe?


    One-Pager No. 15 | October 2011
    The Merkel-Sarkozy Promise to End the Eurozone Crisis

    Failure on the part of EU leaders to address the eurozone crisis is in large part due to the fact that Germany and France are at opposite poles—politically, economically, and culturally. In this context, the announcement by Germany’s Angela Merkel and French President Nicolas Sarkozy that they’ve agreed to a comprehensive package of proposals to solve the eurozone debt crisis is definitely a positive development. It indicates that they have set aside their disagreements—surely no small feat, since domestic political concerns have been pulling the two in completely opposite directions—in order to provide the leadership necessary for euro stability.

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    Author(s):
    C. J. Polychroniou

  • An Unblinking Glance at a National Catastrophe and the Potential Dissolution of the Eurozone


    Working Paper No. 688 | September 2011
    Greece’s Debt Crisis in Context

    According to author and journalist C. J. Polychroniou, Greece was unfit to join the euro: its entry was orchestrated by fabricating the true state of the country’s fiscal condition, and its subsequent “growth performance” rested upon heavy state borrowing and European Union (EU) transfers. Moreover, the Greek economic crisis is also a political and moral crisis, as financial scandals and corruption have been major sources of wealth creation.

    The EU and International Monetary Fund bailout plan (May 2010), which includes a structural adjustment program with harsh austerity measures, has been a social and economic catastrophe. Such policy ensures that Greece will default and be forced to exit the euro, says Polychroniou, but compelling Greek citizens to take charge of their own economic problems and national faults may be the best scenario. Extreme EU neoliberal policies also increase the risk of the eurozone’s dissolution.

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    Author(s):
    C. J. Polychroniou

  • A Modest Proposal for Overcoming the Euro Crisis


    Policy Note 2011/3 | May 2011

    This “Modest Proposal” by authors Varoufakis and Holland outlines a three-pronged, comprehensive solution to the eurozone crisis that simultaneously addresses the three main dimensions of the current crisis in the eurozone (sovereign debt, banking, and underinvestment), restructures both a share of sovereign debt and that of banks, and does not involve a fiscal transfer of taxpayers’ money. Additionally, it requires no moves toward federation, no fiscal union, and no transfer union. It is in this sense, say the authors, that it deserves the epithet modest.

    To stabilize the debt crisis, Varoufakis and Holland recommend a tranche transfer of the sovereign debt of each EU member-state to the European Central Bank (ECB), to be held as ECB bonds. Member-states would continue to service their share of debt, reducing the debt-servicing burden of the most exposed member-states without increasing the debt burden of the others. Rigorous stress testing and recapitalization through the European Financial Stability Facility (in exchange for equity) would cleanse the banks of questionable public and private paper assets, allowing them to turn future liquidity into loans to enterprises and households. And the European Investment Bank (EIB) would assume the role of effecting a “New Deal” for Europe, drawing upon a mix of its own bonds and the new eurobonds. In effect, the EIB would graduate into a European surplus-recycling mechanism—a mechanism without which no currency union can survive for long.

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    Author(s):
    Yanis Varoufakis Stuart Holland

  • What Happens if Germany Exits the Euro?


    Policy Note 2011/1 | February 2011

    Like marriage, membership in the eurozone is supposed to be a lifetime commitment, “for better or for worse.” But as we know, divorce does occur, even if the marriage was entered into with the best of intentions. And the recent turmoil in Europe has given rise to the idea that the euro itself might also be reversible, and that one or more countries might revert to a national currency. The prevailing thought has been that one of the weak periphery countries would be the first to call it a day. It may not, however, work out that way: suddenly, the biggest euro-skeptics in Europe are not the perfidious English but the Germans themselves.

  • Is the Eurozone Doomed?


    One-Pager No. 4 | November 2010
    The Rescue Plan Cannot Address the Central Problem

    The trillion-dollar rescue package European leaders aimed at the continent’s growing debt crisis in May might well have been code-named Panacea. Stocks rose throughout the region, but the reprieve was short-lived: markets fell on the realization that the bailout would not improve government finances going forward. The entire rescue plan rests on the assumption that the eurozone’s “problem children” can eventually get their fiscal houses in order. But no rescue plan can address the central problem: that countries with very different economies are yoked to the same currency.

  • The “Keynesian Moment” in Policymaking, the Perils Ahead, and a Flow-of-funds Interpretation of Fiscal Policy


    Working Paper No. 614 | August 2010

    With the global crisis, the policy stance around the world has been shaken by massive government and central bank efforts to prevent the meltdown of markets, banks, and the economy. Fiscal packages, in varied sizes, have been adopted throughout the world after years of proclaimed fiscal containment. This change in policy regime, though dubbed the “Keynesian moment,” is a “short-run fix” that reflects temporary acceptance of fiscal deficits at a time of political emergency, and contrasts with John Maynard Keynes’s long-run policy propositions. More important, it is doomed to be ineffective if the degree of tolerance of fiscal deficits is too low for full employment.

    Keynes’s view that outside the gold standard fiscal policies face real, not financial, constraints is illustrated by means of a simple flow-of-funds model. This shows that government deficits do not take financial resources from the private sector, and that demand for net financial savings by the private sector can be met by a rising trade surplus at the cost of reduced consumption, or by a rising government deficit financed by the monopoly supply of central bank credit. Fiscal deficits can thus be considered functional to the objective of supplying the private sector with a provision of financial wealth sufficient to restore demand. By contrast, tax hikes and/or spending cuts aimed at reducing the public deficit lower the available savings of the private sector, and, if adopted too soon, will force the adjustment by way of a reduction of demand and standard of living.

    This notion, however, is not applicable to the euro area, where constraints have been deliberately created that limit public deficits and the supply of central bank credit, thus introducing national solvency risks. This is a crucial flaw in the institutional structure of Euroland, where monetary sovereignty has been removed from all existing fiscal authorities. Absent a reassessment of its design, the euro area is facing a deflationary tendency that may further erode the economic welfare of the region.

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