Does Fiscal Consolidation Raise Inequality?

Fiscal tightening, whether based on cutting spending or raising taxes, has raised inequality and lowered the wage share of income. These are the main findings of my co-authored IMF working paper released today. The results are based on 173 episodes of fiscal consolidation during 1978-2009 for 17 OECD economies (Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, Netherlands, Portugal, Spain, Sweden, the United Kingdom, and the United States). Some of the key charts from the paper are given below.

Fiscal consolidation raises inequality (as measured by the Gini Coefficient)
(The horizontal axis shows the year of the consolidation—year 0—and the impact up to 8 years after the consolidation)

Consolidation based on spending cuts raises inequality …

… as does consolidation based on tax increases

Fiscal consolidation lowers the wage share of income

House Prices in Ireland

"House prices slipped back reflecting developments outside Dublin. After stabilizing over much of 2012, national residential property prices fell 2.6 percent in the first quarter of 2013, bringing the index to a new low 51 percent below its pre-crisis peak," according a new IMF report on Ireland. What explains the drop in prices? The report says that "this decline was driven by an almost 4 percent price fall outside Dublin, reflecting divergent market conditions—the stock of property available for sale in Dublin amounts to around 6 months‘ supply, but regional markets face inventories ranging from 20–60 months. Nonetheless, property transaction volumes rose by 14 percent y/y in Q1 2013, and with rents and disposable incomes rising, housing affordability and implied rental yields appear positive by historical standards."

MAULDIN: Economists Are Totally Clueless About The Economy

From Business Insider:

"In November of 2008, as stock markets crashed around the world, the Queen of England visited the London School of Economics to open the New Academic Building. While she was there, she listened in on academic lectures. The Queen, who studiously avoids controversy and almost never lets people know what she's actually thinking, finally asked a simple question about the financial crisis: "How come nobody could foresee it?" No one could answer her."

"If you've suspected all along that economists are useless at the job of forecasting, you would be right. Dozens of studies show that economists are completely incapable of forecasting recessions. But forget forecasting. What's worse is that they fail miserably even at understanding where the economy is today. In one of the broadest studies of whether economists can predict recessions and financial crises, Prakash Loungani of the International Monetary Fund wrote very starkly, "The record of failure to predict recessions is virtually unblemished." He found this to be true not only for official organizations like the IMF, the World Bank, and government agencies but for private forecasters as well. They're all terrible. Loungani concluded that the "inability to predict recessions is a ubiquitous feature of growth forecasts." Most economists were not even able to recognize recessions once they had already started." Read the full article here.

Tackling Unemployment: Return of the Two-Handed Approach

Unemployment in advanced economies averages 8% today, a sharp rise from 5 ½ % at the start of the Great Recession. European unemployment is particularly high—about 11% on average. What can be done?

In a celebrated mid-1980s paper, Olivier Blanchard, along with Rudi Dornbusch and others, argued that tackling the high unemployment and low growth in Europe at that time would require a ‘two-handed approach’: a combination of demand-side and supply-side policies. It is not coincidental that the IMF’s current advice to countries reflects the return of the two-handed approach.

In presentations delivered at the European Commission, ILO, World Bank and other venues, Prakash Loungani—advisor in the Research Department and co-chair of the IMF’s “Jobs & Growth” working group—has made the case for balancing demand and supply initiatives to tackle unemployment in advanced economies. He notes that, contrary to some assertions, unemployment and growth have remained linked during the Great Recession and the Not-So-Great Recovery. This preserves the hope that the jobs will return when the growth does.

Evidence suggests that the bulk of the rise in unemployment in most countries has been cyclical. Hence, as the Wall Street Journal noted recently, it’s time to “stop worrying about the ‘jobless recovery’ [and] start worrying about the recovery-less recovery.” Citing work on Okun’s Law by IMF authors and other recent evidence, the Journal concluded that “it isn’t unemployment benefits or other specific [structural] factors that are holding back hiring. It’s the economy, stupid.”

Several factors are behind the tepid recovery in output. In work done for the recent World Economic Outlook, Ayhan Kose, Prakash Loungani and Marco Terrones note that a key difference between the current global recovery and past global recoveries is that fiscal policy has not been able to provide the support this time that it did in the past—a point that has been picked by many observers including Paul Krugman (see the figure on fiscal spending below and Krugman’s essay here).

Real Primary Government Expenditures

Calibrating the pace of fiscal adjustment to growth conditions—and countering the effects of the adjustment through other policies if possible—to minimize the drag on demand is thus an essential part of the IMF’s advice to restore growth and lower unemployment. This is reflected for instance in the MD’s recent statement on Spain where she welcomed the government’s decision “to pursue a more gradual consolidation path” as a step to help the country in “securing a recovery and creating jobs.”

The two-handed approach does not neglect supply. In a recent Staff Discussion Note, Olivier Blanchard, Florence Jaumotte and Prakash Loungani discuss many labor market reforms that have been advocated in recent IMF programs in Europe. They argue that, by and large, these reforms can be expected to contribute to ‘micro flexibility’ (the ability of the economy to reallocate workers across jobs to boost productivity) and ‘macro flexibility’ (the ability of the economy to adjust to macroeconomic shocks).

House Prices in Switzerland

"House prices are high, but it’s too early to call it a bubble," according to an IMF study on the Swiss Housing Market: What are the risks? It says that "real house prices are high, and at an all-time high for owner-occupied apartments. Prices have been on an increasing trend since the late 1990s and the average price for a single family home has increased by about 49 percent. Prices for owner occupied apartments have increased even more (72 percent) and in the last four years the annualized price increase (5 1/2 percent) substantially exceed nominal GDP growth. When deflating house prices by the CPI, owner-occupied apartment prices are slightly above the peak of the boom-bust period in the late 80s to early 90s. Single family home prices are still below the peak, but still high by historic standards. Residential house price increases are especially pronounced in certain segments and region. Turning to regional patterns, Geneva stands out with price increases far exceeding the other regions in both the single family home and the owner occupied segments. It is also important to note that the price increases started from already high price levels." 

However, "current prices look less elevated when compared to income and rents. Following the
boom in the late 80s housing prices fell dramatically and their subsequent growth remained
subdued relative to growth in rents and in GDP per capita until the late 2000s, when housing price growth accelerated. While these ratios are still well below the levels reached at the peak of the previous boom, the ratio of price to rents for owner occupied apartments is already 15 percent above its long-term average."