Brad Setser

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The IMF’s Recommended Fiscal Path For Japan

by Brad Setser

With a bit of technical assistance, I was able to do a better job of quantifying the IMF’s recommended fiscal path for Japan.

The IMF wants a 50 to 100 basis point rise in Japan’s consumption tax every year for the foreseeable future, starting in 2017. A 50 basis point rise would result in between 20 and 25 basis points of GDP in structural fiscal consolidation a year (the call for the tax increase is in paragraph 23 of the staff report, and is echoed in the IMF’s working paper).

The IMF doesn’t want Japan to continue relying on fiscal stimulus packages, which typically have funds for public investment and the like (paragraph 23). As a result, there is a 60 basis points of GDP consolidation from the roll-off of past stimulus packages (the change in the structural primary balance is in both table 1 on p.38 table 4 on p.41 of the staff report).

That implies 80 to 85 basis points of GDP in structural fiscal consolidation.

But, in the staff working paper (not formal advice, but it clearly reflects the IMF’s overall recommendations), the preferred policy scenario shows an 80 basis point of GDP increase in temporary transfers and public wages to support the proposed incomes policy (this is in the working paper appendix, in table I.1 on p. 33).

Net it all out; the result is basically a neutral stance, not the consolidation I initially suspected. The 0.5 percent of GDP fall in general government net lending/borrowing in table 2 on p. 25 of the working paper stems from a fall in interest payments and an increase in nominal GDP that is projected from the new incomes policy.*

Actually if you look at table 4 in the staff report, Japan’s is expected to receive more in interest income than in pays out in interest in 2017. Japan’s government is projected receive 1.6 percent of GDP in interest on its assets (including its foreign reserves, which are largely held by the ministry of finance) and pay 1.3 percent of GDP in interest on its debt. The total fiscal deficit is thus smaller than the primary fiscal deficit in 2017. Welcome to the world of negative interest rates.

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Do Not Count (European) Fiscal Chickens Before They Hatch

by Brad Setser

The Wall Street Journal, building on a point made by Peterson’s Jacob Kirkegaard, seems convinced that the policy mood has shifted, and Europe is now poised to use fiscal policy to support its recovery.

I, of course, would welcome such a shift. The eurozone runs an external surplus, is operating below potential (in large part because of a premature turn to austerity in 2010 that led to a double-dip recession) and in aggregate has ample fiscal space.

And the public policy case for such a fiscal turn keeps getting stonger. Jan in ‘t Veld’s new paper (hat tip Paul Hannon of the WSJ) suggests that a sustained fiscal expansion in Germany and the Netherlands could have a substantial impact on the rest of the eurozone. A sustained 1 percent of GDP increase in public investment in Germany and the Netherlands helps raise output and lower debt in their eurozone partners.* in ‘t Veld writes:

“Spillovers to the rest of the eurozone are significant … GDP in the rest of the eurozone is around 0.5% higher.”

But it seems a bit too early to break out the champagne.

Actual 2017 fiscal policy has not been set in the key countries, but it is not clear to me that the sum of the fiscal decisions of the main eurozone countries will result in a significant fiscal expansion across the eurozone. Indeed, I cannot even rule out a small net consolidation.

Germany has put forward its 2017 budget. Schauble’s rhetoric has changed a bit. But Citibank estimates that it only would reduce Germany’s structural fiscal surplus by about 0.1 percent of GDP (10 basis points of GDP). It is a step in right direction, but only a baby step. Real loosening doesn’t seem on the cards before 2018.

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There Really Is No Reason for Germany Not to Do a Fiscal Stimulus Right Now

by Brad Setser

Back in May, Greg Ip of the Wall Street Journal argued that Germany didn’t need to stimulate its economy through an increase in public investment as its economy was already growing at a decent clip, and unemployment was low.

I wasn’t convinced then, and I am still not convinced.

A stimulus is needed to reorient Germany’s economy away from exports, to keep private wage growth up and to open up space for Germany’s trade partners in the euro area to adjust without falling into a deflationary trap. Adjustment doesn’t happen magically.

There is solid evidence that Germany’s level of public investment is a bit too low for its long-term health.

And now there is also a growing cyclical case for a German stimulus. German growth is projected to slow significantly in 2017. Reuters reports:

“DIW … lowered its 2017 growth forecast for Germany to 1.0 percent from 1.4 percent.”

Other forecasts are a bit more optimistic, but all expect some slowdown in growth.

And the 2016 surplus is on track to top a percentage point of German GDP. In nominal terms, the surplus should exceed last years’s €30 billion surplus. Germany is clearly not fiscally constrained.

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What To Do When Countries With Fiscal Space Won’t Use It?

by Brad Setser

This isn’t another post about Germany.

Rather it is about Korea, in many ways the Germany of East Asia.

Korea has a current account surplus roughly equal to Germany’s—just below 8 percent in 2015, versus just over 8 percent for Germany.

Like Germany, Korea has a tight fiscal policy. Korea retained a structural fiscal surplus throughout the global crisis (it relied on exports to drive its initial recovery, thanks to the won’s large depreciation in the crisis).* After sliding just a bit between 2012 and 2015, Korea’s fiscal surplus is now heading up again.

Korea’s public debt is below that of Germany.

And as I noted on Monday, Korea’s real exchange rate is well below its pre-crisis levels. So for that matter is Germany’s real exchange ate. According to the BIS, Korea’s real exchange rate so far this year is about 15 percent below its 2005-2007 average; Germany’s real effective exchange rate is about 10 percent below its 2005-2007 average.

The IMF—in its newly published staff report on Korea—recognizes that Korea has fiscal space, and encourages the Koreans to do a bit of stimulus. The IMF also, smartly, recommends beefing up Korea’s rather stingy social safety net.

The Koreans though do not seem all that interested in spending more.

Yes, there is officially a stimulus. But as the Fund notes it will be funded by “revenue over-performance”* rather than any new borrowing.**

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Germany is Running a Fiscal Surplus in 2016 After All

by Brad Setser

It turns out Germany has fiscal space even by German standards!

Germany’s federal government posted a 1.2 percent of GDP fiscal surplus in the first half of 2016. The IMF was forecasting a federal surplus of 0.3 percent (and a general government deficit of 0.1 percent of GDP—see table 2, p. 41); the Germans over-performed.*

Germany’s ongoing fiscal surplus contributes to Germany’s massive current account surplus, and the large and growing external surplus of the eurozone (the eurozone’s surplus reached €350 billion in the last four quarters of data, which now includes q2). The external surplus effectively exports Europe’s demand shortfall to the rest of the world, and puts downward pressure on global interest rates. Cue my usual links to papers warning about the risk of exporting secular stagnation.

Eurozone-current-account-balance

Martin Sandbu of the Financial Times puts it well.

“The government’s surplus adds to the larger private sector surplus which means the nation as a whole consumes much less than it produces, sending the excess abroad in return for increasing financial claims on the rest of the world. German policymakers like to say that the country’s enormous trade surplus is a result of economic fundamentals, not policy—but as far as the budget goes, that claim is untenable. Even if much of the external surplus were beyond the ability of policy to influence, that would be a case to use the government budget to counteract it, not reinforce it.”

The Germans tend to see it differently. Rather than viewing budget surpluses as a beggar-thy-neighbor restraint on demand, they believe their fiscal prudence sets a good example for their neighbors.

But its neighbors need German demand for their goods and services far more than they need Germany to set an example of fiscal prudence. It is clear—given the risk of a debt-deflation trap in Germany’s eurozone partners—that successful adjustment in the eurozone can only come if German prices and wages rise faster than prices and wages in the rest of the eurozone. The alternative mechanism of adjustment—falling wages and prices in the rest of the eurozone—won’t work.

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IMF Cannot Quit Fiscal Consolidation (in Asian Surplus Countries)

by Brad Setser

In theory, the IMF now wants current account surplus countries to rely more heavily on fiscal stimulus and less on monetary stimulus.

This shift makes sense in a world marked by low interest rates, the risk that surplus countries will export liquidity traps to deficit economies, and concerns about contagious secular stagnation. Fiscal expansion tends to lower the surplus of surplus countries and regions, while monetary expansion tends to increase external surpluses.

And large external surpluses should be a concern in a world where imbalances in goods trade are once again quite large—though the goods surpluses now being chalked up in many Asian countries are partially offset by hard-to-track deficits in “intangibles” (to use an old term), notably China’s ongoing deficit in investment income and its ever-rising and ever-harder-to-track deficit in tourism.

In practice, though, the Fund seems to be having trouble actually advocating fiscal expansion in any major economy with a current account surplus.

Best I can tell, the Fund is encouraging fiscal consolidation in China, Japan, and the eurozone. These economies have a combined GDP of close to $30 trillion. The Fund, by contrast, is, perhaps, willing to encourage a tiny bit of fiscal expansion in Sweden (though that isn’t obvious from the 2015 staff report) and in Korea—countries with a combined GDP of $2 trillion.*

I previously have noted that the Fund is advocating a 2017 fiscal consolidation for the eurozone, as the consolidation the Fund advocates in France, Italy, and Spain would overwhelm the modest fiscal expansion the Fund proposed in the Netherlands (The IMF is recommending that Germany stay on the fiscal sidelines in 2017).

The same seems to be true in East Asia’s main surplus economies.

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Why Is The IMF Pushing Fiscal Consolidation in the Eurozone in 2017?

by Brad Setser

The eurozone collectively has a substantial external surplus, and its economy is operating below potential. In the framework set out in the IMF’s external balance assessment, that pretty clearly calls for fiscal expansion:

“Surplus countries that have domestic slack need to rely more on fiscal policy easing, which would address both their output gaps and their external gaps… Meanwhile, deficit countries should actively use monetary policy, where available, to close both internal and external gaps.”

But is the IMF following its own advice (for a currency union that has an external surplus and domestic slack, I am well aware of the fact that the eurozone is not a single country with a single fiscal policy) and actually recommending a fiscal expansion in the eurozone?

Best I can tell, no. Not for 2017.

The IMF of course is for more fiscal stimulus at the European level. But that is a hope, not a reality. The capacity for a common eurozone fiscal policy conducted through borrowing by the center doesn’t currently exist, and it realistically isn’t going to materialize next year.

That means the eurozone’s aggregate fiscal impulse is the sum of the fiscal impulses of each of its main economies. What does the IMF recommend there?

In Italy the IMF seems to want about a half a point of structural fiscal consolidation (see paragraph 35 of the staff report).

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Fiscal Stimulus, Korean Style

by Brad Setser

Korea is one country that unambiguously has fiscal space right now. Low government debt. The on-budget deficit was, until recently, more than offset by the off-budget surplus in Korea’s social security fund. With a slowing economy and a massive (almost 8 percent of GDP in 2015) current account surplus, Korea unambiguously should be running an expansionary fiscal policy. Read Summers and Eggertsson.

But I do not quite see how “paying down debt” can be part of a true fiscal stimulus package.

Nor do I see how a fiscal stimulus can do much to spur the economy if it doesn’t create a new borrowing need. The Wall Street Journal:

“Unlike the heavily debt-funded supplementary budget last year, this year’s supplement will narrow the estimated deficit marginally, thanks to a partial debt repayment by the government. The finance ministry expects the country’s sovereign debt to stand at 39.3% of gross domestic product in 2016, lower than its initial estimate of 40.1%”

Emphasis added.

It seems like Korea’s stimulus will be financed by “surplus” tax revenues, not new debt.

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Can Europe Declare Fiscal Victory and Go Home?

by Brad Setser

Rules are rules and all.

But the application of poorly conceived rules is still a problem. Especially in the face of a negative external shock.

The eurozone’s fiscal policy is, more or less, the fiscal policy adopted by its constituent member states.

Wolfgang Schauble (do follow the link) should be happy: Europe’s fiscal policy is almost entirely inter-governmental.

The eurozone’s big five—Germany, France, Italy, Spain, and the Netherlands—account for over 80 percent of the eurozone GDP. Summing up their national fiscal impulses is a decent approximation of the eurozone’s aggregate fiscal policy.

And, building on the point I outlined two weeks ago (and that my colleague Rob Kahn echoed on his Macro and the Markets blog), 2017 could prove to be a real problem. Bank lending now looks poised to contract, and eurozone banks face (yet again) doubts about their capital. And the sum of national fiscal policies—best I can tell—is pointing to a fiscal consolidation.

In the face of the Brexit shock, standard (MIT?) macroeconomics says that a region that runs a current account surplus, that has a high unemployment rate, that has no inflation to speak of, that cannot easily respond to a short-fall in growth by lowering policy interest rates (policy rates are, umm, already negative, and negative rates are already, cough, adding to problems in some banks), and that can borrow for ten years at a nominal interest rate of less than one should run a modestly expansionary fiscal policy.

The eurozone as a whole clearly has fiscal space. The eurozone’s aggregate fiscal deficit is lower than that of the United States, Japan, the United Kingdom, and China. Adjusted for the cycle, the IMF puts the eurozone’s overall fiscal deficit at about 1 percent of GDP (without adjusting for the cycle, the eurozone’s overall deficit is around 2 percent of GDP). Even without any cyclical adjustments, the eurozone now runs a modest primary surplus, and simply refinancing maturing debt at current interest rates should lead to a lower headline deficit.

But the eurozone isn’t a unified fiscal actor. Right now the countries that could run a bigger fiscal deficit without violating the eurozone’s rules have said they won’t, and the countries that are already running deficits that violate the rules are facing new pressure to comply with the rules. The aggregate fiscal stance of the eurozone thus is likely to be contractionary.

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Meanwhile, in Japan, Household Consumption Continues to Fall

by Brad Setser

In news that you may have missed while strategizing about Article 50, thinking about ways to recapitalize Italian banks or pondering the future course of the renminbi …

Japan’s May household consumption data, based on the demand side household data, surprised to the down side.* And the trend here is, alas, clear. Real household consumption has fallen ever since Japan started its fiscal consolidation in 2014. 2016 does not look to be any different: 2016 consumption is running about 6 percentage points lower than in 2013.

household-consumption

I consequently do not think there is any real mystery as to why Abenomincs is floundering a bit.

It is not primarily a result of the difficulties the Bank of Japan (BoJ) faces keeping the yen weak without breaking the G-7 currency peace through direct intervention. A weak yen on its own did not prove to be a boon to internal demand in 2015.

Nor is it in any simple way a function of a failure to deliver on structural reforms: I agree with Larry Summers’ recent comment that many “OECD standard” reforms have an ambiguous impact when deflation is more of a concern than inflation.

Rather, Japan’s troubles stem from a series of policy choices that had a fairly predictable negative impact on household demand.

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