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Expand and contract
December 2018 / January 2019


In other words, when the Italian government rolls over maturing debt or tries to finance the ongoing budget deficit, the interest cost is roughly 150 basis points higher than before. The public debt is 130 per cent of national output. Most of it does not come up for redemption in the near future, but it is obvious that over time the loss of support from government bondholders could cost taxpayers heavily. Over the long run the extra debt servicing charge implied by the 150-basis-point yield shift will be about 2 per cent of gross domestic product. (It will be 1.5 — which represents the 150 basis points — multiplied by 130 and expressed as a percentage.)  

The situation is potentially counter-productive and perverse. Let us compare the extra interest cost with the increase in the 2019 budget deficit proposed by the populists. Before the Lega Nord and the Five Star movement were elected in March, the intention was that the 2019 budget deficit would be 0.8 per cent of GDP; they now plan that it should be 2.4 per cent of GDP. As anyone can see, the long-run cost of the loss of investor confidence (2 per cent of GDP) is greater than the short-run increase in the deficit (1.6 per cent of GDP). It is this arithmetic that is crucial to understanding why fiscal expansions can be contractionary and fiscal contractions expansionary.

Suppose that in coming months Italy’s populists take an even more bolshie line with the European Commission on the deficit target. Holders of Italian bonds are likely to be further disillusioned. The eventual penalty from the higher interest costs may then be enormous relative to the populists’ “fiscal expansion”, not least because the stock of debt is a multiple of any feasible change in the budget deficit. Financial markets may become so alienated by politicians’ behaviour that a bond sell-off precipitates a violent upward surge (of 500 or 1,000 basis points) in bond yields. (This happened with Greece in 2010.)  The increase in debt interest costs then exceeds the rise in non-interest expenditure (on pensions, welfare and the like), causing the budget deficit to explode without limit.

The supposedly benign and positive effects on the economy of the “relaxation of fiscal policy” are smothered by the Frankenstein monster of runaway public debt. There is nothing moronic in warning populist governments — with no matter how many distinguished Keynesian advisers — that they cannot escape the mathematics of addition and subtraction. In extreme circumstances, out-of-control debt interest costs can make attempted “fiscal expansion” contractionary in its effects.
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untenured
January 6th, 2019
11:01 AM
In the Old Calendar this is New Year's Day, when we celebrate the Final Flourish of the Founding Fathers' Festive Fortnight with the Fireworks in honour of the Birth of the Euro. Why it is imminently expected to replace the U.S. Dollar as the World's base currency is still a mystery, although if you scrunch up your eyes and avoid looking at its manifold defects,,,,,

untenured
December 20th, 2018
4:12 PM
The Fed is apparently just one cog in the machine destroying the U.S. to do down President Trump. By continuing to raise rates against all common sense the day of reckoning is brought even closer than before. It was coming anyway. At least Noam Chomsky will be pleased. The only sunni aspect is the readiness of one group to take advantage as the fighting over the spoils gets going.

untenured
December 12th, 2018
11:12 AM
There have been many attempts to explain the mechanics of "socialist economics". There is no point. The delusion is that socialists could be curious about accounting for their pipe-dreams. They focus on the scapegoats they see conspiring against them and ruthlessly drop them in the shredder, then move on to the next guilty person. Looking beyond Italy and its struggles with the sticky webs spun by the witless EU, which hasn't got a coherent bone in its body, to the World in general, we find the biggest laboratory experiment has been running for the best part of ten years. The World's currency, the US Dollar, is now available in unlimited amounts, at zero interest, underpinning the incontinent borrowing of all the states that have kicked multiple cans down the road. Which school of economists could predict the outcome?

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