Debt crisis: What is to be done now?

I’ll sketch this in five parts. First, the banks. Then the euro. Then monetary policy. Then fiscal policy. Then growth.

But before we begin, accept this: the denial, delay-and-hope, no-creditor-shall-lose bailout strategy pursued since early 2008, as well as being immoral and destructive, has failed. Until policy-makers really embrace that point, at least to themselves, no progress can be made.

The banks

- Introduce Special Administration Regimes for banks. Now. Not tomorrow.

- Make depositors preferred creditors, overturning current bond contracts.

- If banks are insolvent but essentially going concerns, impose debt-equity swaps in special administration and provide unlimited liquidity to see off bank runs.

- If banks are insolvent, restructure or liquidate.

- Withdraw all government guarantees.

- Do not provide any further government recapitalisation funds. Especially resist the temptation to throw yet more good money after bad in the banks previously bailed out.

- Enact longer-term structural reforms – quickly.

The euro

- Accept that quick fix solutions have failed. Only a comprehensive solution can save the euro (and probably the EU) now. Understand that that comprehensive solution cannot be provided by the ECB printing money.

- Accept that this is fundamentally a political project, requiring political union to work.

- Accept that not all current members can be in the euro. Greece in particular.

- Decide who is not in. In particular, decide which of Portugal, Ireland, Finland and Slovakia is out.

- For those that remain, accept that there must be a dramatic change in the balance of expenditure and sovereign control of expenditure. Specifically, “national” Parliaments must become regional spenders, answerable for their spending and debt levels to a central Brussels authority.

- Understand that the transferunion concept, according to which Germans, for decade after decade, send tens of millions to the Italian/Spanish/whomever government to spend as it will is a complete non-starter.

- Instead, much more funds must be spent from Brussels. Members of the euro must accept that they will send currently unprecedented proportions of their budgets to Brussels, and Brussels will then decide whether it purchases the building of this railway or that hospital or funds those training programmes.

Monetary policy

- Try to retain some shred of credibility (and dignity) for your inflation targets and broader central banking policies.

- In particular, when pondering grand schemes for central banks to buy vast quantities of junk bonds, recognise that having your central bank go bust can ruin your entire day.

- Also, for goodness sake stop pretending. Set an inflation target you actually hope might be met.

- Seek to normalise interest rates. The right medium-term objective is not that they be a low as possible. The right objective is that they be at the natural rate of interest, at which investment decisions are socially efficient (not too much, not too little).

- Over the medium-term, understand that inflation targeting has intrinsic flaws that tend to generate credit cycles.  Consider alternatives such as price-level targeting.

Fiscal policy

- Look to your own ramparts. No nation should be so arrogant as to assume that it can afford to run whatever debts it likes.

- Focus deficit reduction programmes on spending cuts. Raise taxes only to the extent that that is required, politically, to deliver the spending cuts.

- In countries that have dramatically raised spending in recent years, such as the UK, cut spending as far and fast as is politically feasible. Once you have completed that, consider cut spending some more.

Growth

- The most powerful tool the government has for promoting growth is to cut spending. The worse the growth outlook gets, the stronger the argument becomes for cutting spending further and faster.

- The next most powerful tool the government has is to increase the productivity of its own spending, in particular by increasing public sector productivity growth. In the UK, if public sector productivity growth were to be only as fast as private sector productivity growth (a modest achievement, given that it fell one third behind from 1997-2007), economic growth would be 0.5 per cent higher each year.

- If the government wants more rapid public sector productivity growth, it needs to unashamedly promote markets, competition, and profit-seeking in health and education.  If it refuses to countenance competition or profit-seeking in health and education, we can confidently assert that though it may will the end of more rapid GDP growth, it does not will the means.

And once you’ve done all these things, do one more: pray.

Could This Deal Raise Budget Deficits?

“From an accounting point of view, it seems obvious that you would reduce G.D.P. if you cut government spending,” said Randall Kroszner, an economics professor at the University of Chicago and a former Fed governor appointed by Mr. Bush. “But the key is really the impact on consumption and investment. If you reduce government spending and if people think that reduces uncertainty about the tax burden down the line, they may be more comfortable with spending.”

FLOYD NORRIS

Notions on high and low finance.

It is virtually impossible to think of the impact of the debt deal as doing anything to help the economy. But give Mr. Kroszner credit for trying, in today’s front-page article by Binyamin Appelbaum and Catherine Rampell.

Notions on high and low finance.

To come up with a rosy scenario, he suggests that uncertainty may somehow be reduced, leading to more consumption and investment. I cannot imagine anyone actually thinking this deal — with its clear potential for another bruising fight and deadlock that will do more to hurt the economy — decreases uncertainty.

In fact, this deal could manage to do the exact opposite of what it promises — raise the deficit.

If that happens, it will be because a major determinant of tax revenue is the health of the economy. Profits and growth bring revenues. This could damage the economy enough to send tax receipts down again. Although you never would have guessed it from the rhetoric, tax receipts are at the lowest level in years, as a percentage of gross domestic product. Get a healthy economy and tax revenues rise while a lot of spending, on such things as unemployment benefits, goes away.

What this has shown is that the Republican Congressional leadership is terrified of the Tea Party and of people like Sarah Palin, who hinted she would support a primary challenge to any Republican who voted to raise the debt ceiling. The leadership knew that not raising the ceiling was unthinkable, but many of the members did not.

The next showdown — assuming Congress passes the deal on Monday — will come directly after the 2012 election, but with the current Congress. So even if these people are thrown out, they have assured themselves one last chance to be totally irresponsible. Then, when the new Congress tries to undo the damage, the ones who are still there can filibuster.

What has been proved by this is that there are a substantial number of members of Congress who basically are opposed to the government and welcome anything that would keep it from functioning. If the Republican leadership again grants them veto power over anything, some of them will think that forcing huge spending cuts at the end of 2012 will have been a triumph, no matter what it does to the economy or to Americans less well off than themselves.

If Mr. Kroszner’s rosy scenario seems unreal, there might still be one. It relies on the fact that fiscal and monetary stimulus work with lags. When recoveries really get going, they can become self-sustaining quickly.

The normal course after recessions before the 1990s was for complaints that nothing was happening to turn overnight to amazement about how fast recovery is taking hold, and then to be followed by complaints that the last round of stimulus was unnecessary.

Is it possible that we have reached an inflection point, and that despite the weak economic numbers there is really no need for more stimulus?

Yes, it is.

Is it likely?

Not so much.

What is clear is that the lessons of the 1930s — that you don’t deal with weakness by cutting back — have been forgotten or were never learned.

Podcast: G.D.P., European Stocks, Bernanke and Bing

If you were hoping for some economic good news to close out July, forget it. Not only did the Commerce Department offer up a gloomy assessment of the second-quarter gross domestic product, it also said the recession of 2007-9 was deeper and the recovery slower than we thought.

As Catherine Rampell reports, the G.D.P. —  that closely watched measurement of economic output —  grew at an annual rate of only 1.3 percent in the second quarter. That’s barely breathing. In fact, the economy over all is smaller now than when the recession began in 2007, she says. 

In the Weekend Business podcast, Ms. Rampell offers up one tiny bright spot: automobile sales were not as bad as expected.

Meanwhile, the Fundamentally columnist for Sunday Business, Paul Lim, urges investors not to run away from stocks in European companies, despite economic uncertainty there. In a podcast interview with Phyllis Korkki, he argues that European companies have fared slightly better over all than their American counterparts.

Steve Lohr talks with the Sunday Business editor, David Gillen, about his article in this week’s section on Microsoft’s high hopes for the search engine Bing — its David to the Goliath Google. And Gregory Mankiw, the Harvard economist, writing in the Economic View column, defends the performance of Ben S. Bernanke, the regularly pummeled chairman of the Federal Reserve.

You can find specific segments of the podcast at these junctures: the G.D.P. report (31:09); news summary (22:52); Microsoft (19:46); Gregory Mankiw (12:45); European stocks (6:24); the week ahead (0:51).

As articles discussed in the podcast are published during the weekend, links will be added to this post.

You can download the program by subscribing from The New York Times’s podcast page or directly from iTunes.

Ranking the Presidents by G.D.P.

The revised G.D.P. numbers damage the economic growth numbers for Obama and the George W. Bush administrations.

There is an element of unfairness in attributing economic growth to a president, of course. The government has limited influence on the economy, and the president can have limited influence on government policy, as anyone watching the current debate in Washington has surely noticed. Normal economic cycles mean that growth is likely to be less impressive for a president who enters office at the end of a boom, as George W. Bush did, and better for one who enters when growth is weak, as Bill Clinton and Ronald Reagan did. If normal cyclical factors return, and President Obama has a second term, his record should end up much better than it currently appears. If he loses, he could be like Gerald Ford, who also took office during a deep recession.

With all those caveats, here are the annualized growth rates for real G.D.P. for every president who took office after the end of World War II.

Each president is given credit for growth through the quarter before he left office. For those who left at the end of their terms, that would be the fourth quarter of the election year. For Richard M. Nixon, who resigned during the third quarter of 1974, it is through the second quarter of that year.

Also shown are the figures for Presidents Bush and Obama that would have appeared had the numbers been calculated before today’s announcement of second quarter data and revisions to earlier numbers.

They are listed in reverse order of growth.

Barack Obama, 1.2% annual G.D.P. growth rate (previously 1.5%)
George W. Bush, 1.6% (previously 1.7%)
George H.W. Bush, 2.1%
Gerald Ford, 2.2%
Dwight Eisenhower, 2.5%
Richard Nixon, 3.0%
Jimmy Carter, 3.2%
Ronald Reagan, 3.5%
Bill Clinton, 3.8%
Lyndon B. Johnson, 5.0%
John F. Kennedy, 5.4%