Sunday, 14 December 2014

Broken windows, broken lives

This is a difficult post for me to write, and there will no doubt be people out there who will be horrified at what I am about to say. But I feel that the hard questions that I shall raise have to be addressed.

In August this year, my mother went into a nursing home. She now has twenty-four hour nursing by specialists in the care of dementia sufferers. It is eyewateringly expensive. And it is being paid for entirely by my father.

This is an appalling tragedy. It is worse than a bereavement. In effect, my father has lost his wife - but he is still paying for her care.

Now, please don't misunderstand. It is not a financial tragedy. My father reckons he can afford to pay for my mother's care for five years without having to sell the house that he still lives in. He observed sadly that the people who will pay are his children and grandchildren, who will inherit far less than he had hoped. But to me, it is only right and proper that the savings he accumulated during his working life should be used to support him and his wife. That money is not ours until they no longer need it - and if that means there is none left for us, so be it. Inheritance is a privilege, not a right.

The tragedy is what this situation has done to my family. My father now faces his first Christmas alone. He will go to see my mother, of course, though I know how hard he finds it to see the ruin of the woman that he loved. I, too, will go and see her, as will other members of my family. Indeed my father and I both go and see her about every couple of weeks: but it is difficult to make myself do this, knowing that we can no longer have the sort of conversations we used to have. She was highly intelligent, incredibly well-informed, and had opinions on everything from politics to gardening. All of that is gone: she can barely speak, her memory is shot to pieces and she is unable to concentrate on anything for more than a few seconds. She is also physically disabled, for reasons that I will explain shortly. The woman that we knew and loved is no longer there. But her crippled body, and the little that is left of her mind, live on, and must be cared for. 

And therein lies the conundrum. For my mother's care, and the care of elderly people like her, is a significant and growing contribution to GDP and gives employment to a lot of people. In effect, it is a transfer of wealth from the old to the young, though not the young my parents had intended.

While my (retired) father was her full-time carer, my mother's care contributed little to GDP: but once he had to admit that caring for a disabled and confused elderly woman was beyond him, her care became an economically productive activity. Prior to that, her care had been provided firstly by my father, out of love, and secondly by the NHS, out of taxation. We have no way of measuring love in GDP, and there are those who deny that public sector activity is "productive". Yet it is the same care.

The problem is that this care is fundamentally unproductive, regardless of who does it and whether or not it is counted in GDP. My mother will never be restored to health and activity. Her carers, and her family, are managing decline. Sometimes, when I see her, her mind seems a little better, and there are flashes of the woman I once knew - but this merely raises false hope. She is never coming back.

It could be argued that keeping my mother alive at such expense is a form of the "broken window" fallacy. This sounds harsh, but to explain why I say this in relation to my own mother I need to tell the story of her decline.

My mother has a range of long-standing health issues including heart failure and renal failure. She had been getting increasingly frail physically, though until August 2013 her mind was as sharp as ever. But in August 2013 she had a fall. She broke her hip and her wrist, and was rushed into Medway Hospital. There, they pinned her hip and her wrist back together. After the operation, they put her on a morphine drip for pain relief. My brother, who saw her not long after the operation, said she was well and cheerful. So the following day, I went to see her with my then 15-year-old daughter.

When we arrived, she was unconscious and fitting. The junior doctor on duty explained that she had a morphine overdose. Apparently they had not checked her notes before giving her a morphine drip....people with renal failure cannot clear morphine from their bodies, so it gradually builds up, resulting in an overdose. They gave her medicine to counteract the morphine, of course, but it was touch and go whether she would live or die: if her heart gave out, they would not resuscitate her.

She lived......but from then on, her mind started to deteriorate. Her concentration wandered: she, who had loved to read, started to find reading too tiring. Holding a conversation with her became increasingly difficult as her mind lost focus and her speech slurred. A CT scan done by the hospital revealed that she had had a stroke, but they didn't know when. She never learned to walk again.

Once she came home, she deteriorated fast. She couldn't move around, she couldn't communicate and her sleep was terribly disordered. She needed 24-hour care: my father, who was doing most of it, became increasingly tired and grumpy. Eventually, after best part of a year, he had to admit that he couldn't cope. She was taken into hospital until a nursing home place could be found.

We do not know whether her rapid decline was due to the morphine overdose or whether it would have happened anyway. But it does raise a question.....Arguably, it would have been better for everyone if she had died in August 2013. Yet the doctors did everything in their power to keep her alive and repair the damage that they had (possibly) caused themselves. And her nurses still do.

Our ability to prolong life far outstrips our ability to improve its quality, and an increasing proportion of our economic activity must therefore go towards caring for the frail elderly. But we have not addressed the ethics of keeping people alive for extended periods of time after their minds and personalities have disintegrated. In 2008, Baroness Warnock suggested that people with dementia had a "duty to die". Her remarks were greeted with horror: yet we do need to have this discussion. For in reacting with shock and horror to the very idea of ending someone's life, we are failing to see the human tragedy of dementia.

The tragedy is not so much for the person concerned, although in the early stages many dementia sufferers are fully aware of what is happening to them and some are horrified - as my mother was in the months after her operation, though she now seems happy. But the real, enduring tragedy is for the families: husband and wife torn apart, family relationships destroyed, and yet no closure, no funeral, no ability to say good-bye to the person that they loved, because even though that person is gone the shell is still alive, and must be cared for at increasing expense. We are caught in a trap of endless grief.

I do not want to see my mother die. But it might be better for everyone if she did. I fear for my father, if her life is prolonged: five years of this, and he loses his home. Is this what she would want for him? And what if he becomes ill or frail himself, and needs care? How would he - would WE - afford both her care and his? What of the children who are dependent on us? In diverting resources to such extended elderly care, are we crippling the development of the next generation? Do we have our priorities right?

The Hippocratic Oath that doctors take says "First, do no harm". But what is meant by "harm"? Is keeping someone alive when their mind is gone and they are physically disabled "doing no harm"? Is helping someone to die when they have no prospect of being restored to physical and mental health "harmful"? I do not know. But "harm" surely goes beyond the person being treated: is the cost to their  family of no consequence?

I am very aware of the possibility of abuse, which is why in this post I have raised the question of financial cost and inheritance. I suspect the majority of people would have the same view as me, namely that the correct use of savings is the care of the elderly: to dispose of an elderly person simply to ensure that his or her descendents could inherit would be an abomination. But there would no doubt be some for whom money talks. Could there be adequate safeguards against such abuse? I do not know. It is, I suspect, in large measure the reason why we have not so far faced up to the consequences of our ability to prolong life but not restore it.

What I do know is that we have to have this debate. We divert ever greater resources to prolonging life, without considering the emotional cost to families or, indeed, the opportunity cost to society as a whole.  Is this what we really want? 





Tuesday, 9 December 2014

The Goldman touch

In my previous post, I cast doubt on the viability of Juncker's investment plan, pointing out that it involves no new money from either the EU or the EIB since it relies on a combination of non-sovereign guarantees and money diverted from other schemes, and questioning whether the private sector would be interested in investing in member state pet projects anyway. To put it bluntly, it appears to be a conjuring trick designed to give the impression that the European Commission is "doing something" about the appallingly low level of investment across the EU. I (somewhat impolitely) commented to a friend that this scheme looked like an attempt by Juncker to prove that he is not a total joke.

But in this extraordinary comment on my post, someone who identifies as "cig" exposes a dimension to Juncker's plan that I had missed:
There is an obvious trade here:

1. get bridge loan of say €100m
2. create SPV
3. have SPV buy €100m worth of senior tranche of EIB project
3. have SPV (alone or with mates) issue covered bond guaranteed on these (+ admin spread)
4. sell covered bond to ECB
5. goto 2 (you've just got your €100m back from the ECB)

No risk for the trader here, she just makes the admin spread and uses zero long term capital (once the 300B are exhausted she gives back the €100m to the bridge lender). In that scenario it makes sense that it's the EIB that decides what project gets done as after all it's the ECB's money we're spending. Technically there's no monetary financing that a normal electorate can notice.
And cig adds:
Now I'd like to know is whether this trade is the very point of the scheme and who understands that... Note that even if it's not, it may still work out that way anyway. 
When I saw this comment, suddenly everything became clear....Draghi's public support for Juncker's scheme in his Jackson Hole speech, followed by the ECB's surprise announcement in September that from November it would buy both ABS (as expected) AND covered bonds. The confidence of policymakers about the likelihood of private sector involvement in this scheme is indeed well-founded. The ECB is standing behind it - not directly, because as I pointed out in the post that would be monetary financing of governments, but indirectly in the name of "monetary policy". Never was falling inflation more opportune. The private sector's involvement in this scheme is completely risk-free, and whether the investment projects actually generate real returns is completely irrelevant.

If "cig" is right, then this scheme has two purposes: overtly, it is to increase investment across the EU - and covertly, it is to circumvent the treaties that prevent the ECB from financing sovereign investment. 

As far as I know, no commentator has spotted this - not even the redoubtable Bruegel. Though I think the Cypriot economist Alex Apostolides understood it. "Why is all this crap better than a treaty change?" he asked me on twitter. Indeed, avoiding treaty change is what it is all about.

No way did Juncker dream up a scheme of such Machiavellian brilliance. This is the Goldman touch. Super Mario is at work.

Related reading:

Draghi's debt trap



Sunday, 7 December 2014

Juncker's CDO

The new President of the European Commission has recently unveiled his second attempt at increasing European investment without raising public debt levels. His first attempt, which envisaged leveraging the ESM, was shot down by the Germans. This version leverages both the EIB and the EU's own budget. By committing 16bn EUR from the EU's budget and 5bn from the EIB, Juncker reckons that upwards of 315bn of new investment could flow into EU-wide projects, increasing jobs and improving infrastructure. It sounds wonderful, doesn't it?

But how would it work, exactly? Here is an explanation from the European Commission's factsheet:
The role of the Fund is to mobilise extra private finance in specific sectors and areas. The Fund is estimated to reach a multiplier effect of 1:15 in real investment in the economy. This is the result of the Fund's initial risk bearing capacity and is an estimated average calculated as follows: For every initial one euro of protection by the Fund, three euro of financing could be provided to a certain project in the form of subordinated debt. Given that this creates a safety buffer in that particular project, private investors can be expected to invest in the senior tranches of that same project. EIB and European Commission experience indicates that 1 euro of subordinated debt catalyses 5 euro in total investment: €1 in subordinated debt and on top of that 4 euro in senior debt. This means that €1 of protection by the fund generates €15 of private investment in the real economy, that would not have happened otherwise. This 1:15 multiplier effect is a prudent average, based on historical experience from EU programmes and the EIB.
I've drawn this up as a leveraged structure:

Note that the actual investment would be Mezzanine + Senior Debt, i.e. EIB subordinated lending plus private sector investment. The Equity portion is described in the factsheet as "protection". There is no actual money involved. It consists of public guarantees, not real money. In effect, the EU and EIB combined are providing insurance to private sector investors - accepting "first losses" of up to 21bn Euros. The EU's portion would guarantee the first 16bn Euros of longer-term infrastructure investment: the EIB would guarantee the first 5bn of capital investment in SMEs.

In fact, let us be completely clear. NONE of this money exists. Not a single Euro of it. This is a synthetic structure based entirely upon insurance, not actual funds.

The key to this is in the footnote of this diagram:




The EU's guarantee of 16bn Euros is only backed 50% by actual funds. If losses exceed 8bn Euros, the EU will have to find new money from somewhere. But worse than that, every euro of the 8bn actually backing this guarantee is already committed to other initiatives. 3.3bn Euros comes from Connecting Europe Facility (which is developing pan-European digital technology and broadband), 2.7bn Euros comes from Horizon 2020 (the EC's framework programme for research & innovation) and the remaining 2bn Euros directly from the existing EU budget. The EU is providing no new money to this initiative whatsoever, apart from the leveraged lending it expects the EIB to provide. All it is doing is placing both its existing investment programmes and the future budgets of member states at risk in the hopes of encouraging increased private sector investment in European projects.

The risk mitigation for the EU lies in the "second pillar" of Juncker's proposal. There would be a new facility in which EU bureaucrats would pick projects for presentation to the private sector as investment opportunities and provide "technical assistance" to investors to help them choose which projects to adopt. According to the EC's press release, projects would be recommended by Member States according to the following criteria:
  • EU value-added projects in support of EU objectives
  • Economic viability and value – prioritising projects with high socio-economic returns
  • Projects that can start at latest within the next three years, i.e. a reasonable expectation for capital expenditure in the 2015-17 period.
Why on earth would the private sector want to invest in projects chosen according to these criteria? Since when have either high socio-economic returns or EU objectives been of interest to private investors? What attracts private investors is returns on their investment - but there is no mention of the need to generate real financial returns. Reducing private sector risk is not enough to encourage investment. After all, investors who don't want risk can buy German bunds.

And it gets worse. These are the sorts of project that the new proposal wishes to encourage:
The new Fund will support strategic investments in infrastructure, notably broadband and energy networks, transport in industrial centres, as well as education, R&D, renewable energy and energy efficiency.
Looks good, yes? But as I noted above, the EU already has initiatives addressing broadband networks and research &innovation, which it is proposing to rob in order to provide guarantees for this new scheme. And that's not all.

It already has numerous energy initiatives - indeed one criticism that could reasonably be levelled at the EU is that it has lots of initiatives but no coherent energy policy. Unless the new funding would go to the existing initiatives, which seems unlikely, this is simply going to create confusion and duplication - as well as creating a golden opportunity for bureaucrats both in member states and in the EU itself to promote their pet projects. Transport in industrial centres looks like a good investment - but if it is so inadequate at the moment, why do private sector investors need public guarantees to encourage them to invest? After all, we assume, the principal beneficiaries of transport in industrial centres are industries. And as for education, it is notoriously difficult to demonstrate tangible benefits from educational programmes. If the programmes directly benefit industries, in that they provide workers with the skills those industries need, surely it would be reasonable to expect the private sector to accept the risk of investment? And if the programmes don't directly benefit industry, why would the private sector invest at all, even with public sector guarantees?

In short, there is a huge amount of muddled thinking going on in this proposal.

On the face of it, the EIB's involvement seems more sensible. Channelling investment funds to SMEs is clearly a good idea, given the paucity of bank lending in much of the Eurozone at the moment. But hang on a minute. Isn't this what the EIB already does? This is what its website says:
Smaller businesses face particular difficulties in accessing finance, particularly since the crisis. Our support has increased substantially since 2008, boosting our already significant long-term commitment. Countries particularly badly affected have received additional assistance. Our support has added impact by encouraging other private banks to on-lend and pass on advantages to businesses.
And these are the forms the EIB's existing support takes:
Loans
All types of investment by smaller businesses are eligible for favourable EIB loans. Support is channelled through our partner network.
Innovative financing options
We use a range of financial techniques to increase the impact of funding from the EIB, the European Commission and others.
Research, development and innovation support
We help with access to debt financing for research, development and innovation projects.
Capital injection & development advice
We invest in venture capital or private equity funds which then help growth.
Microfinance in the EU
Micro-businesses in the EU receive financial and technical assistance from our microfinance programme.
Energy efficiency investment
Green Initiative: energy efficiency for SMEs in new Member States and pre-accession countries. Funded by EIB loans and European Commission grants.
So the 5bn Euros of capital from the EIB isn't quite what it seems, either. It's simply capital the EIB already uses as backing for SME lending. 

In fact the new fund is to be a trust fund within the EIB. But the EIB is getting no new capital to support it, just a bunch of EU guarantees partially backed by money already committed to other things, and it is expected to divert part of its existing capital to support the new fund - which will of course reduce its current lending capability. On the basis of this faux capital, it is supposed to provide 63bn Euros of new subordinated debt. So this, too, is not quite what it seems: it is partly a diversion of lending from the EIB's existing SME support facilities.

Juncker's scheme is a highly-leveraged, complex funding structure reminiscent of a synthetic CDO. And just like the synthetic CDOs that contributed to the financial crisis, it is a clever piece of smoke and mirrors. It is intended to fool people into believing that investments can be guaranteed by the public sector without cost. This is dangerous nonsense. The first losses would go to the EU and the EIB, which ultimately would mean sovereigns coughing up more money, although not at this stage a huge amount. But the next losses would ALSO fall to the EIB, creating further claims on EU sovereigns (since they are the EIB's shareholders). The combined EU sovereigns stand to lose a total of £84bn Euros before the private sector takes any losses at all. 

This strikes me as considerable public sector risk for very little return. Though to my mind the investment opportunity is nowhere near adequate anyway: the criteria make no sense from an investment point of view. I suspect the scheme may begin and end with leveraged lending from the EIB. This would be a viable approach - indeed a lot more EIB lending could be supported - if the EIB's subordinated loans could be packaged up and sold to the ECB. But no-one is going to agree to this, even to support pan-European projects. Monetary financing of all sovereigns is as bad as monetary financing of one, apparently. It's a weird take on "All for one, one for all".

Juncker's claim that this scheme will create at least 315bn Euros of new investment may or may not be true. But one thing is completely clear. Describing this scheme as funded with new investment capital from the EU is wrong. The EU's capital investment in this scheme is zero.

Related reading:

Austria's folly and Juncker's madness - Pieria
The Juncker fund will not revive the Eurozone - Wolfgang Munchau, FT



Friday, 5 December 2014

Lies, damned lies, and the War Loan

http://www.iwm.org.uk/sites/default/files/iwm_solr_field/large/Art.IWM%20PST%2010628.jpg


Back in October, Toby Nangle, head of multi asset allocation and co-head of global asset allocation at Threadneedle Investments, a UK-based fund manager, wrote a guest post on FT Alphaville in which he argued that the Chancellor should call in the UK's War Loan. The War Loan was issued by HM Treasury in 1932 and is one of the oldest bonds in the market today.

"The UK Government could reduce its debt and save the taxpayer £300m by exercising its right to call the ‘War Loan’ and refinance it with new perpetuals with the same coupon but a thirty-year non-call period or new long-dated bonds.", said Nangle.

The Chancellor took his advice. As part of the Autumn Statement, he has announced that the Government will call in not only the War Loan, but other historic gilts too. From HM Treasury's Press Release:
The Chancellor of the Exchequer, George Osborne is today (Wednesday 3 December) announcing that the government will repay all the nation’s First World War debt.
 The Chancellor also announced that the government will adopt a strategy to remove the other remaining undated gilts in the portfolio, some of which have origins going back to the eighteenth century, where it is deemed value for money to do so.
The 1932 War Loan - itself a lower-rate refinancing of a previous War Loan - will be called on March 5th 2015. Other historic gilts will be called in due course.

But HMT's press release includes the following extraordinary statement from the Chancellor:
This is a moment for Britain to be proud of. We can, at last, pay off the debts Britain incurred to fight the First World War. It is a sign of our fiscal credibility and it’s a good deal for this generation of taxpayers. It’s also another fitting way to remember that extraordinary sacrifice of the past.
 "Pay off the debts"? No, George, just no. If I refinance the mortgage on my house to take advantage of today's lower rates, I have not "paid off" my mortgage. I have paid off the old mortgage, yes, but I have taken out a new one for the same amount. I still owe the money.

In fact HMT's press release makes it very clear that the debt is being refinanced, not paid off:
The government will now be able to refinance this debt with new bonds benefiting from today’s very low interest rate environment....
So Osborne's claim that this debt is being "paid off" is simply wrong. It is, in short, an outright lie designed to impress voters.

And there is another lie here, too. The second part of that sentence  reads:
....which in part reflects confidence in the plan the government has put in place to cut borrowing and create a resilient economy.
 Low interest rates are a sign of confidence, are they? Then why are Italian and Spanish government bonds trading at lower interest rates than the UK's? These days, low interest rates don't indicate confidence - they are a forecast of poor growth and low returns. They are a sign of weakness, not strength.

In fact it is hard to argue that there is any confidence at all in the plan the government has put forward to cut borrowing. Osborne has failed to deliver on the plans he set out at the start of this parliament: the deficit is still above 5% of GDP despite recent encouraging growth. And the plans in the Autumn Statement to eliminate the deficit have failed to convince anyone.

UK gilts remain attractive to investors because the UK economy is currently performing well, not because anyone believes anything George says. That is the reason why UK borrowing costs, far from being low, are actually quite high relative to the rates paid by many other developed countries at the moment. And we do not want rates to be any lower. We would like them to be higher, really - that would indicate that the economy is really on the road to recovery. But the government's plan is if anything likely to ensure that they remain very low for a very long time. Spending cuts on the scale envisaged in the Autumn Statement would knock the stuffing out of the economy - again.

Refinancing the War Loan and other long-standing gilts while rates remain low by historic standards is eminently sensible. But the Chancellor's claim that being able to refinance the War Loan at lower rates indicates confidence in government plans is not just a lie, it's a damned lie.







Tuesday, 2 December 2014

Greece's Great Depression, charted

Via the FT's Robin Wigglesworth comes this chart:


Greek RGDP fell by 28% between 2008 and the end of 2013. Since then it has increased by about 2%. This is recovery, apparently.

The most recent inflation figures show CPI inflation at -1.68% and HICP (core) inflation at -1.8%. , Yes, that is deflation. Indeed Greece has been persistently in deflation for the last six years.

Annualised growth figures show RGDP currently growing by 0.6%.

Using either measure of inflation, NGDP is negative. The ECB's preferred HICP measure gives NGDP of -1.2%.

I suppose, when you are starving, crumbs look like a square meal.


Related reading:

Celebrating the Spanish recovery 



Sunday, 30 November 2014

Celebrating the Spanish recovery

Lots of people have been celebrating the Spanish recovery. "From boom to bust to export-led recovery", crowed one Twitter commentator.

This is the reality:
Well, real GDP growth is now positive. I suppose that is a recovery, sort of. Though 0.5% growth is not exactly robust. In the UK we call 0.5% growth "stagnation", not recovery.*

But look at this:


Note the red at the far right. That is deflation. Consumer prices in Spain are falling by about 0.5%, according to the latest figures. To be sure, this is an annual chart: using annual GDP figures, NGDP is about 1%. I don't call that much of a recovery.

And I doubt if the Spanish see it as recovery, either. This is GDP per capita:

Yes, the Spanish are worse off now than they were in 2003. Ouch.

So if the "recovery" is largely due to falling consumer prices flattering real GDP, what about those exports?

Here's the Spanish current account:


This looks like something of a success story. The current account is indeed slightly positive, which might indicate a trade surplus (more on that shortly). More importantly, though, the very large imbalances that built up prior to the 2008 crisis largely due to inflows of capital into Spain's overblown construction industry have unwound. This is a much healthier current account than six years ago. But the cost has been terrible. Spain's construction industry was a major source of employment. This is what happened when the property bubble burst and the construction industry collapsed in 2008:

Spain's unemployment rate is now beginning to fall - though how much of that is due to emigration is unclear. But at 23% for adults and double that for 18-24 year olds, there is an awfully long way to go. Indeed it is by no means certain that unemployment can ever return to pre-2008 levels. The OECD's latest forecast of the sustainable (i.e. non-inflation accelerating) rate of unemployment is 18.9%. This is based upon a Phillips curve relationship which assumes growth returning to something like 3%. But structural unemployment at this level is a considerable drag on both growth and public finances. Putting it bluntly, if Spain is to recover AND put its public finances on to a sustainable path, about a fifth of its current population must leave. 

So for the Spanish people, there really is not much to celebrate, is there? But wait. What about those exports?

Here are Spain's exports:


 And these are imports:

Now, maybe my eyes are deceiving me, but this doesn't look like a story of export success to me. Exports appear simply to have returned to their pre-2008 trend growth rate - in fact if anything the export growth rate appears now to be declining slightly. The real story is the collapse of imports. And that is unquestionably due to the fall in household incomes from benefit cuts, tax increases, wage falls and above all unemployment, coupled with unserviceable debts and an extraordinarily harsh attitude to mortgage defaults. This is no export-led recovery. The current account balance has been achieved almost entirely through a massive fall in the standard of living of Spain's population.

I can't see anything to celebrate.

Related reading:

Structural destruction
Magical thinking at the G20 - Pieria

* This is a chart of quarter-on-quarter percentage RGDP growth. Annual percentage growth is 1.6%.

Saturday, 29 November 2014

Structural destruction

Researchers at the Federal Reserve recently produced a fascinating article in which they argued that severe recessions such as that in 2008-9 leave permanent economic scars.This set of charts shows the effect of the 2008-9 recession on real GDP trend growth for four economic areas - the US, the UK, the Euro area and Canada:


This reminds me of the four-image game on the UK's satirical current affairs show "Have I Got News For You". Spot the odd one out, and explain why.....and no, it isn't the one you think it is.

Actually each chart has a claim to be the odd one out, which just goes to show how the economic effects of the financial crisis varied by country. Or perhaps more accurately, how the response to the crisis by monetary and fiscal authorities varied. These charts show a significant drop in trend RGDP for all four economic areas: Canada, which had neither a property market crash nor a banking crisis, shows the smallest fall. Interestingly - and contrary to popular belief in the States - both the UK and the Euro area appear to have suffered a worse fall in trend RGDP directly attributable to the crisis than the USA did. 

But it is the behaviour of the red lines on these charts that really interests me, since they represent the actual path of RGDP post-crisis. As can be seen, Canada - which did not do QE but maintained fiscal spending (though it recommended austerity for everyone else) - has recovered better than the other three. But even though it didn't get such a kicking as the others, its RGDP is still below the previous trend. The Fed researchers show that even for mild recessions, output remains below previous trend seven years afterwards:

So despite Canada's milder recession, it is still suffering from a hangover. 

But Canada's headache is nothing like as bad as that suffered by the other three. The US, UK and Euro area have not only failed to recover previous trend growth, they have actually slowed down again since the crisis. The US's recovery slowed from 2011 onwards despite continual QE. It is hard to establish any cause for this other than misguided fiscal policy: the shenanigans over the fiscal cliff and the ridiculous sequester have taken their toll. It's an entirely self-inflicted wound and now, thankfully, over. As Matthew Klein puts it, the US has now at last stopped holding back its recovery

The UK's recovery stalled in 2010, prior to the Euro crisis. It is unclear exactly what the cause of this was: Simon Nixon at the WSJ suggested that it was due to misguided monetary tightening by the Bank of England, and I have argued that it was due to failure by both the fiscal and monetary authorities to offset an oil price shock. However, the fact that the UK elected an austerity-minded government in May 2010 whose first action was to raise VAT might also have something to do with it. When the economy is recovering from a severe demand shock, raising consumption taxes is just about the worst thing you can do. After all, if you need people to spend, taxing their spending is completely counterproductive. (Japan has just expensively discovered this.) Anyway, whatever the cause, the UK clearly experienced another shock which knocked it onto an even lower trend path for RGDP.

But the really shocking chart is that for the Euro area. The terrible consequences of the Euro crisis are all too clear. Like the UK, the Euro area suffered a second demand shock. But the response was very different. I criticise the UK government for inappropriate fiscal tightening, but at least it offset it with monetary easing, and latterly added fiscal easing too in the form of tax cuts and support for the housing market. It is these, in my view, that have generated the current recovery. In contrast, the response from EU fiscal and monetary authorities has been woefully inadequate. Such monetary easing as the ECB has done has failed to offset the severity of the demand shock, while procyclical fiscal tightening has actually amplified the shock. Euro area RGDP is on the floor and showing little sign of recovery. Adult unemployment is currently 11.5% across the whole Euro area, and much higher in some periphery countries: youth unemployment is double that of adults. Contrast this with the US, which has done far more to promote job creation than the Euro area despite unemployment only touching 10% at the height of the 2008-9 recession. If the US had unemployment at Euro area levels, it would be doing fiscal and monetary stimulus on an unprecedented scale. I am frankly astounded at the tolerance of the young people, in particular, whose futures are being systematically wrecked. They will bear the scars for life. Why they are not rioting in the streets is a mystery.

As yet, it is unclear what the new trend path for Euro area RGDP will be: the crisis is by no means over. But one thing is clear. The policies of Euro area fiscal and monetary authorities are doing serious damage to the economy. This is not "structural reform" - it is wholesale destruction of the productive capability of the economy. It's an unmitigated disaster. 

But the really worrying part of the Fed research is this chart:

 

This chart shows how growth expectations were gradually revised downwards over the years after the initial shock. This chart applies to the US, obviously, but the researchers found a pattern of downward revisions to growth estimates in 62 recessions from 1989 to 2009 in 23 advanced economies. Underestimating the severity of a shock appears to be an industrial bias among economists. Indeed, in my review of FOMC minutes earlier this year, I noted that FOMC members expected growth to return "any day now", even when indicators were negative, while expecting inflation to disappoint on the upside, even when indicators showed expectations were well-anchored. The combination of these two beliefs would lead monetary authorities to underestimate both the depth and length of demand shocks and therefore respond with inadequate monetary stimulus. 

This is bad enough. But these forecasts also affect the decisions of fiscal policy makers. And it is very clear, to me at any rate, that fiscal policy in the US, UK and Euro area was tightened too soon after the shock and by far too much. The driver for these decisions appears to be over-optimistic growth forecasts coupled with worries about high government deficits. There is also a pernicious belief that monetary easing offsets fiscal tightening even in the aftermath of a severe demand shock. It is now abundantly clear that it does not. Fiscal tightening is always contractionary, and particularly so after a demand shock. That is why the Euro area economy is in such a mess. It is being driven into the ground by inappropriate and in some cases frankly vicious fiscal policy. 

And the consequences are terrible. The OECD's latest forecast of the "non-inflation accelerating rate of unemployment" (NAIRU) for Greece was 17.275%: for Spain, it was 18.9%*. This means that the supply-side of the economy now cannot create enough jobs for the adult population without inflationary consequences. For Spain, nearly a fifth of the workforce must remain unemployed, apparently. If ever there were evidence of the damage done to the supply side of Euro area periphery economies by the combination of severe shocks and misguided policies, this is it. To add insult to injury, having failed to prevent or repair this damage, EU authorities now present the people of these countries with a choice: leave your home and migrate to a foreign land where you do not speak the language (and where you are becoming increasingly unwelcome), or be thrown on the scrap heap. 

The EU authorities continue to talk about the need to do something about unemployment, and in particular youth unemployment. Now and then they even come up with initiatives, usually involving spending very little money relative to the scale of the problem. But while fiscal harshness and lack of monetary support remain the order of the day, there can be no real improvement. 

Eventually, I suppose, the Euro area will recover, because economies always do. But by then an entire generation of Europeans will have been sacrificed to appease the gods of ordoliberalism and hard money. The Euro area depression will be officially the longest and deepest in recorded history. And the rest of the world will be stagnating due to the deflationary impact of the European disaster. 

The "Great Recession" is no longer an adequate name for the time we are living through. As Brad DeLong said, it should now be known as the Greater Depression.

Related reading;


* Earlier version of this post had OECD forecasts from November 2013. Now updated.