Thursday, March 29, 2012

De Nederlandsche Bank

De Nederlandsche Bank is an institution that is so venerable that we Dutch people still write it with the pre-1934 spelling, i.e. with "sch". It was founded by King William I in 1814, right off the boat before they'd even gotten around to writing a definitive constitution for the new kingdom. And in 198 years, they've never let us down, until perhaps now.

Despite the fact that he came in from my alma mater, I was not unequivocally thrilled when Klaas Knot became the new president of the DNB last year. After all, it looked suspiciously like the government had gone out of its way to find the one pro-austerity financial economist in the entire country to fill the vacancy left behind by Nout Wellink. And, true to their word, the DNB are the only voice in the Dutch public policy landscape where economists of weight are advocating a strict adherence to the EU norms. Fortunately, they published an eight-point list earlier this month, listing the reasons why they feel this way. So much the easier for shooting them down...

1. The Debt Crisis cannot be resolved with unlimited new borrowing
Taken at face value, this is a silly thing to say. Of course it can be. There is no reason why the national debt should not rise, rise, and rise still further, as long as GDP increases quicker still. In its explanation, the author talks about increases in debt ratio without explaining why a temporary increase in the debt ratio is bad in the middle of the worst crisis in 80 years.

2. Growth helps, but is not enough to get rid of a high government debt
OK, that's the other half of the argument, so I'm not sure why they split this into two points. In any event, it is wrong. All you need is growth > core deficit as a % of GDP, and time. Here is also where they refer to the infamous Reinhart & Rogoff study, the shortcomings of which are already discussed in many places all over the internet, including here. (Read my lips: Post Hoc Ergo Propter Hoc.) Much better studies, that attempt to control for various reverse causation, etc. issues, have been done by Romer and Romer, for example. (In this blog post by Krugman, where he explains what last year's Nobel Prize was all about, he links to some useful examples.) As for the "unprecedented nature" of having a government debt this high, forgive me if I'm not particularly worried as long as we're still below the debt ratio we had for every single year of the 1990s.

3. Structural reforms are necessary in order to improve the growth potential of the of the economy, but are not a complete alternative for deficit reduction
My apologies for the awkward use of the word "complete" there, but this word is exactly what's wrong here. Structural reforms have nothing to do with short term growth at all. You don't abolish the deductibility of mortgage interest payments or reduce the generosity of unemployment benefits in order to fix the economy now, during the current depression. You do it it in order to improve the economy 5, 10 years down the line. Deficit reduction and structural reforms are completely unrelated topics. (Except insofar as that a crisis is a terrible thing to waste.)

4. Deficit reduction reduces growth in the short term, but this effect is relatively small for the Netherlands
Oh, OK, so we're reducing growth in the middle of a depression, but only by a little, so it's no biggie... (Whether the idea that the bulk of the effect is dissipated due to reduced imports makes sense I'm not sure. I'd have to think about that some more.)

5. Consumer confidence benefits from budgetary consolidation
Never mind the horrible jargon here, but Really? Really? You think that consumers care about whether the government's budget balances rather than whether or not they have a job? (Or whether their relatives, friends and neighbours do?) Why don't we put that to the test: show some consumers a news report that a new budget deal has been struck that involves a balanced budget and, say, 100.000 government layoffs. See what that does to their confidence.

6. Violating the budget rules is not a solution
I'm pretty sure that's not actually an argument. The explanation refers to the PIIGS, which isn't much of an argument either.

7. Financial Markets follow the Netherlands carefully
Yes, if we were downgraded from AAA to AA+, we'd all be dooooomed. But seriously, if we'd ever get downgraded far enough for it to matter, so would everybody else in Europe, and in that case we'd have problems no matter how much deficit reduction we decided to implement.

8. Budgetary sensitivity and large guarantees require a low government debt
Here, finally, do we reach an argument that makes sense, more or less. The problem is that those guarantees have already been given, and no amount of deficit reduction will reduce the blow if they are called up. Shaving one or two percentage points off the debt ratio doesn't really do much good if you're going to get hit with a 20%-point guarantee. As for the sensitivity of the Dutch government's budget deficit to changes in economic growth, that seems like an excellent reason to avoid ruining the economy still further, even if it is only by a little bit (cf. point 4, above).

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