Peterson Institute for International Economics Update Newsletter
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PIIE Update Newsletter
January 20, 2012

"Washington's premier think tank on the global economy"
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FEATURED
 
  Policy Brief 12-4
The European Crisis Deepens
[pdf]

Peter Boone and Simon Johnson
   
  Successive plans to restore confidence in the euro area have failed. A combination of misdiagnosis, lack of political will, and dysfunctional politics across 17 nations have all contributed to the failure so far to stem Europe's growing crisis. Proposals currently on the table also seem likely to fail. Boone and Johnson say the euro area faces two major problems: First, the introduction of sovereign credit risk has made nations and subsequently banks effectively insolvent unless they receive large-scale bailouts. Second, the ensuing credit crunch has exacerbated difficulties in the real economy, causing Europe's periphery to plunge into recession, thus increasing the financing needs of troubled nations well into the future. Five measures are needed to enable the euro area to survive: (1) an immediate program to deal with excessive sovereign debt, (2) far more aggressive plans to reduce budget deficits and make peripheral nations "hypercompetitive" in the near future, (3) supportive monetary policy from the European Central Bank, (4) the introduction of mechanisms that credibly achieve long-term fiscal sustainability, and (5) institutional change that reduces the scope for excessive leverage and consequent instability in the financial sector.

>> Read full policy brief [pdf]
>> See also The Coming Resolution of the European Crisis
>> See also related event

  Working Paper 12-2
Financial Reform after the Crisis: An Early Assessment
[pdf]

Nicolas Véron
   
  Nicolas Véron This working paper aims to take stock of global efforts towards financial reform since the start of the financial crisis in 2007–08 and to provide a synthetic (if simplified) picture of their status as of January 2012. Underlying dynamics are described and analyzed both at the global level (particularly G-20, International Monetary Fund, and the Financial Stability Board) and in individual jurisdictions, as well as the impact the crisis has had on these regions. The possible next steps of financial reform are then reviewed, including: the ongoing crisis management in Europe, the new emphasis on macroprudential approaches, the challenges posed by globally integrated financial firms, the implementation of harmonized global standards, and the links between financial systems and growth.

>> Read full working paper [pdf]

  Op-ed
Stop Coddling Europe's Banks

Morris Goldstein
   
  Morris Goldstein Throughout the European debt soap opera, Europe's leaders have expressed their willingness to do whatever it takes to restore stability and save the euro. In reality, too often, policymakers have in fact been doing whatever it takes to serve the banks. After initial denials, Europe's leaders have started to acknowledge that International Monetary Fund (IMF) Chief Christine Lagarde was right. Policymakers are now showing, through statements and decisions, that they agree with her August 2011 assessment at the Federal Reserve's Jackson Hole symposium that there is an urgent need for recapitalization of Europe's banks. This recognition of reality is the good news. The bad news is the EU's bank recapitalization is being handled in a way that will make a recovery from Europe's debt crisis more problematic than it needs to be. There are five concerns: incentives for deleveraging, absence of firm guidelines on dividends and executive compensation, omissions of a recession scenario and of an unweighted leverage ratio from the stress tests, inequitable burden-sharing during debt restructuring, and insufficient measures to permit an escape from the adverse feedback loop between sovereign debt and bank debt. It is high time for the official sector to truly commit to no longer allowing the banks to act in their own narrow interests.

>> Read full op-ed

  Congressional Testimony
Examining the Impact of the Volcker Rule

Simon Johnson
   
  Simon Johnson Megabanks with a great deal of debt and little equity are prone to major collapses. These structures create a nontransparent contingent liability for the federal budget in the United States. They also damage the nonfinancial business sector both directly—e.g., when there is a credit crunch, followed by a deep recession—and indirectly through creating a future tax liability. The funding advantage of megabanks relative to other financial institutions creates an incentive to become even larger and even more global—thus making them even harder to control and more dangerous in an economic downturn (as seen now in Europe's euro area). One major mechanism through which banks gamble is through various forms of proprietary trading, although this risk taking is not always accurately described as such when banks report on their activities. The legislative intent of the Volcker Rule is to clamp down on these activities, forcing the largest banks to become safer. Not surprisingly, there is a great deal of push back from the heads of these banks, who argue that the Volcker Rule will create costs for the broader economy.

>> Read full congressional testimony

  Policy Brief 12-3
Another Shot at Protection by Stealth: Using the Tax Law to Penalize Foreign Insurance Companies
[pdf]

Gary Clyde Hufbauer
   
  Gary Clyde Hufbauer Together, US federal and state governments impose almost the highest corporate tax rate found among advanced countries, 39 percent. Only Japan is fractionally higher. The high US rate has adverse consequences—lost investment, lost jobs, and less innovation—and goes a long way to explain slipping US competitiveness in the world economy. Some US-based companies that face competition from foreign-based companies think they have found the answer: by one means or another, persuade Congress to impose US taxation on the foreign companies. Instead of attacking the root problem—exceptionally high US corporate taxes—this "solution" seeks to handicap foreign competitors with the same burdensome tax system that handicaps US-based firms when they do business at home and abroad.

If Congress embraces this piece of tax discrimination for insurance companies, US consumers who live in disaster-prone areas could suffer as well. Reinsurance written by foreign affiliates pays a major portion of claims in these regions. This portion of the insurance market will either shut down or premiums will rise to cover the new tax burden. There is no reason for the US Congress to go down the path of tax discrimination, harming relations with foreign partners and imposing high costs on American consumers who live in high-risk areas. Instead, the US Congress should focus on corporate tax reform that puts US companies on the same competitive playing field as their foreign rivals.

>> Read full policy brief [pdf]

  Policy Brief 12-2
Japan Post: Retreat or Advance?
[pdf]

Gary Clyde Hufbauer and Julia Muir
   
  Legislation to reform Japan Post is again gathering steam in Tokyo. A new postal bill is taking shape, in the form of amendments to the existing Postal Privatization Law dating from the Koizumi era—all put forward under the larger banner of post-earthquake reconstruction finance and the government's efforts to minimize consumption tax hikes. The latest version of "postal reform" legislation envisages "privatization" of Japan Post through the sale of up to two-thirds of government shares, but the government would retain at least one-third, effectively maintaining its controlling position. The real question is whether the latest act in this long-running drama will represent true reform or in fact will camouflage an entrenchment of Japan Post's formidable monopoly powers. Hufbauer and Muir say the proposals are squarely "antireform" and if passed into law would create a major hurdle to Japan's membership in the Trans-Pacific Partnership (TPP). Japan Post's operations not only violate the General Agreement on Trade in Services but also are at odds with the drafts on state-owned enterprises now being circulated among the current TPP parties and aspirants. The authors conclude by outlining the elements for a true Japan Post reform bill, one that would represent a step forward rather than a step back.

>> Read full policy brief [pdf]

  Speech
Three Evolutionary Proposals for Reform of the International Monetary System
[pdf]

Edwin M. Truman
   
  Edwin M. Truman The international monetary system needs better tools to deal with threats to the globalized financial system. Inspired by the late Tommaso Padoa-Schioppa, and presented at a conference to his memory in Rome, Truman's remarks outline three interrelated steps through which the international monetary system can and should be improved with respect to surveillance, adjustment and reserve accumulation, and an institutionalized global swap network. The principal missing element in the framework of International Monetary Fund (IMF) surveillance over the international monetary system today is a shared commitment to global economic growth and financial stability. To help address this problem, the Group of Twenty should strongly support a broadening of the IMF's mandate in multilateral surveillance. To address inadequate adjustment and excessive reserve accumulation, on an experimental basis, annual Special Drawing Rights (SDR) allocations of $200 billion per year should be made for the next five years. The dominant lesson from the financial crises of the past four years is that the world is more financially integrated than anyone imagined two decades ago. An institutionalized global swap network is now more urgently needed. A workable approach would be a three-key framework with separate roles for the IMF, central banks collectively, and central banks individually.

>> Read full speech [pdf]

  Op-ed
China and India: Right Policy, Wrong Place

Arvind Subramanian
   
  Arvind Subramanian India and China should reverse strategies on allowing foreigners access to their currencies. In the aftermath of the recent financial crises, India's policymakers have been energetically dismantling restrictions on capital flows. Most recently, as the rupee came under pressure, India has allowed even greater access for foreigners to its stock market. China too has been selectively increasing foreigners' access to the renminbi. But it remains cautious about fundamental reforms. A relatively closed capital account, combined with financial repression, has helped China sustain its mercantilist policy of undervalued exchange rates. But the cost-benefit calculus is now turning. China has over-invested, which is driving down the efficiency of capital use and limiting future economic growth, while mercantilism has rendered China vulnerable to external shocks and led to a large buildup of foreign exchange reserves. India, unlike China, has been running current account deficits and opening itself to outside flows to finance them. It has to be more wary about embracing foreign capital because of the risks to stability and employment-intensive growth. In the future China will have to acquire the zeal for foreign capital exhibited by Indian policymakers to rebalance its economy and reduce the mounting distortions. On attitudes to foreign capital, China and India should swap places.

>> Read full op-ed


Peterson Perspectives Interviews

audio  Europe vs. the Rest of the World
Edwin M. Truman explains why the proposal for an IMF bailout fund for Europe has pitted a dithering European leadership against the United States and the rest of the world.

audio  Making an Example of Greece
Jacob Funk Kirkegaard argues that Greece's balking at reforms sets such a bad example for Europe that contagion from a Greek default might be containable.

audio  Ratcheting Up Economic Pressure on Iran II
Mohsin S. Khan explains how sanctions on Iran's central bank could lead to difficulties for Iran's imports and an effective embargo on its oil exports.

audio  Greece Back on the Front Burner
Nicolas Véron says new tensions have arisen over creditors balking at Greek debt restructuring and Greece itself falling short of its commitment to reform.


Recent Blog Posts

RealTime Economic Issues Watch   China Economic Watch    North Korea:  Witness to Transformation
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On Greece, Growth, and Downgrades

Mike Mussa (1944–2012): When Will They Learn?

Michael Mussa (1944–2012): Memories from the IMF

Mike Mussa (1944–2012): Serenading the IMF Board

Mike Mussa (1944–2012): Perceptive Analysis Wrapped in Humor
  Beware False Prophets of Rebalancing Part II

Beware False Prophets of Rebalancing

Why Soccer Is a Lot Like the Stock Market In China

The Politics of Declining Land Revenues

The World in 2012 - China Predictions
  Glimpses: Philip Meuser, Pyongyang Architectural and Cultural Guide

Iran Update 2: The Iranian Connections and Precedents

The New Year's Editorial

Iran Update 1: The Iran, North Korea, and Syria Nonproliferation Reform and Modernization Act

Satire: Kim Jong-il dropping the bass


PIIE Noted in the News and on the Web

Wall Street Journal
At One Think Tank, Two Opposing Views on the Euro-Zone Outlook
The Wall Street Journal covers the Peterson Institute event in which two opposing views on the outcome of the euro area crisis were presented. Simon Johnson and Peter Boone presented dire predictions, while C. Fred Bergsten and Jacob Funk Kirkegaard remain more optimistic.

Xinhua News Agency
ECB Should Provide Supportive Policy to Stabilize Crisis
China's Xinhau News Agency reports on C. Fred Bergsten and Jacob Funk Kirkegaard's presentation of their latest policy brief.

Fortune
China Can't Grow Its Way Out of a European Recession
Fortune discusses Nicholas R. Lardy's latest book, Sustaining China's Economic Growth after the Global Financial Crisis.



Preview of Our Next Issue

Paper
Augmented Misery Index: Second Half of 2011
Gary Clyde Hufbauer and Woan Foong Wong

 
 
In This Issue
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Event
C. Fred Bergsten The Euro Crisis

C. Fred Bergsten, Simon Johnson, Jacob Funk Kirkegaard, and Peter Boone present differing analyses of the euro crisis.
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