Peterson Institute for International Economics Update Newsletter
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PIIE Update Newsletter
June 21, 2012

"Washington's premier think tank on the global economy"
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Epiphanies from C. Fred Bergsten

with Daniel W. Drezner, Foreign Policy
  C. Fred Bergsten If there is an éminence grise in the world of international political economics, it is C. Fred Bergsten. After a storied career in the US government, from the White House to the Treasury Department, he founded what's now called the Peterson Institute for International Economics, which is counted each year among the world's most important think tanks. As he prepares to step down from running the Institute, Bergsten opens up to Foreign Policy about China, currency wars, and working with Henry Kissinger.

>> Read interview

Making the Most of Doing More

Adam S. Posen
  Adam S. Posen An excessive perception of, and aversion to, risk on the part of investors—businesses, portfolio managers, financial intermediaries, and even households—is the major source of current global economic problems. This perception and aversion has resulted in an excessive desire for liquidity and relative safety, as seen in the very large cash balances accumulated by most sectors of the economy, notably in nonfinancial corporations and the banking system. Some of this cash hoarding is rational, but even allowing for these factors, and for a world that is genuinely riskier than people previously realized, the fear of risky investment has overshot. It is excessive because some credit problems really are due to illiquidity and to financial-market dysfunction rather than to insolvency and indebtedness. The world economy, warns Posen, is at risk of the reluctance to invest becoming a self-fulfilling prophecy, as opposed to investment leading to recovery as in normal situations.

Monetary easing, including all forms of quantity-based easing, should be effective in breaking this cycle and must be pursued to meet central banks' mandated goals. Posen argues for a further round of asset purchases by central banks, focused on private-sector assets. Such asset purchases will allow more direct targeting of financial-sector dysfunctions and have a greater impact on liquidity-preferring investors' portfolios than a similar unit of quantitative easing on government bonds, thereby improving confidence and the real economy. The credit risk on central bank balance sheets, and any negative spillovers on markets or politics, from such purchases should be minimized through government indemnification of losses incurred in the execution of monetary policy.

>> Read full speech [pdf]

  Policy Brief 12-15
Restoring Fiscal Equilibrium in the United States

William R. Cline
  William R. Cline The United States faces a "fiscal cliff" at the end of calendar year 2012, when the two major tax cuts from the Bush era and some other tax provisions will expire and, in the absence of action, scheduled reductions in spending will begin. The subsequent increase in taxes and reduction in spending would dramatically tighten the federal budget deficit at a time when unemployment remains high. On an annual basis the total impact of the fiscal cliff amounts to a reduction in the federal budget deficit of about $800 billion on a direct basis (about 5 percent of GDP). After taking account of revenue losses and extra social spending resulting from induced slowdown in the economy, the Congressional Budget Office places the net fiscal impact at $560 billion for the first nine months of 2013, implying $745 billion or 4.5 percent of GDP for calendar year 2013.

An aging population and rising healthcare costs continue to boost federal spending under current policies, and it is critical that the United States put the budget on a sustainable path, which will require significant changes in spending and tax policies. The expiration of the Bush era tax cuts at the end of 2012 provides a unique opportunity to raise tax rates and/or eliminate tax deductions so that the United States can restore federal revenue to at least 18 percent of GDP and probably more in order to meet growing fiscal needs associated with an aging population. The political pain of higher tax rates should concentrate political minds on the associated task of finding more ways of cutting spending and limiting increases in entitlement spending. It will nonetheless be important to phase in the fiscal adjustment gradually, for example, over the four years of the next presidential term, in order to moderate the output loss that would otherwise occur under current conditions of high unemployment combined with interest rates near zero. Moreover, Cline says the needed structural fiscal adjustment amounts to 3 percent of GDP and the component of overkill included in the fiscal cliff's 5 percent of GDP adjustment should be avoided.

>> Read full policy brief [pdf]

  Policy Brief 12-16
The Trans-Pacific Partnership and Asia-Pacific Integration: Policy Implications

Peter A. Petri and Michael G. Plummer
  The Trans-Pacific Partnership (TPP) agreement, now in negotiation among nine Asia-Pacific countries, could yield annual global income gains of $295 billion (including $78 billion for the United States) and offers a pathway to free trade in the Asia-Pacific with potential gains of $1.9 trillion. The TPP is a crucial step on what is becoming a "Trans-Pacific track" of trade agreements, and its expected template promises to be unusually productive because it offers opportunities for the leading sectors of emerging-market and advanced economies.

A parallel pathway that the authors call the "Asian track" includes agreements centered on the Association of Southeast Asian Nations (ASEAN); negotiations among China, Japan, and Korea; and proposals for pan-Asian free trade areas. Both the TPP and Asian tracks are large, positive-sum projects that would yield substantial net gains. Asian templates prepare the ground for cooperation by addressing primarily goods liberalization, but the TPP is likely to go further by liberalizing sectors important in both emerging-market and advanced economies (such as services and technology), thus expanding opportunities for trade between them.

Together, the TPP and Asian tracks are a dynamic process—an example of competitive liberalization—that could consolidate the "noodle bowl" of existing trade agreements and lead to a Free Trade Area of the Asia Pacific (FTAAP). A comprehensive agreement among all major Asia-Pacific economies does not appear to be feasible in the current macroeconomic and political context but hopefully will become more acceptable in the future. An ambitious TPP template would generate greater benefits from integration than less demanding alternatives, but it will be harder to sell to China and other key regional partners as the TPP evolves toward wider agreements. The importance of Asia-Pacific integration argues for an early conclusion of the TPP negotiations, without jeopardizing the prospects for region-wide or even global agreements based on it in the future.

>> Read full policy brief [pdf]

  Policy Brief 12-17
Southern Europe Ignores Lessons from Latvia at Its Peril

Anders Åslund
  Anders Aslund In the current financial crisis plaguing Europe, Latvia stands out for resolving its financial problems quickly and resolutely. After contracting 24 percent in 2008 and 2009, it grew at the rate of 5.5 percent in 2011. The speed and determination with which the government carried out austerity measures in 2009 and restored confidence after suffering the worst output decline in Europe is a crucial lesson for the ailing South European countries—Greece, Italy, Portugal, and Spain. Latvia has proven that internal devaluation—cutting wages and public expenditures—works and that it can turn an economy around quickly. Many policy observers and economists have dismissed Latvia's crisis resolution as irrelevant to the situation in Southern Europe. The Latvian orange, they say, cannot be compared with the South European apples. Åslund argues otherwise.

Latvia's achievement boils down to five crucial political economy principles, which the South Europeans ignored—and continue to ignore—at their peril. First, Latvia made full use of the grave sense of crisis in the fall of 2008. The sudden large output shock and liquidity freeze made the unthinkable possible and necessary. Second, the government implemented a comprehensive anticrisis program that was heavily front-loaded in the first half of 2009, which restored confidence early. Third, the program contained more expenditure cuts than revenue measures, which made it more realistic and drove structural reforms. Fourth, the International Monetary Fund and the European Union provided early and sufficient—not excessive—international financial support, making the crisis resolution financially sustainable. Finally, the government succeeded in its salesmanship of the adjustment program, by clarifying how severe the crisis was and by ensuring that the burden of the crisis was socially equitable. None of these five crucial conditions, which apply to any crisis resolution, have been satisfied by the South Europeans. They took their time to get a handle on their crises, wasting trust, patience, and resources in the process, and now are paying the price for their indecisiveness and leisurely approach.

>> Read full policy brief [pdf]

Peterson Perspectives Interviews

audio  European Bank Turmoil, Part II: Toward European-wide Bank Supervision
Nicolas Véron says that Europe appears to be moving toward establishing regional banking standards and supervision but that many political obstacles remain to its implementation.

audio  European Bank Turmoil, Part I: Spanish Bailout
Nicolas Véron says the bailout of Spanish banks was a helpful first step but that it must be followed by more restructuring of the Spanish banking system if contagion is to be forestalled.

Recent Blog Posts

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This Week in the Euro Area and What to Expect from Greece on June 17th

Financial Repression and the One-Child Policy

Why Internal Devaluation Is Advantageous

Ireland's Endorsement of Austerity and Other Reasons for Euro Optimism
  Financial Repression and the One-Child Policy

The Politics of a Chinese Slowdown

Capital Stock....and Flow

A Statistical Snapshot

Income Inequality and Economic Rebalancing
  Blame it on the Weather

The Burma Model

Debt follies

Mapping the Succession I: An Overview of Institutional Change

Cho Ryong Hae goes to the funpark

PIIE Noted in the News and on the Web

Council on Foreign Relations
Did the G-20 Help the Eurozone?
Jacob Funk Kirkegaard assesses the G-20 summit in relation to the euro area in this interview.

Bloomberg TV
Bergsten on G-20 Meeting in Mexico, Debt Crisis
C. Fred Bergsten discusses the issues leaders are to address at the G-20 summit in Mexico.

Business News Network
Greek Election Results
Following an update of Greece's performance in the Euro Cup, Jacob Funk Kirkegaard discusses the outcome of Greece's parliamentary elections and the challenges New Democracy faces in forming a governing coalition.

C-SPAN | Washington Journal
Federal Reserve Report on American Wealth
Joseph E. Gagnon discusses the recent Federal Reserve report that found the median net worth for US households declined 39 percent between 2007 and 2010.

Preview of Our Next Issue

Putin's Eurasian Illusion Will Lead to Isolation
Anders Åslund

In This Issue

Congressmen Kevin Brady Outlook for US Trade Policy for 2012–13

Congressmen Brady delivers the keynote speech at a conference covering major trade policy issues facing the United States.

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