Peterson Institute for International Economics Update Newsletter
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PIIE Update Newsletter
August 15, 2012

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  Working Paper 12-12
Sovereign Debt Sustainability in Italy and Spain: A Probabilistic Approach

William R. Cline
  William R. Cline This paper introduces a new probabilistic approach to sovereign debt projections and presents new estimates of debt ratios through 2020 for Italy and Spain. The new approach takes account of likely correlations across 243 alternative scenarios with three states (good, baseline, bad) for five key variables (growth, interest rate, primary surplus, bank recapitalization, and privatization). The 25th and 75th percentile scenarios are reported, as are the baseline and probability-weighted outcomes. The results suggest sovereign debt is sustainable in both Italy (where debt ratios are likely to decline because of a high primary surplus) and Spain (where the ratios rise but at a decelerating pace and from relatively low levels).

>> Read full working paper [pdf]

  Congressional Testimony
The Future of the Euro Area: Outlook and Lessons

Simon Johnson
  Simon Johnson Successive plans to restore confidence in the euro area have failed. The market cost of borrowing is at unsustainable levels for euro banks and a significant number of governments. Two major problems loom over the euro area. 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. This has increased the financing needs of troubled nations well into the future. With governments reaching their presumed debt limits, the European Central Bank (ECB) is now treading a dangerous path. It feels compelled to provide adequate "liquidity" to avert systemic financial collapse, yet must presumably limit its activities in order to prevent a loss of confidence in the euro—i.e., a change in market and political sentiment that could lead to a rapid breakup of the euro area. 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 ECB, (4) the introduction of mechanisms that credibly achieve medium-term fiscal sustainability, and (5) institutional change that reduces the scope for excessive leverage and consequent instability in the financial sector.

>> Read full testimony

The Fairness Paradox

Gary Clyde Hufbauer
  Gary Clyde Hufbauer The Center for American Progress (CAP) has released a new report, Romney Tax Plan: Many Happy Returns for Big Oil, criticizing proposed reductions in the federal corporate tax rate (now 35 percent) to a level around 25 percent. A rate cut, the report argued, would create another unfair break for oil and gas companies, which, according to the study, already receive too many special deductions. The US statutory tax rate is the highest among Organization for Economic Cooperation and Development (OECD) countries and significantly exceeds the level in most emerging countries. Yet the CAP report argues that reducing the US statutory rate would somehow create unearned profits for oil and gas companies. It disregards the fact that cutting the statutory rate would benefit companies and create jobs in every corner of the economy. The oil and gas industry pays an effective tax rate of over 41 percent compared to the Standard and Poor's (S&P) index average of 26.5 percent. Tax policy should strive to promote economic growth while ensuring tax fairness. Arbitrarily revoking protections for certain industries or discouraging policies that would benefit the entire economy in order to target the majors does just the opposite. Sensible reforms can certainly be made to the corporate tax code, but the CAP report misses most of them.

>> Read full op-ed

Recent Blog Posts

RealTime Economic Issues Watch   China Economic Watch    North Korea:  Witness to Transformation
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Posen's Pointed Exit Interview: Team GB Should Do More QE

The Trans-Pacific Partnership: Whither China?

The IMF Embraces FEERs and Acts to Broaden Surveillance

Can India's Power Problems Be Solved?

Will Venezuela's Entry Be Mercosur's Swan Song?
  Investment Above All

China's Recent Financial Reforms: More than the Sum of the Parts?

China's Wild West Interest Rate Liberalization

The Chinese Growth Model: Before and After the Crisis

Financial Repression and the One-Child Policy
  DJ BO set list contest winners!

North Korean Economic Performance in 2011

Wet Hot North Korean Summer: It's Summer Camp Season in Wonsan

To All Olympians: We Salute You!

Good governance or competing for rents? The closure of the Taepung Group

PIIE Noted in the News and on the Web

Financial Times
King Urged to Widen Recovery Measures
Adam S. Posen says the Bank of England could more effectively stimulate an economic recovery if it were willing to purchase private sector assets. Posen states, "I have no question in my mind that what we're doing with QE [quantitative easing] is preventing things from getting much worse, but that doesn't mean you couldn't have an additional or better instrument."

Posen Says BOE Should Go Beyond Conventional QE to Fight Slump
Bloomberg writes that Adam S. Posen believes the Bank of England's Monetary Policy Committee (MPC) "does have the authority to make up its mind on what instruments it wants to use." Posen argues that the MPC should utilize options other than buying government bonds to fight the recession.

Washington Post's Wonk Blog
What the Habsburg Empire Can Tell Us About Breaking Up the Euro Zone
The Washington Post draws upon Anders Åslund's recent Policy Brief and his historical analysis of failed currency unions in the Habsburg Empire, the former Soviet Union, and the former Yugoslavia, all of which resulted in "total economic fiascos."

Wall Street Journal
Spain and Italy Are (Probably) Fine
The Wall Street Journal says that William Cline's newest Working Paper, Sovereign Debt Sustainability in Italy and Spain: A Probabilistic Approach, should "delight policymakers in Rome, Madrid, and Brussels alike.

This Crisis Caused a Much Longer Recession
William R. Cline says the ongoing financial crisis is causing a much longer recession in part because it cannot be solved by simply reducing interest rates.

Atlantic Council
India's Economic Slowdown
Arvind Subramanian gives a presentation on India's economic slowdown and joins Shuja Nawaz, director of the Atlantic Council's South Asia Center, for a discussion broadcast by C-SPAN.
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