Iris J. Lav
This article tackles the issue of comprehensive state budget reform. With structural deficits rampant, reform is needed to maintain the current level of programs that states and localities now provide, but cannot support over time with current revenue policies. Recent “reforms” have mainly focused on cutting both spending and taxes. Nonetheless, it is believed that people want their services and will vote to pay for them, if given that option. The article notes that there have been very few successful state tax reforms in recent years. But modernization of tax systems is needed to alleviate structural deficits. Part of the problem is institutional myopia: improved multiyear budgeting can warn policymakers when proposed actions are likely to create budget problems over the long term.
Robert B. Ward
Over the last decade, observers of state and local finances have been alarmed over an emerging picture of long-term, structural imbalances. This article examines the concept of fiscal sustainability in several formulations and explains that it essentially means limiting expenditure commitments to those that can be met by available revenue streams. It investigates why fiscal sustainability in actual practice, however it might be measured in theory, has fallen into disrepair. The usual lineup of budget-busting culprits is next examined, with the proliferation of entitlement programs standing at the head of the line. Over the past four decades, state and local budget increases reflected the strength of the economy during an unprecedented run of prosperity. Meanwhile, the array of entitlement programs that drove spending was increasingly shaped by political, demographic, and institutional forces, each with its own clientele of beneficiaries. That has made adjustments more difficult when revenues do not keep pace with spending patterns.
Peter Petri and Wendy Dobson
Asia is gradually changing the landscape of regional and global economic cooperation. Institutional reforms are underway to respond to its growing economic clout and pluralism. External expectations of Asian participation in collective goals are growing. But Asians have been major beneficiaries of the global economic system, and remain more comfortable with incremental change than with leading new initiatives or with enforcing global norms and rules. This reticence combined with reluctance of existing players to revamp governance structures in global institutions means that the existing order will continue to function. Economic cooperation in many areas, including new areas such as climate change, is therefore likely to be sluggish as countries face tradeoffs between their domestic priorities and the collective interest.
Eiji Ogawa and Chikafumi Nakamura
This chapter examines the behavior of the Asia Pacific region’s currencies through the lens of the global financial crisis of 2008-2009 and the global imbalances that have been a possible contributor to that crisis. It discusses the “savings glut” hypothesis and identifies the possible causes of global imbalances which include the behavior of asset prices and the U.S. fiscal deficits. It also considers the possibility of an Asian Currency Unit (ACU) or Asian Monetary Unit (AMU).
This chapter analyzes and draws lessons from the Asian financial crisis of 1997-1998. It discusses the underlying factors that led to the crises, the differences from the previous balance of payments crises, and the policies that were adopted to control the crises. These policy responses included changes in exchange rate policies, financial sector reforms and, in several cases, external support from multilateral agencies. This article highlights the benefits of adequate foreign exchange reserves and the dangers of overleveraging.
Austrian business cycle theory (ABCT) is a body of hypotheses embodying particularly Austrian insights and assumptions. The canonical variant associated with Ludwig von Mises and Friedrich A. Hayek is particularly well suited to the Great Depression. However, it is an inadequate account of the recent US recession and financial crisis. This chapter develops a suitable ABCT variant that explicitly incorporates not only the economy’s time structure of production but also (1) its structure of consumption and (2) its risk structure. The continuous input–continuous output nature of the housing market is highlighted, along with the Treasury and the Federal Reserve’s roles in externalizing the risk associated with government-sponsored entities’ (GSEs’) debt. The chapter then extends Roger Garrison’s graphical framework to illustrate this ABCT variant.
Marco del Negro
This article presents the challenges that arise since macroeconomists often work in data-rich environments. It emphasizes multivariate models that can capture the co-movements of macroeconomic time series analysis. It discusses vector autoregressive (VAR) models distinguishing between reduced-form and structural VARs. Reduced-form VARs summarize the autocovariance properties of the data and provide a useful forecasting tool. The article shows how Bayesian methods have been empirically successful in responding to these challenges. It also encounters dynamic stochastic general equilibrium (DSGE) models that potentially differ in their economic implications. With posterior model probabilities, inference and decisions can be based on model averages. This article discusses inference with linearized as well as nonlinear DSGE models and reviews various approaches for evaluating the empirical fit of DSGE models. It concludes with a discussion of model uncertainty and decision-making with multiple models.
Brazil’s Macroeconomic Policy Institutions, Quasi-Stagnation, and the Interest Rate–Exchange Rate Trap
Luiz Carlos Bresser-Perreira
This chapter examines the evolution of macroeconomic policy and institutions over the long term and the ways in which they have influenced the growth path of the Brazilian economy. It establishes that a critical influence on the disappointing growth performance realized was a failure to neutralize the effects of exchange rate induced Dutch Disease. In addition to this, Brazil’s economic dynamism has been inhibited by the pursuit of a growth with current account deficits (“foreign savings”) policy; an exchange rate anchor policy to control inflation; and a high level of interest rates. Collectively, these factors have reduced the productivity and competitiveness of Brazil’s manufacturing industry. In addition, the interest-rate level has remained very high since the Real Plan and, from the late 1970s the investment capacity of the Brazilian state drastically decreased.
Burton G. Malkiel
This article addresses three topics. First, it describes what economists mean when they use the term “bubble,” and contrasts the behavioral finance view of asset pricing with the efficient market paradigm in an attempt to understand why bubbles might persist and why they may not be arbitraged away. Second, it reviews some major historical examples of asset-price bubbles as well as the (minority) view that they may not have been bubbles at all. It also examines the corresponding changes in real economic activity that have followed the bursting of such bubbles. Finally, it examines the most hotly debated aspect of any discussion of asset-price bubbles: what, if anything, should policy makers do about them? Should they react to sharp increases in asset prices that they deem to be unrelated to “fundamentals?” Should they take the view that they know more than the market does? Should they recognize that asset-price bubbles are a periodic flaw of capitalism and conduct their policies so as to temper any developing excesses? Or should they focus solely on their primary targets of inflation and real economic activity? The discussion pays particular attention to bubbles that are associated with sharp increases in credit and leverage.
Mauro Baranzini and Amalia Mirante
This chapter reviews and assesses the genesis and development of the Cambridge post-Keynesian school of income and wealth distribution, the foundations of which were laid in particular by Nicholas Kaldor, Richard Kahn, Luigi Pasinetti, and Geoffrey Harcourt from the middle 1950s onward. The focus of their analysis was to investigate the relationship between the steady-state rate of profits on the one hand, and the saving propensities of the socioeconomic classes and the growth rate of the economy on the other. During half-century and more about 200 scholars have published in this area no fewer than 500 scientific papers and book chapters, as well as thirty volumes. This post-Keynesian school of economic thought has gained a safe entry into the history of economic analysis. In order to evaluate this vast scientific literature this chapter has divided it into eight specific lines: (1) the introduction of a differentiated interest rate on the wealth of the classes; (2) the introduction of the monetary sector and of portfolio choice; (3) the introduction of the public sector, and the Ricardian debt/taxation equivalence; (4) the inclusion of other socioeconomic classes; (5) the introduction of microfoundations; (6) the analysis of the long-term distribution of wealth and of the income share of the socioeconomic classes; (7) the overlapping generation model and the intergenerational transmission of wealth; (8) other general aspects, in particular the applicability of the Meade-Samuelson and Modigliani Dual Theorem.
Central banks affect the resources available to fiscal authorities through the impact of their policies on the public debt, as well as through their income, their mix of assets, their liabilities, and their own solvency. This chapter inspects the ability of the central bank to alleviate the fiscal burden by influencing different terms in the government resource constraint. It discusses five channels: (i) how inflation can (and cannot) lower the real burden of the public debt, (ii) how seigniorage is generated and subject to what constraints, (iii) whether central bank liabilities should count as public debt, (iv) how central bank assets create income risk and whether or not this threatens its solvency, and (v) how the central bank balance sheet can be used for fiscal redistributions. Overall, it concludes that the scope for the central bank to lower the fiscal burden is limited.
This article first lays out the broad contours of state and local government capital spending and the precepts of the capital budgeting process. It then considers how capital spending levels and budgeting processes were affected by the Great Recession. State and local capital spending, which had grown rapidly before the downturn, was slowed considerably by the Great Recession's onset. Federal aid helped to cushion the blow, but capital spending began to decline as many jurisdictions exhausted their influx of federal funds. The Great Recession's effect on capital spending was found to be consistent with the impacts of past recessions, but its depressing effects will continue for several years. Thus, the Great Recession, when its aftershocks are played out, will likely result in unprecedented declines in state and local capital spending and an erosion of the public capital stock.
Mark J. Roe
This article outlines the main weaknesses in the interaction between political institutions and capitalism in both developed and developing nations, illustrates this interplay with historical capital markets examples, and shows how the interaction between capital markets and politics has been seen in the academic literature. It focuses not on the standard and important channel of how institutions affect preferences and outcomes, but on how and when immediate preferences can trump, restructure, and even displace established institutions. The article is organized as follows. First, it describes the concepts of how capital markets depend on political institutions and preferences. The second part shows how political divisions can lead to differing capital markets outcomes in the developed world, describing conflicts between haves and have-nots and fissures among the haves. The third part develops these concepts for the developing world, looking at elites' interests, nonelites' interests, political stability, and the impact of economic inequality. The fourth part examines several contemporary and historical examples in the developed world, including the power of labor in Europe, managers in modern America, populists in American history, and the forces for codetermination in mid-twentieth-century Germany. The fifth part extends and deepens the argument, showing the impact of left-to-right shifts over time and how these can be better analyzed in the academic literature. The sixth part describes overall limits to a political economy approach, while the final section concludes.
John P. Cochran
The recent revival of boom-bust business cycles and the worldwide slow recovery from 2009–2012 has renewed interest in the analysis of a money-production economy developed by Keynes and capital-structure-based Austrian macroeconomics developed by Hayek, Mises, Rothbard, and, most recently, Garrison. Both approaches identify time, money, banking, financial markets, interest, and investment as the major sources of coordination failure leading to recession or depression. When compared with single-aggregate modern macroeconomic models, both Keynes’s and the Austrians’ models, with their lower level of aggregation, provide a better understanding of how an economy goes wrong, However, the chapter argues that Keynes’s model is flawed because it lacks a capital-structure foundation. Keynesian macroeconomic policy is generally unnecessary and, if applied consistently, destabilizes the economy. Austrian economics and its capital-based macroeconomics provide better guidance on cause, recovery, and, more important, prevention.
Jakob de Haan and Jan-Egbert Sturm
Many central banks in the world nowadays regard their external communication as an important tool to achieve their goals. This chapter provides an overview of the different ways in which central banks inform the public about the future direction of monetary policy and how successful they have been in recent years. Forward guidance is either part of a monetary policy strategy in which an explicit inflation target is targeted or is part of a strategy that attempts to circumvent the effective lower bound regarding the nominal interest rate. In both cases, forward guidance attempts to influence longer-term interest rates and inflation expectations through the expected future short-term interest rates.
J. Scott Davis and Mark A. Wynne
Over the past twenty-five years, central bank communications have undergone a major revolution. Central banks that previously shrouded themselves in mystery now embrace social media to get their message out to the widest audience. The volume of information about monetary policy that the Federal Open Market Committee (FOMC) now releases dwarfs what it was releasing a quarter century ago. This chapter focuses on just one channel of FOMC communications, the postmeeting statement. It documents how this has become more detailed over time. Then daily financial-market data are used to estimate a daily time series of US monetary policy shocks. These shocks on Fed statement release days have gotten larger as the statement has gotten longer and more detailed, and the chapter shows that the length and complexity of the statement have a direct effect on the size of the monetary policy shock following a Fed decision.
Michel Aglietta and Benoît Mojon
This chapter describes the emergence of central banks and the evolution of their functions as responses to the monetary and financial crises of the nineteenth and the twentieth centuries. First, central banks have become bankers’ banks to facilitate the settlement of inter-bank payments. Central bank money is the legal tender of all debts, including bank-issued debts that are used as means of payment by non-financial agents. Second, the repetition of liquidity crises has led central banks to regulate and supervise the banking system. These policies aim to prevent excessive risk-taking by one bank threatening the integrity of the payment system. However, because crises cannot always be avoided, central banks stand ready to lend as a last resort if need be. Finally, central banks conduct monetary policy, that is, they supply money to stabilize the unit of account and thereby provide a nominal anchor to the economy.
This chapter analyzes the evolution and effects of central bank crisis management since the mid-1980s based on a Hayek-Mises-Wicksell overinvestment framework. It is shown that given that the traditional transmission mechanism between monetary policy and consumer price inflation has collapsed, asymmetric monetary policy crisis management implies a convergence of interest rates toward zero and a gradual expansion of central bank balance sheets. From a Wicksell-Hayek-Mises perspective, asymmetric central bank crisis management has contributed to financial market bubbles, decreasing marginal efficiency of investment, increasing income inequality, and declining growth dynamics. The economic policy implication is a slow but decisive exit from ultra-expansionary monetary policies.
The financial deregulation in major Western economies in the 1970s and 1980s freed banks from many preexisting constraints, facilitating competition and greater risk-taking and eventually leading to prudential regulation and supervision as a specific, well-defined area of regulatory activity. It was codified in the Basel Accord, which allowed banks considerable discretion in how they met broadly specified regulatory requirements and was focused primarily on individual bank safety. The financial crisis of 2007–2008 highlighted numerous weaknesses in the design and application of this approach. The previous micro-orientation has been complemented by a macroprudential focus, suggesting a strengthened case for central bank involvement in prudential regulation. Microprudential regulation has been strengthened, with changes reflecting less confidence in the previous market-oriented approach and more reliance on direct controls. The wheel has turned such that prederegulation approaches and attitudes have been incorporated into the postcrisis design and approach of prudential regulation.