Reading For The Seven Dwarves

Includes: EWQ, EZU, FGM, SPY, VGK
by: Craig Pirrong

The G8 - perhaps with the conspicuous exception of Angela Merkel - apparently believe that if you say growth enough, like a mantra, it will magically appear. Obama and Hollande and Monti and even Osborne (who seems a great candidate for the Upper Class Twit of the Year Contest: Jeez how British conservatism has devolved) appear convinced that some sort of stimulus funded by more debt is just the ticket to pull Europe out of the morass:

In an interview with CNN to be broadcast on Sunday morning, Mr Monti said: "We link back to the notion of demand … I think we should regard it more positively than the most conservative European authorities do." [Yeah, he's looking at YOU, Angela.]

But reflecting German resistance to authorise monetary easing from the ECB, Mr Monti added: "On the other hand, if it is an across-the-board crusade for more demand, then I believe that the German reluctance to that is not entirely unfounded."

Obama is, of course, desperate for anything that pushes the inevitable reckoning beyond the first Tuesday in November.

Although the Seven Dwarves are importuning Merkel to give in and put German taxpayers to work supporting 55-year-old Greek retirees and French bureaucrats, she will give them short shrift (and good for her!) and respond to the German electorate. Obama doesn't cast a vote in Thuringia or Bavaria, and she will base her calculations on those who do.

Germans are being pulled in opposite directions by years of indoctrination about the necessity of being Good Europeans on the one hand and deep-seated German aversion to profligacy on the other, so it is difficult to predict exactly how her electorate will react. My sense is that ultimately Germans will recognize that shouldering the entire burden of funding Europe will be throwing good money after bad, and that Germany will not take one for the Euro team. Though I would not be surprised if the ultimate decision comes next year, unless events force a decision earlier-which may well be the case.

In the meantime, Merkel might want to circulate this paper by Valerie Ramey to the members of the Anti-Austerity Cult:

This paper asks whether increases in government spending stimulate private activity. The first part of the paper studies private spending. Using a variety of identification methods and samples, I find that in most cases private spending falls
significantly in response to an increase in government spending. These results imply that the average GDP multiplier lies below unity. In order to determine whether concurrent increases in tax rates dampen the spending multiplier, I use
two different methods to adjust for tax effects. Neither method suggests significant effects of current tax rate changes on the spending multiplier. In the second part of the paper, I explore the effects of government spending on labor markets. I find
that increases in government spending lower unemployment. Most specifications and samples imply, however, that virtually all of the effect is through an increase in government employment, not private employment. I thus conclude that on balance government spending does not appear to stimulate private activity.

In other words, "stimulus" via government spending does not translate into growth. Indeed, the Ramey analysis suggests quite the opposite.

Not that it will matter to the Dwarves, but their growth mantra - which presumes that more spending by already nearly bankrupt states will magically reverse Europe's economic problems - is based on a highly dubious theory for which empirical evidence is either lacking, or in the case of the Ramey paper, empirical evidence utterly contradicts. Will Merkel - and the German electorate - have the courage of their convictions and oppose the Dwarves? I am not certain, but when push comes to shove, I believe that she - and they - will do just that.