COVID-Economics Links (May 4)

The permanent scars of fiscal consolidation

The effect that fiscal consolidation has on GDP growth has probably generated more controversy than any other economic debate since the start of the 2008 crisis. How large are fiscal multipliers? Can fiscal contractions be expansionary? Last year, Olivier Blanchard and Daniel Leigh at the IMF produced a paper that claimed that the IMF and other international organizations had underestimated the size of fiscal policy multipliers . The paper argued that the assumed multiplier of about 0.5 was too low and that the right number was about 1.5 (the way you think about this number is the $ impact on GDP of a $1 fiscal policy contraction). While that number is already large, it is possible that the true costs of fiscal consolidations are much larger. In a recent research project (draft coming soon) I have been looking at the effects that fiscal consolidations have on potential GDP. Why is this an interesting topic? Because it happens to be that during the last 5 years we have been seriously re...

Where did the saving glut go?

I have written before about the investment dearth that took place in advanced economies at the same time that we witnessed a global saving glut as illustrated in the chart below. In particular, the 2002-2007 expansion saw lower investment rates than any of the previous two expansions. If one thinks about a simple demand/supply framework using the saving (supply) and investment (demand) curves, this means that the investment curve for these countries must have shifted inwards at the same time that world interest rates were coming down. But what about emerging markets? Emerging markets' investment did not fall during the last 10 years, to the contrary it accelerated very fast after 2000. This is more what one would expect as a reaction to the global saving glut. The additional saving must be going somewhere (saving must equal investment in the world). As interest rates are coming down, emerging markets engage in more investment (whether this is simply a move along a downward-sloppin...

Stock market getting cheaper (relative to bonds)

Several indicators are signaling an increase in the probability of a recession. Most of these indicators are variables that have shown to be statistically leading the recession but they cannot always be seen as the cause of one (for example, an inverted yield curve) In the search of a cause for a recession we typically look for imbalances. One that has mattered in the past is asset price bubbles. Standard valuation metrics of the stock market suggest that in the last quarters the market has gotten cheaper and moved further away from bubble territory. The Financial Times reports that US companies dividend yield is now larger than the interest rates on a 30 year government bond (see image below). This is not at all a new phenomenon in Europe where the dividend yield has been larger than the interest rate on bonds for years and is now reaching record levels. A good way to summarize the improvement in the valuation of stocks is to calculate the ex-ante risk premium. The image below shows t...

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