Fiscal consolidation won’t kill the recovery

- "Conventional economics inspired by the simple Keynes-Hicks IS-LM model assumes that cuts in government budget deficits, especially when they are achieved through government spending reductions, exert contractionary effects on aggregate demand and hence GDP. This
relationship has inspired a number of observers to warn that plans to start reining in deficits in major countries could jeopardise economic recovery and trigger a “double-dip” recession."
- "A closer look at the relationship between changes in the fiscal stance and economic activity raises serious doubts about the validity of the IS-LM model. Correlations between changes of cyclically adjusted primary budget balances and GDP growth for the US, Japan, and the euro area calculated over the last few decades are zero or positive, suggesting that improving structural balances (i.e., a contraction of the fiscal stance) are unrelated to growth or associated with rising growth."
- "Recent economic research offers an explanation for this seemingly counterintuitive result: positive confidence and interest rate effects on private demand triggered especially by government spending cuts can offset or even exceed the direct effect of lower government deficits on aggregate demand."
- "We expect the planned reduction in structural deficits in major countries to be measured. Moreover, fiscal adjustment on balance seems to rely more on reductions in government spending than on tax increases (which should be positive for growth). As a result, we do not expect the economic recovery to be jeopardised by the planned fiscal adjustment. To the contrary, we believe there is a good chance that fiscal adjustment may even bolster the recovery."
- How big is the “Greece premium” in US Treasuries "Uncertainty about the situation in Europe has generated a substantial flow of “safe haven” money into US Treasuries. In this piece we estimate a weekly and a quarterly model of 10-year treasuries and find that the “Greece premium” is between 60bps to 100bps. In other words, 10-year treasuries are 60bps to 100bps lower than what is predicted by short rates, the business cycle, the fiscal stance, and inflation expectations. As the worries about Europe start fading among global
investors – including later this week when the stress tests are released – we would expect the Greece premium in 10-year Treasuries to start shrinking."
DeutscheBank Global Economic Perspectives 20100721

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