Expansionary austerity: It's back! piie.com/blogs/realtime…
Blanchard and Zettelmeyer's argument is: 1) High public debt increases interest rates on public debt; 2) interest rates on public debt are passed through one for one to rates facing private borrowers; 3) higher interest rates reduce real activity enough to offset fiscal boost.
Point 1 sems iffy. They are quite confident that entire 160 basis point increase in Italy's public-debt rate in past 6 months is due to proposed budget (even tho as they note much of increase occurred before budget announced) and would be entirely reversed if EU budegt accepted.
But 2) seems like the real leap. To extent that spreads on sovereign debt reflect concerns over solvency of state there is no reason they should affect other borrowers. If spreads are really about fiscal sustainability, they should be precisely over rates paid by other borrowers.
You can't use an analytic framework in which national govt is risk free borrower and therefore sets benchmark for all other rates, to discuss case where risk of government debt is precisely the issue.
If Europe has a common monetary policy at all, doesn't that mean rates facing private borrowers are set as a spread over policy rate set by ECB? If ECB isn't determining rates on loans in Euro area, in what sense is it doing moentary policy at all?
And if rates for Italy's households and businesses are all set with reference to rate faced by Italian state, what does it mean to talk about financial integration at all? You can't say that capital is free to flow anywhere in Europe and then in the same breath say that everyone>
has to borrow only from their own banking system, at a national interest rate that is independent of rates elsewhere in Euro area.
These guys want to have it both ways. They crow about wonderful benefits of financial integration and then insist that financial markets are totally walled off and separate when that helps make case for constraints on government finances.
