France pays the price for not reforming

There is one consolation for the UK in the recession. It is worse in France.

The French government have just issued their latest budget proposals. This is against a background of three quarters of recession and unemployment of 10.2%. Also the French government budget deficit is significantly higher than it needs to be to meet Euro area rules.

So the French are proposing a 75% tax rate for the really high earners. There is also a new 45% tax rate for those earning more than £120k.

This has an obvious effect on income distribution and that suits the new socialist administration (the LibDem's have similar ideas in the UK). But many say that the French have again missed the point.

The French have resisted making the supply-side reforms which have helped other economies, like the UK, adjust working conditions in the face of the crisis. French employment law continues to discourage firms from employing staff on a permanent basis and raises the cost of employment further beyond the wage rate making employing staff expensive.

The rise in profit taxes makes the prospects for employment worse not better.

The French are caught in a difficult situation. They want to help ease the recession and help the poor and unemployed, but they are finding it hard to make the tough decisions.

The Independent covers the new French budget here

EU 'not in recession'

'Lies, damn lies and statistics' as Disraeli put it can be illustrated by the way Eurostat has claimed that the Eurozone is no longer in recession.

The attached story has the details, but it shows that Italy, Spain and Greece are in dire recessions, with output contracting and France just managed to maintain output. So what is the reason that Eurostat says the Eurozone isn't in recession? Well Germany grew strongly and overall Eurozone GDP rose when added together.

This means that recessions are now not only defined by arbitrary dates, but also arbitrary borders. It depends how you group countries together.

Of course the real point of interest is the effect of cutting government budget deficits on GDP. As Government spending is a component of AD changes in it have a multiplier effect. Add to that higher taxation and we see disposable income falling and so Consumption dragging AD down further.

Today the new French President, a man worryingly named after a sauce, will argue for more stimulus to boost short-run growth. But today the people of Italy, Spain and Greece, and I think France and Britain, might agree with him.

The BBC cover the story here

Another chapter in the Euro crisis?

I am not sure if this is a new chapter or just another plot twist, the Euro saga has continued for so long its critical importance is sometimes forgotten.

The crisis deepens as Italy is now on the brink. Italy isn't like Greece or Ireland, it is a big economy with their government owing 120% of GDP to creditors. Italy is the third biggest economy in the Euro zone and even the enhanced €1 trillion bailout fund is nowhere near enough to save it if default comes.

Italy has no credible plan to resolve the problem and the market knows it. The market is demanding higher and higher interest rates (6.69% is the latest) to fund their overspending and the likelihood is that that rate will rise as Italy must borrow over €300bn next year.

There is a solution. Let the European Central Bank (ECB) lend the money to Italy. The ECB could buy Italian Government bonds and can theoretically supply all of Italy's needs. The Germans, at least, completely oppose this move.

If the ECB buys Italian debt they will do so with money they simply create. As with Quantitative Easing this raises the supply of Euro's in circulation (its printing money). The Germans always have in their minds the hyperinflation of the 1920's caused by printing money and the post-war Deutchmark which was managed so well that inflation was only an issue after the costs of unification with East Germany. They don't want the ECB to start a potentially inflationary process.

Most people disagree with the Germans. They see the need to save the Euro as far greater than the risk of inflation. They also point out that the Germans can only be right when the rate of rise in the money supply is faster than the rate of rise in real output. So far in this period of instability monetary growth has been sluggish and over the period 2009 - 10 the money supply would have fallen but for central bank action. The graphic at the top is a little small but shows M1 and M3 growth in the EU.

It is clear that if the ECB does not act and the Italian government does not change then the danger of a collapse in the Euro is imminent.

The Guardian has details here

The bailout explained

The European bailout plan is complicated. This movie was created by Tom Meltzer of The Guardian to explain the situation.

A video is here

Keeping up with the Euro crisis

Keeping up with the saga of the Euro area crisis is becoming as confusing as watching every third episode of a spy series with a revolving cast.

Today the Germans voted to put extra funds into the 'bail out' fund for defaulting Euro members. Most people think this is nowhere near enough.

The Commission have proposed a tax on all financial transactions to create a 50 billion Euro fund to help pay for the bailout. But the British will never agree to this as it means the UK will be paying to prop up a currency they never joined.

The Euro was never an 'optimal currency area' and as the late Professor Pearce said 'It will never work'. Despite the best, if reluctant, efforts the Euro will probably not survive.

The BBC understand your angst at this long and drawn out affair and have produced a Q&A on the latest IMF/G20/EU proposal. This includes proposals to let Greece partially default which is seen as inevitable now.

The BBC Q&A is here

Consumer confidence a worry

The level of consumer confidence is a key determinant of Aggregate Demand. Although consumption primarily depends upon income levels households have the choice of how much of that income they put into savings.

When consumers are uncertain they are cautious. Cautious people save 'just in case'. This has the effect of reducing consumption, Aggregate Deamnd falls and there is slower growth, or worse still a recession. The slow growth alone is enough to convince households they were right to be cautious and recovery becomes difficult.

There are two problems that compound this problem at present.

1. Governments are cutting back on expenditure in order to reduce their debt. Government spending is another component of Aggregate Demand and also has a multiplier effect making the cuts here even more effective in reducing real GDP.

2. The banks are being forced to recapitlise their balance sheets. This is because they have had to write off bad debts and the new rules (Basel Accords) that demand a higher proportion of capital to liabilities. This means the banks take the extra savings they receive in deposits and keep them to raise their capital reserves rather than lend it to firms or consumers.

While many welcome the strenghtening of the banks and the reduction in household debt it is not good for the short term.

It is now clear that consumer confidence is falling in Europe. This is a problem as 60% of UK trade is with other EU memebrs and exports are another compnent of AD.

While the double dip recession remains unlikely rapid growth still seems quite a way off.

The Guardian reports on EU consumer confidence here