Several of my colleagues on the Harvard faculty have recently been casualties in the cross-fire between fiscal austerians and stimulators.   Economists Carmen Reinhart and Ken Rogoff have received an unbelievable amount of press attention, ever since they were discovered by three researchers at the University of Massachusetts to have made a spreadsheet error in the first of two papers that examined the statistical relationship between debt and growth.   They quickly conceded their mistake.

Then historian Niall Ferguson, also of Harvard, received much flack when — asked to comment on Keynes’ famous phrase  ”In the long run we are all dead” — he “suggested that Keynes was perhaps indifferent to the long run because he had no children, and that he had no children because he was gay.”  

There is more to be said about each of the two cases.  (i) Reinhart and Rogoff’s 2010 estimates had already been superseded by a subsequent 2012 paper of theirs written along with Carmen’s husband, Vincent, which used a more extensive data set where the error does not appear.  (ii) The debt-growth causality is debated.  (iii) “Some of Ferguson’s best friends are gay.”   (iv) Keynes was actually bi-sexual.  (v) He tried to have children.  And so forth.  Most of this has already been said many times by now.  Apparently people are even more fascinated by Harvard than they are about macroeconomic theory.

But what does it all have to do with the debate between austerians and stimulators?   Not much.  But the battle lines of the austerians have been wavering lately under the continuing onslaught of facts (most notably the recessions in Europe and Japan’s recent conversion to stimulus), and the stimulators find the missteps of Reinhart-Rogoff and Ferguson to be convenient stones to throw into the attack as well.   But they are barking up the wrong tree.  Sorry;  they are throwing the wrong stones.

The Reinhart-Rogoff controversy is not in fact relevant to the question whether governments should expand or contract at a given point in time.  The basic finding in their papers continues to hold up, that subsequent growth tends to be lower among countries with debt/GDP ratios above 90% than below 90%; but neither that finding nor their policy advice was designed so as to support the proposition that a recession is a good time to undertake fiscal contraction. 

The Ferguson controversy is even less relevant, because the phrase “in the long run we are all dead” was neither about fiscal policy when Keynes wrote it nor an argument against deferred gratification.   Nor was Keynes in favor of uninhibited fiscal stimulus regardless of economic conditions;  he argued, rather, “the boom, not the slump, is the right time for austerity at the Treasury.”     Fix the hole in the roof when the sun is shining, not when it is raining.

Neither of the controversies bears on the policy proposition that is important at the moment, which is the Keynesian claim that under conditions of high unemployment, low inflation, and low interest rates (the conditions that hold in rich countries today, as in the 1930s), fiscal expansion is expansionary and fiscal contraction is contractionary.

Some research by yet another highly valued colleague at Harvard does bear much more directly on this important proposition.   Alberto Alesina has not been receiving his “fair share of abuse.”  His influential papers with Roberto Perotti  (1995, 1997) and Silvia Ardagna (1998, 2010) found that cutting government spending is not contractionary and that it may even be expansionary.  

It is true that sometimes a country may have no alternative to fiscal “consolidation,” if its creditors insist on it, as has been the case with Greece and some other euro members.  But that does not mean austerity is expansionary, especially if the currency cannot depreciate to stimulate exports.

As with Reinhart and Rogoff, the Alesina papers themselves are much more measured in their conclusions than one would think from the claims of some conservative politicians that academic research finds fiscal austerity to be expansionary in general.  Nevertheless, the conclusions are clear:  “Even major successful adjustments do not seem to have recessionary consequences, on average” (1997).  And “several fiscal adjustments have been associated with expansions even in the short run” (1998).   And “spending cuts are much more effective than tax increases in stabilizing the debt and avoiding economic downturns. In fact, we uncover several episodes in which spending cuts adopted to reduce deficits have been associated with economic expansions rather than recessions” (2010, p.3).   Most recently, a May 2013 paper with Carlo Favero and Francesco Giavazzi finds “that spending-based adjustments have been associated, on average, with mild and short-lived recessions, in many cases with no recession.”  

Alesina’s recent policy advice is that the US should cut spending “right away.”  By contrast, the advice of Reinhart and Rogoff seems to favor postponing fiscal adjustment (trim entitlements in the future, but increase infrastructure spending today) and considering financial repression.  In more far-gone cases like Greece, they lean toward restructuring the debt.   If the thunderstorm is too severe and the roof is too far-gone to be fixed, it may be necessary to rebuild from scratch.

A new attack on Professor Alesina’s econometric findings comes from an unlikely source:   Perotti, the co-author of the first two of the five articles, has now recanted (2013a, b).    He points out some problems with the methodology (including the papers that Alesina wrote with Ardagna).  Under the dating scheme, the same year can count as a consolidation year, a pre-consolidation year, and a post-consolidation year.   It turns out that some of what have been treated as large spending-based consolidations, though announced by the governments, were in fact never implemented.  Currency devaluation, reduced labor costs, and export stimulus played an important part in any instances of growth, for example, the touted stabilizations of Denmark and Ireland in the 1980s.  His conclusions:  “the notion of ‘expansionary fiscal austerity’ in the short run is probably an illusion: a trade-off does seem to exist between fiscal austerity and short-run growth” and so “the fiscal consolidations implemented by several European countries could well aggravate the recession” (2013b, p.10).   To me, this is a more powerful indictment of the reasoning behind recent attempts at fiscal discipline during recession than is a spreadsheet error or a too-flippant line about Keynes’ sexuality.

References
    Alberto Alesina, and Silvia Ardagna, 1998, “Tales of Fiscal Adjustment,” Economic Policy Vol.13, no, 27, October, 487-545.
     Alberto Alesina, and Silvia Ardagna, 2010,  ”Large Changes in Fiscal Policy: Taxes versus Spending,” in Tax Policy and the Economy, Volume 24 (University of Chicago Press).
     Alberto Alesina, Carlo Favero and Francesco Giavazzi, 2013, “The Output Effect of Fiscal Consolidations,” IGIER, May.
     Alberto Alesina and Roberto Perotti. 1995, “Fiscal Expansions and Adjustments in OECD Countries,” Economic Policy, October.  NBER WP 5214.
   Alberto Alesina and Roberto Perotti, 1997, “Fiscal Adjustments In OECD Countries: Composition and Macroeconomic Effects,”  International Monetary Fund Staff Papers, vol.44, no.2, June, 210-248.
     Francesco Giavazzi and Marco Pagano, 1990, “Can Severe Fiscal Contractions be Expansionary?” NBER Macroeconomics Annual 1990, Vol.5, Olivier Blanchard and Stanley Fischer, editors (MIT Press) p. 75 - 122.
    Thomas Herndon, Michael Ash, and Robert Pollin, 2013, “Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff,” Political Economy Research Institute WP Series 322,University of Massachusetts Amherst, April.
     Roberto Perotti, 2013a,”The ‘Austerity Myth’: Gains Without Pain?” A. Alesina and F. Giavazzi, eds.: Fiscal Policy After the Financial Crisis (University of Chicago Press). BIS WP 362.  NBER WP no 17571.
     Roberto Perotti, 2013b, “The Sovereign Debt Crisis in Europe: Lessons from the Past, Questions for the Future,” Academic Consultants Meeting , Federal Reserve Board , Washington DC , May 6 , 2013.  Bocconi University.
     Carmen Reinhart and Ken Rogoff, 2010, “Growth in a Time of Debt,” AER, 100, May, 573-578.
     Carmen Reinhart, Vincent Reinhart, and Kenneth Rogoff, 2012, “Public Debt Overhangs: Advanced-Economy Episodes Since 1800,” Journal of Economic Perspectives, Vol.26, No.3-Summer, 69-86.

 [Comments can be posted at On Deck of Project Syndicate or on the site of the shortened op-ed version.]

An amazing thing has happened over the last five years.   Against all expectations, American emissions of carbon dioxide into the atmosphere, since peaking in 2007, have fallen by 12%, back to 1995 levels.  (As of 2012. US Energy Information Agency).   How can this be?   The United States did not ratify the Kyoto Protocol to cut emissions of greenhouse gases below 1997 levels by 2012, as Europe did.  

Was the achievement a side-effect of reduced economic activity?   It is true that the US economy peaked in late 2007, the same time as emissions.   But the US recession ended in June 2009 and GDP growth since then, though inadequate, has been substantially higher than Europe’s.  Yet US emissions continued to fall, while EU emissions began to rise again after 2009 (EU).  Something else is going on. 

The primary explanation, in a word, is “fracking.”   In fourteen words: the use of horizontal drilling and hydraulic fracturing to recover deposits of shale gas.  

One can virtually prove that shale gas is the major factor behind the fall in US emissions.  Natural gas, especially when burnt in combined-cycle gas turbine power plants, emits only half as much greenhouse gas (GHG) as coal.   Ten years ago domestic natural gas production appeared to be reaching its limits; the industry was so sure of this that it made big investments in terminals to import Liquefied Natural Gas (LNG).  Yet the fracking revolution has increased the supply of natural gas so rapidly since then that LNG port sites are being expensively converted to export.   Clean natural gas occupies a rapidly increasing share of the generation of electric power.   It has come largely at the expense of coal’s share.  Within power generation, natural gas is up 37% since 2007, while coal is down 25%.  As a result, natural gas has drawn close to coal as the number one source of US power — unthinkable a short time ago. Renewables have been rising, but still constitute only 5% of power generation in the US.  This is less than hydroelectric and far less than nuclear, let alone coal or gas.

Meanwhile, the role of coal - the dirtiest fuel — has been rising in the energy mix of the rest of the world, not falling (IEA, Dec. 2012).  Coal’s share of power has even risen since 2010 in Europe (EC), where some countries are phasing out emission-free nuclear power and no shale gas boom has appeared.    (The trans-Atlantic comparison does not offer grounds for self-righteousness, however.   GHG emissions remain far higher in the US than in Europe.)     

The advent of shale gas in the United States has had a variety of implications for the economy, national security, and the environment.  The implications are surely more good than bad. 

Short-run economic advantages include job creation.   Medium-run economic advantages include the “re-shoring” of some manufacturing activities.   Long-run advantages include reducing macroeconomic vulnerability to future global oil shocks such as those that led to serious recessions in the 1970s.  (It would be wrong to claim job creation as an advantage in the long-run.  Jobs that are created in the oil and gas sector would otherwise be created somewhere else.  But during the last five years of high unemployment, every new job has helped.) 

Moving beyond economics, the reduction in net energy imports is good for US national security.  What happens in the Middle East will still matter, but as oil imports fall American foreign policy will not be as constrained as in the past. US net oil imports have already fallen by half since 2007 and the downward trend is expected to continue.   In Europe, the new developments can help break Russia’s troublesome stranglehold on the supply of natural gas.

That leaves the environment.  Here as well the effects on net appear beneficial.   As already noted, the substitution of natural gas in place of coal slows global climate change. Indeed the United States is now on track to meet the Obama administration’s international commitment of emissions 17% below 2005 levels by 2020.  But natural gas is also better for local air quality.  Burning coal puts sulfur dioxide, nitrous oxide, mercury and particulates into the air. 

Yet it is among environmentalists that heartfelt opposition to fracking has arisen.  Why?

Environmentalists seem to have three sets of fears.  First, they worry that shale gas will displace renewable energy sources such as wind and solar power.  But the fact is that GHG emissions can’t be reduced without cutting coal emissions and that shale gas is already displacing coal in the US.  This is not speculation about the future.  It has already been happening.  If renewables or fusion or something else currently unknown can take over after 2050, then great.  But we would still need natural gas as a bridge from here to there. 

Put differently, if the world continues to build coal-fired power plants at the rate it has been, those plants will still be around in 2050 regardless what other technologies have become available in the meantime.  Solar power can’t stop those coal fired plants from being built today.  Natural gas can. 

Cheap natural gas also helps with heating buildings and increasingly with transportation as well - particularly if electric plug-in cars become more widespread.  In overall primary energy production, natural gas at 31% has now surpassed coal, at 26%. The graph below shows the two lines crossing. (Table 1.2,  US EIA).  Solar and wind together account for only 2% of US primary energy production.  

(more…)

Some prominent institutional bond investors are shifting their focus away from traditional benchmark indices that weight countries’ debt issues by market capitalization, toward GDP-weighted indices.   PIMCO (Pacific Investment Management Company, LLC, the world’s largest fixed-income investment firm) and the Government Pension Fund of Norway (one of the world’s largest Sovereign Wealth Funds), have both recently made moves in this direction.  

There is a danger that some investors will lose sight of the purpose of a benchmark index.   The benchmark exists to represent the views of the median investor dollar.  For many investors, going with the benchmark is a good guideline - especially those who recognize themselves to be relatively unsophisticated and also those who think they are sophisticated but really aren’t.   This is the implication of the Efficient Markets Hypothesis (EMH), for example.  

On the one hand, EMH theorists are often too quick to discount the possibility of ways to beat the benchmark.   To take an example, it should not have been so hard to figure out during the 2003-07 credit-fed boom that countries with high foreign-exchange-denominated debt, particularly in Europe, were not paying a sufficiently high return to compensate for risk.  That mistake described Eastern European countries with low ratios of reserves to short-term debt as well as periphery euro members that lacked their own currency.  It probably resulted from easy money, reach for yield, and pervasive underestimation of risk.  Or, to take another example (admittedly, a tougher call), some of these countries’ deeply discounted bonds would have been good buys in early 2012, after heavy mark-downs.   

On the other hand, most investors would do better if they went with a more passive investment strategy - especially due to high management fees among actively managed funds, exacerbated by excessive turnover.   At a minimum, if one is pursuing an activist strategy such as investing more in low-debt countries, it is helpful to frame it explicitly as a departure from the view of the median investor in order to be clear in your mind as to the nature of the bet you are making.

I can think of four functions of a benchmark index.    First, investors who do not figure that they can systematically beat the median investor need to be able to hold passively a portfolio designed to track a benchmark index consisting median investor holdings.   (See Vanguard.)   The second function is to provide an objective standard by which investors can judge the performance of active portfolio-managers who claim to be able to beat the median investor, within a specific asset class like sovereign debt.  (See Morningstar.)   Third, the same weights that are used in the index can be used to compute an average interest rate or sovereign spread in the market, which can serve as an indicator as to where the median investor is currently, in the risk-on, risk-off spectrum. (See J.P.Morgan’s EMBI — Emerging Market Bond Index.)    

The fourth function of a benchmark index is to help active investors to devise a deliberate strategy to depart from the views of the median investor when they think that the latter is erring in a particular direction.  They may think that the median investor is under-estimating risk in general (spreads too low) or under-estimating the downside in countries with some particular characteristic.   Examples of such characteristics include insufficient currency flexibility, inadequate reserves, too much short-term debt, too much foreign-currency debt, too much bank debt, insufficient openness to FDI, insufficient cost competitiveness, excessive budget deficits, insufficient national saving, political risk, and so forth.

For each of these four functions of a benchmark, the correct way of weighting different countries is by market capitalization.  True, the keeper of the index will need to judge what countries and what bonds are in “the market,” i.e., are fully investable.   But this is true for any index.

The logic behind the movement away from traditional bond market indices is that by construction they give a lot of weight to countries with high debt, some of which may be over-indebted and at risk of default.  At first the logic seems unassailable.  But in theory, if the market is functioning well, it should already have factored in high debt levels:  such countries should pay higher interest rates to compensate for the risk, unless there is some special reason to think they can service their debts easily.

It is important to emphasize that many investors will want to depart from the benchmark in various directions, as indicated under the fourth motive for having a benchmark.  An investor’s belief that countries with high debt/GDP ratios are riskier than the median investor realizes would call for a strategy equivalent to moving from the market-cap benchmark in the direction of the GDP-weighted benchmark.  But one is more likely to think about the strategy clearly if it is explicitly phrased in terms of factoring in debt/GDP ratios, rather than phrased as following a new GDP-weighted index.  Furthermore the phrasing may help an investor realize that he or she might want to modify the strategy if, for example, the country in question can borrow readily in terms of its own currency (think of American exorbitant privilege or Japan’s high domestic holdings of own debt) or if, on the other hand, its debt has a particularly vulnerable maturity or currency structure (think of Hungary).

Investors are reacting to what has turned out to be default risk that was higher than they had expected, among some high-debt countries.  Taking greater note of high debt levels last decade would have warned investors away from countries like Greece and Hungary.   But there is always a danger of fighting the last war.   Middle-income countries have paid down much of their debts over the last decade, attaining debt/GDP ratios far below those of advanced economies.    As the chart shows, major emerging markets have relatively low debts [first bars, for each country] compared to GDP [second bar].  That is, their debt/GDP ratios [third bar] are now much lower than in advanced countries.  (Russia’s sovereign debt is now below 7 per cent of GDP.)  As a result, there is only a limited supply of their bonds left to hold.  If the global investor community switches from market-cap-weighted to GDP-weighted investing, the high demand and low supply of bonds from low debt/GDP countries may drive their interest rates to unnaturally low levels, setting off new credit-fed boom-bust cycles in their economies.  

Of course, as a country’s international debt approaches zero, the keepers of the index might drop it altogether.  But the fall in demand for that country’s remaining international bonds from the investment funds that are following the benchmark could then produce an undesirable discontinuous jump in the interest rate.

Many emerging market countries have paid down debt denominated in dollars or other foreign currencies, while continuing to borrow in their local currencies.  (See the table at bottom.)  Such relatively large countries as Thailand, Malaysia, Indonesia, South Africa and Russia, for example, have little dollar-denominated debt left - 3% of GDP or less (shown in the chart as the dark bottom of each first bar).   If an international bond benchmark is to be limited to dollar-denominated debt, then GDP weights could imply a severe imbalance between international investor demand for these countries’ bonds and the small supplies available. 

Accordingly, local currency denominated debt must be included in the most useful benchmarks.  But then a portfolio reallocation away from traditional benchmark indices such as the EMBI would imply a big shift in allocations away from simple credit risk toward currency risk.   True, the ability of emerging market economies to attract foreign investment in their local currencies represents an important strengthening of the global financial system, relative to the currency mismatch and balance sheet vulnerabilities of the 1990s.  Nevertheless, an investor switching from one “benchmark” to the other needs to be aware of the extent to which the reduction in default risk comes at the expense of heighted exposure to currency risk.

In short, it is not crazy for an investor to depart from the market-cap-weighted benchmark in the direction of putting more weight on debt/GDP countries and less weight on high debt/GDP countries.   But the GDP-weighted index should not be mistaken for a neutral benchmark.

[A version of this post originally appeared at Project Syndicate, Feb. 11, 2013.  Comments can be posted there, or at Seeking Alpha.]

Table:  Sovereign debts as a percentage of GDP

     Europe’s fiscal compact went into effect January 1, as a result of its ratification December 21 by the 12^th country, Finland, a year after German Chancellor Angela Merkel prodded eurozone leaders into agreement.   The compact (technically called the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union) requires  member countries to introduce laws limiting their structural government budget deficits to less than ½ % of GDP.  A limit on the “structural deficit” means that a country can run a deficit above the limit to the extent — and only to the extent — that the gap is cyclical, i.e., that its economy is operating below potential due to temporary negative shocks.   In other words, the target is cyclically adjusted.  The budget balance rule must be adopted in each country, preferably in their national constitutions, by the end of 2013.

    Will the new approach help?   The aim is to fix Europe’s long-term fiscal problem, which since the date of the euro’s inception has been evident in the failure of the Stability and Growth Pact (SGP), the crisis in Greece and other periphery countries that surfaced in 2010, and the various ways in which these countries were subsequently bailed out.  

     There is no reason to doubt that the eurozone countries will follow through to the extent of adopting the national rules by the end of the year.  ["The granting of new financial assistance under the European Stability Mechanism is conditional on ratification of the fiscal compact and transposition of the balanced budget rule into national legislation in due time."]  But after that the fiscal compact will probably founder on precisely the same shoals as the SGP.

    Since the inception of the euro, its members have made official fiscal forecasts that are systematically biased in the optimistic direction.   Other countries do this too, but the bias among eurozone countries is, if anything, even worse than that elsewhere.  During a period of economic expansion, such as 2002-07, governments are tempted to forecast that the boom will continue indefinitely.  Forecasts for tax revenue and budget surpluses are correspondingly optimistic and so hide the need for adjustment of fiscal policies.  During a period of recession, such as 2008-2012, governments are tempted to forecast that their economies and budgets will soon rebound.  Since forecasting is subject to so much genuine uncertainty, nobody can prove that the forecasts are biased when they are made.

     Fiscal rules such as the SGP ceilings won’t constrain budget deficits, if forecasts are biased.  The reason is that governments can in any given year forecast that their growth rates, tax revenues, and budget balances will improve in the subsequent years, and then next year say that the shortfalls were unexpected.   Indeed, it turns out that the eurozone bias in official forecasts during 1999-2011 can be neatly characterized as responding to the SGP’s 3% limit on budget deficits by offering over-optimistic forecasts each time governments exceed the limit.  In other words, they adjust their forecasts rather than their policies.   (The results described here come from a new paper, coauthored with Jesse Schreger: “Over-optimistic Official Forecasts and Fiscal Rules in the Eurozone,” forthcoming 2013 in the Review of World Economy, vol.149, no.2, from Germany’s Kiel Institute.)

    Phrasing the budget rules in cyclical terms, while highly desirable in terms of macroeconomic impact, does not help solve the problem of forecast bias.  It can even make it worse.  In a year when a forecast for the actual budget deficit turns out to have been over-optimistic, the government has to admit that it made a mistake, which can carry some embarrassment.  In a year when a forecast for the structural budget deficit turns out to have been over-optimistic, the government can still claim that its own calculations show the shortfall to have been cyclical rather than structural.   After all, estimation of potential output and hence the cyclical versus structural decomposition is notoriously, even after the fact.

   Will it help that under the fiscal compact the rules are to be adopted at the national level, as opposed to the supranational level on which the SGP operated?  A look at the various rules and institutions that have already been tried by European countries shows that some work and others don’t.  Creating an independent fiscal institution that provides its own independent budget forecasts works, in that it reduces the bias in projections.  Euro area governments with an independent budget forecasting institution have a mean bias when making forecasts while in violation of the Excessive Deficit Procedure (EDP) that is smaller by 2.7% of GDP [at the one-year horizon], compared to euro area countries that are in violation of the EDP without such an independent fiscal institution.

    It would be better still if the governments were legally bound to use these independent forecasts in their budget plans (thereby borrowing an innovation from Chile).  

   Regardless how well-designed the rules are, clever and determined politicians can find ways around them.  One of the tricks is the privatization of government enterprises which reduces the budget deficit this year on a one-time non-repeatable basis, but might raise it in the long-term if the enterprise had been earning profits.  Another trick is phony legislated sunsets on tax cuts, in order to make future revenues look larger despite the political intention later to make the tax cuts permanent. 

   Still, other things equal, the right institutions can reduce the procyclicality of fiscal policy in the short run and help deliver debt sustainability in the long run.    Examples of the right institutions are cyclically adjusted budget targets combined with independent agencies that make independent fiscal forecasts.  Things can still go wrong even if such mechanisms are in place; but, as the history of the SGP illustrates, the risk is higher if they are not.

     [The original of this post appears at Project Syndicate.  Comments may be posted there.]

     I have argued that the best way to think of “black swan” events is as developments that, even though low-probability, can in fact be contemplated ahead of time.  Even if they are the sort of thing that has never happened before within an analyst’s memory, similar things may have happened before in the distant past or in other countries.   

     What current possible shocks have probabilities that, even if fairly low, are high enough to warrant thinking about now?  Some have been discussed ad infinitum, others hardly at all.

• Most widely discussed is the danger of a break-up of the euro. Considered unthinkable a short time ago, the probability that one or more euro members will drop out is now well above 50%. Currency unions have disintegrated before.
• Another is the possibility of a hard landing in China, analogous to the crisis that hit Korea and other East Asian markets in 1997.
• An oil crisis in the Mideast is the classic black swan event. Each one catches us by surprise: 1956, 1973, 1979, and 1990 (among others). Oil prices can rise for lots of reasons, not just crises in the Mideast, and have done so in recent years. But the most likely crisis scenarios currently stem from either military conflict with Iran or instability in some Arab government. The threatened loss of supply to world markets typically shows up as a sharp increase in demand for oil inventories and thus in prices.
• The most worrisome financial threat is a crash of currently over-priced bond markets. In theory such a crash could be precipitated by inflation (particularly commodity-induced inflation as in 1973 or 1979). But this seems unlikely. More likely triggers are (i) a breakdown in the eurozone or (ii) political dysfunction in Washington. A default in Greece or some other Mediterranean country could trigger a global debt crisis any time. The evidence of extreme dysfunction in US politics is already there for all to see, in the attempts by some politicians to repeat the macroeconomic policy mistakes of 1937 and in the debt-ceiling show-down of August 2011 (which led S&P to downgrade US government credit rating from AAA to AA). The obvious crunch date comes after the American election, as the “fiscal cliff” approaches in the last two months of this year. In theory, fears of what will happen January 1 should lead investors to start dumping bonds now. But it is still considered a sign of sophistication in financial markets to opine that, precisely because the consequences of going over the cliff would be so bad, the politicians will again find a last-minute way to avoid it. In truth, the fact that we haven’t gone over the cliff before does not necessarily mean we won’t this time. Perhaps observers think that a clear result in the election, one way or the other, would help settle things. A true black swan in the mix would be a repeat in November of the disputed 2000 presidential election; there has been no reform in the meantime to assure people that their votes will be counted or that a disputed outcome would be resolved by independent institutions rather than by interested political appointees.
• Scariest on the list is a terrorist attack with weapons of mass destruction. When politicians have used the specter of a September 11 repeat to scare the American public into supporting unhelpful policy responses, the mistake has been in the unhelpful policy responses, not in the “scare” part. There is long-standing gap between the probability of a nuclear event as perceived by terrorism experts and the probability as perceived by the public. Admittedly the probability is lower now that Osama bin Laden is dead.
• Last on this list is an unprecedented climate disaster. Environmentalists sometimes underestimate the benefits of technological and economic progress when they reason that a finite supply of resources must of necessity be exhausted eventually. But the disbelievers are just as faulty in their reasoning that because a global climate disaster has not happened in the past it can’t happen in the future.

       Throughout history, big economic and political shocks have often occurred in August, when leaders had gone on vacation in the belief that world affairs were quiet.   Examples of geopolitical jolts that came in August include the outbreak of World War I, the Nazi-Soviet pact of 1939 and the Berlin Wall in 1961.  Subsequent examples of economic and other surprises in August have included the Nixon shock of 1971 (when the American president enacted wage-price controls, took the dollar off gold, and imposed trade controls), 1982 eruption in Mexico of the international debt crisis, Iraq’s invasion of Kuwait in 1990, the 1991 Soviet coup, 1992 crisis in the European Exchange Rate Mechanism, Hurricane Katrina in 2005, and US subprime mortgage crisis of 2007.   Many of these shocks constituted events that had previously not even appeared on most radar screens. They were considered unthinkable. 

The phrase “black swans” has come to be used to mean a very unlikely event of this sort.  Managers of Long Term Capital Management in 1998 or of most major banks in 2008 have suggested that they could not be expected to have allowed for a financial collapse such as the one that followed the default of Russia or the one that followed the bursting of the US housing bubble, because it was a “7-standard deviation event,” that is, an event of inconceivably tiny probability…in the realm of the probability that two major meteors hit the earth at the same time.   This is nonsense.  If the statistical model says the probability of a financial crisis is that low, it is the model that is wrong.  This is like the case when “hundred-year floods” turn up every few years.

A bit more enlightened are people who talk about Knightian uncertainty or “unknown unknowns.” Ignorance with humility is better than ignorance without it.    A still better interpretation is that statistical distributions have “fat tails,” in technical terms.  But it would be nice to get beyond the Jurassic Park lesson (”don’t be surprised if things go wrong”), to be able to say intelligent things about what causes tail events. 

       What does “black swan” really mean?   In my view, it should refer to an event that is considered virtually impossible by those whose frame of reference is limited in time span and geographical area, but that is well within the probability distribution for those whose data set includes other countries besides their own and other decades or centuries. 

      Consider five examples of mistakes made by those whose memory did not extend beyond a few years or decades of personal experience in a small number of countries.

1. “All swans are white.”  The origin of the black swan metaphor was the belief that all swans were white, a conclusion that might have been reached by a 19^th century Englishman based on a lifetime of personal observation and David Hume’s principle of induction.   But ornithologists already knew that there in fact existed black swans in Australia, having discovered them in 1697.  A 19^th-century Englishman encountering a black swan for the first time might have considered it an event of unthinkably low probability, even though the relevant information to the contrary had already been available in ornithology books.  It seems a waste of an excellent metaphor to use the term just to mean a highly unexpected event.  A better use of “black swan” would be to mean an event that would not have been quite so unexpected ex ante if forecasters had cast their data net over a broader set of countries and a longer time perspective.

 2. “Terrorists don’t blow up big office buildings.”   Before September 11, 2001, some terrorist experts warned that foreign terrorists might try to blow up tall American office buildings.   These warnings were not taken seriously by those in power at the time.   Many Americans did not know the history of terrorist events taking place in other countries and in other decades.  

 3. “Housing prices don’t fall.” Many Americans up to 2006 based their behavior on the assumption that nominal housing prices, even if they slowed down, would not fall.   After all, “they never had before,” which meant that they had not fallen in living memory in the United States.   They may not have been aware that housing prices had often fallen in other countries, and in the US before the 1940s.  Needless to say, many a decision would have been made very differently, whether by indebted homeowners or leveraged bank executives, if they had thought there was a non-negligible chance of an outright decline in prices.

 4. “Volatilities are low.”   During the years 2004-06, financial markets perceived market risk as very low.  This was most nakedly visible in the implicit volatilities in options prices such as the VIX.  But it was also manifest in junk bond spreads, sovereign spreads, and many other financial prices.  One of the reasons for this historic mis-pricing of risk is that traders were plugging into their Black-Scholes formulas estimates of variances that went back only a few years, or at most a few decades (the period of the late “Great Moderation”).  They should have gone back much farther - or better yet, formed judgments based on a more comprehensive assessment of what risks might lie in wait for the world economy.

 5. “Big banks don’t fail.”   ”Governments of advanced countries don’t default.”   ”European governments don’t default.”  Enough said.  Greece’s debt troubles, in particular, should not have caught anyone by surprise, least of all northern Europeans.   The perception was that euro countries were fundamentally different from emerging markets, that like Germany they were free of default risk.  Suddenly, in 2010, the Greek sovereign spread shot up, exceeding 800% by June. But even when the Greek crisis erupted, leaders in Brussels and Frankfurt seemed to view it as a black swan, instead of recognizing it as a close cousin of the Argentine crisis of ten years earlier, the Mexican crisis of 1994, and many others in history, including among European countries.

      My next blog post will list some of the shocks that, even though low-probability, have high enough probability that they should be treated as thinkable rather than unthinkable, they would have great consequences, and they therefore warrant some advance preparation.

     My preceding post bemoaned the tendency for many US politicians to exhibit a procyclicalist pattern:    supporting tax cuts and spending increases when the economy is booming, which should be the time to save money for a rainy day, and then re-discovering the evils of budget deficits only in times of recession, thus supporting fiscal contraction at precisely the wrong time.  Procyclicalists exacerbate the magnitude of the swings in the business cycle.        This is not just an American problem.  A similar unfortunate cycle — large fiscal deficits when the economy is already expanding anyway, followed by fiscal contraction in response to a recession — has also been visible in the United Kingdom and euroland in recent years.   Greece and Portugal are the two most infamous examples. But the larger European countries, as well, failed to take advantage of the expansionary period 2003-07 to strengthen their public finances, and instead ran budget deficits in excess of the limits (3% of GDP) that they were supposed to obey under the Stability and Growth Pact. Then, over the last few years, politicians in both the UK and the continent have made their recessions worse by imposing aggressive fiscal austerity at precisely the wrong time.      Historically, developing countries used to be the ones where dysfunctional political systems produced procyclical fiscal policies.  Almost all of them showed a positive correlation between government spending and the business cycle during the period 1960-1999.  But things have changed.   Remarkably, during the decade 2000-2010, about a third of emerging market governments - in countries such as China, Chile, Malaysia, Korea, Botswana, and Indonesia - managed to reverse the historical correlation.  They took advantage of the boom years 2003-2007 to strengthen their budget positions, saving up for a rainy day.  They were thus in a good position to ease up when the global recession hit them in 2008-09.        In fact a majority of the governments that have followed countercyclical spending policies since 2000 are in emerging market or developing countries.   They figured out how to achieve countercyclicality during the last decade, precisely the decade when so many politicians in “advanced countries” forgot how to.

Any solution to the euro crisis must meet two objectives.  One is short run and the other is long run.  Unfortunately they tend to conflict.

The first necessary objective is to put Greece, Portugal, and other troubled countries back on a sustainable debt path, defined as a long-term trajectory where the ratio of debt to GDP is declining rather than rising.  Austerity won’t restore debt sustainability.  It has raised debt/GDP ratios, not lowered them.   A write-down would do it.  New bigger bail-outs might too, or might not.  But either write-downs or bailouts would then create moral hazard and thus make even it even harder to satisfy the second necessary objective.

That second objective is to reform the system so as to make it less likely that similar debt crises will recur anew in the future.   Fiscal rectitude in the long run is indeed the way to accomplish this.  But it is hard to commit today to fiscal rectitude in the future.  Rules to cap debt such as the Maastricht fiscal criteria, “no bailout” clause and Stability and Growth Pact (SGP) didn’t work because they were not enforceable.

Eurobonds could be part of the solution, if designed properly to take into account fiscal fundamentals, both short term and long term.  These are defined as government bonds that would be the liability of euroland in the aggregate.

The creation of a standardized Eurobond market would bring a boost to help a reform plan come together, badly needed in light of the damage that years of failed European summits have done to official credibility.  That boost is the latent global portfolio demand for a good eurobond. 

Even when the euro was at the height of its success five years ago, its international currency status suffered from lack of a counterpart to the US Treasury bill market, a deep, liquid, standardized market in low-risk bonds.  Bonds are issued by the 17 member governments.  This fragmentation has hindered European financial integration and impeded any bid by the euro to rival the US dollar as international reserve currency.  Central banks in China and other big developing countries are still desperate for an alternative form in which to hold their foreign exchange reserves – an alternative to holding US government securities, that is.   US Treasury bills pay extremely low interest rates, and the value of the dollar has been on a negative downward trend for 40 years (ever since President Richard Nixon took the dollar off gold and devalued in 1971).   Despite all of Europe’s problems, a Eurobond would be attractive to central bankers and other portfolio investors around the world, both to achieve higher expected returns than on US treasury bills and to diversify risk.

But that latent global demand for Eurobonds will not come to the table unless they are by design backed up with solid economic and political fundamentals.

Germany opposes Eurobonds on the sensible grounds that if individual national governments were allowed to issue them freely, the knowledge that somebody else was paying the bill would make the incentive for member countries to spend beyond their means worse than ever.  This version of Eurobonds would be bound to fail, both economically and politically.   This seems to be the version that some opponents of austerity have in mind, such as the new French president, François Hollande, though it is hard to tell.

A different version of the Eurobond proposal has recently begun to gain traction in Germany.  The German Council of Economic Experts - usually called “wisemen,” although the council includes a woman — proposed last year a European Redemption Fund (hence yet another new acronym, ERF).   The plan would convert into defacto Eurobonds the existing debt of (approved) member nations in excess of 60% of GDP, the supposed threshold specified in the Maastricht and SGP criteria.  The ERF bonds would then be paid off over 25 years.   Steps toward this proposed solution to the short-term debt problem would be paired - politically and logically - with approval of the Fiscal Compact, Angela Merkel’s proposed solution to the long-term problem.

But this seems upside down.  Yes, any solution to save the euro will have to ask German taxpayers to put still more money on the line.   But to use Eurobonds as the mechanism for eliminating the big debt overhang looks like the nail in the coffin of the longer term moral hazard objective.  It offers absolution precisely on the margin where countries in the future will in any case have the most trouble resisting the temptation to sin again, the margin where they cross the 60% threshold.

If the Fiscal Compact or proposed “debt brakes” could be relied on as a firm constraint on future behavior, then fine.  But there is little reason to believe that they could, especially after confirmation of the precedent that individual spendthrifts are relieved of their excess debt burdens.

The new Fiscal Compact is unlikely to succeed where the Maastricht criteria failed, the “no bailout” clause failed, and the SGP failed.  It is less credible that excessive deficits will be punished than it was three years ago - and it wasn’t credible even then.   Rules don’t work without some enforcement mechanism.   The problem with the SGP wasn’t that it wasn’t written strictly enough or even that it wasn’t incorporated into the constitutions of the member countries as the Fiscal Compact would have it.  The problem with the SGP was that no matter how many times a member government’s deficit or debt exceeded the specified limit, the country’s officials could say (often sincerely) that the gap was the fault of unexpected circumstances such as slow growth and low tax receipts and that they expected to do better next time.  Even if some court in Brussels or Frankfurt were given life-and-death power to enforce the rules, exactly which officials would it punish for violations, and how?  No version of the SGP or Fiscal Compact or debt brake proposals has ever provided a satisfactory answer to that question.

Hope by some Europeans that the Fiscal Compact would finally make enforcement credible by writing the constraints into the constitutions of member states might be based on misunderstanding of the US system.   One can see the logic:   The US federal government has never bailed out one of the 50 states and nobody expects it to do so in the future.  How has the US solved the problem of moral hazard that so plagues euroland?  The states have rules to limit deficit spending.  That must be the answer !  (Well, 49 of the states have rules; these laws are voluntary on the part of the states, and Vermont does not have one).  State laws are not the primary explanation for the absence of US moral hazard.  The primary explanation is that the right precedent was set in 1841 when the federal government declined the opportunity to bail out 8 troubled states and let them default.  Euro leaders should have done the same with Greece a year or two ago. A second (related) explanation for absence of moral hazard in the US federal system is that, ever since the 1840s, when American states start to run up questionable levels of debt the private market demands an interest rate premium to compensate for the default risk.   The premium acts as an automatic disincentive to further profligacy.  This mechanism should have operated after the euro was created in 1999, but it never did:  Greece and the other high-borrowers were able to borrow at interest rates that — disturbingly – had fallen virtually to the same levels as German bunds.  

The final explanation is that when citizens started to ask more from their public sectors governments in
the 20^th century (defense, entitlement spending, etc.), the expansion in the case of the United States took place at the federal level, not the state level.  For this reason even the fiscally most dysfunctional of the American states, which is probably California, does not operate on a scale remotely like European national governments.   US federal spending is 24% of GDP versus an EU budget of 1.2% of GDP.  Europeans are not ready to transfer most spending and taxation from the national to the federal level.   And even if they decide some day that they are ready, if the bailout precedent still stands then this federalization will not solve the moral hazard problem regarding the spending that remains at the national level.

The version of Eurobonds that might work is almost the reverse of the Germans’ Redemption Fund proposal.  It goes under the more colorful name of “blue bonds,” originally proposed two years ago by Jacques Delpla and Jakob von Weizäcker at the think tank Bruegel.   Under this plan, only debt issued by national authorities below the 60% criteria could receive eurozone backing, be declared senior, and effectively become Eurobonds.  These are the “blue bonds” that would be viewed as safe by investors.  When a country issued debt above the 60% threshold, the resulting junior “red bonds” would lose eurozone backing.   The individual member state would be liable for them.  This proposal structures the incentives “right side up.”

The blue bonds proposal has been extensively debated in Europe.  As usual in such controversies, many participants in the euro debate fixate on one evil or the other –moral hazard or austerity — and fail to grapple with practical proposals to balance the two.

As I see the plan, the private markets could make the judgment as to whether a country was in the process of crossing the threshold, even before the final statistics were available, and therefore assess whether default risk on the new red bonds required an interest rate premium.  If private investors judged that the new debt had genuinely been incurred in temporary circumstances beyond the government’s control (say a weather disaster), then they would not impose a large interest rate penalty.  Otherwise, the sovereign risk premium mechanism would operate on the red bonds, much as it does among American states, and much as it did in Italy, Greece and the others before they joined the euro.   Similarly, if the ECB after 2000 had operated under a rule prohibiting it from accepting as collateral the debt of SGP-noncompliant countries, the resulting default risk premum might possibly have headed off the entire euro sovereign debt problem early in the decade.

The point is that the red-bond mechanism would be truly automatic, as desired.  Perhaps in ambiguous borderline cases the judgment whether a country had truly exceeded the limit, or whether it was still in good standing so that its debt qualified for eurobond status, would ultimately have to be made by a eurozone agency or court, with an inevitable lag.  But, in the meantime, private investors could apply informed views about the merits from moment to moment.  The resulting market interest rates would provide the missing discipline. Compliance would not rely on discretionary letters from Brussels bureaucrats, which have proven toothless no matter how many exclamation points are put at the end of their penalty threats.  Nor would it require unenforceable debt ceilings legislated at the national level.  The U.S. has one of those too.  It has never had any effect, except on a very few occasions, when Congress has actively used the debt ceiling law to make everything worse.

Of course the euro countries cannot jump to a blue bond regime without first solving the problems of debt overhang and troubled banks that are front and center.   Otherwise, in today’s world, the plan by itself would be destabilizing since it would put almost all countries immediately into the red.   The debt paths that are currently unsustainable in many countries result from the combination of debt/GDP ratios that are already far in excess of 60%, combined with very high sovereign spreads and recessions.    Relieving them of responsibility for debt up to 60% would be substantial assistance, but would not in itself restore sustainability to all members.

Thus Eurobonds are emphatically not the complete solution to these vexing problems.  It is hard to say, at this late date, what the right short-term solutions are.   In Greece’s case, it may be forced to default and to drop out of the euro.  The banks and sovereigns in other countries will then have to be insulated from the conflagration through a combination of acronymic “bailout” money (EFSF, ESM, ECB…) and serious policy conditionality, as always.  Creating this fire break between Greece and the heart of Europe would have been far easier two years ago, before debt/GDP levels and sovereign spreads climbed so high and before the credibility of the euro leaders sank so low, or even one year ago.  Now the fire has spread over a much larger area and there are no natural gaps in sight for creating firebreaks.

But one thing seems clear.  German taxpayers, whose longstanding fears that they would be asked to bail out profligate Mediterranean euro members have been proven correct, will not be happy when asked to put up still more money in the cause of European integration by the same elites whose assurances of the last 20 years have proven false.   They will at a minimum need some credible reason to believe that future repetitions have been rendered unlikely, that the bailout is “just this once.”   Official assurances do not constitute that credible reason.    Nor does the Fiscal Compact, in itself.   The red bonds / blue bonds scheme just might.

[A much condensed version of this posting appears in Project Syndicate, June 14, 2012.  This fuller version also appears on Vox, June 28, 2012.]

The Hour of the Technocrats has arrived.   In desperation from debt crises that their gridlocked political systems have created, Italy and Greece both in November chose new Prime Ministers who are technocratic economists rather than politicians:   Mario Monti and Lucas Papademos, respectively.  One can even describe them as professors:  Monti has been president of the prestigious Bocconi University when not a European Commissioner in Brussels, and Papademos has been my colleague at Harvard Kennedy School in the year since he finished his term as Deputy Governor of the European Central Bank (even teaching a class I usually teach).

No doubt, whatever happens, pundits who evaluate their performance will soon be writing: “Professors Earn ‘A’ in Economics, but Flunk Politics.”   This will be unfair.   It is not lack of political ability that will stymie them, but lack of political power in the mandates they have been given.    Mario Monti, despite very strong popular support among Italians for his technocratic government, does not have a parliamentary majority that he can rely on.   Berlusconi, in boasting that he can pull the plug on Monti anytime he wants, has made it clear that he still will not lay aside his personal political interests for the good of the country even when everyone understands what he is doing.   

Lucas Papademos in Greece has been dealt an even weaker hand.  Despite his best efforts to insist on a term longer than three months and the ability to appoint some members of his cabinet, as requirements for accepting the Prime Ministership, in the end he could not get even these minimum conditions.

The elevation of these two outstanding civil servants comes after a period when some other professors have been squeezed out by the political process.   Several good technocratic economists from emerging market countries were passed over in June, when choosing the successor to Dominique Strauss-Kahn as Managing Director of the International Monetary Fund.

Next, an example from Germany. Axel Weber in January 2011 resigned as President of the Deutsche Bundesbank and member of the Governing Council of the European Central Bank.  The interpretation in the press was that his statements opposing ECB purchases of bonds issued by troubled periphery countries had been evidence of political naivety on his part.   The press could not imagine that a technocrat might voluntarily relinquish a sure shot at a position of great power — successor to Jean Claude Trichet as ECB President — on a matter of principle.    But that is precisely what Weber was doing.  The willingness to give up power if necessary is one of the advantages of professors for such positions.  (It is a different matter that the ECB presidency then went to Mario Draghi, who is also an economist and technocrat, and in fact the perfect man for the job.)

It is a mistake to conflate technocrat elites (they are the ones with the PhDs or other advanced economics degrees) with other kinds of elites (the ones with money or power, especially if they got them from their parents).   Most economists understood very well the possible downside of European monetary union.  In the late 1980s, when Jacques Delors asked major European leaders what the next step should be in the European integration project, they underestimated the technical difficulties when they opted for monetary integration.

Technocrats can play a useful role.  One of their advantages is acting as an honest broker when traditional politicians have become discredited or parties are deadlocked.  Another is the credibility that comes when they are not motivated by getting re-elected, either because their term in office has been limited in advance or because it is know that they in fact prefer the quiet life back at the university.  The most obvious advantage to technocrats comes when the biggest problems facing the country are in large part technical such as proposing economic reforms or negotiating loan terms.  A good precedent in Italy is Carlo Ciampi, who took the governing reins in 1993 after Italy was forced to drop out of the European Exchange Rate Mechanism, but managed to repeal the scala mobile (the wage indexation system), beat down inflation, and re-board the train of European monetary integration. 

Obvious disadvantages of some technocrats include lack of managerial experience, lack of perceived legitimacy, and lack of a domestic political powerbase.   Monti and Papademos both have managerial experience and, for now, perceived legitimacy.   The last of the three factors will be the limiting factor for them.

Among current heads of state who could be considered technocrats are President Felipe Calderón of Mexico, President Sebastián Piñera of Chile, and President Ellen Johnson Sirleaf of Liberia.  Nobody could accuse these three of having led sheltered lives or being unaccustomed to making difficult decisions.   But it happens that all three received their ivory tower training at the Harvard.  Calderón took a record three courses from me.   Unfortunately, dealing with violent drug lords was not on my syllabus. 

Having shiny international credentials is not always an advantage.  When Sirleaf received the Nobel Peace Prize in 2011, the speculation was that this evidence of her good image abroad could hurt her with the voters at home in her campaign for re-election.   Analogously, Prime Ministers Monti and Papademos hold gold card memberships in the clubs of EU and euro elites that will help them obtain support for their countries abroad but leave them vulnerable domestically to charges that they are lackeys of foreign powers.

It is good that Rome and Athens, the two seats of classical western civilization, have turned to these two civilized men for leadership. I hope the politicians realize that Monti and Papademos cannot work miracles if they are not given the political tools to get their policies enacted.   

[A version of this column appeared Nov. 25 on Project Syndicate.  Comments can be posted there]

A subsequent blog post will extend the discussion of technocrats to some recent examples from the United States of highly qualified academics who have been blocked from office for political reasons.

US News and World Report asks, “Who is handling its debt crisis better: Europe or the United States?”   My answer follows.

  In both Europe and the United States, the current public debt woes are attributable to mistakes made by political leaders going back more than a decade.  In both cases the tremendous magnitude of the long-term debt problems has only become evident for all to see recently, by which time it was too late for the straightforward policy solutions that were viable options previously. 

  It is hard to judge whether it is Europe or the United States that has screwed up worse.     On the one hand, Europe is now much closer to full-fledged crisis: the debt problems in Mediterranean members are virtually insoluble at current interest rates, are probably pushing Europe back into recession, and could well result in one or more countries forced to leave the euro.  By contrast, there is no true fiscal crisis here yet; the world’s investors are still buying large quantities of US bonds at low interest rates.

  On the other hand, the mistakes by US politicians are more gratuitously self-inflicted than on the other side of the Atlantic.   In 2001, all we had to do was continue the fiscal progress that had been made during the 1990s: preserve the budget surplus and move on to address the longer term problems of social security and Medicare in a deliberate and balanced manner.  Instead we recklessly enacted massive tax cuts and tripled the rate of growth of federal spending, in ways guaranteed to generate serious fiscal troubles in the decade of the 2010s and beyond.  The debt-ceiling standoff last summer was but the latest self-inflicted wound, new evidence that the US political system is not functioning.  

  To be sure, euroland too has made serious policy mistakes.  But one can sympathize with the difficulty of agreeing policy across 17 sovereign governments.   The political fissures have been inevitable ever since 1999, when the euro members (then 11) adopted a single currency without a single fiscal authority, in what was nevertheless a historic and laudable enterprise.  As they say, “why should anyone be surprised at the difficulty of getting 17 national legislatures to agree, when the United States cannot even do it with one?”

  It is not too late for American politicians to enact the economically sensible policy:  current short-term fiscal stimulus simultaneous with steps to lock in a long-run return to fiscal responsibility (which cannot possibly be accomplished solely by discretionary spending cuts, entitlement reform, or tax revenues, but rather should include all three).   For euroland, unfortunately, even if the politicians could come together, there no longer exists an option for preserving the monetary union in quite the form originally envisioned.

** This column (along with others’ answers to the question) first appeared in the Debate Club of U.S. News & World Report , Nov. 7, 2011, which has the copyright. **

[My reactions to developments in the euro crisis can be seen in four clips from CNBC's Kudlow Report in October and one on BNN in November.]