Iceland President Olafur Ragnar Grimson on Economic Recovery

You're still committed to the post hoc ergo propter hoc fallacy, huh?

Here is an equally plausible explanation for Estonia's macro performance since 2008: there was a global financial crisis and accompanying recession, and then a recovery. Note that fairly standard economic models predict this, as opposed to your non-existant flood of capita theoryl. FIN.

Ah, I can clear this up. Argentina's debt load tripled because it was mostly foreign-denominated (in dollars, not pesos), and they devalued by about 2/3rds from 2001 to 2003. They spent a lot defending the currency peg, but it was a tiny fraction of the effect of the devaluation. Note the nominal external debt amount didn't change much during the crisis.

The only external creditors that will loan you money to defend a currency peg are public entities like the IMF.

Basically. They didn't borrow to buy that currency; they already had it. They blew through it all, ran out of foreign reserves, and had to choose either to raise interest rates so high they'd destroy the economy or abandon the peg.

I don't know! I'd guess it's a combination:

1) For some reason Estonia was able to force its citizens to cut their wages when others had a very hard time doing so. Estonias just sucked it up and did it somehow; usually this is a very nasty political coordination problem.
2) Estonia's debt per-capita is very low, so their real values of citizens debt and repayment ability wasn't impacted much by the wage cuts.
3) This lower wages increased their export competitiveness and they successfully captured more export market share, which helped their economy recovery.

Virtually none of this information is available even in financial news sources, unfortunately; people get sold a lot of horseshit about how this works.

This paper has all sorts of interesting stuff on Argentina's 2000s debt crisis. It still continues to be hilarious how rapidly their economy recovered once they gave up on the peg and slapped on all sorts of capital controls.

Are we all agreed at least that whatever the exact reasons for Estonia managing to not plunge deeper into recession on the backs of austerity, the method is not generalisable to all countries because not every country, at the same time, can increase their exports by more than they lower domestic demand (by definition).

Again: two things. What is "actual" default risk and who defines it? If investors believe you are a risk, then it doesn't really matter that you aren't an "actual" risk, because they are the ones driving the interest rates you pay.

So if following a particular policy, like austerity and joining the Euro, calms investor nerves and staunches the flow of capital out of the country and lowers the cost of borrowing, maybe that's actually the right policy, even if it's only the "right" policy in the eyes of those investors?

No. Once again: you are committing the post hoc ergo propter hoc fallacy. All you've shown is that some events occurred after other events, and that it's plausible that there's a causal relationship there. You've doggedly avoided addressing (or really even acknowledging) other plausible counterfactuals. You've also failed to provide a lick of evidence that the causal relationship exists.

Once again, here is a story that explains the phenomena under examination: there was a global financial crisis and attendant recession, capital fled to safety, as the crisis ebbed capital flows stabilized.

Of course. I said way back that I think there must be different solutions for different countries based on their situation, not a "austerity" or "spend and growth" for all. I also think that with devaluation it's different for each country. For a country like Argentina, devaluation hurts the richest most because it is a huge producer of food and other basic resources, so while food would stay the same price for locals (roughly) the cost of importing luxury items would go up. For other countries, and that includes Estonia and the UK, they are net importers of food, and net exporters of services and manufactured goods. Devaluation for these countries would hurt seem to hurt the poor most, while helping business, therefore an internal devaluation might not be much different in terms of impact on the less well off.

I'm not getting confused about causation and correlation: like most things in Economics it's impossible to be certain of anything. I'm postulating a theory based on the available facts. Note the use of words like "maybe". There's no difference between that and you suggesting an alternative theory, so are you equally as guilty of "committing the post hoc ergo propter hoc fallacy"?

It's also no different to Jason suggesting that the devaluation in Argentina caused their sudden rebound to economic health. He could easily be mistaken in thinking that the fact that the recovery happened after the devaluation was a matter of causation, when it was just coincidence. There are alternative theories for Argentina's recovery that are based on the fact that the price of commodities (Argentina's main export) rose dramatically at around the same time (same thing happened for Russia too) and it was that which saved them.

By your argument Jason, myself, you and everyone else who postulates why things happen in economics is guilty of confusing causation and correlation, which is plainly ridiculous, so maybe you should stop throwing that term around until you understand how to apply it correctly.

Oh and here's a counter factual for you: Hungary. And that's just the first country I looked at. Obviously something different happened in Estonia, and YOU haven't provided a "lick of evidence" for what that might be.



Now you see if Estonia's capital flow had been like Hungary's, then you'd have an argument that their policies haven't improved the situation, especially because, as you say, the whole economic climate seems to have improved, and yet some countries are still struggling.

You seem to be missing my point: you keep asserting - weasel words like maybe aside - that Estonian austerity caused their rebound. That's maybe a plausible story, but I just told you a plausible story that's much simpler (and that, unlike yours, happens to be supported by tried and true economic models). So why are we to believe your story is more likely?

To put it differently: "maybe" is not an interesting statement, it implies a nonzero chance which means it's almost certainly true. The question is, certeris paribus, how likely is it that austerity caused Estonia's rebound? Alternative, more useful formulation: "At a given significance level, what percentage of Estonia's recovery can be attributed to its austerity policies?" Note that from these questions and the statements that answer them, we can say meaningful things about both Estonia and austerity as a policy choice. This is how economics can be useful. Saying "Maybe austerity helped," is neither useful, nor interesting.

You're now asking a different question. To wit, you are now asking if it is not right to follow the policies suggested by perceived default risk instead of actual default risk.

I don't do the whole "shifting from one question to another" thing very well. I prefer to deal with one question at a time, resolve it, and then move on to the next.

Are you satisfied by my roulette example that there is, in fact, a trivial, simple counterexample where actual default risk is different from perceived default risk? I don't think it should be particularly necessary for me to go down the semantic rabbit hole here, because the example is pretty simple: The country will default if the wrong color shows up on the roulette wheel, no matter what the perception is, which means that if the perception is that the country is rock-solid in its ability to repay its debts, that perception is empirically wrong.

Jeff, "maybe" is not a weasel word. The phrase "it has been argued" is also not a weasel word when backed with the actual argument. You really need to learn the meanings of these terms you throw around. Apart from the fact they are just insulting labels for an argument you disagree with, you are using them incorrectly.

I went searching for your "plausible story" that you supported with "tried and true economic models" and found nothing. I did find this rather empty and false argument against my position:

I thought it worth pointing out, given that your repeated posts to me seem to be made up of vapid and dismissive statements based on only a cursory, or even false, understanding of their meaning. Here you give me some "good advice" that is complete nonsense. When Sumner wrote about this it was in relation to consumer prices, not the cost of borrowing, and even if you could somehow extrapolate it to the cost of borrowing, he says this:

"My suggestion is that people should never reason from a price change, but always start one step earlier—what caused the price to change."

Did you notice, or even care, before throwing out this bone of "advice" that this was exactly what I had been doing. I was looking at the cause of the changes in the cost of borrowing, and postulating what might drive that.

Also, as Sumner even points out himself, it's just a suggestion not some golden rule that all must follow or otherwise be proven wrong.

Please, answer this question yourself before putting restrictions on how people in this thread can discuss an issue. It's only fair. And if you don't find it "interesting" to discuss possible reasons for a particular economic outcome, except obviously the one you consider as Truth, then I suggest that you just don't bother discussing them at all.

Oh my bad, I just found Jeff's "plausible story" supported by "tried and true economic models":

So basically Estonia's economic recovery just happened. Brilliant. The fact of Hungary, and other countries, having continuing and worsening problems, with currency, with capital flows, with investor confidence is immaterial. Estonia's recovery just happened because it did. FIN! Their policies had nothing to do with it, even if other countries with different policies failed to recover, and in fact have worsening economic situations. That's "tried and true economic models" for ya.

I don't understand you, Aaron. Of course perceived risk and actual risk are different, but what use is actual risk if you can't know it? In the end the only useful metric is perceived risk, because that's the one that helps drive the cost of borrowing.

It's like with the Euro over the last few years. Lots of people thought the Euro was going to tank, but people also thought it was going to pull through. Those who thought it was going to tank sold it short and its value dropped. In their belief of risk, they helped increase the actual risk of the currency's failure. It's the same with the cost of borrowing - investors fearing that a country cannot pay its debt can make the situation come true by pushing up the cost of borrowing. With that in mind, what is the actual risk? How can it be possibly be known?

You're saying two different things here. If perceived risk and actual risk are different, then, well, they're different. While sometimes perceived risk can have an impact on actual risk (such as your example), at other times it doesn't have an impact on actual risk (the change in perception of default risk for the United States had no corresponding change to actual default risk).

Perceived risk is an imperfect predictive market attempting to ascertain actual default risk. It is not, and should not be confused with, the actual risk of a country defaulting even if it has an effect on same.

I offered a trivial (note that I'm using the word trivial in the math sense of the simplest possible case, not the common sense) example of how one can have an easily quantifiable actual default risk that is vastly different from perceived risk.

Fundamentally, one might not be able to perfectly identify the actual default risk of a country, but it's quite often possible to get a better in-hindsight estimation of it than what is effectively a prediction market's estimation (the perceived default risk before the fact).

I suspect there is an element to bond prices that is more political than genuinely based around fear of default.

Though I don't know, I strongly suspect that the pool of large, price influencing, bond buying entities is actually a relatively small group and composed of institutions like foreign governments and large, diversified, financial institutions that may have alternative reasons to want to drive a particular country into difficulty as a method of economic persuasion.

It was mentioned earlier how Soros was able to tank the pound almost single-handedly. Well I imagine a group of fifty or so Soros like-figures in large banks or at the IMF and influenced by Cato-like think tanks are perfectly capable of, even unconciously, raising up or decimating the bond prices of small European country in service to an economic ideology rather than an economic reality. I belatedly realise I'm mostly just recycling the arguments of Naomi Klein's The Shock Doctrine.

It has been argued that truthiness abounds in this thread. Maybe.

Banquo, "capital flows lead to recovery" is a pretty big assumption you haven't supported at all. I just brought it up to indicate that Estonia has not seen capital come back, just that it just stopped fleeing.

If you look at the other countries trouble there's no immediately obvious association between capital movement and economic status.

Noisy, mostly positive after 2010, economy still sucks:


Flatlined, economy is in great shape anyway:



Most hilariously, Greece was net positive through the entire crisis until a couple of months ago.

Let's not bring Greece up, please. They're such a goddamn basket case that they're not an apples-to-apples comparison in any category for any other country.

That's why it's funny! Clearly with that sort of capital flow performance it's a mystery why everyone's so concerned.

How can you be sure it had no impact on the actual risk? What's your basis for that calculation? Just the mere fact that you can't be sure if perceived risk is impacting actual risk or not would have to impact actual risk. It's clear that perceived risk can and does impact actual risk, so the calculation, if one could be made, for determining actual risk would need to include perceived risk. Therefore it would be impossible to calculate.

I'm only saying one thing: Perceived risk is the only useful metric when looking at the impact of risk on the cost of borrowing. That's because the cost of borrowing isn't set by a computer that knows the actual risk, but by humans who are perceiving risk through whatever filters they think are usefully predictive. If all those investors are right wing pro-austerity types, that may well drive up the cost of borrowing for small countries who run up large debts trying to spend their way out of recession. If they perceive that to be a risky strategy, why would they bet on it for low returns?

As I already said: I was wrong in saying capital flowed back into Estonia, but that doesn't effect my point. The fact that they staunched the flow of capital is enough to help the economy out of recession.

Here's Gerald Epstein, PhD in Economics and co-director of PERI.

"Capital flight can have serious negative effects on economic stability, growth, and inequality."

Part of the reason that the EU was bailing out Greece and the other countries was to prevent the flight of capital. Those countries you show graphs for were had investor nerves calmed by the support of the Eurozone member states. Estonia, at the time of the recession, was a small country of just over a million people trying to prop up its own currency with no guarantee of help from anyone. And you know what austerity and maintaining the value of the Kroon got them?

"I've added an epicycle that indicates why those totally contradictory data points don't count."

We can play the game all day of "you claim something, I find a contradictory data point, you add another epicycle for what it doesn't count." What's your end-to-end theory of why capital flows = financial viability = government rate on bonds = default rate -> economic recovery?