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Jesus Fernandez Villaverde: “We entered the EU for better rules and they won’t work”



Spanish economists with a real academic connection in the United States can be counted on the fingers of one hand, especially after the return of Mas-Colell and Sala i Martín. Jesús Fernández Villaverde (Madrid, 1972) is one of them and despite his commitments and commitments, he does not take his eyes off Spain. He admits that his disillusionment with the failure of the reform campaign, which he followed closely through his friendship with Luis Garricano and other economists who congregated at Nothing’s Free blog, left him disillusioned. His annual visits to the Rafael del Pino Foundation always arouse great interest among his followers. “What do you need to know when you are facing a crisis?” -Two things. First, diagnose how we got to this situation. Second: a clear plan for how to solve the problems indicated by the diagnosis. I’m afraid we don’t have either one or the other now. What kind of crisis do we have now? “A combination of two factors. First, the supply crisis caused by the fallout from COVID-19 and the energy pressure caused by the Russian invasion of Ukraine. Second, the aggregate demand unleashed by the fiscal and monetary stimulus in 2020-2022 which turned out to be excessive. – After the failure of Liz Truss in the UK, José Juan Ruiz argued that market observers are back…why are they back with the UK and not with Italy?-because in the eurozone we have changed from a situation of ‘monetary dominance’ (in which the central bank sets the direction of economic policy and fiscal policy adjusts to it) to one of ‘ Fiscal dominance” (where the central bank internalizes the fiscal situation is a political decision). Since Italy is a small part of the eurozone, its fiscal deviation is unpunished while the European Central Bank intervenes. About the failure of the reform drive of the century “was the main factor that Albert Rivera was more interested in being president than in solving problems”—what should Spain learn from this?—that the European Central Bank has given up its independence and that we are approaching a world with greater inflation that hurts us so much. We joined the EU to have better rules, In the end it will become clear that these rules will not work. Was the ECB wrong to take so long to raise interest rates? -Yes and a lot. The ECB reacted late and insufficiently, and it also engaged in a series of climate change programs that would mean the end of what was left of its independence. Why weren’t the liquidity injections from central banks inflationary until they were? There are two types of crises: demand crises and supply crises. A demand crisis occurs when we do not have enough aggregate demand to use all the resources. In a world where there is not enough aggregate demand, expansionary monetary policy does not translate into inflation. The financial crisis of 2007-2012 is primarily a demand crisis. Economic agents must get rid of indebtedness and for this they are forced to reduce their consumption and investment. A supply crisis occurs when we cannot produce enough. In a world where aggregate supply is not enough, expansionary monetary policy translates into inflation. As I said before, we now have a supply crunch. What has happened in the past 15 years is really what basic macroeconomics expects for the first year: the effects of monetary policy depend on the relative position of aggregate supply and demand. Are we facing the most complex macroeconomic environment since the 1970s? Yes, high inflation rates, weak public finances in the short, medium and long term, and lack of political will to solve structural problems. Many organizations’ forecasts for 2023 are not very optimistic. Is an income agreement a good idea to spread the burden of inflation? -Yes and no. Yes, in the event that the income agreement serves to ensure that the economy adjusts faster and less costly. Not in the event that the income agreement only postpones the inevitable, as was often the case in the seventies. What is the fiscal policy that should be developed under these circumstances? – I’ve argued before that we have very high aggregate demand. Contractionary fiscal policy would help control this aggregate demand and set us on a more sustainable fiscal path over the medium term. ECB mistakes “They got it wrong. They have reacted late and inadequately to the situation »- Is there room in Spain to cut public spending? – Is there room to reduce spending by reducing excesses and waste? A little bit. As much as we resent a politician who has an official car he doesn’t need, the sad truth is that these are budget approximations. Funds from public administrations go to pensions, education, health and interest on debts. Everything else is little. Of course, 75% of readers will not believe this answer because it is easier to believe that the official redundant car is the source of our ills: it allows one to think there is a simple solution and to go about their daily life. I’ve been explaining this since 2012 and I’m like a voice crying out in the desert. Is there room to reduce expenses that are not excesses or waste? Well, it depends on the preferences of each one. Some people think that spending money on a particular cause, for example, a public prize for literature, is a bad idea and others think it is a good idea. As a citizen I have my preferences and have never hidden them, but as an economist I cannot say that spending money on a public prize for literature is bad calculation. Economics says nothing about it. What I can say is that if we want a public prize for literature we will have to pay taxes for it, and if we do not want high taxes we cannot have a public prize for literature. And no one comes to me with this nonsense that if we cut taxes the collection will grow enough to pay for everything. No, Spain is not on the right side of the Lover Curve. Talking about energy talks about geological strategy. Is the definition of our energy framework reliable if we look at our foreign policy? Spain has been tailoring its energy policy since 1977 so that the head of government will have a good opening on the news on Friday night. UCD, PSOE, and PP were just as bad. The Spaniards, for example, are not generally aware of the craze of nuclear shutdowns in the 1983 Nuclear Power Plan. Since I don’t think this will change in the medium term, the answer is that we will continue to have an energy framework that limits and mediates our foreign policy. – In contrast to the 2008 crisis, Germany today is not a risk-free asset? What are the consequences for Europe? I do not see this statement. The German Thirty Year Bund is paying 2.09% today (Oct 26). The United States at 4.14%. The market doesn’t see it either, but the reality is that the German economy may be suffocating due to its dependence on Russian gas. This is what makes it such a risky asset. There are two factors to consider here. First: How sensitive is the German economy to cutting off Russian gas supplies? It’s okay, but not alarmingly so. Natural gas stocks in Germany at peak levels from 2017-2022. And on January 3rd, the first LNG tanker from the United States arrived in Wilhelmshaven. Second: How sensitive is Germany’s ability to service its public debt to energy difficulties? A little bit. Germany’s consolidated public debt is about 67% of GDP. Even two or three very difficult years of energy supplies will bring Germany far below Spain’s debt level. That’s the good thing about being careful in the boom years: to have a big mattress to cushion the blow. The mistake made in Spain “not confronting the basic problems of the economy (poor regulation, poor education system, dysfunctional labor market, …) diagnosed since the 1980s” – You said that Spain’s economy had been stagnant since 2005. Could it have been avoided? What should have been done? —According to the International Monetary Fund’s World Economic Outlook database, Spain’s per capita income in 2006 was €24,142. In 2022, the forecast is €24,528, correcting for inflation so that both numbers can be compared. In other words, from 2006 to 2022, we basically didn’t sleep anything: accumulating 1.5% in 16 years. And no, it wasn’t Covid-19. In 2019, before covid, per capita income was €25,343, which is 5% growth accumulated in 13 years (from 2006 to 2019), which is a pittance. This is not what happened to our neighbors either. Portugal grew 13.3% from 2006 to 2022 (and 10.9% from 2006 to 2019) and has also suffered from the euro crisis and Covid-19. If we compare ourselves to the United States or Germany instead of Portugal, we will end up worse off. In other words, we did something wrong in Spain. that was? Not facing the basic problems of the economy (poor regulation, poor education system, dysfunctional labor market, …) that have been diagnosed since the eighties of the last century. I did a conference at the Rafael del Pino Foundation in 2014 listing all these problems and gambling that if we don’t solve them, we won’t grow. And so it became. The real challenge is understanding why we don’t want to make these fixes. I’m afraid there is no demand from the electorate to solve the problems of the Spanish economy (make no mistake, politicians respond to what the electorate wants, not the other way around) and I still don’t understand why. – With regard to the responsibility of citizens in the absence of reforms, how can it be aligned with responsible policies? -I don’t know! From 2014 to 2019, I wrote dozens of articles about how we weren’t solving the Spanish tax problem and how we were wasting relatively good years without doing our homework. Articles have always been received with two positions. The first, majority, indifference (which did not happen to me when I spoke about many other issues of the Spanish economy). The second, minority but significant “it’s not a big deal.” At a basic level, the Spanish electorate has not grasped the massive structural problems we face in the medium term. But we live in a democracy: If the majority of voters don’t agree with my analysis, it’s not as if I can do much. I have to put up with it, right? Why did the seemingly well-detailed reform movement fail? Various factors. The first and most important: Albert Rivera was more interested in heading the government than in solving Spain’s problems. Few politicians have shown their selfishness in its purest form to the same level as in the last century of Spanish history. The second factor: the Spanish institutional structure, from demography (aging) to electoral arithmetic, does not leave much space for the reformist impulse. – What do you think when they tell you that Spanish talent is leaving because this is the country of waiters? They don’t lack a reason. Although things have improved a bit (especially in the Madrid business world), talent is still less valuable than in English-speaking countries. It would have been much worse for me if I had stayed in Spain. Every night I thank you for telling me to leave Spain in 1996.

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