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Richard Koo (2003) coined the term “balance sheet recession” to characterise the endless travail of Japan following the collapse of its real estate and stock market bubbles in 1990. The Japanese government did not act to repair the balance sheets of the private sector following the crash. Instead, it chose a policy of keeping bank rate near zero so as to reduce deposit rates and let the banks earn their way back into solvency. At the same time it supported the real sector by repeated large doses of Keynesian deficit spending. It took a decade and a half for these policies to bring the Japanese economy back to reasonable health.

At the time, a majority of forecasts predicted that the economy would slip back into depression once defence expenditures were terminated and the armed forces demobilised. The forecasts were wrong. This famous postwar “forecasting debacle” demonstrated how simple income-expenditure reasoning, ignoring the state of balance sheets, can lead one completely astray.

Despite 42 consecutive months of gains in private-sector employment, the unemployment rate is still at 7.3 percent; in December 2007 it was only 4.6 percent. The current unemployment rate is higher now than in 2007 across all age, education, occupation, gender and ethnic groups.

That’s despite the fact that about four million workers have left the labor force, driving the labor force participation rate to a historic low

Although the share of the long-term unemployed has fallen from its peak of 45 percent in 2011 to 38 percent today, it is still far above its 2001-7 average. And about eight million people are working part-time for “economic reasons,”

Italy Falls Back Into Recession, Raising Concern for Eurozone Economy

The economic data and news that Russia was massing troops and military equipment on the Ukrainian border caused stock prices to fall across Europe on Wednesday.

Analysts surmised that the strained relations with Russia as well as turmoil in the Middle East had undercut demand for Italian exports, in particular fashion and other luxury goods.

Worse than the 1930s: Europe’s recession is really a depression

is the mounting evidence produced by labor economists of just how important it is for current graduates to ignore the old-school advice of trying to get ahead by working one's way up the ladder. Instead, it seems, graduates should try to do exactly the thing the older generation bemoans — aim for the top.

starting at the bottom is a recipe for being underpaid for a long time to come.

A recent study, by the economists Philip Oreopoulos, Till Von Wachter and Andrew Heisz, "The Short- and Long-Term Career Effects of Graduating in a Recession" (National Bureau of Economic Research Working Paper 12159, April 2006. http://www.columbia.edu/~vw2112/papers/nber_draft_1.pdf), finds that the setback in earnings for college students who graduate in a recession stays with them for the next 10 years.

This coincided with the bubble years in peripheral Eurozone countries (2003-07). The effect of this is that Germany accumulated large net claims on Eurozone countries, which at the end of 2011 amounted to €634 billion.

Since 2009, when the TARGET2 balances started to take off, current account deficits of the peripheral countries as a whole declined from 9.1% of their GDP to 4.5%. These declines were mainly due to deep recessions in these countries.

the German banking system was lending the money to other Eurozone countries to allow them to buy surplus German products – a highly risky affair.

Cyprus had developed its financial center over three decades ago by having double taxation treaties with a number of countries, the Soviet Union for example. That means if profits are booked and earned and taxed in Cyprus, they are not taxed again in the other country. Russian deposits are there because Cyprus has a low corporate tax rate, much like Malta and Luxembourg, which annoys some people in Europe.

In addition, Cyprus has a legal system based on English law and follows English accounting rules

This government took a country with excellent fiscal finances, a surplus in fiscal accounts, and a banking system that was in excellent health. They started overspending, not only for unproductive government expenditures but also they raised implicit liabilities by raising pension promises, and so forth.

“The current- account deficits of countries that have been under stress diminished over the last years considerably.”

Just two of 14 euro-zone government leaders have kept their posts in elections since late 2009 and extremists such as Golden Dawn in Greece are gaining support.

“The internal rebalancing in the euro area is progressing,” said Fels. “Some of them, especially Spain but also Portugal not to speak of Ireland, are regaining competitiveness.”

Empirical evidence suggests deleveraging episodes accompanied by a housing crisis will take on average five and a half years across high-income OECD countries (or seven years when accompanied by a banking crisis (Aspachs-Bracon et al. 2011, IMF 2012).

In the second narrative, the world’s largest banks remain too big to manage and have strong incentives to engage in precisely the kind of excessive risk-taking that can bring down economies. Last year’s “London Whale” trading losses at JPMorgan Chase are a case in point. And, according to this narrative’s advocates, almost all big banks display symptoms of chronic mismanagement.

I had the opportunity to talk with senior officials and their advisers from various countries, including from Europe. I asked all of them the same question: When will we have a binding framework for cross-border resolution?CommentsView/Create comment on this paragraphThe answers typically ranged from “not in our lifetimes” to “never.” Again, the reason is simple: countries do not want to compromise their sovereignty or tie their hands in any way.

Olivier Blanchard, the IMF’s economic counsellor, stated last June that “many, including me, believed that keeping the peg was likely to be a recipe for disaster, for a long and painful adjustment at best, or more likely, the eventual abandonment of the peg when failure became obvious.” He has been proved wrong.

According to the IMF, Latvia tightened its cyclically adjusted general government deficit by 5.3 per cent of potential GDP between 2008 and 2012,

But Greece’s tightening was 15 per cent of potential GDP between 2009 and 2012.

Its full name is more than a mouthful. Trans-European Automated Real-time Gross Settlement System is better known as TARGET2 for short. It is the behind-the-scene payments system that conveniently enables citizens across the euro area to settle electronic transactions in euro. And at just over €500 billion, its TARGET2 claim on the Eurosystem is also the largest and fastest growing item on the Bundesbank’s balance sheet, as well as a source of much misunderstanding and debate.

The allocation of TARGET2 balances among the seventeen national central banks, which together with the ECB make up the Eurosystem, reflects where the market allocates the money created by the ECB. The fact that the Bundesbank has a large TARGET2 claim (asset) on the Eurosystem, while national central banks in southern Europe and Ireland together have an equally large TARGET2 liability, simply reflects that a lot of the ECB’s newly created money has ended up in Germany. Why? Because of capital flight.

Since the euro eliminated exchange rate risk among its member states, Germany has invested a substantial portion of its savings in Europe’s current account deficit countries. Some of those savings are now returning home. That’s the capital flight.

German exporters were major beneficiaries of this growth. German banks and financial institutions helped finance the growth.

Exports have provided the majority of Germany’s growth in recent years. Germany is heavily reliant on a narrowly based industrial sector, focused on investment goods—automobiles, industrial machinery, chemicals, electronics and medical devices. These sectors make up a quarter of its GDP and the bulk of exports.

Germany’s service sector is weak with lower productivity than comparable countries. While it argues that Greece should deregulate professions, many professions in Germany remain highly regulated. Trades and professions are regulated by complex technical rules and standards rooted in the medieval guild systems. Foreign entrants frequently find these rules difficult and expensive to navigate.

Any event that makes a euro exit by Greece — the most heavily indebted member state, which is off track on its second bailout program and in the fifth year of a recession — seems bound to accelerate those flows, despite repeated statements by EU leaders that Greece is a unique case. “If it does occur, a crisis will propagate itself through the TARGET payments system of the European System of Central Banks,” U.S. economist Peter Garber, now a global strategist with Deutsche Bank, wrote in a prophetic 1999 research paper. Either member governments would always be willing to let their national central banks give unlimited credit to each other, in which case a collapse would be impossible, or they might be unwilling to provide boundless credit, “and this will set the parameters for the dynamics of collapse,” Garber warned.

The immediate consequences of Greece leaving or being forced out of the euro area would certainly be devastating. Capital flight would intensify, fuelling depreciation and inflation. All existing contracts would need to be redenominated and renegotiated, creating financial chaos. Perhaps most politically devastating, fiscal austerity might actually need to intensify, since Greece still runs a primary deficit, which it would have to correct if EU and International Monetary Fund financing vanished.

But this process would also produce a substantially depreciated exchange rate (50 drachmas to the euro, anyone?) And that would set in motion a process of adjustment that would soon reorient the economy and put it on a path of sustainable growth. In fact, Greek growth would probably surge, possibly for a prolonged period, if it adopted sensible policies to rapidly restore and sustain macroeconomic stability.

Just look at what happened to the countries that defaulted and devalued during the financial crises of the 1990s. They all initially suffered severe contractions. But the recessions lasted only one or two years. Then came the rebound. South Korea posted nine years of growth averaging nearly 6 percent. Indonesia, which experienced a wave of defaults that toppled nearly every bank in the entire system, registered growth above 5 percent for a similar period; Argentina close to 8 percent; and Russia above 7 percent. The historical record shows clearly that there is life after financial crises.

It is now a fair guess that the European Monetary Union (or the eurozone) has crossed the Rubicon and is heading towards breakup or collapse. In the periphery of Greece, Portugal, Ireland and Spain, there is despair at the ever-deepening recession. In France and Italy there is burgeoning opposition to long-term austerity. In Germany there is frustration at feckless southerners.

The disaster is likely to start in Greece. The country is in the midst of an unprecedented depression, made largely in Brussels.

Yet the EU is insisting that the country should stick with the failed programme by imposing huge cuts in public expenditure in 2012-14.

But the shortcomings of the agreement have once again undermined renewed confidence in the eurozone and sent the bond yields of several countries higher, including Spain and Italy.

The Spanish government said a predicted rise in GDP next year of 0.4% had proved optimistic, and the economy would suffer another year of recession.

Regional governments deliver the key parts of the welfare state, including health, education and social services.

Reading the official documents from the June 28 summit requires linguistic and divination skills.

The clearest result is that EFSF/ESM funds can be used directly to support banks.