Francesco Giavazzi is one of the most renowned economists in Italy.

He graduated with a degree in electrical engineering from Politecnico di Milano in 1972 and obtained his Ph.D. in economics from the Massachusetts Institute of Technology in 1978, where his doctoral advisor was Rudi Dornbusch, the author of the world-renowned textbook "Macroeconomics."

Giavazzi returned to Italy and has been teaching at Bocconi University in Milan ever since.

In addition to his academic career, he has been actively involved in politics and the implementation of economic policies.

In the 1990s, he was a member of the economic advisory committee to the Italian government under Prime Minister Giuliano Amato and served as the Director General of the Italian Treasury from 1992 to 1994, where he was responsible for privatization affairs.

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Giavazzi is known for his economic label of "austerity."

At first glance, it may seem like a counterintuitive and unconventional theory.

In the 1990s, he and his Italian compatriot, Harvard Professor Alberto Francesco Alesina, transformed "austerity" into a mainstream policy for economic transformation and development, incorporating it into the "Washington Consensus," which became a typical "prescription" for assistance by the International Monetary Fund.

However, the 1997 Asian financial crisis marked a turning point, with social unrest in many Asian countries leading to widespread reflection.

Neo-Keynesians, represented by Joseph Stiglitz, rose to prominence and began to criticize "austerity" and the Washington Consensus, marginalizing Giavazzi's ideas.

The economist Paul Krugman sharply criticized "austerity" as a form of voodoo economics similar to medieval bloodletting—treating the weak by bleeding them.

Neo-Keynesians have been digging into the ideological roots of austerity, and with Giavazzi and Alesina being Italian, they traced the ideology back to the Italian dictator Benito Mussolini.

In 1925, Mussolini, facing stubborn inflation and a devaluing lira, strictly controlled government spending and significantly increased taxes, quickly restoring the lira's convertibility, eliminating the deficit, and ultimately controlling inflation.

However, neo-Keynesians argue that this was a failure, leading to a decline in social welfare, being detrimental to the lower classes, and beneficial to fascist rule.

This alarming "overgeneralization" reflects the neo-Keynesians' attempt to brand "austerity" with a fascist label, thereby providing moral support for their advocacy of currency devaluation and deficit expansion.

The classification of "austerity" ranges from "Austerity 1" to "Austerity 2."

Austerity is not a baseless fallacy.

In fact, the history of austerity can be traced back to the era of the Magna Carta in England, when the king wanted to expand debt, and the nobility wanted the king to adhere to fiscal discipline, as the philosopher John Locke said, "In some sense, a country is like a household, always needing to measure income and expenditure."

Austerity is not a mechanical contraction either.

To use a household analogy, a family with zero savings has daily living expenses, educational expenses, travel expenses, fitness expenses, and expenses on luxury handbags...

Suppose the family income decreases due to wage cuts or unemployment of a family member, and to maintain the original level of expenditure, the family needs to go into debt (for example, by using more credit cards and taking on more debt).

Then the bank (the lender) will closely monitor the family's income changes, becoming increasingly nervous as the debt increases, and eventually refusing the family's borrowing requests.

The family will observe the future actions of the lender, and the best strategy for the family is to improve its financial situation before being rejected.

For example, cutting out the expense on luxury handbags or further cutting travel expenses, but daily living expenses cannot be compressed, and educational and training expenses cannot be casually reduced (because family members' skills need to progress and keep up with the times).

When the family begins to make necessary contractions, its financial situation will be much better, while maintaining future competitiveness in skills and family morale.

The lender feels that it is completely possible to continue lending to it.

This forms an optimal interactive equilibrium.

Giavazzi and Alesina have proved that "this kind of austerity even has some expansionary economic effects."

In their co-authored book "Austerity: When It Works and When It Doesn't," they wrote: "When the economy reaches or approaches the natural unemployment rate, higher short-term deficit spending leads to an increase in interest rates, a reduction in private investment, and a decrease in economic growth rate.

On the contrary, when government spending decreases and the deficit falls, market interest rates will decline, and total demand (private consumption, private investment, and exports) will experience greater growth.

Austerity policies will lead to expansionary effects."

We call this kind of austerity "Austerity 1."

If a family continues to consume crazily without any review and restrictions, and the debt snowballs to an unimaginable extent, even paying interest becomes a problem, and to obtain loans, not only must they cut out luxury goods and travel expenses, but they may even have to cut educational expenses and live frugally, then this kind of "austerity" makes the family seem to have neither good health nor any future competitiveness, and is austerity for austerity's sake.

This helpless austerity that has missed the best timing (missing "Austerity 1") is indeed very tricky and can easily lead to excessive bleeding.

We call this terrible austerity "Austerity 2."

"Austerity 1" and "Austerity 2" imply the need for completely different approaches.

When the opportunity for "Austerity 1" arises, the country's debt level has not yet reached a panic-inducing level, and it is necessary to resolutely clean up the debt.

In 2010, the famous economists Carmen Reinhart and Kenneth Rogoff co-authored a paper titled "Growth in a Time of Debt," published in the American Economic Review, which argues that when "the total external debt reaches 60% of GDP," a country's annual GDP growth rate will decrease by 2%, and when "the external debt level exceeds 90% of GDP," the country's GDP growth rate will definitely be "halved."

The paper by Carmen Reinhart and Kenneth Rogoff implies a "caution about debt and support for austerity policies" orientation, naturally attracting widespread attacks.

In my view, "Growth in a Time of Debt" actually accurately describes the timing of "Austerity 1," but does not provide a reasonable understanding of "Austerity 2."

When "Austerity 2" occurs, neo-Keynesians generally curse "austerity as voodoo economics."

Ridiculously, perhaps the spendthrift families have joined the "cursing" ranks with a clear conscience—such as Greece, one of the "PIIGS countries" after the subprime crisis, where the Greek people have forgotten how they squandered and borrowed.

After the debt has become overwhelming, they treat "austerity" as a conspiracy against the country, with the old European forces hoping for social unrest in Greece, turning Greece into a "failed state."

Similarly, after the subprime crisis, the UK, under the knife of Chancellor George Osborne, carried out austerity, facing widespread challenges, especially being attacked by politicians as "shifting the debt to the working class," leading to "tens of thousands of innocent suicides" and "nearly a million people with depression."

In fact, this is a complete lie, but it has caused George Osborne's "austerity" to be wasted in the UK.

In the United States, which is completely controlled by neo-Keynesians, it can be imagined that they will not accept any "austerity."

Americans have always felt that "we are a family that can owe unlimited debt," and "the bank (the lender) is also us, because we can print unlimited greenbacks," and fiscal sustainability is a problem for other countries, not likely to be a problem for the United States.

The U.S. national debt will always be issued, and at the lowest interest rates in the world.

Therefore, when the United States experienced the subprime crisis or was hit by the COVID-19 pandemic, Americans bravely used a combination of monetary and fiscal stimulus: quantitative easing, zero-interest-rate monetary policy, cash handouts during the pandemic, fiscal subsidy-type industrial policies, and student loan relief for American college students...

Almost most economists did not expect that the United States would encounter extremely difficult high inflation in 2021.

Is violent interest rate hikes an austerity for a "soft landing"?

Starting from 2021, the U.S. inflation rate began to soar, with the overall inflation rate for 2021 reaching a level of 4.7%.

At the beginning of 2022, the Russia-Ukraine conflict broke out, and subsequently, most American economists believed that this round of U.S. inflation from 2021 to 2023 was due to the Russia-Ukraine conflict disrupting the global supply chain.

Few people said that, in fact, the U.S. inflation rate had soared since 2021.

Why did inflation occur in 2021?

The reason is simple: the lingering effects of the superabundant monetary policy in the United States after the subprime crisis and the "effect superposition" of the United States directly giving out 5 trillion U.S. dollars to the public during the COVID-19 pandemic.

Blaming inflation on the Russia-Ukraine conflict is like blaming a plane crash on gravity; although it looks partially correct, it completely misses the point.

The Federal Reserve began "violent interest rate hikes," with Powell absorbing "Volcker's experience."

After inflation was officially confirmed, the Federal Reserve directly "killed" the federal benchmark interest rate from zero interest rates (0-0.25%) to a level of 5.25-5.5% within two years.

Led by the United States, except for a few countries such as Japan and China, the world has converged in interest rate hikes because everyone is troubled by inflation.From the consumer price perspective in November 2023, Powell's tactics have taken effect.

The U.S. inflation rate has dropped from a high of 9.1% in June 2022 to the current level of 3.1%, seemingly on the verge of achieving the 2% inflation target.

Interestingly, the Fed's "aggressive rate hikes" have not led to a recession in the United States.

The U.S. employment rate remains robust, with the unemployment rate at only 3.7%.

The U.S. real estate market is not entirely weak, with the Case-Shiller Index hovering at high levels.

The U.S. stock market is almost the only unbeatable myth in the world, with stock indices still reaching new highs.

Americans continue to consume crazily, with consumption still accounting for 70% of the U.S. GDP.

The U.S. dollar remains the strongest currency in the world, with all paper currencies depreciating against the dollar.

In short, in a world where the economy is drying up, the United States is the only "oasis."

In a world where gravity pulls everything down, the United States rises "against gravity."

This is the popular narrative about the United States.

Whether in the United States or China, most macroeconomists rely on data provided by the U.S. government to make very "timely" and very "routine" research, without insight into some "obvious clues."

Their trumpeting discourse still cannot "cover up" many doubts.

First, in a world where the dollar is strong, the dollar's old "rival" - gold - should theoretically be suppressed by the dollar and plummet.

It is shocking that while the dollar is incredibly strong, gold is also incredibly strong.

Gold prices have steadily stood at a high of $2,000 per ounce.

Central banks from China, Russia, India, and Brazil, as well as market collectors, are flocking to buy gold.

According to past logic, they should embrace the dollar and abandon gold.

Second, the U.S. stock market is now dominated by the "Seven Dwarfs."

The "Seven Dwarfs" refer to the seven major technology stock giants: Apple, Microsoft, Google, Amazon, Meta (Facebook), Tesla, and Nvidia.

They are the only group of stocks that are rising, and their market value has already accounted for more than 30% of the total market value in the United States.

Frankly speaking, only they are rising, and only they are driving the overall rise of the stock market.

Check any large high-quality stock outside the Seven Dwarfs - such as Nike, Boeing, Disney, Netflix... compared with their peak, they have all fallen by at least 15%.

It can be said that the U.S. stock market has entered an era where a few super giants are supporting the market.

If the Seven Dwarfs make a slight mistake, the U.S. stock market will collapse.

Again, the United States experienced a banking collapse crisis in 2023.

Silicon Valley Bank (SVB), Silvergate Bank, and Signature Bank, three medium-sized banks, collapsed and were attributed to investments in cryptocurrencies.

The truth is not so.

The real reason for their collapse is that they actually bet on the price of the highest-quality asset in the United States - U.S. Treasury bonds - to keep rising.

These banks bought a large amount of Treasury bonds when interest rates were at their lowest and prices were at their highest.

As the Fed "aggressively raised interest rates," the interest rates of new Treasury bonds increased and prices fell, leading to a rapid decline in the prices of old Treasury bonds.

These three banks never thought that investing in U.S. Treasury bonds would also lead to huge asset losses.

The bankruptcy of these banks will cause high-value customers with savings exceeding $250,000 to suffer huge losses, thereby triggering a follow-up run.

The Fed urgently established the Bank Term Funding Program (BTFP), which is equivalent to promising to "take over" the bank's loss-making Treasury bonds at the previous high prices to avoid the bank's investment failure in Treasury bonds.

Frankly speaking, what did these three banks do wrong?

They did nothing wrong.

Their bet on Treasury bonds is also a common practice in the banking system.

We can naturally infer that the essence of the collapse of these banks is actually a crisis in the value of U.S. government bonds.

Again, the main driver of the strong U.S. economy is consumer spending.

Before the COVID-19 pandemic, the proportion of goods expenditure and service expenditure in consumer spending changed synchronously, with the ratio of goods expenditure to service expenditure being 4:6.

Buying more goods also meant buying more services.

After the COVID-19 pandemic, consumer spending has completely shifted to goods expenditure, not service expenditure.

It is precisely because consumer spending has shifted to goods that the rise in commodity prices has become the "main driving force" of U.S. inflation, especially food prices.

Although the U.S. inflation data in November has slowed down, food prices have still risen month-on-month.

Prices have not fallen, but have just risen a little slower.

The price of a cup of coffee, assuming it was $5 two years ago, is now at least $6.5, and the price of any food is at least 30% higher than in the past.

During the COVID-19 pandemic, the U.S. government gave a lot of money to the public, and the public naturally spent or invested in stocks with the money.

The money issued by the U.S. government has increased the savings rate of Americans in the short term, reaching a recent high of 6.5%.

Now the U.S. savings rate has quickly fallen below 4%, lower than before the pandemic, which means that the money issued has almost been spent, and also means that more Americans have no savings.

Interestingly, the overall consumption expenditure of the United States is still so strong, is it because the rich spend more?

Not necessarily, middle-class assets and the poor are all frantically consuming loans, especially using a brand-new weapon of consumption installment: BNPL (Buy now, pay later).

BNPL does not belong to the strictly reviewed credit card consumption, it is a consumption installment (not a fixed period of installment) by emerging financial technology institutions (such as Affirm Holdings) in cooperation with retailers.

Financial technology institutions pay merchants and provide customers with various repayment options.

Financial technology institutions directly obtain commissions from merchants, and the commission rate is higher than the credit card rate (this ratio is between 3%-8%).

Half of American adults have used BNPL, most of them are poor, mainly using BNPL to purchase rising prices of food and other necessities to help them through the shortage of money until they receive the next salary and repay BNPL (BNPL is much larger than the past "payday loans").

The scale of BNPL is getting bigger and bigger, almost reaching an annual scale of $72 billion, and the annual growth rate is still over 20%.

We can make some inferences through the consumption expenditure of BNPL that is ignored by the official: BNPL is a hidden high bad debt rate consumption behavior, which is fragile and may be a manifestation of the "cost of living crisis" (Cost of living crisis) on the debt side.

Finally, the strong non-farm employment data issued by the United States is obtained through questionnaires.

The U.S. labor market has a "double-edged sword": the white-collar market employment is not hot, and the empty office buildings with increasing vacancy rates give a clear answer; the blue-collar market employment is indeed hot, and blue-collar wages are also rising.

Even giving people the feeling that the Fed's continuous interest rate hikes will make the overall non-farm employment in the United States even more hot, this abnormal phenomenon proves that the U.S. economy has invincible strong resilience.

However, many people have not considered that the employment statistical data obtained through telephone questionnaires is very vague and highly variable.

Especially in recent years, the blue-collar labor force has appeared "overall part-time situation": one person works part-time for several jobs at the same time.

Part-time work in the United States has accounted for nearly 20% of all employment, and this "part-time" may be counted as multiple jobs in the U.S. statistical approach, thereby overestimating the actual employment rate.

Therefore, we do not think that the current popular view that "the Fed's interest rate hikes have achieved a soft landing for the U.S. economy" is correct.

In many situations where there is a deviation between clues and official data, it is just a blind man in the dark touching an elephant's leg.

From "austerity" to market-driven austerity, the relationship between this round of "aggressive rate hikes" and "economic soft landing" in the United States is "inlaid" in a complex political and economic background.

In addition to the "disturbances" in the global supply chain under the COVID-19 pandemic, the industrial chain movement brought by the geopolitical competition between China and the United States, and the price fluctuations of bulk commodities (natural gas, oil, and food) brought by the Russia-Ukraine conflict (including smaller-scale conflicts between Israel and Hamas), there are also large-scale changes in U.S. industrial policies - especially the Inflation Reduction Act is a large bill, including many strong fiscal stimulus measures, such as the chip bill, new energy electric vehicle investment and subsidies, family paid leave plans, prescription drug price reforms...

The Fed's rapid interest rate hikes are, of course, a "tightening" of capital prices, just like the original idea of "austerity": the expansion of the government or the market is always limited, and the end of expansion is contraction.

Either at the wisest time, take the initiative to "contract" ("austerity 1"), or develop to the "austerity 2" that cannot be salvaged, waiting for the market's spontaneous contraction - just like the trouble Argentina is facing now, they have already "played too far" with the monetization of fiscal deficits, no matter what method the new president Miley uses, whether it is dollarization or privatization, the result is the market's spontaneous contraction.

Frankly speaking, as long as a part of the huge debt must be cashed, it will form an overall "deleveraging."

The mechanism is a bit like the collapse of the stock market or the real estate market bubble: "In the later stage of the bubble," there must be a large number of weak people taking over, and they are often the most likely to have a capital break.

Because they support a huge market value from a marginal perspective - for example, if a stock has a market value of 1,000 billion, the transaction volume in the "bubble later stage" is only 10% (a scale of 100 billion), but the price has increased by 5 times, which means that the 90% of the stocks that did not participate in the stock market transaction also automatically obtained a 5-fold increase.

The market value has expanded by 5 times, which means that to achieve the same turnover rate, a larger amount of funds is needed - and the weak cannot provide such a large amount of funds, so it will definitely induce the strong people who made money before to participate deeply at high positions.

In the end, when the bubble bursts and the stock market falls sharply, most people are "leeks."

The most critical point of this principle is: the market value seems to evaporate a lot, but in fact, it has not lost so much money, not so much money has participated, but most of the existing money has been redistributed, so that the vast majority of participants are losers.

The same principle, fierce inflation also brings this "effect of most people being losers.

"Return to the economic narrative of the United States.

After the subprime crisis, the U.S. adopted a combination of zero interest rates and quantitative easing policies.

However, the reason for the absence of inflation was that the Federal Reserve's money was directly "recorded on the balance sheets of troubled financial institutions (such as AIG)."

When investors saw that these financial institutions had money on their books, they stopped the run, thereby allowing the contraction to terminate automatically.

The Federal Reserve's money, as a form of accounting, did not flow into the market.

At that time, emerging market countries, represented by China, massively increased their holdings of U.S. Treasury bonds and "went all out in production," exporting high-quality and low-cost Chinese products to the United States, sparing American consumers the trouble of inflation.

After the subprime crisis, the United States was originally in a comfortable situation of "contraction 1," and the Federal Reserve did not contract in time.

During Trump's administration, the Federal Reserve, under pressure from his demands, did not dare to raise interest rates but instead slowly reduced its balance sheet.

Long-term low interest rates will, of course, stimulate borrowing, and credit prosperity will lead to widespread improper investments.

Due to cheap capital, investors will invest in more roundabout, "longer production or cash realization processes" technologies, such as "high-tech" industries with "amazing concepts" that cannot immediately yield returns.

Borrowers use the newly acquired funds to purchase new capital goods, and the proportion of total expenditure allocated to "high-tech" capital goods rather than basic consumer goods continues to increase.

Over time, excessive credit leads to mispricing, and mispricing leads to allocation errors, causing a decline in immediate productivity and making basic consumer goods scarce, thereby making inflation visibly apparent.

Ultimately, credit prosperity leads to asset bubbles, inflation, and is accompanied by a decline in actual productivity, and even local market bubbles begin to burst.

Governments generally rescue insolvent banks or continue to increase deficit spending to "stimulate" the economy, exacerbating misallocation and improper investment, and significantly increasing government debt and long-term debt burdens.

Thus, "contraction 2" arrives, and the market begins to contract spontaneously.

Americans initiate geopolitical disputes, and Biden directly gives money to Americans during the COVID-19 pandemic.

The U.S. inflation rate suddenly soars, forcing the Federal Reserve to "aggressively raise interest rates."

This process is not dominated by the Federal Reserve but is a process of spontaneous market contraction, with the Federal Reserve being passive.

It heralds that the U.S. government can no longer enter a comfortable period of economic stimulus.

If the U.S. government waits for a short-term decline in inflation and quickly lowers interest rates in 2024, U.S. inflation is likely to continue to grow; if the U.S. fears that inflation will continue to rise and continues to maintain high interest rates, the economy will contract under high interest rates, and people will suffer the pain of high interest.

In fact, both the Austrian school's economic cycle and Eichengreen's "credit cycle theory" roughly clearly describe the boundary effects of this "spontaneous market contraction."

The only thing that economists are unwilling to believe is that this could happen in the United States.

They are more willing to believe that this is a story that happens in Japan.

The United States is a special country, and the U.S. dollar is the global hegemonic currency.

Half of the United States' national debt is borne by external investors, unlike Japan, whose national debt is entirely "held" by their own people and cannot be shared with others.

However, under the "new Cold War" between the East and the West, the United States is more like Japan.

China, Russia, and many Muslim countries, despite enduring their own economic pains, resolutely reduce their holdings of U.S. debt.

The United States' European allies, Japan, South Korea, and Australia, their declining strength seems unable to hold a large amount of the United States' additional debt, leading to Americans even becoming stingy with the "fighting expenses" given to Ukraine.

The United States' current strategy is to encourage the return of U.S. capital that was originally invested in China (such as letting Western media constantly "sing the praises of" China's economy); or to let the wealthy in China, Russia, and the Middle East convert their wealth into U.S. dollars and then remit it to the United States, thereby completing the external "sharing."

However, countries such as China, Russia, and Turkey have increased their scrutiny and restrictions on this kind of asset outflow, and the wealthy's bodies and money have gained "national borders."

Undoubtedly, the United States is also experiencing "spontaneous market contraction."

In a dialogue with Francesco Giavazzi in "Peking University Financial Review": Professor Giavazzi, your paper "What do we know about the effects of Austerity?"

is a very influential paper, and we believe its views are correct.

If faced with fiscal deficits and inflation, it is very necessary to adopt a method of cutting expenditures in the short term.

How do you view the United States, which quickly raises interest rates but is unwilling to control the deficit?

Do you think the Federal Reserve has effectively controlled inflation through this round of significant consecutive interest rate hikes?

Giavazzi: The recent inflation problem in the United States stems from excessive demand, and the economy is close to full employment, but the significant increase in public spending has caused inflation.

Their mistake mainly lies in the uncertainty about the level of the natural unemployment rate, and therefore there is doubt about how much the labor market can recover.

The memory of the Great Depression leads some people to believe that during the recovery process, public spending is not enough to reduce the unemployment rate to a new natural rate, which is below the pre-crisis natural rate.

However, the Federal Reserve has done a good job in eradicating inflation from the economy because they started early and are taking action quickly.

The lesson learned from this event is that deficits are not always bad.

The real lesson is that before using fiscal deficits to stimulate economic growth, the government should ask how much room there is before reaching the natural unemployment rate.

Of course, this is difficult because the natural unemployment rate will change over time, and people will never know how far the economy is from that level.

"Peking University Financial Review": Is Europe's inflation mainly due to external factors, such as the skyrocketing import prices of oil and natural gas?

How do you view the European Central Bank's rapid interest rate hikes to control inflation?

Giavazzi: Unlike the United States, Europe's recent inflation is entirely due to the conflict between Russia and Ukraine, which has led to an increase in natural gas prices.

In the end, Europe took the right approach.

It implemented price caps on natural gas, and then we saw the inflation rate drop rapidly.

It took almost a full year to persuade all EU countries to implement price caps—the idea was first proposed by Italian Prime Minister Mario Draghi a week after the Russia-Ukraine conflict—while inflation had already spread.

However, the European Central Bank ultimately took the right approach, allowing the inflation rate to drop rapidly.

But compared to the rapid response of the Federal Reserve, the European Central Bank's response was not fast enough: the introduction of price caps was too delayed.

In fact, if the European Central Bank had reacted more quickly, it would have meant a lower inflation rate and the ability to maintain a lower interest rate level than it is currently at.

"Peking University Financial Review": According to the recent statement of the Federal Reserve, they seem to be pausing halfway through the interest rate hikes.

Does this mean that the dollar's strength has come to an end?

What impact will this have on the bonds and capital flows of other countries around the world?

Giavazzi: Yes, I believe the Federal Reserve's interest rate hikes have reached their peak, and they will lower interest rates next.

This will reverse capital flows and have an impact on the exchange rate of the dollar.

"Peking University Financial Review": We are particularly interested in your views on China's interest rate policy from 2021 to 2023.

Do you think China now needs to significantly lower interest rates to get rid of deflation?

Giavazzi: I am not familiar enough with the People's Bank of China's interest rate policy to make a judgment.

I am still stuck in the old impression from 20 years ago.

I wrote a paper around 2005 about the imbalance of the Chinese economy: too much investment and too little consumption.

Chinese families lack a social safety net, which forces them to save too much.

Excessive savings mean too much investment, leading to production bottlenecks (such as rising raw material prices), and therefore there is a risk of inflation.