George Soros - Germany - "To be sure, Germany cannot be blamed for wanting a strong currency and a balanced budget but it can be blamed for imposing its predilection on other countries that have different needs and preferences - like Procrustes, who forced other people to lie in his bed and stretched them or cut off their legs to make them fit. The Procrustes bed inflicted on the eurozone is called deflation.
Unfortunately Germany does not realize what it is doing. It has no desire to impose its will on Europe; all it wants to do is to maintain its competitiveness and avoid becoming the deep pocket to the rest of Europe. But as the strongest and most creditworthy country it is in the driver's seat. As a result Germany objectively determines the financial and macroeconomic policies of the eurozone without being subjectively aware of it. When all the member countries try to be like Germany they are bound to send the eurozone into a deflationary spiral. That is the effect of the policy pursued by Germany and - since Germany is in the driver's seat - these are the policies imposed on the eurozone."
Scott Sumner - Fed and fiscal policy - "My point is that fiscal stimulus must always be examined in the context of monetary policy. If you have conservative central banks that are rigidly targeting the price level, then fiscal stimulus may be ineffective. But in fairness to the other side, I’m sure you could build a plausible argument that under the sort of dysfunctional Fed described above, it might have a stimulative effect. Perhaps Bernanke is not strong enough to take any unconventional policy initiatives, but is strong enough to prevent the conservatives from inhibiting fiscal stimulus through a premature exit strategy. But as I said, I don’t think fiscal policy is very powerful even if there is no push-back from the Fed."
Michael Pettis - Greece - "Greece’s insolvency will not be recognized for many years.
When most of the obligations of an insolvent sovereign were widely dispersed among a wide variety of bondholders, market forces acted relatively quickly to force debt forgiveness. Defaulted bonds trade at deep discounts, and it is a lot easier for someone who bought the debt at one-quarter its face value to agree to 50% debt forgiveness than for someone who made the original loan.
But things are different with the current crop of insolvent European sovereign debts, as they were with the sovereign loans of the 1970s. They are heavily concentrated within the banking system, and the banks cannot recognize the losses without themselves collapsing into insolvency.
That cannot be allowed to happen. The LDC debt crisis of the 1980s raged on nearly a full decade – a decade of stopped payments, capital flight, and agonizingly low growth – before creditors formally acknowledged that most struggling borrowers could not repay their debt and would need partial debt forgiveness. The first formal recognition of debt forgiveness occurred with Mexico’s Brady Plan restructuring in 1990. Growth returned to most countries only after it became clear that they would receive debt forgiveness."
Monday, June 28, 2010
Friday, June 25, 2010
Really great links - Bank equity - China
Andrew Smithers - Supporters of Capitalism Should Read This - "Bankers have brought capitalism into disrepute. To their traditional enemies on the Left they have added those who favour free markets. Despite the remarkable achievement of uniting such a broad spectrum of political opponents, bankers clearly expect to avoid retribution for their misdeeds. Supporters of capitalism, who want its benefits preserved, call for large increases in banks’ equity capital. US banks have responded by buying back their equity. The Left denounce the outrageous pay levels and bankers respond by awarding themselves huge additional bonuses.
These actions suggest that bankers, as a group, are not unduly sensitive people. But it is nonetheless incredible that they do not realise that large increases in their equity will be part of the new regulations. Their motive in buying back part of their already inadequate equity calls therefore for examination."
Scott Sumner - China - "Is there anywhere else in the world where a 1076-foot skyscraper would be built for “farmers” and located not in a city, but in the “countryside?”"
These actions suggest that bankers, as a group, are not unduly sensitive people. But it is nonetheless incredible that they do not realise that large increases in their equity will be part of the new regulations. Their motive in buying back part of their already inadequate equity calls therefore for examination."
Scott Sumner - China - "Is there anywhere else in the world where a 1076-foot skyscraper would be built for “farmers” and located not in a city, but in the “countryside?”"
Tuesday, June 22, 2010
Really great links - Inflation - Deficits - Germany
John Cochrane - Inflation - "The scenario leading to inflation starts with poor growth, possibly reinforced by to larger government distortions, higher tax rates, and policy uncertainty.
Lower growth is the single most important negative influence on the Federal budget. Then, the government may have to make good on its many credit guarantees. A wave of sovereign (Greece), semi-sovreign (California) and private (pension funds, mortgages) bailouts may pave the way. A failure to resolve entitlement programs that everyone sees lead to unsustainable deficits will not help.
When investors see that path coming, they will quite suddenly try to sell government debt and dollar-denominated debt. We will see a rise in interest rates, reflecting expected inflation and a higher risk premium for U.S. government debt. The higher risk premium will exacerbate the inflationary decline in demand for U.S. debt. A substantial inflation will follow — and likely a “stagflation” not inflation associated with a boom. The interest rate rise and inflation can come long before the worst of the deficits and any monetization materialize. As with all forward-looking economics, no obvious piece of news will trigger these events. Officials may rail at “markets” and “speculators.” Economists and the Fed may scratch their heads at the sudden “loss of anchoring” or “Phillips curve shift.”"
John Cochrane - Deficits and default - "Put another way, the U.S. problem, large prospective deficits with a relatively small stock of outstanding debt, would otherwise put us in a real fiscal pickle, since we can’t devalue debt we haven’t issued yet. Even an infinite price level — a default of all outstanding US debt, cutting future interest payments to zero — is not enough to pay for the CBO’s projections of Social Security and Medicare deficits. On the other hand, the fact that real surpluses increase with inflation makes it much more likely that the government will choose inflation rather than explicit spending cuts. Again, one should not think of surpluses as exogenous in this fiscal analysis. Really we should think of the Government’s decision to inflate, trading off distorting taxes, useful or politically popular spending, and the distortions caused by inflation, and the ability to place blame elsewhere in making this decision."
Tyler Cowen - Understanding German fiscal policy - "The Germans see themselves as having made the necessary wage adjustments, in advance, and in a manner that Keynesian economics is skeptical of. The Germans also see themselves as having produced and maintained true credibility about future fiscal policy (how many other countries can claim that?) by a constitutional amendment, a lot of tough talk, and a relatively robust real economy. German bonds are a safe haven investment, even though Germany's numbers, such as the debt-gdp ratio, are not overwhelmingly wonderful. That's a testament to German public sector management.
Did I mention that -- after unification -- the Germans tried (against their will, they had to) more than a decade of massive fiscal stimulus, and subsidization of consumption, starting with well under full employment, and yet with mediocre results? That wasn't long ago."
Lower growth is the single most important negative influence on the Federal budget. Then, the government may have to make good on its many credit guarantees. A wave of sovereign (Greece), semi-sovreign (California) and private (pension funds, mortgages) bailouts may pave the way. A failure to resolve entitlement programs that everyone sees lead to unsustainable deficits will not help.
When investors see that path coming, they will quite suddenly try to sell government debt and dollar-denominated debt. We will see a rise in interest rates, reflecting expected inflation and a higher risk premium for U.S. government debt. The higher risk premium will exacerbate the inflationary decline in demand for U.S. debt. A substantial inflation will follow — and likely a “stagflation” not inflation associated with a boom. The interest rate rise and inflation can come long before the worst of the deficits and any monetization materialize. As with all forward-looking economics, no obvious piece of news will trigger these events. Officials may rail at “markets” and “speculators.” Economists and the Fed may scratch their heads at the sudden “loss of anchoring” or “Phillips curve shift.”"
John Cochrane - Deficits and default - "Put another way, the U.S. problem, large prospective deficits with a relatively small stock of outstanding debt, would otherwise put us in a real fiscal pickle, since we can’t devalue debt we haven’t issued yet. Even an infinite price level — a default of all outstanding US debt, cutting future interest payments to zero — is not enough to pay for the CBO’s projections of Social Security and Medicare deficits. On the other hand, the fact that real surpluses increase with inflation makes it much more likely that the government will choose inflation rather than explicit spending cuts. Again, one should not think of surpluses as exogenous in this fiscal analysis. Really we should think of the Government’s decision to inflate, trading off distorting taxes, useful or politically popular spending, and the distortions caused by inflation, and the ability to place blame elsewhere in making this decision."
Tyler Cowen - Understanding German fiscal policy - "The Germans see themselves as having made the necessary wage adjustments, in advance, and in a manner that Keynesian economics is skeptical of. The Germans also see themselves as having produced and maintained true credibility about future fiscal policy (how many other countries can claim that?) by a constitutional amendment, a lot of tough talk, and a relatively robust real economy. German bonds are a safe haven investment, even though Germany's numbers, such as the debt-gdp ratio, are not overwhelmingly wonderful. That's a testament to German public sector management.
Did I mention that -- after unification -- the Germans tried (against their will, they had to) more than a decade of massive fiscal stimulus, and subsidization of consumption, starting with well under full employment, and yet with mediocre results? That wasn't long ago."
Monday, June 21, 2010
Really great links - Stability - Congressman, Heal Thyself! - Dollar crisis - IMF - Sovereign CDS
Anonymous hedge funder - Financial regulation and stability - "If there's one thing that I wish the regulators understood, it's that the worst blowups are ignited by bad trades that become a consensus stampede. In emerging markets, the crashes always traced back to something everybody considered "the trade of the year." This time, it was the strong and wrong consensus around housing values. The next one may arise from the assumption that developed-markets sovereigns don't default.
Stability depends on disagreement. A constructive regulatory regime would institutionalize disagreement-by, for example, increased risk-weighting for assets that are heavily owned-and, in automatic fashion, lean against monolithic consensus. Alas, politicians so unanimous in their views about the power of regulation to prevent crisis appear to be caught in a consensus stampede of their own."
Paul Kasriel - Congressman, Heal Thyself! - "On one of this past Sunday’s morning political talk shows, I heard a congressman say that the runaway federal government spending had to stop. Congressman, sir, although the spending continues to increase, the rate of growth in that spending has slowed enormously. In the 12 months ended May 2010, the accumulated spending by the federal government totaled $3.437 trillion, enough to keep the late Senator Dirksen spinning in his grave for near eternity. Although an admittedly high level, this 12-month accumulated total federal spending was only 2.6% higher than the 12-month accumulated total federal spending for May 2009 (see Chart 1). This is quite a deceleration in growth from the 15.3% registered for the 12 months ended 2009 vs. 2008, near the trough of the last recession. Moreover, the 2.6% year-over-year growth in the 12-month accumulated total federal outlays in May 2010 is considerably lower than the 8.4% year-over-year growth in the 12-month accumulated total federal outlays in May 2006. Why do I mention May 2006? Because at that time, the congressman’s political party controlled Congress and the White House. Congressman, heal thyself!"
James Hamilton - Inflation or deflation - "The source of my concern about long-run inflation comes not from the expansion of the Fed's balance sheet, but instead from worries about the ability of the U.S. government to fund its fiscal expenditures and debt-servicing obligations as we get another 5 or 10 years down the current path. Just as many analysts have had trouble seeing how Greece can reasonably be expected over the near term to move to primary surpluses sufficient to meet its growing debt servicing costs, I have similar problems squaring the numbers for the U.S. looking a little farther ahead.
The way that I would envision these pressures translating into inflation would be a flight from the dollar by international lenders, leading to depreciation of the exchange rate, increase in the dollar price of traded goods, and possible sharp challenges for rolling over U.S. Treasury debt. We've of course been seeing the exact opposite of this over the last few months, as worries in Europe and elsewhere have resulted in a flight to the dollar and the perceived safety of U.S. Treasuries. That appreciation of the dollar has been one factor keeping U.S. inflation down. So any inflation scare is clearly not an incipient development, but instead something we'd possibly face farther down the road."
Mark Copelovitch - IMF - "The domestic financial interests of the IMF's largest shareholders have been a critical determinant of variation in IMF lending policies over the last three decades. As the Fund's largest quota contributors, the "G-5" countries (the US, Germany, Japan, UK, and France) exercise de facto control over IMF lending decisions. At the same time, the G-5 countries are also home to the largest private creditors in global markets, including the world's largest commercial banks. Consequently, G-5 bank exposure heavily influences these governments' preferences over IMF lending policies. In particular, I find that IMF loan size and conditionality vary widely based on the intensity and heterogeneity of G-5 governments' domestic financial ties to a particular borrower country. When private lenders throughout the G-5 countries are highly exposed to a borrower country, G-5 governments collectively have intense preferences and are more likely to approve larger IMF loans with relatively limited conditionality. In contrast, when G-5 private creditors' exposure to a country is smaller or more unevenly distributed, G-5 governments' interests are weaker and less cohesive, and the Fund approves smaller loans with more extensive conditionality."
Deus Ex Macchiato - Sovereign CDS - "This is a classic example of unintended consequences. One element of Basel 3 is a capital charge for the variation of counterparty valuation adjustment – basically the adjustment derivatives traders take to reflect the credit quality of their counterparties. The CVA is largest on uncollateralised swaps: collateral reduces it massively. And which is the most significant class of counterparties who refuse to post collateral? Sovereigns and supranationals. Therefore making banks hedge their CVA better has the effect of forcing them to buy more sovereign CDS, which in turn may increase government borrowing costs. Spread widening isn’t necessarily caused by the evil CDS market speculating on sovereign default; instead it may well be regulatory action that is the cause."
Stability depends on disagreement. A constructive regulatory regime would institutionalize disagreement-by, for example, increased risk-weighting for assets that are heavily owned-and, in automatic fashion, lean against monolithic consensus. Alas, politicians so unanimous in their views about the power of regulation to prevent crisis appear to be caught in a consensus stampede of their own."
Paul Kasriel - Congressman, Heal Thyself! - "On one of this past Sunday’s morning political talk shows, I heard a congressman say that the runaway federal government spending had to stop. Congressman, sir, although the spending continues to increase, the rate of growth in that spending has slowed enormously. In the 12 months ended May 2010, the accumulated spending by the federal government totaled $3.437 trillion, enough to keep the late Senator Dirksen spinning in his grave for near eternity. Although an admittedly high level, this 12-month accumulated total federal spending was only 2.6% higher than the 12-month accumulated total federal spending for May 2009 (see Chart 1). This is quite a deceleration in growth from the 15.3% registered for the 12 months ended 2009 vs. 2008, near the trough of the last recession. Moreover, the 2.6% year-over-year growth in the 12-month accumulated total federal outlays in May 2010 is considerably lower than the 8.4% year-over-year growth in the 12-month accumulated total federal outlays in May 2006. Why do I mention May 2006? Because at that time, the congressman’s political party controlled Congress and the White House. Congressman, heal thyself!"
James Hamilton - Inflation or deflation - "The source of my concern about long-run inflation comes not from the expansion of the Fed's balance sheet, but instead from worries about the ability of the U.S. government to fund its fiscal expenditures and debt-servicing obligations as we get another 5 or 10 years down the current path. Just as many analysts have had trouble seeing how Greece can reasonably be expected over the near term to move to primary surpluses sufficient to meet its growing debt servicing costs, I have similar problems squaring the numbers for the U.S. looking a little farther ahead.
The way that I would envision these pressures translating into inflation would be a flight from the dollar by international lenders, leading to depreciation of the exchange rate, increase in the dollar price of traded goods, and possible sharp challenges for rolling over U.S. Treasury debt. We've of course been seeing the exact opposite of this over the last few months, as worries in Europe and elsewhere have resulted in a flight to the dollar and the perceived safety of U.S. Treasuries. That appreciation of the dollar has been one factor keeping U.S. inflation down. So any inflation scare is clearly not an incipient development, but instead something we'd possibly face farther down the road."
Mark Copelovitch - IMF - "The domestic financial interests of the IMF's largest shareholders have been a critical determinant of variation in IMF lending policies over the last three decades. As the Fund's largest quota contributors, the "G-5" countries (the US, Germany, Japan, UK, and France) exercise de facto control over IMF lending decisions. At the same time, the G-5 countries are also home to the largest private creditors in global markets, including the world's largest commercial banks. Consequently, G-5 bank exposure heavily influences these governments' preferences over IMF lending policies. In particular, I find that IMF loan size and conditionality vary widely based on the intensity and heterogeneity of G-5 governments' domestic financial ties to a particular borrower country. When private lenders throughout the G-5 countries are highly exposed to a borrower country, G-5 governments collectively have intense preferences and are more likely to approve larger IMF loans with relatively limited conditionality. In contrast, when G-5 private creditors' exposure to a country is smaller or more unevenly distributed, G-5 governments' interests are weaker and less cohesive, and the Fund approves smaller loans with more extensive conditionality."
Deus Ex Macchiato - Sovereign CDS - "This is a classic example of unintended consequences. One element of Basel 3 is a capital charge for the variation of counterparty valuation adjustment – basically the adjustment derivatives traders take to reflect the credit quality of their counterparties. The CVA is largest on uncollateralised swaps: collateral reduces it massively. And which is the most significant class of counterparties who refuse to post collateral? Sovereigns and supranationals. Therefore making banks hedge their CVA better has the effect of forcing them to buy more sovereign CDS, which in turn may increase government borrowing costs. Spread widening isn’t necessarily caused by the evil CDS market speculating on sovereign default; instead it may well be regulatory action that is the cause."
Friday, June 18, 2010
Really great links - Fiscal policy - Carmen Reinhart - Financial repression - Twitter panic - Toward a More Efficient Labor Market
Brad DeLong - Fiscal Policy - Words of wisdom - "For a couple of years now--ever since we slammed into the zero nominal interest rate lower bound--I have been wandering around saying:
Arnold Kling - Capital inflows - "Start with Reinhart. I find her a bit like Paul Samuelson, in that she seems to have a lot of thoughts running through her mind, and only a sample of those thoughts get processed through her vocal cords. This leaves many thoughts unexpressed.
For example, here are three things I thought I heard her saying.
1. Large capital inflows end badly. They are the predecessor for financial crises.
2. Financial liberalization promotes capital inflows.
3. Financial liberalization is a good thing.
The opposite of financial liberalization is financial repression. Under financial repression (think China), about the only savings vehicle available is government bonds. The government then allocates capital. Private capital inflows are minimized, because who wants to invest overseas in low-yielding bonds? Domestic savers get stuck with low yields and low incomes. Reinhart thinks we will see more financial repression in debt-ridden western countries, so that governments can continue to market their debt. Have a nice day.
I assume that some of Reinhart's unexpressed thoughts help to explain how to reconcile the benefits of financial liberalization with a desire to avoid crises caused by large capital inflows. Maybe somebody can look up what she has written and find the answer."
Michael Pettis - Financial repression - "There have periods of inflation in China in recent years, and even a brief inflationary scare in 2007 and 2008, but on average inflation has been far less than what was needed to revalue the currency sufficiently.
So what happened? Why has inflation been muted – as it has by the way in other countries that followed the so-called Asian growth model, including most importantly Japan in the past several decades?
Two months ago University of Chicago economist, Robert Aliber, came to speak at my central banking seminar at the Guanghua School of Peking University. In a fascinating discussion he explained that in fact there was another possible resolution of the imbalances caused by relatively rapid productivity growth in the tradable goods sector.
He pointed out that if the nominal exchange rate is not allowed to rise, policymakers can still contain inflation by what economists call financial repression, made possible by their control over the banking system in countries where banks completely dominate the financial system. In the Chinese context, financial repression exists because the vast bulk of Chinese savings is in the form of bank deposits, and the deposit rate is set at extremely low levels.
This has the effect of transferring large amounts of income away from net savers, which for the most part consists of Chinese households, and in favor of net users of capital. Net users, of course, consist primarily of large, capital intensive businesses, real estate developers, infrastructure investors and local and central governments, including the People’s Bank of China, the largest net borrower of renminbi in China. Net savers are forced into subsidizing net users, in other words.
The consequence is that monetary growth is channeled not into household demand but rather into the production of more goods, and the inflationary impact of monetary expansion is muted. Financial repression is an alternative to currency appreciation or inflation."
Steven Pinker - Twitter panic - "Media critics write as if the brain takes on the qualities of whatever it consumes, the informational equivalent of "you are what you eat." As with primitive peoples who believe that eating fierce animals will make them fierce, they assume that watching quick cuts in rock videos turns your mental life into quick cuts or that reading bullet points and Twitter postings turns your thoughts into bullet points and Twitter postings."
Steve Landsburg - Toward a More Efficient Labor Market - "An anonymous math department chairman reports on his own strategy for cutting down on the workload. He believes that one of the most important determinants of a successful career is luck. So each year, he randomly rejects half the applicants without even reading their folders. That way, he eliminates the unlucky ones."
The obvious policy is the long-term debt neutral stimulus: spending increases and tax cuts for the next three years, standby tax increases with triggers and spending caps with triggers thereafter, all calculated to guarantee that the debt is no larger ten years from now than in the baseline.I haven't found takers--even though those who believe in stimulus spending should think that the short-run gain outweighs the long-run pain, those who believe in confidence think that the long-run pain is good for us and worth the short-run bacchanalia, and the thing should pass unanimously."
Arnold Kling - Capital inflows - "Start with Reinhart. I find her a bit like Paul Samuelson, in that she seems to have a lot of thoughts running through her mind, and only a sample of those thoughts get processed through her vocal cords. This leaves many thoughts unexpressed.
For example, here are three things I thought I heard her saying.
1. Large capital inflows end badly. They are the predecessor for financial crises.
2. Financial liberalization promotes capital inflows.
3. Financial liberalization is a good thing.
The opposite of financial liberalization is financial repression. Under financial repression (think China), about the only savings vehicle available is government bonds. The government then allocates capital. Private capital inflows are minimized, because who wants to invest overseas in low-yielding bonds? Domestic savers get stuck with low yields and low incomes. Reinhart thinks we will see more financial repression in debt-ridden western countries, so that governments can continue to market their debt. Have a nice day.
I assume that some of Reinhart's unexpressed thoughts help to explain how to reconcile the benefits of financial liberalization with a desire to avoid crises caused by large capital inflows. Maybe somebody can look up what she has written and find the answer."
Michael Pettis - Financial repression - "There have periods of inflation in China in recent years, and even a brief inflationary scare in 2007 and 2008, but on average inflation has been far less than what was needed to revalue the currency sufficiently.
So what happened? Why has inflation been muted – as it has by the way in other countries that followed the so-called Asian growth model, including most importantly Japan in the past several decades?
Two months ago University of Chicago economist, Robert Aliber, came to speak at my central banking seminar at the Guanghua School of Peking University. In a fascinating discussion he explained that in fact there was another possible resolution of the imbalances caused by relatively rapid productivity growth in the tradable goods sector.
He pointed out that if the nominal exchange rate is not allowed to rise, policymakers can still contain inflation by what economists call financial repression, made possible by their control over the banking system in countries where banks completely dominate the financial system. In the Chinese context, financial repression exists because the vast bulk of Chinese savings is in the form of bank deposits, and the deposit rate is set at extremely low levels.
This has the effect of transferring large amounts of income away from net savers, which for the most part consists of Chinese households, and in favor of net users of capital. Net users, of course, consist primarily of large, capital intensive businesses, real estate developers, infrastructure investors and local and central governments, including the People’s Bank of China, the largest net borrower of renminbi in China. Net savers are forced into subsidizing net users, in other words.
The consequence is that monetary growth is channeled not into household demand but rather into the production of more goods, and the inflationary impact of monetary expansion is muted. Financial repression is an alternative to currency appreciation or inflation."
Steven Pinker - Twitter panic - "Media critics write as if the brain takes on the qualities of whatever it consumes, the informational equivalent of "you are what you eat." As with primitive peoples who believe that eating fierce animals will make them fierce, they assume that watching quick cuts in rock videos turns your mental life into quick cuts or that reading bullet points and Twitter postings turns your thoughts into bullet points and Twitter postings."
Steve Landsburg - Toward a More Efficient Labor Market - "An anonymous math department chairman reports on his own strategy for cutting down on the workload. He believes that one of the most important determinants of a successful career is luck. So each year, he randomly rejects half the applicants without even reading their folders. That way, he eliminates the unlucky ones."
Tuesday, June 15, 2010
Really great links - Intra-Eurozone competitiveness - Inflation vs. socialism - Ego and politicians
Daniel Pfaendler - Intra-Eurozone competitiveness: A solvable task - "It is frequently stated that SGIP need an internal devaluation in the magnitude of 20-30%. However, this estimate appears wrong on several counts. They are usually derived by comparing the development of nominal unit labour costs (ULC) in Germany with those in SGIP. For example, nominal unit labour costs increased by approx. 8% in Germany since 1999 whereas they increased by approx. 36% in Greece. This suggests that Greece has lost 28% in competitiveness vs. Germany and hence needs an internal devaluation of the same magnitude.
However, one should not forget that Germany joined the Eurozone at an uncompetitive exchange rate. It took Germany several years to restore competitiveness vs. the other monetary union members which was one factor for its weak economic performance early last decade. Assuming that Germany had re-established competitiveness by the end of 2003, reduces the gap in nominal ULC between Greece and Germany to 15% (and 14% for Spain and Ireland and 13% for Portugal). Finally, SGIP need not restore competitiveness vs. Germany but rather vs. the average of the Eurozone. Nominal unit labour costs in SGIP since 1999 increased by 34% whereas ULC in the rest of the Eurozone increased by approx. 21% (see chart below). The difference between these two developments is substantial but not insurmountable. SGIP either need a reduction in nominal unit labour costs of 10% or the rest of the Eurozone needs an increase in nominal ULC of 11% to restore competitiveness in SGIP. More likely though is that we will get a mixture of the two, falling ULC in SGIP and rising ULC in non-SGIP."
Scott Sumner - A little more inflation or a little more socialism? - "In the 1930s the right had to choose between a modest amount of inflation (returning prices to the pre-Depression levels) or more socialism. They weren’t thrilled with big government, but their strongest opposition was reserved toward policies of inflation. So we ended up with deflationary policies between 1929 and 1933. Of course the voters wouldn’t accept 25% unemployment, so we got big government instead of the inflation.
As this video shows, we are essentially facing the same choice today. We could pump up the economy through monetary policy, or we can have Fannie and Freddie continue to throw $100s of billions down the drain, socialize the auto industry, extend unemployment benefits to 99 weeks, etc. And if that isn’t enough there are also calls to move away from free trade policies. And then there’s the higher taxes we’ll pay in the future to cover the costs of debts run up in a futile attempt to stimulate the economy.
Just as in the 1930s, the right seems to have decided that a little bit of socialism is better than a little bit of inflation. What do I mean by a little bit of inflation? I mean enough so that the post-September 2008 trend rate of inflation is the same as the pre-September 2008 trend rate of inflation. Apparently even that little bit of inflation is more distasteful than massive government intervention in the economy."
Barry Ickes - Ego and politicians - "Now we read that Meg Whitman spent at least $85 million to win the Republican nomination for Governor in California. She presumably will spend even more in the general election campaign.
Now Whitman is a billionaire supposedly, so I suppose that this is not much to her. But the question I want to ask is can she not find a better use for this money? What about charity? She could give this to the Gates Foundation, for example, and improve health around the world. Or if she is only concerned with California, then to some California charities.
To choose spending this on her campaign, she has to believe that she is better for California than the next best candidate by more than the value of the charitable contributions. Now most politicians hardly ever make a difference. So she must have a really, really, big ego."
However, one should not forget that Germany joined the Eurozone at an uncompetitive exchange rate. It took Germany several years to restore competitiveness vs. the other monetary union members which was one factor for its weak economic performance early last decade. Assuming that Germany had re-established competitiveness by the end of 2003, reduces the gap in nominal ULC between Greece and Germany to 15% (and 14% for Spain and Ireland and 13% for Portugal). Finally, SGIP need not restore competitiveness vs. Germany but rather vs. the average of the Eurozone. Nominal unit labour costs in SGIP since 1999 increased by 34% whereas ULC in the rest of the Eurozone increased by approx. 21% (see chart below). The difference between these two developments is substantial but not insurmountable. SGIP either need a reduction in nominal unit labour costs of 10% or the rest of the Eurozone needs an increase in nominal ULC of 11% to restore competitiveness in SGIP. More likely though is that we will get a mixture of the two, falling ULC in SGIP and rising ULC in non-SGIP."
Scott Sumner - A little more inflation or a little more socialism? - "In the 1930s the right had to choose between a modest amount of inflation (returning prices to the pre-Depression levels) or more socialism. They weren’t thrilled with big government, but their strongest opposition was reserved toward policies of inflation. So we ended up with deflationary policies between 1929 and 1933. Of course the voters wouldn’t accept 25% unemployment, so we got big government instead of the inflation.
As this video shows, we are essentially facing the same choice today. We could pump up the economy through monetary policy, or we can have Fannie and Freddie continue to throw $100s of billions down the drain, socialize the auto industry, extend unemployment benefits to 99 weeks, etc. And if that isn’t enough there are also calls to move away from free trade policies. And then there’s the higher taxes we’ll pay in the future to cover the costs of debts run up in a futile attempt to stimulate the economy.
Just as in the 1930s, the right seems to have decided that a little bit of socialism is better than a little bit of inflation. What do I mean by a little bit of inflation? I mean enough so that the post-September 2008 trend rate of inflation is the same as the pre-September 2008 trend rate of inflation. Apparently even that little bit of inflation is more distasteful than massive government intervention in the economy."
Barry Ickes - Ego and politicians - "Now we read that Meg Whitman spent at least $85 million to win the Republican nomination for Governor in California. She presumably will spend even more in the general election campaign.
Now Whitman is a billionaire supposedly, so I suppose that this is not much to her. But the question I want to ask is can she not find a better use for this money? What about charity? She could give this to the Gates Foundation, for example, and improve health around the world. Or if she is only concerned with California, then to some California charities.
To choose spending this on her campaign, she has to believe that she is better for California than the next best candidate by more than the value of the charitable contributions. Now most politicians hardly ever make a difference. So she must have a really, really, big ego."
Monday, June 14, 2010
Really great links - Krugman - Eurozone breakup - Haircuts - Scott Sumner - Gold
Paul Krugman - Strange Arguments For Higher Rates - "Rajan’s argument boils down to two assertions:
1. Raising rates a bit wouldn’t significantly deter investment.
2. “Unnaturally low” interest rates are distorting asset prices.
The first thing to say about these two assertions is that they are essentially contradictory. If the difference between current rates and the rates Rajan wants is trivial — just a wafer thin mint — how can that same difference be leading to a major distortion in financial markets? Are we to believe that an interest rate change that matters not at all to firms making real investments somehow has huge effects on speculators? And actually, don’t asset prices themselves matter for real investment?"
Dino Kos - German bonds aren’t the havens they appear to be - - "One compelling reason to hold Bunds (or German bank deposits) is if investors believe a euro break-up is likely and wish to position themselves to have holdings converted into Deutschemarks. That scenario cannot be ruled out. However, euro area officials have been clear: monetary union will be defended and defaults are not on the agenda. That suggests peripheral countries will remain in the euro area and taxpayers in the core are susceptible to additional “calls” for cash in the future."
John Dizard - Euro bondholder haircuts would help - "After the Lehman collapse, only Kazakhstan systematically resorted to bondholder haircuts to pay part of the cost of bank restructuring. I believe they’ll be followed by other authorities."
Scott Sumner - Post-modern macroeconomics - "So why does The Economist imply that a policy of “price stability” failed to ensure economic stability? I think there are two reasons. First, they think the financial crisis (not falling inflation) caused the recession. And second, they don’t think monetary policy could have done much to prevent the fall in inflation."
James Hamilton - Gold and inflation - "There's a common thread to all the above figures, and it's not fears about inflation. Instead it's worries about the level of real economic activity, showing up in a flight to safety. U.S. Treasuries remain the instrument of choice for investors who think nothing looks safe.
But with the long-run fiscal challenges facing the United States, are 10-year Treasuries really the safest place to put your money? The yellow metal seems to be one way some people are hedging that bet."
1. Raising rates a bit wouldn’t significantly deter investment.
2. “Unnaturally low” interest rates are distorting asset prices.
The first thing to say about these two assertions is that they are essentially contradictory. If the difference between current rates and the rates Rajan wants is trivial — just a wafer thin mint — how can that same difference be leading to a major distortion in financial markets? Are we to believe that an interest rate change that matters not at all to firms making real investments somehow has huge effects on speculators? And actually, don’t asset prices themselves matter for real investment?"
Dino Kos - German bonds aren’t the havens they appear to be - - "One compelling reason to hold Bunds (or German bank deposits) is if investors believe a euro break-up is likely and wish to position themselves to have holdings converted into Deutschemarks. That scenario cannot be ruled out. However, euro area officials have been clear: monetary union will be defended and defaults are not on the agenda. That suggests peripheral countries will remain in the euro area and taxpayers in the core are susceptible to additional “calls” for cash in the future."
John Dizard - Euro bondholder haircuts would help - "After the Lehman collapse, only Kazakhstan systematically resorted to bondholder haircuts to pay part of the cost of bank restructuring. I believe they’ll be followed by other authorities."
Scott Sumner - Post-modern macroeconomics - "So why does The Economist imply that a policy of “price stability” failed to ensure economic stability? I think there are two reasons. First, they think the financial crisis (not falling inflation) caused the recession. And second, they don’t think monetary policy could have done much to prevent the fall in inflation."
James Hamilton - Gold and inflation - "There's a common thread to all the above figures, and it's not fears about inflation. Instead it's worries about the level of real economic activity, showing up in a flight to safety. U.S. Treasuries remain the instrument of choice for investors who think nothing looks safe.
But with the long-run fiscal challenges facing the United States, are 10-year Treasuries really the safest place to put your money? The yellow metal seems to be one way some people are hedging that bet."
Friday, June 11, 2010
Really great links - Fed - Central banks and stockmarkets
Andy Harless - Fed and Mankiw rule - "Basically, once we recognize that quantitative easing is an option – and one that is no longer being pursued – we can draw the conclusion that the Fed is much tighter today than what the Mankiw Rule would suggest. Indeed, relative to the Mankiw rule, the Fed is much tighter than at any time during the Greenspan-Bernanke years. Since 1957, when the core CPI data series begins, there have only been two times when the Fed was as tight as it is today relative to the Mankiw Rule. One was in 1973, when the effect of Nixon’s price controls was artificially reducing the retrospective inflation rate used in the Mankiw Rule. The other was during the early 1980’s, when the Fed was targeting monetary aggregates rather than interest rates and attempting (with great success) to reduce the inflation rate dramatically."
Roger Farmer - How to reduce unemployment - A new policy proposal - "A fiscal stimulus is ineffective in my model because it can shift one of the equilibrium relationships, but not the other. In terms of Figure 2, a fiscal expansion shifts the ME curve to the right but leaves the NA curve in its depressed state. As a consequence, the interest rate rises and crowds out private consumption expenditure. I see two possible resolutions to this problem.
First, an investment tax credit that changes the trade-off between holding private capital and government debt would act to shift the NA curve to the right. In combination with a fiscal expansion, this seems to be a promising avenue to explore.
Second, an extension of the quantitative easing that has been engaged in by national central banks throughout the world holds some promise to directly influence asset markets. An extension of this policy would involve the direct intervention of central banks in national stock markets by offering to exchange government debt for private equity at a fixed price."
Roger Farmer - How to reduce unemployment - A new policy proposal - "A fiscal stimulus is ineffective in my model because it can shift one of the equilibrium relationships, but not the other. In terms of Figure 2, a fiscal expansion shifts the ME curve to the right but leaves the NA curve in its depressed state. As a consequence, the interest rate rises and crowds out private consumption expenditure. I see two possible resolutions to this problem.
First, an investment tax credit that changes the trade-off between holding private capital and government debt would act to shift the NA curve to the right. In combination with a fiscal expansion, this seems to be a promising avenue to explore.
Second, an extension of the quantitative easing that has been engaged in by national central banks throughout the world holds some promise to directly influence asset markets. An extension of this policy would involve the direct intervention of central banks in national stock markets by offering to exchange government debt for private equity at a fixed price."
Wednesday, June 9, 2010
Really great links - Tinkerbell in New Keynesian models - Trust - Germany and Spain - Happiness
Nick Rowe - Tinkerbell in New Keynesian models - Absolute must-read - "Framing matters. Tinkerbell is real and all-pervasive. She flies in New Keynesian models all the time.
A. In the IS curve in old Keynesian models, a fall in the real rate of interest causes an increase in demand.
B. In the IS curve in New Keynesian models, a fall in the real rate of interest causes an increase in current demand, relative to planned future demand.
C. In the IS curve in New Keynesian models, a fall in the real rate of interest causes a decrease in planned future demand, relative to current demand.
A and B sound very similar. It's just that B adds an extra variable (planned future demand) that can shift the IS curve. An increase in planned future demand will shift the IS curve to the right. That sounds quite plausible from an Old Keynesian perspective anyway. If planned future demand increases, expected future incomes should increase too, and so people will want to consume more today, and firms will want to invest more today. So B makes the New Keynesian IS curve sound very similar to the Old Keynesian IS curve. It isn't. They are very different.
C sounds totally different from B. But it's not. C and B are logically equivalent. They are just different ways of describing the same Euler equation that underlies the New Keynesian IS curve. C is a way of describing the New Keynesian IS curve that forces you to realise that it is very different from the Old Keynesian IS curve."
Tyler Cowen - Trust - "Call me naive, but I believe that most of these politicians would in fact prefer to spend the money and hand out goodies to favored constituencies.
What may be destroying economic recovery is not fiscal contraction, but rather lack of trust, "Trust" is an underused word in macroeconomics."
Edward Chancellor - The dreadful potential of frugality - "Germany wants countries, such as Spain, to get their public finances in order. Yet if Spain is to reduce its fiscal deficit without too much pain, two conditions are necessary. First, the country’s trade position must shift into surplus. This is problematic since labour costs are high relative to Germany and Spain cannot devalue its currency. Second, the private sector must move back into deficit. Yet it is difficult to see Spanish households and companies wanting to borrow more given the ongoing problems caused by the collapse of the property bubble."
Eric Falkenstein - Arthur Brooks on happiness - "Arthur Brooks, president of the AEI, has a new book out, The Battle, and he makes an interesting claim. He states that the key factor in one's happiness--not experiential happiness, but 'remembered happiness' that is more correlated with 'life satisfaction', see Kahneman on the difference--is 'perceived earned success'. This is the willingness and ability to create value in your life or the life of others. He states that if you ask someone if they feel like they are creating such value, they are happy, regardless of how much they make. Giving people money, via welfare or inheritance, does not make people happy, because this if anything discourages the effort needed to find and develop such a niche."
A. In the IS curve in old Keynesian models, a fall in the real rate of interest causes an increase in demand.
B. In the IS curve in New Keynesian models, a fall in the real rate of interest causes an increase in current demand, relative to planned future demand.
C. In the IS curve in New Keynesian models, a fall in the real rate of interest causes a decrease in planned future demand, relative to current demand.
A and B sound very similar. It's just that B adds an extra variable (planned future demand) that can shift the IS curve. An increase in planned future demand will shift the IS curve to the right. That sounds quite plausible from an Old Keynesian perspective anyway. If planned future demand increases, expected future incomes should increase too, and so people will want to consume more today, and firms will want to invest more today. So B makes the New Keynesian IS curve sound very similar to the Old Keynesian IS curve. It isn't. They are very different.
C sounds totally different from B. But it's not. C and B are logically equivalent. They are just different ways of describing the same Euler equation that underlies the New Keynesian IS curve. C is a way of describing the New Keynesian IS curve that forces you to realise that it is very different from the Old Keynesian IS curve."
Tyler Cowen - Trust - "Call me naive, but I believe that most of these politicians would in fact prefer to spend the money and hand out goodies to favored constituencies.
What may be destroying economic recovery is not fiscal contraction, but rather lack of trust, "Trust" is an underused word in macroeconomics."
Edward Chancellor - The dreadful potential of frugality - "Germany wants countries, such as Spain, to get their public finances in order. Yet if Spain is to reduce its fiscal deficit without too much pain, two conditions are necessary. First, the country’s trade position must shift into surplus. This is problematic since labour costs are high relative to Germany and Spain cannot devalue its currency. Second, the private sector must move back into deficit. Yet it is difficult to see Spanish households and companies wanting to borrow more given the ongoing problems caused by the collapse of the property bubble."
Eric Falkenstein - Arthur Brooks on happiness - "Arthur Brooks, president of the AEI, has a new book out, The Battle, and he makes an interesting claim. He states that the key factor in one's happiness--not experiential happiness, but 'remembered happiness' that is more correlated with 'life satisfaction', see Kahneman on the difference--is 'perceived earned success'. This is the willingness and ability to create value in your life or the life of others. He states that if you ask someone if they feel like they are creating such value, they are happy, regardless of how much they make. Giving people money, via welfare or inheritance, does not make people happy, because this if anything discourages the effort needed to find and develop such a niche."
Monday, June 7, 2010
Really great links - Krugman on solvency - Econbrowser: recovery sluggish - Raghu Rajan - Structural crisis - Dilbert
Paul Krugman - Solvency - "As you can also see, by the debt-and-deficit criteria the US, UK, and (as you can’t see) Japan look similar enough to the crisis countries that if you didn’t know better, you might expect them to be in the same boat.
But they aren’t. As of right now, the interest rates on 10-year bonds are 3.59% in the UK, 3.36% in the US, 1.29% in Japan. CDS spreads for Japan and the UK are only about a third of the level for Italy.
So what does one make of this? One possible answer is, just you wait — any day now there will be a Wile E. Coyote moment, the markets will realize that America is Greece, and all hell will break loose. The other answer is to note that all the crisis countries are in the eurozone, while the US, UK, and Japan aren’t — and to argue that having your own currency makes all the difference.
I’ll choose door number 2."
James Hamilton - Current economic conditions - "Yes, we're still in the economic recovery phase, and yes, it still looks pretty sluggish."
Raghu Rajan - Response to Paul Krugman - "I reproduce Paul Krugman’s “econometric” claim above that Fannie and Freddie did not help cause the crisis above (I do not claim the Community Reinvestment Act was a big factor). I respond only because I have received hate mail from his followers. Paul is, of course, a great theoretical Nobel-prize-winning economist, so his attacks must be taken seriously (and I did take his trade theory classes at MIT, in the interest of full disclosure). Unfortunately, much of the “Fannie and Freddie did not contribute to the crisis” battalion makes arguments that have serious holes. Since these arguments are so prevalent they need to be rebutted again and again (the claimed unwillingness to listen to argument can be played on both sides).
The key graph in Paul’s argument is Figure 4. He claims that restrictions on Fannie and Freddie starting in 2004 kept their share of originations of total residential mortgage originations down, even while housing prices inflated. But this is irrelevant to the question. What we care about though is the amount of Fannie and Freddie’s originations in the sub-prime residential mortgages. And from every source I have seen, these took off precisely in 2004. Indeed, as I argue in my book Fault Lines, in the period 2004-2006 these two giants purchased $ 434 billion in sub-prime mortgage-backed securities. A measure of the size of these purchases is that in 2004, they accounted for 44 percent of the market for these securities. Calomiris and Wallison argue that Fannie and Freddie’s arms were twisted into doing more of this kind of lending starting in 2004 precisely because Congress had them in a vice because of the scandal."
Barry Ickes - Structural Rigidities and Financial Crisis - "Sometimes it is hard to understand the connection between structural rigidities and financial crises.
...
The specific example is rent control. This is quite severe in Portugal:
What is the connection to the financial crisis? Well, these rules limit production of rental housing, and thus force people to purchase rather than rent housing.
Scott Adams - Dilbert - "Let's talk about morality. Can you justify owning stock in companies that are treating the Earth like a prison pillow with a crayon face? Of course you can, but it takes some mental gymnastics. I'm here to help.
If you buy stock in a despicable company, it means some of the previous owners of that company sold it to you. If the stock then rises more than the market average, you successfully screwed the previous owners of the hated company. That's exactly like justice, only better because you made a profit. Then you can sell your stocks for a gain and donate all of your earnings to good causes, such as education for your own kids."
But they aren’t. As of right now, the interest rates on 10-year bonds are 3.59% in the UK, 3.36% in the US, 1.29% in Japan. CDS spreads for Japan and the UK are only about a third of the level for Italy.
So what does one make of this? One possible answer is, just you wait — any day now there will be a Wile E. Coyote moment, the markets will realize that America is Greece, and all hell will break loose. The other answer is to note that all the crisis countries are in the eurozone, while the US, UK, and Japan aren’t — and to argue that having your own currency makes all the difference.
I’ll choose door number 2."
James Hamilton - Current economic conditions - "Yes, we're still in the economic recovery phase, and yes, it still looks pretty sluggish."
Raghu Rajan - Response to Paul Krugman - "I reproduce Paul Krugman’s “econometric” claim above that Fannie and Freddie did not help cause the crisis above (I do not claim the Community Reinvestment Act was a big factor). I respond only because I have received hate mail from his followers. Paul is, of course, a great theoretical Nobel-prize-winning economist, so his attacks must be taken seriously (and I did take his trade theory classes at MIT, in the interest of full disclosure). Unfortunately, much of the “Fannie and Freddie did not contribute to the crisis” battalion makes arguments that have serious holes. Since these arguments are so prevalent they need to be rebutted again and again (the claimed unwillingness to listen to argument can be played on both sides).
The key graph in Paul’s argument is Figure 4. He claims that restrictions on Fannie and Freddie starting in 2004 kept their share of originations of total residential mortgage originations down, even while housing prices inflated. But this is irrelevant to the question. What we care about though is the amount of Fannie and Freddie’s originations in the sub-prime residential mortgages. And from every source I have seen, these took off precisely in 2004. Indeed, as I argue in my book Fault Lines, in the period 2004-2006 these two giants purchased $ 434 billion in sub-prime mortgage-backed securities. A measure of the size of these purchases is that in 2004, they accounted for 44 percent of the market for these securities. Calomiris and Wallison argue that Fannie and Freddie’s arms were twisted into doing more of this kind of lending starting in 2004 precisely because Congress had them in a vice because of the scandal."
Barry Ickes - Structural Rigidities and Financial Crisis - "Sometimes it is hard to understand the connection between structural rigidities and financial crises.
...
The specific example is rent control. This is quite severe in Portugal:
The discrepancy is a result of 100-year-old tenancy rules, which have frozen the rent of hundreds of thousands of tenants and protected them against eviction in Portugal.José Gago da Graça owns a Portuguese real estate company and has two identical apartments in the same building in the heart of Lisbon. One rents for €2,750 a month, the other for almost 40 times less, €75.
What is the connection to the financial crisis? Well, these rules limit production of rental housing, and thus force people to purchase rather than rent housing.
When the opportunities to borrow at low rates -- due to the euro -- presented themselves, Portuguese households took advantage. Rather than rent and save, households were pushed, by rent control, to borrow and purchase. That would not be so bad if the price of housing was not experiencing a bubble."The post-revolution rules helped protect tenants, but also led to a chronic shortage of rental housing. This, in turn, persuaded a new generation of Portuguese to tap recently into low interest rates and buy instead — often in new suburbs — thereby exacerbating the country’s mortgage debt and leaving Portugal with one of Europe’s lowest savings rates, of 7.5 percent.
Scott Adams - Dilbert - "Let's talk about morality. Can you justify owning stock in companies that are treating the Earth like a prison pillow with a crayon face? Of course you can, but it takes some mental gymnastics. I'm here to help.
If you buy stock in a despicable company, it means some of the previous owners of that company sold it to you. If the stock then rises more than the market average, you successfully screwed the previous owners of the hated company. That's exactly like justice, only better because you made a profit. Then you can sell your stocks for a gain and donate all of your earnings to good causes, such as education for your own kids."
Thursday, June 3, 2010
Four myths about European Central Bank
1. Losses on Greek bonds will create inflation
No. Imagine ECB becomes insolvent after Greek default. In this case ECB will lose control of inflation only if there is a run on ECB. During a run on ECB, EUR LIBOR will become lower than ECB deposit rate, meaning that ECB's contractionary policy rate increases would not be honored by the interbank market. Some commentators have raised the possibility of a run on ECB in the form of unilateral exit of Germany from the Eurozone. In my view this is highly unlikely. It is important to recognize that only member states can execute a run on ECB, but commercial banks cannot, as they are regulated by ECB.
Canadian economist and mega-blogger Nick Rowe has raised the possibility that inflationary expectations will arise because ECB has overpaid for Greek junk bonds. However in the comments he has conceded that ECB can successfully operate with negative equity: "Paying interest on reserves is equivalent to the ECB issuing bonds. Issuing bonds doesn't change the net worth of the ECB. But nevertheless, you have a good criticism here. The NPV of a central bank is much greater than the assets on its balance sheet. It's the NPV of all future seigniorage. In other words, it might have to buy an awful lot of really junk bonds in order to trash its balance sheet sufficiently. Hmmm."
2. ECB is sterilising purchases of Greek bonds
No. ECB will provide unlimited 3 month liquidity in a scheduled longer term refinancing intervention on 30 June 2010. This means that any sterilisation will be reversed according to the desires of commercial banks. Only when ECB will stop full allotment in longer term refinancing operations we will be able to talk about real sterilisation. So far the purchases of Greek bonds are de-facto unsterilised.
The instrument of ECB's sterilisation operations is one week term deposits. These deposits are eligible as a collateral in ECB's refinancing operations. Short maturity of deposits and eligibility as a collateral means that these deposits are almost as liquid as overnight deposits at ECB. This is confirmed by the tiny premium on one week deposits required by commercial banks as compared to the ECB overnight deposit rate. We can safely conclude that ECB's sterilisation operations have only minor effect on removing the liquidity in Eurozone.
3. Sterilisation of purchases of Greek bonds is needed to prevent inflation
No. Even with the enormously huge monetary base ECB can control inflation by increasing policy rates. Sterilisation might be desirable for the fine-tuning of the yield curve, but is not necessary for the containment of inflation. Stephen Williamson, the guru of new monetarism, says that sterilisation is an inefficient way of controlling inflation (his models imply that even fine-tuning of the yield curve by sterilization won't work).
4. Current tensions in interbank markets are comparable to Lehman Brothers. For example, WSJ writes: "Euro-zone banks placed a record €316.4 billion ($387.1 billion) in the ECB's ultra-safe overnight deposit facility, ECB data showed Wednesday, bringing back memories of the days following the collapse of U.S. investment bank Lehman Brothers in 2008."
No. The use of ECB's overnight deposit facility is just an indication of the bloated balance sheet of ECB. The balance sheet is bloated precisely because ECB is successfully preventing the repeat of Lehmanesque financial tensions by adding huge amounts of liquidity. In fact, during Lehman crisis, ECB has fought the financial tensions much more successfully than the Fed. ECB started providing unlimited liquidity on October 15 2008. If only Fed had copied the aggressive liquidity stance of ECB in 2008...
No. Imagine ECB becomes insolvent after Greek default. In this case ECB will lose control of inflation only if there is a run on ECB. During a run on ECB, EUR LIBOR will become lower than ECB deposit rate, meaning that ECB's contractionary policy rate increases would not be honored by the interbank market. Some commentators have raised the possibility of a run on ECB in the form of unilateral exit of Germany from the Eurozone. In my view this is highly unlikely. It is important to recognize that only member states can execute a run on ECB, but commercial banks cannot, as they are regulated by ECB.
Canadian economist and mega-blogger Nick Rowe has raised the possibility that inflationary expectations will arise because ECB has overpaid for Greek junk bonds. However in the comments he has conceded that ECB can successfully operate with negative equity: "Paying interest on reserves is equivalent to the ECB issuing bonds. Issuing bonds doesn't change the net worth of the ECB. But nevertheless, you have a good criticism here. The NPV of a central bank is much greater than the assets on its balance sheet. It's the NPV of all future seigniorage. In other words, it might have to buy an awful lot of really junk bonds in order to trash its balance sheet sufficiently. Hmmm."
2. ECB is sterilising purchases of Greek bonds
No. ECB will provide unlimited 3 month liquidity in a scheduled longer term refinancing intervention on 30 June 2010. This means that any sterilisation will be reversed according to the desires of commercial banks. Only when ECB will stop full allotment in longer term refinancing operations we will be able to talk about real sterilisation. So far the purchases of Greek bonds are de-facto unsterilised.
The instrument of ECB's sterilisation operations is one week term deposits. These deposits are eligible as a collateral in ECB's refinancing operations. Short maturity of deposits and eligibility as a collateral means that these deposits are almost as liquid as overnight deposits at ECB. This is confirmed by the tiny premium on one week deposits required by commercial banks as compared to the ECB overnight deposit rate. We can safely conclude that ECB's sterilisation operations have only minor effect on removing the liquidity in Eurozone.
3. Sterilisation of purchases of Greek bonds is needed to prevent inflation
No. Even with the enormously huge monetary base ECB can control inflation by increasing policy rates. Sterilisation might be desirable for the fine-tuning of the yield curve, but is not necessary for the containment of inflation. Stephen Williamson, the guru of new monetarism, says that sterilisation is an inefficient way of controlling inflation (his models imply that even fine-tuning of the yield curve by sterilization won't work).
4. Current tensions in interbank markets are comparable to Lehman Brothers. For example, WSJ writes: "Euro-zone banks placed a record €316.4 billion ($387.1 billion) in the ECB's ultra-safe overnight deposit facility, ECB data showed Wednesday, bringing back memories of the days following the collapse of U.S. investment bank Lehman Brothers in 2008."
No. The use of ECB's overnight deposit facility is just an indication of the bloated balance sheet of ECB. The balance sheet is bloated precisely because ECB is successfully preventing the repeat of Lehmanesque financial tensions by adding huge amounts of liquidity. In fact, during Lehman crisis, ECB has fought the financial tensions much more successfully than the Fed. ECB started providing unlimited liquidity on October 15 2008. If only Fed had copied the aggressive liquidity stance of ECB in 2008...
Really great links - Bernanke's toxic waste - China - Greece
Nick Rowe - Bernanke - "In my old post, I said that Ben Bernanke was betting on the economic recovery, using the Fed's own assets, by buying toxic waste. If there is no recovery, he loses the bet, the toxic assets become worthless, and the increase in the monetary base becomes permanent, because the Fed can't afford to retire the extra money. If there is a recovery, he wins the bet, the toxic assets are worth at least what he paid for them, and the increase in the monetary base can be temporary, because the Fed can afford to retire the extra money. That's the demand curve of recovery."
Scott Sumner - Is China a free market success - "So to summarize, to the extent that China is a free market, it is an economic success, and to the extent it is statist, it is mostly a failure (excluding some sectors like transport.) But the question “Is the Chinese miracle due to a free market economy?” is nonsensical. It isn’t a miracle at all; it is a country rapidly transitioning from being extremely poor to having a so-so economy. That is all."
Felix Salmon - Consensus on Greece - "There was quite a lot of consensus on the panel, and not in a good way: everybody agreed that the bailout of Greece was only postponing the inevitable, and many people reckoned that it wasn’t going to postpone it very long: one pair of hedge fund managers in the audience reckoned that it would last about six months before the default finally happens.
The form of the default, too, seemed pretty clear: an act of parliament in Greece would do most of the work, given that most Greek debt is issued under Greek law. It will be a par exchange — the new bonds will have the same face value as the old bonds, but with lower coupons and extended maturities — so that with a bit of accounting fudgery, no banks would need to mark their Greek debt to market and take a huge loss. And Greece, in a fiscal bind, will probably at some point start issuing its own scrip alongside the formal national currency of the euro, much as California did in 2009."
Scott Sumner - Is China a free market success - "So to summarize, to the extent that China is a free market, it is an economic success, and to the extent it is statist, it is mostly a failure (excluding some sectors like transport.) But the question “Is the Chinese miracle due to a free market economy?” is nonsensical. It isn’t a miracle at all; it is a country rapidly transitioning from being extremely poor to having a so-so economy. That is all."
Felix Salmon - Consensus on Greece - "There was quite a lot of consensus on the panel, and not in a good way: everybody agreed that the bailout of Greece was only postponing the inevitable, and many people reckoned that it wasn’t going to postpone it very long: one pair of hedge fund managers in the audience reckoned that it would last about six months before the default finally happens.
The form of the default, too, seemed pretty clear: an act of parliament in Greece would do most of the work, given that most Greek debt is issued under Greek law. It will be a par exchange — the new bonds will have the same face value as the old bonds, but with lower coupons and extended maturities — so that with a bit of accounting fudgery, no banks would need to mark their Greek debt to market and take a huge loss. And Greece, in a fiscal bind, will probably at some point start issuing its own scrip alongside the formal national currency of the euro, much as California did in 2009."
Tuesday, June 1, 2010
Really great links - Mistakes were made - Tax cuts - ECB - Gold
Charles Evans - Policy easing was not enough - "The U.S. central bank's liquidity support was helpful in containing the 2008 financial crisis but it could have done more, Federal Reserve Bank of Chicago President Charles Evans said on Tuesday. "While the liquidity support we provided the economy was very helpful, it was clearly not enough," Evans, who is not a voting member of the U.S. interest rate-setting panel, said during a panel session at a seminar in Seoul.
"Given the huge resource gaps, and low and declining inflation, more monetary accommodation was appropriate," he added."
Mark Thoma - Why I Changed My Mind about Tax Cuts - "Initially I was critical of how the tax cuts were targeted since so much ended up going to saving rather than consumption. This is the part I am rethinking.
There are different types of recessions, and this one can be termed “a balance sheet” recession. It had a big impact not just on bank balance sheets, but on household (and, for that matter firm) balance sheets as well. Households were particularly hard hit due to declines in stock prices and declines in the value of housing. These losses were large, they upset plans for things such as retirement, and households needed to refill the holes in their balance sheets that had been created (this includes paying off debt).
How do they refill their balance sheets? By saving more and consuming less (paying off debt is a form of saving). Thus, as the recession took hold, we saw a large increase in the saving rate and a corresponding fall in consumption. The tax cuts were an attempt to reverse the decline in consumption, but instead they mostly raised the amount that went into saving.
But that has a benefit. Households are not going to start consuming normally again until their balance sheets are repaired. The faster the holes in their balance sheets are refilled, and tax cuts can help with this, the faster the households can return to their normal rates of consumption — a prerequisite for the economy to return to normal.
So the targeting of the tax cuts that was OK after all. You don’t see the effects of balance sheet rebuilding in the data initially because the tax cuts are being used to fill up balance sheets, there’s no immediate effect on consumption, output, employment, etc., to observe in the data. But since balance sheets are refilled faster, we will emerge from the recession sooner, and that’s an important benefit of tax cuts that’s often overlooked."
Spiegel - ECB - "Bonds worth about €3 billion are now being purchased on every trading day, with €2 billion of the bonds coming from Athens. At the moment, there is no improvement of the situation in sight. "The ECB and the national central banks operating on its behalf are currently the only buyers to speak of," says one market insider.
This policy effectively makes the ECB a so-called "bad bank" (a bank that buys up toxic assets as a means of helping out other institutions), all protestations of its president to the contrary. The pile of junk bonds on the ECB's balance sheet continues to grow. The fact that the ECB is keeping prices artificially high is downright encouraging banks to unload their risky assets onto the central bank.
Thorstein Polleit, the chief economist of Barclays Capital Deutschland, puts it this way: "The ECB is creating excess supply by buying at overinflated prices." In other words, many creditors are more inclined to sell their risky assets to the central bank under these terms. "It's a free lunch," says a top Frankfurt banker. "Anyone who doesn't take advantage of this opportunity to get rid of his securities now only has himself to blame.""
David Rosenberg - Still bullish on gold - What would Moses buy? - "The above makes the bullish case for gold that much more alluring in terms of relative shifts in the supply curve for fiat currency against bullion. What is encouraging too is that after reading the columns in Barron’s (page 38) and the FT (page 10) over the weekend, there are still plenty of skeptics out there on the gold price outlook. Bulls need skeptics — there is nothing worse than universal beliefs as they lead to overcrowded trades. What makes gold different is that, unlike paper money backed by the good word of the government, it has withstood the test of time for thousands of years. It is malleable. It is durable. It can be trusted. It is not the liability of any government. It has an inelastic supply curve. How many times is gold mentioned in the Old Testament? Try 391 times. How many references to silver? Try 117 times. How many times is paper currency mentioned from Noah, to Abraham, to Moses? None. Nada. Efes. Gornisht. Nihil. Rien. Nichts. Niente."
"Given the huge resource gaps, and low and declining inflation, more monetary accommodation was appropriate," he added."
Mark Thoma - Why I Changed My Mind about Tax Cuts - "Initially I was critical of how the tax cuts were targeted since so much ended up going to saving rather than consumption. This is the part I am rethinking.
There are different types of recessions, and this one can be termed “a balance sheet” recession. It had a big impact not just on bank balance sheets, but on household (and, for that matter firm) balance sheets as well. Households were particularly hard hit due to declines in stock prices and declines in the value of housing. These losses were large, they upset plans for things such as retirement, and households needed to refill the holes in their balance sheets that had been created (this includes paying off debt).
How do they refill their balance sheets? By saving more and consuming less (paying off debt is a form of saving). Thus, as the recession took hold, we saw a large increase in the saving rate and a corresponding fall in consumption. The tax cuts were an attempt to reverse the decline in consumption, but instead they mostly raised the amount that went into saving.
But that has a benefit. Households are not going to start consuming normally again until their balance sheets are repaired. The faster the holes in their balance sheets are refilled, and tax cuts can help with this, the faster the households can return to their normal rates of consumption — a prerequisite for the economy to return to normal.
So the targeting of the tax cuts that was OK after all. You don’t see the effects of balance sheet rebuilding in the data initially because the tax cuts are being used to fill up balance sheets, there’s no immediate effect on consumption, output, employment, etc., to observe in the data. But since balance sheets are refilled faster, we will emerge from the recession sooner, and that’s an important benefit of tax cuts that’s often overlooked."
Spiegel - ECB - "Bonds worth about €3 billion are now being purchased on every trading day, with €2 billion of the bonds coming from Athens. At the moment, there is no improvement of the situation in sight. "The ECB and the national central banks operating on its behalf are currently the only buyers to speak of," says one market insider.
This policy effectively makes the ECB a so-called "bad bank" (a bank that buys up toxic assets as a means of helping out other institutions), all protestations of its president to the contrary. The pile of junk bonds on the ECB's balance sheet continues to grow. The fact that the ECB is keeping prices artificially high is downright encouraging banks to unload their risky assets onto the central bank.
Thorstein Polleit, the chief economist of Barclays Capital Deutschland, puts it this way: "The ECB is creating excess supply by buying at overinflated prices." In other words, many creditors are more inclined to sell their risky assets to the central bank under these terms. "It's a free lunch," says a top Frankfurt banker. "Anyone who doesn't take advantage of this opportunity to get rid of his securities now only has himself to blame.""
David Rosenberg - Still bullish on gold - What would Moses buy? - "The above makes the bullish case for gold that much more alluring in terms of relative shifts in the supply curve for fiat currency against bullion. What is encouraging too is that after reading the columns in Barron’s (page 38) and the FT (page 10) over the weekend, there are still plenty of skeptics out there on the gold price outlook. Bulls need skeptics — there is nothing worse than universal beliefs as they lead to overcrowded trades. What makes gold different is that, unlike paper money backed by the good word of the government, it has withstood the test of time for thousands of years. It is malleable. It is durable. It can be trusted. It is not the liability of any government. It has an inelastic supply curve. How many times is gold mentioned in the Old Testament? Try 391 times. How many references to silver? Try 117 times. How many times is paper currency mentioned from Noah, to Abraham, to Moses? None. Nada. Efes. Gornisht. Nihil. Rien. Nichts. Niente."
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