coffeehouse economics

Twin Premieres (cps)

2012-01-26T01:31:00.006+01:00

In case you haven't gotten the news from anywhere else: For the first time in history (drumroll), the Fed announced an explicit inflation target, so finally, we can fill the blank space in its assumed loss function.

As to the second premiere: This is my first post on this blog (or any blog for that matter), so hello everyone. Maybe I can at some point fill in for my "predecessor" fg—let's hope it'll take me a little less than the 98 years it took the Fed to become concrete.

Are EMU-Bonds currently mispriced? (ls)

2012-01-24T13:50:00.001+01:00

Paul deGrauwe makes this case in his article on voxeu. He argues that government bond markets in a monetary union may be subject to self-fulfilling liquidity crises and hence to multiple equilibria. He claims that the sharp widening of the periphery's spreads should be mainly attributed to adverse changes of the market sentiment. The following picture serves him as an argument:

He writes that:

It presents pooled time-series and cross-section observations of the relation between the spreads of ten-year government bond rates of Eurozone governments compared with the German bond rate between 2000 and 2011 (quarterly observations). The red line represents the regression line indicating that increasing spreads are associated with increasing debt-to-GDP ratios. This line could be called the ‘fundamental relation’ between spreads and debt ratios.

How can this regression line be a fundamental one when it is mainly derived from observations in the pre-crisis period? Valuations in the pre-crisis period weren't fundamental at all. He makes this point himself. And I would like to add that we shouldn't exclusively blame the market. Favorable collateral and captial requirements posed by the ECB and by the respective banking supervision authorities played their role as well. But back to the chart: Large deviations of periphery spreads from the fitted regression line are taken as a sign of irrationality. This seems inconsistent to me, as the fitted line itself cannot serve as a fundamental benchmark. Drastically rising spreads do not imply a deviation from fundamentals, but rather a deviation from the optimistic pre-crisis consensus how to (under)price sovereign risk. In the end, we cannot distinguish whether we witness an adequate repricing or pure exaggeration.

Thank you for your service, Mr. Bini Smaghi (amv)

2011-12-23T15:26:00.012+01:00

Lorenzo Bini Smaghi is going to leave the ECB's Executive Board at the end of this year. This is bad news for two reasons: First, he is an "intellectual heavyweight" as the FT correctly points out (unsurprisingly, Bini Smaghi is Chicago-trained). Second, the reason why he has to exit the Board reminds us that nationality still matters in the conduct of monetary policy. Bini Smaghi must leave since France insists on a less Italian-dominated Board, given Mario Draghi's presidency since Nov 2011. Benoît Coeuré - a Frenchman, of course - will take his place. I do not argue that Coeuré is less able than the average Board member. Yet, given that Bini Smaghi was one of the Board's most able members, it seems clear that the selection process does not sort between "competent" and "less competent" decision makers, but between nationalities - evidently able to sort out the most effective policymaker, while leaving others in place.

The most interesting statements by a central banker are probably those he makes when leaving office. Accordingly, the FT took advantage and promtly interviewed Bini Smaghi. Mr. Weidmann should listen carefully to what he has to say: "[...] not deciding, or postponing decisions, is not an option and leads to worse outcomes." Decision makers shall not "hide behind lawyers to avoid taking action." Wooha! Eat this, Bundesbank.

Bini Smaghi is in favour of QE. I like that. He also favors the ECB as Lender of Last Resort (LOLR) to sovereigns. In a short policy note, I recently made the distinction between potentially insolvent and illiquid sovereign, and only supported the ECB as a LOLR to the latter group. Now this is Bini Smaghi: "If the issue is not one of insolvency but rather illiquidity, then the ECB has room for action - one could even say that the ECB has a duty of action." For the former group, I'm still in favor of haircuts and of the ECB to act as the Owner of Last Resort (OLR) to the European banking sector. I'm pretty sure that Smaghi wouldn't buy in as he still opposes Private Sector Involvement (PSI). He is quite honest: "No central bank in the world would consider the default of its sovereign desirable or possible."

I also disagree with another point he makes: "[T]he lender of last resort function is typically characterised by constructive ambiguity. Central banks try to avoid committing themselves in advance on the specific conditions in which they will intervene. [...] Central banks should use as much constructive ambiguity as possible and avoid committing to act – or not to act – at a time of high uncertainty." How can he say that? Modern monetary policy boils down to the control of market expectations. The expectation channel is key! Also when it comes to the LOLR-function. Without a credible commitment to a potentially unlimited swap line - exchanging sovereign bonds for central bank liabilities -, the ECB actually has to purchase sovereign bonds in significant amounts. Also QE will prove ineffective, if the ECB refuses to control/determine market expectations.

Nevertheless, thank you for your service!

"The hottest question in Europe" (amv)

2011-12-16T18:19:00.006+01:00

is: "Did the ECB just pull off a Back-Door Bailout that will end the crisis?" by Simone Foxman. Reactions: Karl Smith, Modeled Behavior; Tyler Cowen, Marginal Revolution; Gareth Gore; Free Exchange (The Economist); Felix Salmon. I side with Smith and Salmon. Final update: Izabella Kaminska (FT Alphaville) resolves the issue (see also her previous post).

10 inconvenient Euro-truths by David Marsh (amv)

2011-12-14T17:10:00.001+01:00

Excellent post by David Marsh (OMFIF):

Below are 10 key facts on the present position of the euro that many people overlook. Perhaps the most salient point concerns the direction of trade flows - the opposite of what you might expect. A classic case of ‘man bites dog’. The UK, a resolute non-member of the euro, has been busy over the past decade building trade ties with EMU. Yet Germany, in whose name and with whose currency monetary union was built, has been successfully integrating with the non-euro area – with fast-growing states in non-EMU Europe and Asia – and is doing progressively less trade with the euro bloc. Germany’s relative trade links with the peripheral countries have fallen particularly sharply. Considering these countries’ financing requires so much treasure from the taxpayers of Germany and other creditor countries, the imbalance between falling trade and rising demand for finance is at the bottom of the growing reluctance of the creditor countries to pledge more money to solve the conundrum. Confused about all this? Now read on.

The ECB as Lender and Owner of Last Resort (amv)

2011-12-12T09:14:00.004+01:00

I wrote a non-technical policy note on the sovereign debt crisis in the Eurozone. I argue that the only feasible as well as incentive-compatible solution to the current sovereign debt crisis in the Eurozone involves the European Central Bank (ECB)

as a Lender of Last Resort to the Eurozone’s core countries like France, Austria, Finland, and The Netherlands, and
as the Owner of Last Resort to the European banking system, thereby setting the stage for haircuts on the debt of potentially insolvent peripheral Member States like Greece, Italy, Spain, and Portugal.

Lars Christensen (The Market Monetarist) and Kantoos (Kantoos Economics) kindly published a summary of the paper. I am grateful to both of them.

Remark: It is argued that a proper management of NGDP-expectations would suffice to eliminate all distress on financial markets. Even though my paper argues that a shift by the ECB to an output-gap adjusted price-level-targeting regime is important to ease the debt crisis, I doubt that such a regime-change will be sufficient. One important reason is that there will be no return to the "old normal". Markets as well as regulators finally come to understand that there ain't no such thing like a "risk-free asset". The time of the zero-risk weighting rule is over. Positive risk-weights will remain, and so will higher equilibrium yields on sovereign bonds. It follows that recapitalization needs are real even in the case of perfect NGDP-expectation management.

New working paper (ls)

2011-11-16T14:03:00.001+01:00

I'm going for some shameless self-promotion. fg and I wrote a working paper where we have set up a macro-finance model, in which policymakers have to deal with endogenously arising boom-bust cycles on financial markets and their real-economy impact. It can be downloaded here.

Abstract:

We merge a financial market model with leverage-constrained, heterogeneous agents with a reduced-form version of the New-Keynesian standard model. Agents in both submodels are assumed to be boundedly rational. The financial market model produces endogenously arising boom-bust cycles. It is also capable to generate highly non-linear deleveraging processes, fire sales and ultimately a default scenario. Asset price booms are triggered via self-ful filling prophecies. Asset price busts are induced by agents' choice of an increasingly fragile balance sheet structure during good times. Their vulnerability is inevitably revealed by small, randomly occurring shocks. Our transmission channel of fi nancial market activity to the real sector embraces a recent strand of literature shedding light on the link between the active balance sheet management of nancial market participants, the induced procyclical fluctuations of desired risk compensations and their final impact on the real economy. We show that a systematic central bank reaction on financial market developments dampens macroeconomic volatility considerably. Furthermore, restricting leverage in a countercyclical fashion limits the magnitude of fi nancial cycles and hence their impact on the real economy.

We truly welcome feedback. Our contact details can be found here.

Are we rational? (os)

2011-11-10T15:15:00.002+01:00

Ok, you can open up a really big debate on what is rational and what is not. At least one can settle down at a very basic textbook distinction between adaptive (naive and extrapolative) on the one hand and rational expectations on the other. In our models, inflation expectations are typically assumed to be rational in this sense, hence, no systematic error is undertaken.

However, if I take a look at the "data" (i always wanted to say that), this assumption seems to be hasty. The graphic shows inflation de facto, hence the ex-post measured and published hcpi from the ecb (red with asterisk) and expectations on inflation taken from the survey of professional forecasters of the ecb (green with dots). And there are two things to mention:

First: before 2007, inflation was always underestimated. It seems like, observers always had confidence in the ecb to bring down inflation below but close to 2% (in the near future), but in reality this never happened.

Second: After 2007, inflation seems to be rather adaptive than rational. Of course, there is a nearly simultaneous behaviour of both lines but, the green line is the 4 quarter ahead expectation! Hence, take 2008q4, the first dot after the peak. Expectations go down, but these expectations are only evaluated at 2008q4, these are the expectations for 2009q4. In this light, they seem to be a little bit to late. So expectations do adopt the real values just to late to be labeled anything like rational, but rather adaptive.

chasing greece (os)

2011-11-10T13:16:00.000+01:00

totally off topic? (os)

2011-11-07T15:55:00.002+01:00

Seems that everybody is ill right now? This video is to some extend totally off topic. But on the other hand not really. I know that especially amv is fascinated (oh that is a big word) by what is called "swarm intelligence". I think this video captures the idea of swarm intelligence - which comes from the behavior of bird or fishes – very well.

Charles Goodhart on Investment Banking (ls)

2011-10-31T10:53:00.000+01:00

Great piece at voxeu.org

Key statements:

So, investment banks are the main intermediaries between large-scale borrowers and lenders, and, as such, provide essential services in keeping wholesale capital markets functioning efficiently. Sometimes they even run such markets themselves, (eg dark-pools); more often they provide the channel through which almost all orders get transmitted to the market (eg derivatives markets). Such intermediation services are essential to the continued functioning of our complex modern economy. The chaos that occurred after the failure of Lehman Brothers, an investment bank without any retail banking involvement, is testimony to that. The idea that investment banks can be liquidated with far less social costs than ‘pure’ retail banks is incorrect, though alas common.

Markets get made by participants taking positions. No one objects to agents taking positions if they bear the loss themselves. Problems arise when there are major externalities to society from such losses. It is the thesis of this note that the role of investment banks is so central to the efficient operation of our complex financial system that losses to such banks have major social externalities. The idea that, once you have carved out the ‘socially valuable’ parts of retail banking, ie the payments system and retail lending and deposit-taking, you can liquidate the rest without massive adverse effects is not only tragically mistaken but also horribly dangerous.

A really pleasant - since differentiated - view.

Nobel Laureates 2011: Chris Sims and Thomas Sargent (ls)

2011-10-10T14:47:00.000+02:00

Find the official statement here. You may also be interested in a more detailed review of their work.

As always, the forecasts failed. ;-)

Nobel Prize Predictions (ls)

2011-10-09T20:45:00.000+02:00

Find Thomson's traditional predicitons here.

Bond spreads and governance (ls)

2011-10-06T11:55:00.000+02:00

Tito Boeri worte a nice piece on voxeu. He shows how the relative underperformance of Italian government bonds compared to Spanish ones during the last four months can be attributed to the different style of politicians in dealing with the debt crisis and nervous markets. It is not surprising that the obviously bad governance of the Berlusconi administration is found to be the main driver of rising spreads.

Jürgen Stark on the Financial Crisis and Monetary Policy (ls)

2011-10-04T14:35:00.001+02:00

Find the recent speech of ECB's outgoing chief economist here.

I find the following passage particularly interesting:

[...] also from a monetary policy perspective, greater emphasis on “ex-ante” prevention is warranted. To the extent that financial imbalances are accompanied by excessive monetary and credit growth with possible implications for the medium term outlook on inflation, central banks do indeed have an obligation to take appropriate action. With respect to the ECB, our focus on medium term definitions of price stability, as well as the use of money and credit in our monetary pillar, already provides some ‘leaning’ against the build up of asset price imbalances. Therefore, in my view, a cautious leaning against excessive money and credit growth and building up of financial imbalances as part of our general monetary policy framework cannot only contribute to financial stability, but most importantly to achieve our primary objective of maintaining price stability.

This line of arguing closely resembles the ideas brought foward in the excellent report of Eichengreen and others (see my recent post). It seems that we are heading towards a post-crisis consensus...

Eurobonds and Modigliani-Miller (ls)

2011-09-24T11:56:00.000+02:00

Economists tend to be skeptical towards Eurobonds for various reasons. See for instance the reflections of Daniel Gros here. I would like to add another argument: I make the point that Eurobonds won't bring down the weighted average capital costs of the periphery countries to a heavy extent. Why?

Consider the introduction of two types of bonds: There are jointly guaranteed blue bonds, which each country can use to finance its debt up to a certain threshold (e.g. the Maastricht criterion). If a country is running higher debt levels, it has to finance them via country-specific red bonds. There is no joint guarantee on them, and they are by construction subordinated.

A country with under-average credit quality might consequently be able to conduct a part of its financing cheaper via blue bonds. But the residual debt has to be financed by red bonds. Obviously, investors will demand extremely high yields, due to the lack of joint guarantee and - most importantly - due to subordination. Hence, the averaged costs of debt services remain the same. This is in fact Modigliani-Miller in its essence. Changing the capital structure doesn't affect average capital costs.

Admittedly, this is not a perfect MM-world, since we introduce some type of exogenous guarantee mechanisms. This will indeed bring the average capital costs down, since the core countries lend some creditworthiness to the periphery. But these effect will probably be of a much smaller magnitude than expected, due to the mechanism described above.

Breaking the Law (fg)

2011-09-23T14:10:00.004+02:00

Miscellaneous:

It seems that the particle neutrino breaks light-speed limit. This stands in sharp contradiction to Einstein's special theory of relativity and constants in nature.

If neutrinos are travelling faster than light speed, then one of the most fundamental assumptions of science — that the rules of physics are the same for all observers — would be invalidated.

Here are some links:
- Nature: particles break light speed limit

- original scientific paper written by CERN staff.

A German joke on that issue:

Der Barkeeper sagt: "Tut mir leid, wir bedienen keine Neutrinos, die schneller sind als das Licht." Ein Neutrino kommt in eine Bar.

WTF?

Rethinking Central Banking (ls)

2011-09-20T09:09:00.000+02:00

Eichengreen, Rajan, Rodrik, di Mauro, Shin, Rogoff and other leading economists have released a brillant report on the future of Central Banking. The report can be downloaded here, a summary can be found on vox.

They especially focus on the debate of whether central banks should pursue a financial stability goal. They reach a conclusion which I fully share. Here are their key points (my emphasis, originally taken from the vox summary):

It is time to move beyond dissatisfaction with the prevailing framework and properly flesh out an alternative. In our view [...] that alternative should have the following elements:
Financial stability should be an explicit mandate of central banks.
Other micro- and macroprudential policies should be deployed first, wherever possible, in the pursuit of financial stability, but monetary policy should be regarded a legitimate part of the macroprudential supervisors’ toolkit.
When rapid credit growth or other indicators of financial excess accompany asset price increases, the authorities should employ stress tests to measure the effects of changes in credit conditions on asset prices, economic activity, and financial stability.
Instead of seeking to identify bubbles, the authorities should simply ask whether current financing conditions are raising the likelihood of sharp reversals in asset prices that are disruptive to economic activity.
Where the answer to the aforementioned question is yes, central bankers should then lean against the wind using a combination of the tools at their disposal, turning first to non-monetary micro- and macroprudential tools, but also to monetary policy tools when necessary.
If this results in periods when, in the interests of financial stability, the central bank sets policies that could result in deviations from its inflation target, then so be it.
Responsibility for the maintenance of financial stability can be assigned either to the central bank or to a self-standing financial supervisory authority. But in both setups, close coordination between the central bank and other agencies that contribute to ensuring the stability of financial conditions is essential.
This is particularly important when policymakers have to evaluate the tradeoffs between the use of monetary tools and prudential measures and make decisions on the appropriate mix.
Central banks already require substantial operational independence in order to pursue their mandates. They will require even greater independence when a financial-stability objective is added to those mandates.
They will, in turn, have to establish the legitimacy of their actions in circumstances where the nature of threats to financial stability is poorly understood.
[...] Independence is politically viable only with accountability, and the best way to enhance accountability is for central banks to become more transparent and forthright about their objectives and tactics.
The spillover effects of a central bank’s policies in other countries are a legitimate concern.
At present, central banks do little to internalise these effects. Admittedly, they may have difficulty in justifying actions taken in the effort to do so to domestic political authorities.
This tension points to the need for further changes in prevailing policy framework. Specifically, domestic political authorities should be persuaded to allow such considerations to play an explicit role in the central bank’s monetary policy framework in large economies. Large-country central banks should pay more attention to their collective policy stance and its global implications. Where appropriate, they should consider coordinated action to help stabilise the global economy in times of stress.

Market Monetarism - a (dis)equilibrium story? (amv)

2011-09-19T14:21:00.003+02:00

You may be interest in my guest post at Kantoos Economics. UPDATE: see also Sumner's discussion. UPDATE II: Also Josh Hendrickson discusses my post. UPDATE III: Nick Rowe weighs in.

Revealing equity prices (amv)

2011-09-18T15:10:00.000+02:00

Further evidence by Bluedorn et al. (©VoxEU.org) supporting the view that central banks should target market forecasts.

Abstract:

There are concerns that the recent sharp drop in equity prices in the advanced economies may signal a rise in the risk of a double-dip recession. This column examines the performance of equity prices as predictors of new recessions in the G7 economies. The findings suggest that equity prices are useful predictors of recessions in most of these countries. Recent drops in equity prices suggest that the probability of a double-dip recession in France, the UK, and the US has increased substantially.

The damaged ECB legitimacy (fg)

2011-09-15T14:48:00.002+02:00

Please find a worth reading comment of Anne Sibert (© VoxEU.org )on the ECB's changing legitimacy since August 2007. Besides the well-known critic on the ECB's liquidity provisions and Secutrity Market Program, the voting procedure, indeed, seems at odds with procedual transparency

It turns out that votes on policy rates are never taken. Apparently, some small subset of the Governing Council decides, prior to the meeting, what the policy rate will be and this is then presented to the entire Governing Council, which we are to believe always or almost always unanimously approves. This explains how the Governing Council is able to produce the lengthy post-policy meeting statement that Mr Trichet views as the ECB’s major contribution to transparency. With the decision made before the meeting, there is ample time to prepare it.
That this extraordinary decision-making mechanism has gone on for so long with no formal explanation beggars belief. Who gets to make the decision? Why is it that no Governing Council member has ever insisted upon their legal right to a vote on monetary policy? Is there really never any dissent? How can that be? That we are able to ask these questions about an institution that is supposed to be one of the world’s two most important central banks is not good for its legitimacy. Moreover, while this arrangement has functioned well enough so far, what would happen if some future president were a little less like Mr Trichet and a little more like, say, Davíð Oddsson?
In Mr Trichet and the Governing Council’s defence, the ECB is woefully badly designed. The Governing Council has 23 members – a ludicrous size for a decision-making body. If each member gets a ten-minute opening statement, the rate-setting meeting would have gone on for almost four hours before any actual debate begins. With no formal way of reducing the size of the decision-making body, Mr Trichet may have had little choice but to make monetary policy informally.

Inflation expectations, past and present (os)

2011-09-14T14:47:00.003+02:00

Just a little work I have done lately. What you see in the upper part is the standard deviation of inflation expectations and in the lower part the mean of the expected inflation. Both graphs are from 2000q1 till 2011q3 on a quarterly basis. The data are taken from the ECB survey of professional forecasters.

As you can see, long term inflation expectations are well anchored, although there has been some frictions (in terms of std. dev.) around 08/09. Also you see a "massive" drop in expectations at roughly the same time. But be aware: The drop in 34 (which is about 2008) means: Expectations in 2008 about what the inflation will be in 2009.

Never the less it seems that after some turbulence, long and short term expectations seem to converge lately, accompanied by a decline in uncertainty measured in terms of the std deviation.

How to Bash Germany? (fg)

2011-09-13T08:25:00.003+02:00

Here is a statement of M. Trichet how to do it:

Question: We had a debate today in the German Parliament, and the leader of the opposition, Mr Gabriel, attacked the government, but he also attacked the ECB very much. He said that the Securities Markets Programme is the socialisation of debt and he said and I quote “Mrs Merkel, who pushed you to buy those bonds?” and then he said “The €130 billion is the first tranche of Merkel Bonds” and he said to Mrs Merkel “You transformed the ECB from an anchor of stability into a European bad bank”. He said that the ECB is damaged in a sustainable way and that the stability of the money is in danger. It is normal people who are arguing that way in Germany and, if you talk to economists on an off-the-record basis, they say “maybe we should discuss going back to the Deutsche Mark”. What do you tell those people?

Trichet: I will say the following: first, we were called to deliver price stability! We were called on by all the democracies of Europe to deliver price stability and, in particular, of course by the 17 democracies that asked us to issue the currency in their 17 countries. We have delivered price stability over the first 12-13 years of the euro! Impeccably! I would like very much to hear some congratulations for this institution, which has delivered price stability in Germany over almost 13 years at approximately 1.55% - as the yearly average of inflation - we will recalculate the figure to the second decimal. This figure is better than any ever obtained in this country over a period of 13 years in the past 50 years. So, my first remark is this: we have a mandate and we deliver on our mandate! And we deliver in a way that is not only numerically convincing, but which is better than anything achieved in the past.

A second remark I would like to make is that, in the worst crisis since the Second World War, we have maintained confidence in the currency and confidence in our capacity to deliver price stability. This did not happen by chance. It happened because we decided frequently to do things that we were not recommended to do by the various governments. Our independence is inflexible. We were asked to decrease rates in 2004 by the Heads of State or Government of France and Germany, when we were at 2% and the United States was at 1%. We said no and we did not decrease rates. At the end of 2005, we increased rates when ten governments out of twelve were telling us not to do so. We also received the good advice not to do so of the IMF and of the OECD. So, it is not by chance that we have delivered price stability. If we embarked on the Securities Markets Programme for monetary policy reasons and to help restore a better transmission of our interest rate decision, it was because the governments in question, despite everything that we had said to them, did not behave properly and did not monitor things as they should have done. May I remind you that, in 2004 and 2005, some important governments in Europe were asking for a weakening of the Stability and Growth Pact? Do you remember that? And do you remember which governments were asking to weaken the Stability and Growth Pact? The three big governments of Europe, namely France, Germany and Italy! So, let me remind you that we are in the worst crisis since the Second World War. We are doing our job and it is not an easy one! The way in which our democracies are organised such that we have a living debate is excellent. I do not, of course, take part in any kind of public or political debate. We issue the currency for all of our fellow citizens, of all sensitivities, and we deliver price stability. Also, I should mention that it is the most vulnerable, the weakest and the poorest of our fellow citizens who most require us to be absolutely sure to deliver price stability. The situation is difficult, but we have taken all of our decisions in full independence and we try to live up to our responsibilities, even when these are very heavy responsibilities. We expect all other authorities to live up to their responsibilities as well. We are aware that this is not easy for any particular authority in the present circumstances. We have full respect for the difficulty involved in taking the decisions, whether these decisions are taken by governments or by parliaments, as well as full respect for the challenges posed by these times and for the fact that our fellow citizens are the masters – at the end of the day, as a fiercely independent institution, we depend on the sentiment of 332 million fellow citizens, as does any independent entity in democracies. Thank you for your excellent question, which was very stimulating!

Rating of Euro Bonds (os)

2011-09-05T08:55:00.006+02:00

As mentioned earlier at this site, I am not quite convinced by some jointly emitted bonds of the euro zone. Yesterday, Standard & Poor’s Managing Director of European Sovereign Ratings Moritz Kraemer stated that euro bonds would receive the lowest ranking - or at least the ranking of the weakest country.

“If it is a joint and not a several guarantee, then it would be the weakest link approach. If the euro bond is structured like this [smaller federal states that don’t have enough issuance volume “gang together” and “everyone guarantees just his own bit], and we have public criteria on that, the answer is very simple. If we have a euro bond where Germany guarantees 27 percent, France 20 percent and Greece 2 percent, then the rating of this euro bond would be CC, which is the rating of Greece.”

Clearly, this would make the blue bond totally worthless and the whole idea ad absurdum.

See also: here and here

Update: After some discussion during our delicious dinner, how it could be that a bond would receive the least valuable rating instead of an "average-of-all-involved" rating, my dear colleague ls found this article at herdentrieb, which is exactly the solution we came up with (sorry to those who could not join our meal :-)

Rogoff on Europe and the IMF (amv)

2011-09-03T18:14:00.001+02:00

Click here for a very insightful article by Kenneth Rogoff. Teasers:

The IMF needs to bring much more of this brand of skepticism to its assessment of eurozone debt dynamics, instead of constantly seeking strained assumptions that would make the debt appear sustainable. Anyone looking closely at Europe’s complex options for extricating itself from its debt straightjacket should realize that political constraints will be a huge obstacle no matter which route Europe takes.

Even outside Europe, the IMF has long given too much credence to sitting governments, rather than focusing on the long-term interests of the country and its people. The Fund is doing Europe’s people no favor by failing to push aggressively for a more realistic solution, including dramatic debt write-downs for peripheral eurozone countries and re-allocating core-country guarantees elsewhere.

Now that the Fund has squarely acknowledged the huge capital holes in many European banks, it should start pressing forcefully for a comprehensiveand credible solution to the eurozone debt crisis, a solution that will involve either partial breakup of the eurozone or fundamental constitutional reform. Europe’s future, not to mention the future of the IMF, depends on it.

Since I don't see how the current incentive system can bring about a beneficial constitutional reform, we are left with Rogoff's other proposal: a partial breakup (check also Henry Kaspar @ Kantoos).

Liquidity support leads to excessive risk-taking (amv)

2011-09-02T20:03:00.001+02:00

Incentive systems play a pivotal role in economics (as I argue here). As already emphasized by Adam Smith, the extent to which markets translate 'individual rationality' into 'collective rationality' (i.e., the extent to which markets are 'efficient') depends on institutional configurations or, more precisely, on the proximity of actual institutions to the 'system of natural liberty'. Mark Mink (© voxEU.org) applies neat rational-choice reasoning to 'show' that an institutional setting characterized by central bank liquidity support is likely to cause excessive risk-taking and, thus, is likely to cause (future) instability:

"Since the outbreak of the global financial crisis in 2007, and particularly since the bankruptcy of Lehman brothers in September 2008, central banks in their roles as lenders of last resort have provided large-scale liquidity support not only to individual banks, but also to the banking sector as a whole. [...] While these extraordinary measures were deemed inevitable in stabilising the banking sector, in Mink (2011) I show that the prospect of receiving liquidity support may distort banks’ risk-taking incentives to a much larger extent than has been acknowledged up to now. In particular, in addition to stimulating excessive maturity transformation, the prospect of receiving liquidity support provides banks with an incentive to increase their leverage, diversify their asset portfolio, lower their lending standards, and to do so in a procyclical manner."

In other words: there ain't no such thing as a free lunch!

Macro Markets and Risk Sharing (fg)

2011-09-02T09:06:00.002+02:00

I highly recommend a set of readings of Bob Shiller on creating new market segments that allow to truely insure and hedge aggregate home country and global economic risk:

Shiller proposes a new set of markets that could in theory provide much better diversification opportunities. These so-called macro markets would be large international markets trading, in the form of futures contracts, long-term claims on major components of incomes shared by a large number of people or organizations. For example, in a macro market for the United States, an investor could buy a claim on the U.S. national income and then receive, for as long as the claim is held, dividends equal to a specified fraction of U.S. national income. Such a claim is comparable to a share in a corporation, except that the dividend would equal a share of national income rather than a share of corporate profits. Such markets might exist for entire countries— the United States, Japan, and Brazil—or for regions— such as the European Union and North America. Even a market for claims on the combined incomes of the entire world could be formed. Prices would rise and fall in these markets as new information about national, regional, or global economies became available, just as prices rise and fall in the stock market as new information
about corporate profits is revealed. The potential future importance of these markets is supported by the most basic principle of finance diversification. People could use macro markets to hedge their own national income risks and to invest in the rest of the world. This investment strategy would reduce income growth uncertainty and lead to a more secure financial future

Good to know Bob Shiller already has a patent on a specification on macro markets with nominal GDP securities ;) . The work on this subject includes

Bob Shiller (1993), Macro Markets. Creating Institutions for for Mangaing Society's Largest Economic Risk, Oxford.
Bob Shiller (2003), The New Financial Order. Risk in the 21th Century. Princeton.
Bob Shiller et al (1999), Macro Markets and Financial Security, FRBNY Economic Policy.

I also refer to the idea of Scott Sumner on using nominal GDP futures to extract market expectations on future nominal GDP as both information and target variable for monetary policy.

Irving Fisher and Debt (fg)

2011-09-02T08:28:00.005+02:00

Every student of Economics, at least one time during her studies, has stumbled over Irving Fisher's theory of debt deflation. One passage in his book, The Purchasing Power of Money (1911), resembles a behavioral approach to explain the build-up of debt:

The public psychology of going into debt for gain passes through several more or less distinct phases: (a) the lure of big prospective dividends or gains in income in the remote future; (b) the hope of selling at a profit, and realizing a capital gain in the immediate future; (c) the vogue of reckless promotions, taking advantage of the habituation of the public to great expectations; (d) the development of downright fraud, imposing on a public which had grown credulous and gullible (p.349)

Jackson Hole Economic Symposium (fg)

2011-08-28T17:00:00.004+02:00

Jackson Hole Economic Policy Symposium 2011.

Papers include topics on 'Assessing Current Trends in Global Growth', 'Balancing Growth with Equity', 'Managing Natural Resources in Developing Economies', 'Regulating Financial Markets and Institutions to Promote Growth, and 'Aligning International Capital Flows with Growth'.

A paper I find worth mentioning is from R. Levine on regulating financial markets and insitutions to promote growth:

A broader, long-run consideration of financial development suggests that financial innovation is essential for growth. [...] Without corresponding innovations in finance that match the increases in complexity associated with economic growth, the quality of the financial services diminishes, slowing future growth

Furthermore, both bank and stock market development are independently
associated with growth, suggesting that the policy debate about whether to promote a bank-based system or a market-based financial system misses the big point. Banks and markets matter for growth.

Real Rates, Inflation and the Monetary Policy Stance (fg)

2011-08-27T15:20:00.015+02:00

I totally agree with amv that the level of nominal interest rates per se has nothing to say about the stance of monetary policy.

In order to address the stance, we need a reference model against we can judge monetary policy actions. John Taylor proposed such a beginners'-rule where the equilibrium, Wicksellian rate is assumed to be constant and monetary policy is advised to change the policy rate more than one-by-one when inflation and/or output move. Rule-based reaction functions evolved out of this research with natural rates being specified as time-varying and determined by real factors (see for instance Laubach/Williams (2003), Measuring the Natural Rate of Interest, Review of Economics & Statistics, 85). Other benchmarks include checking the path of nominal GDP whether monetary policy is tight or loose.

One important transmission mechanism, according to standard theory, is the long-term real interest rate to which aggregate demand reacts most sensitive. If monetary policy has no leverage power to affect the long-term real interest, then monetary policy is ineffective. As long as there is an impulse, the financial, ex-ante real interest rate as measured by in the TIPS market deviates from the equilibrium, natural, Wicksellian rate.

Gerlach/Moretti (© voxEU.org) argue that in the long-run, monetary policy cannot influence steady state equilibrium and, thus, the natural rate of interest. D'accord! If there is a one-time move in the policy rate, then, this effect should cancel out. As the natural rate is determined by productivity and thrift in goods market and due to no-arbitrage considerations (efficient market hypothesis), the real return on real capital sould be equal to the inflation-adjusted return on financial assets which cannot be affected by monetary policy in equilibrium.

Two points are worth making:

(1) Monetary policy operates on a regular basis. Consequenlty, in each point in time, market expectations about the future stance of policy are imbedded in the nominal as well as real yield curve, they do not cancel out in the medium term depending on the duration of monetary transmission; but they do converge to a time-varying level that is assumed to prevail in the long-run: the long-run inflation-adjusted rate which is a market belief of market participants (including the central bank). This rate, again, should be equal to the natural rate by no-arbitrage consideration in equilibrium. When jointly and consistently investigating nominal and real yields which are, again, linked by the efficient market hypothesis, we can decompose the long rate and the long-term forward rate into its components. It becomes clear that (i) most of the declince in the real long rate has been the result of the decrease in the financial market risk premium (ii) the risk-neutral expectation of market participants remains constant so that expectations of the Wicksellian rate remain constant, too (2%, iterate forward and you get the long-run version) and (iii) indeed, there was a decline in the risk-neutral real rate in 2000.

Figures are from Backus 2007, Brooking Papers on Economic Activity, and further estimates are kindly provided by Hördahl et al. 2010, ECB working paper.

(2) Gerlach/Moretti claim that

Real interest rates fell for reasons unrelated to monetary policy.

I am a bit sceptical on that unidirectional statement for a variety of reasons. Firstly, research shows that monetary policy affects the behavior towards risk through lowering both the quantitiy of risk and the market price of risk (risk appetite). Therefore, monetary policy contributed to the decline in the long rate through falling risk premia. Secondly, real rates massively fell when the FED communicated that it was likely to stay accommodative for a considerable period of time (not mirrored by policy moves). Such communication might have fostered the market view of low policy rates in the future thereby promoting low long-term interest rates and further risk-taking. Thirdly, if studies in the spirit of Taylor are conducted with time-varying natural rates, there still remains a negative real rate gap for the US for the period 2003-2006. Forthly, inflation did pick up speed in the US with above average nominal GDP growth. Break-even and survey measures of inflation did pick up in July 2003 and inflation was increasing in the euro area and the US (Clarida, 2010). Headline inflation in the US rose to 4.5% (CPI inflation even to more than 5.5%) in 2008 and core inflation picked up to 2.6%. Fithly, a transmission mechanism that allows for spill-overs to financial markets and back to the real economy shows that reacting inversely to risk premium dynamics is optimal for monetary policy that wants to stabilize inflation and output. Moreover, it is hard to imagine that goods markets can be in full equilibrium, and hence growth can be sustainable, in the presence of the observed credit boom in the run-up to 2007. The subsequent full-blown financial crisis suggests that the unusually rapid credit expansion was a sign that market rates were below the natural rate that did not show up too much in goods inflation but in asset price inflation by way of plumping discount rates (risk-neutral part as well as the risk premium) which are used to price financial assets and capital goods.

Gerlach/Moretti vs. Taylor (amv)

2011-08-26T10:48:00.008+02:00

Stefan Gerlach and Laura Moretti provide a very suggestive analysis of monetary policy before the crisis (© voxEU.org). They essentially argue that - in contrast to what John Taylor wants us to believe - low policy rates during 2002-5 do not indicate an expansive stance of monetary policy. Rather, the Fed simply responded (sluggishly) to a fall in the Wicksellian rate (determined by real data alone). As a theorist and historian of economics, and since I make this point repeatedly, I especially welcome the following statements:

"Furthermore, standard macroeconomic models hold that monetary policy has, at most, temporary effects on real variables, and thus they have a difficult time explaining this decline [the decline in 10y TIPS-yields]. Hence, a reduction in the federal funds rate – a nominal overnight rate – cannot have depressed 10-year real interest rates over a decade. In turn, this suggests that monetary policy played at most a limited role in setting the stage for the crisis." [my emphasis]

"[T]he Wicksellian interest rate is independent of monetary policy but may change in response to real economic disturbances, such as to changes in economic growth. Since deviations of the real interest rate from the Wicksellian interest rate are temporary, long-term real interest rates, represented by the yields on TIPS in the empirical analysis above, are largely driven by expectations of the Wicksellian rate." [my emphasis]

See also: Michael Woodford about his distaste for QE3, his hopes for better Fed-communication in general, and his advice to Bernanke with respect to his Jackson Hole speech today.

Nobel Laureate Meeting at Lindau (fg)

2011-08-25T18:44:00.005+02:00

Please find some enlightening speeches of Nobel Laureates at this year's meeting at Lindau including R. Mundell, J. Nash, R. Auman, E. Prescott, M. Scholes, W. Sharpe.

Mundell: Curreny Wars, Euro Mania, and the Price of Gold; he proposes an international Dollar/Euro fixed exchange rate system

UPDATE: The Financial Times (FTD) reports on Mundell's idea of a new exchange rate system.

Auman: Challenging Nash Equilibrium and the Role of Rational Expectations in Games; why the Nash equilibrium is flawed

Prescott: The Current State of Aggregate Economics; he reviews aggregate modeling and the role of disutility from work.

Selgin on 'Skidelsky's Late Punch' (amv)

2011-08-20T17:49:00.001+02:00

This post is just a follow-up on fg's hint at Skidelsky's 'Keynes-Hayek Rematch'. Here is George Selgin's reaction.

How to get out of a Recession - or the Keynes-Hayek Rematch (fg)

2011-08-19T12:05:00.006+02:00

I really do not want to get into another debate on the origins (mal-investment, low articifal interest rates, bad luck, lack of transparency that contributed to the build of systemic risk, etc???), the trigger of the crisis (Lehman, loss in confidence, reduction in expected GDP???) and the ways how to get out of it (stabilizing spending expectations vs. austerity???). For the sake of completeness, I just want to link a recent contribution of Robert Skidelsky on the different views of Keynes and Hayek about how to produce a recovery (see also a recent amv's post in our blog). According to him,

Whereas for Hayek recovery requires the liquidation of excessive investments and an increase in consumer saving, for Keynes it consists in reducing the propensity to save and increasing consumption in order to sustain companies’ profit expectations. Hayek demands more austerity, Keynes more spending.

Foreigners' Acquisitions of US Securities (fg)

2011-08-16T14:42:00.002+02:00

According to new data released by the US Treasury Department, in June 2011, foreign investors sold US Treasury Securities (net -4,5 Mrd. USD). Whereas, net purchases of the foreign private sector had been -18.3 Mrd USD, net purchases of foreign central banks was 13.8 Mrd. USD. In so far, the increased uncertainty of the sustainability of US public debt triggered a massive private outlow of foreing asset holders (the highest since 2008). It is for that reason, both economists and market observers claim that the US dowgrade of S&P had been already anticiapted(1,2) by the market and priced accordingly.

Nick Rowe strikes back (amv)

2011-08-16T00:33:00.000+02:00

Nick Rowe sent me his response and gave me the permission to post it. You find my remarks at the end of his reply. So here we go:

Thanks for your response. I've got several different things I want to say in response, so i will just number them for clarity:

1. Yes, you understood what I'm saying. That's always a relief. I wasn't sure if I was clear enough.

2. As you say, my critique about fragility in the limit is different from Peter Howitt's critique about dynamic instability under learning. But my intuition (OK, my "gut") tells me that the two are closely related. That if a model is very fragile in my sense it will be unlearnable in Peter's sense. Because if they haven't learned it yet that will cause big changes in how the model behaves, so what they learn from observing the model will be very different from the RE equilibrium.

3. OK, if half the agents make one mistake, and the other half make the exact opposite mistake, the model might behave exactly like an RE model in aggregate. But what if 49.9% make one mistake, and the other 50.1 make the exact opposite mistake? If it's a robust model, that's no big deal. The predictions will be almost identical to full RE. But if the model is "fragile in the limit", that small difference will cause a big bang in the predictions.

4. OK, I concede your main point! A model that is "fragile in the limit" might still be a "useful" model in some sense. But that's a very different sense from the one that we usually have in mind when we talk about models being "useful". Normally we mean something like "there's some sort of rough correspondence between the world and the model". But models can sometimes be "useful" in another way. The Modigliani Miller Theorem would be my favourite example. Someone could argue that the MM model is totally useless as a theory of how the world works, but is still a really useful theory because it tells us what assumptions we need to reject if we want to understand firms' financing.

5. Now I want to go totally off-topic. Well, not totally, but close. Whatever are you guys doing learning that stuff about stability of equilibrium in a Walrasian (OK, Arrow-Debreu, but same difference) economy? We live in a monetary exchange economy with n-1 markets (2 goods each, one of which is the medium of exchange), not a Walrasian economy with one big market where all n goods are traded simultaneously. So Walras' Law is misspecified, because there are n-1 different excess demands for money. Plus, if prices are at disequilibrium levels, either buyers or sellers will be rationed (they won't be able to buy or sell as much as they want), so will reformulate their notional demands and supplies taking those quantity constraints into account. So Walras' Law can't apply anyway, because their demands and supplies in each market are based on the quantity constraints in all the *other* markets, so the sum of the excess demands don't conform to any unified decision-making process based on a single (budget) constraint. We (old) guys learned that in the 1980's. It was called "disequilibrium macro". Then Lucas came along, and (almost) everyone forgot it. But doing stability proofs in a non-monetary economy with a Walrasian auctioneer with "notional" excess demand functions that ignore quantity constraints....now that really is useless. As well as "fragile in the limit"! ;-)

Since it's quite late in good old Germany, I will only comment on #5. Well, perhaps my recourse to the SMD results becomes more comprehensible if I tell you that I'm a historian of economics. So my job is to cope with the 'wrong ideas of dead men' (or at least quite old men). That may explain my focus on Arrow-Debreu models. Yet note that I used the SMD results only as an example to make my point. You could find other frameworks to make the same point. I'm just writing about SMD, so it seemed natural to use it. Actually, I would be pleased if SMD results would figure more prominently in our curricula. Since it is a highly negative result, applied economists should be aware of it. In particular when you are a Arrow-Debreu sceptic, you should welcome higher awareness of the generic impossibility to establish global uniqueness and stability by means of 'proper microfoundations'. This is because Arrow-Debreu reasoning is not as dead as perhaps it should be. Be it as it may, I'm happy that you concede my main argument (#4).

Actually, I concede your point about Walras' Law. Right because I'm a historian of economics, I'm well aware of the precious results by Clower and Leijonhuvfud that you "(old) guys" studied some hundred years ago (more or less), and that unfortunately disappeared from modern curricula. In concrete, I concede that in a monetary economy it is crucial to distinguish between notational and effective demand and, hence, to know of Clower's dual decision hypothesis. Consequently, I do accept that Walras' Law applies if and only if effective demands coincide with notational demands and that this do not have to be the case. So you preach to the converted!

A response to Nick Rowe: Fragility at the limit (amv)

2011-08-15T15:38:00.006+02:00

I promised Nick Rowe to respond to his post on what he calls "fragility at the limit'. It is a follow-up on the debate on Kocherlakota's argument that it is possible to determine long-run inflation expectations by setting nominal yields according to the Fisher relation. Let me start with a disclaimer: I do not believe that central banking is or should be using nominal yields in the way Kocherlakota suggests. I am interested in the theoretical model underlying Kocherlakota's argument. I further believe there is a grain of truth in his statement, since I 'believe' in long-run neutrality. As I mentioned many times before, I side with Sumner & his allies on NGDP- or (at least) price-level targeting.

Nick introduces an interesting argument. If I got him right, he accepts that Kocherlakota's argument is a sound REE-prediction. He however argues that the model is 'fragile'. To show what he means, he partitions the set of agents by defining a fraction f of adaptive agents on [0,1] (and, accordingly, a fraction (1-f) of RE-agents). The same fraction partitions the bahavior of firms, that is, f gives the fraction of sluggish price setters, while (1-f) gives the set of instantaneous price setters.

He starts with f=1 and argues, correctly, that an 1% increase in nominal yields suggests a 1% increase in real yields and, thus, initiates a sluggish deflationary (or disinflationary) process. As f approaches zero, that is, as the fraction of RE-agents who adjust prices instantaneously increases, the same 1% increase in nominal yields results in ever faster deflationary processes. As f approaches zero, increasing nominal yields suggests "instant explosive deflation". At the limit, however, that is, for f=0, Kocherlakota's model applies, that is, a 1% increase in nominal yields suggest 1% higher inflation expectations.

Nick concludes: "Suppose that the predictions in the limit (as the assumptions approached the model's assumptions) were totally different from the predictions at the limit. That would be a model that is fragile in the limit. And that, to my mind, would be a totally useless model."

Now, in this post I do not want to talk about monetary policy. As I mentioned before (in some comment section), I dislike DeGrauwe-type models, because they suggest that RE is a restriction on individual behavior. I rather side with Arrow, who convincingly argues that RE as an individual assumption is prohibitively restrictive. RE is a general equilibrium notion; REE defines a class of GE models; REE-price systems reflect information as if agents had the super-human capabilities Arrow is referring to. What is needed, of course, is some kind of mechanism, like Sandroni's market selection process, that establishes convergence in case of agents with bounded cognitive and information-processing capabilities. In case of monetary macro models, other learning processes are relevant, like Howitt's, who argues that if QTM-logic applies, and if central banks can manipulate nominal interest rates only by adjusting monetary base in the inverse direction, then a Kocherlakota-type REE is unlearnable. Note, however, that this is about the REE's dynamic stability and not about Nick's concept of 'fragility at the limit'.

To show what I mean, let me take an example that is totally unrelated to monetary policy. Let me talk about the Sonnenschein-Mantel-Debreu results (SMD). The Debreu version (1974) claims that given any function, say g, from the unit price simplex to a k-dimensional commodity space satisfying continuity, homogeneity, Walras's Law, and a boundary condition, then for every compact subset of the price simplex there exists an exchange economy with k 'well-behaved' agents such that the aggregate excess demand of that economy is equal to g(p) on the compact subset. Thus, if structure is imposed by restrictions on individuals (those restrictions that suggest utility and profit maximization), most of it is lost by aggregation (only continuity, homogeneity, and Walras' Law survive the adding-up of individual demands). Thus, sufficiency conditions for global uniqueness and global stability imposed on the system like gross substitutionality do not have microfoundations.

The SMD results are true for arbitrary dispersions of individual characteristics like preference and endowments. Imagine a convergent sequence of Arrow-Debreu exchange economies with a large but finite number of agents and commodities, decreasing in the dispersions of such primitives. States differently: for any sufficiently large n in the index set we have arbitrary dispersions of primitives; as n increases, dispersion decreases; in the limit, all agents have identical preferences and endowments. The last such economy in the sequence before we reach the limit is one with identical preferences and collinear endowments. As shown by Kirman and Koch (1986), the SMD results still apply. Up to this economy, there is no hope for global uniqueness and stability. But this is evidently not true for the limit economy, which in fact is a quasi-Crusoe economy. Global uniqueness and stability is trivial. Thus, as in Nick's framework, the sequence is discontinuous, that is, it jumps at the limit.

According to Nick's definition, we can say that the SMD results are 'fragile at the limit'. But his core statements that this implies 'uselessness' does not follow. It just tells us if we find an economy with strictly identical agents, we can hope for global uniqueness and stability. Otherwise, we have to make other restrictions than those on individuals (see Werner Hildenbrand on this). What this shows is that Nick's argument is not generically true as it is implied to be. An even though the SMD results tell us something about global stability of each economy in our sequence (or rather the lack thereof), Nick's notion of 'fragility at the limit' is about the continuity properties of a sequence of models (or rather about the lack thereof). As he insists, many economist do not pay enough attention to stability properties. I also believe that this is important. But as I tried to argue, his notion of 'fragility at the limit' is not concerned with dynamic stability issues.

Kocherlakota vs. Selgin (amv)

2011-08-11T22:54:00.005+02:00

I am currently engaged in a discussion with George Selgin and Nick Rowe on two only partly related subjects (check the comment section of Sumner's post):

The discussion emerged in reaction to Kocherlakota's (K in the following) controversial statement exactly a year ago. There he states the following:

It is conventional for central banks to attribute deflationary outcomes to temporary shortfalls in aggregate demand. Given that interpretation, central banks then respond to deflation by easing monetary policy in order to generate extra demand. Unfortunately, this conventional response leads to problems if followed for too long. The fed funds rate is roughly the sum of two components: the real, net-of-inflation, return on safe short-term investments and anticipated inflation. Monetary policy does affect the real return on safe investments over short periods of time. But over the long run, money is, as we economists like to say,neutral. This means that no matter what the inflation rate is and no matter what the FOMC does, the real return on safe short-term investments averages about 1-2 percent over the long run.

Long-run monetary neutrality is an uncontroversial, simple, but nonetheless profound proposition. In particular, it implies that if the FOMC maintains the fed funds rate at its current level of 0-25 basis points for too long, both anticipated and actual inflation have to become negative. Why? It’s simple arithmetic. Let’s say that the real rate of return on safe investments is 1 percent and we need to add an amount of anticipated inflation that will result in a fed funds rate of 0.25 percent. The only way to get that is to add a negative number—in this case, –0.75 percent. [...] To sum up, over the long run, a low fed funds rate must lead to consistent—but low—levels of deflation.

My position is that, if you accept K's premises, then his statement is fundamentally correct (no inconsistencies). I argue further that if you accept modern modelling practices, then K's premises are quite conventional. The reason for the outlandish flavor of his prediction may follow from a discrepancy between the representative economist's believe of how the real world behaves and the world described by their own models.

I entered the debate not to defend K. I entered it to debate Selgin's use of Wicksell's concept of interest spead. In concrete, Selgin argues that - given the FOMC's promise to hold FFR close to zero up to mid-2013 - if for whatever reason Wicksell's natural or equilibrium rate turns positive before mid-2013, then (1) either will the Fed engage in open market operations to keep FFR at the promised level and, thus, will act inflationary, (2) or the Fed will tighten policy to depress the natural rate to the zero level to keep its promise without allowing for inflation, (3) or the Fed has to break its promise (see also the comment section here).

(1) Let me begin with Wicksell. I entered the comment section by arguing that - given Wicksell's own premise of perfectly flexible prices - his framework is not robust for alternative assumptions of how agents form expectations. In contrast to NK models, Wicksell induces persistency no by price rigidities, but by assuming adaptive expectations. If you substitute rational for adaptive expectations, you get rid of all persistency. You have an essentially frictionsless model. Then, of course, the entire notion of Wicksell's interest rate spread breaks down.

Why is this? In Wicksell's pure credit economy (or cashless economy, if you wish) - given passive monetary policy - a shock to the natural real rate of interest is accommodated by an increase of the consolidated balance sheet of the banking system such that the inflation-adjusted monetary rate remains constant. Thus, we have an interest spread indicating an increase in AD. Since Wicksell assumes neutrality, the real output level remains constant in his deterministic, stationary model. Thus, a positive shock to the natural rate suggests a positive aggregate excess demand and, thus, a rising price level (vice versa for negative shocks to the natural rate). Evidently, Wicksell's cumulative process is disequilibrium analysis, because - in contrast to modern theorists - he is endowed with a static long-run notion of equilibrium only. He recommends monetary policy to increase the inflation-adjusted rate of interest as soon as the central bank observes inflation. Optimal policy sets the policy rate equal to the natural rate (implicit target: zero inflation).

What happens in case of RE in Wicksell's otherwise frictionless economy? RE suggests that agents know the true model; they understand that inflation is a function of aggregate excess demand. Further, actual inflation equals expected inflation. It follows that the inflation-adjusted monetary rate always and by necessity equals the natural rate (a real rate, of course). Further, monetary policy cannot influence the inflation-adjusted money rate of interest; money is neutral even in the short-run. Thus, Wicksell's concept of the spread between the real money rate and the natural rate breaks down if you substitute rational for adaptive expectations.

Note that Selgin applies Wicksell's aggregate excess demand concept to the case of frictionless RE models (see item (5) in his last comment here). As argued above, this is illegitimate.

(2) Now that I have clarified my position, let us turn to Kocherlakota. Before, however, I bring in some theory. In contrast to K, let me maintain the assumption that our reference model is frictionless and that it predicts REE. I will relax the former assumption later. In concrete, I assume a RBC model that implements Arrow-Debreu allocations and, thus, predicts optimal sequences. Of course, there is no medium of exchange in our model; but this is also true for NK-variations (see Woodford's cashless economy). Thus, Selgin's OMO-based story does not apply. In fact, we are faced with Say's Identity, that is, aggregate purchasing power is determined by aggregate supply, always and by necessity. RBC does not house Wicksellian processes; monetary disequilibria are ruled out.

There is, however, a role for money as a unit of account! Choose a commodity as numeraire. The role of the central bank is not to control AD, but to fix nominal values by determining the relative price of the unit of account over time. One way to do so is by making use of the Fisher relation. Since the inflation-adjusted interest rate is an intertemporal price relation determined by primitives, the central bank determines the expected time path of the relative price of the numeraire-commodity by communicating its preferred nominal yield curve. This, essentially, is K's logic.

(3) Finally, I have to show how the unit-of-account model relates to NK models: RBC is at the core of the NK model that allows us to measure the deviation from optimal time-series due to sticky prices (or information). Such persistency is implemented by adjustung a forward-looking Phillips-curve. Some Taylor-rule accounts for the central banks ability to alter the representative household's intertemporal consumption plan such that welfare-losses are minimized.

K effectively argues (see the bold emphasis above) that - in contrast to standard Calvo-pricing - persistency fades out in the long-run. If, for instance, persistency is due to the average length of contracts, a promise of the central bank at an initial date to hold nominal rates at zero for a period extending the average length of contracts, markets rationally apply the unit-of-account model to predict inflation rates beyond that average length. For earlier periods, markets apply the NK model. It is this deviation from standard theory that accounts for so much confusion with K's statement.

I'm still surprised by Sumner who sides with Selgin and Rowe. After all, he often refers to Friedman's correct observation:

After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.

Certainly, the high interest rates in the 70s were not due to high natural rates of interest (due to positive growth prospects), but due to high inflation expectations. Likewise, falling nominal yields in the 80s cannot be explained by falling growth expectations only, but by expected disinflation.

Disclaimer: All this does not mean that I prefer interest-based monetary policy. I prefer some kind of level-targeting making use of whatever instruments necessary to control expectations.

Money is too tight! (amv)

2011-08-09T23:36:00.002+02:00

I get increasingly upset with the ECB. I sincerely doubt that its monetary policy which persistently is 'behind the curve' (due to the ECB's refusal to target expectations) and discretionary is appropriate for edgy market sentiments all around the globe. It is frustrating that so many continental economists cannot identify that monetary policy is extremely tight at the moment (I guess, because most confuse low nominal yields with expansionary policy and because they do not trust their own models). Fortunately, we have Kantoos who provides an excellent argument for why, in fact, money is too tight in Europe.

His core statement:

It is time to realize that the policy of the ECB has been extremely tight since 2008, measured by the concept of macroeconomic stability and is therefore an important cause of the current mess.

Some Evidence:

Policy conclusion:

[...] The essence of this: choose a higher inflation, or even better, nominal spending target the more diverse (read: suboptimal) your currency union is. For the Euro area, an inflation target of below 2% is inadequate.

Kenneth Rogoff on the Great Contraction (fg)

2011-08-09T11:19:00.004+02:00

Kenneth Rogoff writes on the recent uncertainties surrounding a possible second fall down in world economic growth within 4 years. He comments:

Moreover, too many policymakers have relied on the belief that, at the end of the day, this is just a deep recession that can be subdued by a generous helping of conventional policy tools, whether fiscal policy or massive bailouts. But the real problem is that the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation.

Some observers regard any suggestion of even modestly elevated inflation as a form of heresy. But Great Contractions, as opposed to recessions, are very infrequent events, occurring perhaps once every 70 or 80 years. These are times when central banks need to spend some of the credibility that they accumulate in normal times. The big rush to jump on the “Great Recession” bandwagon happened because most analysts and policymakers simply had the wrong framework in mind. Unfortunately, by now it is far too clear how wrong they were.

I do not feel happy with such kind of proposal. O. Blanchard and others similarly called for higher inflation targets in order to escape the `lower-bound' of short-term policy rates. Rogoff, instead, makes a point in favor of higher medium-term inflation in order to transfer wealth and to reduce both leverage and debt burdens - a quite different logic.

On S&P and the US-Downgrade (amv)

2011-08-08T08:52:00.013+02:00

When it comes to rating agencies, I generically side with the view expressed by my fellow co-blogger ls. S&P's rationale for the recent US-downgrade, however, is somewhat unconvincing: it is not so much based on economic fundamentals (let us forget for the moment the $2 trillion error in calculating US discretionary spending that S&P conceded), but on S&P's fuzzy political judgement:

More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.

Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government's debt dynamics any time soon.

Ah, I see! But the expenditure orgies of President Bush Jr. justified AAA? I'm not sure, to say the least, if and to what extent S&P has comparative advantages as a 'public policy think tank'. I, for one, doubt that the extrapolation of the current political mess in D.C. is appropriate to justify the downgrade. More precisely, I doubt that S&P has a robust model relating the recent political turmoil associated with the insane Tea Party with US default risk.

As you all know, everything is relative. In economics, however, everything is even more relative! I still see no alternative to the deep and, thus, liquid US-treasury markets. Anyone in the house who really believes that the Eurozone is going to outperform the US? Politically? Economically? Further, the Swiss market is simply too small to house the global demand for (relatively!) risk-free assets. This is also true for our economically and politically sound Scandinavian neighbors. Or does anyone really believe that China or other Asian countries will outperform the US? In the next 10 years? Because they have better political systems?

Anyway, my scepticism is reinforced by the Economics of Contempt (HT Thoma).

UPDATE: Still relying on the EMH, I would be quite uncomfortable to make such statements without market backing. I don't believe that I'm smarter than the market. Markets, however, do accommodate my position as you can check here:

Source: Bloomberg

green: current yield curve

red: yield curve at previous close

Treasury yields have fallen along the entire yield curve! Two-year yields are on a record low! Bad news for S&P: your downgrade is not credible; you are detached from the market.

BBC's Keynes vs. Hayek Debate (amv)

2011-08-04T10:01:00.001+02:00

Check it out. Good stuff. The 'Yo Hayek!' crowd is evidently larger and more enthusiastic than the 'Yo Keynes!' crowd.

Yet another reason to target core inflation ... (amv)

2011-08-03T23:43:00.002+02:00

... or even better, to target expectations on core inflation; or even better, to target core-price-level expectations; or even better, to target NGDP-level path expectations. Zheng Liu and Justin Weidner for the FRBSF Economic Letter:

The recent rise in headline inflation following surges in food and energy prices has prompted concerns that high inflation could persist. However, sustained high inflation is unlikely as long as inflation expectations remain well anchored. With low pass-through of commodity prices to consumer prices and well-anchored inflation expectations, core inflation is likely to remain low and stable, and headline inflation is likely to fall to the levels of core inflation as the effects of commodity price increases dissipate.

Also recall this post.

UPDATE (04.08.): If you are still unconvinced (yeah, I mean you Mr. ls), you may want to check Paul Krugman's viewpoint here and, most recently, here.

Mankiw suggests price level targeting for the US (amv)

2011-07-30T22:42:00.001+02:00

Click here. It's good to have an atomic economist on my side. Here the relevant excerpt:

What the Fed could do, however, is codify its projected price path of 2 percent. That is, the Fed could announce that, hereafter, it would aim for a price level that rises 2 percent a year. And it would promise to pursue policies to get back to the target price path if shocks to the economy ever pushed the actual price level away from it.

Such an announcement could help mollify critics on both the left and right. If we started to see the Japanese-style deflation that the left fears, the Fed would maintain a loose monetary policy and even allow a bit of extra inflation to make up for past tracking errors. If we faced the high inflation that worries the right, the Fed would be committed to raising interest rates aggressively to bring inflation back on target.

Sumner is back and rocks the boat (amv)

2011-07-17T16:59:00.001+02:00

The opportunity costs of blogging are extremely high at the moment. This explains my absence in the last couple of weeks. The good news is that a much more able economists has returned to the blogosphere after endless months of absence:

Scott Sumner provides a very suggestive summary of his viewpoint on the GFC. As regular readers of 'the coffeehouse' know, I usually share his theory-based perspective. This time is not different. I especially like this: "The hero is the EMH [...]." I could not agree more.

Convergence or divergence (os)

2011-07-08T14:06:00.005+02:00

It's Friday and right in front of my window, the local university day is going to start; so just a nice graph from the FAZ page. It shows the long term yield on German and Italian government bonds. It looks like that the convergence process, which ended in a nearly perfect synchronism by the end of 1998, is now going to change into a newly process of diverging yields. One of the triggers seems to be the low productivity. Nevertheless, this is only a trigger, the fear of a new vicious circle comes around the corner. Higher interest rate, combined with a large and inefficient general government are no good combination.

As deviating long term interest rates come as no surprise, to me, the time before the actual crisis looks quite amazing. Again, nothing new, but look at the huge spread in 1995 which was about 6,5 percent and declined further to nearly zero percent witin only 3 years. This must have been a great time for Italian citizens - just as for the Greeks.

Bashing Rating Agencies is foolish (ls)

2011-07-07T13:50:00.002+02:00

During the last days, politicians were keen on bashing rating agencies. Their reluctance to accept a model of a bailout with private-sector participation, their threat to react by lowering the Greek rating to (selective) default and the recent massive downgrade of Portugal has led to sharp reaction amongst policymakers.

These reactions are completely ridicolous. Policymakers desperately look for someone to blame for the current mess. In fact, rating agencies are only delivering the bad news. The myth of illiquid but principally solvent periphery states has eventually been revealed as surreal.

What bothers me most, is the idea of creating a European agency. What should be the outcome? Judgements going hand in hand with policymakers' preferences? AAA-Ratings for Greece? If their is the slightest doubt concerning its independency - and there would be good reason for such doubts - the market just will not listen. In principle, governments could impose ratings on their debt instruments themselves. Concerning credibility, this would essentially be the same. On the other hand, a completely independent agency will basically reach the same conclusions as S&P, Moody's and Fitch. People who argue that the rating agencies are a vehicle of the United States and their perceived interest to prevent the Euro becoming a key currency are just misleaded conspiracists. To me, it's the same as thinking of 9/11 as an inside job or as regarding Goldman Sachs as the very source of all evil.

Concerning contagion effects of a Greek default, you can find very insightful research here. Based on an econometric analysis of sovereign CDS spreads the authors reach the following conclusion:

[...] the evidence suggests that contagion has become less likely today relative to the past couple of years. After a relatively long period when markets bundled EU sovereign risks together, financial markets have started to discriminate more. This means two things. First, an orderly restructuring of Greek sovereign debt is less likely to produce a disruptive “rush out of Europe” than in the past, and second, the fate of other problematic countries, such as Italy, rests, now more than ever, in their own hands.

This puts doubts on the story of dangerous contagion effects and a systemic event à la Lehman. Admittedly, I held another opinion at the beginning of the debt crisis. Amv probably loves to read this. I still feel great sympathy for the idea of leveraged buybacks which was proposed here. It's puzzling to me that this proposal doesn't find its way into the current debate.

Too Big to Fail: The HBO-Movie (amv)

2011-07-01T20:32:00.002+02:00

Trailer

HT Mankiw

millions, billions, ... (os)

2011-06-30T11:28:00.006+02:00

Yesterday, the Greece parliament has adopted a gigantic savings plan in order to reduce further government spending and the debt accumulated so far. Well, you can think of this plan from different views, whether it is necessary or not, whether it will improve or worsen the situation (and I am sure there are different opinions) and so on. Never the less, what can be stated - at least in my opinion - is that this plan is really, really huge. Roughly 80 Billion Euro are supposed to be saved. This is 17% of the 2010 GDP of Greece!

But what is interesting to me, is the "real" value of this sum. Or in other words, what does it mean to save 17% of GDP in terms of cutbacks or tax raises? Compared to Germany this would mean a savings plan about 425 Billion Euro. At Spiegel.de you can find a "list" of potential sources for savings. Ok, lets see how we could get 425 Billion Euro:

Cut all senior citizen payments: 80 Billions
Cut all unemployment payments: 40 Billions
Cut all kindergartens, schools, universities payments: 100 Billions
Raise "Soli" from 5.5% to 11%: 13 Billions
Raise VAT to 25%: 70 Billions

Saved till now: 303 Billions...... damn!

A nice portrait of Akerlof the Great (ls)

2011-06-29T23:45:00.001+02:00

Find it here. (HT Mankiw)

Some teasers:

While unemployment is the topic that has motivated him the most, it is his 1970 article showing how markets might break down in the presence of asymmetric (or unequal) information that won him the Nobel Prize. Indeed, if you play a game of word association with an economics PhD and say “Akerlof,” chances are the response will be “lemons.”

Hmmm... probably true. ;-)

This is because the example Akerlof gave was of used car markets, where sellers have better knowledge of whether their car is a good one or a “lemon.” The buyers’ best guess is that the car is of average quality, so they will only be willing to pay the price of a car of average quality. This means, however, that owners of good cars will not place their cars in the used car market. But that in turn lowers the average quality of cars on the market, causing buyers to revise downward their expectations of quality. Now even owners of moderately good cars are unable to sell, and so the market spirals toward collapse. Akerlof says that the problem dates back to one that has confronted horse traders over the ages: “If he wants to sell that horse, do I really want to buy it?” But problems of asymmetric information are present in most markets, particularly in financial markets. “This [recent financial] crisis gave us glaring examples,” says Akerlof. “Ordinary people thought they were buying homes, not the complex derivatives that they later realized they had ended up buying.”Akerlof says he chose the example of used cars to make his paper “more palatable” to U.S. readers. But his interest in the subject had been triggered when, during his stay in India in 1967–68, he noticed people’s difficulty obtaining credit. He kept this example in the paper, along with sections on how the “lemons principle” could also explain why the elderly had trouble obtaining insurance and why minorities had difficulty obtaining employment. All this proved too exotic for much of the academic market of the time; the paper was turned down by three leading journals before it was finally published [...]

Find the paper here. It is a must-read for students. In my humble opinion it's one of the most brillant papers ever written, since it introduces the extremely powerful concept of adverse selection in a way which is really easy to understand.

A new book is in town...(os)

2011-06-27T12:30:00.002+02:00

... and it is called "Poor Economics". Unfortunately the authors Esther Duflo and Abhijit Vinayak Banerjee, both MIT, do not find a superior way to overcome world poverty and hunger. Never the less, they have used methods of microeconomics and social sciences and so on to evaluate habits of people living in poverty. In this manner, it differs from previous books and advices, favoring manly "liberal market solutions". This description shows promise.

Heightened Sensitivity towards Macro Risks (fg)

2011-06-27T10:38:00.006+02:00

It seems, this time, the Bank for International Settlements (BIS) gets its attention across worldwide newspapers. Yesterday, BIS published its latest Annual Report which includes extensive data analysis and research.

Global economic growth must slow - the imbalances caused by unsustainable growth before the crisis now need to be rectified, and as they are, growth is bound to be slow. Policymakers should not hinder this inevitable adjustment. The prolonged period of very low interet rates entails risk of creating serious financial distortions, misallocations of resources and delay in the necessary deleveraging in those countries most affected by the latest crisis.
Highly accommodative monetary policies are fast becoming a threat to price stability
The fact that interest rates have been very low for a prolonged period of time, gives rise to (unintented) evolving financial risk
There are already immense threats to price- and financial stability in emerging countries including China, India and Brazil. All three countries experience similar macroeconomic dynamics as it has been the case for the US, UK, Ireland and Spain in the run-up to the financial crisis 2007. In particular, credit, debt and leverage dynamics of both the financial and the non-financial sector are sky-rocketing - total credit growth is in total over 20% p.a. in China and India. Partly this 'unsustainable' (according to BIS) credit and investment boom is a byproduct of a low-yield environement in industrial countries, thereby providing huge incentives for global investors to invest in emerging countries.

Moral hazard matters! (amv)

2011-06-24T08:51:00.007+02:00

Ich habe fremdgebloggt. Kantoos war so freundlich, mich als Gastblogger zu rekrutieren. Meinen Beitrag findet ihr hier.

UPDATE: F. Luebberding diskutiert mit.

Meine Replik (bei Kantoos):

zu "Die Politik hatte sich bis 2007 immer an diesem Konsens orientiert. Die Folgen sieht man heute. Das ist auch der Grund, warum sich niemand mehr für den Marktkonsens interessiert. Man kann sich nämlich auch gemeinsam irren. Weil Märkte aber nach Ansicht einiger Zeitgenossen a priori nicht kollektiv irren können, muss man natürlich eine Erklärung finden, dass sie a posteriori doch eine tiefere Wahrheit antizpierten."

Habe ich nicht explizit die Möglichkeit des ex-ante Irrtums eingeräumt? Meine gesamte Argumentationslinie (basierend auf der Systemintelligenz des Marktes) basiert darauf. Dass sich alle gemeinsam irren können, stimmt zwar, aber wenn alle dieselben falschen Erwartungen haben, kommt kein Assethandel zustande.

Es muss immer jemand bereit sein, eine Gegenposition einzunehmen. Insoweit muss es ex post zu eine Reallokation von Marktzugang kommen, und zwar hin zu den relativ besseren Entscheidern.

Ansonsten kann ich es kurz machen: der gesamte Beitrag ist eine völlige Falschdarstellung meiner Argumentation. Luebberding hängt sich an einer Aussage auf, die ich nicht getroffen habe. Vielleicht hätte er meinen Beitrag lesen sollen (oder dabei die Ideologie-Brille abnehmen).

UPDATE 2: Hier ein wichtiger Punkt, der sich aus der Debatte ergeben hat (siehe die Kommentarsektion bei Kantoos Economics):

@ aloa: "Ich rede von Gewinnen. Und wenn, dann wäre das einzige was interessiert wie sich die akkummulierten Gewinne über die Jahre im Verhältnis zum Verlust am Ende verhalten. Und auch das nur wenn überhaupt(!) diejenigen welche die Gewinne einfahren mit denen welche die Verluste am Ende einfahren identisch sind."

Sehr guter Punkt! Auch wenn ich Deine Schlußfolgerung nicht teile. Du weist zurecht auf ein Problem hin. Wenn eine Falschentscheidung eine Serie von Kapitalgewinnen produziert und erst dann Kapitalverluste zur Folge hat, dann scheint es auf die Relation von frühen Gewinnen und späten Verlusten zu achten. Hier ein paar Punkte:
(1) Eine Entscheidung, die frühe Erträge und späte Verluste bringt nennt man eine Disinvestition. Sol eine Entscheidung ist oft sinnvoll und nicht von vornherein als Zeichen von Fehlverhalten zu interptetieren. Sie ist immer dann rational, wenn irgendwo in der globalen Ökonomik eine Investition derart produktiv erscheint, dass es lohnend wird anderswo Ressourcen freizugeben. So führt ein extrem hoher Renditevorsprung einer Investition dazu, dass vermehrt Geldkapital zur Realisierung nachgefragt wird. Ist sind die betroffenen Sektoren signifikant (groß und/oder zahlreich), dann steigt der Zins (ggf. auch weil Risikoprämien steigen, weil der Markt ins Risiko geht). Steigende Zinsen diskriminieren gegen andere Investitionsprojekte und gleichzeitig erhöhen sie die Renatibilität von Disinvestitionen (der relative Kapitalwert solcher Aktivitäten steigen). Insgesamt werden die Ressourcen zur produktiveren Verwendung freigesetzt.

(2) Hingegen ist es problematisch, wenn eine rationale "Blase’ (ich benutze den Begriff unter Vorbehalten)vorliegt: man reitet auf steigenden Preisen mit, wohlwissend dass die Preise sich von den Fundamentaldaten entfernen, in der Hoffnung, frühzeitig abspringen zu können, d.h. bevor die Verluste deutlich werden. Wenn hinreichend viele so handeln, entsteht eine rationale Blase. Aber nur die wenigsten können diese Hoffnung realisieren; qua Natur der Sache. Das bedeutet, dass die überwiegende Zahl der Blasen-Reiter ihre Ressourcen verliert und zwar an die anderen Marktteilnehmer, inklusive derjenigen Minderheit, die sich schnell genug verabschiedet hat. Nur letztere werden dafür belohnt, eine Blase mit herbeigeführt zu haben. Ein Problem entsteht aber nur, wenn diese Gruppe SYSTEMATISCH GLÜCK hat, rechtzeitig abzuspringen. Systematisch Glück haben ist aber mit an Sicherheit grenzender Wahrscheinlichkeit ausgeschlossen.

Ich bleibe dabei: Wenn die Politik die Verlierer systematisch rettet, ist die nächste Krise am wahrscheinlichsten.

The CISS Indicator (fg)

2011-06-22T08:38:00.008+02:00

There is a new indicator for measuring the systemic risk component of financial risk generated by ECB staff and recently published in the latest ECB Financial Stability Review; it's called the “composite indicator of systemic stress", or simpliy CISS.

The aim of CISS is to monitor the current level of systemic risk in financial markets by aggregating individual risk measures of various market segments including the bank and non-bank financial intermediaries sector, money markets, equity and bond markets, and foreign exchange markets. According to Hollo/Kremer/Duca (2011), each sub-index is calculated as the simple mean of the transformed values of three individual stress measures for each market segment. The five sub-indices are then aggregated on the basis of their time-varying cross-correlation structure in the same way as the overall risk of an asset portfolio is calculated from the risk characteristics of its individual assets. The novel feature of CISS is that the systemic risk measure relatively increases in times of high correlation of the sub-indices where stress prevails in several market segments at the same time. Such a situation implies that for financial investors, it becomes difficult to diversify and hedge their portfolios since market segments are nearly perfectly correlated.

Meanwhile the indicator nicely features the massive soaring of systemic risk starting in 2007 and it quite solidly depicts the implications of the sovereign debt crisis in the euro area, there is one decisive weakness in this measure: it is a measure designed to give a current picture of financial stress. However, it is incapable of mirroring the build-up of financial instability in the run-up to the financial crisis.

For monetary policy and macroprudential regulation, what is essentiel is the reliance on an ex-ante measure for the degree of financial instability and the likelihood of a near-time costly bust in economic terms. In this respect, the CISS is, like any other currently existing indicator, not able to quantitively sketch the build-up of systemic risk in the background of the financial system, where, at the same time, most current risk measures do NOT indicate future financial stress (see, for instance, the low measured corporate risk spreads in 2004-07 which did not indicate financial instability despite evolving financial imbalances due to massive lenghtening of financial intermediation chains and increased network activity). Consequently, it would turn out to be productive, if the CISS would be applied in order to address the issue of evolving financial imbalances ex-ante.

(Again) Target II (os)

2011-06-20T08:12:00.006+02:00

A nice article of Karl Whelan on the controversial debate of the target II system started by Hans Werner Sinn. In essence, the question is whether loans that are provided to the GIPS countries via the target II system are no longer available to german debitors, or not. (You can find the links to the original HWS articles below Karl Whelans post.)

And to add some color to this gray Monday morning, two graphs from the Bundesbank on this issue:

p.s. amv just told me, what he did the weekend:
discussion, post, discussion, post, ....

Targeting the monetary aggregates? (os)

2011-06-15T15:52:00.004+02:00

Here you can find a nice, short article "why the fed has moved away from targeting monetary aggregates in conducting monetary policy" written by John Williams of the FRBSF. The answer: essentially, due to the change in the payment behaviour of Americans away from cash on to credit cards and such developments as paypal etc. So why don't target a different, broader monetary aggregate such as M2 for example? Well (and I like the american, pictorial way): "despite repeated efforts, like the mythical city of El Dorado, this ideal measure of money has proven elusive".

(This short article is part of a speech covering various other issues such as reserve policy or the asset purchasing program of the Fed.)

Paradigm Shift on Part of Central Banks? (fg)

2011-05-26T20:56:00.004+02:00

Please find an enlightening speech of L. Bini-Smaghi, member of the exectutive board of the ECB, on monetary policy, the setting of interest rates, financial stability concerns and linkages to macroprudential regulation.

It is not asset prices per se that a central bank should incorporate in its policy framework. After all, the equilibrium value of assets – particularly real assets, such as claims on companies and houses – is difficult to compute and is certainly state-contingent. So, there is little merit in an unconditional monetary policy response to asset price changes. The policy response should be conditional.[...] This being said, monetary policy needs support in its ex ante action to resist the formation and build-up of toxic financial imbalances. There is a clear need for a corresponding policy framework to foster financial stability; we need to understand how it interacts with monetary policy in order to minimise frictions between the two and exploit possible synergies.[...]Could there be consequences for the setting of monetary policy? It is too early to tell, but given the various levels of interplay with macro-prudential policies that I have described, and the need to coordinate the latter, we need to think more about the international dimension of monetary policy, which may be driven by financial stability concerns. This will be on our agenda for the coming years.

For a related discussion on monetary policy and asset price dynamics see the work of Fahr et al (2011) In particular, asset price busts are induced by market participants’ choice of an increasingly fragile balance sheet structure during good times. Their vulnerability is inevitably revealed by some small, randomly occurring shocks which cause the need for sharp deleveraging - which even triggers defaults and macroeconomic contractions. Some recent work and simulation results on this issue can be found here or here.

On DSK, Lévy, and the Invisible Hand (amv)

2011-05-21T18:48:00.003+02:00

HT Mankiw

The economy as a complex adaptive system (amv)

2011-05-20T18:26:00.001+02:00

Herbert Gintis discusses Eric Beinhocker's Origin of Wealth: Evolution, Complexity, and the Radical Remaking of Economics and thereby provides the basics of complex adaptive systems. Highly recommended.

Lagarde? Warum eigentlich? (amv)

2011-05-20T11:01:00.001+02:00

Kurzer Kommentar von Heike Göbel (FAZ.NET) über die hoch gehandelte Nachfolgekandidatin von DSK. Highlight:

Warum eigentlich Lagarde? [...] Der Ministerin mit dem ausgeprägten Hang zum Interventionismus verdankt Deutschland die krude Empfehlung, seine Exportstärke durch höhere Löhne zu dämpfen, sich quasi der Wettbewerbsfähigkeit durch staatliche Eingriffe in die Lohnpolitik zu berauben. Lagarde steht in der französischen Tradition, im Zweifel für mehr Koordination als für mehr Wettbewerb zu sprechen. Sie ist die Haupt-Advokatin ungebremster Staatshilfe, private Kreditgeber will sie an der Rettung zahlungsunfähiger Euroländer nicht beteiligen.

Besonders erfreulich ist, dass der Antagonismus zwischen 'Koordination' und Wettbewerb gesehen wird. Die Eurozone ist entweder eine Stabilitäts- und Wettbewerbsgemeinschaft, oder aber eine Haftungs- und Transfergemeinschaft. Insofern ist auch der sogenannte 'Pakt für Wettbewerbsfähigkeit' nichts anderes als ein Beispiel für Orwellschen Newspeak. Aber auch hier ist auf FAZ.NET Verlass.

European debt crisis: Ansgar Belke weighs in (amv)

2011-05-19T09:10:00.000+02:00

Ansgar Belke on the controversy between the Plenum der Ökonomen and FTD: here. Good stuff! (I guess, I like it also because he was one of my teachers; so I'm biased).

The profession's favorite economic thinkers (amv)

2011-05-17T10:10:00.004+02:00

Check out William L. Davis et al. on Economics Professors’ Favorite Economic Thinkers, Journals, and Blogs (along with Party and Policy Views). Teaser:

Favorite Pre-Twentieth Century economists

Favorite Twentieth-Century economists, deceased

Favorite Living economists Age 60 or Older

HT Mankiw

Frankel on the ECB's three mistakes (amv)

2011-05-16T08:45:00.000+02:00

According to Jeffrey Frankel © VoxEU.org, the ECB made major mistakes by

"the decision in 2000 to admit Greece in the Eurozone",
"allowing the interest rate spreads on sovereign bonds issued by Greece (and other periphery countries) to fall almost to zero during the period 2002-2007" by accepting "Greek debt as collateral, on a par with German debt",
"the failure to send Greece to the IMF early in the crisis".

For the details, visit VoxEU.org.

In defense of speculation (amv)

2011-05-14T10:34:00.000+02:00

'Noah Smith' explains why speculation on futures markets stabilizes spot prices. Good stuff!

Eichengreen on debt restructuring (ls)

2011-05-12T13:39:00.000+02:00

Find the article here. He sketches out how a restructuring of Greek debt can be carried out while the potential for systemic risk remains contained.

Key points:

Greece needs to default on its existing bonds and replace it by new ones carriying a significant haircut. The ongoing losses for creditors should be tax deductible in order to limit the impact on banks' profits.
The ECB could offer favourable collateral rules concerning these new bonds.
Accounting rules should be modified in a way which allows banks to stretch their losses over an extended period.

Procyclicality, Waves, and Leverage (fg)

2011-05-11T17:59:00.000+02:00

To be continued ...

The case for targeting core inflation (amv)

2011-05-08T20:37:00.004+02:00

Matt Rognlie provides an excellent discussion of the Mankiw/Reis paper on What Measure of Inflation Should a Central Bank Target? (2003). The arguments are strong, indeed.

Abstract:

This paper assumes that a central bank commits itself to maintaining an inflation target and then asks what measure of the inflation rate the central bank should use if it wants to maximize economic stability. The paper first formalizes this problem and examines its microeconomic foundations. It then shows how the weight of a sector in the stability price index depends on the sector’s characteristics, including size, cyclical sensitivity, sluggishness of price adjustment, and magnitude of sectoral shocks. When a numerical illustration of the problem is calibrated to U.S. data, one tentative conclusion is that a central bank that wants to achieve maximum stability of economic activity should use a price index that gives substantial weight to the level of nominal wages.

HT Mankiw

Robert W. Clower 1926-2011 (amv)

2011-05-06T18:52:00.002+02:00

I am sorry to inform you that the great Robert W. Clower passed away earlier this week.

Issing on Inflation Targeting (ls)

2011-05-05T17:25:00.000+02:00

Another quote from Otmar Issing's speech 'Lessons for Monetary Policy. What should be Consensus' at the IMF.

Consider a statement by Lars Svensson, whom I have chosen not only because he is one of the gurus of the concept of inflation targeting but also because his statement shows how you can immunize a strategy against any critique.'In the end, my main conclusion so far from the crisis is that flexible inflation targeting, applied the right way and using all the information about financial factors that is relevant for the forecast of inflation and resource utilization at any horizon, remains the best-practice monetary policy before, during, and after the financial crisis.' His statement is that if it hasn't worked as you had expected, either it was not applied properly, or you missed some information. But the strategy was fine. In this way, you can continue with such concepts indefinitely, having made mistake after mistake.

However, cheering for the monetary pillar as a diagnostic tool for financial imbalances is ex post argumentation as well. The monetary pillar was always seen to detect medium- and long-run risks for price stability on the goods market in the spirit of the quantity theory (and the Bundesbank ). A lot of recent research shows that trend deviations of monetary aggregates and credit aggregates do a pretty good job in prediciting financial instability. Hence, the two-pillar strategy is likely to be appropriate in dealing with the bulid-up of imbalances and the corresponding build-up of medium-term risks for price stability. But its original purpose is a different one. ECB officials silently rededicated the monetary pillar towards ensuring financial stability.

Keynes vs. Hayek - Vol. II (amv)

2011-04-28T17:57:00.003+02:00

This is Keynes vs. Hayek, Vol. II. It's excellent, much better than Vol I. Keynes wins the first round, and loses all the others (just my view, of course). Check it out:

Good news for Hohenheim grads (amv)

2011-04-25T11:58:00.002+02:00

You guys are Top 10 in economics and business administration: check

More literature (amv)

2011-04-19T11:50:00.003+02:00

1. The Plenum für Ökonomen provides some insightful comments regarding the European Debt Crisis (in German). UPDATE: Check also this excellent Frontal 21 video.

2. David Altig (macroblog) has a nice post on the Atlanta Fed's annual Financial Market Conference. I especially recommend CAUGHT BETWEEN SCYLLA AND CHARYBDIS? REGULATING BANK LEVERAGE WHEN THERE IS RENT-SEEKING AND RISK-SHIFTING by Acharya et al.

Abstract:

We consider a model in which banks face two moral hazard problems: 1) asset substitution by shareholders, which can occur when banks make risky, negative net-present-value loans; and 2) managerial rent-seeking, the result of bank owners investing in inefficient "pet" projects or shirking in effort. The privately optimal level of bank leverage is neither too low nor too high: It efficiently balances the market discipline that owners of risky debt impose on managerial rent-seeking against the asset substitution induced at high levels of leverage. However, when correlated bank failures can impose significant social costs, regulators may bail out bank creditors. Anticipation of this action generates an equilibrium featuring systemic risk, in which all banks choose inefficiently high leverage to fund correlated, excessively risky assets. Leverage can be reduced via a minimum equity capital requirement, which can also rule out asset substitution. But this also compromises market discipline by making bank debt too safe. Optimal capital regulation requires that a part of bank capital be unavailable to creditors upon failure so as to retain market discipline and be made available to shareholders only contingent on good performance in order to contain risk-taking.

FAZ once again: Hyun Song Shin on Financial Stability (fg)

2011-04-19T09:49:00.004+02:00

Princeton's Hyun Song Shin über Geldpolitik, Finanzmarktstabilität und Geldmengenaggregate in der FAZ.

Es ist richtig, dass ich in meinen Arbeiten das Verhalten von Finanzunternehmen und hierzu auch Geldmengen untersuche. Aber ich tue das aus anderen Gründen. Friedman und die anderen Monetaristen analysierten Geldmengen mit Blick auf die Inflation. Ich analysiere Geldmengen mit Blick auf die Stabilität des Finanzsystems.

In der Welt der direkten Inflationssteuerung sorgt die Leitzinsänderung dafür, dass sich die Inflationserwartungen der Menschen ändern. Das sorgt für Veränderungen des langfristigen Zinses, die wiederum Einfluss auf realwirtschaftliche Größen wie Konsum und Investition nehmen. Die Geldpolitik wirkt in diesem Modell über Anpassungen der Zinskurve. Ich frage, was nach Änderungen der Leitzinsen im Finanzsektor geschieht, und hier vor allem in den Banken. Diese Einflüsse sind sehr wichtig. Änderungen von Leitzinsen beeinflussen die Refinanzierungskosten von Banken und nehmen daher Einfluss auf deren Gestaltung der Bilanz. Änderungen der Bankbilanzen beeinflussen anschließend die reale Wirtschaft.

Ein Plädoyer für eine Übertragung des Finanzmarktstabilitäts-Ziels an die Notenbank.

Grüner Zeitgeist: Protektionismus (amv)

2011-04-18T19:29:00.003+02:00

Hier eine interessante Studie von Thomas Bernauer zur Frage: Sind umweltbewusste Personen Protektionisten? Die Antwort ist wenig überraschend.
Ergebnisse:

Insgesamt lässt sich feststellen, dass Individuen mit stärkerem Umweltbewusstsein eine kritischere Haltung gegenüber der wirtschaftlichen Globalisierung insgesamt an den Tag legen und eher protektionistische Massnahmen befürworten. Vereinfacht formuliert: Wenn sich das Umweltbewusstsein einer Person von einer Standardabweichung unterhalb auf eine Standardabweichung oberhalb des Mittelwertes erhöht – dies entspricht ungefähr einer 35%igen Zunahme der Stärke der Umweltpräferenz innerhalb der tatsächlich beobachteten Werte auf dieser Variable – steigt die Wahrscheinlichkeit einer protektionistischen Einstellung um durchschnittlich rund 10%. Angesichts der Tatsache, dass aussenwirtschaftliche Präferenzen von diversen Faktoren beeinflusst werden, ist dieser Zusammenhang beachtlich. Er liegt ungefähr in der Grössenordnung des Effekts von Faktoren, die traditionellerweise von der Aussenhandelstheorie in den Vordergrund gestellt werden (v.a. die wirtschaftlichen Umverteilungseffekte von Freihandel). Die Grafik zeigt, dass der Zusammenhang auch bei unterschiedlichen Formulierungen der Protektionismus-Frage in die gleiche Richtung tendiert und statistisch weitgehend signifikant ist.

Warum internationaler Handel eine durch und durch gute Sache ist, erklärt Tom Palmer in 3 Minuten (für Dummies):

Ich habe Tom in meiner Zeit beim Cato Institute kennengelernt. Bis heute kenne ich niemanden, der so belesen ist. Intellektuell ist er ein Gigant; menschlich ist er mehr als das.

Otmar Issing on consensus views (fg)

2011-04-18T11:10:00.002+02:00

Quote from Otmar Issing's speech 'Lessons for Monetary Policy. What should be Consensus' at IMF.

My question is—always, and not only from hindsight–whether this [Sticking to Inflation Targeting and to the benign neglect view of dealing with asset prices] is all. Because if this is your position, that monetary policy should deal with asset prices only on the way down, it is a totally asymmetric approach. It implies that as long as asset prices go up, the central bank is saying, it's not our business. If asset prices collapse after a bubble bursts, then the central banks have to come to the rescue. They are the savior. I think this asymmetric approach implies the risk of a series of ever-increasing bubbles, because you never correct the causes that have led to the bubble.

FAZ on Monetary Policy Strategy (fg)

2011-04-18T08:50:00.002+02:00

FAZ: Die Rennaisance der monetären Analyse:

Die monetäre Analyse ähnelt heute einer Baustelle, aber dies gilt auch für die direkte Inflationssteuerung. Am Ende könnte die von Issing eingeführte pragmatische „Zwei-Säulen-Strategie“ der EZB, die realwirtschaftliche und monetäre Analysen verbindet, das brauchbarste heute verfügbare geldpolitische Konzept darstellen, auch wenn ihm die theoretische Eleganz fehlen mag.

Acemoglu, Rajan, Roberts, Sumner (amv)

2011-04-15T14:09:00.002+02:00

Some non-technical introductions to important topics:

A nice piece by Scott Sumner making The Case for NGDP Targeting (Adam Smith Institute, UK). Very neat introduction to the topic, esp. part 3 on level targeting and forecast targeting. I would only add that if the target rate of NGDP-growth is sufficiently low (i.e., only accommodating the increase of factor supplies), then markets can infer information about productivity growth from stochastic price-level processes. Sumner's article is also discussed at Bloomberg.
A great informal summary of the Great Recession and its roots by Russ Roberts. Roberts is a razor-sharp economic thinker as well as a terrific writer and clever communicator. BTW: this piece gives you a clear understanding of the superiority of rational-choice reasoning. It is a neat explanation of the crisis without resuming to empty 'people-just-went-crazy' arguments dominating behavioural approaches.
Here the link to Daron Acemoglu's appearance on Econtalk. Might be of particular interest for ls. Here the summary:
Daron Acemoglu of MIT talks with EconTalk host Russ Roberts about the role income inequality may have played in creating the financial crisis. Raghuram Rajan in his book, Fault Lines, argues that growing income inequality in the last part of the 20th century created a political demand for redistribution and various policy changes. This in turn created the push for higher home ownership rates and led to the distortions of the housing market that in turn led to excessive risk-taking in the financial market. Acemoglu suggests a simpler story where the financial sector through its political influence distorted the rules of the game, benefiting executives in the industry, which in turn led to outsized rewards and ultimate instability in the financial industry. The conversation discusses ways of distinguishing between these two arguments and what might be done to change the incentives of politicians.

Why higher interest rates are a bad idea (amv)

2011-04-09T13:25:00.001+02:00

In contrast to ls, I believe that the ECB decision to increase the short-term rate by 25 BPS is highly problematic. The WSJ provides the essential arguments (check the free FB version). HT to Kantoos Economics, who augments the WSJ's line of reasoning.

+25 Bp. (ls)

2011-04-08T12:51:00.001+02:00

The ECB raised the key refinancing rate to 1,25% yesterday. Find the statement here.

Several points are worth mentioning:

The interest rate decision relies almost entirely on the economic analysis. Key drivers were rising commodity prices and expected increases of indirect taxes and administered prices due to the necessary fiscal consolidation.
Trichet emphasized that the stance of monetary policy has still to be regarded as "accomodative". This wording makes further rate increases likely, especially if second-round effects occur.
The growth rates of monetary aggregates are still moderate. The large liquidity positions of the financial system don't seem to contribute to the current inflation pressures.

In general, this decision is a welcomed step back to doing business as usual and to refocusing on inflation targets rather than on financial market and currency union stabilisation.

Habermas über Merkel (os)

2011-04-07T16:23:00.003+02:00

Ein schöner Aufsatz von Jürgen Habermas in der SZ über Bundeskanzlerin Merkel - spezielle ihre Europapolitik. Es geht aber auch um Nationalstaatlichkeit, Politiker-Journalisten Klüngel und natürlich hat er auch was zur Währungsunion zu sagen. Lesenswert.

Über den Rubikon III: Sinn bringt es auf den Punkt (amv)

2011-04-06T17:07:00.000+02:00

Hans-Werner Sinn über die Rettungspakete (ich zitiere aus einer internen, leicht modifizierten Version):

Mit dem Beschluss über die Rettungspakete sei die Gemeinschaftswährung nun dauerhaft stabilisiert, sagt Bundeskanzlerin Angela Merkel der deutschen Bevölkerung. Davon kann leider überhaupt nicht die Rede sein. Das Rettungssystem ist vielmehr eine tickende Zeitbombe, deren Sprengkraft selbst die schlimmsten Ahnungen der Öffentlichkeit übersteigt.

[...] Die Länder hätten nun eigentlich aufhören müssen, über ihre Verhältnisse zu leben, aber den dazu nötigen harten Sparkurs wollte kein Politiker verantworten. Stattdessen versuchte die Politik, die zur Finanzierung des Lebensstandards ihrer Bürger ausfallenden privaten Kreditflüsse durch öffentliche Kredite zu ersetzen. Dies geschah auf fünffache Weise:

Zuerst kamen diese Kredite von der Europäischen Zentralbank, die im Zuge ihrer „Vollzuteilungspolitik“ bereitwillig Geld druckte und verlieh.
Die Zentralbank finanzierte auch die Staatsbudgets der GIPS‐Länder, indem sie Staatspapiere kaufte, was Bundesbankpräsident Axel Weber veranlasste, von seinem Posten zurück zu treten. Ein solches Verhalten war der Bundesbank früher wegen der Inflationserfahrungen aus der Weimarer Republik verboten.
Die EZB erlaubte den nationalen Notenbanken, außerhalb der normalen Geldschöpfung, neues Geld zu schöpfen und gegen mindere Sicherheiten an die jeweiligen Geschäftsbanken zu verleihen (ELA, Emergency Liquidity Assistance).
Vor allem aber gaben einzelne Zentralbanken, an erster Stelle die Bundesbank, den Zentralbanken der GIPS‐Länder über die EZB in gigantischem Umfang Kredite, um den versiegenden privaten Kreditfluss zu ersetzen. Dies geschah unter der technischen Bezeichnung „Target‐2‐Salden“ von der Öffentlichkeit weitgehend unbemerkt, ohne Mitwirkung parlamentarischer Gremien und ohne Spuren in der Bilanz der EZB zu hinterlassen. Diese verhängnisvollen Geschäfte funktionieren wie eine Art Überziehungskredit: Die jeweiligen Zinserträge und ‐kosten werden über das EZB‐System sozialisiert – weshalb die Bundesbank nicht von einer Kreditvergabe sprechen möchte. Tatsächlich aber floss in riesigem Umfang öffentlicher Kredit von Deutschland in die GIPS‐Staaten, um dort den Abfluss von Geldern zu neutralisieren. Wenn diese Staaten nicht zurückzahlen können, ist der deutsche Steuerzahler dran; dazu unten mehr.
Und nun gibt es die neuen EU‐Beschlüsse zur Ausweitung des Rettungsfonds in Luxemburg, die der wissenschaftliche Beirat beim Bundesministerium der Finanzen zu Recht als „Besorgnis erregend“ bezeichnet. Der Fonds wird die europäischen Ungleichgewichte, die durch die überbordende Entwicklung der Preise und Einkommen zustande kamen, verlängern und die Auslandsschulden der GIPS‐Länder immer weiter anwachsen lassen. Mit jedem Jahr, während dessen die Kredite der Staatengemeinschaft die versiegenden privaten Kredite ersetzen, entfernt sich das Eurosystem weiter von der Lösung seiner Probleme. Und Deutschland sitzt nun in der Falle. Denn je mehr Schulden die betroffenen Länder bei anderen Euroländern aufbauen, desto größer ist ihr Drohpotenzial, wenn es darum geht, eine Transferunion in Europa zu erzwingen. Im Endeffekt wird Deutschland die Schulden der GIPS‐Länder an sich selbst zurückzahlen müssen.
[...] Summa summarum liegen die Hilfszusagen für bedrängte Euroländer damit bei 1542 Milliarden Euro, und Deutschland haftet mit 391 Milliarden Euro.

[...] Offiziell wird argumentiert, der „Pakt für den Euro“ werde sicherstellen, dass größere Haftungssummen niemals fällig werden. Hoffen wir, dass es so ist. Man muss aber bedenken, dass es sich bei den Schuldengrenzen nicht um bindende Verträge handelt, sondern nur um vage politische Absichtserklärungen. Sie lassen sich durch politische Einflussnahme und Druck dehnen wie Gummi. Zudem verwandeln sich die vermeintlichen Schuldengrenzen angesichts der Weigerung der Märkte, die Außenhandelsdefizite der GIPS‐Länder weiter zu finanzieren, faktisch in Verschuldungsrechte, denn man wird einem Land die Gemeinschaftskredite nicht verwehren können, wenn es sich an die gemeinsam beschlossenen Schuldengrenzen hält.

Über den Rubikon II (amv)

2011-04-06T10:40:00.003+02:00

Es ist bedauerlich, dass angesichts der aktuellen Themendichte die Transformation der EU zur Transferunion in den Medien kaum stattfindet. Bedauerlich ist auch, dass soweit die Installation des ESM (European Stability Mechanism) überhaupt behandelt wird, kritische Einwände als anti-europäische Attitüde abgetan werden. Einer sachlichen Debatte steht das natürlich im Wege: wer hat schon ein Interesse, als Anti-Europäer klassifiziert zu werden. Martin Walzer hat in einem anderen Zusammenhang den Begriff der 'Moralkeule' geprägt. Wer den politischen Entscheidungen auf EU-Ebene entgegentritt, hat zu befürchten, als moralisch minderwertig, populistisch und chauvinistisch stigmatisiert zu werden. In diesem Klima werden sachliche Argumente und objektive Debatten unterdrückt ... und das zum Nachteil der Europäischen Integration.

Selbst wenn man die Transferunion grundsätzlich befürwortet, kann man mit den konkreten Ergebnissen politischer Entscheidungsfindung kaum zufrieden sein. Wie Manasse argumentiert, sind die eingesetzten Summen zu klein und kommen mit 2013 zu spät, um die Finanzmärkte zu stabilisieren. Zudem erhöhen die Regelungen des ESM die Wahrscheinlichkeit der Ansteckung: Weil die eingesetzten Summen auch von potentiellen Krisenländer eingebracht werden müssen, wird die akute Krise eines oder mehrerer dieser Länder zu geringeren fiskalischen Spielräumen bei anderen Krisenländer führen. Auch die Einstimmigkeitsregelungen sind aus einer Public-Choice Perspektive höchst problematisch.

Hätte Europa doch auf ihre Ökonomen erster Güte gehört, wie z.B. Wolfgang Franz, Clemens Fuest, Martin Hellwig und Hans-Werner Sinn. Diese haben bereits im Juni 2010 eine konsistente und ökonomisch nachhaltige Lösung vorgeschlagen. Hier ihre 10 notwendigen Bedingungen für die Reform der Währungsunion (ich habe nur Probleme mit Punkt 4):

1. Hilfen können bedrängten Staaten grundsätzlich nur nach einer einstimmigen Feststellung der drohenden Zahlungsunfähigkeit durch die an den Hilfsaktionen beteiligten Länder und den IWF gewährt werden.
2. Die Hilfen sollten als verzinsliche Bürgschaften (Avalkredite) oder als Kredite gewährt werden, deren Zins um einen angemessenen Prozentsatz (möglicherweise 3,5 Punkte) über dem europäischen Durchschnittszins liegt. Die Kredite sollten einen bestimmten maximalen Prozentanteil des Bruttoinlandsproduktes des hilfsbedürftigen Landes nicht überschreiten.
3. Zugleich mit der Gewährung der Hilfen müssen die Altgläubiger durch einen sogenannten Haircut auf einen Teil ihrer Ansprüche verzichten. Der maximale Verzicht sollte klar beziffert werden, um eine panikartige Zuspitzung des Krisengeschehens auszuschließen. Wir halten einen Haircut von 5 Prozent pro Jahr seit der Emission eines Staatspapiers für angemessen. Das begrenzt den Zinsaufschlag, den Gläubiger im Vorhinein fordern, auf maximal etwa 5 Prozentpunkte. Man könnte zusätzlich eine pauschale Laufzeitverlängerung für Papiere mit einer Restlaufzeit unter drei Jahren vorsehen. Entscheidend ist, dass die Kapitalmärkte eine klare Kalkulationsgrundlage haben.
4. Das Budget des von der Zahlungsunfähigkeit bedrohten Landes wird unter die Kontrolle der EU-Kommission gestellt. Die Kommission erarbeitet mit dem betreffenden Land ein Programm zur Sanierung der Staatsfinanzen, das auch Reformen zur Stärkung des Wirtschaftswachstums beinhalten kann. Die Hilfen werden unter der Bedingung aufrechterhalten, dass das Land die Auflagen des Programms erfüllt.
5. Diese Insolvenzordnung darf keinesfalls durch andere Hilfssysteme unterlaufen werden, die Anreize zu opportunistischem Verhalten geben, insbesondere nicht durch die von manchen Schuldenländern favorisierten Eurobonds. Eurobonds bedeuten eine vollkommene Zinsangleichung ungeachtet der Bonität der Schuldenländer und kommen deshalb einer Subventionierung des Kapitalflusses in diese Länder gleich. Sie wären ein Freibrief für abermalige Verschuldungsexzesse und hätte darüber hinaus die erwähnten negativen Folgen für das deutsche Wirtschaftswachstum. Eine besonders große Gefahr bei den nun anstehenden Verhandlungen liegt darin, dass Deutschland eine Insolvenzordnung zugestanden wird, wenn es den Eurobonds zustimmt. Wir halten es darüber hinaus für erforderlich, die politischen Schuldenschranken nach der Art des Stabilitäts- und Wachstumspaktes zu stärken. Wir betonen aber, dass diese Schranken die von den Finanzmärkten ausgehende Disziplinierung über bonitätsabhängige Zinsaufschläge nicht ersetzen können. Im Einzelnen sollten folgende Vorkehrungen getroffen werden.
6. Die Defizitgrenze des Stabilitäts- und Wachstumspaktes sollte in Abhängigkeit von der Schuldenquote modifiziert werden, um von hochverschuldeten Ländern frühzeitig mehr Schuldendisziplin einzufordern. Beispielsweise könnte man die Grenze für je 10 Prozentpunkte, um die die Schuldenquote über 60 Prozent liegt, um je einen Prozentpunkt kürzen. Ein Land mit einer Schuldenquote von 80 Prozent dürfte dann nur maximal ein Defizit in Höhe von 1 Prozent des Bruttoinlandsproduktes haben. Ein Land mit einer Schuldenquote von 110 Prozent müsste einen Budgetüberschuss von mindestens 2 Prozent erzielen.
7. Für die Überschreitung der Schuldengrenzen sind Strafen zu definieren, die automatisch ohne weiteren politischen Entscheid fällig werden, wenn Eurostat die Defizite formell festgestellt hat. Die Strafen können pekuniärer Natur sein und die Form von Pfandbriefen annehmen, die mit privatisierbarem Staatsvermögen besichert sind, und sie können auch nichtpekuniäre Elemente enthalten wie zum Beispiel den Entzug von Stimmrechten.
8. Eurostat erhält zum Zweck der Feststellung der Defizite und Schuldenquoten die Befugnis, von allen Ebenen der nationalen Statistikbehörden direkt Auskunft zu verlangen und vor Ort eigenständige Kontrollen der Erhebungsprozeduren vorzunehmen.
9. Schlussendlich sollte für den Fall, dass alle genannten Hilfs- und Kontrollsysteme versagt haben und dennoch eine abermalige Insolvenz eintritt, der Austritt des betroffenen Landes aus dem Euro-Verbund durch mehrheitlichen Beschluss der Euro-Länder ermöglicht werden.
10. Der freiwillige Austritt aus dem Euro-Verbund sollte jederzeit möglich sein.
UPDATE: Stellungnahme des Plenums der Ökonomen

Capital requirements are not enough (ls)

2011-04-05T16:54:00.000+02:00

Great Paper by Shin & Shin.

Abstract:

Financial intermediaries borrow in order to lend. When credit is increasing rapidly, the traditional deposit funding (core liabilities) is supplemented with other funding (non-core liabilities). We explore the hypothesis that monetary aggregates reflect the size of non-core and core liabilities and hence convey information on the stage of the financial cycle. In emerging economies with open capital markets, non-core liabilities of the banking system take the form of short-term foreign exchange liabilities, increasing the vulnerability to the outbreak of “twin crises” where a liquidity crisis is compounded by a currency crisis.

None of the Basel III measures to be introduced within the next years deals with the procyclical increase of non-core-liabilities such as interbank funding and their implications for systemic risk. Focusing only on assets and equity neglects the importance of fragile (short-term) liability networks and potentially adverse contagion mechanisms.

Mankiw/Weinzierl: An Exploration of Optimal Stabilization Policy (amv)

2011-03-30T15:18:00.002+02:00

Very interesting working paper (my emphasis):

What is the optimal response of monetary and fiscal policy to an economy-wide decline in wealth and aggregate demand? This question has been at the forefront of many economists’minds over the past several years. In the aftermath of the 2008-2009 housing bust, financial crisis, and stock market decline, people were feeling poorer than they did a few years earlier and, as a result, were less eager to spend. The decline in the aggregate demand for goods and services led to the most severe recession in a generation or more.

The textbook answer to such a situation is for policymakers to use the tools of monetary and fiscal policy to prop up aggregate demand. And, indeed, during this recent episode, the Federal Reserve reduced the federal funds rate - its primary policy instrument - almost all the way to zero. With monetary policy having used up its ammunition of interest rate cuts, economists and policymakers increasingly looked elsewhere for a solution. In particular, they focused on fiscal policy and unconventional instruments of monetary policy.

To traditional Keynesians, the solution is startlingly simple: The government should increase its spending to make up for the shortfall in private spending. Indeed, this was a main motivation for the $800 billion stimulus package proposed by President Obama and passed by Congress in early 2009. The logic behind this policy should be familiar to anyone who has taken a macroeconomics principles course anytime over the past half century.

Yet many Americans (including quite a few congressional Republicans) are skeptical that increased govenrnment spending is the right policy response. They are motivated by some basic economic and political questions: If we as individual citizens are feeling poorer and cutting back on our spending, why should our elected representatives in effect reverse these private decisions by increasing spending and going into debt on our behalf? If the goal of government is to express the collective will of the citizenry, shouldn't it follow the lead of those it represents by tightening its own belt?

Traditional Keynesians have a standard answer to this line of thinking. According to the paradox of thrift, increased saving may be individually rational but collectively irrational. As individuals try to save more, they depress aggregate demand and thus national income. In the end, saving might not increase at all. Increased thrift might lead only to depressed economic activity, a malady that can be remedied by an increase in government purchases of goods and services.

The goal of this paper is to address this set of issues in light of modern macroeconomic theory. Unlike traditional Keynesian analysis of fiscal policy, modern macro theory begins with the preferences and constraints facing households and firms and builds from there. This feature of modern theory is not a mere fetish for microeconomic foundations. Instead, it allows policy prescriptions to be founded on the basic principles of welfare economics. This feature seems particularly important for the case at hand, because the Keynesian recommendation is to have the government undo the actions that private citizens are taking on their own behalf. Figuring out whether such a policy can improve the well-being of those citizens is the key issue, a task that seems impossible to address without some reliable measure of welfare.

[...] We begin with the benchmark case in which the economy does not face the zero lower bound for nominal interest rates. In this case, the only stabilization tool that is necessary is conventional monetary policy. Once monetary policy is set to maintain full employment, fiscal policy should be determined based on classical principles. In particular, government purchases should be set to equate their marginal bene…t with the marginal benefit of private consumption. As a result, government purchases are procyclical: When private citizens are cutting back on their private consumption spending, the government should cut back on public consumption as well.

We then examine the complications that arise because nominal interest rates cannot be set below zero. We show that even this constraint on monetary policy does not by itself give a role for traditional fiscal policy as a stabilization tool. Instead, the optimal policy is for the central bank to commit to future monetary policy actions in order to increase current aggregate demand. Fiscal policy continues to be set on classical principles.

A role for countercyclical fiscal policy might potentially arise if the central bank both hits the zero lower bound on the current short-term interest rate and is unable to commit itself to expansionary future policy. In this case, monetary policy cannot maintain full-employment of productive resources on its own. Absent any fiscal policy, the economy would find itself in a non-classical short-run equilibrium. Optimal fiscal policy then looks decidedly Keynesian. If the only instrument of fiscal policy is the level of government purchases, optimal policy is to increase those purchases to increase the demand for idle productive resources, even if the marginal value of the public goods being purchased is low.

This very Keynesian result, however, is overturned once the set of fiscal tools available to policymakers is expanded. Optimal fiscal policy in this situation is the one that tries to replicate the allocation of resources that would be achieved if prices were flexible. An increase in government purchases cannot accomplish that goal: While it can yield the same level of national income, it cannot achieve the same composition of it. We discuss how tax instruments might be used to induce a better allocation of resources. The model suggests that tax policy should aim at increasing the level of investment spending. Something like an investment tax credit comes to mind. In essence, optimal fiscal policy in this situation tries to produce incentives similar to what would be achieved if the central bank were somehow able to reduce interest rates below zero.

UPDATE (10.04): I just found out about an earlier post by Kantoos Economics introducing the same paper. The arguments about Keynesianism and Friedman are debatable, the relevant demarcations quite imprecise.

Mankiw: It’s 2026, and the Debt Is Due (amv)

2011-03-30T14:13:00.003+02:00

NYT, Economic View: Mankiw meets Bastiat. A great article on the US; Germany is not there yet ... but it will, if we remain in the European transfer union - this ugly beast that is a pretentious institutionalization of economic ignorance. As Mankiw recalls, "crises take longer to arrive than you think, but then they happen much faster than you could have imagined." In poker-slang, Germany is the fish in the European money game.

UPDATE: check also this.

Financial Regulation: the 'Fama View' strengthened (amv)

2011-03-28T22:49:00.002+02:00

Here, Fama suggests to approach the 'too-big-to-fail' issue by really heavy equity requirements (40%-50% ). Basel III asks for a minimum common equity requirement of 4,5% (Basel II: 2%) + a capital conversation buffer of 2,5% + a countercyclical buffer of 2,5% in case of excess credit growth (providing a negative feedback on potential 'bubbles') = 7%-9,5% (whereby the definition of what accounts as common equity is more restrictive and the asset base is broader). Basel III is more than this and, of course, is also concerned with liquidity management, etc.

Here some research results:

Admati et al.: Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Expensive

We examine the pervasive view that “equity is expensive,” which leads to claims that high capital requirements are costly and would affect credit markets adversely. We find that arguments made to support this view are either fallacious, irrelevant, or very weak. For example, the return on equity contains a risk premium that must go down if banks have more equity. It is thus incorrect to assume that the required return on equity remains fixed as capital requirements increase. It is also incorrect to translate higher taxes paid by banks to a social cost. Policies that subsidize debt and indirectly penalize equity through taxes and implicit guarantees are distortive.

Any desirable public subsidies to banks’ activities should be given directly and not in ways that encourage leverage. Finally, suggestions that high leverage serves a necessary disciplining role are based on inadequate theory lacking empirical support.

We conclude that bank equity is not socially expensive, and that high leverage is not necessary for banks to perform all their socially valuable functions, including lending, taking deposits and issuing money-like securities. To the contrary, better capitalized banks suffer fewer distortions in lending decisions and would perform better. The fact that banks choose high leverage does not imply that this is socially optimal, and, viewed from an ex ante perspective, high leverage may not even be privately optimal for banks.

Setting equity requirements significantly higher than the levels currently proposed would entail large social benefits and minimal, if any, social costs. Approaches based on equity dominate alternatives, including contingent capital. To achieve better capitalization quickly and efficiently and prevent disruption to lending, regulators must actively control equity payouts and issuance. If remaining challenges are addressed, capital regulation can be a powerful tool for enhancing the role of banks in the economy.

Miles et al.: Optimal bank capital

This paper reports estimates of the costs and benefits of banks having higher levels of loss-absorbing capital. Measuring those costs requires careful consideration of a wide range of issues about how shifts in funding affect required rates of return and on how costs are influenced by the tax system; it also requires a clear distinction to be drawn between costs to individual institutions (private costs) and overall economic (or social) costs. Without a calculation of the benefits from having banks holding more capital no estimate of costs — however accurate — can tell us what the optimal level of bank capital is. We use empirical evidence on UK banks to assess costs; we use data from shocks to incomes from a wide range of countries over a long period to assess risks to banks and how equity funding (or capital) protects against those risks. We find that the amount of equity capital that is likely to be desirable for banks to hold is very much larger than banks have held in recent years and also higher than targets agreed under the Basel III framework.

UPDATE: the government-induced link between bank size and risk taking: here.

Über den Rubikon auf dem Weg zur Transferunion (amv)

2011-03-24T11:56:00.001+01:00

Gerade hat der Bundestag den letzten Schritt zu Transferunion beschlossen. Ein schlechter Tag für Deutschland und Europa: anstatt sich den ökonomischen Gesetzmäßigkeiten unterzuordnen, gilt nun vollends das Primat der Politik. Hier ein guter Beitrag von Werner Mussier (FAZ.NET):

Das steht nun in der Tat auf der Tagesordnung. Das neue Regelwerk kennt eine tief greifende Änderung: die dauerhafte Krisenhilfe. Der Haftungsausschluss der No-Bailout-Klausel ist damit abgeschafft worden. Eine Insolvenzordnung für Staaten gibt es weiterhin nicht. An den bestehenden Konstruktionsfehlern der Währungsunion hat sich ansonsten wenig geändert. Der Stabilitätspakt wird ein wenig schärfer, die Sanktionen werden etwas „automatischer“ verhängt. Aber die Mitgliedstaaten bleiben die Herren der Defizitverfahren. Es darf bezweifelt werden, dass das zur Mitentscheidung befugte Europaparlament daran im Kern noch etwas ändern kann.

Der Fall Libyen (amv)

2011-03-22T21:18:00.044+01:00

Die Bundesregierung steht unter Beschuss. Zumindest die veröffentlichte Meinung in Deutschland, aber auch viele Stimmen im Ausland, werfen der Bundesregierung vor, aus der westlichen Allianz auszuscheren und ihrer Verantwortung nicht gerecht zu werden. Es folgen ein paar Fragen und Anmerkungen:

Werteorientierte Außenpolitik vs. Realpolitik: Die Befürworter des Militäreinsatzes argumentieren, dass es humanitäre Pflicht sei, auf Libyen militärisch einzuwirken. Wenn es allein um Moral ginge, müsste die westliche Allianz in vielen Krisengebieten eingreifen. Niemand möchte das. Es geht auch gar nicht, weil unsere militärischen Kapazitäten nicht ausreichen. Also müssen weitere Kriterien herangezogen werden, um die möglichen Einsätze sinnvoll einzugrenzen. Und schon sind wir im Bereich der Realpolitik, welche nationale Interessen in den Vordergrund stellt. Was sind die deutschen Interessen? Hier geht es um Migrationbewegungen, um ökonomische Stabilität (z.B. Energiepolitik), um die Positionierung im westlichen Bündnis, um die Vermeidung militärischer Überdehnung, etc. Hier geht es um ein sachliches Für und Wider, also um Abwägungen; es geht um ganz viel grau, und nie um schwarz oder weiß. Die moraltriefenden Argumentationlinien, die in Deutschland seit Joschka Fischers Holocaust-Begründung für den Kosovo-Einsatz gängig sind, führen nicht notwendigerweise zu den Ergebnissen, die wir uns alle wünschen. 'Gut gemeint' ist nicht gleich 'gut gemacht'. Es ist schon erstaunlich, dass ein Bundespräsident sich genötigt sieht zurückzutreten, weil er die Selbstverständlichkeit ausspricht, dass Deutschland seine Handelswege sichert, während ein Hals-über-Kopf Beschluss zu einem Militäreinsatz in Lybien auf große Sympathie stößt.
Deutschland und die Welt: Die aktuelle Debatte legt nahe, dass Deutschland sich außenpolitisch isoliert. Mag sein. Aber noch ist Deutschland ein souveräner Staat und darf seine Interessen selbstbewusst formulieren. Niemand darf Deutschland vorhalten, internationale Verpflichtungen nicht ernstzunehmen. De facto, sind auch die Amerikaner skeptisch und vor allem sind sie müde, den Weltpolizisten zu geben. Aufgrund Ihrer Sonderrolle als primus inter pares sehen sie sich jedoch genötigt, für eine kurze (!) Zeit dem Drängen Frankreichs und Englands nachzugeben. Und gerade in Hinsicht auf die arabische Welt hat die NATO vor wenigen Wochen ihren Abschied von solchen Einsätzen beschlossen. Im Grunde handelt Deutschland so, wie die USA gerne handeln würde. Gott sei Dank sind wir nicht Führungsmacht der westlichen Welt und können selbstständig entscheiden. Davon Gebrauch zu machen, ist sicher keine Schande. Des Weiteren: Es geht rechtlich nicht um Gadaffi vs. Zivilisten als homogene Masse. Es geht um Gadaffi und die Bevölkerungsgruppen, die von ihm profitieren, vs. eine bewaffnete Rebellenmiliz. Die eigentlichen Zivilisten stehen dazwischen. Völkerrechtlich ist es problematisch, sich auf die Seite der Rebellenmiliz zu schlagen. Und glauben Sie nicht, dass diese Rechtsstaat und Demokratie für Libyen entdecken sobald Gadaffi beseitigt ist. Lybien ist kein Nationalstaat, sondern eine Stammesgesellschaft. Was am Ende geschieht, d.h. welches von den multiplen Gleichgewichten sich einstellt, ist nicht absehbar. Es gilt also die eigentliche Frage: gegeben der hohen Unsicherheit, sollen wir trotz berechtigter Zweifel eingreifen oder nicht? Die Beweislast, so meine Meinung, liegt bei jenen, die den militärischen Einsatz befürworten. Vor allem: was machen wir mit den Nachbarländern, in denen die Herrschaftselite ebenfalls auf unbewaffnete Zivilisten schießt? Wenn wir nicht überall eingreifen, dann sind unsere Werte unglaubwürdig.
Wahlkampf als Motiv: Sind die anstehenden Landtagswahlen ein Motiv der Bundesregierung? Wird Staatsräson dem schnöden Machterhalt untergeordnet? Mag sein. Aber ist es nicht so, dass Frankreichs Präsident innenpolitisch unter Druck steht und besonders aggressiv handelt, um seine besonders innige Umarmung nordafrikanischer Despoten vergessen zu machen? Soll die deutsche Politik die eigenen Mehrheiten ignorieren, um Präsident Sarkozy in seinem Wahlkampf zu unterstützen? Sollen deutsche Soldaten nicht deutschen Interessen dienen, aber wie selbstverständlich Figuren im französischen Machtkalkül werden? Ist es nicht eher die französische Position, die Fakten schafft, ohne auf die europäischen Partner Rücksicht zu nehmen? Immerhin ist der französische Außenminister Juppe eigenständig nach Libyen gefahren, um zu erklären, dass die Rebellen einwandfreie Positionen vertreten. Frankreich hat diese dann einseitig und ohne europäische Abstimmung als legitime Vertreter der lybischen Bevölkerung anerkannt. Und ist es nicht die französische Regierung, die einen Keil zwischen die NATO-Partner treibt: den kurzfristigen Ruhm für die Grande Nation, die langfristigen Folgen für die NATO-Partner?
Im UN Sicherheitrat zustimmen; sich aber militärisch entziehen: ist das eine Option? Ist das nicht bigot? Würde sich die Bundesregierung nicht der berechtigten Kritik aussetzen, ihren eigenen Beschluss im Sicherheitsrat zu unterlaufen? Kann die größte europäische Nation und wichtiges NATO-Mitglied sich eine derart inkonsistente Haltung leisten? Verschafft uns das mehr Gewicht und Respekt im Ausland? Sind die chaotischen Zustände innerhalb der NATO nicht problematisch genug, auch ohne ein klares deutsches 'Jein'? Und warum sind Frankreich und England für den militärischen Einsatz, aber gegen ein Ölembargo? Immerhin gilt: ohne Moos nix los ... gilt auch für Gadaffi. Genau: wegen realpolitischen Abwägungen sind Frankreich und England dagegen. Fair! Aber dann können auch wir uns ebenfalls realpolitisch verhalten: wir wollen halt ein Embargo, aber keinen Militäreinsatz.
Die Araber: Erst drängt die Arabische Liga den Westen zum militärischen Einsatz. Bei der ersten Gelegenheit macht sie dann einen Rückzieher. Sind das jetzt unsere verlässlichen Partner? Wo sind denn die zugesagten Kampfjets aus den Arabischen Emiraten und aus Qatar? Und ist es nicht ebenfalls bigot, den Despoten Gadaffi mit der Unterstützung der Despoten aus Saudi-Arabien zu begegnen? Ist das werteorientierte Außenpolitik? Immerhin haben die Saudis ihre Truppen nach Bahrain entsandt, um die schiitische Volksgruppe in Schach zu halten. Warum gehen wir gegen den einen vor, aber nicht gegen die anderen? Antwort: aus realpolitischen Abwägungen! Wenn den Arabern die libyische Bevölkerung derart am Herzen liegt, dann sollten sie selbst eingreifen. Kampfjets haben sie genug; wir (der Westen) haben sie ja alle geliefert. Grundsätzlich gilt: die arabische Welt muss sich selbst von ihren orientalischen Tyrannen befreien. Das kann ihnen niemand abnehmen. Und wer sind die Araber eigentlich? Ich weiß von keinen soliden repräsentativen Umfragen unter Arabern, die uns belastbare Daten über ihre Einstellung geben. Alles andere ist anekdotische Evidenz und damit mehr oder weniger wertlos. Demnach sind alle Vereinnahmungen der Araber für die eine oder andere Position bestenfalls problematisch.

Also: Bitte weniger Herz für ein bißchen mehr Verstand!

PS: Wenn wir den Yasmin-Bewegungen in Nordafrika unter die Arme greifen wollen, wie wäre es mit der Öffnung unserer Agrarmärkte für deren Produkte? Ohne wirtschaftlichen Erfolg werden die neuen Regime in Ägypten und sonstwo keine Chance haben. Schon vergessen? Wir Deutschen haben die Demokratie umarmt, weil sie mit dem Wirtschaftswunder kam! Zuvor hatten wir die Demokratie verraten, weil wir Massenarbeitslosigkeit, Hyperinflation und Hunger im Zuge der Großen Depression erlitten.

FAZ.NET: Kleine Geschichte der Zentralbank (amv)

2011-03-21T09:35:00.000+01:00

Vor 400 Jahren beendete die Wisselbank das holländische Währungschaos - und wurde zum Pionier des Zentralbanksystems. Doch das Modell der modernen Zentralbank entstand allmählich erst im 20. Jahrhundert und ihr Entwicklungsprozess ist längst nicht beendet.

... mehr

Conference on Heterogeneous Expectations and Economic Stability (amv)

2011-03-20T18:30:00.002+01:00

Organizers: Ricardo Reis and Michael Woodford

Conventional models in both macroeconomics and finance are based on the hypothesis of rational expectations, under which all agents are assumed to have common expectations, corresponding to the probabilities implied by the economist’s model. The adequacy of this familiar hypothesis has been called into question by recent events, however, notably the instability resulting from the boom and bust in real estate prices. The purpose of this conference is to bring together researchers exploring alternative approaches to modeling the dynamics of expectations, with particular attention to applications in macroeconomics and finance. We have sought to bring together proponents of a variety of approaches, who may not frequently engage one another, in the hope of reaching conclusions about which directions are most promising at this time.

Click here for the papers.

Good stuff ... especially Stanford's Mordecai Kurz and his Rational Belief approach.

Leijonhuvud on adaptive systems, volatility and endogenous behavioral time horizons (fg)

2011-02-25T12:39:00.003+01:00

A. Leijonhuvud gives a further insight on the state of macro research. Starting from the critique on rational expectations, he emphasizes the importance of agents adapting to an open system where agents must refine and adapt to events whose probability had not been estimated correctly. Intertemporal optimization cannot be the true representation of behavior, but it represents an approximation. In volatile times, however, agents are forced to react to current events. Volatility shortens time hoirzons in which short-sighted adaptive behavior generates non-linear dynamics with positive feedback.

Furthermore, Leijonhuvud distinguishes between three forms of feedback regions: region (1) with exclusive negative feedback dynamics and equilibrim outcomes, region (2) with tightly bounded positive feedback loops and business cycle fluctuations, for instance generated by the multiplier concept or the financial accelerator; and region (3) with dangerous instabilites and high positive feedback loops (Fisherian debt-deflation). Region 3 ist reached when budget constraints are violated; whereas the transformation from region (2) to region (3) is caused by leverage and financial budget constraint violations. The slow build-up of leverage in the economy increases the connectivity of the network of debts and claims, and combined with underlying maturity mismatch, it makes the system more fragile.

His main conclusion:

The first is that we have to think of an economy as an “open system” in the ontological sense of Tony Lawson (this will require us to adapt out methods to the nature of an economy – to change how we do economics).
The second is that the economy is not globally stable but harbors instabilities

Ken Rogoff wins the Deutsche Bank prize (ls)

2011-02-21T14:28:00.000+01:00

Find the official statement here. Great choice in my opinion. Former laureates were Michael Woodford and Robert Shiller.

Do you know what is most impressive in his CV? He was awarded Grandmaster of Chess in 1978. Only a few hundred persons in the world hold this title and they are usually professional chess players. For him, it was just a by-product on his way to become Harvard professor. Unbelievable...

Inequality, leverage and crises (ls)

2011-02-09T17:29:00.001+01:00

The IMF published a very interesting working paper. See also this article on voxeu for a short version.

Key thesis:

"Rising inequality in a climate of rising consumption can lead poorer households to increase their leverage, thereby making a crisis more likely."

The descriptive evidence seems to be striking:

The simulation results of their model look insightful as well:

Their reasoning is supported by several additional arguments:

Rajan (2010) argues that rising inequality creates a political incentive to facilitate the access of poorer people to mortgages and consumer loans.
Fitoussi (2010) points out that rising inequality leads to an increase of the average propensity to save since rich agents tend to save a larger share of their income. This consequently brings down the average propensity of consumption and causes a persistent weakness in aggregate demand. Central banks respond to this developement by loosening their policy stance, thereby giving rise to the build-up of financial imbalances.

All in all, this seems to be a very interesting point which hasn't been stressed prominently yet.

Weimann über Subventionslawinen am Beispiel der Photovoltaik (amv)

2011-01-31T11:14:00.000+01:00

Hervorragender Beitrag in der FAZ.net.

Roman Frydman on REH (amv)

2011-01-24T17:20:00.000+01:00

Again a Must Read of John Cochrane (fg)

2011-01-10T16:50:00.004+01:00

Hi folks,

interested in the macro-finance view? Then you definitely need to read the new working paper of John Cochrane on discount rates, variation of risk premia and return forecastibility.

I argue that characterizing discount rate variation over time and across assets has replaced informational efficiency as the central organizing question of asset pricing research. I survey the facts: in the last 40 years we have learned that discount rates vary dramatically. Most views of the world changed 100%, we thought 100% of the variation in market dividend yields was due to variation in expected cashflows; now we know 100% is due to variation in discount rates. We thought 100% of the cross-sectional variation in expected returns came from the CAPM, now we think that’s about zero and a zoo of new factors describes the cross section. I show how time-series, cross-section, regression, and portfolio approaches are really the same, and think about how the empirical project can achieve a needed unification.

One possible definition of “bubble” is “prices that are high on expectations of subsequent
higher prices; people buy just because they think they can sell to a greater fool.” This is a
“rational bubble,” a violation of the transversality condition. In such a bubble expected returns are always the same, so higher valuations do not make it more likely to see a low return. As we saw above, the data speak strongly against this form of bubble. Higher valuations do correspond to lower returns, and “just enough” to fully “explain” price variation. Once we look at a 15 year horizon, high prices do not correspond to ever-higher prices. To continue sensibly, then, a “bubble” must be defined as a high valuation, which corresponds to a discount rate that is “too low” in some sense. The fact is that high valuations correspond to low long-run returns, period. Now, we have something solid to talk about. Perhaps low risk premium in economic booms correspond to low macroeconomic risk premiums, and high risk premiums in recessions correspond to higher macroeconomic risk premiums. I survey those theories below. Perhaps the same variation in risk premiums corresponds to something “wrong” either in psychology, market frictions, monetary policy, etc. Good. At least we know what we’re talking about. That’s progress.
Bonds/term structure. A rising yield curve signals better one-year return for long-term
bonds, not higher future interest rates. A one percentage point rise in the n year forward
rate over the spot rate signals a one percentage point risk in the expected one year return
on n year bonds. Forward-spot spreads do not forecast one-year changes in spot rates
(Fama and Bliss (1987); Campbell and Shiller (1991)).
Macroeconomists have not digested this lesson. The Federal Reserve looks at long-term
treasuries and the TIPS spread to gauge inflation expectations, and at Federal Funds futures to gauge policy expectations (Piazzesi and Swanson (2008)) . These spreads forecast returns, not the intended objects.
Bonds/credit spreads. Credit spreads are higher than default probabilities, and variation
in credit spreads over time largely signals changes in expected returns, not changes in
probabilities of default. ( Berndt and Duffie (2010).)
Foreign exchange.High foreign interest rates relative to domestic rates signal a higher
return on foreign bonds, not a devaluation—the “carry trade.” (Hansen and Hodrick (1980), Fama (1984).)

Mankiw's open letter to Obama (amv)

2011-01-06T20:17:00.000+01:00

A great NY Times piece by Greg Mankiw.

Taxation and football stars (ls)

2011-01-06T14:57:00.000+01:00

This column on voxeu "analyses the movement of Europe’s footballers between the top 14 leagues and finds that a major influence on player decisions to move is the difference in the tax regime – with policy implications going well beyond the football pitch."

Well, I don't care about policy implications. The city of Stuttgart needs to make drastic tax cuts for high-skilled workers immediately in order to attract some superstars for our suffering football club.

By the way: Happy new year to everybody!

"Ten Economic Questions for 2011" (amv)

2011-01-03T08:32:00.002+01:00

by Calculated Risk:

1) House Prices: How much further will house prices fall on the national repeat sales indexes (Case-Shiller, CoreLogic)? Will house prices bottom in 2011?

2) Residential Investment: It appears residential investment (RI) bottomed in 2010, and will probably make a positive contribution to GDP growth in 2011 for the first time since 2005. RI is mostly investment in new single family structures, multifamily structures, home improvement and commissions on existing home sales. Historically RI has been the best leading indicator for the economy, but the growth in RI will probably be modest because of the large overhang of excess housing units. How much will RI grow in 2011?

3) Distressed house sales: Foreclosure activity is very high, although activity has slowed recently - probably because of "foreclosure gate" issues. The number of REOs (Real Estate Owned by lenders) is increasing again, although still below the levels of late 2008. How much will foreclosure activity pick up in 2011? Will the number of REOs peak in 2011 and start to decline?

4) Economic growth: After I took the "over" for 2011 back in November, a number of analysts have upgraded their forecasts. As an example, Goldman Sachs noted Friday: "The US economic outlook for 2011 has improved further with enactment of the fiscal compromise, as well as a stronger trend in recent data. As we forewarned, we are revising up our forecasts to incorporate this news and now expect real GDP to rise 3.4% in 2011 and 3.8% in 2012 (up from 2.7% and 3.6%) ..." It does appear GDP growth will increase in 2011, although GDP growth will probably still be sluggish relative to the slack in the system. How much will the economy grow in 2011?

5) Employment: The U.S. economy added about 87 thousands payroll jobs per month in 2010 through November. This was extremely weak payroll growth for a recovery. How many payroll jobs will be added in 2011?

6) Unemployment Rate: The post-Depression record for consecutive months with the unemployment rate above 9% was 19 months in the early '80s. That record will be broken this month, and it is very possible that the unemployment rate will still be above 9% in December 2011. This high level of unemployment - and the number of long term unemployed - is an economic tragedy. The economy probably needs to add around 125 thousand payroll jobs per month just to keep the unemployment rate from rising (payroll jobs and unemployment rate come from two different surveys, so there is no perfect relationship, and the rate also depends on the participation rate). What will the unemployment rate be in December 2011?

7) State and Local Governments: How much of a drag will state and local budget problems have on economic growth and employment? Will there be any significant muni defaults?

8) Europe and the Euro: What will happen in Europe? When will the next blowup happen? How much of a drag will the problems in Europe have on U.S. growth?

9) Inflation: With all the slack in the system, will the U.S. inflation rate stay below target? Will there be any spillover from rising inflation rates in China and elsewhere?

10) Monetary Policy: Will the Fed expand QE2 (probably not)? Will the Fed reverse any of the Large Scale Asset Purchases? Probably not. Will the Fed raise the Fed Funds rate? Very unlikely.

Holiday reading (ls)

2010-12-27T21:53:00.000+01:00

www.voxeu.org is always a source of insightful comments and policy proposals. They especially cover the financial crisis from their very beginning and the following Euro debt crisis.

You can find an overview of some of the most remarkable pieces here. It includes articles by Barry Eichengreen, Paul de Grauwe, Charles Wyplosz and others. Great stuff.