Greenspan Putlessness

In the 1990s, there was the idea that equities were made safe because activist monetary policy would always be able to respond to a plunge, saving the real economy, and thus expectations of a sharp recession were thereby stabilised in the first place, making crashes less likely.

The recent days’ trading takes place in a different world.

First, the tools to back up the threat implicit in the put are not there to the extent that they once were.  Monetary policy in the West is still at practically maximal stimulus.  Fiscal policy is not to be depended on.   In the US, Japan, the Euro Area and the UK, there are idiosyncratic reasons why we would have to be really optimistic to expect the local politics to rustle up an adequate fiscal stimulus to take the place of monetary policy.   In the US, Congress is at war with itself.  In the UK, the government is divided, paralysed by Brexit and the wisdom of a large further stimulus is controversial [the Tory brand rules it out].  In Japan, fiscal policy has done as much as it can.  In the Euro Area, the North is temperamentally opposed to counter-cyclical fiscal policy, and many other countries cannot afford it.

Further, the Great Financial Crisis rather unravelled, such as it was, public perceptions about the capability, even when the tools are available, of policymakers to keep the business cycle under control.  It would be much harder to publish a paper nowadays entitled  ‘The Science of Monetary Policy’.

It’s arguable whether the Greenspan put was ever more than an idea.  But both because the tools are lacking, and a reasonable person’s estimation of the authorities’ ability to wield them to good effect has fallen, it makes even less sense now.  For this reason, we might expect equities to be more jittery now than they were pre-2008.

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Would a 2nd referendum be more likely to be won by Remain

Danny Finkelstein enumerates some reasons why not in his Times column today, and they are pretty convincing.  But I think he misses some factors out, so I list them here, repeating Tweets sent earlier.

  1.  Leave were able to unite – sort of – around the ‘Leave’ box on the Referendum ballot paper because the ambiguity about the end state cast a wide net over their very different views of what that end state should be.   In a second referendum, the ambiguity disappears, and not only does this potentially send voters who were in favour of Leave towards Remain [and perhaps vice versa] but it also pits the elements of the campaigning establishment against one another, which could make the campaign itself run very un-smoothly.
  2. One might predict that Labour would opportunistically choose Remain over whatever deal is voted on in order to turn the referendum into one on the government and Toryism [‘Tory Brexit’], in order to destabilise it.  This would recruit some of the ‘kick the incumbent’ Referendum votes to the side of Remain, when they were trying to kick Cameron, and by association Remain, before.
  3.  Polls seem to have shifted in favour of Remain, albeit by not much.
  4.  Unless the deal offered was a very soft Brexit, and assuming that a fair amount of the shift in favour of Labour at GE17 was a tactical switch towards Remain, and with Corbyn this time onside in the 2nd Referendum [a lot of ifs there], one might predict a repeat of the ‘youthquake’, or perhaps better named ‘notthatyoungquake’ swelling turnout in favour of Remain.
  5. The grisly march of time will have replaced old eligible voters with new young ones, tilting towards Remain.
  6. Against all these factors, there is now no large English party in favour of Remain as there were before.  Even if Labour were to campaign against a proposed Brexit deal and therefore in favour of Remain, Labour have said a lot of things about the costs of Remaining [eg concerning freedom of movement, industrial policy] that could be used against them.
  7. Danny notes how the relative certainty of the end state for Remain in the first Referendum would not play so effectively the second time around.  One could add to this a forecast that 1) even the Cameron modifications negotiated last time would not be on the table 2) noises made in favour of deeper fiscal integration in the Euro area, and on EU defence, both of which will be off-putting for many of those who voted Leave last time.
  8. Turkey is clearly not joining the EU now, so some of those old posters can be shown to have been false.
  9. Imagine if all journalism were re-written in numbered note form.  It would not be a great read, would it?
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Brexit and the analysis of its economic consequences: iteration 2

Alberto Nardelli at Buzzfeed broke the story that government economists have undertaken a new analysis of the consequences of different variants of Brexit.  And come up with the unsurprising conclusion that they would all be costly.

In one sense, this should not be news.  Nothing has changed.  A few economists have studied the same question and got the same answer as before.  Apart from a few on the fringes, everyone who has looked at this accepts the basic logic.  For a brief recap, the story goes thus:

Except from Brexit In Name Only [in which we stay members of the single market and the EU’s customs union] leaving will raise non-tariff barriers and perhaps tariff barriers too with the EU.  Unless something happens to overturn the iron logic of trade ‘gravity’ – the tendency for us to trade much less with countries far away from us, of a given size – striking new Free Trade Agreements will not replace lost trade with the EU.  Add to that the observation that the deal with the EU is very deep – it created a market with very few frictions indeed – and deals with other 3rd parties are likely to be much shallower and thus even less likely to replenish lost EU trade.

Indeed, because of the Brexiters’ distaste for submitting to mutually agreed and neutrally enforced regulations – it’s the loss of ‘sovereignty’ that our doing just this with our nearest trade partners in the EU that bugs them –  it’s inevitable that such deals will be shallower.  Shallower deals leave us with more ‘freedom’ in the Brexit lexicon.

So less trade, and, invoking another empirical regularity, therefore lower income per head.

However, the leak does seem to be being treated as news.   Why?

No doubt one reason is that the studies are embarrassing.

The old Treasury analysis from before the referendum could be dismissed as cooked by arch Remainer Osborne [albeit meaning that we have to make the silly accusation that Charlie Bean would have signed up to such cooking].  Outside expert analysis could be dismissed as just that;  also part of the Remainer establishment.

This new analysis has been done under the piloting of a government committed to a Brexit that means Brexit [now partially translated as Brexit means less £] and ‘making a success of it’.  So it’s harder to set aside.

Doing so would involve creating new distance between the policy makers with the power, and those sponsoring the sceptical analysis:  cleaving from the unrepentant Remainer ministers who stand by it and perhaps from the senior economists who produced it.  Just as this government was not embarrassed by the analysis of the old Treasury, a new one could renew and purify itself to avoid  blushes [‘all our options are worse than the status quo!’] caused by the thinking of the economists in the former, contaminated government.

Given that answering the same question with the same evidence and logical tools is bound to lead to getting the same answer, one has to ask why anyone bothered?

Perhaps the idea was that some part of the May government thought the old studies [and all the outsider work] was cooked, so to make sure they needed to have another look.

Or was it a calculated move by the moderate government members:  new analysis can’t be so easily dismissed, and will help tilt the agreement sought to Brexit In Name Only, or dare the Ultras to break with us and try to form their own leadership.  That tactic only works if the analysis is leaked, of course, or there is a credible threat of leaking it.

Another possibility is that new information has come along, either about the economics, or what the Government might want, or what the EU might put on offer.  But this seems unlikely.  There’s no new economics I am aware of.  And the other matters are at the level of detail that would not affect the higher level debate that has still not concluded [hard or soft?].

As a result of the leak, social media has filled up again with the confusion about conditional and unconditional forecasts that sullied the pre-referendum debate.  [I suppose one could have seen that coming].

This from Iain Martin, editor of ReactionLife, and Times columnist:

Screen Shot 2018-01-30 at 10.54.27

If you can’t think why this might be a misguided thing to say:  it’s as though you are sceptical of all the past evidence linking pizza and beer over-consumption and lack of exercise to weight which moved your doctor to advise you to go teetotal, cut back on the pizza, and take up jogging, and all because all kinds of other things could happen to you along the way.

Christian May was also at it:

Screen Shot 2018-01-30 at 11.01.27

One of the ironies of all this is that Brexiters seem to reject the idea that you should do policy analysis based on conditional forecast thought experiments.

Yet this is precisely what they are doing all the time.   Contemplating that Brexit might be beneficial involves all kinds of such thought experiments:  That new FTA’s with far away countries will more than make up for lost trade;  that breaking out of the EU will reshape the EU itself around a more minimalist FTA, loosening the elements of political union and redistribution.

And often, shaky unconditional forecasting creeps in, for example predicting that technology will revolutionise trade and national border bureaucracy, eliminating the need for people in uniforms stopping lorries and searching them, or making the distance between economies that used to depress trade irrelevant [which it has not so far, incidentally].


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The death of the Bitcoin coder

One of the few ideas in literary theory that made its way across the chasm that separates me from it is the notion of the ‘death of the author’.  By analogy with the original idea, with no more than a cursory link to the Wikipedia entry and disregarding Barthes and subsequent scholarship as irrelevant, I will take this to refer to the observation that whatever the intentions of the author in writing a text, the effective meaning and substance of it is in how it presents itself to the mass of readers.

We could say the same about Bitcoin and other cryptocurrencies.  ‘What Bitcoin is for’ is a frequent topic of discussion.  This is a difficult question to address conclusively.

We could ask ourselves what Satoshi Nakamoto thought Bitcoin was for, and consult as evidence his white paper on Bitcoin.  But once Bitcoin code was written and operationalised, and the protocols evolved, what he thought it was for is less relevant.  Nakamoto cannot control what Bitcoin is for now, any more than the workers at Los Alamos could dictate what nuclear weapons were ‘for’ once the recipe was known more widely.

From the perspective of miners and many holders, it may be nothing more than an opportunity to make money out of those willing to part with something of real worth.

For some users it is no doubt an instrument to facilitate crime.  For others participants Bitcoin maybe a political or intellectual hobby taking a kind of material form.  The subject in my experience tends to draw to it futurologists, techno-optimists and anti-state libertarians like moths to a lamp.  What Bitcoin is for is in that sense subjective, will differ from person to person, and over time.

By the same token, [excuse the pun], the fact that Bitcoin has not fulfilled many of purposes projected onto it by its original enthusiasts does not negate the fact that those intentions were sincerely held, and that they remain latent possibilities.

Bitcoin may yet turn into a currency, or tame the characteristics of existing currencies;  its distributed ledger technology may yet disintermediate some of the thing its fans hope it will.  The tens of millions being spent by existing large financial intermediaries – an irony probably not foreseen by Nakamoto or the originalists – may yet unearth something that Bitcoin indeed will be for.

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Bitcoin and the underpinning of illicit fundamentals

One approach to pricing Bitcoin [and similar] has to been try to ask oneself what the fundamental value might be in terms of its enduring use and appeal to the community wishing to store value or make payments outside the reach of regulatory and tax authorities.

John Cochrane’s recent post has an element of this, attempting to distinguish between “speculative” and “fundamental” values for Bitcoin.

Bitcoin’s current high cost of individual payments make it unappealing for small and legal payments.  For small payments, the payment fee is a large fraction or multiple of the actual payment, and so highly inefficient.  For legal payments, there are cheaper alternatives and no obvious benefit, yet to using Bitcoin.  However, for those seeking to keep their wealth hidden, and move it around without the knowledge of the authorities, or being taxed, Bitcoin may still be useful.

However, there are no laws enforcing the use of crypto-currency in the illicit communities imagined here.  No law of legal tender.  The value of a medium of exchange in that community depends just as much on trust as it does for conventional monies in the overground communities.  That is, whether I accept Bitcoin for the drugs or guns that I sell illegally is going to depend on what I think others will think about taking Bitcoin from me when I try to turn the proceeds of my arms and drugs dealing into something I need myself.  [Readers will note that I am talking hypothetically at all points here].  And that, as always, will involve me thinking about what a putative future holder of Bitcoin will imagine that the next holder might think of it.  And so on.

This point – that there is no real fundamental value for the currency – is all the more important because the illicit and legal communities are intertwined.  For many of the illicit activities, of course, the whole point is to extract resources from the legal community and they are entirely parasitical in that respect.  For others, we can think of illicits trading contraband for legal goods.  And of course for that to happen, the reverse goes on:  those working in the legal economy trade the legally gotten gains of their labour for something under the counter.  Therefore, amongst the potential future holders’ beliefs that illicit agents have to factor in when they are assessing what the future value of Bitcoin might be are those of the legal agents [agents who earn legally].

Just as the quantity equation for conventional money does not provide useful guidance about its price when real central bank money demand is fluctuating a lot, so here the size of the illicit economy is not sufficient to say much about the floor to Bitcoin.  The complex judgements about how others think others think others think….  the exchangeability of Bitcoin will proceed have to be made by Bitcoin users, and changes in these judgements will cause girations in the value of Bitcoin.  There may be a fundamental demand for illicit goods, but that need not generate much restraint on the price of Bitcoin either way.

Misbehaviour by governments and central banks has in the past resulted in rapid coordination by private agents in economies on the rejection of the local currency in favour of the dollar, or commodities.  Although Bitcoin itself can’t be over-issued in the same way, it is easy to think of other events, like further forks, sudden regulatory interventions, exchange fraud, that could lead the illicit community to coordinate on rejecting Bitcoin [and similar] too.

A related phenomenon is the history of technological standards that emerged that were not necessarily optimal.  The econ 101 example of this was the Sony Betamax video recording format, which was dropped in favour of VHS despite being technologically superior.  The relevance is that the ‘fundamental’ characteristics of the thing were less important than whether others used the thing and were expected to use it in the future.

I think it’s a mistake to think of Bitcoin’s value, therefore, as underpinned by a reliable long term demand from badly behaved or private people;  that community may be as fickle in coordinating on a currency as our own, and as responsive to what they think we will do as we are to them.


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Moving the Bank of England to Birmingham won’t help monetary or financial policy

A report in the FT today reveals that Labour commissioned two consulting firms – GFC and Clearpoint – and the report is said to conclude that the BoE’s London location “leads to the regions being underweighted in policy decisions.” The recommendation is to move the Bank of England to Birmingham.

This is disheartening.  Two reasons.  First, there are actual things that could be fixed in the Bank of England.  Like the relationship between monetary and fiscal policy at the zero bound;  transparency in the models and forecasts;  the lack of an action plan for unconventional policies in the event of another crisis;  the vagueness of the financial stability mandate;  the preponderance of internal members on the Monetary Policy Committee;  the refusal of the MPC to present clear forecasts of what they intend to do;  the lack of clarity about how they trade-off real and nominal variables… and much more.  Instead the headline is about a report on something that does not need fixing.

A few points.

How would monetary or financial policy settings ideally have been different?  Tighter or looser?  Why?

The Bank of England’s mandates do not mention the regions explicitly as part of monetary or financial stability targets.

The BoE’s monetary policy remit does mention the regions:

“The Committee’s performance and procedures will be reviewed by the Bank of England’s Court on an ongoing basis (with particular regard to ensuring the Bank is collecting proper regional and sectoral information).”
But this is interpreted by the BoE, and a reasonable reader, as meaning that in figuring out the appropriate policy in pursuit of its aggregate policy objectives, it should collect the right information.  Part of the clue is in the mentioning of sectoral, as well as regional.  That is not to give the BoE two extra goals – adjudicating on the regional and sectoral distribution of activity and inflation – but to instruct it about dimensions of the distribution of activity that might be important for its aggregate goals.
I think the text is arguable, and bendable in the direction of regionalists and sectoralists.  But this is certainly how the MPC interpret it, for example, as evidenced many times, including a recent Treasury Committee hearing,and how it should be interpreted.
In pursuit of stability in aggregate inflation and activity [and financial stability], distributions are not irrelevant;  the prevalence of a small group of highly indebted individuals, and others who were highly exposed was one of the drivers of the financial crisis.  Had the debt or the exposures been shared out more equally, there would not have been the defaults and fire-sales.  Mismatch between where jobs and workers are – in actual and occupational space – reduces effective labour supply.  Because rich people have lower marginal propensities to consume than do the poor, inequality affects aggregate consumption.  But these effects are important for the BoE only because they affect the aggregates that they seek to control.  And they often come with important aggregate signals – like the spread on risky assets, aggregate consumption, or aggregate unemployment and vacancies.  And financial effects aside, they are often not particularly time-varying or large effects.
But where is the evidence that the BoE gives insufficient weight to these considerations?  How did monetary or financial policy suffer?
Even if the BoE were to given regional goals, they would not be able to achieve them.
The BoE’s main tools are aggregate tools, not capable of policing a regional distribution even if it wanted to.
Imagine trying to set regional central bank interest rates.  Counterparties would turn up for the lowest deposit rate, and the highest lending rate, and then lend on to others confronting less favourable rates, being set to achieve some regional goal.  Without policing the regional destination of onward lending, and in fact instituting separate regional currencies, you could not sustain regionally divergent risk free interest rates.
Regional macro-pru might be possible, but again it would be hard to police intermediation arbitrage without essentially going as far as instituting regional financial authorities.
Regional purchases of local government bonds would be possible, but most of the time would not make much difference [assuming that they were ultimately reversed, and not regionally differentiated monetary finance].  Regional purchases of private sector bonds would be possible;  but the market is not large, and currently concentrated with London and South East issuers, so such a policy could not make that much difference….  and we could go on.
Regional policy is for the government to sort out;  it has the legitimacy to undertake the necessary deliberate redistribution.  And it has the tools best suited to do it.
The Bank has a regional network of 12 Agencies, which it advertises conducts 9k visits with business contacts per year, and hosts 60 visits with ‘policymakers’.   My feeling is that it spends too much effort, and with insufficient science, collecting its own regional information.  We don’t ask the BoE to collect inflation or GDP data.  Partly because we ask it to specialise in monetary and financial economics, not statistics [ok so they do collect monetary and bank balance sheet data…].  And partly because it does not look good to collect the data against which you will be subsequently judged.  There is enough trouble with inflation and GDP truthers as it is.  The Agency set up is an unwieldy mix between a PR/accountability function – the BoE has to be seen to be listening, and seeing the real activities of the real people and firms its policies affect, and taking its case to those constituent – and a dubious data gathering function.
If there is a failure – which I don’t see – how is the accountability system monitoring the Bank giving rise to it?  And why could this not be addressed simply by giving regional concerns more weight in the hearings of MPC and FPC members?  Moving BoE functions to Birmingham would presumably mean replacing a bunch of visits to Birmingham with a bunch of visits to London.  How would policy be improved by that?
Despite all this, I am not particularly against moving the BoE.
As part of an orchestrated move to dismantle the success of London’s economy, and try to recreate it for a part of the country that had so far missed out, there is at least a case to argue.  But we should not kid ourselves that it would help any actual policy that the BoE conducts.
I would propose something different.  Rather than uprooting and dismantling successful institutions and local economies, squishing the London tax surplus in the process in the hope that it reappears somewhere else, preserve and spend that surplus on better transport facilities and universities in neglected areas.
Oh, and rename the Bank of England ‘The Central Bank of the United Kingdom’ and rotate MPC and FPC meetings through towns like Penrith, Bangor, Peterborough, Thurso and similar.
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Time for an opportunistic inflation

The title of this post is a play on a paper by Orhapnides [ex Governor of the central bank of Cyprus] and Wilcox, the Opportunistic Approach to Disinflation.  That paper described a policymaker that would not seek to engineer low inflation through deliberate monetary policy, but would wait for the good fortune of disinflationary shocks to do it for them, locking in low inflation later.

What is the relevance of this now?

Post the Great Financial Crisis, the UK and other economies are stuck with very low real rates for the foreseeable future.  Other things equal, this means lower central bank rates.  The resting point for rates is perhaps as low as 2-3%.  This means that there is little room to respond to the next crisis.  Recall that interest rates started out at 5.5% in the Summer of 2008.  A way round this is to raise the inflation target.  This would, once met, tend to raise the resting point for central bank rates.  There are arguments against.  Getting a reputation for moving the monetary goalposts.  The traditional case for the costs of inflation which underpin the inflation target in the first place.

Another – and a clincher for me at the time – was the fact that central banks were having a lot of trouble hitting the old target of 2%.  Raising the target was just setting up the central bank for failure.

But here comes the relevance of the opportunistic approach.  In the UK, the unfortunate decision by UK voting turkeys to vote for their economic Christmas caused Sterling to fall, and has led to a protracted period of inflation greater than 3%.  In some ways this is the perfect time to raise the target.  There is a good chance of achieving it, with the right mix of monetary and fiscal policy, and a good chance of a promise to hit a higher target being believed, with inflation itself already high.

Some would cry foul, and assume that the authorities were never serious about the target, and complain that the higher target would be a step along a slippery slope.  But despite those risks it would be worth it to regain monetary potency in time for the next recession.

If you think QE is a perfect substitute for conventional monetary policy, or you are happy with the de facto return of managing the inflation target back to the Treasury, who wield the other remaining fiscal instruments, or you are ok with reforming monetary institutions to allow for very negative interest rates, then you won’t see raising the target as necessary or desirable.  But if you are not wholly in any of those camps, you should.

The implied position of the Government and in particular Mr Hammond, given the recent renewal of the inflation target remit, is that everything is fine as it is.  With inflation now fortuitously high, time to look at this again.

The Labour Party seem to have been doing some thinking about shaking up the Bank of England.  But it is distressing that with important matters of policy substance that could be addressed, like the level of the target, they chose to focus instead on the case for moving it to Birmingham.

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