The global surplus bogeyman recycling mechanism

It’s becoming almost a standard narrative that actually the crisis was not caused by the Greek’s overborrowing, but instead by inadequate demand in Germany, needing involuntary demand for Germany’s exports to stabilise Germany, a demand that later wreaks havoc.

Before this takes hold too tightly, I think it’s worth remembering basic open economy models of trade, in which current account surpluses arise naturally, and improve everyone’s lot, if they are related to the relative demands and supplies for future consumption, and relative returns.

Thus, as a mature economy, with scope for future income growth limited, and an aging one, with demand for saving higher to provide for old age, it would be natural for capital to flow to countries engaged in a process of catching up levels of average factor productivity in Germany, where marginal returns are higher.  Like Greece for instance.

In such a world, policy could shut off this intertemporal trade, but at great cost to both parties.

Part of the standard narrative is that this pernicious German saving was aggravated and helped along by the creation of the Euro, which, because of the weakness of the other countries, meant that German exports were overvalued.

The counterpoint to this is that nominal exchange rate regimes should not matter for anything much, intertemporal trade included, beyond horizons of 5 years or so.  Certainly not at the frequency of 2 decades, which is what some of the versions of the evil savings hypothesis deploy.

All is not quite so simple, of course, in the real world.  For the welfare improvements long- term current account surpluses and deficits to be there for the having requires that parties on either side of the trade understood the relative income profiles correctly, and also correctly understood the risks around them.

In the case of Greece and the other catch-up countries, it’s plausible to think that there ought to have been great uncertainty about just how far, given existing institutions, or plausible assumptions about how they would evolve, Greece’s income per head would catch up.  And that it was easy, in the early phases of that catch up, to guess the end point wrongly.  And we know now that there is much evidence, not least hindsight, that risks were not correctly priced in, or, if they were understood, were understood to be the business of someone else [in the case of mysteriously narrow spreads on EZ peripheral sovereign bonds].

Seen this way, the appropriate response is not radical and far-reaching intervention to prevent countries that want to save from saving, but mechanisms to tackle market failure in risk bearing and risk pricing.  Which is what, slowly and clumsily, is going on.

All that said, there are lots of problems with and puzzles for the basic toolkit on which those insights [they aren’t mine] are built.  But it should take more to displace it than simply the assertion and global recycling of the story of an evil capitalist saving bogeyman.

Charles Wyplosz urges Syriza to get ready for Grexit

Amusing:  just after blogging about why I think making a plan ready for Grexit would have been self-fulfilling, and sabotaging of plan A, Charles Wyplosz writes on VoxEU that they should indeed be doing that now.

His argument is – echoing Krugman, who is mystified this plan wasn’t executed earlier – that by planning for it carefully, the risk of hardship and chaos associated with a currency interregnum can be reduced, and this makes Grexit a more attractive option.

However, as I stated last time, I’d guess that by planning, openly, Syriza would make any other option extremely unlikely.

It would accentuate the current bank run.  While Greece’s future finances were dependent on Eurozone generosity it would also preclude there being any return of the vast sums of money that escaped Greece before capital controls were imposed from returning.

It would also surely harden the creditors’ stance.  For a start, it would strain to the limit the ECB’s preparedness to extend ELA to Greek banks.  It would act as a counter-signal about the government’s preparedness to implement the conditionality associated with a bail-out.   It would make it more likely that the creditors would judge Grexit as the eventual outcome, and thus make them less likely to fund Greece in what would, in that eventuality, be a futile attempt to keep them in the Euro.  Full readiness might cost several hundred million euros.  Are the Eurozone going to want to see their funding used for that?

From the creditors’ point of view, if such a plan were allowed to be pursued, what kind of precedent would that set for other troubled sovereigns?  Imagine how it would change the characteristics of the euro for its holders to know there were vast locked warehouses of many other currencies dotted around the territory.  A typical euro holder would be much more reluctant to leave wealth in the form of deposits domiciled close to one of those warehouses.  Knowing that the local polity could simply unlock the doors at the slightest whiff of a public financing problem would make a local deposit holder fear re-denomination.  Taking into account all this, the creditors will strain to make sure that such warehouses of alternative money are not built, nor the equally important operational ‘warehouses’ of battleplans for currency law change.

 

Greek plan B would have been self-fulfilling and sabotaged plan A.

Some are debating why Syriza appeared to have no plan B when it became clear that their strategy of trying to gain significantly easier terms for a new bailout was going to fail.  Paul Krugman puts it down to incompetence.  Aristos Doxiadis argues instead that having a plan B would have turned the Greek electorate against Syriza, since they were determined to stay within the Euro;  and that the act of spelling the plan B out would have revealed how bad it was, causing them to back down.

I think there was another reason.  Setting in motion operational plans for creating its own currency would have made that plan B self-fulfilling, by accelerating the bank jog into a full-scale bank run, as people feared their deposits being re-denominated into a new currency they rightly presume would be less valuable.

Such plans require contracts with large-scale printing firms;  they require brainstorming, drafting, agreement, sequencing.   A process that would need to involve at least dozens of senior officials across government, the central bank and the banks themselves.  Careful thinking has to go into which button to press when.  Much legislation would have to be drafted and passed.  Action plans would need to involve the police and armed forces, and someone who owns a lot of trucks.

It would be impossible to carry out these tasks in secret without leaks in any government.  And certainly in trauma-torn Syriza.  [Witness the pulling-his-hair-out cry for help document written by central bank governor Kournaras a few weeks ago].  Leaks would sew panic and chaos, and probably jeopardise negotiations over the terms of plan A, the  bailout.  [‘Why should we fund them if they are about to cut and run?’]

The lack of a ready to go plan B is therefore not an accident.  Look around the other countries in the Euro, and my guess would be that there is also no ready to go plan B.  Because having one would undermine the degree to which being in the Euro constitutes an act of hand-tying;  and therefore erode one of the key supposed benefits of being a member.

A Plan B that was already worked out and ready to execute at speed would be like a marriage in which both parties have their kitchen walls adorned with post-its for divorce-lawyers and ready to go applications for internet dating websites.

 

Should the UK Treasury appoint another ‘dove’ to the Monetary Policy Committee?

Recently, ex-MPC member Danny Blanchflower, known for his ‘dove-ish’ views on interest rates, wondered who would get the ‘dove-ish’ seat on the Monetary Policy Committee that David Miles was vacating [leave aside that DM would reject that label], and Danny and others before him had filled.

This begs old questions like what is a dove or a hawk anyway, and are there places for these people on the Committee.  The answer, in my opinion, is:  yes and no!

The inflation targeting mandate is decided by the Treasury, so there is no question that those who are not prepared to accept that objective – and put aside their own personal views about the optimal inflation rate – should not be given the job.  Otherwise, the delicate but beneficial separation of powers [between the power that the BoE has to control the instrument as it sees fit, and the power of HMT to set the goal that the BoE aims for] would be lost.

The MPC are, however, asked to determine the ideal trade-off between fluctuations in inflation and real activity.  Partly because there is no hard and fast answer to this important question, it is delegated to the experts.  And for the same reason, there is scope for disagreement amongst MPC members about that trade-off.  Reasonable people can differ on unsettled questions in economics.

A ‘dove’ might then be someone who is relatively tolerant of inflation fluctuations, and prefers instead to keep unemployment/real activity stable.  Given a long enough run of business cycle experience, however, that should not translate into this dove voting for a level of interest rates that differs from average from someone who was hawkish defined this way.

Since that’s true only for a ‘long enough run’ of experience, though, it might well be possible for an MPC member to differ on average for 1, 2 or even 3 year terms, and still be behaving in a way that is acceptable according to this technical definition of a dove.  Such a person would be hard to distinguish from an MPC member that simply preferred a different inflation rate from the target set by HMT.

On this definition of a dove, there probably is a role for seeking out a range of views for the MPC and ensuring balance.  Ideally, the only qualification would be a preparedness to look at the question of the trade-off afresh and assess on the basis of the evidence at the time.  But, since it’s hard to verify whether this is being done faithfully, and people inevitably have prior exposure to this grandest of policy questions, that ideal is not likely to be feasible.  So it would be natural to seek a distribution of views that reflects professional uncertainty about the trade-off.

So, if there is a role for these kind of doves and hawks, how would you find them?  If life were as simple as a New Keynesian model, you could simply ask them about a few of its primitive parameters and be done with it.  But it’s not.  Could you just ask them whether they were comfortable with the current policy stance to get a feel for their trade-off-dove-ishness relative to those currently voting?

Sometimes.  But the read-across from trade-off dove-ishness to views about the current policy stance would not always be straightforward.  As the MPC were experiencing a large trade-off inducing shock in the early phase of the crisis, allowing inflation to rise to >5% as output and employment were driven down, the job was easier.  A trade-off dove was one that was relaxed about the choice to allow inflation to go so high.

However, supposing that right now we are in the middle not of a trade-off inducing shock, but a straightforward case of too-weak demand, [driving both inflation and activity below ideal levels] then you can’t infer trade-off dove-ishness from how relaxed people are about the current large undershoot of the inflation target.

For all these reasons, it would not be right to try to populate the MPC with doves or hawks more conventionally defined – just preferring lower or higher interest rates right now, simply for the sake of it.

Of course there’s more to it than the above lets on.  If there were not, there would be no scope for disagreement about the current level of interest rates.  Assuming that I diagnosed the current shock correctly.  But of course I may not have; and in fact there may be reasonable disagreement about the extent to which the current constellation of shocks is trade-off-inducing.  And there may be disagreement about the costs of pulling the policy levers to stabilise the economy.  Or disagreement about the persistence of the shocks hitting the economy.  Or, in fact, about any number of things.

None of these things mitigate against seeking a range of views about the current level of interest rates.  Far from it, but they do mean that it could be hard to know what kind of person you are getting for your current interest rate vote, so that conventionally defined ‘doveishness’ is not to be prized for its own sake.  [Or hawkishness for that matter, of course].

Mark Carney and the yield curve

Mark Carney hints that interest rates may rise at the end of the year, and many of the more compressed media pieces on his intervention turn a hint about the obvious into something that sounds like a racing certainty.  For the purposes of balance, therefore, it’s worth mentioning the following:

1.  De jure, Carney speaks for how he will cast his own vote only, though, de facto, the voting record shows that the internal members of the Monetary Policy Committee cast votes that are disproportionately correlated with each other.

2.  We can recall from Carney’s two interventions around his 2014 Mansion House speech that he is capable of back-tracking quickly.  After that, a rational Carney watcher puts a higher weight on any given signal containing more noise.  This is to put to one side the debacle of Carney’s unemployment-trigger-forward guidance;  the non-stimulative policy that was nevertheless meant to ‘secure the recovery’, and which scuppered the chances of a future MPC using genuine forward guidance as a preventative tool against the next crisis.

3.  Weighing against the policy guidance are several factors:  the hard to quantify, depressing effects of the ongoing Eurozone crisis and the risk of a disorderly workout;  the continued headwinds from fiscal policy, which, despite the inappropriateness of this when close to the zero bound, will be tight for the foreseeable future.  And not to mention the fact that inflation has failed to begin its return to target as predicted.  On Radio 4 this morning Andrew Sentance claimed that rates needed to rise before inflation began rising back to target.  Waiting until afterwards would be waiting until it was too late, he implied.  Well, that’s not consistent with the Bank’s own model, I wager, nor with any that I know.

4.  Despite the confident assertions that the MPC ‘have the tools’ to loosen should it be necessary, the reality, in my view, is less heartening.  Even QE believers worry that the marginal returns from this policy have fallen.  Despite needing to ‘secure’ that recovery, Carney urged the MPC to set aside this tool, probably for the reason that they felt those marginal returns had fallen too far.  Interest rates can be lowered a bit, but to what effect we don’t know.  The Government has boxed itself in again so that a significant loosening would be an embarrassing back-track.  (Although against that there is no real opposition to capitalise).  On the other side of the risk-management balance sheet:  should it prove necessary, fiscal, interest rate, asset purchase and macroprudential tools can all be tightened, with at least 3 of those policies highly likely to work in the way intended.

5.  These factors mean that the risks of a premature tightening outweigh the risks of one that is too late, considerably, a judgement that is coloured by recent anecdote in the form of the Swedish and Eurozone experiences.  In David Miles’ last speech he concluded that there were not great risks of a deflationary spiral as the economy approached the zero bound.  But I don’t agree.  The crisis has given us one observation only on that issue.  And one that can be read a number of ways [eg:  it takes extraordinary, extreme monetary and fiscal stimulus to avert a deflationary spiral].  And the models we have to make sense of most macro policy issues tell us that there are tangible risks of such spirals.  David leaves the Committee with central bank rates having been trapped at the zero bound for the duration of his stay.  Not necessarily an experience that endorses the view that we know how to provide adequate monetary stimulus to combat a large recession.

So, don’t be too sure that it would be optimal to raise rates quite that soon, nor that the MPC will conclude that it is.

Caught between a Eurosceptic rock and a hard place

A new dilemma for David Cameron.

On the one hand, he will want to make a show of objecting to the EU using the European Financial Stabilisation Mechanism [for which the UK would most likely be on the hook] to provide bridging finance for Greece, because he is, to some extent, forced to do this by the Eurosceptic wing of his party.

On the other, if he tries too hard, he may lose allies in the European Union that would have previously helped him deliver some kind of EU reform that could be sold to moderate Tory Eurosceptics before a referendum on the UK’s membership of the EU.  Precipitating chaos in his own party and many campaigning for a ‘No’.

Presumably, this is a policy dilemma that will be repeated over and over.

As a Europhile, it’s disappointing to think that the UK would object to helping Greece through these means.

Those against might argue that the root cause of Greece’s troubles is the design of the Eurozone institutions, not something the UK was responsible for.  So why should we pay?  But that we had the choice of not joining is arguably just our collective good fortune in inheriting a long history of relatively stable monetary, financial and legal institutions.  For the UK, unlike Greece, we could weigh relatively cosmetic arguments like those in the ‘Five Tests’ document.  For Greece, joining was a way to secure the final leg on the journey to economic and political modernity.

And, stepping back, the cause of this crisis is the profession-wide failure to apprehend and control risks in the financial system.  And the UK was at the forefront of that particular blindness.

 

Greek Bank bread and Buiter

Willem Buiter and co at Citi [no link, since it’s a proprietory research note] propose to transfer regulation and ownership of Greek banks out of the Greek state, and into a common entity owned and controlled by the remaining Eurozone countries.  This being a way to ‘break the vicious circle between banks and sovereigns’ a phrase trotted out with either aplomb or irony in EZ commentary depending on the circumstances.

Remaining Eurozone countries become sole equity holders in the new banks as a reward for recapitalising them, and, since they then control them, can prevent them becoming unnecessarily exposed to Greek government bonds in the future, and, since they take future risk, be compensated for that by taking the rents too, and having control over operations.

Although this is an intrusion in normal economic sovereignty, the idea is to free Greece from other interference.

That’s all well and good provided that the Troika are prepared to let the Greeks run their economy as they choose, and therefore let the chances of the legacy debt being paid off depend entirely on Greek politics.

One way out of that might be to tie re-entry as an equal partner into this impromptu banking union to ‘good behaviour’ generally, either on fiscal or microeconomic policy.  Adherence to pre-agreed policy targets, could be rewarded with shares or influence, or adjustments to risk-weights on Greek bonds in the new Greek Bank controlling entity.  This would also allow a path towards normalising Greece as a politically and financially equal partner in the union again, should that be what they want.

Moralising about Greece

Much of the moralising about the crisis seems to miss a couple of points.

First, the parties to the struggle over resources (that’s all this is) are not single people.  But they are often discussed as though they were.  They are, in fact, coalitions of representatives of multitudes of individuals, looking out for themselves, constrained by the fact that the multitudes they represent are also looking out for themselves.  That is surely true on both sides.

And these coalitions of representatives know that the other party is trying to get all they can, and that neither can commit.  And that they are probably going to confront the same struggle again with the same adversary.  And possibly with others.  The representatives themselves are also locked in games with their electorates, struggling to convince that they can commit and deliver, and at the same time preserve as much room for discretion as possible.

Seen like this, moralising about the parties strikes me as highly inaccurate.  Not least, somewhat pointless.  What will it change?  Are the moralisers hoping to change a few million minds?  Or wave away all the interlocking struggles on either side of the negotiation?  Good luck with that.

[Added later:  Incidentally, this argument applies as much to those against Syriza as for it, who personify the complex systems that produce Greek political system, Greek tax collection/evasion, or inefficient Greek public services, and divine laziness or untrustworthiness.  And therefore see the crisis as comeuppance.  Not so.  These malfunctions are just uncooperative equilibria, nothing more.]

Second, suppose we adopt a moral position regarding the crisis.

The proposition seems to be that we would have a better world if the creditors made a large one-off transfer to the Greeks.  But, hang on.  If we could find some way to wrestle these resources from the hands of the creditors, would we really transfer money to the Greeks?  The Greek economy is suffering terribly.  But marginal utilities are probably a lot higher in the dozens of other countries with a lower GDP per head.  Why not forgive some debt elsewhere?

If the argument were about righting wrongs – adopting, for the moment, the lazy personification of complex multitudes of limited commitment games that such moral judgements require- I am sure we can find a few other financial wrongs that afflicted poorer nations.

Syriza and the SNP playbook

There’s an echo in Syriza’s presentation of the options to the Greek people in the SNP’s approach to the independence referendum in September 2014.

The SNP campaigned promising a plan A of keeping Sterling, (because they knew the Scots were afraid of the unknown alternatives), yet having full sovereignty over fiscal policy.  All other UK parties announced that this would not be conceded.

The SNP revealed no plan B, on the basis that they insisted it would be in the interests of the  Rest of UK [RUK] to grant continued membership.  This was a pretty astonishing claim.  Given the unfolding of the Eurozone crisis, caused by a combination of independent fiscal policies and a common monetary policy, just what the SNP were asking for, it is pretty plausible that the RUK parties claim that Sterling membership would not be on offer was real, and not a ploy.

So Syriza are campaigning promising Euro membership, which they know is popular in Greece, safe deposits, but a rejection of terms offered by the creditors.  Yet without the creditors (probably even with them) deposits are nothing like safe.  And without the creditors, the governments’ financing needs cannot be met any other way than either starving those dependent on the public sector, and many others, or printing their own currency.   Syriza are offering something it is not in their power to offer, because the creditors won’t agree to it.

Just like with the SNP, Syriza try to portray their own demands as in the interests of the creditors themselves.  And they have done this month after month in spite of the creditors’ resistance.  And in spite of the fears of contagion on which Syriza’s argument that giving in is wise for the creditors  depends, not being realised.  Just as with the SNP, Syriza reveal no plan B in case their demands are not met.  Just as in the indyref, therefore, voters can’t gauge the benefits of supporting their representatives in pursuit of plan A, since they don’t know what they will actually get by pursuing it.

A genuine vote in the independence referendum depended on the Scots seeing through the SNPs rhetoric on complex matters of macro and finance.  Who knows whether they did or not.  Likewise, a genuine vote on Sunday depends on the Greeks understanding the likely consequences of a yes or a no.

As I watch events unfold, it’s particularly sad to see the emphasis placed by Syriza on the referendum being the ultimate expression of democracy.   When the consequences of the different votes are not explained properly, and in fact are actively concealed, the vote can’t be said to be an informed one.  That is a very poor expression of democracy from its inventors.

 

Transfer unions and contagion

Whether or not partial or whole Grexit prompts contagion will depend on the forces in favour of a transfer union amongst the remaining members.  Syriza has been talking up the risks of contagion, describing it as a near certainty, because this was its main bargaining chip in seeking easier terms from the creditors.  Unfortunately for them, so far at least, all the data that has come out has pointed to there being no run on other sovereigns.  This implies that markets think that the forces in favour of the risk mutualisation required for calling the markets’ bluff (that would take place on the ECB balance sheet) are healthy.

This might seem surprising, since one way of looking at the current impasse is that the Greeks are asking for terms that might have existed if there were a transfer union in place beforehand.  And the creditors are objecting, because from their perspective they did not sign up to a transfer union.

However, as Chris Giles pointed out when he circulated my last blog post, it may be easier to engage in transfer union behaviour [transfer unity?] once the outlying or dissenting former club member is out of the picture.  The previous reluctance fades because the new core membership worry less that they will end up on the wrong side of the union, since, ex ante, all of them look more similar.  The new members start to resemble Rawls’ hypothetical individuals in the original position, less sure who it is who will be unfortunate enough to have to dip into the pot they are proposing to fund together.

The other force propelling this kind of integration is, of course, the realisation that the current difficulties were caused by not having it in the first place.  It doesn’t seem cut and dry that this would be a force for togetherness.  The lesson might be that it is either all or nothing as far as the transfer union goes.  In which case enough might choose ‘nothing’ to cause disintegration.  But, so far at least, this is not what is being concluded by investors, and that does not augur well for Syriza’s current strategy.