Eurogroup may figure Grexit doesn’t have to be the end of the Euro

There has been a continual flow of text in the Eurozone crisis based on this idea:  if Greece goes, this is the end of the Euro.  Because of that, the Eurogroup will step back from the brink and make the necessary compromise, provide Syriza with the financing it needs with less or no conditionality, and Grexit will be avoided.  Robert Peston repeats this idea as a near certainty in his blog today on the BBC website.  He had a go repeating it on the Today program, but, mysteriously, the line was cut before he got going.  (Coincidence, or intervention by Schauble?  You decide).

This idea is greatly overplayed.

Greece is a very small country.  It’s too small and different to learn any kind of lessons about how the large, troubled countries would be dealt with.  Those being Spain, Italy, even France.  I’d say that the Germans would not be able or willing to finance any of those countries on their own, or together.  They are too large.  Greece staying or going does not change that calculus, because it doesn’t change the size of that potential bail-out.

What about the smaller countries:  Portugal, Ireland, Cyprus, Belgium…?  Would Eurogroup want to avoid suggesting that there could be exits of those countries?   Yes, but not at any cost:  the moral hazard argument weighs just as heavily.  The choice may between an exit, or [entering Eurogroup minds here] throwing good money after bad, and then exit.

And besides, the other small bail-out countries have been tamed, and the medicine can be argued to be working.  Regardless, with OMTs and QE, there are instruments already in place to fight a test of the exit domino theory.  Greece going would not alter the calculus that the others are too safe or easily protectable, to leave.  There is also, probably, not only an ability to protect those countries, but solidarity too, since they swallowed the pill and did what they were told.

The symbolic damage of Greece exiting is also not as project-destroying as Peston and others make out.  Notice that in the midst of all the chaos the Eurozone admitted a new member, Lithuania.

The calculus that the Euro is an idea – the current set of rules and regulations (discretionarily arrived at since 2010!) – may be as powerful in Eurogroup minds as the statement that it is a particular geographic construct.  If you follow that through, better to let Greece go, leaving the ‘idea’ intact, and maybe one day come back if it chooses.

Pissarides’ Euro apocalypse was different.  He asserted that markets everywhere would run looking for a safe-haven (outside the Euro).  They may.  But he didn’t put any weight on the observation that they haven’t so far run from anywhere except Greek banks.  And there has been  no response but this each time Eurogroup has turned the screw.

My tweets about this generated the response ‘they didn’t run before the Lehman’s run either’.  [eg from Jo Michell at UWE].

That’s a good point.  However, three responses.

First, Lehman’s is fresh in the mind.  That would tell me we would be more likely to experience a pre-Grexit run than otherwise.  [‘I didn’t make it out the door fast enough last time, so this time I’m not going to make that mistake’].

Second, 80% of the exposure to Greek sovereign debt is to other governments.  And there has been lots of time for the private sector to arrange their affairs to cope with the rest.

Third, markets have not been thrown any Bear Sterns-like dummy by Eurogroup to precipitate a repeat of the Lehman’s surprise.  If anything, Eurogroup [is it Eurogroup, or ‘the Eurogroup’?] have erred on the side of tough-talking.  ‘Get out while you can because we are not giving in’.

[HT Robin Wigglesworth for reminding me of the cold war domino analogy.]

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Greece the wheels by keeping emotion out of it

The leading protagonists on either side of the creditor-debtor struggle are using personal and emotive comments as a regular ploy.  The latest incident is Schauble’s remark that he ‘pities’ the Greeks for electing an ‘irresponsible’ Government.  But there have been many more, and from Syriza’s side too. There was the visit to the Nazi-assasinated partisan’s graves, picked from the many things that could have been done to symbolise Syriza’s left-wing credentials, to cause offence and raise the issue of grievance.  And many more.

This is comprehensible as a tactic to solidify political support for a line chosen by each party;  to maintain and sustain the bond between the elected representatives and the voters, who, leaders might suspect, must be shown empathy for the emotions they are feeling.  So that when the inevitable dirty compromise is struck, there won’t be too much political damage, and their respective electorates will think ‘they saw it how we did, and did all they could.’

However, I can’t help worrying that it really IS getting personal, and the protagonists ARE pissed off, and won’t see coolly what needs to be done.  Political histories are full of examples where, after the fact, historians agree that personality and emotion got in the way.

Moreover, although comprehensible as a tactic, it’s also risky.  Emotions, once whipped up, can’t always be kept under control by the politicians who stoked them.

So, if any of them are reading, which they probably are not, calm down, stop giving those interviews, and spend more time iterating over those spreadsheets until you find the one that works.

With fiscal friends like these….

A link to my guest blog on Chunomics, curated by the Independent’s economics editor Ben Chu.

Feb BoE Inflation Report post mortem

A few stream of consciousness points coming out of Thu Feb 12’s Inflation Report Press Conference.

The MPC are determined to ‘look through’ the effects of commodity price falls, and describe balancing risks either side of their effects.  I don’t see that at all.  There are presumably risks either side of their assumptions about the income effects of lower oil prices.  But there is a decidedly downward tilt to distribution over outcomes for inflation expectations, and whether they fall, extrapolating the fall in headline inflation.

It was notable that we learned that the floor to interest rates has been lowered.  Carney gave a very good answer to a question about this at the press conference.  Previous worries that lowering rates too much would damage the balance sheets of banks and building societies had abated, because those balance sheets were now in better health.  (I wondered too whether there was any change in the mismatch between the tracking of deposit and lending rates to Bank Rate, which was the driver for the projected balance sheet harm before).  But when exactly did this analysis shift?  The fiasco of the first forward guidance (was it a stimulus or not?) could have been avoided if the floor to rates could have been dropped back when Carney first took office.

It would have been nice to know what the floor now was.  0.25%, 0, <0?  This could make quite a difference to longer interest rate forecasts, and the stimulus that could potentially got by allowing market forecasts of future rates to do the easing for MPC, should such a need arise.  Given the new premium put on clarity and managing expectations of future rates, it is an ommission not to give more certainty about the new floor.

The revision to the floor suggests to me a determination not to resort to QE again.  Which begs questions about MPC’s current views about the efficacy of the stimulus imparted by assets purchased thus far.  For sure, MPCs view of its efficacy cannot have risen.  The best guess is that the median member views this to be less effective.  Is this manifest in the forecast?

Carney’s answers to questions on the impact of Grexit did not satisfy me.  He described it as a hypothetical that can be reacted to as and when.  Well, there are many hypotheticals built into the forecast.  The entire edifice is a distribution over hypotheticals.  The fact is, there are probabilities of things working themselves out in various ways regarding the negotiations over Greece, and these weigh on a rational forecast of EZ demand for UK exports and are manifest in all kinds of asset prices now.  MPC can’t have coherent views about the other things in their forecast if they can’t disentangle the superimposing of Grexit risks on current and future data is doing to their outlook.

At some point, the dreaded ‘price level shocks’ term got a wheeling-out.   This is a favourite of central-bank-economics-speak.  But makes little economic sense.  Let’s stare at a model like the one the BoE itself uses for forecasting.  There are various kinds of shocks in that model.  Shocks to technology, demand, government spending, perhaps financial spreads, tastes, with home and foreign varieties of all of these.  Some of these shocks might affect relative prices, and some might not.  Given the lags with which monetary policy works, and normal policy reactions, all of these shocks will affect the price level over shortish horizons.  And what happens over longer horizons is up to the central bank.  (In a macro model with flexible prices, a somewhat unrealistic but illuminating example, monetary policy works instantaneously, and what happens to the price level at any horizon is up to the central bank.)

So the label ‘price level shocks’ is highly misleading.  It implies that there is just stuff out there moving this unrelated thing ‘the price level’ around that can’t be responded to, and luckily, since they don’t affect that other thing ‘the inflation rate’, don’t have to be responded to.

Whether shocks need responding to depends on what caused them, and whether, (as Carney pointed out, in fairness) they can be responded to quickly enough (before the effects of the shock dissipate, for example), and not on some bogus calculus about their being shocks that affect the price level or the inflation rate.   In the future, I hope central bankers get booed if they use the term ‘price level shocks’.

At times like this, shortly before an election with great uncertainty about what fiscal plans are beyond it, great strain is placed on the – imperfectly applied – BoE convention of forecasting conditional on existing fiscal plans.  This convention is there to avoid the embarrassment of having to forecast that the Government of the day would do something different from what it said it would.  But it was often and rightly disregarded in some of its details. Because of course the lags between a policy change and its effects mean that the BoE need to know what will happen to fiscal instruments, not what is ‘planned’.  So, how on earth is a distribution being formed over post-May-2015 fiscal variables?  I’m intrigued.  We’d need to forecast the election result (a coalition, but between whom) and how negotiations would tilt plans from those announced by each party.

Final gripe.  The Report describes the current policy challenge as returning both inflation and capacity utilisation back to targets, objectives over which there is no trade-off.  But we must surely think that financial sector impairment is still a significant factor, and, if so, that there IS a trade-off, ie that ideally we would be aiming for above target inflation to ‘over-stimulate’ the economy and make up for the financial constraints on the supply-side (which may explain some part of the very low productivity right now).  (In general, the two-goal-variable characterisation of policy is far too simplistic.  It works in the very simplest New Keynesian model.  But in a model like the one the BoE uses, there are many factors to weigh up in figuring out optimal policy and it is not just a simple matter of weighing inflation and spare capacity.  Spreads would enter, consumption and investment would enter separately, nominal wages, the real exchange rate…..  the list goes on.)

Greece, Acemoglu and Robinson

Recapping on tweets today.

The dominant narrative in discussions of Greece is that if Greece wants further relief from sovereign debt, those who pay for it want something in return, in particular something that makes it less likely that Greece will have to be subsidised again.  The way creditors see it, that something is the catch-all ‘structural reform’.  Which means changes that bring the institutions and markets of Greece closer to the norms of European capitalism.

Given that, many watching Syriza’s opening salvos at the head of Government have been dismayed by them announcing that they will raise the minimum wage, halt privatisations, and hand out free food and energy to those in poverty.  These things seemingly lower the natural rate of output in Greece.

However, if you look at this through the lens of Acemoglu and Robinson’s account of institutions and markets, this may not necessarily be as bad as it looks (from the point of view of the institutions-free neoclassical account of economics).

In particular, it may not be right, as A&R pointed out, to think of a quasi-market system like Greece, where public and private sectors are the outcome of complex power-plays between social groups, as something that could be brought towards a capitalist system by undoing what we would think of as ‘distortions’.

A classic example, understood before A&R brought out their book, is that it may be unwise to privatise state functions into a private sector that is not a functioning market, but a power-play between private elites who even have their own violent enforcers.  Responding to my tweets, Tomas Hirst pointed to Russia, and the naivety of Western advisors leaping in after the fall of the Soviet Union;  Alan Beattie cited the privatisation of Mexican telecoms company Telmex (which, Alan points out, enriched Carlos Slim).

For the sake of argument, let’s suppose that the key thing to achieve first, to begin a movement of Greece towards a functioning mixed economy welfare state, is undoing the power of ‘the oligarchs’ [it’s starting to sound ridiculous recycling that label, but, in the absence of a smarter one…].  And suppose that achieving that requires a sustained and powerful political coalition of forces.  Well then it may well be efficient in the long run for the Government to do all kinds of things that, superimposed on an otherwise efficient Western economy would do harm, if it buys loyalty for that long fight.  Once those elites are defeated [whatever that means], and the coalition has served its purpose, the apparently harmful loyalty gifts [the ‘distortions’] can be taken back, and in the expectation that the losers will be compensated by the benefits that flow from unlocking true, glorious capitalism!

Of course, Syriza may not see things this way.  They may have other motives for halting privatisation.  They are a union of Marxists of different persuasions, after all, each of whose philosophies responded in different ways to the dying convulsions of Soviet communism.  But so what?  If their actions have the unintended effect of attacking the key non-market-distortion first, the Marxist program can be embraced, rather than derided, if it buys a better chance of long-term mixed-economy-welfare-statism taking root. In fact, one could adopt a conspiracist position on this, imputing an ironic form of false-consciousness on the part of Syriza and view Marxism as part of the necessary glue to keep a powerful coalition together to tackle the elites who control the commanding heights of the ‘state’ and ‘private’ sectors.

[State and private in quotes because in a quasi-market economy apparent ownership does not tell all.  False consciousness dubbed ironic because Marxists view capitalism as infecting its worker-bees with the false consciousness of liberalism, in order to preserve the status quo of class relations.  Here benign capitalists infect people with Marxism, not liberalism, to defeat oligarchic despotism, and deliver the fruits of  capitalism].

I’m not suggesting that Syriza’s plan corresponds to an institutionally literate reform program that will ultimately give birth to enlightened capitalism.  But neither should one dismiss it out of hand using the neoclassical logic that adding a distortion to an undistorted, institution-free economy makes things worse.

Greece: a debt-for-equity swap, or just something for something else?

During Varoufakis’ European tour, there was much discussion of a proposed swap of Greek sovereign debt for a new contract that would link payments to the performance of the Greek economy.   For lay readers, this kind of contract is a bit like UK student loans, which don’t have to be paid back at all unless graduates clear an earnings threshold.

This sounds exciting, ingenious, rational;  even fair.  But we should remember that the Greek sovereign debt is not really debt any more anyway.  The large face value [174% of GDP, before a new contraction set in] translates into an interest burden [2% ish of that same hazy GDP number] lower than Spain or Italy, because of the already very generous terms, recognising that, in essence, the debt is partially forgiven already.

How much it’s forgiven is unstated, but would surely depend on how well the Greek economy was doing.  And because there has been one renegotiation of terms already, any equity-like feature of the new debt would of course be just as hazy, really, since those terms could be renegotiated down the line.

So what is really being proposed is an exchange of one renegotiable contract whose eventual repayments are variable and related to Greek economic performance, for another.

It has the symbolism of communicating that Greece is being let off something again.  But really such a swap would be repackaging.  It’s also a rather academic kind of symbolism to invest in for political reasons.  And carries political risks for both sides.

Consider a hypothetical German punter/ tabloid editor:  ‘eh?  now they can tank their own economy to get out of the debt!’.  And the Greek equivalent:  ‘Syriza have been taken over by investment bankers!  Just as Greece is doing well the Troika are swooping in to steal more!’

The idea of linking sovereign debt-repayments to growth is one contained in Robert Shiller’s urgings.  He described a beautiful utopia in which governments worked to lay off all idiosyncratic country risk in their bond issues.  This would allow countries to focus on their comparative advantages – and not labour over statist industrial policies that tried to diversify their economies – and provide beneficial insurance.

Whether a Greek debt-for-equity swap gets us closer to this utopia is moot.  This would be after renegotiations of the debt, and where future renegotiations are threatened.  Shiller was thinking of a world where governments start out issuing such contracts, and honour them.

It’s also moot whether such a swap is ‘fair’.  On the one hand, bondholders signed a bond contract, not a something else contract.  Yet on the other, given a long history of sovereign debt restructuring, bondholders bear some responsibility for recognising that contractual promises are not and cannot always be kept.

 

On John Taylor’s defence of the Taylor Rule bill

This post responds, though JT directs his fire at Paul Krugman, not myself.

JT points out that the legislation isn’t designed to pressure the Fed to follow the Taylor Rule. This defence is hollow. JT thinks the crisis was caused by deviating from it, and supports the legislation. Even in the same post he refers to research extolling its performance in macro models. Clearly he thinks future Fed policy would improve, the appropriate metric being closeness to the Taylor Rule. Asserting that it would not get him everything he wants does not refute the main point.

JT makes reference in support of his Bill to the literature on rules versus discretion. I think this does him no favours for a few reasons.

First, we have to dispense with the part of that literature that concerns itself with the tendency for pure discretion to induce too high levels of average inflation. That’s not at issue here given the Feds price stability mandate.

The relevant part concerns how to eliminate the ‘stabilisation bias’, the tendency for discretion to induce ineffective over-smoothing of the cycle.

Studies do show a benefit of commitment over discretion. But these benefits are not that large and its arguable whether they can be achieved.

Even more contentious is whether suboptimal policy under commitment (Taylor rule) dominates optimal policy under discretion. I’d guess it would be a close run thing.

Finally, the dynamic rules versus discretion comparison is conducted under certainty. Under something that captured the profound model uncertainty the crisis revealed, these benefits could well disappear.

JT does not address the concern that his legislation makes it easier for political and discretionary interference to be brought to bear on operational matters. It erodes Fed independence over policy conduct, judged bad by reasoning from the rules versus discretion logic. Less fed discretion, more political discretion.

JT also defends his TR agenda against the accusation that the zero bound was not ignored. But he does not respond to the observation that theoretically at least religious adherence to the TR induces a trap at that bound. It’s easy to dismiss this concern: the model (in which ignoring the bad steady state gives good performance for the TR) is not nearly true. But then we have to reduce our confidence in the rule’s appropriateness.

JT continues to maintain that the crisis was caused by TR deviancy. Yet the models in which the TR does well have no financial sector that could produce systemic financial crises. Those models suggest TR deviancy has small and short lasting effects that many economist would dismiss (not me actually) as not worth bothering about. But they can’t produce 2 decade long Real balance sheet and leverage accumulation, followed by a bust.

Repeating my earlier points, the crisis does not teach us about the costs of TR deviancy, it reminded us that we are much further than we thought from having perfected what used to be dubbed a ‘science of monetary policy’, and nowhere near the point where an institution could credibly commit, on the basis of sound evidence, to a monetary policy rule.