Category Archives: Economics

Chart of the week, IMF edition

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Via the TUC Blog, this chart from the IMF is worth studying. It shows the sources of public debt in Europe since 2007 for Germany, Italy, France, and the UK.

You will notice that: yes, Virginia, the Germans bailed out the banks. Also, the Germans carried out the biggest discretionary fiscal stimulus in Europe at 5% of GDP. In all, German public debt increased as a percentage of GDP by more than Italy or France’s and second only to the UK’s. Also, Italy’s problems are entirely to do with growth or else with interest rates. And it looks like the political ability to pull in taxes is pretty important (something Daniel Davies pointed out not so long ago).

Irrelevant Merkozy

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So “Merkel acts to save the euro”, as various British headline writers misleadingly put it. This action consists of proposing that the 17 eurozone states make a side-agreement – therefore not requiring a full Inter-Governmental Conference – to have a European authority scrutinise their budgets and fine them if they run big budget deficits. Crucially, this would be approved by qualified-majority voting rather than unanimity, so there would be no national veto over the sanctions. It is somehow amusing how literally every great and little issue in the European Union seems to end up in a row about qualified-majority voting. Of course, this is an example of the basic truth that politics is about power. But it is in practice pretty rare that the distinction matters much.

Now, don’t kid yourself that any of this is going to happen quickly. All 17 will have to get round a table, agree, ratify, etc. Although Merkel apparently said that it wouldn’t affect German sovereignty (I’m moving home and reliant on spotty Internet connectivity, so I don’t have her actual words to hand, so this may be wrong), I find it hard to imagine that the same little caucus of law professors as always will not demand that the Constitutional Court rule on the matter, so we’ll probably be waiting a good long time while the sages of Karlsruhe mull it over.

But speed is not really the biggest problem here. It’s a big problem – one of the underreported issues in the mainstream media is the degree to which this crisis is still about banks and the dread of a run on the banks, and few things move faster than a bank crisis. Here’s a data point – the volume of funds banks (and big industrial companies that happen to have a bank licence somewhere around, like Siemens) are holding on deposit at the European Central Bank, for fear of putting them anywhere else, is spiking. But it’s not the only problem with this proposal. The problem with this proposal is that it is simply irrelevant in terms of its content.

Had it been in force through the 2000s, what would have been different? It would have been much easier to sanction the decade’s violators of the Stability & Growth Pact – Germany and France. Of course they got sanctioned anyway, but perhaps they would have had to pay a fine. Let’s be charitable for a moment and assume that this would indeed have caused them to run a lower public sector deficit. This would have changed what, precisely? Had it depressed internal demand in Germany, all other things being equal, it would have caused Germany to increase its trade surplus. A bigger trade surplus implies a bigger deficit elsewhere, and it also implies that German and French banks would have lent the private sector “elsewhere” the money they needed to buy the additional exports. An additional problem might have been that, had German bonds been in shorter supply, investors would have sought other AAA-rated assets and piled up even more bubbly mortgage-backed securities, which the banks would have been delighted to sell them.

Perhaps lower deficits in Germany or France would have inspired German and French consumers to spend via the magic of Ricardian equivalence, but this does feel awfully like assuming a pony. You can argue about that.

But one thing this proposal would categorically not have done is to stop Italy or Spain or Ireland running up more public debt. Public debt fell in these countries from 1995 to 2007. Even Portugal and Greece didn’t exactly explode. Ireland would still have a budget surplus if it hadn’t massacred itself to save the banks (in part because the ECB wouldn’t help). Greece, well, perhaps, but it seems to be clear that just yelling at the Greeks is insufficient to fix Greece’s problems.

Public debt/GDP for EU crisis states, 1995-today

We’ve had a massive asset price bubble, funded by an explosion of private debt, largely borrowed from a few huge banks that grew to enormous size processing the international settlements required by the huge intra-eurozone trade imbalance. But this proposal says nothing about asset prices, private debts, banks, or trade, and very little about growth. Instead, if we were to try to reverse engineer this proposal’s purpose from its design, we would have to conclude that the source of the eurozone crisis is that the German Government has too much debt.

And I think we can all agree that, whatever explanation you prefer for the crisis, that isn’t it.

There are other problems, too. The combination of “Durchgriffsrechte” – rights of direct intervention – with no eurobonds has toxic politics, as it gives whoever will “durchgreifen” power without giving them any responsibility, and also doesn’t give the other eurozone states any benefit (like lower interest rates) in exchange for this concession. It seems hard to imagine why anyone would accept this.

Last Days Of Pompeii?

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This week we got what seemed to be some good news in the ongoing Euro debt crisis. Bond spreads in many of the countries on Europe’s periphery tightened vis-their German equivalents. Unfortunately we also got some bad news to go with it (no silver lining these days without the accompanying black cloud it seems): the tighter spreads were the result of a weakening of German bunds (or a rise in their yields) following what many considered to be a failed bond auction.
Continue reading →

How Would You React To The News Your Local Central Bank Just Went Bust?

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Well, it’s been more time than I care to remember since I posted anything on this site. In the interim many things have happened, especially on the European sovereign debt front. I think I now have plenty of stuff lined up to waffle about, but maybe one simple way to ease myself back in to the world of blogging would be to republish the lengthy interview I just gave to the website Barcelona International Network. The topics covered range from the debt crisis itself, to prospects for Spain under the new Partido Popular government of Mariano Rajoy, and to the kinds of tensions with might arise in the months and years to come between Catalonia and the rest of Spain, and, of course, how this relationship might itself in turn have an impact on the debt crisis itself. Continue reading →

Don’t make decisions about money when you are poor

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Ah, behavioural economics. Remember when we imported evolutionary biology into psychology and how suddenly neither field had any stupid ideas in it? It looks like we’ve done it again. Astonishingly, hungry people value filling, energy-dense food a lot. Well, yes. That’s what the word “hungry” means.

You should never make decisions about food when you are starving. When you go to the supermarket hungry, the food you are drawn to is high-calorie junk food,” said Dr Alain Dagher, a neurologist at the Montreal Neurological Institute. “You assign way too much value to calories and so way too little to health and other things.”

No, you should never make decisions about food when you are starving. By the same logic, I suppose, you should never make decisions about money when you are poor, or about charity when you are rich. Of course, if you’re hungry it is rational to want calories. You do, in fact, want calories in the old sense of the word “want” – you need more of them. Presumably, you should wait until you aren’t as hungry before deciding what to eat?

Before we descend into cheap snark, there’s an important point here. Dagher is quoted down at the bottom of the article as saying that this may explain why people who miss meals and eat at irregular hours tend to get fat. Fair enough, and good advice. But the problem is that by the time you get off the third bus and stand in front of the aerosol-cheese aisle, you’re hungry. You’re not somehow faking it, and signs lecturing you about healthy eating aren’t going to stop you eating. The point is to avoid getting into this position in the first place, which might involve things like changing jobs or moving that are difficult and require resources.

Similarly, fans of “nudge” tend to complain that poor people make bad decisions about money, typically by prizing cash up front above everything. To put it in econospeak, irrational discounting leads them to have extremely high liquidity preference. But liquidity is useful, and people tend to want it if they are facing a dangerously uncertain future. And typical reasons to need cash fast include things like “topping up the electricity meter”, “the kids are hungry”, “collection goons are threatening physical violence”. It’s not as if they don’t need cash on hand for very good reasons.

Where is the line between responses that are merely insufficient, and ones that actually tip over into mockery?

Is the best NGDP targeter a union?

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So, a good row in comments at Nick Rowe’s blog, about nominal GDP targeting. I think I should probably develop the argument a little more. This particular “leftie” has doubts about NGDP targeting because, basically, I think it relies on assumptions about political economy that don’t hold.

Chris Dillow argues that the Bank of England is currently operating something very much like an NGDP target, in that it seems to have decided that inflation being over target isn’t a problem as GDP is in the toilet. I would add that the UK Treasury has a declared policy of austerity plus “monetary activism” – i.e. a ZIRP, quantitative easing, and at least benign neglect of the sterling exchange rate. (Although it devalued sharply early in the recession, it’s now picked up somewhat, so you can’t really say that they have a policy of competitive devaluation. But they certainly aren’t trying to push it up, and I suspect they’d welcome it if the rate went lower still.)

Now, this policy is certainly managing to add quite a bit of inflation to the flat or falling real GDP. Even the relatively low-reading CPI is over 5%. This is probably helping with the debts from the Great Bubble, but is it working for the real economy? The problem here is that prices are rising at an impressive clip but wages aren’t. The simple truths of household budgeting can only mean that consumption, the biggest chunk of aggregate demand, will be declining and that’s precisely what the statistics show. On the following chart, the red line shows the change in private consumption, the green line shows the change in wages, and the blue line shows the change in the consumer price index. Consumption obviously tracks wages, but it seems to be strongly influenced by the spread between wage and price inflation.

UK households get squeezed by shadow-NGDP targeting

As a result, absent a massive export (what, with depression in the EU?) or investment boom (and a pony), the economy is going nowhere fast. If this situation persists, whatever is gained by inflating off the debts will be lost on GDP growth. The exact reckoning depends on how much the impact on wealth-effect of reduced debt helps demand vs. how much the squeeze on household budgets hurts it. But the key point is that the effects of the policy are working against each other, reducing its effectiveness

At this point, Nick Rowe accused me of being fallacious, being like Ron Paul (the guy whose newsletter advised readers to arm themselves in order to shoot at their black neighbours because “the animals are coming”, and worse, a big fan of let’em starve gold standard macroeconomics – stay classy, Nick), and being like Michal Kalecki. I guess that last one is an improvement.

His point is that, in theory, changes in the unit of account (like inflation) shouldn’t change anything in the real economy. Knock a zero off the currency, or tack one on, and relative prices – like pints of beer per hour of labour – should remain the same.

Well, that’s sensible enough in as far as it goes. However, it may not go very far. It’s trivially obvious that inflation (or deflation) does have different effects on different actors in the economy. People with lots of liquid savings lose out, people with debts benefit. People whose money is invested in bonds (if they aren’t indexlinked) lose out; people whose money is invested in shares tend to benefit. Entrepreneurs do well, rentiers don’t. In general, inflation (or deflation) changes the terms-of-trade between the present and the future. Inflation causes people to bring forward purchases, deflation to put them off.

To understand this, let’s work through the process. So there is inflation, and both prices and wages rise. But for some reason, prices inflate more than wages. Aggregate demand will, all other things being equal, be reduced. What happens if prices keep going up faster than wages? Eventually, they will price themselves out of the market and there will be a recession, which will eventually drag prices back in line. Mr. Keynes, however, will remind us that the long run can be very long indeed. If nominal prices were frictionless, of course, this wouldn’t be a problem, and I wouldn’t write this and you wouldn’t read this, and Nick Rowe would be out of a job as a macro-economist. We have to deal with the empirical realities.

Of course, I’ve left out an important actor here. What about workers? Sticking with the standard economic apparatus, you’d probably say that if prices inflate faster than wages, “wage bargainers” will integrate higher inflation expectations into their negotiating position and bid wages up. This is all very well if they can negotiate a raise. But we’re starting off in a recession, in the zero lower bound environment, with millions unemployed! Worse, we’re coming off 30 years of macro-economic policy designed to defeat the wage-price spiral – i.e. to damn well stop them bargaining wages upwards and to set expectations of wage inflation as low as possible.

This is where the political economy comes in. The idea of getting out of depression via NGDP targeting requires robust wage bargaining. In the absence of it, in a political context that has invested huge efforts in the destruction of expectations of wage growth, it is useless if not actively harmful.

There’s also another trap here. If prices have to overshoot and fall back in order for monetary neutrality to work, this requires deflation. Deflation is not generally considered – even by the most ferocious monetarist – to be a great recovery plan. And it is the exact opposite of an inflationary exit from a balance sheet recession.

Update!

Here’s a helpful chart of consumer price inflation and wage inflation in Canada from 1970 to the present day! As you can see, there is absolutely no spread between them. Or…is there?

Prices can rise faster than wages

More energetic remedies

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“We [Eurozone] all have to become more competitive” — Jens Weidmann, Bundesbank President, in a FT interview.

Alice in Wonderland, Chapter III:

‘But she must have a prize herself, you know,’ said the Mouse.
‘Of course,’ the Dodo replied very gravely. ‘What else have you got in your pocket?’ he went on, turning to Alice.
‘Only a thimble,’ said Alice sadly.
‘Hand it over here,’ said the Dodo.
Then they all crowded round her once more, while the Dodo solemnly presented the thimble, saying ‘We beg your acceptance of this elegant thimble’; and, when it had finished this short speech, they all cheered.

Sympathy for the devil. Well, at least he’s not Berlusconi

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Well, what a week that was. 7% was the new 6%, the cows broke through the ECB’s electric fence, the Greeks took a week to decide who ought to be prime minister after, to be honest, the G20 decided George Papandreou shouldn’t be, and Silvio Berlusconi went the same way.

It’s hard to feel much for bunga boy, but this post from James Hamilton at Econbrowser explains why I feel some sympathy for the old devil. Basically, as everyone sort of knows, the long term constraint on a government budget is that nominal GDP growth is ahead of the nominal interest rate on the debt it needs to raise (or roll-over) every year. As Italy is close to primary-balance, the roll-overs are the interesting bit.

How you think about this is important – quite a few people are arguing over whether Italy is “illiquid or insolvent”. But this is a distinction without a difference, as it’s quite possible to get from solvency to insolvency (or the other way around) just through changes in the nominal interest rate. The rate is both cause and effect at once. On the other hand, you could say the same about GDP and indeed Hamilton and our own Ed Hugh do.

But once you accept this, there are some important policy implications. For a start, it creates the possibility of self-defeating austerity.

If you decide to increase taxes and/or reduce government spending in order to increase the primary surplus and pay down the debt faster, you are basically going to reduce nominal GDP. Public-sector saving is a withdrawal from national income. You may argue that this represents supply-side reform that will have good consequences down the line, but does anyone imagine that the long run was uppermost in anyone’s mind last week? And if it was, how come Italy can sell one-year treasury bills at better rates than it can 10-year bonds? Clearly, the markets actually expect that the worst is still to come.

Similarly, you might argue that it is internal devaluation, but then, the constraint is nominal GDP growth higher than nominal interest rates. And you’d have to make some brave assumptions about the price-elasticity of your exports, the percentage of their price accounted for by labour, and the impact on the consumer sector of the internal devaluation. The condition of non-exploding debts says nothing about whether growth is internal or export-led.

Another problem is that the market can stay irrational longer than you can stay president. Imagine a scenario in which there really is some package of reforms that need a dramatic cuts plan right now, but certainly will pay off in higher GDP growth in the future. I mean, I can’t, but perhaps others can, as so many politicians seem to manage it. Does anyone doubt that, if it depressed GDP in the first year enough to get significantly under the constraint, that the interest rate wouldn’t spike high enough to bring about a massive budget crisis in short order?

So yes, Berlusconi was dancing around the very real possibility of a completely pointless and indeed self-defeating purgebinge. Wouldn’t you?

There is a wider point here. Kantoos is very keen on the point that Italy lost a sizable margin of competitiveness during the 2000s. (And who’s responsible for that? we all cry – would it be the dynamic businessman from Milan with the permanently refilled Viagra prescription by any chance?) But this Street Light post makes an excellent point. Southern Europeans put in more hours per worker, and in some countries more of them work, than Germans. The fact that all this effort is going to waste should embarrass everybody, and especially Silvio Berlusconi. But it is more embarrassing that the proposed solution is to put a lot of them out of work!

That reminded me of this post of Peter Dorman’s at Econospeak on another frequent AFOE concern, demography. He makes the excellent point that it is a problem in so far as productivity growth per worker doesn’t keep up with the dependency ratio, and only in so far as it doesn’t. If you want me to take you seriously about why Italian or Greek wages should fall, kindly set out your proposals for what Italian and Greek management can do to close the productivity gap.

There’s an argument that the best thing managers could do would be to resign and leave the workers to self-manage, but it’s somehow unlikely that this will be on offer. It’s true, however, that getting rid of employment protections has no measurable benefit in terms of GDP growth.

All that said, Dani Rodrik has a fascinating paper out on manufacturing and productivity. Specifically, it’s the only sector that shows a clear global trend in which less productive economies catch up with the best in class. Worryingly, this is most pronounced in exactly the subsectors that the German economy is strongest in. That certainly puts this Blodget Insider post in an interesting light. On the other hand, even in China, we’re seeing the end of cheap labour.

Sewing? No. Reaping.

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The deflationary settlement of intra-eurozone imbalances has not necessarily developed to Germany’s advantage. German industrial order books shrank by 12.1% for exports to the eurozone, while orders from the home market fell 3% and from the rest of the world by 0.3%. Interestingly, the worst sub-sector was semi-manufactured goods and chemicals, i.e. inputs into industrial supply chains. This, to me, suggests that the crisis is affecting places like northern Italy – not just selling fewer BMWs to the periphery, but also selling fewer fancy chemicals to go into the plant in La Spezia that made the propellers for the Queen Elizabeth class aircraft carriers.

Meanwhile, does it worry anyone else that no media outlet has managed to report Angela Merkel’s actual words leaving the G20? Reuters started it, but didn’t provide an actual quote, and anyway it’s usually good practice to distrust any English-speaking journalist’s German. At the same time, the Guardian‘s live blog gave up and started reporting what people were posting on Twitter. Not just that – I’ve also seen journalists referring to “Berlusconi’s economic stimulus plan”. If only!

It’s been a bizarre week, but if the papers can’t do mindless stenography of the words of the powerful, what are they for?