Soros comes really, really close to nailing it

This post will seem more disrespectful to George Soros than it actually is.  As the following quotation shows, Soros correctly diagnoses the problem and comes very close to nailing the solution:

To be a little more specific, let me suggest the outlines of a European solution to the euro crisis. It involves a delicate two-phase maneuver, similar to the one that got us out of the crash of 2008. When a car is skidding, you first have to turn the steering wheel in the direction of the skid, and only after you have regained control can you correct your direction. In this case, you must first impose strict fiscal discipline on the deficit countries and encourage structural reforms; but then you must find some stimulus to get you out of the deflationary vicious circle—because structural reforms alone will not do it. The stimulus will have to come from the European Union and it will have to be guaranteed jointly and severally. It is likely to involve eurobonds in one guise or another. It is important, however, to spell out the solution in advance. Without a clear game plan Europe will remain mired in a larger vicious circle in which economic decline and political disintegration mutually reinforce each other.

Here’s what Soros is right about:

1.  He’s right that countries like Greece must tighten fiscal policy as they are running out of investors willing to lend them money and not be repaid.

2.  He’s right that the eurozone desperately needs stimulus.

What’s the obvious solution?  They need tighter fiscal policy in the periphery and strong monetary stimulus from the ECB to sharply raise NGDP growth in Europe.  But there is no mention of monetary policy at all.  And yet his diagnosis virtually cries out for a market monetarist solution.

Instead Soros seems to imply the deus ex machina of eurobonds saving the day.  But countries like Germany will rightly see that as a move toward fiscal union, a way to get them to pay for the economic policy mistakes of the poorer regions.  Read the following facts and tell me how likely this is to work:

1.  One of the major parties in Italy’s governing coalition is the Northern League.  Their support is largely based on resentment against the way the north of Italy has to pay taxes to subsidize the south.  Some want to secede.  Even though southerners are fellow Italians.  In contrast, the US has no major political movement to split the country along regional lines.  The US fiscal union is not a model for Europe.

2.  Southern Italy isn’t the only fiscal burden, the same is true of Greece, Andalucia, and Portugal.  Even worse, their problems are not due to something like the legacy of slavery, or the mistreatment of native Americans, which makes at least some Americans have a sense of obligation to lower income ethic groups.

3.  If there really were a fiscal union, the regions I mentioned would not be first in line, as many parts of Eastern Europe are much poorer.  They’re not all in the euro yet, but they are moving in that direction.  So add big subsidies to Eastern Europe on top of those to the southern periphery.

4.  West Germany recently spent an enormous amount of money bailing out a very small country called East Germany.  Even though East Germans are the same culture, and even though ethic ties count for a lot in Germany (as compared to say France), the West Germans were resentful of the amount of money they had to spend.

5.  West Germany is not a rich country.  Its income per capita (PPP) isn’t much different from poor American states like Alabama or Arkansas.

Given those facts, how many people believe fiscal union is a feasible long term policy response to the failures of the eurozone?  Why would Germany and Finland and the Netherlands and Austria agree to this sort of new regime?  Will Germans get to vote on boondoggle public spending projects in Sicily?

I’m under no illusion that NGDP targeting is on the immediate agenda for the ECB.  But if we keep pushing these ideas it’s possible to at least imagine a change of heart, where the Germans (correctly) realize that NGDP targeting, eurozone breakup, and fiscal union are the three alternatives, and NGDP targeting is the lesser of evils.  Fiscal union?  I just can’t see how it can work.  I don’t know why Soros doesn’t see that as well.

PS.  I’m not saying the north won’t end up providing a partial bailout this time.  I’m saying they’ll be very reluctant to make that the new fiscal regime for Europe.  Does Europe want to move to a permanent state of fiscal crisis?


Tags:

 
 
 

70 Responses to “Soros comes really, really close to nailing it”

  1. Gravatar of Tyler Cowen Tyler Cowen
    11. February 2012 at 08:36

    Not disagreeing at all, but have you given much thought as to whether this is a “country by country” ngdp target, a “weighted average of the North and South countries” target, or a numerical target for the eurozone as a whole? Your own analysis suggests this makes a big difference, and furthermore those differing ngdp figures don’t move in tandem or even close to it.

  2. Gravatar of anon anon
    11. February 2012 at 08:57

    ISTM that the ECB should target NGDP for the Eurozone as a whole. Yes, there may be local imbalances, since the Eurozone is not tightly integrated. But these can be addressed with local mechanisms–fiscal policy or perhaps investment taxes and subsidies.

  3. Gravatar of Morgan Warstler Morgan Warstler
    11. February 2012 at 09:48

    My first question was similar to Tyler’s – pls explain NGDP targeting across Europe.

    However, the real solution lies in the US model.

    It is actually a stronger US model because it doesn’t have the a strong Federal Gvt. running deficits like the US.

    So you GAIN the “no budget deficits” rule of the states (strict 3% deficits for the countries) AND you get the equivalent of a US budget deficit.

    It is like the US where the 16th amendment never happened.

    GOOD TIMES ARE AHEAD.

    ——

    The US approach works fine:

    1. Every country in Europe MUST get on the Swedish trend of a smaller state as part of their GDP.

    2. The southern Euro block must do EXACTLY what the southern US states have done since the 1950′s

    a. de-regulate
    b. de-unionize
    c. reduce corporate taxes

    They must allow ENSURE their best and brightest go into the private sector and are the boss of everybody. When the public sector of Southern states subjugates themselves to the whims of their betters, everything will be fine.

    Greece should legalize prostitution and gambling, sell off any public coast line that can be and cheer for immediate influx of tourists and developers. Florida and a de-unionized Las Vegas will turn Greece around the fastest.

  4. Gravatar of Ricardo Urdaneta Ricardo Urdaneta
    11. February 2012 at 10:05

    What’s the collective outcome in each scenario?

    1- Eurozone breakup: two-speed Europe, huge financial and political costs… It’s a step backwards. Might eventually have to settle for a smaller, less relevant EU.

    2- NGDP targeting: works brilliantly, may generate inflation and resentment in the countries that don’t need stimulus, but eventually (and sooner than any alternative) everything goes back to the way it was when the going was good.

    2- Fiscal union: It’s how the US was built by Hamilton, against the wishes of Massachusetts which had paid its own debt, and of Virginia, which was broke but didn’t want to surrender any sovereignty. Everybody answers jointly and severally, as Mr. Soros says, and eventually a much stronger EU government comes up so as to service the new unified debt.

    NGDP targeting is far more logical economically, fiscal union seems to make more sense politically in the long run if only Europe had a strong leader with a big project. Bismarck rather than Merkel.

  5. Gravatar of ssumner ssumner
    11. February 2012 at 11:33

    Tyler, In my view a country by country target is impossible with a currency union (unless there are truly huge fiscal transfers.) I’d target overall eurozone NGDP with the full understanding that this reduces, but does not completely solve, the economic problems of the periphery. The NGDP crash made the problem dramatically worse (as theory would predict), so it’s not a reach to assume that a large rise in NGDP could make the problem dramatically better. Since the eurozone seems to be close to the edge of a major crisis, a dramatic improvement would be a really big deal. Greece would still default, but the periphery as a whole would do substantially better.

    It’s theoretically possible that all the extra NGDP growth would go to Germany, but that seems unlikely given that its economy is much closer to full employment.

    It’s possible that it would do nothing but create inflation. I have two responses to that:

    1. Even that would reduce the debt crisis.
    2. Given the NGDP crash dragged down RGDP, and given the asset markets respond to expansionary monetary news as if it would boost real growth, I find it very hard to believe that you’d just get inflation.

    anon, I agree.

    Morgan, Lots of good ideas and I mostly agree, but I’m too much of an effete snob to be rooting for the Vegas-ization of Greece.

    Ricardo, My sense is that the gaps in Europe are too large (cultural, political, economic) to make the US model work, but obviously the Europeans have surprised us before, so we will see.

  6. Gravatar of StatsGuy StatsGuy
    11. February 2012 at 11:40

    ssumner – so what are the rules for determining an optimal currency region? (While we watch Greece, cometh California and Illinois.)

    Soros gets one thing very right – the cost of the EU dragging Greece through the muck isn’t benefiting anyone. They are doing it because they’re making Greece into an example. They’re going to hurt Greece so bad that no fiscal authority will even think about repeating their behavior for 40 years.

    Same reason banks waited 4 years to begin Coasian bargaining with homeowners. Jean Tirole / optimal punishment theory in oligarchic collusion.

  7. Gravatar of Morgan Warstler Morgan Warstler
    11. February 2012 at 11:54

    “Soros gets one thing very right – the cost of the EU dragging Greece through the muck isn’t benefiting anyone. They are doing it because they’re making Greece into an example. They’re going to hurt Greece so bad that no fiscal authority will even think about repeating their behavior for 40 years.”

    Exactly my strategy for dealing with the first boy my daughters date.

    Greece needs a beating, they are gong to get a beating.

    The only question is do they get beat to stay in the Euro, or do they get beat when they leave the Euro?

    ——-

    GOTTA LOVE the “what if Germany sucks up all the NGDP” hypothetical.

    Now Scott, you may be an effete snob, but you should AT LEAST have the nuts to explain in detail HOW:

    Under your 4.5% level target here – to becomes obvious that giving public employees raises sucks up all the NGDP.

    No one but me focuses on it, but you are able to in a single response when you are talking about Europe.

    And in your example, you just dance by saying Germany is fully employed.

    In MY EXAMPLE, public employees don’t get raises even then, they get them based on productivity gains – firing bob, to pay tom more.

    Be more honest Scott, being effete shouldn’t make you weak.

  8. Gravatar of Jon Jon
    11. February 2012 at 12:24

    Scott,

    I’m blessed with many friends from the EU. Well before the crisis there was already a lot of griping in my circle about the transfer payments. When I’ve visited counties such as Greece and Romania, there are usually glaring examples of public waste–I have one town in mind where the mayor has been obsessed with installing fountains. Inevitably after asking who is paying for these luxuries the answer comes back: the EU.

    So these concerns aren’t just bigotry either; it’s a clear principal agent problem.

  9. Gravatar of bob bob
    11. February 2012 at 13:01

    Extremely different cultures sharing a currency is a recipe for disaster. A better monetary policy can male this less awful, but will not fix the competitiveness issues. Without the folly of trying to Germanize the periphery or Latinize Germany, there is no way to save the Euro.

    So yes, whack the ECB in the head and get them to do level targetting: But the minute the periphery returns to growth, we have to start thinking of a way to split the Eurozone. Let the Greeks be Greek, and the Germans be German

  10. Gravatar of Ben Wolf Ben Wolf
    11. February 2012 at 13:03

    “They’re going to hurt Greece so bad that no fiscal authority will even think about repeating their behavior for 40 years.”

    That’s the delusion: that if everyone just tries hard enough this will never happen again. But the reality of trade imbalances in the EMU means this exact problem will occur again and again without a fiscal tranfer union. So long as they continue to operate in a foregin currency with no supra-national entity possessing a monopoly on it, the eurozone will be vulnerable to repeated debt crises.

  11. Gravatar of anon anon
    11. February 2012 at 13:34

    Morgan, the deep problem with Greece is that they lack an engrained tradition of civic virtue. They were part of large empires basically from ancient history until the late 19th century, and then they were under a military dictatorship for much of the 20th century. Your policy advice is broadly sound, though I agree with Scott that legalizing gambling and the like might not work very well. (In fact, I also think more civic-oriented places are better equipped to deal with such “questionable” industries.)

    bob and Ben, I think one can avoid macro imbalances in a currency union by using either differential taxation/subsidization of investments, or running budget deficits/surpluses. The former may be seen as a “lite” version of capital controls, avoiding most of their distortions. I’m not sure why a transfer union would be needed.

  12. Gravatar of Morgan Warstler Morgan Warstler
    11. February 2012 at 13:37

    Ben and Bob,

    The Greeks will eat it. Ultimately they gain nothing from leaving (still can’t borrow money).

    So the moment the ECB just lets them go, they will bend.

    The southern US states BENT – they became more free market, they became more anti-labor, and it works.

    For you to be right, you have to argue South Carolina hasn’t changed.

    The debts can always be forgiven, the issue is actually living on taxes. That’s the part that forces them to kill their public institutions.

  13. Gravatar of Vivian Darkbloom Vivian Darkbloom
    11. February 2012 at 13:42

    “5. West Germany is not a rich country. ”

    Not to mention the fact that it is not even a country.

  14. Gravatar of Greg Ransom Greg Ransom
    11. February 2012 at 14:12

    Can’t the Greeks go on living beyond their ability to produce if the German’s & American’s simply give them the means to do so?

    And isn’t this what the Bankers & Hedge Fund guys want — they want to continue to make extreme profits as the ultimate bag man for the looting of the German’s and Americans for the benefit of the Greeks and the Super Rich Banksters and Fundsters?

  15. Gravatar of Greg Ransom Greg Ransom
    11. February 2012 at 14:13

    Why not eliminate Greece from the equationa and directly send U.S. tax dollars to Soros and the German & French bankers?

  16. Gravatar of Greg Ransom Greg Ransom
    11. February 2012 at 14:16

    Too cynical?

    No, not cynical enough.

  17. Gravatar of Benjamin Cole Benjamin Cole
    11. February 2012 at 14:32

    I read the Soros piece in the NYROB, and it was an interesting apolitical take on the mess.

    How sad that Europe is taking itself drown–not because bombs have wiped out factories, not because of a plague. They are suffering from the invisible, from IOUs, from blips on chips somewhere.

    Again Sumner is the world’s best economist, as he understands that fiscal common sense (roughly balanced budgets, perhaps setting aside capital budgets) and monetary stimulus are the best combo, especially now.

    Egads ECB and Fed. Print more money, print more money, print more money until we are excreting Euros into piles of Ben Franklins.

    Japan has shown the way to pay back debts with a deflating currency. It appears to be the way to permanent immiseration.

  18. Gravatar of 123 123
    11. February 2012 at 14:34

    Scott, congratulations! You have won. There is a central bank where the size of monetary base is endogenous, set in the Hansonian auction process. Auction participants try to profit from the discrepancy between the current prices of auction collateral and prices of collateral that would prevail if market expectations were consistent with the central bank’s mandate. Monetary base expands until the discrepancy is no longer there. The head of central bank has the following comment when asked about the forthcoming expansion of base money: “…the specialists in this field say that it should be substantial . I have no more information on this.”
    That central bank is … the ECB.

  19. Gravatar of Steve Steve
    11. February 2012 at 14:51

    Scott,

    I agree NGDP targeting would be very helpful as NGDP a being at trend is a necessary precondition for differentiating between structural imbalances and temporary cyclical conditions. Europe, like the US, could start fighting real economic problems rather than chimeras if only they could see the world through the prism of at-trend NGDP.

    However, I’m concerned that even NGDP targeting would not be enough for Europe. It would probably become uncomfortably inflationary for Germany, and the Bundesbank would see that INFLATION IS A FISCAL TRANSFER. And the Bundesbank thinks it runs Europe. So we immediately get back to the fiscal transfer union problem.

    Ultimately I think the Eurozone has to break up. At this point Greece would be much more likely to implement reform without being bossed around by Germany. It’s like a teenage kid rebelling against parents right now.

  20. Gravatar of Ben Wolf Ben Wolf
    11. February 2012 at 15:56

    @Morgan

    The Greeks have everything to gain from leaving and they will. It is not possible for them to cut their way to prosperity and the austerity measures they’ve already enacted will damage economic growth for a generation. Once they control their own currency again they will have no need to borrow, just as the U.S. and Japan do not borrow.

  21. Gravatar of Steve Steve
    11. February 2012 at 16:19

    @Morgan Warstler

    “Greece should legalize prostitution and gambling, sell off any public coast line that can be and cheer for immediate influx of tourists and developers. Florida and a de-unionized Las Vegas will turn Greece around the fastest.”

    Well, this is a tasteless idea. On the other hand, it looks like Mel Gibson had your idea first:
    http://www.starpulse.com/news/index.php/2011/06/19/mel_gibson_dating_greek_goth_fetish_mo?page=1

  22. Gravatar of Bonnie Bonnie
    11. February 2012 at 16:19

    Off Topic (and you might have already seen this, but I thought it was worth pointing out):

    http://www.bloomberg.com/news/2012-02-10/bernanke-says-housing-slump-is-holding-back-fed-s-efforts-to-boost-economy.html

    It’s a Bloomberg article that talks about Bernanke saying that “…the central bank’s efforts to spur economic growth are being blunted by impediments to mortgage lending.”

    That sounds a bit odd to me, but maybe it makes some sense to you. There might be an agenda behind this article, or perhaps there is something to all the things that have been done trying to push down real interest rates. I don’t know what the percentages are of option ARMs out there, but if its large, the Fed just might be a bit focused on keeping rates down so that when they reset, the mortgage payments attached to them go down. I guess if the FOMC is put in a tight political situation over QE, it might be the only thing it believes it can get away with, because I don’t see any real reason that the Fed couldn’t boost economic activity in a general way which would help the housing market recover on its own.

  23. Gravatar of Morgan Warstler Morgan Warstler
    11. February 2012 at 16:22

    Ben,

    You do not understand the hegemony dear boy.

    If you think the folks who EXPECT to own the new Greek currency, the folks who EXPECT to be the boss in any new Greek society…

    If you think they are going to join a system, that doesn’t live on the taxes collected, you are a fool.

    Listen, I WANT Greece to drop out, I want them to get nailed to the cross of no-one-will-loan-to-us.

    I just don’t EXPECT it. Because it isn’t in the interest of the people that matter, it is only in the interest of the people who don’t.

  24. Gravatar of Steve Steve
    11. February 2012 at 16:49

    @ Scott

    I’ve seen several Soros interviews; my impression is that he also expects the Eurozone to break up EVENTUALLY. There is a process underway where the banks sell off their foreign sovereign debt (to the ECB, or EFSF) or haircut it (through PSI) and buy more of their own sovereign (using the LTRO). Soros believes that once banks own only their own sovereigns, the Eurozone will be easier to split.

  25. Gravatar of michael gordon michael gordon
    11. February 2012 at 17:28

    “Greece should legalize prostitution and gambling, sell off any public coast line that can be and cheer for immediate influx of tourists and developers. Florida and a de-unionized Las Vegas will turn Greece around the fastest.” — @Morgan Warstler

    Morgan:

    Greece already has casinos in 9 cities, and prostitution has been legal for well over a decade. What you’re additionally arguing for — getting rid of unions in the country — is about as likely as the rich and the affluent middle-class Greeks will decide overnight, out of a miraculous sense of civic duty, to start paying the income tax that their actual incomes warrant.

    ….

    Specifically, in factual, down-to-earth data, about a quarter of Greece’s 5 million or so active workforce is unionized — a figure about a third more than Germany’s equivalent union percentage, more than three times higher than France’s, but lower by about 25 percent than Italy’s, and way below the Scandinavian countries (where around 75% or so of the workforce is in unions).

    More to the point, any efforts by any Greek government to reduce union membership would almost certainly entail not just massive protests by workers in both the private and public spheres that would cripple the economy, but the likely resort to violence of various sorts.

    ….

    Enter natural gas and oil.

    Recently, the Israelis have discovered large gas and oil deposits in waters that they claim are theirs, just as Greece has found the same in waters around the Greek areas offshore Cypress. Both the Israelis and Greeks have moved closer in security matters to protect their petroleum finds from Turkish interference (and threats), not least because Israel would need Greek cooperation in building a safe pipeline of its new-found oil-and-gas reserves — a massive leviathan-size amount — to supply the rest of Europe.

    See http://english.al-akhbar.com/content/emerging-ties-israel-cyprus-and-greece-new-electricity-deal.

    Whether the new petroleum-based wealth for Greece would be an unqualified blessing is another matter. For Israel, yes. It has a vigorous, cutting-edge economy that is well balanced. Petroleum-wealth for Greece, by contrast, might entail a Pandora-box full of political excuses that would stop even incremental if steady changes in their institutions and spending-habits.

    ..

    Michael

    ….

  26. Gravatar of Morgan Warstler Morgan Warstler
    11. February 2012 at 18:00

    michael,

    As a young man, I spent some time in Athens, and actually left early to go back to Amsterdam. That’s my suggestion for Greece, become the travel destination for Sodomites – the New Amsterdam.

    While in Athens I spent time with tech start ups that were HQ’d in the state run telco – it was not conducive to entrepreneurship at any level.

    Shipping and New Amsterdam those are my suggestions.

    Either way the public unions are done, one way or the other, the entrepreneurs will be gaining power and the bureaucrats will lose power.

    All roads lead to Rome.

  27. Gravatar of StatsGuy StatsGuy
    11. February 2012 at 18:04

    Morgan…

    “Exactly my strategy for dealing with the first boy my daughters date.”

    Yep. Just in case they don’t get the clue…

    http://www.youtube.com/watch?v=WOoUVeyaY_8

  28. Gravatar of StatsGuy StatsGuy
    11. February 2012 at 18:12

    @ Ben Wolf

    “But the reality of trade imbalances in the EMU means this exact problem will occur again and again without a fiscal tranfer union.”

    I’m not sure we’re talking about the same problem. I don’t think Germany has it in for Spain, or even Portugal, or Ireland the way they have it in for Greece. They are hugely ticked off that Greece cooked the books, and that Greece refuses to alter the retirement structure or even collect taxes. “This exact problem” – the problem that happened in Greece from 1999 on – was more than a currency valuation problem… And the Germans know it.

    http://www.spiegel.de/international/europe/0,1518,676634,00.html

    After the Germans make a proper example out of Greece, they will handle the others a bit more gently. Even so, it’s quite likely they won’t go far enough in providing monetary stimulus to make a significant impact on Spain, etc. We’ll see.

  29. Gravatar of Ben Wolf Ben Wolf
    11. February 2012 at 18:33

    @Morgan

    I’ll excuse your lack of manners, but insulting others only diminishes your arguments.

    I suggest you make an effort to understand the difference between a currency issuer and a currency user. Once Greece is sovereign again it will have the capacity to deal with its debts as it chooses; the EMU should never have come into existence and will not survive in anything resembling its current form.

  30. Gravatar of Ben Wolf Ben Wolf
    11. February 2012 at 18:48

    @StatsGuy

    “I’m not sure we’re talking about the same problem. I don’t think Germany has it in for Spain, or even Portugal, or Ireland the way they have it in for Greece. They are hugely ticked off that Greece cooked the books, and that Greece refuses to alter the retirement structure or even collect taxes.”

    The two are ultimately related. When a country’s external sector (trade) is in deficit net financial assets flow out of the private sector. Its material wealth increases but at the same time it becomes financially poorer. Unless that drain is countered by government spending the financial drain grows worse over time and impoverishes the private sector, reducing demand. Greece’s government compensated for the drain by borrowing and spending heavily, too heavily for its tax base to support.

    In the U.S. we have the same financial drain. Last year the external sector drew nearly $600 billion from the private sector, but the current budget deficits are sufficient to replace the lost dollars and avoid a further fall in domestic demand. Greece, being limited by a currency which it does not control, can no longer sustain deficits sufficient to replace the lost money.

    Without some permanent facility through which those financial assets can be replenished this same problem will emerge as trade deficit nations in the EMU export euros to their trade surplus neighbors. This means Italy, Spain, Portugal and other peripheral members are going to have continuing debt problems so long as these imbalances persist.

  31. Gravatar of anon anon
    11. February 2012 at 19:35

    “The two are ultimately related. When a country’s external sector (trade) is in deficit net financial assets flow out of the private sector. Its material wealth increases but at the same time it becomes financially poorer.”

    This is broadly correct: macro imbalances in a currency union can cause money to flow out of the country, which is bad. Still, not all is lost. One can either (1) attract capital inflows, to replenish the country’s money supply, (2) increase velocity, to sustain demand despite a falling quantity of money, or (3) in a pinch, use incomes policies to reduce the price level and restore demand through the real money balances effect. Fiscal deficits address both (1) and (2). Less obviously, this is also true of investment subsidies, since increased investment opportunities will attract foreign capital and stimulate bank lending (which increases V). In practice, investment subsidies are quite efficient, and many kinds of supply side reforms are also conducive to increased investment.

  32. Gravatar of Benjamin Cole Benjamin Cole
    11. February 2012 at 19:38

    BTW, Lars at Market Monetarism has this snippet on Greenspan—the first Market Monetarist?

    “Alan Greenspan saying the following at a FOMC meeting in 1992:

    “Let me put it to you this way. If you ask whether we are confirming our view to contain the success that we’ve had to date on inflation, the answer is “yes.” I think that policy is implicit among the members of this Committee, and the specific instruments that we may be using or not using are really a quite secondary question. As I read it, there is no debate within this Committee to abandon our view that a non-inflationary environment is best for this country over the longer term. Everything else, once we’ve said that, becomes technical questions. I would say in that context that on the basis of the studies, we have seen that to drive nominal GDP, let’s assume at 4-1/2 percent, in our old philosophy we would have said that [requires] a 4-1/2 percent growth in M2. In today’s analysis, we would say it’s significantly less than that. I’m basically arguing that we are really in a sense using [unintelligible] a nominal GDP goal of which the money supply relationships are technical mechanisms to achieve that. And I don’t see any change in our view…and we will know they are convinced (about “price stability”) when we see the 30-year Treasury at 5-1/2 percent.“

  33. Gravatar of Morgan Warstler Morgan Warstler
    11. February 2012 at 22:46

    Ben,

    I suggest you learn the definition of the word hegemony.

    Monetary policy and money itself, indeed government itself is not a democratic institution…

    Not at the level you hope.

    I assume you are working from the premise that since Greece operated with their own currency before, and suffered through rampant state run corruption, that now after the fact they ca go back to such a system.

    I’m saying something different, the EURO happened in part because it was a tool to bring upon the death of the Greek system – not in its first intention, but to guys like Mundell (and me) Greece no longer getting to be Greece was imagined and acceptable.

    But within Greece, there were those who did not want to be more like Turkey, they wanted to be Italy – and those guys are the most competent…. they are the ones who don’t need the leg up.

    Also in Greece as the ones who are incompetent, and saw the Euro a great way to live at and easy.

    The war between those two parties is great – and it TRULY is that war between those two parties, that guys like Mundell expected.

    Mundell explicitly says “no pensions over 50% of salary”

    If Greece leaves the Euro, the competent leave Greece (if they haven’t already).

    I suspect you want to believe Greece can be self-sufficient, they can warm themselves on the fire of their indignation and teach us all a lesson – they can’t – they would slide into third world status, and Turkey would pass them headed up the free market pole.

    What is it about the competent Greeks that make you think they want to carry the incompetent on their back, while the entire Euroblock treats them like a leper.

  34. Gravatar of Daniel Daniel
    12. February 2012 at 03:08

    NGDP targeting at a level sufficient to restore employment levels in the periphery would also mean significant inflation in the core, wouldn’t it?

    Is there a way to make inflation seem less threatening to Germans? Some sort of inflation-indexed income transfer from the ECB – “if we inflict inflation on your country for the sake of Spain, we transfer you money to keep your fixed-income pensioners from suffering.” Is that feasible?

    As long as “NGDP targeting” gets translated in German minds to “we suffer inflation so that the Spanish can have jobs”, it’ll be a hard sell. So I wonder if there are any inflation-ameliorating provisions that could be rolled into the package to make it an easier sell to Germany.

  35. Gravatar of anon anon
    12. February 2012 at 03:35

    Daniel, the Germans could e.g. run budget surpluses in order to slow down inflationary NGDP growth. They could also enact supply-side reforms. Regardless, as other Eurozone countries escape recession, the German economy will probably feature increased real growth in the tradables sector–the “enrich thy neighbor” effect.

  36. Gravatar of StatsGuy StatsGuy
    12. February 2012 at 06:34

    Ben/anon

    “This means Italy, Spain, Portugal and other peripheral members are going to have continuing debt problems so long as these imbalances persist.”

    I don’t doubt this – I’ve agreed on Scott’s multiple posts on the Germany attitude toward the ECB. And it may be that the ECB is entirely unwilling to accommodate the EU to the degree required by the southern members. However, the spectacle we’re witnessing with Greece goes well beyond that.

    Moreover, while Spain’s problems can certainly be argued to result from the effect you are presenting (especially given the deficit trajectory pre-2008), Greece is entirely different. Since well before joining the Euro, they had tax non-compliance, a too-generous pension system, excess govt. employment, and other structural problems which they LIED to mask over. The German response is not short term rational. It’s long term rational and short term visceral.

  37. Gravatar of StatsGuy StatsGuy
    12. February 2012 at 06:36

    Morgan

    “I suspect you want to believe Greece can be self-sufficient, they can warm themselves on the fire of their indignation and teach us all a lesson – they can’t – they would slide into third world status, and Turkey would pass them headed up the free market pole.”

    I suspect you would agree that Greece can be monetarily self-sufficient as long as they invite in FDI and keep their new currency low, they will simply need to function without credit for a while. No one is self-sufficient with regard to overall trade.

  38. Gravatar of ssumner ssumner
    12. February 2012 at 06:57

    Statsguy, I don’t see Greece as the victim here. They’re the ones who committed fraud and stole all that money from Northern Europe. If Greece was a person, not a country, they be sitting in jail next to Bernie Madoff right now. And that’s not hyperbole. That money the bondholders are not getting back was lost due to accounting fraud by the Greek government.

    Once a country (or it’s government, if you like) has behaved the way Greece has, it should expect pretty draconian terms if it wants to borrow even more money.

    There are no “rules” for optimal currency zones, just a bunch of varying opinions held by different economists.

    Morgan, Separate issue, I’m still not interested.

    Jon, I agree.

    Bob, I agree.

    anon, I actually favor legal gambling in Greece. I was making an aesthetic comment about architecture.

    Vivian, Oops, I’m just 20 years out of date.

    Greg, This time your cynicism may be justified.

    Thanks Ben.

    123, I’m going to assume that’s a joke. If they are doing NGDP (or CPI) futures targeting, please send the info.

    Steve, I don’t see NGDP targeting as a fiscal transfer, it adopts a neutral stance vis a vis debtors and creditors. Inflation doesn’t matter at all, only NGDP growth matters.

    I agree that Europe would be better off w/o the euro.

    Bonnie, Good comments, I tend to agree.

    Michael, Cyprus is a separate country, how does that help Greece?

    Ben, Thanks, That’s a great quotation.

    Daniel, You said;

    “NGDP targeting at a level sufficient to restore employment levels in the periphery would also mean significant inflation in the core, wouldn’t it?”

    Yes, and this is why that policy should NEVER be done. You should target overall eurozone NGDP, not regional employment levels. You need stable eurozone NGDP growth. Inflation doesn’t matter to economic welfare; where people falsely think inflation is a problem, the actual problem is excessive rapid NGDP growth.

    No monetary policy will ever be optimal for all members, and each country knew that when they joined. But since 2008 policy hasn’t even been optimal for the overall average of the eurozone, it’s been way too tight.

  39. Gravatar of StatsGuy StatsGuy
    12. February 2012 at 08:04

    @ “Statsguy, I don’t see Greece as the victim here”

    Neither do I… I’m saving my sympathy for the people of Homs.

  40. Gravatar of Morgan Warstler Morgan Warstler
    12. February 2012 at 08:54

    Stats,

    “keep their new currency low”

    LOL. If they could keep their currency low, they wouldn’t need to leave the Euro.

    This is NOT about debts, this is about actually living on taxes, which the Greeks can’t do.

    Printing money is not an option, because the capital and talent flight has already begun and will continue.

    Bow down to the private sector, make like South Carolina.

    All roads lead to Rome.

  41. Gravatar of michael gordon michael gordon
    12. February 2012 at 09:05

    A good query, Scott. My reply?

    Well, I’ll be very brief about a complex tangle of Cypriot identities, growing oil and gas finds not just around Cypriot waters, but much closer to Greece as well. And rising tensions between Turkey on one side and Israel and Greece on the other.

    1. Greek-Cypriots continue to feel Greek. Turkish-Cypriots are shown in opinion polls to feel much less Turkish, despite their historical tensions with the Southern island Greeks.

    2. Turkey continues to maintain occupational troops in the north of Cyprus, while referring openly to the Greek-Cypriot government in the island as though it were illegitimate.

    3. The new large oil and gas reserves in the waters off Israel, Cyprus, Crete, and near to Greece itself — the latter identified reserves so far being 250 million barrels of oil (now near to being extracted by American firms that continue to search for more reserves) — have intensified the historical conflicts between Greece and Turkey, just as recent conflicts between Turkey and Israel have emerged.

    4. Here’s one quote that helps illustrate the growing tensions:

    “Israeli energy firm Delek Group is seeking to work with Cyprus on natural gas exploration and extraction near the Leviathan gas field off the Israeli coast where Delek is already active.[2] The large oil and gas field, and the opportunities of joint exploitation, have brought the two countries closer together. This however has opened a new source of frictions between both countries and Turkey.

    “Noble Energy, a US company, is also involved in the Leviathan field and this may lead to US government involvement in the gas fields dispute.

    “Turkey claimed that the Greek-Cypriot government in the southern part of the island did not have the authority to sign deals with Israel which could be detrimental to the Turkish-Cypriot population in the North. The discovery of oil fields in the Mediterranean allowed Turkey Prime Minister Recep Tayyip Erdoğan to continue his diplomatic confrontation on two fronts: one with Israel, and one with Cyprus.[3]

    “Cyprus President Dimitris Christofias visited Israel in March 2011 for the first-ever official visit by a Cypriot head of state.[4] Minister of Commerce, Industry and Tourism Antonis Paschalides noted howeveer that, despite all the enthusiasm, Cyprus could not ignore Israeli tourism and real estate projects in the island’s north, which was under disputed Turkish control.”

    Showing the Flag:

    “According to Turkish media reports in September 2011, Israel Air Force fighter planes flew through the airspace of both Cyprus and Turkish Cyprus after taking off to face a Turkish seismic research ship in the Eastern Mediterranean. The reports added that Turkey responded by launching two fighters to track the Israeli planes, at which point the Israeli fighter jets returned to Israeli airspace. The Turkish research vessel was seen as a Turkish provocation in the dispute over gas fields. The operation of Israeli planes in Cyprus airspace was interpreted as a further sign of close Israel-Cyprus ties.[5]

    “A Cyprus-based group including Greece’s state-controlled power utility Public Power Corporation of Greece (PPC, also known as DEH) is planning to lay the world’s longest subsea power cable, linking Israel, Cyprus and Greece. The link, called the EuroAsia Interconnector project, would be the longest in the world” http://en.wikipedia.org/wiki/Cyprus%E2%80%93Israel_relations

    4. As Israel starts tapping its huge oil and gas reserves, it is dealing with Greek’s government — much to Turkish ire — for supplying Europe with a pipeline that begins on Greek territory . . . even as the Greeks continue to hire American petroleum firms to search for more reserves in its territorial and near-territory waters.

    In the end, Greece may not be a petroleum giant the way Israel is likely to be, but its economy is bound to be aided by what is going on in oil and gas exploration and production in the Eastern Mediterranean waters . . . always assuming there is no actual war between the Turks and others over ownership.

    ..

    Michael

  42. Gravatar of James in London James in London
    12. February 2012 at 11:33

    What a lot of views. Yet no discussion I can see about current policy. There is a consensus in Europe we have a huge back door QE in operation right now with the three year LTROs. I think it is only a liquidity support programme for the banks and not a form of monetary policy. I’d be interested in what commenters here think of the new LTROs.

    However, if consensus believes there will be further LTROs and that they are a form of monetary policy, and they alter expectations, money velocity could rise and they will have worked as Draghi may secretely hope they will. Just don’t tell the Germans!

  43. Gravatar of 123 123
    12. February 2012 at 11:43

    Scott,
    that was not a joke.

    What is the source of your skepticism?
    Do you doubt that since early December the ECB’s monetary base is endogenous, and determined in an auction process where monetary base expands until the prices of auction collateral converge to the prices that would hold if auction participants expected that CPI will be 2% over the medium term? (i.e. ECB operates a collateral price peg)
    Or do you doubt that the auction described above has the same effect as a 3-year CPI futures targeting auction?

  44. Gravatar of 123 123
    12. February 2012 at 14:15

    The futarchy is here:
    http://www.ecb.int/press/pressconf/2011/html/is111208.en.html
    “First, to conduct two longer-term refinancing operations (LTROs) with a maturity of 36 months and the option of early repayment after one year. The operations will be conducted as fixed rate tender procedures with full allotment. The rate in these operations will be fixed at the average rate of the main refinancing operations over the life of the respective operation. Interest will be paid when the respective operation matures. The first operation will be allotted on 21 December 2011 and will replace the 12-month LTRO announced on 6 October 2011.”

    Here is how you steer the wheel of monetary policy if you are a Eurozone bank:
    1. You purchase a collateral bond, the value of which would be higher if CPI expectations were on target.
    2. You get a LTRO loan in order to partially finance your purchase and in order to hedge your deflation risk. LTRO loan is equivalent to a short CPI futures position – LTRO loan will be expensive if CPI will be above target, and it will be cheap if CPI will be below target.
    3. Profit! Increase the size of the monetary base! “Full allotment” means that there is no limit to your CPI hedging if you have the required collateral

  45. Gravatar of Ben Wolf Ben Wolf
    12. February 2012 at 19:30

    @Morgan

    You’re missing the forest for the trees. The Germans WANT Greece out of the eurozone, and have deliberately dragged out the “rescue” for over two years to buy time to insulate the EMU from the effects of Greece’s exit. The whole point of demanding the Greeks accept increasingly onerous bailout packages is to inflict ever-greater levels of pain until they willingly leave.

  46. Gravatar of Morgan Warstler Morgan Warstler
    12. February 2012 at 20:50

    Ben, you just have a victim mindset. You don’t LIKE admitting Greece is a piece of shit loser of a country. And if you can’t say that OUT LOUD, your assumptions are suspect.

    Greece has to become South Carolina, everything they like they have to give up, everything they resent they must learn to love.

    That’s the forest. Now please, stop looking at the trees.

  47. Gravatar of Ben Wolf Ben Wolf
    13. February 2012 at 05:27

    @Morgan

    “Ben, you just have a victim mindset. You don’t LIKE admitting Greece is a piece of shit loser of a country.”

    That isn’t analysis, it’s polemics. South Carolina has an unemployment rate not much superior to Greece’s, a low level of access to heath care, one of the highest poverty rates in the U.S, and it is a net drain on the nation’s treasury as the federal government must transfer more wealth into it to keep the state afloat than it can collect in taxes. In addition the state has disproportionately high rates of violent crime, drug abuse, suicide and abortion.

    Exactly who is it you think this sort of environment is good for?

  48. Gravatar of ssumner ssumner
    13. February 2012 at 06:26

    Statsguy, Exactly, A human being is only capable of feeling sorry for X number of people at once. And Greece is not on the top of my list. (And I like Greece, BTW.)

    Michael, Thanks for that info.

    James. That could be–I don’t know enough to comment. My best guess is that it would help a little but not a lot (sort of like QE2 in the US.) Europe needs a lot of help, not a little.

    123, I don’t follow your argument at all. The quote you provide that supposedly shows they are targeting CPI futures, doesn’t even mention the CPI. So I don’t see your argument.

  49. Gravatar of Morgan Warstler Morgan Warstler
    13. February 2012 at 06:26

    South Carolinians.

    1) it is good for the IMPORTANT South Carolinians – the ones who PRODUCE THINGS.
    2) it is good for the less important in South Carolina – the ones who aren’t very productive…. because of 1.

    Ben, it is incredibly hard to speak to someone with such a twisted view of the world.

    This isn’t polemics. GDP/capita Greece is $27K SC is $35K, but in real life it is far different.

    Any stat you use that compares Greece to South Carolina favorably is a juked stat. Life is not about some weird false narrative you have about the bottom of society – its about how free the builders are to build.

    I’ve been to both places, I’ve shopped in grocery stores in each place, studies menus in their restaurants, and I’ve done business with tech start up in each state.

    And Greece is not India, but dude, you are delusional – Greece is closer to Turkey than even say Ireland.

    Now granted, I do not like olives… but people in S.C. actually work, they produce things for a market rate, they work late, they come in early…

    And I’ve seen the juked stats on Greece and the hours worked yearly, and it was not what I saw at all. AT 5 o’clock offices emptied, restaurants closed by 8 maybe 9. Everything was slow and lazy the way that SC used to be.

    SC fortunes have turned around by changing their approach, that’s the fact. Greece can do the same.

    My point is: you don’t WANT Greece to do what SC has done to compete.

  50. Gravatar of Mike Sax Mike Sax
    13. February 2012 at 07:05

    “Why would Germany and Finland and the Netherlands and Austria agree to this sort of new regime?”

    “NGDP targeting, eurozone breakup, and fiscal union are the three alternatives”

    Putting aside NGDP targeting the case can be made for fiscal union as opposed to eurozone breakup. All you have to do to make the case for fiscal union is show that eurozone breakup is worse.

    As you admit that at least a partial bailout is in the cards this shows that eurozone breakup is not a very exciting idea-if it were they wouldn’t provide any bailout.

    When a big country like France starts asking for fiscal union-which they started doing at the end of 2011 you see it could happen.

    I think you oversell the hardship on Germany and company. At one point even Finland and Austria began to see their yields swell. So even they might have to change their minds in view of that.

    Overall though I just don’t see how the eurozone can work in the future without larger fiscal union because of what Krugman calls the Rubicon Effect. The way the Eurozone workes now, you have the worst of all worlds. Countries surrender the right of printing their own money, large chunks of their overall national sovereigty in exchange for effectively having now lender of last resort, or effecdtive monetary policy as the EU is unwilling to do its job.

    Yet even the idea of NGDP targeting or inlfation level targeting or whatever rule you like is more problematic for the EU. Afterall targeting the NGDP is much more complex when you are dealing with 20 some ode member states each with their own national economies than say the US or Britain.

    What will be targeted-each country will have a different NGDP rate, I don;t think simply taking the average and targeting against that will necessarily be that easy. Withint the various EU countries there would be quite a lot of divergence. You could have a mean NGDP that is largely in line with the target but a median NGDP for the EU that is quite divergent.

  51. Gravatar of anon anon
    13. February 2012 at 08:05

    Mike Sax, by your own admission the ECB is unwilling to do it’s job properly. Why do you assume fiscal union would work any better? As Scott says, it would be a huge political problem for most EU states.

    Yes, countries will vary in their NGDP growth rates. But any such variations can be contained if the ECB targets a stable path for Eurozone NGDP. Beyond that, local policies could enhance stability to an even greater extent. (These policies would incur some distortions in real prices, but they may be worthwhile nonetheless because short-run nominal stickiness seems to be very much location-specific.)

  52. Gravatar of Mike Sax Mike Sax
    13. February 2012 at 09:43

    Anon, if the Euro had a 5% NGDP target that might be way too low for some countries, too low for others. To be sure, if it is done on a historical basis there would be an argument for a lower target as GDP growth in Europe is about roughly 1% GDP-or more-lower than the US

    There is no “Eurozone economy” in the sense that there is a British or American economy. Germany and Greece aren’t even part of the same economy in the sense that California and Texas are.

    I don’t know that it couldn’t work out but it would be probelmatic,

    If a fiscal union can’t work, then maybe a breakup is the best solution-clearly the status quo is a failure.

    As I think that Germany has some pretty good reasons not to want that fiscal union might be preferable as much as they may not like that.

    Things have a way of changing anyway. Germany reasons that it’s the strongest member and it doesn’t want to be dragged down to the level of the weak members. Of course it was not long ago that is was the sick man of Europe. Maybe in the future it will be different again.

    I think that this has changed in large part due to the start of the Eurozone. It’s ironic too that Germany talks so much about discipline but that if the rules had been enforced it would never have been let in anyway,

  53. Gravatar of 123 123
    13. February 2012 at 12:39

    Scott:
    “The quote you provide that supposedly shows they are targeting CPI futures, doesn’t even mention the CPI.”

    The obfuscation in the ECB quote is worthy of Greenspan. Try this mental exercise in three steps:
    1. “Fixed rate operation” is actually a floating rate operation, where the rate is calculated as a “average rate of the main refinancing operations over the life of the respective operation.” That is, the interest rate of the LTRO loan is the average ECB policy rate over the next three years paid at the end of operation.
    2. Decompose the floating rate loan into a fixed rate loan and an interest rate swap.
    3. Assume the worst. Assume that the ECB sets the policy rate according to a Taylor rule that ignores the output gap term and that only the deviation of CPI from target is used. Notice that in this case the interest rate swap embedded in the LTRO loan is a CPI swap.
    QED.
    (If only I had done this exercise in early December. If I did, I would have increased my allocation to stocks, and would have earned money from the rally caused by the switch to a market-monetarist central banking mechanism)

    If you relax the assumption #3 (maybe you shouldn’t), and if you model the policy rate using the full Taylor rule, this means that the ECB is offering to sell an unlimited amount of CPI swaps paired with output-gap swaps. So this means that ECB is selling the unlimited amount of CPI and output-gap swap baskets. Such unlimited tender offer means that the market price of such swap baskets is pegged by the ECB.

    Oh, and if you combine a CPI swap and an output-gap swap in the right proportion, you get something that closely resembles the NGDP swap :)

  54. Gravatar of ssumner ssumner
    14. February 2012 at 17:19

    Mike Sax, Targeting NGDP in the eurozone is not different from the US. We have 50 states, each very different.

    I think a fiscal union would be much worse than a euro breakup.

    123, I don’t follow your argument at all, but maybe it’s just me. Are you saying that people who correctly predict ECB failure can easily make money? Where to I line up to take advantage of their incompetence?

  55. Gravatar of 123 123
    15. February 2012 at 10:32

    Scott, what is your interpretation of 3-year LTRO auctions?

    “I don’t follow your argument at all, but maybe it’s just me.”
    Maybe it’s just the technical details of ECB’s operating procedures. A few days ago I discussed this with Lars. When I wrote that Draghi likes to base the monetary policy on market expectations, he asked what led me to conclude that Draghi likes to look at market expectations. A quick reply was sufficient: “Draghi doesn’t have to look anywhere. The auction process and the profit motive of participants does all the work in making sure that the policy is right on target.”

    You said:
    “Are you saying that people who correctly predict ECB failure can easily make money? Where to I line up to take advantage of their incompetence?”

    The ECB are running auctions where they are ready to sell an unlimited quantity of deflation hedges at a sensible price, so people who correctly predict ECB failure to reach a medium-term price stability target (aka 2% CPI target) can easily make money. Unfortunately, you need a Eurozone commercial banking license to participate. However, as Eurozone commercial banks are much more risk-averse to Eurozone AD problems than a typical market participant, this is not a problem. The effect of ECB’s offer to peg the price of deflation hedges gets transmitted to other markets. The next auction is scheduled after two weeks. I hope it won’t be the last.

    Three years ago I started reading this blog when Cowen linked to it. At that time it was the only blog that continued the Friedman’s monetarist tradition, and even better, it was a NGDP interpretation of monetarism. The discussion of futures targeting was just an interesting intellectual puzzle for me, as I always thought that the NGDP targeting will come first in practice, as there are lots of technical obstacles to using auctions to drive the monetary policy. Draghi has proved me wrong. These all are important questions, and if you prefer, we can move this discussion to an e-mail, or have a Skype call.

  56. Gravatar of James in London James in London
    16. February 2012 at 02:26

    Are the ECB 3yr LTROs monetary policy? It is a key question of the day. So, I’d like to know what Scott thinks of the LTROs too. Please don’t take the discussion offline. I don’t think they are, but in a way that doesn’t matter. It’s what the market thinks that matters, and it seems to think the are, so they are. A paradox needing a solution?

  57. Gravatar of 123 123
    16. February 2012 at 02:41

    @James

    3yr LTROs increase the size of monetary base, so it is very clear that they are monetary policy.

  58. Gravatar of orionorbit orionorbit
    16. February 2012 at 06:53

    ” Southern Italy isn’t the only fiscal burden, the same is true of Greece, Andalucia, and Portugal. Even worse, their problems are not due to something like the legacy of slavery, or the mistreatment of native Americans, which makes at least some Americans have a sense of obligation to lower income ethic groups.”

    OK, I imagine the death of 10% of Greek population in four years of the worst terror this place has met in 2500 years of recorded history (Including completely wiping out the 100000 Jews of Thessaloniki), complete destruction of the infrastructure and industrial base of the country, confiscating 80 billion in present day value of gold reserves and never paying it back, getting a write-off to the tune of 70 billion present day euros for war reparations debt (an independent claim from the stolen gold btw), subsidising (together with other Nato countries) Germany’s national defence for no less than 50 years, none of these things quallify Greeks for the same kind of sympathy as native and african Americans, even though many of the people who suffered as a result of the above are alive today, as opposed to being sixth generation descendants.

    Interresting.

  59. Gravatar of ssumner ssumner
    16. February 2012 at 11:30

    123, What I can’t understand is whether these intruments actually have payoffs explicitly linked to actual CPI outcomes, or if you are simply asserting your opinion that their market value is correlated with the CPI.

    I am a bit overextended right now, so it’s very possible that you are right, and I’m just not focusing enough, But I’d need a bit more specifics. I had thought these were just three year loans from the ECB to commercial banks, but I haven’t been paying close attention.

    123 and James. But in a world of interest bearing reserves, it’s not obvious that the monetary base is a good indicator of monetary policy. I certainly agree that the direction is expansionary, just not sure how much.

    orionorbit. You are attacking a straw man. I said Greece’s current problems aren’t due to things like discrimination. Yes, Germany mistreated Greece in the 1940s. But that doesn’t explain the current economic problems in Greece. In any case, it’s clear the German’s don’t have a lot of sympathy for Greece, it’s irrelvant to my argument whether they should have a lot of sympathy–they don’t.

  60. Gravatar of orionorbit orionorbit
    16. February 2012 at 12:13

    Scott, I wasn’t attacking anyone, my point was exactly that you were right. I just thought it was worthy to stress out that for all the history between us the Germans don’t feel the same kind of sympathy most Americans feel for native Indians. The reason I stressed it was because it relates to your point about culture, meaning that if there’s a country in the eurozone that doesn’t have what you call a “western” culture, that’s certainly not Greece.

    But since this is the second time you accuse me of attacking straw men, well, let’s attack something real then.

    “Statsguy, I don’t see Greece as the victim here. They’re the ones who committed fraud and stole all that money from Northern Europe. If Greece was a person, not a country, they be sitting in jail next to Bernie Madoff right now. And that’s not hyperbole”

    Oh, but that’s the very definition of hyperbole. As I said before, what the Greek government did was to hide the debt in complex credit derivatives, not lie about it. This kind of thing was certainly unethical, but it was done massively by a lot of investment bankers (not me) and no, they didn’t end up next to Bernie Madoff. If you have any reliable source that says otherwise, you’d be the first one to come forward with it, because I haven’t heard that kind of accusations even from the most indignant Germans.

    Don’t get me wrong, there are members of two previous governments that should have gone to jail (for instance the late 90s defense minister for accepting Thyssen group bribes and the conservative deputy finance minister for exchanging 800m worth of state land with a lake claimed by the church) but my point is that your opinion is not based on any facts, you’re just simply repeating variants of the same old lies that Merkel uses to attract the populist vote. On top of that, when you are confronted with the facts all you have to say is some trivial comment on my choice of data set. And on top of that, you have the nerve to come out and say something like this:

    “A human being is only capable of feeling sorry for X number of people at once. And Greece is not on the top of my list. ”

    well, nobody asked you for your sympathy. But a little objectivity would be nice.

    Oh, by the way, that you like Greece is irrelevant, yes we know it’s a nice place but it doesn’t make you any more objective. The “I like Greece” kind of comment in discussions like this is the second most annoying thing an expat Greek can hear; the most annoying being people that come to you saying something to the effect of “hey, Orionorbit, we know that you are an honest and hard working person, we don’t have anything against you personally, it’s only your friends and relatives back home we’d want to see killed, raped and mutilated”.

  61. Gravatar of 123 123
    17. February 2012 at 09:47

    Scott: “What I can’t understand is whether these intruments actually have payoffs explicitly linked to actual CPI outcomes, or if you are simply asserting your opinion that their market value is correlated with the CPI.”

    There three different issues – payoffs, market value of payoffs and correlations of payoffs:
    1. The payoff is a simple average of ECB policy rate for the next three years, calculated and paid after three years.
    2. As the LTRO offer is “full allotment” – i.e. the ECB stands ready to supply an unlimited amount of such loans, the offer effectively pegs the market price of such payoff. This means that the ECB’s mode of operation from Dec 2011 till March 2012 represents a regime change that can be compared to Roosevelt’s 1933 dollar devaluation. If ECB had wanted to peg the price of 3 year loans (an option that the Fed dismissed in June 2003), it would have done so. The ECB has pegged the price of its future policy rate instead.
    3. Then there is the issue of correlations. What is the correlation of ECB’s policy rate and AD? Has the ECB pegged the price of AD? If you are afraid of deflation, then the most dangerous case is the ECB that will set the future interest rates by the Taylor rule that ignores the output gap and uses only the deviation of CPI from target. In this interpretation, the ECB is pegging the price of CPI swap. If you have a better opinion about the ECB’s policy rate setting process, you will think that the ECB has pegged the price of a swap that is more closely related to AD than a simple CPI swap.

    A couple of caveats. In effect the ECB has pegged the price of a swap, but what is the price of that swap? Does it correspond to a 2% CPI, 1% CPI or 3% CPI? You have to estimate that. The Germans are afraid that as collateral requirements a very lax for LTRO loans, so the loan is effectively subsidised, this means that the ECB has pegged the CPI above 2% (i.e. eurozone commercial banks will pay a market price of a LTRO loan if CPI is expected to be say 2.5%). Another problem is the problem of CPI risk premium, as the southern commercial banks might go bust if inflation is below target, they are not risk neutral to inflation, and they are incentivised to overbid during the LTRO auctions, causing the excess expansion of monetary base.

    “I am a bit overextended right now, so it’s very possible that you are right, and I’m just not focusing enough, But I’d need a bit more specifics. I had thought these were just three year loans from the ECB to commercial banks, but I haven’t been paying close attention.”

    My offer to have a longer discussion in another format still stands. Anyway, just ask yourself the question – what is the price that the ECB is pegging with its unlimited offer of three year loans to commercial banks. Compare the LTRO to Bernanke’s credit easing. Bernanke’s credit easing failed, because he used the wrong figure for the size of credit easing – as a result the Fed has failed to expand the monetary base to the extent needed to restore AD. LTRO asks markets to calculate the size of monetary base needed to restore AD. LTRO is safer than Bernanke’s policy, as it does not use non-recourse loans.

    “But in a world of interest bearing reserves, it’s not obvious that the monetary base is a good indicator of monetary policy. I certainly agree that the direction is expansionary, just not sure how much.”

    The pair (size monetary base, IOR) is the new indicator of monetary policy.
    There are noises that some Germans are considering kicking Greece out, because they feel safe that AD will be protected by the LTRO. It would be an excellent test of your thesis that futures targeting would have preserved AD in the face of Lehman shock. I’d prefer not to have such test :)

  62. Gravatar of ssumner ssumner
    18. February 2012 at 08:13

    Orionorbit, You said:

    “Oh, by the way, that you like Greece is irrelevant, yes we know it’s a nice place but it doesn’t make you any more objective. The “I like Greece” kind of comment in discussions like this is the second most annoying thing an expat Greek can hear; the most annoying being people that come to you saying something to the effect of “hey, Orionorbit, we know that you are an honest and hard working person, we don’t have anything against you personally, it’s only your friends and relatives back home we’d want to see killed, raped and mutilated”.”

    Hyperbole?

    I stand by my comment suggesting that if the Greek government was a private firm then what it did could have put it in jail. Lots of people have gone to jail for using accounting tricks to hide debts. Again, I acknowledged that governments are above the law, so it wasn’t literally illegal. But morally it was just as bad as the Enron accounting, etc.

    123, All I can get by reading your comment is that you are assuming the ECB is inflation targeting because inflation targeting is more conservative than a Taylor Rule, and the ECB is conservative. It may well be targeting inflation, but this policy doesn’t seem at all analogous to futures targeting, unless I am missing something.

    I see nothing preventing actual eurozone inflation averaging 1% over the next three years. How would a commercial bank profit from that outcome?

    I don’t agree that the monetary base and IOR are good indicators of monetary policy. With a much more expansionary monetary policy the base would be lower and IOR would be higher.

  63. Gravatar of 123 123
    18. February 2012 at 13:27

    Scott: “I see nothing preventing actual eurozone inflation averaging 1% over the next three years. ”

    LTRO auctions stabilize ex-post inflation by changing the current ex-ante inflation expectations.

    “How would a commercial bank profit from that outcome?”
    If a commercial bank is expecting eurozone inflation averaging 1% over the next three years, then the forecasted future ECB policy rate is low (remember that the interest rate paid on LTRO loan is an average of future ex-post policy rates). The forecasted cost of LTRO loan is very low, especially when compared to the alternative sources of funding. The expected cost of alternative sources of funding is very high, if 1% inflation is expected. For such a commercial bank, a LTRO loan is a perfect deflation hedge. The amount of LTRO loans outstanding increases, the size of ECB’s balance sheet expands, the monetary base grows.

    On the other hand, if a commercial bank is expecting eurozone inflation averaging 3% over the next three years, then the expected cost of a LTRO loan is high, compared to the alternative sources of funding. For such a commercial bank, there is no business sense to get a LTRO loan. The amount of LTRO loans outstanding does not increase, the ECB’s balance sheet does not expand, the monetary base does not grow.

    The operation of LTRO auction is similar to one of your futures targeting proposals, whereby the outside demand for deflation hedges causes the automatic expansion of monetary base.

    “I don’t agree that the monetary base and IOR are good indicators of monetary policy. With a much more expansionary monetary policy the base would be lower and IOR would be higher.”
    I agree. Of course, what I meant is that the deviation of the pair (monetary base, IOR) from a neutral level could describe the stance of the policy (of course, this neutral level is always changing).

    “All I can get by reading your comment is that you are assuming the ECB is inflation targeting because inflation targeting is more conservative than a Taylor Rule, and the ECB is conservative.”
    The discussion of Taylor Rules is only related to the modelling of LTRO loan payoffs.

    “It may well be targeting inflation, but this policy doesn’t seem at all analogous to futures targeting, unless I am missing something.”
    There is an AD future embedded in the LTRO loan. As the interest rate on LTRO loan is not fixed, you need to separate the LTRO loan into two parts. The first part is a regular fixed interest rate loan at a market price, the second is a derivative financial instrument. The ECB is effectively pegging the market price of this derivative financial instrument. The payoffs of this derivative are closely related to future AD. It is this peg that is currently driving the expected future AD.

  64. Gravatar of ssumner ssumner
    19. February 2012 at 06:57

    123, When rates are near zero the LTRO is not such a great deal. We saw the Fed pump lots of reserves into the US economy with little impact on inflation. They just sat there.

    I also don’t agree that banks can assume the ECB won’t raise rates at the wrong time–they raised rates in early 2011.

  65. Gravatar of 123 123
    19. February 2012 at 08:24

    Scott: “When rates are near zero the LTRO is not such a great deal. We saw the Fed pump lots of reserves into the US economy with little impact on inflation. They just sat there.”
    I disagree:
    1. The Fed did not pump enough reserves, Bernanke was not aggressive enough. If he had pumped enough reserves, he could have restored the AD.
    2. The reserves that Bernanke pumped had a huge impact on inflation. It is scary to even think about the counterfactual without those pumped reserves.
    3. The participants of LTRO auctions will take into account the fact that the demand for reserves is currently elevated.

    “I also don’t agree that banks can assume the ECB won’t raise rates at the wrong time–they raised rates in early 2011.”
    If the ECB raises the rates at the wrong time, the cost of the alternative sources of funding will increase much more than the cost of a LTRO loan. We have seen this in 2011. That is, the attractiveness of LTRO loans as a deflation hedge is not diminished by the risk of interest rate setting mistakes.
    To the extent the commercial banks anticipate the risk of ECB’s interest rate setting mistakes, they will increase the demand for LTRO loans, and the monetary base will grow, restoring the expectations of future inflation.
    Some time ago market monetarists have blogged about how Krugman was wrong when he said that the zero rate bound makes it impossible to hit some levels of AD. Here we are dealing about the “ECB policy rate bound” making it impossible to hit AD targets according to NK models that ignore the quantity of money. I am saying the markets will print enough euros to overcome the “ECB policy rate bound”.

  66. Gravatar of ssumner ssumner
    20. February 2012 at 17:49

    123, I certainly agree that if Bernanke had done much more QE it would have helped. And I’m willing to entertain your hypothesis that this program might help Europe a lot. I’ll take a wait and see attitude, as I don’t know enough about Europe to make a judgment either way. For instance–if the ECB hits it’s 2% inflation target, does that boost NGDP a lot, or is Europe already running roughly 2% inflation?

    I do think the equity markets in Europe are telling us that it’s helping, but my initial resistance was to your claim that it was some sort of futures targeting, I think that’s a bit of a leap of faith. But I’ll keep watching, and I might change my mind. If I wasn’t teaching now I’d have more time to research the question.

  67. Gravatar of 123 123
    21. February 2012 at 09:45

    Scott:”For instance–if the ECB hits it’s 2% inflation target, does that boost NGDP a lot, or is Europe already running roughly 2% inflation?”
    Yoy CPI is 2,7% in the Eurozone, however, this mostly reflects inflation during the first half of 2011.
    The ECB’s inflation target is certainly a big problem, but it is politically impossible to change it. While Bernanke has recently creatively reinterpreted the Fed’s mandate, this route is closed to the ECB. The challenge the ECB faced was to preserve the medium term price stability when NGDP expectations crashed in August-November 2011. The solution was to implement a new monetary policy regime. On the 3rd of December two LTRO auctions were announced, recerve requirement ratio was reduced from 2% to 1%, and the set of available collateral was expanded. While Christina Romer is saying “But this [2008/09] episode has also shown that policy is very hard to get right. The policy response is inherently based on forecasts, which are subject to great uncertainty”, Draghi has implemented a policy that is not based on forecasts made by policymakers. As a result, the panic of 2011 will cause a much lighter damage to NGDP compared to the damage the panic of 2008 has caused. One big unknown is whether these 3y LTRO auctions will be continued after February.

    “I do think the equity markets in Europe are telling us that it’s helping, but my initial resistance was to your claim that it was some sort of futures targeting, I think that’s a bit of a leap of faith.”
    In my first comment I did not mention futures targeting at all. I said that the size of monetary base is endogenously determined in an auction setting, and that as a result the prices of collateral converge to levels compatible with the central bank’s mandate. Well – the extent to which the prices of collateral have changed illustrates the depth of the AD problem that LTRO auctions have cured.

    There are some differences between 3 year LTRO and your futures targeting proposals:
    1. In your proposal futures positions would have to be combined with a subsidized deposit facility for the tenth of the futures position, while LTRO combines a swap and a fixed rate collateralized loan. This is actually an advantage of LTRO. There is a powerful transmission in the LTRO process itself where the auction results directly impact the market prices of collateral. Futures peg has to rely on arbitrage for transmission, and we know that the required return on arbitrage activities sharply rises during financial panics.
    2. There is no formal CPI swap in a LTRO loan. The presence of an unfortunate habit of raising interest rates at the wrong time (summer 2008, spring 2011) whenever CPI goes above the target gives the LTRO loan a payoff structure very similar to a formal CPI swap. I am not really disappointed by the fact that the ECB retains the discretion in setting the LTRO payoffs.
    3. The price of a quasi-CPI swap is not formally determined. I have previously argued that it is not clear if the ECB has pegged the CPI at 1,5%, 2% or 2,5% level. However, formal futures targeting has a disadvantage of time-varying inflation risk premium that creates a gap between the price of future and the actual expectations of market participants. On this point I actually think that LTROs are a bit better.
    4. In your proposal short futures positions are separate from the monetary base, while the ECB combines monetary base with the short quasi-CPI swap position by using IOR. There is no real difference here. As IOR is 75bps cheaper than the LTRO rate, “hot potato” effect remains.

  68. Gravatar of ssumner ssumner
    21. February 2012 at 18:48

    123, You said;

    “Futures peg has to rely on arbitrage for transmission, and we know that the required return on arbitrage activities sharply rises during financial panics.”

    No, arbitrage plays no role in NGDP futures targeting proposal. It’s pure speculation.

    The risk premium is likely to be very small, even in financial crises. This market would be used for speculation, not hedging. There’s no demand for NGDP hedging. It’d be like saying bettors would put more money on the red numbers in roulette during financial crises, it’s unrelated. The price will be an unbiased forecast.

    I don’t really understand the LTRO, Is this how it works:

    1. The banks borrow at 1%. They buy government bonds paying higher rates. The sellers of the government bonds redeposit the money they receive back in the banks, and the banks sit on the reserves, earning 1/4% IOR. Thus they earn 1/4%, plus the spread between the government bond rate and the 1% LTRO rate.

  69. Gravatar of 123 123
    22. February 2012 at 12:33

    Scott:”There’s no demand for NGDP hedging.”

    I disagree. S&P 500 OTM puts and VIX futures are very popular. These expensive products allow you to hedge your asset portfolio against negative NGDP shocks. Cheap NGDP insurance would replace these products to a large extent, and the total amount insured would expand. The problem today is that there are no natural sellers of NGDP insurance. Arbitrage between a NGDP futures market and asset markets would be a very important channel of monetary policy under the futures targeting. During the financial crisis, leveraged investors would discover that they need much more NGDP insurance than they had purchased before, so it is important to make sure that arbitrage between NGDP futures and asset markets is not impaired.

    “I don’t really understand the LTRO, Is this how it works:
    1. The banks borrow at 1%.”

    The current repo rate is 1%, but it would be a mistake to assume that the banks borrow at 1% for 3 years. The LTRO rate is an average of repo rates during the next three years, calculated and paid after three years. You might do well to assume that the banks will pay 1,5% for a three year loan, and they will receive a rebate if inflation falls below target during the next three years, and they will pay a surcharge if the inflation increases above target during the next three years (here the assumption is that the market expects that the market interest rate for such loans should be 1,5% when AD expectations are at 2%CPI).

    “They buy government bonds paying higher rates.”
    LTRO loans are overcollateralized, and the risk of the collateral stays with the commercial bank. If the market value of the collateral falls, commercial bank must post additional collateral. The list of eligible collateral has been expanded recently, for example, performing 10 year loans to small Italian companies are eligible as a collateral with a 80% haircut. So the ECB is basically making a bunch of safe three year loans to the commercial banking sector. The size of the haircut depends on the riskiness of the collateral.

    Then there is an arbitrage between the LTRO loans and the collateral markets. In equilibrium, the expected risk adjusted cost of the LTRO loan should be equal to the expected risk adjusted return on German bonds, Irish bonds, single A rated ABS securities backed by residential mortgages. And the expected risk adjusted return of the LTRO loan should be equal to the expected risk adjusted return on performing Italian small business loans.

    “The sellers of the government bonds redeposit the money they receive back in the banks, and the banks sit on the reserves, earning 1/4% IOR.”

    If the the financial sector purchases government bonds from the non-financial sector, then the the non-financial sector increases their holdings of M2, as only the banks are allowed to hold non-cash base money.

    If the purchases happen inside the financial sector, then some banks increase their holdings of government bonds, while other banks increase their holdings of monetary base.

    In both cases the process is associated with higher expected AD.

    “Thus they earn 1/4%”
    It would be wrong to assume that the IOR rate will not change for the next three years.

    The question is – does the “hot potato” effect exist for the IOR-paying monetary base? If such effect is weak, then the commercial banks could earn profit by overbidding in the LTRO auction. In such scenario, there would be an enormous expansion of the ECB’s balance sheet, AD would reach the target solely via the collateral arbitrage channel, and the ECB would run a large risk of loss. On the other hand, if the “hot potato” effect is strong, the demand in the LTRO auctions would be lower, the expansion of base money would be smaller, and the ECB would not run a large risk of loss. Judging from the results of an auction, it looks like the “hot potato” effect is strong.

    “Thus they earn 1/4%, plus the spread between the government bond rate and the 1% LTRO rate.”
    This is wrong, as the calculation of economic profit should make adjustments for risk, term structure, overcollateralization feature, and the fact that LTRO and IOR rates are likely to change during the next three years.

  70. Gravatar of TheMoneyIllusion » George Soros nails it TheMoneyIllusion » George Soros nails it
    17. April 2012 at 08:45

    [...] Two months ago I quoted Soros as follows: To be a little more specific, let me suggest the outlines of a European solution to the euro crisis. It involves a delicate two-phase maneuver, similar to the one that got us out of the crash of 2008. When a car is skidding, you first have to turn the steering wheel in the direction of the skid, and only after you have regained control can you correct your direction. In this case, you must first impose strict fiscal discipline on the deficit countries and encourage structural reforms; but then you must find some stimulus to get you out of the deflationary vicious circle—because structural reforms alone will not do it. The stimulus will have to come from the European Union and it will have to be guaranteed jointly and severally. It is likely to involve eurobonds in one guise or another. It is important, however, to spell out the solution in advance. Without a clear game plan Europe will remain mired in a larger vicious circle in which economic decline and political disintegration mutually reinforce each other. [...]

Leave a Reply