Game theory gone awry?
Christopher Mahoney sent me the following from the FT:
The ECB is widely expected to leave its main interest rate unchanged at 1 per cent at its governing council on Wednesday.
The deterioration in the eurozone economic outlook would appear to justify a cut. But the ECB has broader considerations. Uncertainty created by Greece’s election on June 17 as well as parliamentary elections in France have strengthened the case for delaying ECB action. Mario Draghi, ECB president, also wants to keep pressure on governments to take steps to resolve the crisis.
Here’s the problem I see. Imagine the set of possible eurozone compromises, where each compromise represents some mix if German support and PIIGS internal devaluation. As expected eurozone NGDP growth rises, the set of possible compromises expands. Of course it’s possible that the set is empty for a fairly wide range of NGDP growth rates.
Now think about Draghi’s policy. It does put pressure on governments to act, but it also shrinks the set of feasible compromises. Pressure can lead to action, but pressure can also cause a complex system to crack.
Tags:
2. June 2012 at 10:40
The ECB is like a guy who wants to break up with his girlfriend, but doesn’t have the guts to do it. So he makes her life as miserable as possible until she walks away from him. Then he can blame her for being crazy when he tells his friends that she left him, and future girlfriends won’t know he’s a jerk.
2. June 2012 at 10:48
Wow, Mario Draghi sounds exactly like Morgan Warstler.
2. June 2012 at 11:01
Statsguy, Good analogy.
Desolation, Morgan will love it! He gets a thrill from seeing losers suffer.
2. June 2012 at 11:08
the “keeping pressure on governments” approach has only one stable Nash equilibrium.
2. June 2012 at 11:24
Scott I was thinking the same thing-flattery will get you every where with Morgan! LOL
2. June 2012 at 11:26
KRUGMAN UNDERSTANDS EXPECTATIONS, WHEN HE WANTS TO:
“Nonetheless, the ECB raised rates “” and that was when the euro really began falling apart. The direct effects of the rate increase can’t explain that unraveling, but the effect on expectations “” aha, so they really are that fanatical about price stability! “” can.”
http://krugman.blogs.nytimes.com/2012/06/02/catastrophic-credibility/
2. June 2012 at 11:29
I realized that the Eurozone is already past the point of no return last week. Two reason:
1) Madrid buses are going to run ads for Krugman’s book.
2) Spanish diplomats openly calling Germans “Taliban”
Bye Bye Euro!
2. June 2012 at 11:31
The Euro project is dead but no one wants to be the first to make the official pronouncement. Letting the “Greek bug” fester, Spain was mortally infected…
2. June 2012 at 11:33
Steve, +2
2. June 2012 at 12:49
This is what really steams me. Since when is the Central Bank’s job to pressure governments to do anything? So now instead of the Sumner Critique about the Central Bank reaction function offsetting fiscal stimulus, we have the Draghi Critique where the Central Bank more than offsets fiscal stimulus to punish elected officials? Will the ECB tolerate higher NGDP under fiscal policies it approves of than fiscal policies it doesn’t approve of?
I assume Draghi would say I’m mischaracterizing his views, but that’s what it sounds like to me.
2. June 2012 at 15:01
“Here’s the problem I see.”
The Euro project is dead but no one wants to be the first to make the official pronouncement.”
So 5 years from now, at least Spain and maybe Greece hasn’t dropped out and the Euro is still happening…
you are both wrong.
From 30K feet, looking at he whole forest, one can easily imagine a history where Greece is the tragic figure, that drops out, and suffers soooooooo badly, the other nations with a near break even account deficit get their spine together decide the Greeks were criminal people and tough it out.
—-
Have you seen how many public employees in Wisconsin, when they weren’t required to pay dues, didn’t?
The people of Greece are ready to let go and become civilized.
MOST WI public employees and Greek citizens will decide they can survive without the system.
If an economist assumes MOST Greek rent seekers are willing to sop seeking rent – there isn’t that much to fear in Spain.
2. June 2012 at 15:28
Mario Draghi, ECB president, also wants to keep pressure on governments to take steps to resolve the crisis.
“With water filling one compartment after another, the captain destroyed all the lifeboats to put pressure on the engineers to plug the hole.”
In fact, the entire euro adventure seems to have been based on this operating principle from the start. If they really wanted a European fixed exchange rate regime, they could have obtained 90% of the benefit while avoiding all the worst-case risk (seen today) by keeping national currencies and tying them to the new euro at a fixed exchange rate. If a nation handled this well for dozen years or so, passing all tests (fiscal, institutional, trade, etc.) then it could switch to using euro itself, growing a single currency area. If a nation turned out to be Greece, it could float its currency boat and sail away to the benefit of all parties, with only small fraction of the complications faced today. But instead…
“The good ship Euro will be the safest ship to ever sail the seas. It is being built without lifeboats so everyone on board knows that if it sinks they are all going down with it — *guaranteeing* that it will be run as the safest ship ever.
“And now that we have the safest ship ever, to sell out all berths we’re planning an exciting high-speed cruise through the Arctic ice fields. Hey, you Greeks, get on board, it’ll be fun!”
2. June 2012 at 15:34
[…] the moment it appears Draghi is refusing to cut interest rates below 1% to blackmail Greece and France into policies deemed favourable to “Article 119 of the Treaty […]
2. June 2012 at 16:15
From 30K feet, looking at he whole forest, one can easily imagine a history where Greece is the tragic figure, that drops out, and suffers soooooooo badly, the other nations with a near break even account deficit get their spine together decide the Greeks were criminal people and tough it out.
that’s definitely a possibility. Greece drops out and since the govt has to print drachmas just to pay the bills due to widespread tax evasion, hyperinflation ensues.
while its a possibility, the EU has only a miniscule window of time to prevent capital flight, which is already happening in Spain. The kinds of changes they need to prevent the breakdown require treaty changes (German parliament has not even ratified the stability fund and does not plan to until july 9th).
Meanwhile Spain is going to dip its toes in the bond market next week (who’s dumb enough to buy those bonds??).
Another possibility is that Greece and Spain decide to go together. Greece lacks the resources to get drachmas printed (they need hard currency to pay for that probably) while Spain might just say F-U with 25% unemployment.
I pretty sure what ever the outcome is, it will be totally surprising and completely logical after the fact.
2. June 2012 at 22:06
Scott,
This thing has its own logic. Game theory cannot cover it. Maybe economists have too much exposure to axiomatic theorizing and inherently flawed empirical work to realize that certain things will go on or break in ways that can pnly be partially explained in economics terms. In fact, the 20th century was the triumph of politics over economics…
The most likely outcome for Greece is to stay in the EUR but with the local central bank (temporarily) becoming an ECB branch and the Greece-headquartered banks being controlled by the entity that is now under construction. That will destroy all political policy space for a while. If that works in Greece (remember, Greece’s economy is irrelevant for the rest, only its reputational impact is), the larger countries could copy that model without the bite maybe necessary to tame the Greek elite.
3. June 2012 at 02:30
Negation: “Since when is the Central Bank’s job to pressure governments to do anything?”
Central Bankers were political since forever. Go read Alesina-Ardagna paper about CB accommodating fiscal austerity more than fiscal stimuli (I know it is masked as “economy getting our of recession” but anyone reading this blog knows they are the same. The only difference is that now Central Bankers are more important than ever. And they failed big.
Another reason why to get the responsibility for steering AD away from this gang of maniacs and put it into the hands of public (explicit NGDP targeting).
3. June 2012 at 06:34
dwb, And I’m guessing it’s not a good one.
Steve, Thanks, I did a post.
Marcus, Exactly.
Negation, I hadn’t thought of that–he’s discrediting the Sumner critique.
Morgan, I’ll be very interested in the WI results.
Jim Glass, Good analogy.
Rien, What makes you think I don’t understand that this is political? I think your prediction is quite plausible, but so are a 100 different predictions I’ve seen.
3. June 2012 at 06:40
In any relationship there is a weaker party.
This isn’t a good or bad thing, it is just a thing.
If you don’t like this fact, and you fight it, it will ruin most of your days.
If you completely accept this fact, regardless of whether you like ti or not, Scott will say you like to see people suffer.
Southern states in Europe have a clear path, they simply need to follow the Southern states in the US.
They need to go union-less.
If Greece, Italy, and Spain announce they are going to end unions, they will find a FLOOD OF INVESTMENT.
Any dispassionate observer simply expects them to end unions, to accept that they must make themselves the the stronger player on the team.
Most of you pay only lip service to the idea that Greece needs reform.
REAL REFORM is / will be gut wrenching. But the PIIGS can EASILY get access to investment dollars, they just have to sacrifice the wants of a few.
One more time: 66% of Wisconsin public employees stopped paying dues. They are willing to give it a go.
Don’t assume the Greek people don’t have it in them. Don’t have a soft-bigotry of low expectations.
3. June 2012 at 06:42
Scott the WI vote is less important than the de-funding of unions.
3. June 2012 at 19:27
Morgan – “From 30K feet, looking at he whole forest, one can easily imagine a history where Greece is the tragic figure, that drops out, and suffers soooooooo badly, the other nations with a near break even account deficit get their spine together decide the Greeks were criminal people and tough it out.”
The implication is that the worst result for the Euro is that a Greek withdrawal goes smoothly; i.e. the two possible worlds we are facing are ones where either the Euro project is dead or Greece is dead.
The more important question is whether the Eurozone is good for the world. I don’t see why monetary union, beyond symbolism, is desirable in the first place. Is it really impossible for a rough Greek exit to co-exist with other states exiting, like Spain or Portugal?