Adam Tooze’s great insights into the history of Europe

I spend the weekend with my family in the Christensen vacation home in Skåne (Southern Sweden). I didn’t do any reading, but I had time to watch a fantastic lecture series on YouTube with one of my absolute favourite historians Adam Tooze.

Tooze did the lectures last year at Stanford University’s Europe Center. Watch the great lectures here:

“Making Peace in Europe 1917-1919: Brest-Litovsk and Versailles”
“Hegemony: Europe, America and the problem of financial reconstruction, 1916-1933″
“Unsettled Lands: the interwar crisis of agrarian Europe”

While I do not agree with all of Tooze’s thinking continue to think that he is one of the most inspiring historians in the world to listen to – particularly for economists. Enjoy the lectures!

PS I equally recommend Tooze’s two latest books Wages of Destruction and The Deluge. Both books give great insight not only into history, but also teaches us great lessons for today’s world.

—-

Update: For some reason I had missed David Frum’s excellent review of Wages of Destruction and The Deluge – and Brad DeLong’s “thoughts on David From’s review”.

An intra-European hot-pot effect

This morning I feel like qouting myself:

Over the past month, CEE and other non-euro European currencies have indeed been strengthening. This is ‘forcing’ central banks from the Swedish Riksbank to the Polish central bank to cut interest rates. So, we are getting a double effect of European monetary policy. The ECB is easing monetary policy, which on its own is stimulating Central and Eastern European growth through an export channel and at the same time the CEE central banks is moving towards further monetary easing, which is directly stimulating CEE domestic demand. This is good news for the CEE fixed income and equity markets particularly and for the CEE economies in general. As a result, we are becoming more upbeat on the outlook for growth in Poland, Hungary and the Czech Republic.

This is essentially what we call an intra-Europe hot-potato effect. The ECB is creating liquidity, some of which is spreading across Europe, like a hot potato being passed along. It is basically all part of a European portfolio rebalancing, combined with a monetary reaction in countries such as Poland.

We think this hot-potato effect will force CEE central banks to cut interest rates further to curb the appreciation of their currencies. This is likely to push the key policy rates of countries such as Poland, Hungary and Romania closer to the zero lower bound and, ultimately, this could force the central banks to use other policy instruments than the interest rate such as quantitative easing or currency intervention. The Czech Republic is already at the zero lower bound and the Czech central bank (CNB) has put a floor under EUR/CZK at 27. It has recently inched close to this floor and it is becoming increasingly likely that the CNB will be forced to intervene in the FX market to defend it. This is likely to cause increased focus on the underlying appreciation pressure on all of the CEE currencies.

And yes, this is an intra-European currency war and I believe it is good news for European growth. In a deflationary, slow growth scenario you should celebrate when central banks competie to ease monetary policy.

Ramblings on “neutral money” and the workings of the ‘monetary machinery’

I recently got reminded of an excellent quote from John Stuart Mill (The Principles of Political Economy with Some of Their Applications to Social Philosophy, 1848):

“There cannot . . . be a more intrinsically insignificant thing, in the economy of society, than money: . . . It is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it: and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order.”

So what is Mill saying? The story essentially is that as long as monetary policy “works” everybody basically forgets about monetary policy. Hence, as long as the monetary regime does not distort relative prices and mess up the economic system nobody will pay attention to the monetary system. It is only when the machinery for some reason breaks down that people are starting to notice and discuss monetary policy matters.

This is why most economists during the Great Moderation showed little interest in monetary policy matters. After all, what impact did monetary policy have? Well, it have great impact in the sense that we in generally from the mid-1980s and until 2008 in the Western world had fairly well-functioning monetary policy and a regime that in general did not distort relative prices. The monetary regime ensured stable and predictable growth in nominal spending and low and stable inflation.

The is no optimal monetary regime, but there is an “optimal purpose”

I have often thought about why two so prominent thinkers as Milton Friedman and F.A. Hayek did not consistently advocate the same monetary policy regime through their lives. Instead both of them at times argued in favour of some kind of commodity standard, both at certain times seemed to have advocated full reserve banking, Friedman famously also argued for a fixed monetary supply growth rate, but later argued for a “frozen” money base. Both to some degree at some point also favoured Free Banking.

So while both Friedman and Hayek’s monetary thinking didn’t change much over the years they both nonetheless ended up again and again changing their preferred monetary policy regime.

I don’t think that this illustrates some kind of inconsistency in their thinking. Rather I believe that it illustrates that there is no such thing as an “optimal” monetary regime. What is “optimal” changes over time and is also different from country to country.

Just think of the US and Iceland. The US is the largest economy in the world and nobody questions the US’ ability to maintain the dollar. On the other hand a very small country like Iceland might not rationally be big enough to maintain a currency of its own.

Similarly we can easily argue for nominal GDP targeting in the US. But how about NGDP targeting for Zimbabwe? Would we trust that the NGDP data for Zimbabwe is good and timely enough for us to conduct monetary policy based on it?

And finally what is or is not an “Optimal Currency Area” today might not maintain that status in the future – just think of institutional and legal changes, technological development etc. Normally we for example say that labour mobility is key to different countries sharing a currency, but what if the technological development means that we in the future will be able to do most of our work from home?

I believe that these examples illustrate that there we should not expect that there is a “one size fits all” monetary policy regime. That is also why while I am happy to advocate NGDP level targeting for the US or the euro zone, but is much less inclined to advocate it for Iceland or Angola.

Instead I think it is helpful instead of starting out with discussing monetary rules we should start out discussing what we want our monetary machine to produce. Furthermore, we also want to discuss what the monetary machine cannot produce.

And here I think the answer is pretty clear. To me the monetary machine should basically ensure “neutrality” – not in the traditional textbook form of money neutrality – but rather in the normative form of the word. Neutrality in my definition means a monetary policy that does not distort relative prices in the economy.

Or as Hayek at length explains in Prices and Production (1931):

“In order to preserve, in a money economy, the tendencies towards a stage of equilibrium which are described by general economic theory, it would be necessary to secure the existence of all the conditions, which the theory of neutral money has to establish. It is however very probable that this is practically impossible. It will be necessary to take into account the fact that the existence of a generally used medium of exchange will always lead to the existence of long-term contracts in terms of this medium of exchange, which will have been concluded in the expectation of a certain future price level. It may further be necessary to take into account the fact that many other prices possess a considerable degree of rigidity and will be particularly difficult to reduce. All these ”frictions” which obstruct the smooth adaptation of the price system to changed conditions, which would be necessary if the money supply were to be kept neutral, are of course of the greatest importance for all practical problems of monetary policy. And it may be necessary to seek for a compromise between two aims which can be realized only alternatively: the greatest possible realization of the forces working toward a state of equilibrium, and the avoidance of excessive frictional resistance.  But it is important to realize fully that in this case the elimination of the active influence of money [on all relative prices, the time structure of production, and the relations between production, consumption, savings and investment], has ceased to be the only, or even a fully realizable, purpose of monetary policy.”

The true relationship between the theoretical concept of neutral money, and the practical ideal of monetary policy is, therefore, that the former provides one criterion for judging the latter; the degree to which a concrete system approaches the condition of neutrality is one and perhaps the most important, but not the only criterion by which one has to judge the appropriateness of a given course of policy. It is quite conceivable that a distortion of relative prices and a misdirection of production by monetary influences could only be avoided if, firstly, the total money stream remained constant, and secondly, all prices were completely flexible, and, thirdly, all long term contracts were based on a correct anticipation of future price movements. This would mean that, if the second and third conditions are not given, the ideal could not be realized by any kind of monetary policy.”

So what Hayek is telling us is that any monetary policy rule should be based on its ability to ensure neutrality in the sense of ensuring that there will be no distortion of relative prices. But Hayek is also telling us that it might not be possible to find the “perfect” monetary policy rule among other things because of institutional factors such as price rigidities and contracts.

Therefore when we discuss actual monetary reform rather than just talk on a purely theoretical basis institutional factors come into play.

If it ain’t broke, don’t fix it

Since we cannot in practical terms talk about an “optimal” monetary regime we are in that – for the revolutionary-minded monetary reformer (like myself) – unpleasant situation that we essentially have to choose between different imperfect regimes.

For example imagine that we have a system that most of the time provides a stable monetary machinery with a high degree of nominal stability and little distortion of relative prices, but every 7-8 years something goes wrong and we get a mid-size recession or a asset bubble and every 30 years we get a nasty “Great Recession” or a “Great Inflation”.

So the Machine is certainly not perfect, but for most of the time it works well and most importantly the system is not questioned by policy makers in general and therefore is to a very large extent rule based.

Maybe this is how we should think of the gold standard or inflation targeting. Both are regimes that have worked fairly well during fairly long periods of times, but then in the case of the gold standard finally broke down in the 1930s and presently we might be in a process of abandoning inflation targeting.

One could of course argue that somebody should have ended the gold standard before or reformed it before it collapsed, but that would have meant opening the door for a discussion of alternative monetary regimes that would be much less rule based and potentially would provide even less monetary stability.

What I here is trying to articulate is that there might be a trade-off between the wish for a well-functioning monetary machine (nominal stability, no distortion of relative prices) and the wish for a “robust” monetary machine in the sense that the machine cannot be “high-jacked” by crazy policy makers of some kind.

An example that comes to mind is Canada’s inflation targeting regime. Overall, if we look at the economic performance of the Canadian economy since the early 1990s when the present regime was introduced the regime has been a huge success.

However, we all also know that theoretically at least the system could be improved if we moved from inflation targeting to nominal GDP targeting as there is an in-build tendency for inflation targeting central banks to react to supply shock and hence distort relative prices, which should be a no-go for any central bank.

However, should the Canadians throw out a regime that overall has worked fairly to experiment with another regime – such as NGDP targeting? By opening the door for change one would maybe in the process change the political perception of the regime and thereby make the regime less robust. And not sure about the answer, but I do believe that sometimes we should accept what we have and maybe go for gradual reform of the regime rather than risk making “regime choice” something we make every 3-4 years.

Many ways to nominal stability

I finally want to say sorry to my readers for this post probably not being the best organised post I – I wrote over a number of days and frankly speaking this is mostly part of my “thinking process” regarding the question of how to choose a monetary regime. I am sure I soon will return to the topic and I hope I haven’t been wasting your time to get to the conclusion – nominal stability can be relatively clearly defined, but there are many ways that can lead us to nominal stability.

HT DL

The Open Borders Manifesto

Today is Open Borders day. As I wholeheartedly believe in the free global movement of goods, capital and labour I encourage my readers to have a look at the Open Borders Manifesto.

This is from the Manifesto:

Freedom of movement is a basic liberty that governments should respect and protect unless justified by extenuating circumstances. This extends to movement across international boundaries.
International law and many domestic laws already recognise the right of any individual to leave his or her country…

We believe international and domestic law should similarly extend such protections to individuals seeking to enter another country…The border enforcement status quo is both morally unconscionable and economically destructive. Border controls predominantly restrict the movement of people who bear no ill intentions. Most of the people legally barred from moving across international borders today are fleeing persecution or poverty, desire a better job or home, or simply want to see the city lights.

The border status quo bars ordinary people from pursuing the life and opportunity they desire, not because they lack merit or because they pose a danger to others. Billions of people are legally barred from realising their full potential and ambitions purely on the basis of an accident of birth: where they were born. This is both a drain on the economic and innovative potential of human societies across the world, and indefensible in any order that recognises the moral worth and dignity of every human being.

We seek legal and policy reforms that will reduce and eventually remove these bars to movement for billions of ordinary people around the world…

Prediction market: Fed on track to hit 4% NGDP growth in 2015

Since December last year the prediction market site Hypermind has been running a prediction market for US nominal GDP growth for 2015 (plus markets for each quarter of the year).

I think the development of a prediction market for NGDP growth is extremely interesting and such market can help us much better to understand monetary and economic issues. Furthermore, the Federal Reserve should be very excited about such markets as they provide a minute-by-minute “tracker” of the Fed’s performance and credibility.

Of course the Federal Reserve does not official target nominal GDP growth, but I have earlier argued that the Fed effectively since Q2 2009 has kept US NGDP on a (very narrow) path close to a 4% trend. The graph below shows this.

What does the Hypermind’s prediction market then tell us? Well, guess what – right now the market is predicting NGDP growth to be exactly 4% in 2015! So at least judging from the prediction market US monetary policy is right now perfectly calibrated to keep actual NGDP on the 4% path through 2015.

NGDP prediction market Hypermind

This of course does not mean that US monetary policy is “perfect”. First, of all the Fed does not official have a 4% NGDP target. Second, communication about the Fed’s policy instrument(s) is far from perfect. But if we decide to say that the Fed effectively has a 4% NGDP target then at least the “market” now perceives this target as credible.

I have earlier argued that central bankers should endorse prediction markets such as Hypermind. This is what I wrote back in 2012:

My point is that the “average” forecast of the market often is a better forecast than the forecast of the individual forecaster. Furthermore, I know of no macroeconomic forecaster who has consistently over long periods been better than the “consensus” expectation. If my readers know of any such super forecaster I will be happy to know about them.

…Unlike the market where the profit motive rules central banks and governments are not guided by an objective profit motive but rather than by political motives – that might or might not be noble and objective.

It is well known among academic economists and market participants that the forecasts of government institutions are biased. For example Karl Brunner and Allan Meltzer have demonstrated that the IMF consistently are biased in a too optimistic direction in their forecasts.

…Instead of relying on in-house forecasts central banks could consult the market about the outlook for the economy and markets. Scott Sumner has for example argued that monetary policy should be conducted by targeting NGDP futures. I think that is an excellent idea. However, first of all it could be hard to set-up a genuine NGDP futures markets. Second, the experience with inflation linked bonds shows that the prices on these bonds often are distorted by for example lack of liquidity in the particular markets.

I believe that these problems can be solved and I think Scott’s suggestion ideally is the right one. However, there is a more simple solution, which in principle is the same thing, but which would be much less costly and complicated to operate. My suggestion is the central bank simply set-up a prediction market for key macroeconomic variables – including of the variables that the central bank targets (or could target) such as NGDP level and growth, inflation, the price level.

…The experience with prediction markets is quite good and prediction markets have been used to forecast everything from the outcome of elections to how much a movie will bring in at the box office. A clear advantage with prediction markets is that they are quite easy to set-up and run. Furthermore, it has been shown that even relatively small size bets give good and reliable predictions. This mean that if a central bank set up a prediction market then the average citizen in the country could easily participate in the “monetary policy market”.

I hence believe that prediction markets could be a very useful tool for central banks – both as a forecasting tool but also as a communication tool. A truly credible central bank would have no problem relying on market forecasts rather than on internal forecast.

I of course understand that central banks for all kind of reasons would be very reluctant to base monetary policy on market predictions, but imagine that the Federal Reserve had had a prediction market for NGDP (or inflation for that matter) in 2007-8. Then there is no doubt that it would have had a real-time indication of how much monetary conditions had tightened and that likely would caused the Fed into action much earlier than was actually the case. A problem with traditional macroeconomic forecasts is that they take time to do and hence are not available to policy makers before sometime has gone by.

With Hypermind’s NGDP prediction market we now have such a market I was calling for back in 2012 and in the future I will try to keep track of the Hypermind’s NGDP prediction market as I believe that such markets can teach us quite a bit about the workings of monetary policy.

Furthermore, it would be extremely interesting to see a similar market being set up for the euro zone so I hope Hypermind in the future will find a sponsor to set up such a market.

—-

Some of my earlier posts on prediction markets:

The Crowd: “Lars, you are fat!”
Prediction markets and UK monetary policy
Leave it to the market to decide on “tapering”
Guest post: Central bankers should watch the Eurovision (by Jens Pedersen)
Remembering the “Market” in Market Monetarism
Gabe Newell on prediction markets – NGDP level targeting and Lindsay Lohan
Yet another argument for prediction markets: “Reputation and Forecast Revisions: Evidence from the FOMC”
Benn & Ben – would prediction markets be of interest to you?
Prediction markets and government budget forecasts
Central banks should set up prediction markets
Markets are telling us where NGDP growth is heading
Scott’s prediction market
Bank of England should leave forecasting to Ladbrokes
Ben maybe you should try “policy futures”?
Robin Hanson’s brilliant idea for central bank decision-making

Mikio Kumada tells the right story about the Japanese GDP numbers

Earlier today we got numbers for Japanese GDP numbers for Q4 2014. Watch my friend Mikio Kumada comment on the numbers here.

I fully share Mikio’s optimistic reading of the numbers. Bank of Japan’s quantitative easing is working and is lifting nominal spending growth.

Does that solve all Japan’s problems? No certainly not. It cannot do anything about Japan’s structural problems – particularly the negative demographics – but it is pulling Japan out of the deflationary-trap. And that is exactly what BoJ governor Kuroda set out to do. Now Prime Minister Abe has to deliver on structural reform, but that can be said about every industrialized country in the world.

PS Yes, I am positive about the Bank of Japan’s policy actions, but I still think it would have been much better with a NGDP level target for Japan rather than a 2% inflation target.

“Now the enriched country merely declares it is insolvent and spits on Its victims.”

I can’t help of thinking of events in the 1930s when I see the headlines in the financial media these days. One thing is the geopolitical situation – another thing is the new Greek government’s attempt to negotiate a new debt deal with the EU.

To me it is striking to what extent the economic and political situation in Greece resembles that of Germany in the early 1930s. And similar the position of Germany today – both that of the German media and of the German government is very similar to the French position in the early 1930s.

In 1931 the German economy was in a deep crisis with deflation and ever mounting debt – both public and private. A rigid monetary regime – the gold standard – was strangulating the German economy – while extremist parties on the left and right became increasingly popular among voters. At the same time the position of French government was uncompromising – Germany’s problems is of her own making. The answer was more austerity and there could be no talk of a new debt deal for Germany. Nobody seemed to think there was a monetary solution.

I therefore think we can learn a lot from studying events in the early 1930s if we want to find solutions for the euro zone crisis and it might be particularly suiting for the German newspapers to take a look at what they themselves were writing in early 1930s about the French position and then compare that with what today is written in Greek newspapers about the German position today.

Or compare what the French media was saying about Germany in 1931. Just take a look at this quote:

(The French newspaper) L’Intransigeant describes Germany‘s financial methods as frankly dishonest bankruptcy. “In 1923,” it states, “Germany reduced the national debt to nothing, then borrowed abroad on short terms credit which was invested on long terms, and is thus unable to repay her creditors. Now the enriched country merely declares it is insolvent and spits on Its victims.”

I am pretty sure I could find a similar quote in the Bild Zeitung today about Greece.

I encourage my readers to have a look at the newspaper achieves from 1931 to find similarities with the situation today in regard to the relationship between France and German in 1931 and Germany and Greece today. I will be happy to publish your findings (drop me a mail at lacsen@gmail.com).

Selgin on Haber and Calomiris

There is no doubt that I very much like Stephen Haber and Charles Calomiris’ great book “Fragile by Design” on the constitutional origin of banking crisis (take a look at my earlier posts on the book here and here)

I do, however, not agree with everything in the book and now George Selgin has a review of “Fragile by Design” that addresses some of these issues. It is a great review. The read the read book and read the review.

Here is the abstract from George’s review:

 In Fragile by Design (2014), Charles Calomiris and Stephen Haber argue that banking crises, instead of being traceable to inherent weaknesses of fractional-reserve banking, have their roots in politically-motivated government interference with banking systems that might otherwise be robust. The evidence they offer in defense of their thesis, and their manner of presenting it, are compelling. Yet their otherwise persuasive work is not without significant shortcomings. These shortcomings consist of (1) a misleading account of governments’ necessary and desirable role in banking; (2) a tendency to overlook the adverse historical consequences of government interference with banks’ ability to issue paper currency; (3) an unsuccessful (because overly deterministic) attempt to draw general conclusions concerning the bearing of different political arrangements on banking structure; and (4) an almost complete neglect the of role of ideas, and of economists’ ideas especially, in shaping banking systems, both for good and for evil. The last two shortcomings are especially unfortunate, because they suffuse Fragile by Design with a fatalism that is likely to limit its effectiveness in sponsoring needed change.

PS my recent presentation of monetary and currency reform in Iceland was very much in the spirit of Fragile by Design.

Kuroda’s new team member – Yutaka Harada

If monetary policy is credible and strictly rules based who is running the central bank has little importance. However, if the central bank has not established full credibility then who is running the show will actually be important. Therefore, last week’s news that Yutaka Harada has been nominated for Bank of Japan’s board should certainly be noticed.

I personally have little knowledge of Professor Harada, but I of course have noticed that he has been both described as a “reflationist” and a “monetarist”.

Furthermore, it is notable that he is said to favour fiscal consolidation and structural reforms for Japan. This of course is as Scott Sumner notices the unique market monetarist “policy cocktail” that would be the right one for Japan in the present situation.

Harada’s monetarist insights

As I previously had not even heard of Harada I have done a bit of research on his views. Doing that I came across a paper – “Using Monetary Policy to End Stagnation” – he authored back in 2010. I am not sure Harada would describe himself as a monetarist, but his 2010 paper is certainly quite monetarist. Here is a few quotes…

First on the BOJ’s “restrictive policy”:

Compared with a growth strategy with indeterminate effects, stabilizing the value of the yen would produce quick results. Why has the yen become strong? The reason is a restrictive monetary policy. How can we say that policy has been tightened when interest rates remain so low? To answer this, we need to look at not interest rates but the money supply to see how much money is being fed into the economy.

Japan’s bias toward restrictive monetary control was excessive even in the wake of the global financial crisis…

…The BOJ argues that other countries needed to expand the monetary base in order to absorb the shock to their financial systems from the emergence of vast quantities of bad debts, and that Japan had no such need because domestic banks were not burdened by a heavy load of nonperforming loans. It is true that bad debts did not hobble Japan’s banks. Nonetheless, the global recession dealt a sharp shock to external demand, and the rising yen delivered a follow-up blow.

So we got a Hetzelian/Sumnerian explanation for the weak Japanese recovery after the “Lehman shock” in 2008 – the Japanese recovery in 2009-10 was weak because monetary policy was tight. The markets – the yen – is telling us that and low rates is not a sign a sign that monetary policy is easy.

So the crisis is one of weak demand, but Harada is skeptical that fiscal policy can be used to solve the problem:

Using fiscal policy to generate demand means stepping up government spending, which has to be paid for by either issuing government bonds or hiking taxes. Both of these funding methods involve collecting money from the public. Basically the government just takes money out of citizens’ right pockets and puts it back in their left pockets. Monetary policy works in a different way. A central bank is capable of expanding the money supply without limit. It can, for instance, buy government bonds and supply the market with funds. These are not funds it collects from the public, and so it can put money in citizens’ left pockets without taking anything from their right pockets.”

So Harada welcomes quantitative easing, but it needs to be done within a rule-based framework:

“Of course, adopting such a policy over an extended period of time would invite criticism, since it would trigger inflation and could wind up causing the kind of hyperinflation Zimbabwe has been suffering from. A policy of significantly expanding the money supply must therefore be left in place only for a while, after which the central bank must redirect its aim at a modest inflation rate of, say, 2%. This would be a policy of inflation targeting, and it provides one way of terminating more aggressive monetary relaxation.

Harada goes on to take on the traditional deflationist views of the BoJ (you could easily replace BoJ with ECB):

Although Japan’s prewar elite had some outstanding members, notably Takahashi Korekiyo, these days everyone seems to have swallowed the nonsensical line of the BOJ. Monetary policy, the bank argues, is not involved in the ongoing deflation. It points instead to such factors as inexpensive imports from China and other low-wage countries, price markdowns due to streamlining in distribution and deregulation, a sustained wage decline, and a lowering of growth expectations. Deflation is structural factor, the BOJ says, and no amount of money supply expansion would bring it to a stop.

We need to note, however, that whereas China is exporting low-priced goods around the world, it is only in Japan that prices are falling. Distribution streamlining and deregulation may well cause prices to drop, but they should also be expected to speed up the economy’s growth rate, and that has not occurred. Wages are indeed in the midst of a downward trend, but that is because of the ongoing deflation and business slump, which have been caused by the BOJ’s passive policy stance. Companies are hardly likely to hike wages at a time of falling prices and slim profits. An expectation of slower growth in the future is a certainly a cause of diminished demand, since many people will tighten their purse strings, but that does not automatically make it a deflationary factor. Slower growth would also cause future supply to diminish, and that would be an inflationary factor. Supply and demand factors are both involved in price movements, and we would need to know which is larger before calling lowered expectations a deflationary force.

And finally echoing Milton Friedman Harada explains the relationship between the stance of monetary policy and the level of interest rates:

“Here we should note that interest rates are low today not because the BOJ has adopted a policy of easy money but because it is sticking to a policy that is fostering deflation. If the BOJ had acted in the same way the Bank of Korea did when it expanded the monetary base to deal with the global financial crisis, probably the yen would not have appreciated, exports would not have dropped so far, and employment would not have been cut back so sharply. Japanese production would have recovered in tandem with the recovery of the world economy, and prices would not have fallen. With output expanding, profits would have improved, and both real and nominal GDP would have increased. All this would have set the stage for expectations of an upturn, and short- and long-term interest rates would have risen.”

We will see how Yutaka Harada actually performs on the BoJ’s board, but I think it is fair to say that the BoJ will take a step further in a monetarist direction with the nomination of Yutaka Harada to the BoJ board.

Jens Weidmann should be promoting (some of) Varoufakis’ ideas

The new Greek Finance Minister Yanis Varoufakis is all over the international media these day and surprise, surprise he is making a lot more sense than a lot of people (including myself) had feared.

I have certainly not been optimistic about what the new hardcore leftist Greek government would come up with. However, I most admit that I have some (considerable) sympathy for the fact that Greek public finance problems are not entirely a result of Greek economic-political mismanagement (even though there has been a lot of that).

Hence, the sharp rise in Greek public debt to GDP since 2008 to large extent is a result of the collapse of Greek nominal GDP and I have often been arguing that we do not (primarily) have a debt crisis in the euro zone. We have a nominal GDP crisis and the euro crisis is primarily a result of overly tight monetary policy.

While Varoufakis certainly is not a monetarist he fully well understands that at the core of the Greek crisis is the collapse in NGDP and I was very pleasantly surprised to see his proposal for a new Greek debt deal with the EU.

This is what Financial Times writes about Varoufakis’ new proposals:

Attempting to sound an emollient note, Mr Varoufakis told the Financial Times the government would no longer call for a headline write-off of Greece’s €315bn foreign debt. Rather it would request a “menu of debt swaps” to ease the burden, including two types of new bonds.

The first type, indexed to nominal economic growth, would replace European rescue loans, and the second, which he termed “perpetual bonds”, would replace European Central Bank-owned Greek bonds.

He said his proposal for a debt swap would be a form of “smart debt engineering” that would avoid the need to use a term such as a debt “haircut”, politically unacceptable in Germany and other creditor countries because it sounds to taxpayers like an outright loss.

So Varoufakis is suggesting is to swap the Greek debt to the EU (and ECB) with nominal GDP linked bonds. What can I say? Great idea Yanis!

I have of course for years be arguing that governments should issue debt linked to nominal GDP – not only because NGDP linked bonds would provide a very good measure of the monetary policy stance, but also because it would be good from a public finance perspective (and from a general macroeconomic stability perspective).

I therefore wholeheartedly support Varoufakis’ proposal – as a general principle to debt restructuring. Obviously to make a deal it should be in the common interest of both the EU and Greece and there are certainly very good arguments against just sending another big cheque to Athens. But this is exactly the point – this would (in general) be in the interest of both Greek and German taxpayers.

What we want to see is a situation where Greek government continues to service its debt. But we also want a situation where this doesn’t push Greece to a disorderly default and a disorderly exit, which would jeopardize economic and financial stability in Europe. I believe that a new debt deal that to a larger extent links Greek public debt to the future developments in nominal GDP would make it easier for Greece to service the debt, but also make it less likely that we get a disorderly collapse.

How would it work?

The general idea with NGDP linked bonds is that the servicing of the public debt is linked to the performance of Greek NGDP. This would mean that if growth picked up in Greece then the Greek government would pay of more debt, while is NGDP growth slows then Greece will pay of less debt.

This of course would make Greek public finances much less sensitive to shocks to NGDP and therefore reduce the likelihood that the Greek government would be forced to defaults if growth fails to pick-up. On the other hand German taxpayers should welcome that if there I a pick-up in NGDP growth in Greece then the Greek government would actually pay back its debt faster than under the present debt agreement.

Furthermore, more if public debt servicing is linked to the development in NGDP growth then Greek public finances would become significantly more counter-cyclical rather than pro-cyclical.

Jens Weidmann should be Varoufakis’ best friend

Hence, there are some very clear advantages with NGDP linked bonds. The most important, however, might be that if Greek public debt is linked to NGDP then it would significantly ease the pressure on the ECB to do things that fundamentally has nothing to do with monetary policy.

The ECB’s job odd to be to ensure nominal stability in the euro zone economy. It is not and should not be the job of ECB to bail out governments and banks. Unfortunately again and again over the past six years the ECB has been forced to bailout euro zone countries for example through the so-called OMT programme. Hence, ECB has again and again conducted credit policy (rather than monetary policy) to avoid euro zone countries defaulting.

The ECB is largely to blame for this itself because it has kept monetary conditions far too tight. However, it does not change the fact that the ECB has been under tremendous pressure to bailout nations and banks rather than conduct sound monetary policies.

By linking Greek public debt to NGDP (in Greece) Greek public finances would be more immune to monetary policy failure in the euro zone.

And this is why the hawkish Bundesbank chief Jens Weidmann should be an enthusiastical support for Varoufakis’ debt plan as the “cost” of tight monetary policies in the euro zone would be smaller.

Just imagine that all public debt in the euro zone had been linked one-to-one to euro zone NGDP. The ECB might have failed in 2008 to keep NGDP “on track”, but there would not have been any public finances crisis in the euro zone as public debt to (N)GDP ratios would have remained fairly stable and it would have been very unlikely that Greece would have needed an bailout. In such a situation the pressure to the ECB to support government lending would have been much smaller.

The graph below illustrates the very close correlation between NGDP growth and public debt developments in the euro zone. Greek debt ratio spiked primarily because Greek NGDP growth collapsed.

I have a lot of sympathy for the “German view” that the ECB should not bailout banks and countries, but if the ECB fails to deliver nominal stability it is unavoidable that there will be pressure on the ECB to do things it shouldn’t be doing.

Therefore, Jens Weidmann should not only endorse the general principle that Greek public debt to a larger extent should be linked to NGDP growth, but he should also advocate that public debt across the euro zone should be NGDP linked as it would significantly reduce the pressures the ECB to conduct problematic credit policies, which increases moral hazard problems.

Varoufakis should pay tribute to David Eagle

Yanis Varoufakis probably never heard of David Eagle. In fact economists never heard of David Eagle. However, I believe that David is the economist in the world who has done the most interesting academic work on what he has termed quasi-real indexing. David’s work centres on both the principle of making debt linked to the development in nominal GDP and on the advantages of NGDP targeting.

David back in 2012 wrote a numbers of very insightful guess posts on this blog about these topics. Everybody interested in the theoretically foundation for Varoufakis’ ideas should read this guest post. Here is an overview:

Guest post: GDP-Linked Bonds (by David Eagle)

Guest blog: NGDP Targeting is NOT just for Central Banks! (David Eagle)

Guest Blog: The Two Fundamental Welfare Principles of Monetary Economics (By David Eagle)

Guest post: Why I Support NGDP Targeting (by David Eagle)

Guest post: Central Banks Should Quit “Kicking Them While They Are Down!” (by David Eagle)

Quasi-Real indexing – indexing for Market Monetarists

David Eagle’s framework and the micro-foundation of Market Monetarism

Dubai, Iceland, Baltics – can David Eagle explain the bubbles?

A simple housing rescue package – QRI Mortgages and NGDP targeting

Supporting NGDP-linked bonds, but not the entire “Syriza package”

I have in this blog post voiced my support for the Greek Finance Minister’s suggests for a debt swap based on NGDP bonds. I should stress that that does certainly not mean that I in any other way supports the Greek government’s economic proposals. In fact I am deeply concerned about some of the ideas, which has been floated by the Greek government. The governing Syriza party is an extreme leftist party, which is strongly opposed to the free markets ideals I hold dearly, but on the issue of the desirability of NGDP linked bonds the Greek government has my full support.

Follow

Get every new post delivered to your Inbox.

Join 4,552 other followers

%d bloggers like this: