Could Central Banks do More during the Crisis?

September 7, 2018 3 comments

I rarely disagree with Martin Sandbu’s Free Lunch. But today’s piece on central banks is one of these cases.

In short, Martin argues that while the main culprit for the slow recovery is fiscal policy, almost everywhere too timid if not outright procyclical (we are all on board on that!), the mistakes of fiscal authorities do not exempt central banks from bearing part of the responsibility. In particular, he dismisses the claim that it was technically impossible to lower long-term interest rates further, and/or bring policy rates even more into negative territory.

I agree with this point. Interest rates could have been lowered further. Nevertheless, I think that this would have made very little difference, because after 2008 central banks were essentially pushing on a string.  This point of disagreement between us can be traced to a different view about what is the liquidity trap.

I recently published a book, La Scienza inutile (a general public account of a century of debates in macroeconomics. For the moment it is in Italian and in French, English translation in progress), in which I discuss the different notions of liquidity trap. Here is the quote (sorry, a bit too long):

 The first source of trouble that Keynes considers is the most extreme, the so-called liquidity trap: `There is the possibility, […] that, after the rate of interest has fallen to a certain level, liquidity-preference may become virtually absolute in the sense that almost everyone prefers cash to holding a debt which yields so low a rate of interest. In this event the monetary authority would have lost effective control over the rate of interest’ (Keynes 1936, p.207). In slightly more technical terms, the interest elasticity of money demand is near-infinite: no matter how much liquidity the central bank injects into the economy, it is entirely hoarded by agents and hence it leaks out of the system in its entirety. Monetary expansion is not effective in lowering interest rates.

There may be different reasons why the economy enters a liquidity trap. Keynes argued, by looking at the great depression, that this usually happens at very low (but not necessarily nil) levels of the interest rate, because in this case agents would expect interest rates to rise in the future and thus would be willing to hold any extra amount of money and postpone the purchase of bonds to the moment when interest rates will be up again. More recently the liquidity trap has been defined as a situation in which the interest rate that equates savings and investment is negative, and therefore cannot be attained by the central bank (the so-called Zero Lower Bound, or ZLB; see e.g. Krugman 2000). This latter definition leaves some room for monetary policy effectiveness: if the central bank manages to trigger the expectation of positive inflation, the real interest rate (the nominal interest rate minus the inflation rate) will become negative and lead to the full employment equilibrium.

So, if we think in terms of ZLB, it exists a real interest rate at which the output gap would be closed. If that interest rate is negative, then it is harder to reach, as central banks need to raise inflation expectations and try to push short term rates as much as possible in negative territory, which requires boldness and creativity (we have seen this). But, once again I agree with Martin on that, this can be done. If instead private expenditure becomes irresponsive to interest rates, the ‘Keynes definition’, then there is little central banks could do. I had noticed, back in 2016, that while it succeeded in easing credit conditions, EMU Quantitative Easing seemed to have done little to boost confidence and expected demand (the ultimate driver of firm’s credit needs). The EMU most recent Bank Lending Survey seems to confirm the prediction of the time. Both chart 4 (enterprises) and chart 12 (households) depict a flat demand for loans, that picks up only when the EMU economic outlook brightens.

This is by no means hard evidence (I am not aware of any papers thoroughly investigating the impact of QE on credit demand). But stylized facts seem to acquit central bankers.

 

 

ps

The two works cited in the quote:

Keynes, J. M. (1936). The General Theory of Employment, Interest, and Money. London: McMillan.

Krugman, P. (2000). Thinking About the Liquidity Trap. Journal of the Japanese and International Economies 14(4), 221–237.

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Democratising Europe begins with ECB nominations

January 30, 2018 1 comment

I repost here a post from Thomas Piketty’s Blog, originally published as an op-ed on Le Monde, which I was happy to sign.
This collective op-ed was initially published on January 22 2018 in Le Monde (in French) and in VoxEurop (in English).

While our eyes are glued to the interminable vicissitudes of the German Groko, a no less important story is playing out in Brussels, but has so far met with indifference. On January 22nd and February 19th, Eurogroup finance ministers will hold private meetings that will mark the beginning of a profound renewal of the European Central Bank executive board. The first big change will be the planned replacement of current Vice-President, Vitor Constancio. In the next two years, no less than 4 of the 6 members of the executive body of the ECB, Mario Draghi included, will be replaced.

All signs indicate that the future of economic, fiscal and monetary policy in eurozone countries is at stake in this series of nominations. The ECB of 2018, after all, barely resembles that earlier organisation which spent its relatively quieter days at the periphery of European policy, protected by its independent status. Built by governments and financial markets as an institutional recourse, the ECB started wielding more power thanks to the 2008 economic and financial crisis. Whether it’s telling member states how to finance their market debts, suggesting the adoption of a budgetary treaty (Fiscal Compact), notifying Irish or Italian heads of state that they should undertake without delay a raft of onerous reforms, or directly intervening in negotiations on the Greek crisis by controlling access to liquidities, it is always as a veritable co-ruler of the eurozone that the ECB operates.

After a decade of crisis, the ECB is no longer the same institution that was drawn up by the Treaties and consecrated to the sacro-saint goal of price stability: it has established itself, estimates at the ready, as Chief Economist of the eurozone; it has acquired executive power via the troika (with the European Commission and the IMF), which defines and ensures the execution of memoranda in countries being “helped”; it plays a central role in eurozone and Eurogroup summits which coordinate national economies; it has become a regulator of the banking world, deciding on the life and death of the largest banks in the eurozone; it has established itself as a reformer, working with coalitions built on prioritising “structural reforms” (labour markets), “competitiveness” (restrictive salary policies), etc.; it speaks on equal terms with the four other “presidents” of the Union (of the Commission, the Council, Eurogroup, and, finally, the European Parliament) when it comes to designing the political and institutional future of eurozone government, etc.

And yet, it as if the coming nominations are just another technicality. While there is in fact a rare occasion for leading parties and actors of representative politics to make their weight felt on the crucial issue of eurozone governance, everything seems set to keep nominations behind closed doors. Finance ministers are wary of having their decisions in Brussels held to account by their national parliaments; Eurogroup, an institution barely recognised by European treaties but which in fact plays a decisive role in the matter, has no form of political control. As is often the case, the European Parliament, which will hold a hearing for the chosen candidate, will arrive after the dust has settled, after negotiations have been concluded and compromises have been accepted, to give its… consultative opinion.

Meanwhile, there’s no lack of questions concerning the future of ECB policies and the role it should play: what position should it take in the reform of eurozone governance? What will its commitments be with regard to the European Parliament? What will become of its monetary policy when inflation has disappeared? What support can to bring to the Union’s policies? What are its priorities for the next eight years in terms of banking regulations? What place will be given to social partners? What form of policy will there be against conflicts of interest for the banking regulator? What redistributive effects can we expect from ECB policies? No doubt, the responses to these questions will determine the future course of the government of the eurozone. Candidates need to be questioned, and their responses should be known and debated.

Financial markets and governments seem satisfied with the current situation, happy to throw a veil of ignorance over the nomination process. And the signals coming from Brussels are hardly reassuring, leading us to suspect that Spain, imagining that its time has come, will propose it’s current minister for the economy, Luis de Guindos, for the vice-presidency on January 22nd. One of de Guindos’s main claims to fame is having been the executive president for Spain and Portugal’s branch of the Lehman Brothers during the peak of the financial crisis…

In the absence of the eurozone parliamentary assembly called for in the treaty for the democratisation of the eurozone (T-dem), of which one function would be precisely the political supervision of ECB nominations, there is still nothing preventing finance ministers from making public the criteria which justify their preferences for this or that candidate, and the conditions they want to impose on them.

The nomination process does not have to be conducted in private. It doesn’t have to be yet another game of European musical chairs. Nothing, in effect, is stopping finance ministers from making their decisions, and the reasons behind those decisions, public. Nothing is stopping candidates, those for the presidency most of all, from stepping forward in the coming months, being heard by national representatives, and stating their commitments.

And nothing, finally, is stopping the European Parliament from making its participation in the nomination process conditional on its own basic political requirements. This is how European parties, unions and NGOs can cut a path and begin weighing in on the decisions which will decide economic, fiscal and monetary policies within the eurozone. This would be the first real step – however modest – towards the democratisation of Europe.

Last September, in Athens, Emmanuel Macron called emphatically Europe to bring more « democracy, controversy, debate, building through critical spirit and dialogue ». It is now time that words and deeds go hand in hand.

First signatories :

Sébastien Adalid, jurist, professer at the University of Le Havre

Michel Aglietta, economist and professor emeritus at the University of Paris Nanterre

Peter Bofinger, economist, professor at Saarland University

Loïc Blondiaux, political scientist, professor at the Paris 1 University

Julia Cagé, economist, professer at Sciences Po, Paris

Amandine Crespy, political scientist, professor at the Université libre of Brussels

Anne-Laure Delatte, economist, director of research at CNRS

Bastien François, political scientist, professor at the University of Paris 1

Ulrike Guérot, political scientist, professor at the Danube University

Stéphanie Hennette, jurist, professer at Paris Nanterre University

Justine Lacroix, political scientist, professor at the Université libre of Brussels

Rémi Lefebvre, political scientist, professor at the University of Lille 2

Nicolas Leron, political scientist, think tank EuroCité

Ulrike Liebert, political scientist, professor at the Bremen Univeristy

Paul Magnette, political analyst, mayor of Charleroi

Francesco Martucci, lawyer, professor at Paris 2 University

Thomas Piketty, economist, director of studies at EHESS

Ruth Rubio Marín, lawyer, professor at Sevilla University

Guillaume Sacriste, political analyst, lecturer at Pantheon-Sorbonne University

Francesco Saraceno, economist, OFCE

Frédéric Sawicki, political scientist, professor at the University of Paris 1

Laurence Scialom, economist, professer at Paris Nanterre University

Xavier Timbeau, economist, principal director of OFCE

Antoine Vauchez, political analyst, director of research at CNRS

Translated by Ciaran Lawles

Public Debt. I can’t Believe we are Still There

January 25, 2018 3 comments

The crisis is supposedly over, as the European economy started growing again. There will be time to assess whether we are really out of the wood, or whether there is still some slack. But this matters little to those who, as soon as things got slightly better, turned to their old obsession: DEBT! Bear in mind, not private debt, that seems to have disappeared from the radars. No, what seems to keep policy makers and pundits awake at night is ugly public debt, the source of all troubles (past, present and future).

Take my country, Italy. A few days ago this tweet showing the difference between the Italian and the German debt made a few headlines:

 

The ratio increased, so DEBT is the Italian most pressing problem. Not the slack in the labour market. Not the differentials in productivity. I can’t stop asking: why aren’t Italians desperately tweeting this figure?

2018_01_25_Public_Debt1

This shows the relative performance of Italy and Germany along two very common measures of productivity, Multifactor productivity and GDP per capita. I took these variables (quick and dirt from the OECD site), but any other measure of real performance would have depicted a similar picture.

So what? The public debt crusaders will argue that precisely because of debt, Italy has poor real performance. The profligate public sector prevented virtuous market adjustments, and hampered real convergence.  The causality goes from high debt to poor real performance, they will argue. Reduce debt!

Well, think again. Research is much more nuanced on this. A paper by Pescatori and coauthors shows for example that countries with high public debt exhibit high GDP volatility, but not necessarily lower growth rates. High but stable levels of debt are less harmful than low but increasing ones. In a recent Fiscal Monitor the IMF has shifted the focus back to private debt (which, it is worth remembering is the root cause of the crisis), arguing that the deleveraging that will necessarily continue in the next few years will require accompanying measures from the public sector: on one side, renewed attention to the financial sector, to make sure that liquidity problems of firms, but also of financial institutions) do not degenerate into solvency problems. On the other side, the macroeconomic consequences of deleveraging, most notably the increase of savings and the reduction of private expenditure, may need to be compensated by Keynesian support to aggregate demand, thus implying that public debt may temporarily increase in order to sustain growth (self promotion: the preceding paragraph is taken from my book on the relevance of the history of thought to understand current controversies. French version available, Italian version coming out in March, English version coming out eventually).

In just a sentence, the causal link between high debt and low growth is far from being uncontroversial.

Last, but not least, it is worth remembering that Italy was not profligate during the crisis; unfortunately, I would add.  Let’s look at structural deficit (since 2010; ask the Commission why we don’t have the data for earlier years), which as we know washes away the impact of cyclical factors on public finances.

2018_01_25_Public_Debt2

The Italian figures were slightly worse than the German ones, but not dramatically so. And if we take interest expenditure away, so that we have a measure of what the Italian government could actually control, then Italy was more rigorous (Debt obsessive pundits would use the term “virtuous”) than Germany.

The thing is that the Italian debt ratio is more or less stable, in spite of sluggish growth (current and potential) and low inflation. It is not an issue that should worry our policy makers, who should instead really try to boost productivity and growth. Said it differently, it is more urgent for Italy to work on increasing the denominator of the ratio between debt and GDP than to focus on the numerator. And I think this may actually require more public expenditure and a temporary increase in debt (some help from the rest of the EMU, starting from Germany, would not hurt). It is a pity that the “Italian debt problem” is all over the place.

The Euro Debate: Back to Square One

November 20, 2017 2 comments

I was glad to write a preface for the Italian translation (La moneta rinnegata) of Martin Sandbu’s latest effort (Europe’s Orphan). A somewhat shorter version can be found on the website of LuissOpen.

In a few sentences, I believe that the interest of the book lies in two points:

  • First, its rebuttal of the “flawed euro” narrative. This narrative is shared by euro skeptics and federalists (including myself more often than not), and it fatally hurts the capacity of the latter to win the argument. If the euro is flawed, and if a political union is not in the cards, then it is hard to argue against XX-exiters with arguments other than fear. And fear (Brexit docet) does not work.
  • Second, Sandbu shows masterfully something I have also been saying, much less effectively: institutions (and money is one) do not make policies. People do. None of the policy mistakes that disseminate the euro crisis Via Crucis  was inevitable. In the piece for LuissOpen I notice that institutions may still bias the choice in certain directions (think of the Stability Pact), but in spite of that I join Sandbu in believing that the Euro is the scapegoat for policies that could and should have been different. La moneta rinnegata, indeed.

I would add something, that came to my mind after I had sent out the piece. Sandbu puts at the center of his narrative the issue of debt restructuring. It is the refusal of EU creditors to consider forgiveness for a debt that was anyway never to be repaid, that led to self-defeating austerity. Sharing the burden (debt relief) would have entailed lower costs and eventually, would have increased resilience and more sustainable public finances. The IMF recognized this fundamental contradiction, but the other creditors (must notably Germany) did not.

And they still don’t. I believe that the whole debate about risk sharing versus risk reduction, that shapes the discussion on EMU reforms, replicates the fault lines we saw at work for debt crisis management. On one side those who believe that market mechanisms or policy constraints, alone, cannot dampen the centrifugal forces that are inevitably built in any monetary union. On the other, those who believe that the collective convergence will happen once each member behaves, so that enhanced rules and firewalls are all that is needed for the euro to thrive.

Thus Sandbu’s book helps making sense of what happened, but also to assess the proposals for the future. Refusal to share costs linked to the debt crisis turned out to be a huge mistake. We should avoid making another one by refusing to fight divergence through risk sharing.

A German Model?

September 23, 2017 1 comment

Tomorrow Germany votes, and there is little suspense, besides the highly symbolic question of whether the far right will make it into the Bundestag.

Angela Merkel will be Chancellor for the fourth time, marking a long period of political and policy stability. In the past fifteen years Germany emerged as the model to follow for the other large economies. For since its economy has performed better, in terms of growth and unemployment, than France or Italy.

I have at discussed at length, here and elsewhere, the costs of the German success in terms of global imbalances and uncooperative behaviours. Last week I wrote a piece for the newly born magazine LuissOpen (Ad: Follow it on twitter! There is plenty of interesting content well beyond economics! End of Ad).

The piece lists, in a non exhaustive way, a number of weaknesses that can be spotted behind the shining macroeconomic results, and also argues that there is much more than labour market liberalization behind a successful economic model (including in Germany).

The original piece can be found here (and here in Italian). I copy and paste it below

Three months after his commencement, Emmanuel Macron delivered last week one of the most important, and controversial, promises of his agenda. The loi travail that will become operational in the next few weeks mostly deals employment protection, which is weakened especially for small and medium enterprises. The aim is to lift constraints for firms hiring, and thus increase employment. This first set of norms should be followed in the next weeks or months by norms aimed at improving training and employability of unemployed workers. Once completed, the package would be the French version of the flexicurity that Scandinavian countries put in place in the past, with different degrees of success.

Without entering into the details of the law, the set of norms approved by the French government, just as the Italian Jobs Act voted in 2014, is a bold step towards the flexibilization of  labour market relations that Germany has in place since the early years 2000, with the so-called “Hartz Reforms”. The German experience, and to a minor extent the first few years of application of the Job Act, can help understand how the French labour market could evolve in the next few years.

Germany in fact sets itself as an example. The argument goes that the reforms it implemented in 2003-2005, did liberalize labour markets, and since then, with the exception of the first years of the crisis, unemployment has been steadily decreasing. But in fact, this is a misleading example, because the Hartz reforms were embedded in a complex institutional setting, which goes well beyond labour market flexibility.

First, an important segment of the German labour market, the one linked to manufacturing and business services, has always been ruled by long-term agreements between employers, workers, and local work councils. For these insider workers a system of work relations was in place, in which highly paid workers acquired skills through vocational training (within or outside the firm), and were protected by an all-encompassing welfare system. Vocational training created robust bonds between the firms, that had often invested substantial resources in the training, and the workers, whose specific skills could not easily be transferred to other sectors or even to other firms.

At the turn of the century, globalized markets coupled with the aftermath of the reunification, exerted a serious pressure for a restructuring  of labour relations.  This restructuring happened through a consensus process that did not involve the government, and kept untouched the bond between the firm and the worker created by vocational training.

The mutual interest in preserving the long-term relationship between workers and firms in the insider markets, led to agreements aimed at reducing costs or to increase productivity without increasing turnover or reducing average job tenure. These agreements could involve on the workers’ side labour sharing, flexibility in hours and in labour mobility, wage concessions, reductions in absenteeism. In exchange for this, firms would guarantee continued investments in innovation and in the (vocational) training of workers, and job security.

It is crucial to understand that the Hartz reform did not touch the insiders market (manufacturing, finance, insurance and business, etc), that as we just said had already begun restructuring without government intervention. The reform made the welfare system less generous, while  allowing access to benefits even for workers with low earnings, thus de facto introducing incentives to low-paid jobs. Furthermore, it liberalized temporary work contracts, and made more flexible a few sectors subject to competition from posted workers (i.e. construction).

The combined result of reforms and endogenous restructuring yielded a spike in part time jobs, and an increase of employment. But it also widened the gap in earnings and in protection between workers in the export-oriented sectors and the others.

The second feature of the German system that made it resilient during the crisis is the existence of a dense network  of local public savings banks (the Sparkassen). Savings bank were a defining feature of the banking sectors of a number of European countries (e.g. Spain, Italy), but have progressively become marginal. Germany is therefore an exception in that its local savings banks are still a pillar of its economy.

Local savings banks have specific public interest missions, as they are involved in the development of local communities, and in financing households and firms (in particular SMEs). The law only allows operation within the region of competence, which shields them from competition while keeping them close to their stakeholders. Similarly, the ambit of their operations is limited (for example, they face limits in their capacity to engage in securities trading or in excessively risky financing).

To avoid that these limitations hamper their effectiveness and their solidity, the banks work as a network  among them. The network exhibits economies of scale and of scope, while remaining close, in its individual components, to local communities. Furthermore, the existence of solidarity mechanisms (rescue funds) ensures that temporary difficulties of a bank are tackled without spreading contagion.

The major private commercial banks, very active in international markets, did suffer like in most other countries, were a drain on public finances, and drastically contracted their lending to the real sector. The Sparkassen on the other hand kept their financing steady (especially to SMEs) and required virtually no state aid. As a consequence, the local savings banks cushioned the impact of the financial crisis on the German economy, and their continued financing of firms is certainly a major factor in explaining the quick rebound of the German economy after 2010.

If taken together, the banking sector and the labour market institutions design a remarkably efficient system, geared towards the establishment of long run relationships in which the interests and the objectives (between entrepreneurs and workers, between banks and firms) were aligned.

But this effectiveness did not come without costs. From a macroeconomic point of view, profitability and competitiveness increased, but also precautionary savings, induced by a less generous welfare state, and by the increased uncertainty faced by workers. The “success” of the German export-led economy, that had a 9% current account surplus in 2016, is based on the compression of domestic demand, and on a labour market that is increasingly split in two, and in which inequality increased dramatically.  The low unemployment that should make other countries envious hides a massive increase of the so-called working poor. (See figure 2 here)

I would push this even further: the Hartz Reform had a strong impact on labour market dualism and precariousness, but only a minor one in explaining the resilience of the economy. A recent CER policy brief makes a somewhat similar point.

Following the Jobs Act, the Italian labour market seems to be headed in a similar direction as the German one. The recent data released by ISTAT on labour market development certified the return of employed people to the pre-crisis peak (2008), thus marking, symbolically the end of the crisis. Yet, GDP is still 7% below its 2008 level, meaning that the increase of employment happened in low value added sectors (such as for example tourism and catering), and often with part-time contracts. These are typically sectors with low and very low wages, and stagnant productivity dynamics. At the same time, wages (but not employment) increase in manufacturing-export oriented sectors. The Italian labour market, in a sentence, is heading towards the same dualistic structure that characterizes the German one. This explains why, like in Germany, Italian domestic demand stagnates; why the increase in employment is obtained at the price of increased precariousness and of the working poor; why, finally, while the numbers say that the crisis is beyond us, the actual experience of households is often different. Italy, and to a minor extent Germany, are the best proof that employment and growth do not necessarily go hand in hand with increased well-being.

Focusing exclusively on labour market flexibility, Italy and in France only imported one element of the German “model”; and probably the one that is by far the least important.  The German capacity to put in place long term relationships, the real key to economic resilience success, is lost in our countries.

Can France Survive Without Europe?

May 6, 2017 2 comments

I should begin by saying that it is sad to see that my last post dates from February 20. Lots of things going on right now, in particular the wrapping up a book on the history of macro, that is draining all my energies. But I need to try harder to keep the blog going…

At any rate, tomorrow France votes. And I wrote a piece for Social Europe, in which I try to put the outcome of the election in the European context. If you do not want to read all of it, here are the bullet points:

  1. France is considered the sick man of Europe for the standard reasons (rigidity lack of reform etc)
  2. 2) But in fact “hard” data are not that bad, rather the contrary (productivity investment FDI, etc). Just look at Thomas Piketty’s blog post from a few months ago.
  3. lost competitiveness is price competitiveness, that is not France’s fault, but Germany’s (wage deflation).
  4. In fact the sick man of Europe is Europe itself, because it forces countries into a dilemma:
    • They can engage in fiscal competition and internal devaluation. But let’s not fool ourselves, there is no way that this can be done without killing the European social model. Only the downsizing of the welfare state can allow reducing taxes and labour costs and keeping public finances sustainable;
    • Or, they (try to) protect their social model, but pay the price of low competitiveness and slow growth.
  5. France oscillated between Scylla and Charybdis, leaning more towards the second path.  And it suffers, because most other countries did take the internal devaluation  path, willingly or not . Everything in the way the EMU is constructed, pushes countries to engage in deflationary policies.
  6. Exiting (from the Euro, from the ECU, from the EU) would in no way subtract countries to the dilemma. A small open economy would have an even harder time carrying on autonomous economic policies (more in general, what I think of XXexit is well summarized here. To be fair to my colleagues, I contributed very little to that piece, but was happy to sign it).
  7. Thus, the survival of the French model is in Europe, or it is nowhere. The next President’s fate will have to be decided there
  8. If France wants to save its social model, it needs to trigger change in the EU. It will save its model. Otherwise it is doomed; it will not survive, socially and electorally, to five more years of muddling through.
  9. And viceversa, if there is a chance for Europe to change, that chance is represented by a coalition against deflationary policies that only France would have the strength to form and lead. There is one way, and only one way, to escape Scylla and Charybdis.

I did not write that in the Social Europe piece, but I want to add that the path is very narrow. Macron has the virtue of putting Europe at the center of his project, but his reform proposals are for the moment very vague. And more importantly, his tax reduction plan resembles a bit too much to the good ol’  supply side measures that sank Jean-Baptiste Hollande.  But then, what do we know? First, policies are shaped by events; and second Le Pen would of course mean the end of the Euro right now. So, we can just hope that (and fight for) France and Europe will walk that narrow path.