Month: November 2014

Monetary policy tradeoffs in CESEE###

Lars E.O. Svensson

http://larseosvensson.se
Department of Economics, Stockholm School of Economics, P.O. Box 6501, SE-113 83 Stockholm, Sweden, www.sse.edu

Conference on European Economic Integration (CEEI) 2014 Vienna, November 24, 2014

Monetary policy’s best contribution to financial stability?
* Inflation on target and resource utilization at long-run sustainable rate
* Suppose 2% inflation and 3% real growth, nominal growth 5% of asset prices and disposable income, doubling every 14 years
* For any given nominal debt, LTV and DTI ratios halved in 14 years. Pretty good for repair of balance sheets.
* Monetary policy should only be the very last line of defense of financial stability, normally not to be used

Outline
* What can monetary policy achieve?
* Do not ask to much from monetary policy
* What is the relation between monetary policy and financial stability?
* Monetary policy and financial-stability policy are very different
* In normal times: Best conducted separately, also when conducted by the same institution
* But each policy should be fully informed about and take into account the conduct of the other policy
* In crisis times: Full cooperation between the relevant authorities
* Monetary policy should be the very last line of defense of financial stability, not to be used in normal times

What can – and cannot – monetary policy achieve?
* MP can stabilize inflation around a given inflation target
* MP can stabilize overall resource utilization around a long-run sustainable rate
* But the latter is determined by nonmonetary, structural factors
* MP cannot affect the long-run sustainable rate of resource utilization
* This requires structural policies
* MP cannot solve structural problems
* This requires structural policies

What can – and cannot – monetary policy achieve?
* MP cannot achieve financial stability
* This requires financial-stability policy (macroprudential policy)
* Leaning against the wind cannot solve debt problems
* See Riksbank bad example (FT Big Read Nov 20)
* In Swedish case, benefits of leaning are just around 0.4% of costs (should have be more than 100% of costs to justify policy)
* Inherent flaw in leaning
* Running inflation below a credible inflation target increases
households’ and other agents’ real debt burden
* It also increases unemployment

What can – and cannot – monetary policy achieve?
* Do not ask too much of monetary policy

What is the relation between monetary policy and financial stability?
* Distinguish economic policies according to:
* (1) objectives,
* (2) suitable instruments, and
* (3) responsible authorities
* MP and financial-stability policy (FSP) are clearly separate policies, with different objectives and different suitable instruments, regardless of whether they have the same or different responsible authorities

Monetary policy
* Objective
* Flexible inflation targeting: Price stability and real stability
* Instruments
* Normal times: Policy rate, communication
* Crisis times: Also unconventional measures, balance sheet policies, FX policy, …
* Responsible authority
* Centralbank

Financial-stability policy
* Objective
* Financial stability: Financial system fulfilling 3 main functions w/ sufficient resilience to disturbances that threaten those functions
* Instruments
* Normaltimes:Regulation,supervision,macroprudentialpolicy, buffers, capital requirements, LTV caps, LCRs, NSFRs, taxes, deposit insurance, …
* Crisis times: Lending of last resort, liquidity support, capital injections, guarantees, banking resolution, …
* Authority(ies)
* Varies across countries
* FSA, CB, banking-resolution authority, MoF, …

What is the relation between monetary policy and financial-stability policy?
* Very different policies
* In normal times: Conduct independently, also when conducted by the same authority
* Each policy should be fully informed about and take into account the conduct of the other’s policy
* Similar to MP and fiscal policy (Nash equilibrium rather than coordinated equilibrium (joint optimization)
* In crisis times: Full cooperation and joint policies by FSA, CB, MoF, banking-resolution authority…

Monetary policy’s best contribution to financial stability?
* Inflation on target and resource utilization at long-run sustainable rate
* Suppose 2% inflation and 3% real growth, nominal growth 5% of asset prices and disposable income, doubling every 14 years
* For any given nominal debt, LTV and DTI ratios halved in 14 years. Pretty good for repair of balance sheets.
* Monetary policy should only be the very last line of defense of financial stability, normally not to be used

Svensson.pdf

Over at Project Syndicate: Last month in this space we reviewed the pulling-apart of America as it has become a vastly more unequal place since 1979: top 1% incomes grew at 3.6%/year, rest of the top fifth grew at 1.6%/year, middle three-fifths grew at 0.9%/year, bottom fifth at 0.5%/year-—with the proviso that improved access to medical care was worth a good deal more than its market cost. But the past generation has seen a third industrial revolution, a worthy information-age successor to the first of steam, iron, cotton, and machines and to the second of internal combustion, electricity, steel, and chemicals. Not everyone, but almost everyone in the North Atlantic and many and soon most in the world, can now if they wish have a smartphone–and so gain cheap access to the universe of human knowledge and entertainment to a degree that was far beyond the reach of all but the richest of a generation ago.

How much does this matter? How much does this mean that conventional measures of real income and real standard of living understate how much we, even the relatively poor of we, have progressed toward utopia?

The conventional economic growth accounting tells us that consumption expenditures on telecommunications, information processing, and audiovisual entertainment are 2% and net investment in information processing equipment and software 3% of output. That means that a price fall of 10%/year in that category of high-tech goods contributes 0.2%+0.3%=0.5%/year to economic growth in standards of living. The problem is that the bulk of that increase is already in the estimates. The share of spending has to signficantly underestimate the marginal salience of information-age goods and services in human well-being in order to make the argument that this third industrial revolution is a boost above rather than an important component of measured modern economic growth.

Now it is plausible that this is the case. Human well-being requires not just the expenditure of money purchasing goods and services but the use of the time that is the stuff of our lives to utilize those goods and services properly, and time is along with money a very scarce resource. And information-age goods and services, because they require our attention, are time-intensive. Suppose—a reasonable guess–the coming of the broadband internet since 1999 has doubled the utility that humans get out of the two hours a day that those of us in the North Atlantic typically spend interacting with our audio-visual technologies. Those two hours are one-fifth of the time we spend awake that is our own, and not our bosses’. That’s an extra 0.6%/year in growth of standards of living since 1990—much bigger than the 0.2%/year that the growth-accounting cost-based literature leads us to.

However, such a calculation requires that we be or become the type of people whose lives are truly enriched by our kindles and our tablets and our computers and our smartphones—that we value Netflix and Youtube and Google’s window into the online library of humanity and Facebook and the rest as massively superior to the ways we previously learned, gossiped, listened, and watched. It is certainly true that we today have information-age capabilities that are literally those of kings in the past: if in the seventeenth century you wanted to watch “MacBeth” in your house, you had better be named James Stuart, have William Shakespeare and his acting company on retainer, and be King of England and Scotland so that you could have a full-sized theater in your palace of Whitehall. And ever since Homer chanted his “Iliad” around the campfire after dark we have been willing to pay through the nose for our culture of stories and information.

Yet not all of us are all that devoted to our FaceBook friends. And much of what many of us desire goods and services for is as indicia of relative status. Perhaps the right way to view the situation is that before the information age began our estimates of economic growth overstated true reality by perhaps 0.5%/year as the extra well-being we got from increased real wealth and income was offset by our noticing that the Jones’s next door had more, better, and newer than we did? Perhaps the right way to view the situation is that those parts of the information age that escape conventional growth-accounting calculations simply neutralize those forces of envy and spite that were never included in the calculations in the first place? That is my tentative judgment–or rather guess–today.

791 words

Conference on European Economic Integration (CEEI)

Re: Richard Koo http://www.oenb.at/dms/oenb/Publikationen/Volkswirtschaft/CEEI/2014/koo_ppp/Koo_PPP.pdf

I am not sure that I can ask this question coherently. So if I do not, please feel free to just say “that was not coherent” and move on to answering the coherent questions…

The conventional arguments of those whom Martin Wolf calls the Austerians runs more-or-less like this: someday QE will succeed in shifting beliefs from an expectation of permanent depression to an expectation of rapid normalization. Savers then look at their holdings of maturing government bonds and roll them over only if they are offered a normal and positive real interest rate. And then the price level will rise very rapidly to a value at which–as John Maynard Keynes said of France during its inflation of the 1920s–real future government primary surpluses discounted at the normal real interest rate are equal to the nominal debt divided by the price level.

In your framework, that would be a sudden very large shift in private-sector net savings behavior from surplus to deficit. And in your framework such a shift is almost inconceivable. But in their framework such a shift seems almost inevitable. Can you tell me why judgments of likelihood of a near-hyperinflationary collapse upon normalization are so different in the two frameworks? I know that 25 years of history strongly suggest that they are wrong, but why? It was, after all, right for France in the 1920s. It was possibly right for peripheral European countries trapped in the eurozone. It was right for Argentina. Why is it not right–or not possible for any reasonable probability–for reserve currency-issuing credible sovereigns?

Koo slides:

UPDATE: perhaps the real issue is that we have three underlying models of macroeconomics. The first is the quantity theory of money MV = PY: the stock of money times its velocity equals the price level times production. The second is the Wicksellian savings investment equation S = I + (G-T): savings either finances investment or is absorbed by the government deficit. The third is the fiscal theory of the price level D/P = PV(-d_p,r): the real stock of debt–the nominal debt divided by the price level–is equal to the present value of future primary surpluses discounted at the real interest rate. All three of these must be true at the same time, which means that at any time two of them are likely to be nearly redundant. For those two, shifts in what are supposed to be their driving variables are neutralized by countervailing forces. Right now, for example, increases in the money stock are offset one-for-one by reductions in velocity, and increases in the nominal debt are offset one-for-one by higher future primary surpluses and reductions in future real interest rates.

From this perspective, the key question of macroeconomics is always: when do each of these three models have primary traction, and why? Richard Koo just said that the state of the economy shifts like the flick of a switch: Enter a balance-sheet recession in which firms are engaged in minimizing debt, and it is S = I + (G-T) and the impact of balance sheets on S and I that governs the state of the economy. Leave–flick the switch–and the quantity theory of money holds for a near-constant velocity, with small shifts in the quantity of money driving adjustments that make the Wicksellian S = I + (G-T) hold.

But when do you enter and when do you leave depression–or balance-sheet–economics, with Wicksell’s equation the driver and the other two more-or-less passive adjusters? When do you enter and when you leave monetarist economics? And when do you enter and when do you leave the quasi-hyperinflationary economics that is the fiscal theory of the price level?

Until I figure this out, I am going to have a hard time teaching this stuff. Until I figure this out, I’m going to have a hard time even thinking about this stuff.

• .pptx
• .pdf
• .key
• https://www.icloud.com/keynote/AwBUCAESEAuX22e8rlul-6x66WWpxX4aKZ47DgLL1fC2IoxtkRkTbcGbpFs8qxcW_MK2BTdYUvG8dGqTHaK4yPx6MCUCAQEEILPNgaRVHQYpnPC_VA4ETvzObM2Zl2pYY8ELeZoNt0w-#2014-11-24_Mo–DeLong_CEEI.key

Must- and Shall-Reads:

• Toby N.:
  The wrongest thing ever? My defence of multi-billionaire hegde fund inflation truthers
  Ryan Avent: Free exchange: No country for young people

1. Wolfgang Münchau:
   Radical left is right about Europe’s debt: “Assume that you share the global consensus view on what the eurozone should do right now. Specifically, you want to see more public-sector investment and debt restructuring. Now ask yourself the following question: if you were a citizen of a eurozone country, which political party would you support for that to happen? You may be surprised to see that there is not much choice. In Germany, the only one that comes close to such an agenda is Die Linke, the former Communists. In Greece, it would be Syriza; and in Spain, it would be Podemos…. You may not consider yourself a supporter of the radical left. But if you lived in the eurozone and supported those policies, that would be your only choice. What about Europe’s centre-left parties, the social democrats and socialists? Do they not support such an agenda? They may do so when they are in opposition. But once in government they feel the need to become respectable, at which point they discover their supply-side genes…. Of the radical parties that have emerged recently, the one to watch is Podemos…. Nacho Alvarez, a senior member of the party’s economics team, laid out his programme with a refreshing clarity… renegotiation of interest rates, grace periods, debt rescheduling and a haircut… Podemos’ goal was not to leave the eurozone…. The aim is the economic wellbeing of the country. To an outsider, that seems a balanced position. Not so in Spain. The establishment fears that this agenda will turn the country into a European version of Venezuela. But there is nothing controversial about the statement that if debt is unsustainable it needs to be restructured…. It is logically inconsistent for the single currency to enter a secular stagnation and not restructure its debt. Since nothing is being done to avoid the former, there is a probability approaching 100 per cent of the latter happening. Yet, for the moment, European governments keep playing the ‘extend and pretend’ game…”

2. Ed Luce:
   Washington’s two foreign policies:
   “It goes without saying that almost any deal would be unacceptable to Benyamin Netanyahu’s Israel. The same applies to Saudi Arabia and other US Gulf allies. The Saudis have been putting it about that Riyadh would start its own nuclear programme if the US struck a deal that fell short of fully dismantling Iran’s…. Not only, it seems, will there be two US foreign policies. But most of America’s Middle East allies will be backing Capitol Hill’s. Can Mr Obama thread a path through this? The most dramatic example of clashing US foreign policies was after the first world war. President Woodrow Wilson put his authority on the line in Paris to create a League of Nations that the US would lead. His enemies in Congress, led by the patrician Henry Cabot Lodge, had different ideas. They sunk the treaty and with it America’s engagement on the world stage for the next 20 years. An Iran deal would also be faced with Congressional hostility. The big difference is that Mr Wilson pulled out all stops to sell his treaty. It still foundered. In the words of Vali Nasr, a former Obama official, this president sees an Iran deal as a ‘nice to have’, rather than a ‘must have’. Unless ‘must have’ becomes both the goal of Mr Obama and Congress, a Wilsonian fate awaits.”
   

3. Lawrence Summers:
   Companies on Trial: “Lord Chancellor Edward Thurlow… corporations have ‘no soul to be damned, no body to kick’…. Garrett’s data and his narrative provide a textured understanding of these trade-offs and many others in dealing with corporate crime…. The current trend towards large fines as the response to corporate wrongdoing seems to promote a somewhat unattractive combination of individual incentives. Managers do not find it personally costly to part with even billions of dollars of their shareholders’ money, especially when fines represent only a small fraction of total market value. Paying with shareholders’ money as the price of protecting themselves is a very attractive trade-off. Enforcement authorities like to either collect large fines or be seen as delivering compensation for those who have been victimised by corporate wrongdoing. So they are all too happy to go along. In the process, punishment of individuals who do wrong or who fail in their managerial duty to monitor the behaviour of their subordinates is short-changed. And deterrence is undermined. There is a broader cultural phenomenon here as well. Relative to other countries such as the UK or Japan, the principle that leaders should resign to take responsibility for failure on their watch even when they did not directly do wrong is less established in the US. This is probably an area where we have something to learn…”

4. Matthew Yglesias: The GOP’s political strategy against Obama keeps leading to policies conservatives hate: “Republicans’ strategy has been savvy politics, but it’s forced them — repeatedly — to accept worse policy outcomes than they otherwise could have obtained. Alleged presidential overreach is largely a mirror-image of systematic congressional underreach… deliberately choos[ing] to leave obtainable policy concessions on the cutting room floor…. The clearest example of obstructionism leading to policy costs is probably the Affordable Care Act. Democrats had the votes to get this done, but the party was plainly desperate for bipartisan cover. In exchange for votes, Republican members of congress could have gotten tort reform or other policy priorities. But they preferred to keep their fingerprints off the bill, even if that meant a policy outcome they liked less. On climate change, Republican behavior was even more counterproductive…. A similar preference for worse policy outcomes has manifested itself through inaction…. Obama, in other words, was offering a real policy concession (entitlement cuts) in exchange for political cover for tax hikes that were going to happen anyway. But Republicans preferred to keep their fingerprints off any kind of action, even if that meant a policy outcome they liked less. These triple-breakdowns of bipartisanship have made Obama a much less popular and successful-looking president…. But… fFor a party driven by a core commitment to low taxes and welfare state rollback, it’s a bit odd…. [The Republican] Congress is, itself, violating a basic norm of American politics — the norm that says given a choice between a better policy outcome and a worse one, a legislator should choose the better outcome…. If Republicans wanted more conservative-friendly policy outcomes, they could be getting them. But they prefer more Republican-friendly political outcomes…

5. Richard Milne: Central banks: Stockholm Syndrome: “When the global financial crisis broke in 2008, Sweden’s central bank seemed to be one of the best-equipped to fight it. The Riksbank was led by Stefan Ingves, a former senior official at the International Monetary Fund whose expertise lay in financial crises and how to avoid them. One of its deputy governors was Lars Svensson, an expert on Japan’s long battle against deflation and a top thinker on monetary policy. With these credentials, the two men seemed ideally suited to guide the Riksbank’s policy through the turmoil…. At first, they found common ground as the Riksbank cut interest rates in 2009 to 0.25 per cent, their lowest level since its founding in 1668. But for the next two years, the duo clashed bitterly…. The Riksbank’s decision in 2010 to start raising rates–an idea Mr Svensson firmly opposed – has transformed the Swedish central bank from a small but respected institution to a cautionary tale for central banks worldwide.
   ‘Sweden has done an experiment the whole world is interested in’, Mr Odendahl says. ‘What should we do when monetary policy should be accommodative but there are financial risks? The Swedish lesson is that tightening policy prematurely isn’t the answer’.”

6. Ann Marie Marciarille: Missouri State of Mind: The Hidden Co-Pay in Community Based Long Term Care: “Allison Hoffman has an interesting post… I admire… for its discussion of the cost to ‘next friends’ or caregivers in our increasingly home and family based system of long term care…. ‘Hidden co-pay’ — as marvelous as it is — may not do justice to the real story of the impact of family based and institutionally based long term care on women. One of the  most common nursing home resident stories is one about the institutionalization of a former female caregiver, herself, after all.”

Should Be Aware of:

• Shane Ferro: Ello: Last night at the Financial Follies
• Jeet Heer: Hitler Victorious, Science Fiction, and Alternative History: notes from a talk by Nicholas Ruddick (with tweets) · JeetHeer1 · Storify
• Kathleen Hunter et al.:
  Democratic Opposition Grows to Obama Pick of Weiss to Treasury

1. Michael Ignatieff:
   Advice to Young Liberals:
   “I may have come into politics with an unacknowledged condescension toward the game and the people who played it, but I left with more respect for politicians than when I went in. The worst of them—the careerists and predators—you find in all professions. The best… a credit to democracy… knew the difference between an adversary and an enemy, knew when to take half a loaf and when to insist on the whole bakery, knew when to trust their own judgment and when to listen to the people…. It is really something in life to be utterly disabused about human motive, venality, capacity for double-crossing, and yet still come to work every day, trying to get something done. Liberalism will become an enclave conviction of a shrinking minority unless those who call themselves liberal reconnect their faith in tolerance, equality, opportunity for all with the more difficult faith in the dirty, loud-mouthed, false, lying business of politics itself. This disdain is cynicism, masking as high principle. The ultimate allegiance of a democratic politician is not to party, not even to principle, but to the venal process called politics. So my final advice is this: Politics is not a vulgar means to a goal, it’s a noble life unto itself, and unless you love it, you can’t do it well. I didn’t get there, but I hope you will.”

2. Adair Turner:
   Germany’s Secret Credit Addiction: “With recent data showing that German exports fell 5.8% from July to August, and that industrial production shrank by 4%, it has become clear that the country’s unsustainable credit-fueled expansion is ending. But frugal Germans typically do not see it that way. After all, German household and company debt has fallen as a share of GDP for 15 years, and public debt, too, is now on a downward path. ‘What credit-fueled expansion?’ they might ask. The answer lies in the reality of our interconnected global economy…. Today’s total debt level seems both unsustainable and impossible to reduce without depressing the economy…. This poses two questions to which orthodox economics and conventional policy have provided an inadequate response. First, how can we ensure that economies grow without rapid private credit growth, which leads to crisis and a debt overhang? Second – and the crucial issue today – how can we escape the debt trap in which past credit growth has left us?… Relying solely on ultra-easy monetary policy is dangerous. It encourages excessive financial risk-taking, increases inequality, and can work only by regenerating the rapid private credit growth that got us into this mess in the first place. Relying on competitive exchange rates, meanwhile, is collectively impossible…. We need to stimulate growth and increase inflation without generating higher private or public leverage. The only way to do that is to run increased fiscal deficits, permanently financed by central-bank money…”
   

Why Am I Not Surprised?: Barry Eichengreen’s Superb “Hall of Mirrors: The Great Depression, The Great Recession, and the Uses-and Misuses-of History” (Brad DeLong’s Grasping Reality…): What is best in life?

What is best in life is to spend the 11 hours of a Northern Hemisphere polar winter’s night one spends in the belly of an A340-300 in transit from SFX to ZRH (a) eating Swiss chocolate, and (b) reading Barry Eichengreen’s (2015) brilliant and superb Hall of Mirrors: The Great Depression, The Great Recession, and the Uses-and Misuses-of History (Oxford: Oxford University Press: 0199392005).

More–hopefully much more–to follow…