A generation or two ago, the push for central-bank independence was all about harnessing central banks’ credibility as inflation fighters in a context in which it was feared that elected legislators would lean overboard on the excessive spending side.

Today, Simon Wren-Lewis calls for transferring not just monetary policy but fiscal policy stabilization authority over to central banks, on the grounds that their technocratic chops are much better for fiscal policy then relying on elected legislators who are the prisoners of ordoliberal ideologies, the belief the governments like households need to balance their budgets, and of the austerity-loving 0.1%.

What could possibly go wrong?

Simon Wren-Lewis: Post Recession Lessons: “I regard 2010 as a fateful year for the advanced economies…

…the year that the US, UK and Eurozone switched from fiscal stimulus to fiscal contraction… this policy switch is directly responsible for the weak recovery in all three countries/zones. A huge amount of resources have been needlessly wasted as a result, and much misery prolonged. This post is… about… taking that as given and asking what should we conclude…. To answer that question, what happened in Greece (in 2010, not two days ago) may be critical…. Let me paint a relatively optimistic picture of the recent past. Greece had to default because previous governments had been profligate and had hidden that fact from everyone…. Recessions… tend to be when things like that get exposed. If Greece had been a country with its own exchange rate, then it would have been a footnote… fiscal stimulus that had begun in all three countries/zones in 2009 would have continued (or at least not been reversed), and the recovery would have been robust. Instead Greece was part of the Eurozone…. Policy makers in other union countries prevaricated…. So the Greek crisis became a Eurozone periphery crisis…. This led to panic not just in the Eurozone but in all the advanced economies. Stimulus turned to austerity. By the time some in organisations like the IMF began to realise that this shift to austerity had been a mistake, it was too late. The recovery had been anemic.

Why is that an optimistic account? Because it is basically a story of bad luck…. Now for the pessimistic version. The political right in all three countries/zones was always set against fiscal stimulus…. Without Greece, we still would have had a Conservative led government taking power in the UK in 2010, and we still would have had Republicans blocking stimulus moves and then forcing fiscal austerity. The right’s strength in the media, together with the ‘commonsense’ idea that governments like individuals need to tighten their belts in bad times… [meant] austerity was bound to prevail…. Greece may have just voted against austerity, but there is every chance that in the UK the Conservatives will retain power this year on an austerity platform and the Republicans are just the presidency away from complete control in the US. If the pessimistic account is right, then it has important implications for macroeconomics. Although it may be true that fiscal stimulus is capable of assisting monetary policy when interest rates are at the ZLB, the political economy of the situation will mean it may well not happen….

When some economists over the last few years began to push the idea of helicopter money, I was initially rather sceptical… helicopter money when you have inflation targets is identical to tax cuts plus Quantitative Easing (QE), so why not just argue for an expansionary fiscal policy?… However, if the pessimistic account is correct, then arguing with politicians for better fiscal policy is quite likely to be a waste of time…. A more robust response is to argue for institutional changes so that politicians find it much more difficult to embark on austerity at the ZLB…. Central banks have QE, but helicopter money would be a much more effective instrument. To put it another way, central bank independence was all about taking macroeconomic stabilisation away from politicians, because politicians were not very good at it. The last five years have demonstrated how bad at it they can be…

Aristotle: Slavery or Technology? From Politics: “Since then sufficient material resources are necessary for every household…

…the means of procuring them must certainly be part of household management, for without the material necessities it is impossible to live, let alone live well. All the arts share the property that the proper tools must be available if they are to be properly proper conducted. So is it in the art of managing a family. Now of tools, some of them are alive and others are not. With respect to the pilot of the ship, the tiller is not alive, the sailor is alive. In many arts the necessary tools include servants. Property in general is a tool for living. An estate is a collection of such tools. And a slave is a living tool. A tool that can take care of its own self is a more valuable one than any other tool. Suppose if every tool could, at command, or from discerning its owner’s desires, carry out its tasks (as the story goes of the automatons of Daedalus; or what the poet tells us of the serving-carts of Vulcan, ‘that they rolled of their own will into the gathering of the gods’), so that the shuttle would then weave and the lyre play of itself. Then the architect would not want living servants, or the owner want living slaves…

Alan Rappaport of the New York Times here exemplifies the biggest problem with our current policy dialogue: when it is thought to be unfair to a current of thought to even report in plain language what they have been saying, we are all in big trouble:

Paul Krugman: Whitewashing the Crazy, Fed Edition: “How does one report on politics…

…when a significant wing of the political spectrum is… stark raving mad?…. There’s a temptation to soft-pedal the crazy…. Matt O’Brien notes that Ted Cruz has now joined the ‘anti-Fed crazy train’…. [But] Alan Rappeport [of the New York Times who]… does… convey… how crazy Rick Perry was… uses a euphemism….

Republicans have questioned the Fed’s moves to stimulate the economy since the financial crisis, arguing that the expansion of its balance sheet will create economic instability.

Well, actually they have spent the past six years warning about ‘currency debasement and inflation‘. The chart shows how that prediction has turned out. And that in turn makes the fact that the anti-Fed ranks are swelling, not shrinking, a much more remarkable political story than the whitewashed version would indicate.

Must- and Shall-Reads:

• Paul Krugman: Those Radical VSPs
• Avery Palmer: States with Weak Gun Laws and Higher Gun Ownership Lead Nation in Gun Deaths, New Data for 2013 Confirms
• Alan S. Blinder: Beware of Woolly-Minded Attacks on the Fed
• Joseph E. Stiglitz: Europe’s Lapse of Reason

 

1. Gernot Wagner: Climate Shock: It’s Not Over ‘Til the Fat Tail Zings: “Presenting his new book ‘Climate Shock’ co-authored with Martin Weitzman. If you had a 10 percent chance of having a fatal car accident, you’d take necessary precautions. If your finances had a 10 percent chance of suffering a severe loss, you’d re-evaluate your assets. So if we know the world is warming and there’s a 10 percent chance this might eventually lead to a catastrophe beyond anything we could imagine, why aren’t we doing more about climate change right now? We insure our lives against an uncertain future–why not our planet?…”

2. Jeet Heer: The New Republic’s Legacy on Race: From Du Bois to the Bell Curve: “Between the late ’30s and the mid-’70s, The New Republic was one of the best magazines outside the black press in its coverage of the rise of the civil rights movement. Thomas Sancton, Sr., managing editor from 1942–1943, was a particularly radical advocate, holding FDR’s feet to the fire for his compromises with the Jim Crow South, and doing brave reporting on the Detroit race riots of 1943…. [But when] the country’s conversation about race turned to more ambiguous debates over busing, affirmative action, and overcoming economic hurdles. The owner who would oversee that new era was Martin Peretz…”

3. Jaume Ventura: Capital in the 21st Century: “On 19th December, CEPR and the Bank of England hosted a joint workshop to discuss Thomas Piketty’s seminal work ‘Capital in the 21st Century’. Chaired by the Bank’s Chief Economist Andy Haldane, the panel comprised Orazio Attanasio, Tim Besley, Peter Lindert, Thomas Piketty and Jaume Ventura…”

4. Daniel Davies: Rules for Contrarians: 1. Don’t whine. That is all: “I like to think that I know a little bit about contrarianism. So I’m disturbed to see that people who are making roughly infinity more money than me out of the practice aren’t sticking to the unwritten rules of the game…. The whole idea of contrarianism is that you’re… setting out to annoy people…. If annoying people is what you’re trying to do, then you can hardly complain when annoying people is what you actually do. If you start a fight, you can hardly be surprised that you’re in a fight. It’s the definition of passive-aggression and really quite unseemly, to set out to provoke people, and then when they react passionately and defensively, to criticise them for not holding to your standards of a calm and rational debate. If [Levitt and Dubner’s] Superfreakonomics wanted a calm and rational debate, this chapter would have been called something like: ‘Geoengineering: Issues in Relative Cost Estimation of SO2 Shielding’ [rather than ‘Global Cooling’], and the book would have sold about five copies….

5. As Safe as Houses: “According to… Oscar Jorda, Moritz Schularick and Alan Taylor, the traditional view that banks primarily lend to businesses is out of date. In 1900 only 30% of bank lending was to buy residential property; now that figure is around 60%…. The growth of mortgage lending has led to property bubbles and financial instability… rising levels of mortgage debt are a better predictor of financial crises than surges in other forms of lending… financial crunches caused by mortgage binges result in deeper recessions and slower recoveries than episodes caused by other forms of debt. If mortgage lending is so risky, why are bankers so keen on it? The answer lies partly in public subsidies for mortgages, which have boosted home-owner…”

Should Be Aware of:

• Daniel Davies (2012): The Christmas Sermon 2012–“On Not Believing In Canada”
• Mark Ames: Andrew Sullivan is not the Future of Journalism
• Steve M.: Kathleen Paker: The Republicans Forced Palin to Embarrass Herself

 

1. Jeet Heer: The New Republic’s Legacy on Race: From Du Bois to the Bell Curve: “The magazine’s myopia on racial issues was never more apparent than in Peretz’s and editor Andrew Sullivan’s decision in 1994 to excerpt The Bell Curve…. The book had not been peer-reviewed, nor were galleys sent to the relevant scientific journals… ‘swept forward by a strategy that provided book galleys to likely supporters while withholding them from likely critics.’… The magazine can be seen as not just reflecting the media’s diversity problem, but actively contributing to it. Because most of the critiques were political and philosophic in nature, many readers were left with the false impression that the book had some scientific validity. By the time devastating scientific reviews appeared… the book already enjoyed unmerited prestige, thanks to the imprimatur of The New Republic. The Bell Curve was perhaps the most impactful, and unfortunate, example of the magazine’s embrace of racial mythmaking…”

2. Peter Weinhart: Rape and Consolatio: “Augustine is the first to address rape victims with consolatio, and in so doing he turns consolation into social critique: [Melanie Webb] ‘his consolation cannot simply be an exhortation to rape-survivors to re-orient themselves within a society that regards them with shaming suspicion. It must also be an admonition to civil leaders to re-orient society toward rape-survivors as dignified women without requiring “proof” of innocence. Augustine initiates his project of social criticism through the genre of consolatio’…”

3. : The New Republic’s Legacy on Race: From Du Bois to the Bell Curve: “A 1995 piece by Ruth Shalit argued that if The Washington Post hired strictly on merit, it would be an all-white newspaper: ‘The Post, of course, is in an agonizing position. If editors refuse to adjust their traditional hiring standards, they will end up with a nearly all-white staff. But if they do reach out aggressively to ensure proportionate representation for each relevant minority, they transform not just the complexion but the content of the paper.’ Shalit’s piece made no mention of the fact that the magazine she was writing for had an almost all-white editorial staff. After the piece appeared, roughly half of the 28 Post staffers Shalit interviewed wrote in to say that she had either lied about what they told her or misrepresented them; The New Republic printed only a fraction of these complaints…. Likewise… Stephen Glass penned a 1996 piece about the Washington, D.C. taxi cab industry that seemed to cater to Peretz’s appetite for melodramas illustrating black cultural pathology…. One may also ask if a staff dominated by privileged white males might not have benefited from greater diversity, and not just along racial lines. ‘Marty [Peretz] doesn’t take women seriously for positions of responsibility,’ staff writer Henry Fairlie told Esquire magazine in 1985…”

4. Fredrik deBoer: I don’t know what to do, you guys: “You’ll forgive me when I roll my eyes at the army of media liberals, stuffed into their narrow enclaves, responding to Chait by insisting that there is no problem here and that anyone who says there is should be considered the enemy…. The culprits overwhelmingly were not women of color. That’s always how this conversation goes down: if you say, hey, we appear to have a real problem with how we talk to other people, we are losing potential allies left and right, then the response is always ‘stop lecturing women of color.’ But these codes aren’t enforced by women of color, in the overwhelming majority of the time. They’re enforced by the children of privilege. I know. I live here. I am on campus. I have been in the activist meetings and the lefty coffee houses…. I know I’ll get read the intersectionality riot act, even though everyone I’m criticizing here is white, educated, and privileged…. Christ, I wish people would think outside of their social circle for 5 minutes…. I want a left that can win, and there’s no way I can have that when the actually-existing left sheds potential allies at an impossible rate. But the prohibition against ever telling anyone to be friendlier and more forgiving is so powerful and calcified it’s a permanent feature of today’s progressivism. And I’m left as this sad old 33 year old teacher who no longer has the slightest f—ing idea what to say to the many brilliant, passionate young people whose only crime is not already being perfect…”

5. Michelle Goldberg: Jonathan Chait and the New PC: “Unlike some of Chait’s critics, I think there is such a thing as renascent political correctness…. But… he conflates several different things… genuine suppression of speech… annoying rhetorical tropes of online discourse… energetic debate…. Chait describes a torrent of online derision directed at his friend Hanna Rosin under the hashtag #RIPpatriarchy. In Chait’s version, the hashtag is a reaction to her book, The End of Men…. In fact, the hashtag was spurred by a related Slate piece with the trollish headline, ‘The Patriarchy is Dead: Feminists, accept it.’ The patriarchy not being dead, feminists did not accept it. That’s not stifling political correctness. It’s responding to speech with more speech…. ‘Her response since then has been to avoid committing a provocation, especially on Twitter,’ Chait writes of Rosin…. Social media has dramatically raised the psychic cost of voicing unpopular opinions…. To which, I suspect, many on Twitter would reply boo-fucking-hoo…. For Twitter’s guardians of righteousness, if privileged journalists feel more inhibited about bucking lefty pieties, so much the better…. Such a style, of course, was a hallmark of the Old New Republic… the magazine mistook common prejudice for unspoken truths…”

Hoisted from the Archives: The conventional Fisher-Friedman approach to the determination of nominal spending and income focuses on the equilibrium demand and supply of money through the quantity theory:

(1) PY = MV(i)

If the economy’s money-supply process has produced “too little” money for the current level of spending, businesses and households attempt to shift their portfolios and accumulate more money by (i) trying to sell some of their other financial assets for cash, and (ii) cutting back on their spending. Thus the flow of spending—and income, and production—falls until PY has fallen by enough to make households and businesses no longer seek to increase their money holdings. Combine this focus on money supply and money demand equilibrium with some model of price theory and price adjustment, and the result is a theory of the monetary business cycle.

At the zero-interest rate lower nominal bound, this Fisher-Friedman framework breaks down. With no opportunity cost to holding wealth in money rather than in other short-duration safe nominal assets, there is no reason for changes in the money stock to induce any changes in the flow of spending at all. Anybody seeking to model nominal and real income determination must then find another, alternative equilibrium condition to focus on.

The conventional theoretical macroeconomic step to take is to focus on the intertemporal Euler equation of a representative household with rational expectations: is it on an optimal consumption-savings path? But focusing on the Euler equation requires that there be (a) no disagreements between investors, and (b) a meaningful representative household, with (c ) correct rational expectations. If we are unwilling to make those assumptions, we are then driven back to the equilibrium condition from which, given the existence of no disagreements, a representative household, and rational expectations, the Euler equation was derived.

This equilibrium condition–appropriate for a more general theory—-is the Wicksell-Hicks flow-of-funds through financial markets condition: the supply of savings vehicles must be equal to the demand for savings vehicles. If the demand for savings vehicles is greater than the supply, people will cut back on spending their savings on currently-produced goods and services as they try to boost their holdings of savings vehicles. Spending, production, and incomes will fall until people feel so poor that they no longer wish to boost their holdings of savings vehicles. When the supply of savings vehicles is greater than demand, people will increase their spending as they try to turn their excess asset holdings into current consumption. Spending, production, and incomes will rise until the richer society is happy holding the existing supply of savings vehicles.

Thus theories about the effectiveness or ineffectiveness of any kind of policy—monetary, fiscal, banking, whatever—at the zero nominal interest rate lower bound are ways of deploying Wicksell-Hicks flow-of-funds equilibrium condition. They are theories about:

(2) B + S = B + I + (G – T)

about the demand for savings vehicles—the sum of the current stock of financial assets in the economy B and desired additions to that stock through savings S—and the supply of savings vehicles—the sum of the current supply of financial assets B plus business investment I plus government debt issuance G – T.

Note that if you wish to assume a (a) representative agent with (b) rational expectations you are still committed to an analysis via (2). It is a consequence of your intertemporal Euler equation. If and only if (2) holds, then your representative agent with rational expectations is on its optimal consumption-savings path.

Equation (2) gives us insight into the potential effectiveness of monetary policy at the zero lower bound. Such non-fiscal policies do not, by definition, change the supply of savings vehicles: they simply swap one savings vehicle in private portfolios for another—cash for Treasuries, short Treasuries for GSEs, private obligations subject to bankruptcy risk for private obligations backstopped by a government guarantee. For them to boost the economy therefore, they too must work via their effects on reducing private savings S or boosting private investment I.

How can they do this?

Mostly, they do this by convincing financiers that the path of real interest rates will be lower in the future than they had expected. Even though at the zero nominal lower bound the current size of the money stock is irrelevant because the opportunity cost of holding money is zero, this will not always be the case. Someday the size of the money stock will matter again. And if the central bank now takes steps that credibly promise such a larger money stock in the future when it matters, then expectations of lower nominal interest rates and higher price levels in the future which should boost investment and other real interest-sensitive components of spending now.

What are these policies?

Jawboning to reduce anticipated real interest rates: The central bank can claim that it will maintain interest rates in the future at a lower level and the money stock at a higher level than that of its normal policy reaction function. Thus, the central bank would claim, inflation will be higher in the future than forecasts based on normal reaction functions would allow. That means that real interest rates will be lower—and that would push down savings and push up investment.

The potential difficulty is that open-market operations can be unwound. That the Federal Reserve has raised the money stock this year does not necessarily mean that it will keep the money stock five years hence above the level called for by its standard reaction function. Pure jawboning is the ultimate in cheap talk. Jawboning backed by quantitative easing at the short end of the term structure is not quite pure cheap talk: the central bank is taking action. The problem is that the action is easily reversible.

Quantitative easing at the short end to reduce anticipated real interest rates: The central bank can claim that it will maintain interest rates in the future at a lower level and the money stock at a higher level than that of its normal policy reaction function—and back up those claims by expanding the money stock now by continuing to buy short-term government bonds for cash even though this is simply a swap of one zero-yielding short term safe nominal asset for another. The idea is that the Federal Reserve is not just claiming it will expand the money stock in the future—it has already expanded the money stock.

The potential difficulty is that open-market operations can be unwound. That the Federal Reserve has raised the money stock this year does not necessarily mean that it will keep the money stock five years hence above the level called for by its standard reaction function. Pure jawboning is the ultimate in cheap talk. Jawboning backed by quantitative easing at the short end of the term structure is not quite pure cheap talk: the central bank is taking action. The problem is that the action is easily reversible.

Quantitative easing at the long end to reduce anticipated real interest rates: The central bank can claim that it will maintain interest rates in the future at a lower level and the money stock at a higher level than that of its normal policy reaction function—and back up those claims by expanding the money stock now by to buying long-term government, agency, and private bonds for cash and committing to holding them to maturity. The idea is that the Federal Reserve is not just claiming it will expand the money stock in the future—it has already expanded the money stock. And such transactions are not or at least are not as easily unwound. Price pressure effects mean that the Federal Reserve will, embarrassingly, probably lose money on the round trip if it breaks its commitment to hold its purchased securities to maturity.

Quantitative easing at the long end may have another significant effect as well. By taking duration and, in the case of private bonds, default risk onto its balance sheet the Federal Reserve transfers that risk from the marginal investor to the marginal taxpayer. If the marginal taxpayer is at a corner solution in their financial market holdings or has a higher rate of time discount than the marginal investor or simply does not see through the government’s balance sheet, one consequence of quantitative easing at the long end is that investors will then have unused risk-bearing capacity. Duration and default risk spreads should then fall, and this fall in spreads should turn more investment projects into positive NPV ones. Quantitative easing at the long end thus has not only its potential principle effect on private investment and other forms of interest-sensitive spending via expectations of inflation and thus of real safe interest rates but also a secondary effect on investment via the government’s assumption of a role as a risk-bearing partner in private enterprise.

Back-of-the-envelope calculations based on standard finance principles suggest that this portfolio-composition effect should be insignificantly small. But similar arguments based on standard finance principles have long suggested that standard open-market operations in normal times should not be able to shake the intertemporal price system out for thirty years either, and there is a lot of evidence that standard open market operations in normal times do in fact have substantial effects.

Quantitative easing accompanied by declarations that the central bank has not changed its long-run inflation and price level targets: I do not understand why a central ban would pursue such a policy.

But that is the policy that the Federal Reserve appears to have decided to pursue.

Ryan Avent:

Monetary policy: The Fed’s communications problem: As I’ve written before, the commitment to allow higher inflation in the future is one of the key methods through which the central bank can have a positive effect on an economy stuck at the zero lower bound. The Fed’s efforts to clarify and push out the date at which it is likely to raise rates strikes me as a means to try and commit itself to higher inflation in the future. But the Fed’s communications efforts in this regard run up against a serious obstacle in the form of the Fed’s long-term inflation forecast, which is 2%. The Fed can’t force future central banks to keep to any policy path. If the Fed were to project a long-run inflation rate above 2% then, as Mr Bini Smaghi says, markets might suppose that monetary tightening lay ahead, whatever the fine print says.

This is not an unsolvable problem but is, I think, one of the tight spots in which the Fed finds itself as it transitions from a framework that wasn’t very good at boosting the economy at the ZLB to one that might be. One way to get around the problem would be to change the target, to 3% inflation or to something else, like a price or nominal GDP level, that implies future inflation above currently acceptable levels. The Fed may get there eventually, but probably not soon enough to have a meaningful impact on this recovery.

An alternative might be to bring the point at which future inflation is tolerated a bit closer to the present. That is, the Fed doesn’t necessarily run into problems of inconsistency if it projects inflation above 2% 1 or 2 years from now—a timeframe over which markets readily understand this group of policymakers to have control—while maintaining the long-run 2% goal. Achieving that would require the Fed to give itself a framework within which it’s acceptable to have inflation above 2% (and even to try to generate inflation above 2%), and as I wrote last week, I thought the Fed took a big step in that direction at its latest meeting. But one then has to choose to act within that framework. I suspect that what that will take is a near-term projection of inflation above 2% combined with action—asset purchases—designed to demonstrate that, yes, the Fed is actually trying to create a little catch-up inflation. At the last press conference, Ben Bernanke all but admitted that that would be a sensible thing to do. Now we just need to excise the “all but”.

2025 words

Gernot Wagner: Climate Shock: It’s Not Over ‘Til the Fat Tail Zings: “Presenting his new book ‘Climate Shock’…

…co-authored with Martin Weitzman. If you had a 10 percent chance of having a fatal car accident, you’d take necessary precautions. If your finances had a 10 percent chance of suffering a severe loss, you’d re-evaluate your assets. So if we know the world is warming and there’s a 10 percent chance this might eventually lead to a catastrophe beyond anything we could imagine, why aren’t we doing more about climate change right now? We insure our lives against an uncertain future–why not our planet?…

**Jeet Heer**: [The New Republic’s Legacy on Race: From Du Bois to the Bell Curve](http://www.newrepublic.com/article/120884/new-republics-legacy-race): “Between the late ’30s and the mid-’70s…>…*The New Republic* was one of the best magazines outside the black press in its coverage of the rise of the civil rights movement. Thomas Sancton, Sr., managing editor from 1942–1943, was a particularly radical advocate, holding FDR’s feet to the fire for his compromises with the Jim Crow South, and doing brave reporting on the Detroit race riots of 1943…. [But when] the country’s conversation about race turned to more ambiguous debates over busing, affirmative action, and overcoming economic hurdles. The owner who would oversee that new era was Martin Peretz…

Jaume Ventura: Capital in the 21st Century: “On 19th December…

…CEPR and the Bank of England hosted a joint workshop to discuss Thomas Piketty’s seminal work ‘Capital in the 21st Century’. Chaired by the Bank’s Chief Economist Andy Haldane, the panel comprised Orazio Attanasio, Tim Besley, Peter Lindert, Thomas Piketty and Jaume Ventura…

Apropos of Jonathan Chait’s “Not a Very P.C. Thing to Say” and Hanna Rosin’s “The Patriarchy Is Dead”, some constructive advice from Daniel Davies:

Daniel Davies: Rules for Contrarians: 1. Don’t whine. That is all: “I like to think that I know a little bit about contrarianism…

…So I’m disturbed to see that people who are making roughly infinity more money than me out of the practice aren’t sticking to the unwritten rules of the game…. The whole idea of contrarianism is that you’re… setting out to annoy people…. If annoying people is what you’re trying to do, then you can hardly complain when annoying people is what you actually do. If you start a fight, you can hardly be surprised that you’re in a fight. It’s the definition of passive-aggression and really quite unseemly, to set out to provoke people, and then when they react passionately and defensively, to criticise them for not holding to your standards of a calm and rational debate. If [Levitt and Dubner’s] Superfreakonomics wanted a calm and rational debate, this chapter would have been called something like: ‘Geoengineering: Issues in Relative Cost Estimation of SO2 Shielding’ [rather than the book being subtitled ‘Global Cooling’], and the book would have sold about five copies….

The other point of contrarianism is that, if it’s well done, you assemble a whole load of points which are individually uncontroversial (or at least, solidly substantiated) and put them together to support a conclusion which is surprising and counterintuitive…. Because of this, if you’re writing a contrarian piece properly, you ought to be well aware of what point it looks like you’re making, because the entire point is to make a defensible argument which strongly resembles a controversial one. So having done this intentionally, you don’t get to complain that people have ‘misinterpreted’ your piece by taking you to be saying exactly what you carefully constructed the argument to look like you were saying…. A degree of diffidence is appropriate here, because the confusion is entirely and intentionally your fault: ‘(That is the ‘global cooling’ in our subtitle. If someone interprets our brief mention of the global-cooling scare of the 1970’s as an assertion of ‘a scientific consensus that the planet was cooling,’ that feels like a willful misreading.)’ No it doesn’t; it feels like someone read the first two pages for the plain meaning of the words and didn’t spot that you were actually playing a little crossword-puzzle game… ‘global cooling’ meant, it was put on the cover in full knowledge of the impression it would give… so… it is not legitimate to complain that this phrase was interpreted in the way in which it was intended to be interpreted. In general, contrarians ought to have thick skins, because their entire raison d’etre is the giving of intellectual offence to others. So don’t whine, for heaven’s sake. Own your bullshit…

Readings:

• FastFT: Greek bond rout deepens as Syriza fears mount – fastFT
• Paul Krugman: Greece: Think Flows, Not Stocks
• Paul Krugman: Thinking About the New Greek Crisis
• Daniel Davies: Greece, the EU and Aunt Agatha
• Daniel Davies: Greek games and scenarios
• Barry Eichengreen: Eurozone breakup would trigger the mother of all financial crises

Sokrates Son of Sophroniskos: You are out of your century, and out of your country…

Titus Pomponius Atticus: I claim this to be my country, and here by the docks of the Piraeus to be my place. I am not called “Atticus” for nothing, you know…

Axiothea: Why are you called “Atticus”? It doesn’t sound like a very Roman name…

Atticus: I made it up. My father had only two names–good old Titus Pomponius, no claims to triple-barreled noble senatorial-class names he, just an equestrian.

Sokrates: So you have a triple-barreled name because?

Atticus: My mother wanted it: Caecilia Metella–one of the Metelli. Her family was at the top in the years surrounding my birth, providing the Republic with seven consuls in the generation between 123 BC and 98 BC: Quintus Caecilius Metellus Balearicus, Lucius Caecilius Metellus Dalmaticus, Lucius Caecilius Metellus Diadematus, Marcus Caecilius Metellus, Gaius Caecilius Metellus Caprarius, Quintus Caecilius Metellus Numidicus, and Quintus Caecilius Metellus Nepos.

Hypatia: “BC”?

Atticus: So it’s an anachronism. Sue me?

Glaukon: “Caprarius”? “Goat”?

Atticus: Don’t ask. So, anyway, I had to have a triple-barreled name. So my mother insisted I choose one. And I chose Atticus…

Glaukon: But what are you doing out of your century?

Atticus: What are you doing out of yours? This isn’t the Piraeus of the fifth century BC: This is a twenty-first century AD container port.

Aristokles: So then why are we here?

Daniel Davies: Syriza has won the Greek elections. There has been a lot of rather contradictory comment on what the party’s negotiation strategy might actually be, but nevertheless, it certainly seems that the ‘ultimatum’ approach to debt reduction is very much on the table, and in any case, a dogmatic refusal to continue with past agreements on structural measures would end up having the same effect. It’s worth wargaming out what the various parties might be thinking and how their strategies might interact…

Sappho: Why has that man covered himself with blue paint?

Atticus: We are here not to have a Socratic debate, but to watch one.

Axiothea: And our role is to be a more-or-less MST3K to the situation?

Atticus: Less rude, and more informative. We will see how it develops.

Aristokles: Who put you in charge?

Atticus: That I own the time machine? That even though most of you know me only as the guy whom my friend Marcus Tullius Cicero ranted and vented to, and even though I spent a huge amount of my time trying to keep Cicero from getting himself killed either by his political enemies or by my sister, I did have a day job: I am a banker. This is my territory.

Thrasymakhos: Hush. A second interlocutor approaches.

Barry Eichengreen: The decision to join the Eurozone is effectively irreversible. The insurmountable obstacle to exit is procedural. Reintroducing the national currency would have to be preceded by very extensive discussion. In 1998, the founding members of the Eurozone agreed to lock their exchange rates at the then-prevailing levels to rule out depressing national currencies in order to steal a competitive advantage. In contrast, today the very motivation for leaving would be to change the parity. A system-wide bank run would follow. Investors anticipating that their claims on, say, the Italian government would be redenominated into lira would shift into claims on other Eurozone governments. It would be unlikely that the ECB would provide extensive lender-of-last-resort support. And the government would not be able to borrow to bail out the banks and buy back its debt. This would be the mother of all financial crises. What government invested in its own survival would contemplate this option? As soon as discussions of leaving the Eurozone become serious, it is those discussions, and not the area itself, that will end.

Glaukon: These people are long-winded.

Cnaeus Pompeius Magnus: Have people become more intelligent since our days? I remember how Marcus Porcius Cato, Cicero, and I agreed that we had Gaius Julius Caesar trapped–that for him to cross the Rubicon would be so disastrous as to be totally inconceivable. And so I wound up dead on a beach in Alexandria…

Hypatia: I know how that feels…

Sokrates: It is a disease of twenty-first century economists–that people will invariably walk down and examine the leaves of the game-theoretic strategy tree and so avoid disastrous branches. We see it often:

Daniel Davies: One thing it’s important to make clear is that the European policy makers aren’t stupid. I have lost count of the number of articles I’ve read where some opinion columnist or other acts as if the fact that Greece’s debt burden is unsustainable and cannot ever be repaid is some special insight available only to readers of his newspaper, and that the benighted fools of the Commission, ECB and Eurogroup are so ideologically blinkered that they can’t see this obvious fact. Often enough, this piece of pontificating is attached to some distinctly dodgy theorising about the peculiar national characteristics of ‘Germans’. The fact is, everyone knows that the total burden of Greek debt is too big to be serviced by the Greek GDP, and that if it isn’t written down, then Greece will always be reliant on an increasing stream of official financing to meet its roll-overs. Everyone also knows, although some of them might not be ready to admit it to themselves, that an indefinite commitment to financing the roll-over of an ever increasing debt burden is a fiscal transfer in all but name. The thing is, though, while the Eurosystem bureaucrats know this at least as well as anyone else, they have jobs in which they can’t simply bemoan the fact in print, then submit their copy and go off to think about something else.

Socrates: There, for example.

Axiothea: But not all of them:

Paul Krugman: Daniel Davies tells us that ‘European policy makers aren’t stupid.’ But they do say stupid things, still talking about expansionary austerity, still treating debt as a purely moral issue. Can and will they be realistic, accept that they can’t extract blood from a stone–at any rate not at the rate of 4.5 percent of [annual] GDP [per year]–in time to avert a spiral into disaster?

Axiothea: See?

Atticus: And Krugman believes we need to focus on the essentials:

Paul Krugman: Markets are panicking. It’s important to understand that this is not a verdict on the new Greek government, or at any rate only the new Greek government; it’s a judgment that the risk of no agreement, and a disorderly breakdown of the whole process, is high. I think it’s important to be as clear as we can about the stakes and the real interests here, lest players stumble into a disaster they could and should have avoided…

Aristokles: I am lost.

Atticus: Let’s back up:

Daniel Davies: Don’t think of the Greek debt burden, either in cash € terms or as a ratio to GDP, as an economic quantity. It isn’t an economically meaningful number any more. It is a political quantity–the means by which control is exercised over the Greek budget by the Eurosystem. The regular rituals are the way in which the solvent Euroland nations exercise the kind of political control that they feel they need to have if they are going to be fiscally responsible for the bills.

Aristokles: Can we go over that again?

Daniel Davies: Consider a young man–to make it concrete, let’s call him Jim–who is living rather beyond his means–every month, he has income of £5000 and expenses of £5500. He is maxed out on his credit card with £5,000 of debt. So his only source of funding is Aunt Agatha. Aunt Agatha makes Jim sign an IOU and pay interest, but the interest rate is pretty low compared to the credit card, and every time the debt comes due, she is content to extend the term and roll it over into a new loan. Jim has, over the last few years, amassed a balance of £50,000 in debt to his beloved aunt. Then disaster strikes and Jim’s income falls to £3000 a month. Aunt Agatha is prepared to increased her monthly loans from £500 to £2500, but she has a number of firm conditions attached. Some of these are things that Jim has been planning anyway, but some of them–like giving up on his foreign language course–seem counterproductive to him and he doesn’t really want to do them. What should he do? I hope everyone can see that the following piece of advice would be dreadful:

Well, the problem is your debt/income ratio, which is now around 153%. And Aunt Agatha is by far your biggest creditor. Tell her that you can’t pay her back and need her to write off half of your debt.

Thrasymakhos: Why is he named “Jim” rather than “Bertie Wooster”?

Glaukon: To explicitly compare Greece, its voters, and its politicians to a P.G. Wodehouse character would attract the scrutiny of the United Nations High Commissioner for Human Rights.

Aristokles: Why is it such bad advice, again?

Daniel Davies: Aunt Agatha is a very unusual kind of creditor. She is lending, at concessional rates, in circumstances where no other lender would be prepared to, and most importantly, she is the sole provider of finance to cover Jim’s deficit. If his relationship with her breaks down, he has no other sources of funding and would have to reduce his consumption, immediately, to equal his income…

Aristokles: So writing down the Greek debt actually makes Greece poorer because it comes at the cost of the end of current transfers to Greece?

Hypatia: Actually, I don’t think that is true…

Paul Krugman: The question is how much Greece will transfer to its creditors by running primary surpluses–and yes, at this point that’s the question, there’s no possibility that the creditors will transfer more resources to Greece. If Greece were to adhere totally to the previous terms, over the next five years it would make resource transfers of about 20 percent of one year’s GDP. From the point of view of the creditors, that’s a trivial sum. From the point of the Greeks, however, it’s crucial; the difference between a primary surplus of 4.5 percent of GDP and, say, 1.5 percent of GDP for the Greek economy and the welfare of its citizens is huge. There was modest de facto aid to Greece in 2010-2012, but no aid is currently flowing, nor will it.

Axiothea: Davies does admit that that word-picture was the past, not the present:

Daniel Davies: Things have moved on a bit. Jim gave in to Aunt Agatha’s demands and has stabilised his monthly situation, with income of £3500 and expenditure of £3500. But he has an interest bill on his credit card of £100 every month so he still needs to borrow a bit from Aunt Agatha. And he has got a new girlfriend who keeps telling him that he really ought to start the language course again if he is going to have any prospects. This is Greece now. Primary balance has been achieved and growth is positive again. Syriza wants to make more investment spending. But it seems clear to me that the following strategy is not going to help Jim.

If you stopped paying interest on Aunt Agatha’s IOUs and told her to write off half your debt, you could afford to take those language courses again.

Aristokles: Why not?

Daniel Davies: Because it’s not true–messing around with the debt interest on the EU debt doesn’t free up any material resources for the Greek state budget, unless the EU can be persuaded to advance more money. If you can persuade the EU to finance some deficit spending, then the problem is already solved. Negotiating with Aunt Agatha about the language course would be a sensible course of action, but not kicking off those negotiations with a load of demands that her to confront the reality that she is throwing good money after bad.

Thrasymakhos: So Greece should shape its negotiating strategy to avoid hurting the German government’s feelings?

Sokrates: I agree it does not fit with Davies’s earlier description of European policymakers as flint-eyed Machiavellian realists who do not let empty verbiage and meaningless accounting entries distract them.

Axiothea: But even that is wrong!

Paul Krugman: As both Daniel Davies and James Galbraith point out, at this point Greek debt, measured as a stock, is not a very meaningful number. The debt is an accounting fiction: whatever the governments trying to dictate terms to Greece decide to say it is. Focus on the aspect of the situation that isn’t a matter of definitions: Greece’s primary surplus, the difference between what it takes in via taxes and what it spends on things other than interest, the amount Greece is actually paying, in the form of real resources, to its creditors. Greece has been running a primary surplus since 2013, and according to its agreements with the troika it’s supposed to run a surplus of 4.5 percent of GDP for many years to come…

Atticus: The focus on real resource transfers is a very important point. And Davies does recognize that looking forward:

Daniel Davies: The EU program for Greece assumes large primary surpluses for the years 2016–2020. And that changes the dynamics significantly. In a couple of years’ time, Jim’s income has reached £4000 a month, but his expenditure is still £3500, per Aunt Agatha’s original budget. He’s paying down his credit card, and he really really wants to get back on that language course. At this point, the “Tell Aunt Agatha to get stuffed” advice is… well, I still wouldn’t regard it as prudent, even if one ignores the morality of short-changing a beloved aunt. But it’s no longer actively suicidal. If the language course helps Jim get a high flying job elsewhere, then it could kick-start his comeback to a state where he can pay all his debts and persuade the fair Cecilia to marry him. If Syriza think that diverting [future primary] surpluses into fiscal stimulus could kick-start a recovery, then it would make sense to ignore the troika and start playing real hardball.

Glaukon: “Cecilia”? “Caecilia”? Is someone going to run off with your mother, Atticus?

Sokrates: No, it’s just that the appearance of that name in Daniel Davies’s piece was what triggered this off. But that “beloved aunt” stuff–once again it doesn’t quite seem to fit the rhetorical pose of the down-to-earth Welshman who doesn’t trust flowery motives…

Glaukon: And what Daniel Davies sees as the future, in which Syriza might change its negotiating strategy without catastrophe, Paul Krugman sees as the present. For Paul, now is the time to figure out what to do with Greece’s 2015-2020 primary surpluses…

Atticus: There is a point to it:

Daniel Davies: I wouldn’t advise this though, for one very good reason, which the more cynical readers and afficionados of PG Wodehouse novels may already have skipped ahead to… One day, Aunt Agatha is going to die. When she does, it’s very likely that her will is going to release Jim from his IOUs; although she is much too straight-laced and Calvinist to admit any such awful thought. Wouldn’t it be a terrible shame to shut yourself off from such a generous aunt, particularly as the rosy future on the language course is far from assured? One day, fiscal union will happen in the EU and Greece’s debts will disappear into a common pool. Everyone knows this, but it’s not politically acceptable to say so at present. Given that, it makes little sense to risk the relationship for a short term gain. Syriza has a much more appealing strategy in a negotiated settlement, involving less primary surplus and more stimulus spending.

Thrasymakhos: Now I am lost. It seems to me that Daniel Davies is saying that the fact that even though the Euro Troika has done the wrong thing over the past seven years Syriza should still avoid trying to play hardball because the Troika are going to do the right thing in the future, any day now. I do not see where that confidence comes from.

Hypatia: Say, rather, that Daniel Davies believes that being inside the charmed circle of the European Union as a member in good standing is going to be an enormous source of wealth for Greece over the next two generations:

Daniel Davies: Seeing the peripheral Eurozone debt in isolation from the politics of European integration is a sure way to lead yourself up blind alleys. It is, therefore, totally inimical to the Eurosystem to hold out any hope of the kind of debt writedown that Syriza wants. Syriza wants to get a major up-front reduction in the debt number is to create political space to execute the rest of their program. The people who don’t understand it are the ones writing editorials in the business press which support the debt reduction but don’t think that Syriza should be given carte blanche to do everything it wants.

Hypatia: In Daniel Davies’s mind, not calling for a large writedown of Greece’s formal debt is a way for Greece to demonstrate that it is playing by the rules in the game of European unification–and that it is in Greece’s long-run interest to do so:

Daniel Davies: There’s more than a couple of Germans I’ve spoken to over the last few years who have pointed out that although Germany got massive debt relief in the twentieth century, it got it in the context of an equally massive national admission that the entire political system was rotten and needed to be totally restructured with foreign help.

Thrasymakhos: But the cost of playing by the rules and running large primary budget surpluses over the next six years as long as Germany keeps ECB monetary policy inappropriately tight is absolutely enormous:

Paul Krugman: Relax[ing] that [primary surplus] target would not mean demanding that creditors throw good money after bad; everyone has already implicitly acknowledged that the debt will never be fully paid. [If] Greece stopped running a primary surplus at all, you might think that this would let the Greeks spend an additional 4.5 percent of GDP–but the benefits to Greece would actually be much bigger. The extra spending would mean a stronger economy, which means more revenue. Suppose that the multiplier is 1.3 and that Greece can collect 40 percent of a rise in GDP in revenue. Then an additional billion euros in spending should generate around 0.5 billion euros in revenue, reducing the primary surplus by only 0.5 billion euros. Dropping the requirement that Greece run a primary surplus of 4.5 percent of GDP would allow spending to rise by 9 percent of GDP and raise GDP by 12 percent relative to what it would have been otherwise. Unemployment would fall by around 10 percentage points relative to no relief. The question of how large a primary surplus Greece runs is real and has powerful implications for the economic outlook. Keep your eyes on that ball.

Thrasymakhos: Can Aunt Agatha’s will be generous enough to make up for that!?

Atticus: You got me.

Sokrates: There are dangers for the rest of Europe from walking down the no-resolution branches of this strategy tree as well:

Paul Krugman: The consequences of playing hardball with Greece over its banks could very easily be immense. Up until now, the euro has proved very durable, largely thanks to the point Barry Eichengreen emphasized: any country that even hinted at the possibility of leaving would face the mother of all bank runs. But as I worried some time ago, this argument becomes moot if the banking system has already collapsed. If it turns out that the single currency is not irreversible, do you really think there would be no contagion? At the moment, Germany is talking as if it intends to follow the Michael Corleone strategy. But do we really think that Syriza will or even can retreat with its tail between its legs immediately after winning a dramatic election victory? Again, wanna bet on it? Wanna bet on it?

Atticus: Daniel Davies really disagrees:
Daniel Davies: Tsipras’ strategy is… cute. I think it might even have worked if tried three years ago; as far as I can tell, something like it was the unspoken threat under the table which led to the restructuring of the Irish bailout liability. It’s a blackmail game that is best played by a left-wing populist, because in order for the threat to be credible, it needs to be made by someone who is not susceptible to apocalyptic warnings and who is even prepared to dice with the prospect of actual bank runs. I can entirely see why it’s attractive to Syriza and Tsipras. But this isn’t three years ago. I think that if faced with this sort of behaviour by a Syriza government, the ECB would definitely decide to call the bluff. Euroland had a real, credible stress test and it wasn’t the one that we were all looking at. The real stress test in 2014 was the restructuring of Banco Espirito Santo. Stress tests are not a test of the banking system; they’re a test of the bailout system. The purpose of a stress test isn’t to bore the pants off us with megabytes of accounting data telling us things we already knew. The purpose is always to put the weakest banks in the system into a position where they need to be recapitalised, and thereby to demonstrate that the system is capable of dealing with capital shortages, and doing so without an unreasonable fiscal burden. The quick and brutal treatment of BES demonstrated that even in a comparatively large European bank, and even in one of peripheral Europe’s shakiest fiscal systems, it was possible to carry out a refinancing and resolution over a weekend, with legal certainty and without contagion to other banks or interruption of vital services. The successful outcome from BES must surely encourage the Eurosystem policy makers to think that Greek euro exit, if it happens, could be contained…

Thrasymakhos: So how is all this likely to end?

Atticus: Let’s listen:

Daniel Davies: Syriza plays the ‘madman strategy’ and gets given meaningful concessions to keep it in the Euro. One would expect this to be associated with a lot of self-congratulation from the ECB and repetition of ‘whatever it takes’ speeches, and the end result would be to either monetise or mutualise a load of the Greek debt burden. This would be very bullish.

Hypatia: That would seem to be the usual way that Eurozone crises have been dealt with over the past seven years…

Sokrates: Although very inadequately, from the standpoint of recovery of employment. Good for banks and capital holders, not so good for…

Atticus: Hush!

Daniel Davies: If Syriza plays the ‘madman strategy’ and Greece leaves the euro, this would be the mother of all buying opportunities as it would surely be associated with a massive risk-off trade, but the market would be quick to subsequently realise that the actual effect on the Eurozone was heavily quarantined.

Hypatia: And then?

Thrasymakhos: Davies’s implicit view is that Greece is then in trouble–cast out of the European Union into the status of a Belarus or a Turkey or an Algeria–and loses big long-term…

Sokrates: But the Eurozone recovers..

Atticus: Hush!

Daniel Davies: So my view is, I guess, that if you can close your eyes and open them again in January 2016, you buy Eurozone risk and hold it. The best trading strategy would be to keep some powder dry. Mon-Greek peripheral credit looks like it could be cheap, and potentially a way of parking cash somewhere without equity downside but some share in the upside when things get resolved and the market snaps back.