Central Bank /ESRI position: Joint Macro Modelling Project Manager

The Central Bank of Ireland (CBI) and the Economic and Social Research Institute (ESRI) plan to develop jointly a suite of modern macroeconomic/econometric models of the Irish economy as a basis for informing macroeconomic, monetary, financial sector and fiscal policy decisions.  This project is of critical importance to both organisations particularly in light of the current challenges facing the economy. The CBI/ESRI is seeking to appoint an individual to head a team of researchers to undertake this project.  This is an exciting opportunity with the successful candidate playing a central role in developing our understanding of the Irish economy as well as influencing domestic policy formulation at this critical juncture. The appointment will be initially for a three year period and the position could be filled on a secondment basis. Grade and salary will be commensurate with the skills, experience and qualifications of the successful candidate.  Appointment can be made up to Deputy Head of Function Level.

Details here.

Derek Scally’s Interview with Wolfgang Schäuble

In today’s Irish Times Derek Scally reports on an interesting interview with German Finance Minister, Wolgang Schäuble.   (Edited transcript available here.)     Overall, Mr. Schäuble comes across as thoughtful and strongly committed to finding a way through the crisis that preserves the euro zone.    But the claim that further official assistance in the form of relieving some of the burden of banking-related debt could worsen Irish prospects is not convincing.  

Put yourself in the shoes of a potential investor in Irish debt.   On hearing of a reduced burden on official debt, would you: (a) upgrade your view on the ability of the Irish State to avoid default on private debt based on its improved financial position; or (b) panic because the situation must be worse than previously believed, or else the increased official support would not be forthcoming?   I would think that potential investors are well aware of the objective facts of Ireland’s situation.  One of these facts is the extent of available official assistance.  

Of course, the German government can choose not to support actions aimed at “further improving the sustainability of the well-performing adjustment programme” (July 29th communiqué).   But this argument for withholding such support should be strongly challenged.  

(It is noteworthy that Jörg Asmussen, a member of the Executive Board of the ECB, made a similar argument in his IIEA speech in April – see here.) 

Amortising Bonds and Sovereign Annuities

Details of the today’s sale of “amortising bonds” by the NTMA are available here.   See here for the “information memorandum”.  The NTMA statement announcing the intention to sell the bonds in response to demands following the annoucement of the revised Pensions Board funding standard is here.

The new bonds will facilitate the development of “sovereign annuities”.   While there is no easy answer to the funding crisis in defined-benefit pension schemes, risks placed on pensioners through default risk on sovereign bonds should not be neglected. 

A briefing statement on sovereign annuities from the The Society of Actuaries in Ireland is available here.   Guidance to trustees and providers of sovereign of annuities is available from this Pensions Board link (see Related Documents).  A FAQ on the revised funding standard is available here.

Ireland as an International Financial Centre

The CSO has put out its latest report on the international portfolio allocations of Irish-resident investors – see here.

At 1.4 trillion euro, the total foreign portfolio assets are nearly ten times Irish GDP, illustrating the overwhelming role played by international financial intermediaries (mutual funds, hedge funds, etc) in the foreign assets and foreign liabilities of Ireland.  Little can be inferred from these data about the international financial positions of Irish households (direct holdings and indirect holdings via pension funds, insurance firms and mutual funds).

Inflation in Ireland and the Euro area

In an earlier post I drew attention to the extent to which Ireland’s recent apparent competitive gains reflected the weakness of the euro relative to the dollar and sterling.

Another component of competitiveness is, of course, our rate of inflation relative to that of the Euro area as a whole.

It is therefore of interest to put on record the inflation rates in Ireland and in the Euro area since 1999.

This is facilitated by the European Central Bank’s website, from which monthly data on the rate of inflation as measured by the Harmonised Index of Consumer Prices (HICP) may be readily downloaded.

The following Chart tells the story.

It may be seen that for the first five years of the new monetary union Ireland’s inflation rate was – contrary to expectations – significantly higher than the Euro area average.  This resulted in a significant loss of competitiveness relative to the rest of the Euro area.

For the years between 2004 and 2007 our inflation rate behaved as expected in a monetary union and differed little from that of the Euro area average.

During 2009 and 2010 we experienced more deflation than the rest of the Euro area. This helped restore some of the competitiveness we had lost in the early years of membership and the ‘internal devaluation’ was hailed at the time in the belief that it would play a big role in getting the economy moving again.

Since 2010, however, our inflation rate has been climbing back up towards the Euro area average.

It would seem that any further ‘restoration of competitiveness’ will require further weakness of the euro on the foreign exchange markets.

Charles Wyplosz on Italy’s “Bad Equilibrium”

Charles Wyplosz issues a stark warning here – a warning well worth heeding.  

But is he too pessimistic?    The fact is that the ECB has the power to cap bond yields.   With bond yields capped at a reasonably low level – say 4.5 percent – the Italian government should be able to avoid default, even with a formal adjustment programme of structural reforms and fiscal adjustments.   I doubt the programme would have to involve much beyond what the country is already doing.   Mario Draghi has held out the promise – albeit maybe a bit too vaguely – of such support in return for conditionality.   All sides have to move.

Simon Wren-Lewis on conditionality in bond-buying programmes

Simon has an interesting post that challenges arguments against unconditional bond-buying (QE) by the ECB.   He makes a convincing case that such bond-buying for specific countries to avoid a “bad equilibrium” would not violate the ECB’s price stability mandate.   

But I think his analysis misses another key (if implicit) aspect of the ECB’s mandate: in a highly incomplete political union, the ECB must minimise the risk of redistributions between members through its monetary policy (see this earlier post).   Losses on bonds will be shared across the monetary union.   Concerns that monetary union is a vehicle for such redistributions could doom the entire project.   Of course, there is risk of such losses even on normal monetary policy operations.   But this is why these operations take place within a strict risk control framework.   For bond-buying, fiscal conditionality can be viewed as an effort to reduce the risk of losses, and ultimately redistributions between monetary union members.  

Now it could be argued that fiscal conditionality actually increases the risk of losses.   This would be the case if fiscal conditionality is self-defeating — that is, slows the economy so much that the fiscal situation actually deteriorates.   Opinions differ on whether this is the case.   However, if influential members believe that the ECB’s actions would unacceptably increase the risks of losses without conditionality, then the ECB would find it difficult to proceed with bond-buying, and find it particularly difficult to make the strong commitment necessary to keep yields low enough to credibly remove the danger of the bad equilibrium (see here).

The bottom line that redistributive politics within the monetary union mean that the kind of strong commitment needed to keep yields low is near impossible without conditionality.   The choice may be for the ECB to act with conditionality or not to act at all. 

Reminder: DEW October Conference

Proposals are still being accepted for the DEW conference in Galway on October 12-14 next. Topics in any area of economic policy will be considered and proposals should be emailed to colm.mccarthy@ucd.ie

Daivid Laidler (University of Western Ontario) will be the keynote speaker and the programme, with booking details, will be issued early in September.

Measured Macroeconomic Performance

In a series of informative comments across recent threads, Michael Hennigan has raised important questions relating to the reliability of the recorded growth in key macroeconomic aggregates, and also the employment performance of internationally traded sector in general and the foreign-sector in particular. (See here for a useful summary from his Finfacts website).  Although Michael watches these figures much more closely than I do, and so I hesitate to contradict him, I find it hard to share some of his concerns.  

First a point of agreement:  At roughly 100 percent of GDP, Irish exports are strongly influenced by the activities of multinationals operating in Ireland, and the numbers tell us little about value added and incomes in Ireland.   Where I have difficulty following Michael is in his concerns about the reliability of Irish GNP and GDP figures.   GNP excludes the profits of multinationals (and not just repatriated profits), and so should be immune from concerns over tax-driven transfer pricing.    GDP excludes imports (including intermediate imports and royalties).    Michael says the Irish exports are overstated by one third.   If he has a chance, he might explain this in more detail, and also how he sees it affecting measured GNP and GDP given the exclusions just noted. 

Michael also notes that employment in the foreign-owned sector has fallen from 166,000 in 2000 to 144,000 in 2011.   This fall is certainly very regrettable.   But it occurred during a massive bubble-driven, structural mal-adjustment of the economy.   Given the extent to which the bubble affected the allocation of resources, I am surprised the damage done to the traded sector was not much greater.  Part of the answer would appear to be the highly elastic labour supply response – notably through immigration – which allowed the construction and other non-internationally traded sectors to expand, while limiting the damage to the traded sector. 

I do share Michael’s concern over risks around the projected return to robust growth after 2013.  But my main concern is a prolonged “balance-sheet recession”—and not just in Ireland.    While Michael’s description of the nature of much multinational activity in Ireland seems accurate, I find it hard to share his concerns about its implications for measured Irish growth performance.   I am ready to be corrected. 

Trends in public sector numbers

Have the Troika’s 2014 targets on jobs numbers have already been met? This new working paper by UCD’s Niamh Hardiman and the IPA’s Muiris MacCarthaigh seems to suggest it has. The 2014 target is here on page 64 of the national recovery plan.

From a recent Dail question:

The numbers working in the public service have continued to fall, with the provisional outturn for the end of last year now standing at 296,900, which means we are now at close to the 2005 staffing levels. This is a year-on-year reduction from the end of 2010 of more than 8,500. The employment control framework ceiling for the public service in 2011 was 301,000. To exceed this target by more than 4,000 is impressive.

The authors make good use of the new department of public expenditure and reform’s databank in their work, and it produces this figure.


Some thoughts on bond buying

Michael Hennigan noted fairly enough that my previous post was a bit on the arcane side.   I’m afraid he will see this one as no better.  

I think it is worthwhile to take a step back and think about how ECB bond buying could have positive effect, and to think about the effectiveness of past and possible future bond-buying programmes in that light.   A useful starting point is to recognise that the willingness to pay for a bond with a given face value and coupon rate depends on the “risk free rate” and the perception of default risk.   If everyone agreed on the default risk, then the demand curve for bonds would be perfectly flat.   If a bond buying programme did not actually change the perception of default risk, then bond buying would have no effect on secondary market price and thus on yields.   (A useful way of thinking about official bond buying is that it shifts the market supply curve leftwards; if the market demand curve is horizontal, then there will be no change in price (and thus yields)).  

However, if there are varying perceptions of default risk, then – even if the bond buying programme itself does not change anyone’s perception of default risk – the programme will raise bond prices (and reduce yields), as the market moves up along a downward sloping demand curve.   (The differing perceptions of default risk is what makes the demand curve downward sloping, given the resulting variation in willingness to pay.)   My sense is that this is what broadly happened in the first phase of bond buying.  The weak commitment to the programme did little to change actual perceptions of default risk.   Thus, while purchases were somewhat effective in reducing yields, the positive impact was very limited, as ultimate default risks were left largely unchanged.  The programme ended up in failure.

It seems Mario Draghi is well aware of this, and he wants any future to operate quite differently.   The key is to provide a credible commitment to keep yields down and ensure that expectations of a “bad expectational equilibrium” do not take hold.  But there is understandable concern over moral hazard.   Although some European policy makers seem to have a difficult time giving up on market discipline (even after Deauville), I don’t see how we can pull out of the crisis unless the perception of default risk is kept low.  This leaves “conditionality” as the only feasible disciplining device.   But I don’t see how the ECB would be in a position to make a credible commitment to do what it takes unless this alternative disciplining device is in place, which explains the requirement that benefiting countries enter a programme.  

The goal should be to take risk of sovereign debt restructuring off the table as far as possible in any future programme.   (The example of Greece shows that the possibility of restructuring cannot be completely removed; and it did the credibility of the Trichet-led ECB no good to make ludicrous statements that restructuring was impossible.)  Mr. Draghi’s (vague) commitment to revisit ECB seniority can be viewed as backing up this approach, so that even in the low probability event that there is a restructuring, the losses would be shared with official creditors.  

(As an aside, I think that a major factor behind the fall in Irish yields is the that, even if there is need for a second programme, the risk of a debt restructuring being part of that programme has fallen significantly.)  

Overall, Mr. Draghi seems to moving in the right direction.   Let’s hope he can deliver.

Redistributions in a monetary union

Karl Whelan has a good post on the exaggerated fears of ECB insolvency, rightly pointing out that standard ideas of bank or non-bank-corporate insolvency do not transfer well to a central bank with the power to create liabilities at will.

But I think Karl’s post underplays the importance of potential redistribution effects of monetary policy within a monetary union.   (Although the ECB’s stress on price stability gets most attention, my sense is that the avoidance of redistributions between members plays at least as important a role in their thinking.)   One way of seeing this is to recognise that the amount of seigniorage-related revenues available for ultimate distribution to member governments is fixed by the inflation target (given real growth and other determinants of the change in money demand.)   Losses on asset purchases will lower these revenues. 

This also relates to discussions of design flaws in the euro, and especially the absence of effective bailout mechanisms.   The revealed fragility of creditworthiness within the monetary union shows the seriousness of this flaw.  But the “no-bailout-rule” was there to reduce the risk of redistributions, and without it many countries would not have signed up.   The revealed design flaw will have to be fixed if the euro is to survive.   Yet I think there is a better chance of effective negotiated change if legitimate concerns over redistributions are recognised.

Simon Wren-Lewis, the EMU chess game, Italy and the IMF

Simon Wren-Lewis has a nice post here. The whole situation makes you wonder whether, despite all the ECB’s talk of independence, there is a major Western central bank more subject to political constraints anywhere in the world.

I would add a couple of points.

First, the ECB and the rest of us are fixated on what will fly politically in Germany; but there are 16 other member states in the Eurozone, and not all of them are as pliable as little, eager-to-please Ireland. In particular, I have always thought that there were two reasons to avoid having Italy enter a bailout programme: not just the fact that EFSF/ESM won’t have enough money, but the fact that if this happens, Italy may decide to leave EMU. The reason why economists like Paul de Grauwe have been asking for ECB intervention is so that an Italian bailout becomes unnecessary; now it seems that Italy will only get ECB intervention if it enters a bailout programme. The whole thing seems upside down, and people are playing with fire here. Despite its large debts, Italy wouldn’t be having these difficulties on the market if it wasn’t in EMU: to ask a big, important country with a sense of its own dignity to give up sovereignty — and potentially enter the same death spiral as Greece, and now apparently Spain — simply so that it can remain in a single currency that isn’t working seems like a bit of a stretch to me.

Second, I agree with Simon that the ECB’s worrying about the moral hazard facing states like Italy in a situation like this is pretty stupid. (I would add that it is also wrong because it mixes up fiscal and monetary policy. Let the ECB stick to monetary policy, and let governments, individually and collectively, stick to fiscal policy.) But in our dysfunctional, destructive monetary union it may indeed be politically necessary for the ECB to insist on fiscal policy conditionality before doing the job of a central bank. Forcing Italy into a bailout programme seems like a particularly dangerous way of doing this, however.

There is a better way I think. The IMF is signaling that Spain and Italy are doing all that could be reasonably asked of them right now. Surely if the IMF is willing to certify that a country is running a sensible fiscal policy, this should be enough to allow the ECB to do what needs to be done?

UPDATE: Francesco Giavazzi is quoted here as making an obvious and very important point: for an unelected technocrat like Monti to steer Italy into a bailout programme, with the consequent loss of sovereignty that would be involved, prior to elections, would be unacceptable.