Not irrelevant in Ireland. AEP, here.
Archive for the ‘EMU’ Category
Paul Krugman is quite right: the most recent Eurozone GDP numbers are really disappointing. But hardly surprising, given current policies, unless you’re the sort of person who thinks that peripheral yields are the only thing that matters. (Not a great metric of success you would think, if they have been falling in Greece, but there you go.)
I recently read someone (can’t remember where, perhaps you can) saying — based on the yields — that the eurozone crisis was now over economically speaking, and that the only thing that might derail things now was the politics. Which made me think two things:
1. It is surely unacceptable intellectually to regard the predictable political consequences of lousy economic policy as being somehow ‘exogenous’ and none of our business as economists.
2 If the politics of the eurozone crisis eventually turns sour, won’t this show up in various financial spreads , and wasn’t this the whole point of the ‘second generation’ crisis models we all starting teaching our students in the early 1990s?
Even if it’s cancer that kills you, death coincides with cardiac arrest.
The details for the calibration of the EU-wide bank stress test are now available. Looking only at Ireland, and only at one of the key variables in the stress test, the calibration looks problematic. It may be coincidental that the Irish adverse scenario has been badly chosen; it might be that all the other member countries have reasonable calibrations. If the others are as problematic as in the Irish case, this is not a reliable EU banking sector stress test.
Under the adverse scenario, Irish property prices are assumed to suffer a cumulative three-year drop of 3.03%; equivalent to a decline of 1.02% each year for three years in a row. Over the period covered by CSO data, 2005-2013, Irish residential property prices had an annual sample volatility of 11.7%. This in turn implies (under reasonable assumptions) a three-year volatility of 20.27%. In risk analysis it is conventional analytical shorthand to measure adverse outcomes in “x-sigma” units defined as the outcome as a multiple of the standard deviation. For an adverse scenario calibration, the assumed outcome is usually roughly a two-sigma or three-sigma event. Using a four-sigma shock would not be unusual (due to fat tails in some probability distributions). The EBA has calibrated the adverse price shock as a 0.1492-sigma event. That is not credible as an adverse scenario in a stress test.
Keep in mind that the stress test is meant to reassure market participants that even in an adverse scenario the Irish banks are sound. This test reassures us that if property prices fall by as much as one percent a year over the next three years, the banks have enough capital. In the case of a two-percent fall, there are no promises.
As a caveat, this does not mean that the Irish banks need equity capital. They have already had a credible stress test (in 2011) and a big capital injection. Also, the Irish property market although very volatile has a maximum likelihood price change which is positive over the next three years. However the asset class also has considerable “downside” potential and continued high volatility. Conventionally, at least in the case of portfolio risk analysis, the unconditional mean of a stressed variable is set equal to zero for risk analysis purposes. The EBA has chosen to build in a big positive benchmark price rise for Irish property assets, and this is part of the reason that the adverse scenario is unacceptably mild. In any case, this calibration is extremely mild as an adverse scenario and not reassuring for the EU-wide test.
Calling something a banking union does not make it so; Philippe Legrain joins the ranks of people like Colm McCarthy and Wolfgang Münchau pointing out that this is an emperor without clothes.
In a recent post, we read that
With the Social Democrats (S&D) and the conservatives (EPP) neck-and-neck in ever more refined EU wide opinion pools, the lead up to the European elections has never been more exciting. It’s down to one seat whether the next Commission president is Social Democrat or Conservative.
I am sure that there are some in Brussels who think that giving voters an indirect say in who becomes Commission President is exactly what we need to boost interest in the forthcoming European elections, and give the European project some democratic legitimacy.
By the way, does anyone know what the EPP or Social Democratic position on the Eurozone crisis is? (I think I know what Marine Le Pen wants.)
I have another proposal to enhance the democratic legitimacy of the project: allow voters to fundamentally change the direction of policy, should they so choose. Reverse the “treaty-isation” of particular economic policies. Stop trying to make the commitment to austerity democracy-proof.
I have a piece on the subject in the most recent issue of Finance and Development, available here.
Production lags being what they are, I wrote the article in mid-December. Since then, Wolfgang Münchau has declared the Eurozone policy debate over (and not in a good way); the German Constitutional Court has issued a ruling on OMT that is potentially much less benign than is commonly assumed; and Italy has installed its third non-elected Prime Minister in a row, with a notorious multiplier denier as Finance Minister thrown in for good measure. None of this has cheered me up.
This morning’s Eurointelligence briefing put me on to this article in Les Echos, which in turn led me to this Ipsos opinion poll. It contains several sobering findings, notably with respect to foreigners. But the finding that struck me most — since this is something I have been writing about for years now — is that a majority of French working class voters now want to leave the Euro. Indeed, only 34% of French workers think that EU membership is a good thing.
Isn’t it amazing how short run blips in various economic indicators can lead powerful people to assume that all is well with the EMU project? It is slow moving variables — long term unemployment, gradual shifts in public opinion, and so on — that pose the greatest threat to the Euro’s survival. If the far right does as well as people now seem to think it will in the European elections, this will presumably be presented in the media as a “shock” to the system, but has it not been obvious since 2010 at the latest that something like this was likely, given Eurozone macroeconomic policies? And has it not been obvious for years that actually existing EMU is harming the broader European project?
Europe’s political leaders should remember what Ernest Hemingway said about bankruptcy.
I dare say it will strike most people as pie in the sky, but it makes sense that people who want to preserve the Euro start formulating proposals such as this. Two reasonable conditions attaching to any such proposal seem to me to be that: (a) entry to any such community be decided by popular referenda in each country; and (b) that there be some sort of Connecticut compromise in place so that the rights of small states are protected.
The Irish Times today features two contrasting strategies for dealing with the debt legacy created by the Irish bank bailout.
- Ireland urged to play ‘hardball’ to get a deal on legacy bank debt
- Sale of State’s AIB stake will not rule out retroactive aid
An interview RTE’s Sean Whelan did with Willem Buiter is available here.
The Economist has been hosting a roundtable discussion on deflation in the Eurozone, and asked me to say something about this from a historical perspective. My contribution is here. (I should also say that the copyeditor removed my reference to Barry Eichengreen, the go-to person on these matters.)
Arguing against Say at a time like this is like shooting fish in a barrel, so let’s not even bother. The more alarming point is what this tells us about the European left: to all intents and purposes, in many countries there is none. Ambrose Evans-Pritchard puts it well, I think:
Trade unions in the West are strangely silent, pushed to the margins by the atomised structure of modern work. Europe’s political Left is so compromised by ideological defence of monetary union – a Right-wing project, or “bankers’ ramp” as the Old Left used to say – that it cannot muster any articulate policy.
Hollande’s extraordinary statement that supply creates its own demand, at a time when the Eurozone economy is up against the zero lower bound, and unemployment is terrifyingly high in several EMU member states, is just an extreme, self-satirizing, example of the phenomenon. If what Europe needs is for France to make Germany an offer it can’t refuse — allow the ECB to seriously loosen monetary policy, or we may not be able to stick with EMU — then we’re not getting it any time soon.
Now, if you’re on the right I suppose you might welcome the fact that the left is committing hara kiri on the altar of European orthodoxy, but you shouldn’t. For the reality is that orthodoxy is letting the people badly down, as Martin Wolf pointed out today, and the people aren’t stupid. If the left is not going to offer them an alternative, then Eurosceptic parties will. And unfortunately most of those are on the extreme right.
(H/T Mark Thoma.)
This is a terrific graph courtesy of Paul Krugman, that speaks a thousand words.
Ashoka Mody has a new Bruegel essay proposing a “Schuman compact” for the Euro area, available here.
The financial architecture of the Eurozone is still a mess. One possible improvement might be a wave of cross-border bank takeovers and mergers. Such a change might make the Eurozone less fragile since country-specific economic shocks would not have a two-way negative-feedback through the balance sheet of country-specific banks. This change would also kill the potential for country-specific deposit runs. The bank regulatory authorities in the U.S.A. (FDIC and Federal Reserve) often arrange mergers and takeovers of troubled banks to snuff out liquidity/solvency crises at individual banks and/or dampen regional shocks. J.P. Morgan was encouraged to take over Bear Stearns and Washington Mutual by the regulators for exactly these reasons. Now, quite appropriately, J.P. Morgan is responsible for the “legacy liability” issues of these two absorbed banks, and it looks like the final bill for J.P. Morgan could be over $10 billion. J.P. Morgan is the legal successor and a change of ownership does not eliminate the liability, even if (as in this case) the regulator gave you a Best Boy in Class ribbon when you agreed to the takeovers. The J.P. Morgan case is in a foreign jurisdiction, but nonetheless this case will have knock-on effects for the Eurozone. The J.P. Morgan case makes it less likely that there will be any takeovers of troubled or formerly-troubled Irish banks.
It has always struck me that the first order consequence of making it easier for firms to fire people in the middle of a depression would be that…firms would fire more people. And it has never struck me that this would be desirable.
Now Gauti Eggertsson, Andrea Ferrero and Andrea Raffo have a new paper pointing out that at the zero lower bound, where monetary policy cannot offset the deflationary impact of structural reforms that would otherwise be desirable (lowering mark-ups in product and labour markets), such reforms can be contractionary (by generating expectations of deflation and raising real interest rates).
All of which seems obvious once you think about it, but it needed someone to point it out. And this is a problem for a continent whose leaders refuse to take the demand side of the economy seriously, and are hoping that “structural reforms” will obviate the need for them to rethink their macroeconomic strategy.
Another chance for Paul Krugman to cite St Agustin!
“Thailand without the baht” is a useful way of thinking about the Irish economy’s boom, bust, and subsequent flat-lining, so it’s great to see that Paul Krugman is about to get his teeth stuck into the Asia-Euro comparison.
Some people argued in 1997/1998 that the crisis showed that the entire East Asian growth model was flawed. Whatever the benefits or costs of that model may have been, the subsequent rebound showed that these economies were still capable of delivering long run growth once their short run macro problems had been resolved. Seen from the inside the Irish growth model seems pretty rickety, but respectable if unexciting growth rates of the sort you see in countries close to the technological frontier should be attainable in the future once our own short run macro problems, and those of the Eurozone as a whole, have been resolved. Unfortunately this doesn’t seem to be on the horizon right now, which is why the “default and devalue” scenario has to be an option now in Greece, and may eventually come onto the policy agenda in other Eurozone periphery countries as well. The problem with the “short run” is that it can continue for an awfully long time unless corrective action is taken.
Jeff Frankel has a terrific piece here on the unsatisfactory way in which recessions and recoveries are called in Europe.
The current European definition of a recession (two successive quarters of declining GDP) is particularly unsuitable in Ireland, given its dodgy and volatile GDP statistics — looking at a broader range of indicators over a longer period of time would surely make more sense here.
There is an additional cost to the two-quarter rule of thumb in the Irish and Eurozone context: it implies that Ireland is periodically proclaimed to be out of recession. This then allows Eurozone politicians and central bankers to defend the status quo monetary and fiscal policies prolonging the economic crisis in Ireland and elsewhere. (And to express “surprise” when Ireland tips into recession “again”, despite its model pupil status.)
Update: the CEPR’s Euro area business cycle dating committee does not use the “two-quarter GDP decline” rule of thumb. Details of their methodology are available here.
We know that rising unemployment is not something that will make the EU admit that their current macroeconomic policy mix isn’t working.
We know that two successive years of GDP contraction is not something that will make them admit it either. Even though some of them denied at the time that this could be a consequence of austerity.
Will spiralling debt/GDP ratios do the trick? This is, after all, the number they have been fixated on since 2010, and the figures show that, even on its own terms, the current strategy has not been working.
This is where dodgy GDP forecasting becomes so pernicious: no matter how much of a basket case the Eurozone becomes, over-optimistic forecasts — notice how good we expect 2014 will be!! — will always make it possible for discredited politicians, central bankers and eurocrats to cling on to the hope that good times are just around the corner. The risk is that they will wake up one day and find that it is too late to change course, both for themselves and for the euro.
My thanks to commenter Eamonn Moran who pointed me to this paper recently published by the Central Bank, and which deserves a wide readership, especially among advocates of “internal devaluation” strategies across the Eurozone periphery. The Irish figures are very striking, not just in terms of how few firms have cut wages here, but of the reasons why.
There are costs and benefits to everything, even emigration at a time of economic crisis. We Irish have probably gotten so used to (silently) thanking our lucky stars that our young are not hanging around at home being unemployed (or at least, not to the same extent as the young in the Mediterranean), that we may have forgotten this. Indeed, I had forgotten that I wrote this back in 2010. But now Paul Krugman points us to this post (and see also this one) which brings up the issue, and it is worth thinking about it seriously.
Long run GDP and tax revenue may not suffer that much if people return home eventually, especially if they bring home new skills and contacts, but what if funding crises happen before then? And are we perhaps too optimistic about the prospects for return migration? My generation came home in droves because of the 1990s boom, but that sort of growth is obviously never going to be replicated: you can only catch up on the technological frontier once. And as I pointed out in that earlier post, there is scope for negative feedback loops here, related to the overhang of government debt.
All in all, another reason to think that debt restructuring is going to eventually have to take place around the Eurozone periphery.
(H/T Alan Taylor who suggested the title of the post. That is a clue as to what it refers to by the way.)
Worth a look, Breugel’s assessment of the programmes in Greece and Ireland in particular, and the differential roles and internal tensions played by the individual members of the Troika, particularly the Commission. The large effects these programmes are having on unemployment is a key feature of the report.