Given that an agreement looks likely, it’s probably worth opening a thread on what commenters believe the new programme for government should contain, what it might contain, what that weird intersection of politics and economics means it will contain.
I’m writing an economics column in Critical Quarterly, a humanities journal, which is a bit of fun. They are supposedly free to view for 12 months after publication. I already posted a link to the first, on the European democratic deficit, but neglected to link to the second, on migration. The third, on secular stagnation, is available here.
The conference on macroprudential regulation originally scheduled for September 4th has been postponed to Friday, January 29th, 2016. See here for all details on the conference. A full programme will be provided closer to the date.
Yesterday, the First of July, was Canada Day.
Discussing the crisis in the Eurozone with some visiting Canadian relatives led to the question How stable is the Canadian currency union?
At first sight it seems to be much more stable than its European counterpart. The Canadian banking system is renowned for its solidness. It is dominated by five national banks that operate coast to coast, supervised by the much-admired Bank of Canada. There is a large national budget that includes important elements of inter-provincial fiscal equalization. Internal labour mobility is relatively high.
But on the other hand the provincial governments are not constrained in their borrowing, there are enormous differences between the economic structures of the provinces, and there is always the Quebec question.
In fact, to a surprising extent, the stability of the Canadian union appears to depend on the fact that, as the author of this article puts it,”there are no Greeces here”. He draws attention to flaws in the design of the Canadian currency union that could come home to roost some day.
Tom Flavin, Brian O’Kelly and myself have a new working paper on the restructuring and recovery of the Irish financial sector, covering the period late 2008-2014. Helpful comments (cautiously) welcomed.
Call for Papers: Macroprudential regulation: policy dynamics and limitations
A joint academic-practitioner conference with the theme Macroprudential regulation: policy dynamics and limitations will be held in Dublin, Ireland on Friday September 4th, 2015, organized by the Financial Mathematics and Computation Cluster (FMC2), the Department of Economics, Finance & Accounting at Maynooth University and the UCD School of Business at University College Dublin.
Macroprudential regulation is fairly new, and there are many unanswered questions. Can macroprudential constraints on credit be reliably attuned with the business cycle and/or credit cycle? Are fixed constraints on credit safer and more reliable than attempts at dynamic anti-cyclical ones? Should regulators take account of market or regulatory imperfections, such as in the construction sector, in setting constraints on credit growth? Is macroprudential control by an independent central bank consistent with the democratic accountability of government economic and social policies? Potential topics include:
* Business cycles, financial cycles, and the feasibility of dynamic macroprudential control
* The desirability and effectiveness of LTI and LTV limits on mortgage lending
* Democratic accountability and central bank independence
* Modelling house price movements and household debt and their interactions
* Controlling credit growth and credit flows in the Eurozone
* International case studies of macroprudential regulation.
* Assessment of macroprudential credit-restricting policies
Please send papers or detailed proposals by June 15th, 2015 at the latest to Irene.firstname.lastname@example.org; all papers must be submitted electronically in adobe pdf format. There will be both main conference sessions and poster sessions. We will consider proposed contributions to the poster session until 31st July. The academic coordinators for the conference are Gregory Connor and John Cotter, who can be contacted at Gregory.email@example.com or John.firstname.lastname@example.org.
There are no submission fees or attendance fees for the conference. We are grateful to the Science Foundation of Ireland and the Irish Institute of Bankers for their generous support of this conference. The Financial Mathematics Computation Cluster (FMC2) is a collaboration between University College Dublin, Maynooth University, Dublin City University and industry partners, with support from the Science Foundation of Ireland.
The latest in an important series of papers by Jordà, Schularick and Taylor is described here.
Although they don’t spin it this way (which is not surprising, since they don’t provide evidence about the impact of fiscal policy on housing booms and busts), the work suggests to this reader potential arguments (on top of the more standard ones) regarding the benefits of automatic stabilisers and countercyclical fiscal policy.
The Irish Central Bank is planning to impose macroprudential risk regulation on the domestic banking sector (see here). The general approach of the Irish Central Bank has been widely welcomed by economists, although the specifics of the proposals are controversial.
John Cotter (UCD) and I are planning a conference in September 2015 on macroprudential regulation, the fifth in our series of FMCC conferences on financial risk and regulation. Macroprudential regulation is fairly new, and there are many unanswered questions. Can macroprudential constraints on credit be reliably attuned with the business cycle and/or credit cycle? Are a-cyclical constraints on credit safer and more reliable than attempts at anti-cyclical ones? Should regulators take account of market imperfections, such as the poor performance of the Irish property development industry and the high costs of new housing construction in Ireland, in setting constraints on credit growth?
Macroprudential regulation has particular importance in Ireland, a small open economy buffeted by credit flows from bigger neighbours. The failure to impose macroprudential regulatory control on the Irish banking sector was a central cause of the Irish financial crisis of 2008-2011. During 2000-2007, within a flawed eurozone currency system, a politically-neutered Irish Central Bank ignored a runaway inflow of foreign credit into the Irish banking system. This massive credit inflow undermined the stability of the Irish financial system and led to the disastrous failure of the Irish domestic banking sector.
There is a varied range of views among economists on macroprudential regulation. This is clear in the responses to the Irish Central Bank’s policy discussion document. Three thoughtful responses come from David Duffy and Kieran McQuinn (both at ESRI) here, Ronan Lyons (TCD) here, and Karl Whelan (UCD) here. (For full disclosure, my own response to the Irish Central Bank discussion document is here.) Lyons recommends fixed, a-cyclical credit controls whereas Duffy and McQuinn argue for dynamic, anti-cyclical controls. Duffy and McQuinn stress the need for more new housing in light of fast Irish demographic growth, and the positive role of high housing prices (aided by bank credit growth) in eliciting an adequate supply response. Lyons argues that excessive bank credit growth should not be used as a hidden subsidy for a cost-inefficient building industry.
Lyons makes a case for no loan-to-income (LTI) constraint, instead relying only upon a loan-to-value (LTV) constraint for macroprudential credit control. This contrasts sharply with the view of Karl Whelan who argues for LTI-only macroprudential controls in the current Irish case. Duffy and McQuinn advocate for both controls. I share the view of Duffy and McQuinn. Lyons does not consider the importance of dual-trigger mortgage default in Ireland (that is, mortgage default which is triggered jointly by income stress and negative equity). The amount of Irish mortgage arrears is likely to remain large and volatile, and this is a key potential source of market instability. Both initial LTI and initial LTV ratios are linked to subsequent mortgage default probabilities, so both should be controlled.
There are certainly many points for discussion, which should make for an interesting conference! A formal Call for Papers will follow shortly – if there are particular themes or panels that we should include, feel free to mention them in the comments thread below.
Summary press release here. More details to follow.
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.
Fiona Muldoon, Director of Credit Institutions and Insurance Supervision at the Irish Central Bank, gave a speech yesterday in Glenties at the MacGill summer school (h/t John Gallaher). The topic of the speech was “Restoring Confidence in the Irish Financial System.” Ms Muldoon gave a fairly upbeat assessment of progress. I am less sanguine. The problem is not lack of international confidence in Irish banks and businesses, but rather lack of international confidence in Irish financial regulation. It is still not clear if the Irish Central Bank has the backbone for the tough tasks it faces in the current environment.
It is important to remember that the weak regulatory stance of the Irish Central Bank during the credit bubble period was one of the chief causes of the Irish economic crisis. The Irish Central Bank’s soft and timid approach, and its willingness to be swayed by political and business interests, was a major cause of Ireland’s economic disaster (for evidence, see my paper with Brian O’Kelly). Has the Irish Central Bank sufficiently altered its approach?
The Irish Central Bank has reformed enough so that if the challenges of 2002-2008 ever reoccur, it will be ready for them. This new resolve to block credit bubbles is not likely to be tested for many decades. The Irish Central Bank needs to have the strength and fortitude to deal with the very different challenges of 2013.
The Irish Central Bank showed no leadership during the fiasco of the 2009 Land Reform Act/Dunne Judgement. The previous government (perhaps deliberately) slashed a gaping hole in Irish financial contract law when it passed the flawed 2009 Land Reform Act. The flaw was pointed out by Justice Dunne, and the judiciary reasonably expected that such an egregious flaw (called a “lacuna” in legal parlance) would be fixed by amending legislation. However the legal flaw was politically convenient since enforcing mortgage contracts would have been politically painful at the time. Ignoring the Dunne Judgement and leaving the flaw in place was very poor practice in terms of restoring international confidence in the Irish financial system, but it was politically convenient for a domestic audience. The government did nothing at all about this legal flaw, despite the obvious impact on Ireland’s international reputation.
It took outside interference by the Troika to get this legal flaw fixed. The Troika repeatedly noted the unacceptable situation in their quarterly reviews, and when government action was still not taken the Troika demanded that the Irish government act by an imposed deadline or face a cut-off in national debt funding. Throughout this long, confidence-draining saga, the Irish Central Bank stood meekly by and said nothing. A stronger-willed central bank (US, UK, Germany, others) would have been screaming from the rooftops about the need to fix such a gaping hole in the country’s financial contracting law. It is not to the credit of the Irish Central Bank that we needed Troika intervention to get this problem acknowledged and fixed.
The Central Bank’s response, or lack thereof, to the explosive growth in mortgage arrears is another case where its stance was timid. Even by late 2011 it was obvious to hard-headed observers that some substantial fraction of the mortgage arrears explosion could be traced to strategic behaviour by households. Mentioning strategic default is offensive to many people since it means acknowledging that some Irish people are acting dishonestly in their own self-interest against the interests of society. A few people were brave enough to mention the obvious (take a bow, Karl Deeter!) but none at the Irish Central Bank. Up until early 2013, the Irish Central Bank effectively had a ban on any mention of strategic default by any central bank spokesperson. This gave rise to some stilted presentations, where Central Bank senior spokespeople railed about the explosion in mortgage arrears without any mention of one of the key causal factors. This omerta was finally broken by Patrick Honohan in early 2013. That was too late in the process to be an international confidence-booster. A strong imperative by the Irish Central Bank not to cause anyone any offence is not a good foundation for building international confidence in Irish financial regulation.
On the positive side, the Irish Central Bank’s actions against Quinn Insurance were tough and bold. So the bottom line is that in terms of restoring confidence the Irish Central Bank has a mixed record over recent years.
The Eurozone banking system is not working properly due to fragmentation between core and peripheral banking systems. In a recent speech, the president of the ECB, Mario Draghi, has acknowledged this, but argues that fixing this problem is someone else’s responsibility. The ECB has the tools to address this crucial flaw in the Eurozone system, and over the medium term horizon there is no other Eurozone institution that can. The ECB should use the tools available to fix this market fragmentation, in particular, the ECB should engage in aggressive, long-term asset refinancing on sufficiently generous terms to encourage bank participation. Continue reading “ECB Policy Responsibilities and Banking System Fragmentation”
Call for Papers
Bank Resolution Mechanisms
A joint academic-practitioner conference with the theme Bank Resolution Mechanisms wil be held in Dublin, Ireland on Thursday May 23rd, 2013, organized by the Financial Mathematics and Computation Cluster (FMCC) at University College, Dublin and the Department of Economics, Finance & Accounting at National University of Ireland Maynooth. Continue reading “Call for papers – conference on bank resolution mechanisms, Spring 2013”
Six months ago on this blog I made a quasi-prediction that the number of new residential mortgages in Ireland might shrink to zero-plus-noise. Arguably this has now happened. I claim no great insight and concede that it might have been dumb luck. My quasi-prediction was based on some informal liquidity-risk analysis of the Irish banks. The banks are in a corner solution with respect to long-term illiquid assets. There is little good reason for an Irish-domiciled bank to issue a new residential mortgage, rather, they might be keen to sell any of their existing long-term illiquid assets at a loss. This has only second-order policy importance relative to Greece, etc., but is worth documenting.
The most recent Final Conference to Save the Euro ended in disarray when the UK refused to sign up to a proposed set of EU treaty changes. The UK’s veto was due to the inclusion of an EU-wide Tobin Tax on security transactions in the set of proposals. The justification for an international Tobin Tax is quite strong. Hypercompetitive securities markets with excessively-large trading volumes and hyper-fast price changes are a serious danger to global financial stability. A Tobin Tax would eliminate these dangerous trading excesses without impinging much on underlying market efficiency. On other hand, the UK government’s refusal to sign up to an EU-only Tobin Tax, imposed on the City of London while the US and Asian global financial centres remain outside the tax net, was an obvious and sensible policy decision for the UK.
After the proposed EU treaty changes were restricted to a coalition of the willing, the Irish government fretted that a Tobin Tax might particularly disadvantage the Irish financial services industry, given that the UK will be outside the tax net.
What should be Ireland’s policy stance toward an international Tobin Tax? Should Ireland do the right thing as a global citizen by supporting such a tax within the Eurozone, or should it protect its international financial services industry from UK (and non-EU) predation and therefore veto any such tax proposal? It would be much better for all concerned if the Tobin Tax could be imposed at a global rather than EU level.
Sometime in the future, May 6th 2010 might rank with August 9th 2007 as a “warning date” for a subsequent financial market disaster. Recall that starting on August 9th 2007, quant-trading hedge funds experienced an extremely turbulent, credit-market-related meltdown. Although the quant-trading markets calmed down after about two weeks, many analysts now recognize this as an early warning signal of the subsequent global credit crisis. In an interesting parallel, on May 6th 2010, high-frequency trading systems generated a “flash crash” of US equity markets, causing a 9% fall and 9% rise of the US stock market within a 20 minute period. Some individual stock prices went bananas; completed trades at crazy prices during this short “flash crash” period were annulled that evening by the NYSE board. Since the markets righted themselves within a day or two, many analysts have forgotten about this incident. But could this “flash crash” be an early warning sign of a subsequent “permo-crash”? High frequency trading (HFT), using entirely computerized systems to trade at hyper-second frequency, now constitutes 70% of US equity and equity-related (equity baskets, futures, options) trading volume, and 30% in the UK. If HFT generates a flash-crash at the end of the trading day, rather than mid-day as on May 6th, and something else goes wrong at the same time, it could lead to an enormous disaster.
Tobin originally proposed his tax for the foreign exchange market, which was the first financial market to have hyper-competitive trading costs. He saw that most of the trading volume in forex markets provided very little economic value. A small tax would have a big influence on trading volume, rendering purely speculative and potentially destabilizing trading strategies unprofitable, while having little or no impact on the real economic value of these markets. Tobin called it “throwing sand in the wheels” of securities market trading. Nowadays, Tobin’s “sand in the wheels” metaphor is widely misunderstood. Tobin was a World War Two naval officer and throwing sand in the wheels was an accepted way to improve machine performance in his day. For mid-twentieth century machinery a little sand in the wheels would slow down the mechanism (think of something like a navy ship’s water pumps) and make for more reliable performance with less chance of overheating. With modern precision engineering the notion of “sand in the wheels” as a repair method seems ridiculous, so commentators assume Tobin is advocating sabotage of securities markets. That was not what he meant – “sand in the wheels” is an old-fashioned procedure to slow down machinery so that performance improves, not a means of sabotage. Oddly, the tax is designed to generate minimum revenue – it relies on the elasticity of trading volume to net costs, and tries to drive out destabilizing short-term trading strategies while collecting minimal tax revenue.
Now, after decades of hard-fought liberalization, US and UK equity markets have the same hyper-competitive trading costs as forex markets. HFT has hijacked this and feeds off this market cost improvement (and by earning net profits from “normal” market traders) with trading systems that add little real efficiency improvement for markets. Eliminating their net profits with a small tax would do little harm, and make markets safer. The very bright computer scientists who run these HFT firms could go back to socially useful activities like designing better software.
There is another interesting parallel to the global credit crisis. US housing regulators worked for thirty years to increase access to owner-occupied housing for lower and middle income households and this was a big success. Then, they took that policy too far, and the policy was hijacked by self-interested actors in the US property lending and securities trading sectors. There was too much of a good thing in terms of the too-low-credit-quality US residential property lending market. The same applies now with securities market trading costs and trading access. Regulators have succeeded in driving out bad securities trading practices and greatly lowering trading costs, but this process has gone too far. It has been hijacked by HFT. I call this the Too Much of a Good Thing (TMGT) theory of regulatory capture.
During the credit bubble, Ireland enthusiastically joined the dumb-down contest to impose the minimal possible regulation on the financial services sector. Perhaps now Irish policy leaders could make amends by joining the push for a Tobin Tax.
How would a Tobin tax impact the competitive draw of Dublin for its brand of “off shore” financial services? Perhaps it would be the death knell for the Irish stock exchange since all trading volume might migrate to London. Ireland policymakers should encourage a global solution, bringing the US and UK in particular into the plan. Asian markets (which are not yet competitive for HFT) might be willing to cooperate as well, since there is no great cost for them.
The latest attempt by the ECB to get a grip on the Eurozone crisis might work. It has the potential both to push sovereign market yields toward sustainable rates, and to block self-fulfilling institutional bank runs in which corporate deposits move to stronger Eurozone countries, draining weaker member banking systems of liquidity and credit.
Colm McCarthy was keen on a “reverse tap” in which the ECB enforces a maximum yield (minimum market price) on Italian/Spanish/etc sovereign bonds using its money-creation potential to back up this policy. The problem with his plan, in my view, was the lack of a surveillance mechanism to ensure the funded countries were continuing their needed restructuring. Germany would not accept that solution. My own preference was for the IMF to serve as conduit for sovereign funding via official IMF programs backed by ECB-funded bonds. Colm criticized this as an unnecessary intermediation by the IMF in a problem that needed to be solved by Europe.
The new ECB unlimited-three-year bank funding strategy uses the banks themselves as the monitor for sovereign discipline. It also provides direct bank liquidity so that the slow-motion institutional bank run phenomenon is less likely to lead to the negative feedback loop (corporate depositors distrust the PIIGS banks, PIIGS banks lose liquidity and restrict credit flow to their national economies, PIIGS national economies slow down due to shortage of credit, PIIGS banks suffer due to national economic slowdowns). Actually the “G” does not belong in this acronym anymore since it is a separate case. Perhaps PISI? Commercial banks in the PISI who lose corporate deposits to Germany or elsewhere can replace them with even cheaper funding from the ECB.
Might the new ECB strategy work?
The exchange rate is 1:1 Euro:Guilder. That’s a lot better than the 1:2.2 fixed in 1999.
So far, the new/old currency is accepted in a few localities only.
The Financial Regulator, Matthew Elderfield, received a clamour of popular support recently when he publicly objected to the Irish domestic banks planned decision not to decrease variable mortgage rates in response to the ECB cut in interest rates. The political establishment was warmly enthusiastic for Elderfield’s intervention. The government used its shareholding and political muscle to ensure that the banks’ decisions were reversed. The government also offered to provide the financial regulator with legislative power to determine banks’ mortgage rates. Wiser heads within the Central Bank prevailed, and the government was told by the Central Bank “thanks, but no thanks” for the offer of new legal power to set retail mortgage rates. Continue reading “Variable-rate Mortgages, Liquidity Funding, and the Euro”
The Eurocrats are anxious not to waste the current debt crisis. In today’s Financial Times, Manfred Schepers of the European Bank for Reconstruction and Development proposes not one, but two new EU institutions, to be staffed by transfers from the senior civil services of member states, and promotions within the Brussels/Frankfurt bureaucracies. There will be a new European Monetary Fund, taking on the roles of the International Monetary Fund managing troubled sovereigns, but working on a permanent rather than temporary basis within the Eurozone. Then there will be a new European Debt Agency, managing debt issuance and deficit control for all member states. At a minimum, Schepers’ proposal will aid the Brussels and/or Frankfurt commercial real estate markets, since these bodies will need a lot of office space.
Schepers is keen to retain the ECB’s restricted mandate as a central bank without the ability to engage in quantitative easing, restricting its work to commercial bank liquidity provision and inflation control. He holds this view despite the growing evidence that this central bank design does not work, and the alternative, more flexible mandate of e.g., the Bank of England and US Federal Reserve, does work.
Much more sensible are the views (via a skype video) of Jeff Sachs suggesting that the IMF, together with a reformed ECB acting as a lender of last resort, be brought in to restore stability and confidence to the Eurozone, in the interests both of Europe and the world economy. We also get a glimpse of Professor Sachs’ chi-chi Manhattan kitchen in the background of the video.
Colm McCarthy and many other commentators want the ECB to print euros to whatever extent is necessary in order to keep essentially-solvent Euro states from being unable to finance their deficits. Colm argues that this ECB-provided unlimited funding back-up can prevent an inefficient coordination-game outcome in which investors flee Euro bond markets … because other investors are doing likewise. Once the unshakeable resolve and money-printing firepower of the ECB is demonstrated clearly, the Euro crisis will diminish, in Colm’s view. Many other commentators, e.g, Gavyn Davies, Mervyn King, numerous Germans, argue that this money-printing solution will just generate an indirect subsidy of wasteful Euro governments by prudent ones, with Euro-wide inflation or eventual ECB capital losses serving as the income-transfer mechanism.
There is some talk in today’s papers of a Eurobond system linked to closer EU control over national finances. The EU’s record for governance of this type of national fiscal oversight is not good, and the core nations are rightly sceptical.
Why not a combination policy? The IMF agrees to run sovereign bailout programmes for any Euro countries as needed, with funding provided via IMF-issued, ECB-purchased bonds. The ECB gets a decent, non-exorbitant yield on all new Euros issued, and the IMF has access to an unlimited supply of Euro funding as needed. The guarantee from the IMF-ECB that Italy, Spain and France could be brought within this bailout process as needed, with no funding limits, would probably eliminate the need to bail them out at all (via the same “good equilibrium” mechanism that Colm suggests). To make it credible this programme would need to be ready to activate as needed without exception. Recalcitrant Euro governments who failed IMF programme criteria would be booted from their bailout programmes in the normal way.
Reuters reports that, because Ireland will likely need more financing, it is downgrading Ireland’s credit status to Ba1–of questionable credit quality. The expectation is that there are further falls to come as the prospect of burden sharing, refinancing, or some other combination of unpleasant events, looks increasingly likely. RTE report that the Department of Finance think this is a ‘disappointing development’. Me too.
I’m interested in commenters’ reactions to this news. Does it matter? Is it a sign of things to come?
Colm was right when he said we should fasten our seatbelts.
LBS’s many fans on this Blog will want to read about the controversy surrounding his continued membership of the ECB’s Executive Board. If he does not step down Nicolas Sarkozy is threatening to block Mario Draghi’s accession to the Presidency. The Financial Times account is here.
Silvio Berlusconi has called on him to step down, although no definite decision has been taken to offer him the post as head of Banca d’Italia in succession to Draghi.
According to the Corriere della Sera LBS had ‘no comment’ about the issue on leaving the palazzo Chigi. However, La Repubblica quotes him (on leaving a conference in the Vatican) to the effect that he cannot be removed before the end of his eight-year term. He underlined that ‘personal independence is one of the doctrines on which the independence of the Bank rests.’
Hans-Werner Sinn replies to his critics in relation to Target 2 balances here. Readers of this blog will undoubtedly draw their own conclusions. At the heart of his fallacy is the conceptual absurdity of separate regional credit policies in a monetary union with perfect capital mobility.
Doug Irwin provides a nice account of the historical links between exchange rate and trade policy here.
See the following contribution here from Hans-Werner Sinn. It is certainly original but frankly alarmist. It focuses on the fact that National Central Banks within the euro system are lending bilaterally to each other though without changing the monetary base as a whole. Sinn jumps from there to draw apparently worrying conclusions: that these are “forced capital exports”; that they are the counterparty to current account deficits and that “the PIGS would have had a hard time finding the money to pay for their net imports”.
There is not a scintilla of evidence that the private non-bank sector in the PIGS has lost access to normal European financial markets. If the Bundesbank lends to the Central Bank of Ireland, it does not, in any sense, expand the availability of credit to the private non-bank sector in Ireland. Similarly, German households and firms do not suffer a credit contraction. This is, of course, because there is free movement of capital within the single currency area.
The second non-sequitur in Sinn’s article is the association of accumulated current account deficits in the PIGS with these bilateral loans. Ireland has, of course, a current account surplus so the point is completely irrelevant to at least one of the PIGS. Sinn notes that Italy has not availed of these inter NCB loans, despite its current account deficit, but mistakenly attributes this to virtuous policy on the part of the Italian authorities! It is of course because Italy so far has not yet suffered from a banking or sovereign debt crisis. And for no other reason.
My suspicion is that Target 2 credit is ultimately guaranteed by the ECB: that the Bundesbank loans to the Central Bank of Ireland should be considered as contingent items on the ECB balance sheet. In short, that Target 2 credit is simply a mechanism for implementing ECB policy. But I remain to be corrected on this.
Paul Krugman has a thoughtful survey of the Euro crisis in this week’s New York Times Magazine (forthcoming on Sunday but available on-line now). This is not stockbroker-economist-type research, which tends to be long on buzzwords and hyperbole. It is a well-reasoned feature-length review with some policy suggestions. It has a central focus on Ireland and the other troubled peripheral states.
There are obvious difficulties and constraints on monetary policy in the 16-member Eurozone compared to more fully integrated currency zones like the fifty states of the USA, the ten provinces of Canada, etc. But could the lack of integration in the 16-member eurozone be used advantageously for some types of policies? Continue reading “Regional Quantitative Easing in the Eurozone”
Over a VoxEU, Stanley Black suggests a way of breaking the EMU without breaking the Euro.