The full Monti, and Papademos too

Mario Monti in Italy and Lucas Papademos have substituted the fragile and questioned prime ministers in their respective countries. Monti was an European Commissioner with great experience with the EU institutions, while Papademos was the president of the Bank of Greece and vice president of the ECB. Both are economists. The notion is that now with serious and responsible technical men in charge the chances for a solution, which is still in the view of European authorities more austerity, have increased.

The only possible logical diagnosis in which that would be true is if this would have been a crisis of "confidence." As that is not the case the crisis will continue, and become more intractable. Today, after the Eurozone bonds of almost all countries, including France, were forced to pay a higher risk premium the chief economist of JPMorgan Asset Management said that "Germany [is] the only functioning bond market left in the eurozone." A zone of one.

Three things you thought you knew about economics

Great post by Robert Vienneau who correctly claims that the three propositions below are well-established, namely :

"1. Adam Smith did not use the phrase "The invisible hand" to refer to the optimality properties of a static general equilibrium supposedly brought about by the workings of competitive markets. 

2. Thomas Carlyle did not coin the phrase "The dismal science" to refer to Thomas Malthus's anti-utopian theory of population. According to that theory, human population responds endogenously to increased prosperity, thereby making impossible any rapidly established, long-lasting general rise in per capita income beyond the custom and habits of mankind. 

3. John Maynard Keynes, in The General Theory of Employment, Interest, and Money, did not explain widespread and persistent unemployment by sticky, rigid, or slowly adjusting money wages and prices - a pre-Keynesian theory that, in fact, he opposed. Many economists, I claim, teach the opposite of these propositions. 

(...) 

It seems to be a quixotic and never-ending task to oppose demonstrably false statements about economics, often made by economists."

It is absolutely true. I would even say the majority of economists teach the opposite. I have insisted more on 3 here, but 1 and 2 are equally true, and 1 at least as important as 3. I should probably use this in my history of thought lectures from now on.

Income distribution in advanced capitalist economies

Massimo Pivetti has been central for the development of the so-called monetary theory of distribution, which develops the work of Piero Sraffa. The link (here) is to a talk at UNAM, in México last week (intro in Spanish, but Pivetti gives the talk in English starting at around minute 3). A good paper to follow what he says can be found here. You can see all the videos and other good stuff here.

PS: The classic book on the topic here.

Original Sin And The Euro Crisis

Krugman has now twice argued that Europe faces an original sin problem (here and here). Let me be absolutely clear. Europe does NOT have an original sin problem. The original sin, a term invented by Ricardo Hausmann (see here), is a situation in which the domestic currency cannot be used to borrow in international markets or to borrow long-term in domestic markets. By the way, a new name for an old problem that was well known by Raúl Prebisch and other Latin American structuralists at ECLAC back in the 1950s, who recommended avoiding excessive borrowing in  foreign currency.

It is true that there are no European bonds, and that Greece, as the other countries of the euro, do borrow in a currency they do not control. However, the ECB can buy Greek bonds, and does print euros. That is not the case in a developing country that borrows in foreign currency, and does have an original sin problem. In that sense, the problem in the Eurozone is the unwillingness of the ECB to monetize even small amounts of debt. Misplaced monetarism, not the original sin, is the problem in Europe.

Yield curves and recessions

Let me get back to my discussion of the neo-Wicksellian macro model. One important feature of the model, is that it suggests that the central bank controls the rate of interest, and it should try to flatten the yield curve. That is, the bank rate (short run) should adjust to the natural rate (long run). In many respects this is the general rule behind all conventional stories about central banking. The Taylor Rule or the New Keynesian ideas behind Clarida, Galí and Gertler are basically a variation of Wicksell's story.

One thing that is also important about Wicksell's rule is that if the yield curve is negatively sloped (the bank rate is higher than the natural rate) then a recession (deflationary forces) are to be expected. The graph below uses the Fed Funds for the bank rate and the 10 year Treasury bond rate for the natural rate. In between the gray lines the official NBER recessions are shown.

As it can be seen, after the red line (Fed Funds) moves above the blue line (Treasury bonds rate) a recession always follows. There are many problems with the Wicksellian model, not the least the assumption of a natural rate of interest, that was severely criticized by Keynes in the General Theory. But the empirical notion that an inverted yield curve forecasts a recession seems to survive any possible theoretical critique. More on the critique will be left for other posts.

Mario Draghing the feet on monetary policy

Central Banks have been at the epicenter of the current crisis, and have been, for good and for bad, fundamental for the policy response mounted to avoid a new Great Depression. Recently Christina Romer argued that the Fed should start targeting nominal Gross Domestic Product (GDP) instead of inflation. As I noted previously (see here), this is strange since it is far from clear that the Fed actually targets just inflation, or that targeting nominal output would make any significant difference.

Further, the idea that a central bank has the ability to actually hit a targeted level of output, or inflation for that matter, under the current circumstances in particular, is wishful thinking. Central banks can ease the credit conditions by reducing interest rates, a range of rates from the short to the long, to stimulate spending, and pump money into the system, fundamentally to avoid systemic crisis caused by bankruptcies. The ability of Ben Bernanke or Mario Draghi, the newly appointed head of the European Central Bank (ECB) that reduced the rate of interest in Europe as his first measure (see here), to further reduce interest rates and with that help the staggering recovery in the US or the free fall in the periphery of Europe is very limited.

Read the rest here.

Neo-Wicksellian macroeconomics

Modern macro has more to do with Wicksell's Interest and Prices than with Keynes' General Theory. For one, the idea of a natural rate of unemployment derives directly from Wicksell's natural rate of interest, as Friedman noted. So here is a brief explanation of Wicksell's main argument in that book.

Wicksell distinguished between the natural rate of interest (R*) and the monetary or bank rate of interest (R). The former was determined by the marginal productivity of capital (I) and the intertemporal decisions of consumption (leading to savings S), along the lines of what became known as the loanable funds theory. The monetary rate was determined by bank decisions. That is, banks supplied credit (Ms) at the chosen rate of interest (R), according to money demand (Md). Monetary equilibrium occurred when the two rates coincided (see figure below). The natural rate is the gravitational center around which the bank rate fluctuates. Real and monetary shocks could cause deviations of the bank rate from equilibrium.

Wicksell assumes that a positive productivity shock raises the natural rate of interest, and that banks maintain the initial monetary rate. Thus, with a low bank rate, investment exceeds savings and once the system reaches full employment prices would go up. However, continuous lending would reduce bank reserves, and as a result banks would be forced to increase the monetary bank until a new equilibrium was reached. Inflation resulted from a bank rate that was too low, as much as deflation (and temporary unemployment) from a bank rate that was too high.

The low bank rate implies overinvestment, and the need for additional savings. The inflationary process by reducing the ability of consumers to spend provides the additional 'forced savings.' Inflation acts as a tax that provides the additional resources needed to finance investment. The business cycle can be explained by exogenous shocks to productivity (the I curve), changes in consumers preferences (shocks to S), or by the misconduct of the banking sector (shocks to Ms). Wicksell, as much as the modern Real Business Cycle (RBC) School, favored the former.

Walk out on Mankiw

As has been reported in some blogs (Robert Viennau and Daniel McDonald) students were planning to walk out of Mankiw's class to protest the type of economics he teaches and in solidarity with the Occupy movement (Adbusters has had a campaign for a while here). That's right on the mark. The teaching of economics is a central part of the process by which the mainstream and the liberalization and deregulation policies that led to the crisis have been perpetuated. The Harvard Crimson reports on the protest here. The anti-Mankiw blog is here.

More old debates on the euro

Someone pointed this link on the The Economist site, about British economists (on the left and right of the political spectrum) that were against the euro. Vicky Chick, a very good post-Keynesian monetary economist, appears here.

"Just as the political opposition to a single currency spans both socialists and the free-market right, says Victoria Chick of University College, London (a self-described “left-wing anti”), so the economic Noes contain both old-style Keynesians and Marxists on the one hand, and monetarists on the other. However, says Ms Chick, left and right have different reasons for opposing a single currency. For instance, she and economists like her think that the ECB has an in-built bias towards being too tough on inflation—which is unlikely to concern the right.
That said, the two wings have some objections in common. The left-wingers say that the ECB lacks democratic accountability. So, from the other flank, does Patrick Minford, a monetarist at Cardiff Business School. “The idea that credibility requires unaccountable central bankers is wrong,” he says. “Central bank independence has been oversold.” Far from making the ECB an exact copy of the German Bundesbank as is often supposed, he says, the new bank’s designers forgot how much the Bundesbank relied on its political legitimacy.
Besides this, the anti camp—left, right and centre—have two main objections to joining the single currency. First, they say, monetary union has imposed a “one-size-fits-all” monetary policy on the euro-zone: in booming Ireland and slumping Germany alike, interest rates are 2.5%. To complicate matters, thanks to variations in the structure of economies, a given change in interest rates may have quite different effects in two different countries. Britain’s housing market, says Andrew Hughes Hallett of Strathclyde University, is dominated by variable-rate debt, making British consumption and housing expenditure far more sensitive to changes in interest rates than elsewhere in Europe. Meanwhile, German corporations’ reliance on debt rather than equity finance makes the supply of capital more sensitive to interest rates than, say, in Britain.
On top of this, there is little scope for fiscal policy to cushion the effects of economic shocks affecting different countries in different ways. The stability and growth pact limits national budget deficits to 3%. And the EU budget is not big enough for international transfers to take the strain instead.
This leads to the second objection: that Europe’s labour and product markets are too inflexible to deal with the strains that EMU will put on them. If interest rates, exchange rates and fiscal transfers cannot be called on to deal with economic shocks, then wages and prices will have to do the job. “The consequence of one-size-fits-all”, says John Flemming, warden of Wadham College, Oxford (and a former chief economist at the Bank of England) “is that the strain is likely to be taken by unemployment.”"

The whole thing is worth reading to remember the 1999 mood, and those that actually saw it coming.

Reuters on Greece's tiny debt load

Pedro da Costa, from Reuters, in their Macroscope blog, says that:

"No, that is not a typo in the headline. Greece has long been the focal point of Europe’s crisis. It was the first country to reveal some cracks in a monetary union that lacks a fiscal authority to back it. Indeed, Greek politics were dominating the headlines on Friday, with news that the prime minister had survived a confidence vote in parliament restoring a momentary sense of calm to a still very dramatic situation.

However, Greece’s actual debt load is only large relative to its own small and struggling economy. In the larger context of the euro zone, the actual amount of debt being haggled over is rather puny."

The rest of the post here. I can't but agree with him, in particular taking in consideration the expert he cites.

John Cassidy on Wynne Godley

On my way to the euro conference in Austin. Just read this nice piece on Wynne Godley (for whom I worked back in the 1990s) in the last issue of the New Yorker. Indeed Wynne was for the European Union, but skeptical about the way the common currency was being pushed. Must read. I have also a post here.

The Crisis in the Eurozone

A conference on the euro crisis at the University of Texas, Austin, organized by Jamie Galbraith, will be held this Thursday and Friday, and a live webcast will be available here. The program is here. The event will focus on “A Modest Proposal for Overcoming the Euro Crisis” by Yanis Varoufakis and Stuart Holland, a plan which would combine the innovation of the Eurobond with a “New Deal” approach to European development.

Nominal output targeting

Christina Romer wrote this Sunday about the necessity for the Fed to target nominal output. The implication seems to be that so far the Fed had been targeting inflation, which is obviously incorrect. That would be the ECB. Krugman (here) for some reason liked it. By the way the idea is not new, Samuel Brittan had argued for that not long ago (here), and as noted by David Beckworth so have two other prominent FT columnists (Clive Crook and Martin Wolf).

First of all, Romer calls this a Volcker moment, which is from a historical point of view (and she is a macroeconomic historian) preposterous. Volcker is the guy that tried to use nominal monetary targets, as in Milton Friedman's monetary growth rule (now he is much better and is against de-regulation and too big too fail among other things).

Further, it's not clear how a nominal GDP target would be different from what the Fed is already doing, namely acting as a lender of last resort, and keeping interest rates (short and long, the latter through QE) low. Worse, her argument smells to the confidence fairy stuff you hear from the crazies serious people, and that correctly Krugman deplores. She says:

"By pledging to do whatever it takes to return nominal G.D.P. to its pre-crisis trajectory, the Fed could improve confidence and expectations of future growth."

Sure as objective targets come, nominal GDP is better than inflation,  but since the Fed does not target inflation what is she fighting? Ben Bernanke is fine, Super Mario (Mario Draghi), the new president of the ECB needs whatever is the reverse of a Volcker moment. The US (and Europe) need more fiscal expansion.