24 December 2011

Reasons To Be Cheerful

I finaly noticed the new zeitgeist. It was an article in yesterday's FT that brought it home to me, but more of that later.

Four years on from the start of the crisis, a new common sense is emerging and it is roted in ideas of equality. The first idea is a rejection of the gross inequality that has grown over recent decades. The super rich are revealed as undeserving. They did not acsend to the heights of wealth on merit - through education, talent, innovation or risk-taking. Much of the wealth comes from the extraction of economic rent combined with a redirection of the spoils to the agents rather than the owners of firms. Some time ago I described this as agency capitalism.

Meriit is a key part of the new zeitgeist. The good society needs not just a concern for the weakest but it demands a contribution from each of its members. This is the idea of fairness as decribed in Will Hutton's book Them and Us. To anyone who read Hutton's latest work, Ed Miliband's conference speech made perfect sense. It only seemed odd to a commentariat who did not yet see how the times are changing.

Then yesterday, in the FT, Martin Wolf wrote a column on rising inequality and identified the demand for a huge agenda, covering education, employment, corporate governance, finacial reform and "elements of redistribution".

For me the idea that a mainstream commentator has seen the importance of tackling inequality means that the zeitgeist is taking root.

I will have more to say on this. It is afterall the soul of this blog. Merry Christmas.

To update: I will add the links and correct the typos when I get to my desktop.

22 December 2011

Austerity Can Drive Up Interest Rates

Chancellor Osborne boasts continually that his austerity programme has reduced British interest rates compared to our European neighbours. (He means the rate at which government can borrow not the rate you pay on your mortgage but he doesn't always make that clear.)

Via Krugman, we have this from Olivier Blanchard, the Chief Economist at the IMF:
... it does not take large multipliers for the joint effects of fiscal consolidation and the implied lower growth to lead in the end to an increase, not a decrease, in risk spreads on government bonds
In other words austerity programmes can push up the interest rate on government borrowing as a result of the slower growth which they cause and which bond markets are beginning to price in.

To be clear Blanchard's claim is hedged with caveats. This is based on estimates which the IMF is still working on. We already know that austerity can fail to reduce the government debt ratio when it slows economic growth. Now it seems it it might increase the cost of government borrowing making reducing the deficit more difficult.

19 December 2011

It's Not Fair!

My seven year old was very upset the other day. My better half had just told her off for some minor misdemeanour. She was inconsolable and  the reason was not the telling off so much as that her older brother had done it first and not been seen.
It's not fair , he did it first and he didn't get into trouble!
It sort of reminds me of France reacting to the threat of a downgrade of its credit rating.

Update: I explained to my daughter that my son didn't get into trouble because he has his own currency which can devalue to stimulate net exports, that he has his own central bank which can act as a lender of last resort and that he only needs to refinance half as much of his debt each year.

14 December 2011

ECB's Dangerous Game?

Here is an odd thing. The EU summit failed to produce a credible plan for fiscal union. The ECB did not become the "lender of last resort" as economist's believe is necessary to end the crisis. Yet, the roof did not fall in and the panic has ebbed. With no political or monetary intervention to calm the markets, the Euro has muddled on through another week.

What has happened? Perhaps Mr Draghi has not been as invisible as I previously thought. The ECB did inject liquidity into Europe's struggling banks. That seemed to be a response to the freezing up of interbank lending which could have led to a new credit crunch. It seems to have done something else. The liquidity has found its way to the bond markets easing the pressure on Italy and other peripheral governments.

Coincidence? Or conspiracy? There is a fascinating analysis of ECB policy on Vox, published before the summit. It claims that, far from being a weak central bank unable to do what its peers can by guaranteeing government debt, the ECB is using its political independence to play a very political game.
The ECB is a full-blooded political actor engaging in a strategy aimed at forcing EU political leaders to embrace fiscal rectitude and a quantum leap forward in European integration.

The allegation is that Mario Draghi is using the crisis to force reform on reluctant governments. The ECB is doing just enough to keep their economies from collapse but not enough to get the market off their backs. In fact it wants the markets to keep the pressure on. Comparing the ECB approach to military strategy the article claims:
Its philosophy is that you never offer your opponent certainty (by pre-committing to buy all Italian debt at 5% yields, for example). Rather, you constantly seek the dislocation of your opponent’s mind until this dislocation (10-year interest rates above 6-7%) renders the delivery of a decisive blow practicable.
Indeed the article alleges that the ECB played a part in the ejection of Mr Berlusconi from office.

The implications of this analysis are profound. Are democratic governments being undermined? What legitimacy has the ECB for acting as a political player? Who decides on the policy agenda of the ECB and who can hold it to account?

Apart from legitimacy, is its policy correct? By backing a particular theory which puts supply side reform above addressing the deficiency in demand, is the ECB pursuing the wrong policy? That is one danger if the ECB is playing a political game: that it may be pursuing a disastrous policy.

Another danger of the ECB's alleged political role lies in the implementation of the policy. Could the ECB make the fine judgements necessary to keep the bond markets on edge without starting a bank run that would ruin us all?

Source: Jacob Funk Kirkegaard, The next strategic target: De Gaulle’s EU legacy, Vox, 30/11/2011

13 December 2011

ECB to the Rescue, Not

Last week's excitement about a summit to save the Euro was all based on the idea that once a "fiscal compact" was agreed the ECB would act. I was sceptical, and even before the summit reached agreement on the pact Mario Draghi was explaining why he could not do what was expected.

So why did everyone get so excited? The problem is that ECB political independence means that there can be no explicit deal between the Bank and governments. Yet markets and commentators alike thought there was some kind of a deal.

I know I've said this before but I think the logic went like this:
1 - A deal between Angela Merkel and the ECB could not be announced publicly.
2 - No deal was announced publicly.
3 - Therefore there they have done a deal.

06 December 2011

Getting Fiscal

Flash, I love you but we only have three days to save the Euro.

The depressing part of this week's narrative is that fiscal union is completely irrelevant to resolving the Euro crisis.

Would fiscal union have prevented the current crisis? A moment's recollection is enough to see that it wouldn't. Spain ran a budget surplus in the three years before the crisis and brought its debt ratio down to 32%. Ireland too ran a surplus and at 25% was well below the Maastricht limits until it took on the debt of its failing banks. Even Italy had its debt on a declining path from around 120% in 1996 to 103% before the crisis.

OK there was Greece, but Greece was prepared to lie and cheat on its national accounts. Ordinary rules cannot catch a determined cheat.

There are two aspects of a fiscal union which could help. One is transfers from stronger countries to weaker ones. The second is a common treasury issuing common bonds. That is why fiscal union works in the US; but both are off the table in the Eurozone.

So why is there a buzz of hope around the Merkozy proposal? The answer is that Signor Draghi dropped a hint that, with a fiscal compact agreed, the ECB might do something. What the ECB needs to do is massive. It has to underwrite the bonds of all Eurozone governments without limit. A suggestion of a possible undefined move doesn't quite fill me with confidence.