About P O Neill

is Irish and lives in America.

Multipliers and adding up

Bank for International Settlements 84th Annual Report, page 11 –

Second, as growing evidence suggests, balance sheet recessions are less responsive to traditional demand management measures (Chapter V). One reason is that banks need to repair their balance sheets. As long as asset quality is poor and capital meagre, banks will tend to restrict overall credit supply and, more importantly, misallocate it. As they lick their wounds, they will naturally retrench. But they will keep on lending to derelict borrowers (to avoid recognising losses) while cutting back on credit or making it dearer for those in better shape. A second, even more important, reason is that overly indebted agents will wish to pay down debt and save more. Give them an additional unit of income, as fiscal policy would do, and they will save it, not spend it. Encourage them to borrow more by reducing interest rates, as monetary policy would do, and they will refuse to oblige.

Note the contradictory logic of the two reasons. The first says that banks will only lend to bad borrowers and willing good borrowers can’t get credit. The second says people getting extra income from fiscal or monetary stimulus will only use it to  pay down debt, reducing demand. But what about those good borrowers who can’t get credit due to the first reason? And what about those people who are paying down debt, thus helping banks get into better shape and thus, er, lend?

What starts out as an argument for weak multipliers doesn’t add up, and it’s not made any easier to follow by the apparent decision not to directly address their main critic on this point, Paul Krugman.

Before the Euro, there was the EMS

IE_CSO_unemploymentPaul Krugman, reacting to what appears to be a somewhat self-serving discussion by EU elites at the ECB Forum in Portugal –

Sorry, but depression-level slumps didn’t happen in Europe before the coming of the euro. 

The chart is unemployment in Ireland since 1983; we’ve used the longest span of consistent series produced by the Central Statistics Office. And the mid-1980s was no picnic for other high-debt EEC (as it then was) countries either. Granted, the Euro probably locked in some of the forces that could be quarantined back then through devaluations. But you don’t have be that old in Ireland to have been around for the second macroeconomic destruction of your economy in your lifetime.

The central bankers are in Sintra, Portugal discussing how banking supervision and monetary policy should evolve in the aftermath of the global financial crisis. They might want to discuss instead whether anything fundamental about the politics of boom and bust has changed in the last 6 years.

Those Ukraine speeches really knocked him out

As the expression has been put back in the news, here’s the text of what became known as the Chicken Kiev* speech of President George HW Bush (the elder) in 1991. The title speaks to the changed times: Remarks to the Supreme Soviet of the Republic of the Ukraine in Kiev, Soviet Union. The speech takes as a guiding frame that the USSR will continue in some form and is sceptical about the ongoing process of USSR disintegration, especially economic disintegration. The paragraph that caused Bush 41 trouble back home (a reaction that no doubt had some influence on Bush 43) was this one:

Yet freedom is not the same as independence. Americans will not support those who seek independence in order to replace a far-off tyranny with a local despotism. They will not aid those who promote a suicidal nationalism based upon ethnic hatred. 

For US domestic politics, too deferential to the Soviet status quo. But he did manage to avoid accusations that he was stirring things up and a few months later, Ukraine had voted for independence. Anyway, read the whole thing.

*The appellation is apparently due to William Safire.

Lvov Offensive

Does Herman van Rompuy really need to be telling the people of western Ukraine that if it wasn’t for some pesky border-drawing issue, they would be 3 times better off than they are now? For a Brussels elite that likes to pitch every European Union achievement in terms of the aftermath of World War 2, it’s a remarkably tone-deaf boast.

ECB uses legal word games to dodge bailout accountability

The European Parliament sent a questionnaire to the Eurozone bailout “Troika” members (ECB, IMF, and European Commission) so as to better understand their specific roles in the 4 lending programme countries (Ireland, Greece, Portugal, and Cyprus). The ECB has published its response. One set of questions and answer is as follows –

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Was the Ukraine shambles avoidable?

With Saturday bringing news of police in Kiev brutally breaking up what had been a peaceful pro-EU protest, it’s even clearer now than before the botched partnership summit in Vilnius that things could get out of hand on a large scale. Perhaps what stands out the most about Ukraine is the sense of slow-motion crisis: an indigenous “colour revolution” that was diverted, every economic indicator pointing to an old-style IMF program very soon, and months of signals from Russia that its Eurasian Customs Union would be an offer that its neighbours couldn’t refuse.

The day also brings a fairly toughly worded statement of condemnation of the protest break-up from the European Commission, but what hope it has of generating any momentum is not clear with the world into its weekend (and for the USA, Thanksgiving) distractions. But the question for the EU has to be: what did they expect? The noises were there for months when Armenia wavered at the Eastern Partnership. There was a further message in how aggressively Russia played its cards on Syria, but maybe that was given a pass for having headed off US military action.

Even over the last few days though, the mis-steps mounted. It was clear ahead of the Vilnius Summit that President Yanukovich was boxed in by pressure from Russia. So why maintain the pretense that a deal could be done, why go ahead with the summit theatrics, why release the video of him getting a dressing down by Angela Merkel, and then put a bullseye on Moldova as what a country might get if its plays nicely with the EU?

There were other pitfalls embedded in the EU-Ukraine negotiations process. Writing in the New York Times, Oleh Kotsyuba notes the way that social conservatives in Ukraine used the partnership component on tolerance of sexual orientation against it. For others, it became a polarised personality dispute with the focus on Yulia Tymoshenko ($ link).

Of course, we don’t know the dynamics inside the EU capitals and Brussels about who wanted what (was Iran consuming their attention?). But there seems to be several points at which expectations could have managed and temperatures lowered. Perhaps the bigger question is whether the EU has a full understanding of what kind of Russia it is dealing with. It’s going to be a fun Russian G8 Presidency in 2014!

Let’s get structural



European Central Bank’s Financial Stability Review November 2013, page 19. The left chart is output gaps (blue 2007, red 2013) i.e. differences between current and estimated potential or “full employment” GDP. Most eurozone countries have output gaps below 2.5 percent, including some with extremely high unemployment, like Ireland. Output gaps were large and positive in 2007. Current unemployment rates associated with these small output gaps can be surmised from the right-hand chart — many are in double digits. Among the many implicit assumptions of the typical analysis that accompanies such charts is that if two extreme points have been attained, then somewhere in between must be feasible.

Secular Stagnation: Greed is Good

As you’ll know if you’ve been near any economics-oriented blogs, secular stagnation is the hot topic i.e. that advanced economies are prone to needing negative real interest rates to achieve full employment and in the inability to achieve that at low inflation, bubbles might be helpful. One surprising thing about the debate is that given the Cambridge Mass. lineage of those involved in it, the concept of “dynamic inefficiency” has not been raised in tandem.

This was something that emerged in the  modeling of overlapping generations economies by Paul Samuelson and Peter Diamond, and referred in particular to the possibility of the economy where “the” interest rate was less than the growth rate and thus in a sense the economy’s saving vehicles were less efficient at transferring wealth to the future than its growth process. The intuition was that such an economy had accumulated too much capital and driven down its return, while the saving needed to maintain the capital at that level (due to depreciation) was squeezing current consumption.

Such an economy has the possibility that weird stuff — like bubbles, paper money, and unfunded social security — can make everyone better off. Also, the government can pile up debt, and seemingly dubious investments like land are good for everyone.

Indeed, such an economy is essentially a long-term version of the liquidity trap, where the standard instincts about good and bad policy don’t work very well. It’s also mathematically interesting, which perhaps is why it’s such a staple of graduate level textbooks.

So why is no one talking about it, at least not explicitly? Is it that the intuition of overinvestment doesn’t sound right for economies seemingly short of infrastructure, like the USA and Germany? Or correspondingly that the high saving part doesn’t sound right, at least for the USA? Perhaps it’s the fact that various means of increasing current consumption at the non-expense of future generations — like selfish tax cuts! — are helpful.

In any event, much of the secular stagnation discussion has been conducted in terms of the static relationship between saving and investment. The dynamic inefficiency tradition has the merit of looking at the cumulative impact over time of all that excess saving. In the secular stagnation world, where is all that capital going?

No questions asked?

As noted by FT Alphaville the other day, the ECB has released its guidance for the use of Emergency Liquidity Assistance (ELA) by national central banks (NCBs) in the Eurosystem. Among the rules

As a rule, NCBs inform the ECB of the details of any ELA operation, at the latest, within two business days after the operation was carried out. The information needs to include, at least, the following elements: …

the prudential supervisor’s assessment, over the short and medium term, of the liquidity position and solvency of the institution receiving the ELA, including the criteria used to come to a positive conclusion with respect to solvency;

Since Irish and Cypriot taxpayers have ended up on the hook for ELA provided to busted banks by their central banks, aren’t they entitled to now see this information?

There is a tide in the affairs of men

Above a suggested choice for the single take-away chart from the presentations at the Kansas City Fed’s economic policy symposium in Jackson Hole, Wyoming. It’s from Helene Rey’s paper (London Business School). It shows all types of capital inflows expressed a percentage of world GDP on a quarterly basis since 1990, plotted against the VIX, which is a measure of perceived volatility embedded in options markets (in green, higher level=lower risk).

The argument (which has been confirmed by deeper research of herself and others) is that there is a remarkably simple (conceptually) component in capital inflows worldwide which seems to correspond to a single driver across many markets, countries, asset types, and exchange rate regimes.

As she notes, the implication is that these capital flows might need to be regulated, including by various instruments that wouldn’t have been mentioned in polite economic society a few years ago.

The open question may be that if this capital flow beast is so virulent and global, are normal means of country policy and international coordination strong enough to do anything about it? We might actually need one of these global super-regulators that people seem to think we already have.