ECB Taper News

What Business Insider’s Mike Bird somewhat ironically calls #euroboom2015 seems to be well and truly with us.

The WSJ’s Simon Nixon spelled  it out for us in his “QE is Working Better than the ECB Dared Hope” article:  “one month into the ECB’s €1 trillion ($1.06 trillion) quantitative-easing program, and ECB President Mario Draghi was only too happy to take credit for a remarkable turnaround in the economy’s fortunes at Wednesday’s news conference.” And he goes on to give examples:

“Growth forecasts have been continually revised up since January when the program was announced: the International Monetary Fund said this week it now expects the eurozone to grow by 1.5% in 2015. Business and consumer confidence are the highest since 2007. Bank lending is finally picking up.”

“The strongest growth is coming from former crisis countries: Spain is forecast to grow by up to 3% and Ireland up to 4% this year. Meanwhile German policy makers fret that with growth likely to hit 2.5%, the economy may overheat.”

 Naturally, as he also says, “not all of this can be traced to quantitative easing.” But then, here comes the point: “Indeed, if the ECB had delayed its decision on quantitative easing until March, as the Bundesbank had urged, it may have concluded it didn’t need to buy any bonds at all.” Continue reading

The snakes-and-ladders model, again

They say the first rule of editing is “kill your darlings”. The first rule of science, however, is “sacrifice your darlings humanely in accordance with the research ethics committee guidelines, but keep their brains for further investigation”. So it is with this post. Per Mason, apparently the GFC looks a lot different to past recessions and it’s important to include the full span of the ECEC data back to 1986. So here goes.

The ECEC civilian workers series doesn’t go back to 1986, and neither does all workers, so I picked on the series for “private industry” – after all you’d expect public sector employment to be less responsive to the business cycle by definition – which does. The orange dots on the chart mark ECEC data points, while the blue ones mark the composition-weighted ECI series for private industry. ECEC after 2002 is quarterly, and is averaged to give an annual figure.

snakes

The big orange outlier is 2002. ECEC was issued as a slightly different series in 2002-2003, so perhaps we should exclude that one. I’ve plotted regression lines for the two series, orange and blue respectively, and for ECEC excluding 2002, black.

As you can see, ECI is still more cyclical than ECEC (R^2=0.33 vs 0.03 – ten times as much). Excluding 2002 helps a bit, but not enough (R^2=0.33 vs 0.11, three times as much). The correlation between the change in ECEC for the private sector and the output gap is 0.19, and that between private sector ECI and the output gap is 0.58. The blue outlier is 1985-1986.

Purely visually, it looks like the difference between the two series is in fact greatest in the 1980s, but any effect is accounted for by three data points (’86, ’87, ’88) and in any case, it seems to have disappeared 30 years ago. Alternatively, the BLS has changed the method it uses to collect ECEC several times in that period and this might be an artefact.

Is The Crisis Now History In Spain?

Mariano Rajoy is a man who is not shy when it comes to being controversial, as the storm surrounding his stance over the recent Greek bailout negotiations clearly illustrates (and here). So it is perhaps not surprising that he did not notably blush when he informed a Madrid audience recently that “In many ways, the crisis is history.” Such was the storm that followed that he was forced to at least partially retract the offending phrase after a meeting with union officials some four days later. “In many ways the crisis is history, but its consequences are not,” he clarified.

Of course all of this is mainly political rhetoric at the start of what is set to be an election year, but still, it does raise interesting questions. Where exactly is Spain? What is the outlook for the future? Is the country still in crisis, or is it, as Rajoy 2.0 suggests simply suffering from the legacy of an earlier one? These questions are not as easy to answer as they seem at first sight, nonetheless in what follows I will take a shot at it. Continue reading

Testing the snakes-and-ladders model

Just to follow up on this post, a simple test of the model would be to check if the ECEC (i.e. not normalised for compositional shifts) wages series is strongly correlated with the output gap. Output gap is easy enough – real potential GDP and real GDP are in FRED, and we convert this to a gap expressed in % of GDP:

The ECEC’s not in FRED, though, and in fact it’s tiresomely split up into three series (here, here, and here). But that shouldn’t detain us long. Without further ado, here’s the chart:

ecec-rgap

Looks like a nice smooth correlation, and in fact the correlation coefficient is a very decent 0.51 for the annual data from 1991 to 2014. For the period 2003-2014 I’ve averaged the quarterly observations. But that’s just the classical effect, right? We need to compare the two indices. Here’s a plot with both series from 2002 to 2014 against the output gap.

ecec-vs-eci

It doesn’t look like I can replicate the result that the ECEC is more cyclical than the ECI, at least for the period 2002-2014. The correlation between the annual change in ECI and the output gap for that period is 0.83 and that for ECEC is 0.73. The covariance in ECEC is higher than ECI but both are really low (0.03 and 0.01).

A little model of the labour market.

JW Mason has an interesting discovery among the data. Specifically, it looks like the US data series for wages, normalised for shifts in the composition of jobs, is much less cyclical than the raw data. In other words, the business cycle seems to affect wages through composition shifts. In recessions, people lose jobs and eventually get hired back into ones with lower productivity and pay than they had before. People who manage to stick to their jobs through the crisis don’t see much difference. In booms, people who lose their jobs (or quit) tend to get hired into ones with higher productivity, and pay, than they had before.

This makes sense. Imagine that people try to pick a job that suits them – or in economicspeak, that maximises their labour productivity. Imagine also that firms try to hire people who suit their requirements. I doubt this will be very difficult. This is a pretty basic market setup, matching workers and vacancies. Now, consider that people tend to acquire skills and knowledge as they work. This might be something exciting, or it might be as dull as someone in sales building up a contacts book. As a result, people will tend to get onto some sort of career path, picking a speciality and getting better at it.

This might be horizontal – people with a highly transferable skill who move across industries – but I think it’s more likely to be vertical. As they gain in skill, knowledge, or just insidership, they are likely to get paid more. We should at least consider that this matches higher productivity. But then, there’s an explosion – suddenly a lot of firms fail, and their employees are on the dole. They now need to search their way back into work. It is likely, at least, that if they have to find it in another sector or even another firm they will lose some of the human capital they acquired in the past. The unemployed are suddenly driven off their optimal productivity path, and are usually under pressure to take any job that comes along, no matter how suboptimal. Until they get back to where they were before the crisis, on their new paths or on their old ones, the economy will forego the difference between their potential and actual production. You could call it an output gap, but that’s taken, so let’s call it the snakes-and-ladders model.

This, in itself, is enough to explain why unemployment is a thing – you can’t price yourself back into a job with a firm that has gone bust – and why productivity might be depressed for some time post-crisis. In the long term people will climb the ladder again, but this is deceptive. Society, and even firms, can think of a long term. Individuals cannot, as life is short. As the man said – in the long run, we are all dead. Hanging around at reduced productivity is a waste of your time. The recovery phase represents a substantial deadweight loss of production to everyone, concentrated on the unemployed. And there are dynamic effects. Contact books get stale, and technology changes, so the longer people stay either unemployed or underemployed, the bigger the gap. This little model also gives us hysteresis.

But we can go further with the snakes-and-ladders model. Markets, we are often told, are information-processing mechanisms. Let’s look at this from a Diego Gambetta-inspired signalling perspective. The only genuinely reliable way to know if someone is any good at a job is to let them try. I have, after all, every reason to pad my CV, overstate my achievements, and conceal my failures. The only genuinely reliable way to know if someone is an acceptable boss is to work for them. They have every reason to talk in circles about pay and repress their authoritarian streak.

In a tight labour market, people move along close-to-optimal career paths. In doing so, they gain both experience, and also reputation, its outward sign. Importantly, they also gain information about themselves – you don’t know, after all, if you can do the job until you try. The same process is happening with firms and with individual entrepreneurs or managers. Because the information is the product of actual experience, it is costly and therefore trustworthy.

Now let’s blow the system up. We introduce a shock that causes a large number of basically random firms to fail and sack everyone. Because the failure of these firms is not informative about the individuals in them, the effect is to destroy the accumulated information in the labour market. Whatever the workers knew about Bust plc is now irrelevant. In so far as they’re now looking for jobs outside the industry, what Bust plc knew about them is also irrelevant. In the absence of information, the market for labour is now in an inefficient out-of-equilibrium state, where it will stay until the information is re-created. Walrasian tatonnement, right?

This explains an important point in Mason’s data that we’ve not got to yet. Why should people thrown off their career paths take much lower productivity jobs? You don’t need much information to know if someone can mow the lawn. In the post-crisis, disequilibrium state, low productivity jobs are privileged over high productivity jobs.

It strikes me that this little model explains a number of major economic problems. The UK’s productivity paradox, for example, is nicely explained by a huge compositional shift, in part driven by labour market reforms designed to make the unemployed take the first job-ish that comes along. Students who graduate into a recession lose out by about $100,000 over their lives. Verdoorn’s law, the strong empirical correlation between productivity and employment, also seems pretty obvious. Axel Leijonhufvud’s idea of the corridor of stability also fits. In the corridor, the market is self-adjusting, but once it gets outside its control limits, anything can happen.

And, you know, despite all the heterodoxy, it’s microfounded. Workers and employers are entirely rational. Money is just money. It’s not quite simple enough to have a single representative agent, because it needs at least two employers and two workers with dissimilar endowments, but it doesn’t need any actors who aren’t empirically observable.

It also has clear policy implications. If the unemployed sit it out and look for something better, you would expect a jobless recovery and then a productivity boom – like the US in the 1990s. If the unemployed take the first job-like position that comes along, you would expect a jobs miracle with terrible productivity growth, flat to falling wages, and a long period of foregone GDP growth. Like the UK in the 2010s. And if your labour market institutions are designed to prevent the information destruction in the first place, with a fallback to Keynesian reflation if that doesn’t cut it? Well, that sounds like Germany in the 2010s.

Call it Hayekian Keynesianism. Macroeconomic stabilisation is vital to keep the information-processing function of the labour market from breaking down.

That said, I wouldn’t be me if I didn’t point out that there are a whole lot of structural forces here that discriminate against specific groups. The post-crisis skew to low productivity jobs wouldn’t work, after all, if workers weren’t forced sellers of labour to capitalists. And there is one very large group of people who tend to get kicked off their optimal career path with lasting consequences. They’re about 50% of the population.

Is Finland’s Economy Suffering From Secular Stagnation?

After the Great Depression, secular stagnation turned out to be a figment of economists’ imaginations……..it is still too soon to tell if this will also be the case after the Great Recession. However, the risks of secular stagnation are much greater in depressed Eurozone economies than in the US, due to less favourable demographics, lower productivity growth, the burden of fiscal consolidation, and the ECB’s strict focus on low inflation.”
Nick Crafts – Secular stagnation: US hypochondria, European disease? – In Secular Stagnation: Facts, Causes and Cures, Edited by Coen Teulings and Richard Baldwin

 Finland’s economy has been attracting a lot of interest of late. And not for the right reasons, unfortunately. The economy in a country previously renowned for being highly placed in the World Bank’s “Ease of Doing Business Index” has just contracted for the third consecutive year. Once famous for being a symbol of “ultra competitiveness” (it came number 4 in the latest edition of the WEF Global Competitiveness Index) the country is now fast becoming the flagship example of another, less commendable, phenomenon: secular stagnation.The origins of the theory of secular stagnation go back to the US economist Alvin Hansen (see here) who first used the expression in the 1930s. The hallmark of secular stagnation, he said, was a series of sick “recoveries which die in their infancy and depressions which feed on themselves and leave a hard and seemingly immovable core of unemployment.” This seems to fit the Finish case to a T. Continue reading

When Will The ECB Start To Taper?

What matters isn’t what you think should happen, it’s what others think will happen that counts.

Funny days these, the world seems to be constantly turning upside down. I could be talking about the arrival of negative interest rates in many European economies, but I’m not. What I have in mind is the crossover that seems to be taking place in the perceived fortunes of the US and the Euro Area economies. At the end of 2014 it was all “Europe bad, USA good” to the point that most observers were expecting an imminent rate rise from  the Federal Reserve, even while the Euro was in such a bad state that ECB was being steadily pushed – kicking and screaming – towards a full blown programme of sovereign bond buying QE. Continue reading

Why Is Spain’s Population Loss An Economic Problem?

“Growth theory was invented to provide a systematic way to talk about and to compare equilibrium paths for the economy. In that task it succeeded reasonably well. In doing so, however, it failed to come to grips adequately with an equally important and interesting problem: the right way to deal with deviations from equilibrium growth……..if one looks at substantial more-than-quarterly departures from equilibrium growth……….. it is impossible to believe that the equilibrium growth path itself is unaffected by the short- to medium-run experience…….So a simultaneous analysis of trend and fluctuations really does involve an integration of long-run and short-run, or equilibrium and disequilibrium.
Robert Solow, Nobel Acceptance Speech

When the IMF said last year that Spain’s unemployment level was unacceptably high, I was pretty critical of the fact that they didn’t spell out the consequences of this, or offer any substantial policy alternative. The most obvious impact of this failure to find an alternative is being seen right now, with the emergence of political movements which could well turn the country’s two party system completely upside down, and the steady flow of talented young people out of the country in search of work.

Continue reading

Does The Arrival Of Negative Interest Rates Change the Attractivess of EMU?

This is the second in a series of posts (first one here) in  which I try to argue that the balance between costs and benefits of belonging to the European monetary union has shifted in the post crisis world, especially for heavily indebted countries such as those to be found on the European periphery. Continue reading

Pay no attention to the social democrat behind the curtain.

Perhaps we’ve been watching the wrong German politician throughout the whole Greece/Eurogroup drama. Usually, the Vice-Chancellor of Germany is one of those posts that comes with a lot more dignity than it does power, like the US vice-presidency in the pre-Cheney days when it wasn’t worth a pitcher of warm spit. It tends to be given out as a decorative title to a junior coalition partner, rather in the way Nick Clegg was given the title of Deputy Prime Minister, something which has even less basis in British constitutional practice.

But Bernd Hüttemann reminded me of something important on Twitter yesterday, as follows.

Sigmar Gabriel, for it is he, is not just vice-chancellor and SPD leader, but also federal minister of economic affairs, and the minister responsible for government-wide coordination of European policy. The ministry gives details of its role here.

It has to ensure that the German government has a common line-to-take towards the European institutions, to keep the Bundestag informed, and to give directions to the German representatives in COREPER 1. That’s the boring-but-important stuff such as Competition, Energy, Agriculture, etc. It also gives directions jointly with the ministry of foreign affairs to German representatives in the more politically glamorous COREPER 2, including the General Affairs council, Justice & Home, and crucially, ECOFIN. It is the government’s authority on European law. Its officials chair most committees on European issues within the German federal government, including the permanent secretaries’ committee on European affairs, which they lead jointly with the foreign ministry.

The foreign minister is, of course, Gabriel’s fellow Social Democrat, Frank-Walter Steinmeier. This gives him a lot of agenda-setting power and a lot of access to Angela Merkel. He probably has more executive power than Joschka Fischer did as vice-chancellor and foreign minister. Having a bigger gang behind him, and also a European crisis, means he also has more than FDP leaders Westerwelle or Rösler although they had the same ministry.

This is important. In a sense, even decades after reunification, we still see two Germanies. People on the Left tend to swing between admiration for its social democracy, long tenancies, environmental commitment, demonstrative feminism, cycleways, safe-standing terraces at the football, and the like, and utter exasperation with its commitment to European monetarism, bourgeoisity, inflation dread, and tolerance of Bild Zeitung‘s ravings at the Greeks. People on the Right tend to wish they could have a budget surplus, a Bundesbanky monetary policy, and more public churchiness, except when they’re convinced Germany is a terrible warning of the inevitable doom of the welfare state. It wasn’t that long ago.

Wolfgang Schäuble, of course, personifies the hard-money version of Germany. But Germany doesn’t only have a finance ministry. It also has a ministry of economic affairs that has an eye to industrial priorities and real institutional strength, rather like the brief Department of Economic Affairs Harold Wilson set up in the UK back in the 1960s was meant to be. The DEA was intended pretty much as an anti-Treasury, and I think we can read Gabriel’s role at the moment as something similar – a growth-oriented lobby that would structurally lean towards a lower exchange rate, because it represents mostly export-heavy manufacturers and industrial workers.

In practice, a lower effective exchange rate for Germany means keeping the Euro show on the road, complete with Greece. Either leaving the euro, or kicking out the south, would surely cause the rate to rocket upwards with ruinous consequences for Gabriel’s clients. It’s therefore very significant that the export lobby in German politics has managed to get more influence over Germany’s interface with the European institutions. And here’s the man himself:

This might explain an important feature of the agreement the Eurogroup eventually reached. Greece is said to have “capitulated” by accepting the “November 2012 targets”. However, the agreement specifically doesn’t set any fiscal target for the year 2015, and proposes that we meet again in June to negotiate a new program replacing that of November 2012. Therefore, the targets don’t exist for this year, and those for future years are by the by. Perhaps they will influence the talks in June, but this strikes me as a concession without much substance. A bit like making the FDP leader vice-chancellor. And the talks will be heavily influenced by the boring technical stuff Gabriel’s ministry has most power over.

This might also explain why Schäuble seems quite so grumpy these days. Much of the content of policy reaches German officials in Brussels and elsewhere via Gabriel and Steinmeier’s staffs. In a real sense, he only has full and undivided control when ECOFIN (or the Eurogroup, which isn’t explicitly evoked by the ministry’s text) is meeting at ministerial level, and he is physically present. Which puts an interesting light on the whole row about that nonpaper that was supposedly issued after he left the building…

When he isn’t, his main means of influence is either shouting the odds in the media, or else going via Angela Merkel, who is of course free to support him or not. Merkel’s interests are well served by this. She keeps the options open, and avoids having to explicitly back either lobby. At the same time, it rules out either the two social democrats, or else Schäuble plus one of them, ganging up on her to commit Germany to some policy of their own. I would therefore cautiously discount some of Schäuble’s bluster in front of journalists.