Is Finland’s Economy Suffering From Secular Stagnation?

After the Great Depression, secular stagnation turned out to be a figment of economists’ imaginations…… 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.

EuroGroup – Money For Nothing And Your Debt For Free?

There’s an interesting question about “analysis” which confronts anyone who seriously wants to engage in it: do you organize your focus around what you want to happen (practical policy emphasis) or do you concentrate your efforts in detailing and outlining what you think will happen? Naturally the closer you are to having an ideological discourse the harder this distinction is to either see or maintain. But even for “non ideological” thinking the issue is far from being an easy one. Whether or not there is any such thing as “objectivity” is a complex philosophical question and attempts to achieve it fraught with all manner of difficulty, but surely we at least have to try? Continue reading

Spain’s “Good” Deflation?

Spain’s domestic economy is booming, or so the story goes, and in no small part this boom comes thanks to the arrival of what is being termed the “good kind of deflation”, the sort everyone would like to have, a world where prices fall, real incomes rise, jobs are created, and everyone gets to live happily ever after. Let’s not worry that in the process the boom is steadily transforming an export lead recovery into a domestic consumption – or import driven – one. Continue reading

When contracts are contractionary

An interesting twitter debate between Alan Beattie and Frances Coppola, regarding the connection between Greek “structural reforms” and the macro-economy.

Alan argues that shortening business-to-business payment terms and improving contract enforcement should just generally be a good thing and shouldn’t have any macro effects in the short term.

Frances retorts that it’s always cash flow that causes businesses to fail, and anything that tightens cash flow will cause more business failures as the first-round effect.

Alan responds that companies who benefit from going slow on payments are usually just well-connected rent seekers and that they’re exploiting ones that have more potential upside.

I think we can be a bit more precise here. If money gets rid of the need for a double coincidence of wants, finance gets rid of the need for a double coincidence of timing. I don’t necessarily need to wait to sell in order to buy, if I can use trade credit, for example. One of the earliest known financial instruments is just a bill issued by one business that gives the customer 30 or 90 days or whatever to pay, and can be assigned to someone else.

The point here is to increase the value of economic activity that you can carry out before you have to draw on your working capital to pay a bill in cash. The presumption is that businesses are usually constrained by their cash flow, and trade credit is a way of relaxing this constraint and using their holdings of cash more intensively. In that sense, it’s a social mechanism that increases the money supply by increasing the velocity of circulation.

It’s possible to create a huge credit bubble based just on this financial technology – Kindleberger is full of them – even if the cash paid in final settlement is gold or silver or big rocks.

If we now intervene in some way and insist that people settle up their accounts, for cash, faster, what happens? Well, one way of looking at it is that all this informal credit is non-monetary economic activity. Now, it has to become monetised, which means that the demand for money has increased sharply. Another way of looking at it was the one I hinted at earlier. If we count the trade credit as an increase in the supply of money, then either the rest of the money supply must expand to accommodate it, or else the money supply must shrink.

Whether we look at this as an increase in the demand for money, or a reduction of the supply of money, it does mean that the marginal borrower’s interest rate is going up, possibly dramatically, and they also face liquidity risk. Here’s your contraction.

Now of course this can be solved; monetary policy can change.

In practice, the most likely route by which the outstanding bills get monetised is through a bank, because where else do you go to get cash? We can get around this problem if the banking sector’s balance sheet expands enough to take on the outstanding trade credit, or alternatively, if the monetary authority puts more money into circulation. (This is the same thing, in a sense – imagine an economy with one bank.)

The first option means that the banks may need more capital, because they are taking up a bigger share of outstanding risks, the second, that monetary policy must be adjusted. In fact, taking up the first option will probably involve some of the second, as the banks bring more paper into the central bank discount window. But if the banking sector is structurally constrained in some way, and the monetary authority is located in some other country, well, yes, the reform will be contractionary. Better, it will be contractionary, full stop, unless someone does something to counter it.

It’s true, as Alan Beattie says, that slow payment might be one of the ways rent-seekers exploit their suppliers. Anyone who’s ever been involved with a small business will know that there are a lot of unreliable payers out there. However, this is true of the UK and probably of Finland. It’s also idiosyncratically true, not the sort of thing easily accessible by airport-to-hotel reformers. And it’s more true that small businesses will be more likely to run out of cash, if there’s a general drive to collect on bills quicker, than big ones.

The classic mechanism of an economic crisis in an economy that runs on store credit is set out very well in Kindleberger. Chains of bills, representing the outstanding volumes at risk, grow until something happens and causes the marginal creditor to demand cash money. Then a cascade-failure of bankruptcies occurs. It is not obvious, to say the least, that this is desirable.

Yes, this reform is contractionary, and implementing it requires that the monetary authority pushes against the contraction.

Stocks, Flows, GDP Warrants, Negotiating Constraints, Inter-Blogger Tension: Greece

So, if we were to make a little leap of faith, how could SYRIZA and the troika, or eurogroup, or shall we just say the Euros, come to an agreement?

The first issue, I think, is that any agreement needs to pass two tests. It needs to be both acceptable, or it wouldn’t be agreement, and it needs to be effective, or it would be pointless. The red-lines on both sides are pretty clear. SYRIZA went to the polls demanding some measure of debt relief. I take that to mean a reduction in the face value of the outstanding stock of debt to the Eurozone, plus the ECB, plus the IMF. Angela Merkel has stated that no further “haircut” is acceptable. Everyone assumes she is the ultimate veto actor on the Euros’ side.

On the other hand, as everyone seems to think, the debt service, i.e. the interest on the outstanding stock of debt, isn’t a big deal and therefore the stock of debt isn’t either. What matters is the primary surplus, the net transfer from Greece to the Euros, that the current agreement requires every year from here on in. The test of an effective agreement is whether it reduces this enough to restart the Greek economy. The Euros’ target is 4.5% of GDP. Yanis Varoufakis, Greek finance minister and everyone in the blogosphere’s new best mate, wants to cut it to between 1 and 1.5%. Clearly, agreement is possible somewhere between the two values, especially as nobody on the Euros’ side has committed to veto any particular number.

Ironically, the parties can agree on quite a few different options that would work to a greater or lesser extent, but they can’t accept them politically. This is of course better than the other way around. Arguably, the other way around is what we’ve had so far – acceptable, but ineffective.

A lot of people would also agree that the outstanding stock of debts is not really very important. It is, per Krugman, an accounting fiction, per Daniel Davies, the means by which the Euros try to control the Greek government budget, in order to impose something called “structural reform”. Alan Beattie, in a superb blog post, points out that the phrase “structural reform” is nonsensical.

First of all, there is no such thing as “reform” as such. You can’t ring up and order 20 40′ containers full of reform. Reforms are, more than anything else, inherently specific and context-dependent. The enterprise of structural reform is based on the idea that the market knows best, as it embodies the diffuse wisdom of those most concerned. But the reforms are meant to be chosen and delivered by civil servants parachuted (or rather, airlanded) in from some other country, usually isolated from everyone but the airport-to-hotel cab driver. This is at least ironic, and arguably perverse.

Second, reform has goals and in this case the goal is the delivery of the 4.5% annual primary surplus. Looking at this from a sectoral-balance point of view, if the public sector is to net-save 4.5% of GDP, either the private sector must take on a similar amount of net debt, or else the country must run a similar current-account surplus. So far, Greece has tried to reduce its CA deficit by demand destruction, or in other words, cutting down trees around Athens to save on fuel oil. What the structural reformers have in their heads, though, is that Greece increases its exports.

This implies both that somebody else imports them, and also that the Greek private sector increases its capacity. Firms expand by using more capital, one way or another. This seems unlikely in the context of debt-deflation. Reform very often costs money; when Germany carried out what it now thinks of as structural reform in the early 2000s, it blew its budget deficit targets with the Euros quite comprehensively.

Also, the difference between Alan Beattie and Daniel Davies is that Alan accepts that structural reform can be, and often is, stupid. Beattie’s archetypal Christmas-tree program includes a mixture of ideas anyone could agree with, ideas that are impossible to implement, and ideas that in context are insane, but might, tragically, be implemented. Capacity has to go up but demand has to go down. The private sector needs to borrow to invest, but credit has to be tighter. Pensions must be cut to increase the pensioners’ competitiveness in the cut-throat business of retirement. Daniel Davies’ Aunt Agatha doesn’t just want you to do language classes; she also wants you to wear earplugs during them, and also attend the right sort of church like the right sort of people, just to show willing, like.

There is surely a case that the Greeks are the best placed to know what their problems are, and further that SYRIZA is the party that is least complicit in keeping the problems that way. That means, of course, that the reforms must be acceptable to them.

But we already know that the level of the primary surplus is negotiable. We’ve established that. The point is how to deliver something that amounts to debt relief in Greece, but not to a write-off at face value. How can we get to yes?

Here’s an important chart, showing the annual repayments in euros for the various official loans.


You’ll notice that in the short term, the IMF predominates. You’ll also notice that a lot of the repayments are in the really long, we-are-all-dead run, out to the 2040s and 2050s. This is the very definition of a political number. And who owns it? You might be surprised.

Everyone always says Germany, but out of the €194bn owing to Eurozone sovereigns, €104bn came from France, Spain, and Italy together. When the history is written, it should take note that Spain in its troubles put its hand in its pocket for serious amounts of money. At the time, there was a lot of talk that the EFSF-and-then-EFSM-and-then-ESM had no credibility because they stood behind it. The record shows they came through. Of course, this makes the idea of a southern front against austerity so much more difficult, as they can afford to lose the money so much less.

This is, I think, where there is a bit of play in the mechanism. The Greeks are floating the idea of linking the debt repayments to growth, like an income-contingent student loan or perhaps more like a debt-for-equity swap. This is, of course, rather like the GDP warrants proposal that was fashionable a couple of years back.

In context, this means that the payoff comes through if the reforms actually work; a discipline never before imposed on such a programme, although of course they always want it for everyone else. This is substantially better than the other option, which is just to extend-and-pretend again.

Although the payoff structure is equity-like, it’s still an obligation of the same face value, so it does not constitute a write-off in the strict sense. As it doesn’t require a cash transfer until some target is reached, though, it is debt relief in a very important sense from a Greek point of view. In an accounting sense, of course, it is – the risk-adjusted net present value would be lower by some percentage depending on your guess about the path of Greek GDP in the fairly distant future.

The further out you go, of course, the easier this is, but then again, the test of effectiveness is what happens to the primary surplus requirement – right? And a swap of bonds for warrants with terms out in the 2040s is a better bet, I think, than hoping for a European fiscal union with actual transfers and without balanced-budget amendments.

As for the IMF, well, will this mean another story about the Europeans hoping the Americans will lend a hand?

Confusion in Frankfurt or Athens

European Central Bank statement last October in reaction to a New York Times article about Emergency Liquidity Assistance management in Cyprus –

The ECB neither provides nor approves emergency liquidity assistance. It is the national central bank, in this case the Central Bank of Cyprus, that provides ELA to an institution that it judges to be solvent at its own risks and under its own terms and conditions. The ECB can object on monetary policy grounds; in order to do so at least two thirds of the Governing Council must see the provision of emergency liquidity as interfering with the tasks and objectives of euro area monetary policy.

Reuters story today based on Bank of Greece source –

Greece’s central bank has moved to protect its banks from any fallout from the coming general election, asking the European Central Bank to approve a stand-by domestic emergency funding line, a Bank of Greece official said on Saturday. The move comes after two major banks applied to be able to tap an emergency liquidity assistance (ELA) window on Friday as Greeks withdraw cash before the snap election on Jan. 25. “We have sent a request to the ECB on ELA approval for all four major banks to have a shield for the banking system,” the official said, declining to be named.

UPDATE: Karl Whelan points out that the ECB has given itself some approval authority through certain “in the event of” clauses in the ELA rules.