Greek Re-entry (or Grentry) Not The Game Changer Many Think It Is

There is no doubt that Greece’s recent bond sale was an exciting and even invigorating moment for many people. The WSJ’s Simon Nixon, for example, called it “a symbolically important moment for the euro crisis”. Reuters’ Marius Zaharia suggested the speed of the come back could even be a game-changer for the heavily indebted southern European country. Certainly there can be little doubt that, as Nixon puts it, the turn round in market fortunes was a remarkable achievement, illustrative of just “how far market sentiment toward Southern Europe has changed”. 
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On The Trail Of Italian Debt

Looking for trends and correlations in that landslide of economic data which arrives, day in and day out, on our desks is normally something akin to trying to find a needle in a very large and raggedy haystack. From time to time, however, some things are just to obvious not to be noticed, like the ever rising levels of debt on the EU periphery and the growing demand from political leaders there for some kind of QE type initiative from the European central bank, for example. Sure, there is no obvious causal connecting here – the missing “middle term” linking the two would probably be all that ongoing deflation risk – but the inability of governments to contain their debt levels is a consequence of having low growth and low inflation, as is the wish being ever more insistently expressed by Southern Europe’s political leaders that the ECB were more like the Bank of Japan. Continue reading

Inflate!

Here’s an interesting chart.

The eurozone version of this is the debate about to what extent the relative increase in prices in southern Europe in the 2000s represented an increase in wage costs, and to what extent it represented wider inflation. I certainly remember a lot of concern about “mileuristas”, and of course the Greek version of living on €1,000 a month was living on €700 a month. The classic example is the fact that the CPI doesn’t include housing costs, and there was a housing bubble, dammit.

I used to be quite snarky about people who claimed there was really huge inflation because they saw someone selling this or that for so much and it wasn’t like that in my day. I am less so now. In a real sense, if inflation doesn’t include food or housing or healthcare or energy, is it a useful measurement?

So you might think I would be pleased at the content of this piece. But I’m very far from it. The reason is, basically, Piketty.

If you want r to get under g and stay there, inflation and financial-repression is a big part of the picture. And for this to be of any use, it has to be proper inflation – i.e. the sort that includes wages. You could make a case that the price stability the ECB achieved was actually more like “wage stability”. I wonder if prices expressed in terms of earnings is a measure we should monitor.

Firmly Anchored Expectations, No Postponement of Purchases?

This article from former European Central Bank board member Jürgen Stark (Doomsayers risk a self-fulfilling prophecy) has been occasioning a lot of commentary over the last week or so. According to Stark, the current deflation debate “lacks three important points: an in-depth analysis of the forces driving inflation down; a clear distinction between “benign disinflation” and “bad deflation”, with a spiral of decreasing prices, wages and output triggered by negative expectations; and a better understanding of the European Central Bank’s approach”. Continue reading

Price and quantity

An upshot from the last post. Markets can adjust by price, or by quantity. Economics usually assumes that they do both simultaneously, although the maths usually doesn’t work that way. There is no reason I can think of to prefer either mode of adjustment a priori, but practical applications will usually show that one or the other would be better.

In the radical view that markets are institutions that are defined by the societies that create them, it is a very important question whether a new one (or an old one undergoing change) will tend to adjust price-first or quantity-first.

Still in search of requisite variety: UK housing edition

The search for requisite variety goes on. At the moment, the big guessing game in British macroeconomics is “when does the Bank put up interest rates?” The following story suggests that this is beside the point.

The statement noted that mortgage demand was up 40% in the year to January, while surveys by the main mortgage lenders suggested prices were around 10% higher in February than a year earlier.

It said: “In a continuation of a longer-term trend, mortgages at loan-to-income ratios above four times accounted for a higher share of new mortgages in the third quarter of 2013 than at any time since the data series began in 2005. New mortgage lending at high loan-to-value ratios remained low by historical standards, though the number of mortgage products offering higher loan-to-value ratios had doubled over the previous six months.

“Given the increasing momentum, the FPC will remain vigilant to emerging vulnerabilities, will continue to monitor conditions closely and will take further proportionate and graduated action if warranted.”

Threadneedle Street intends to oblige banks and building societies to carry out stringent stress tests later this year to see whether they would find themselves in trouble in the event of a slump in house prices or a sharp rise in interest rates.

Oh jesus here we go again

Yeah. Interestingly, most of the classic bubble pathologies are showing up – try this for size – but for the first time in my life, this seems to be accompanied by dread, not euphoria. Nobody is cheering.

These stress tests are interesting. First of all, the fact that the Bank needs to audit the banks to work out if it is actually possible to increase the policy rate without triggering a major bank failure is itself evidence that the situation I described in the original In Search of Requisite Variety post is coming to pass. The rest of the economy is more than lacklustre but the housing market is going ape again.

Secondly, the version of that story that appeared in the paper contained several paragraphs that don’t appear in the web version. For example:

Amid growing concern that the central London property market is already overheating, the Bank’s financial policy committee said that from June it wanted to have the powers to set the interest rate scenarios lenders would have to consider when granting home loans

Another quotes Brian Hilliard of Société Générale as saying:

Both of these metrics, loan-to-value and loan-to-income, appear in the list of potential future tools the committee could use. The FPC would probably move first on loan-to-income. The problem with controlling loan-to-value ratios is that it might be thought to run contrary to the idea of the government’s Help to Buy scheme

What’s going on here is that the Bank is seeking requisite variety. Specifically, they’re trying to create policy tools to address a housing bubble without imposing monetary contraction on the whole economy. Setting “the interest rate scenarios lenders must consider” and then auditing them should lead the lenders to turn down more applications for very large mortgages. Setting a limit in terms of loan-to-income would have a similar effect on mortgages applied for by borrowers who might struggle to repay them. Rather than changing the price of credit economy-wide, this would mean that some new applications would be credit-rationed.

This, of course, represents finance being re-regulated. In the de-regulation era, it was thought that the big issue was the overall price of credit, which a central bank could control. Its distribution among borrowers, sectors, and geography would find its own level. Brad DeLong’s Republic of the Central Bankers gets at this weird combination of enormous central-planning power vested in the Fed, and its restriction to hugely general and rough measures.

It was hoped that this represented a sensible compromise between the need for a stabilisation policy, and the avoidance of what was thought to be harmful bureaucracy. But another way of looking at the republic of the central bankers is that it is rather like Russia – it has a stash of nuclear weapons with which it can destroy the economy and that’s basically it. Precisely because its chief policy options are “Nobody notices” and “Blow everything up”, its day to day influence is often less than it imagines. It is also superbly, peerlessly unaccountable.

I am much in favour of re-creating a variety of policy responses. I am, though, worried that the regulatory power is being re-created in the unaccountable and often explicitly anti-democratic domain of the central bank. This is evidence, though, that the political system itself lacks requisite variety. Who do I vote for to re-regulate mortgage finance? As a result, the problem landed with the people who did have enough degrees of freedom to do something: the Bank.

Mark Carney agrees.

“This focus initially made sense since one of the greatest challenges for macroeconomic policy in the late 1970s and 1980s was the fight against inflation,” he said. “However, with time, a healthy focus became a dangerous distraction.”

He described the move by Brown in 1997 to give the Bank independence to set interest rates focusing on an inflation target as a “deconstruction of the old model of central banking”.

“In my view, while there were enormous innovations of enduring value during this period, the reductionist vision of a central bank’s role that was adopted around the world was fatally flawed,” Carney said in his Mais Lecture at the Cass Business School in London.

The Growing Mess Which Will Be Left Behind By The Abenomics Experiment

According to wikipedia, “overdetermination is a phenomenon whereby a single observed effect is determined by multiple causes at once, any one of which alone might be enough to account for (“determine”) the effect.That is, there are more causes present than are necessary to generate the effect”.  In this strictly technical sense Japan’s deflation problem is overdetermined – there are multiple causes at work, any one of which could account for the observed phenomenon. Those who have been following the debate can simply choose their favourite – balance sheet recession, liquidity trap, fertility trap – each one, taken alone, could be sufficient as a cause. The problem this situation presents is simply epistemological – in a scientific environment the conundrum could be resolved by devising the requisite, consensually grounded, tests. Continue reading

A Simple Chart Illustrating Why Japan Style Deflation Is Now More Or Less Inevitable In Spain

Here’s one simple chart which illustrates why I think Japan style deflation is now more or less inevitable in Spain. Curiously it comes from the Ministry of Employment and illustrates the relation between the movement in average wages caused by actual movements in the real wage and those caused by what is known as the “compositional effect”. This latter is known by this name because it is the result of movements in the composition of the workforce, whether this be in terms of the average skill level or the average level of experience (or seniority premium, if you prefer). Seniority has historically played a very important part in the Spanish wage structure – ie the longer you have worked the more you are likely to earn.

Now if you look at the data superficially, you find that in the first years of the crisis average real salaries went up sharply (the blue line). This surge in average salaries was not due to salaries actually rising to this extent, rather it was the result of the composition of the workforce having changed (the average skill level went up) as unskilled workers in construction lost their jobs. Hence the 2009 spike in the composition effect.

According to Bank of Spain data in 2008 skilled workers represented 23.55% of the total while by 2012 the proportion had risen to 28.2%. On the other hand, over the same time period unskilled workers fell from 14.8% to 10.2% of the total.This naturally had an impact on average wage levels.

Now, however, the labour market has stabilised, and unskilled workers are no longer losing their jobs (at least not in net terms). According to the Spanish newspaper Expansion the Spanish statistics office estimate average hourly labour costs (not unit labour costs, note) fell in Spain by 2.9% en 2012, 1.9% in 2013 and they are expected to fall another 1.7% this year.

Again, looking at the chart you can see that the green (compositional effect) line which surged in 2009 has now flattened.  It has flattened but the impact is still there and has stabilised at a more or less constant rate. Subsequently it is quite possible that the compositional effect will even turn negative due to the impact of the 2012 labour market reform:  average salaries are no longer falling due to labour shedding producing a changing skill composition but due to AGE CHURN. Older workers with long term contracts and lots of seniority are being steadily replaced by younger ones on less well paid contracts, thus dragging down the average wage. The line is flat and extends out in to the future. This can go on for years now, and indeed the compositional effect can even turn negative.This is exactly what has been happening over the years in Japan, and is the principal reason why Abenomics isn’t working.

Incidentally, here I have been talking about average hourly labour costs NOT  those famous unit labour costs. These, as we all know, fell significantly in Spain after the onset of the crisis. What isn’t so well understood is that this fall wasn’t due to falling hourly wage costs (these didn’t really start falling till mid 2010, see blue line in chart) but due to massive labour shedding. Spain’s GDP has fallen by something like 7% while employment is down by around 20%.

On the surface this shows a large gain in productivity. Where this gain is actually coming from hasn’t been sufficiently analysed yet, but part surely comes from a compositional shift in the labour force. One thing is, however, reasonably clear and that is that it hasn’t come from industrial productivity, since industrial output is down by some 30% since the pre-crisis peak, even more than the reduction in employment.(I’m afraid you’ll have to stare very hard at the industrial output chart if you want to see signs of the much proclaimed recovery – you’ll have to stare very hard since there is so little sign of it).

So why do I think this suggests deflation may become endemic in Spain? Well, with average real wages falling, real pensions falling, and credit still shrinking by around 6% a year it is hard to see where the demand is going to come from, especially with very little happening in the way of new employment – the shortfall is becoming structurally implanted.

For more argument on all this (in Spanish) see my book which is being published by Ediciones Deusto next week. You can find a list of chapter headings here.

Could Mario Draghi Implementing QE At The ECB Possibly Help Matteo Renzi Raise the Italian Deficit?

What a convoluted title! Still, the lack of formal elegance might just be compensated for by its communicative efficacy. The aim of the above header is to link two names in people’s minds, both of them Italian: Mario Draghi and Matteo Renzi. Naturally the idea is not original, the FT’s Peter Spiegel  recently published an entire blog post ( Does Renzi owe his job to Draghi?) trying to establish some sort of  connection between the arrival in office of Italy’s Matteo Renzi and the recent German Constitutional Court ruling – in the process casting the central bank President in the role of midwife. Indeed, according to the FT,  Italy itself is currently rife with rumours about what might actually lie behind Renzi’s meteoric rise, and  again the role alloted to Mr Draghi seems to be  rather more than an incidental one. Continue reading

These Five Charts We Totally Stole Explain What’s Up With the Italian Economy

I’ve been wanting this for a while. What happened to the powerhouse Italian SMBs of the 1980s? We’ve known for quite a while that it was productivity, not wages, not hours, not savings that gapped-out between northern and southern Europe in the 2000s. I made the point back in 2011 and again that this is the responsibility of management, and perhaps of government.

Here is a great VoxEU post on productivity in Italy from Fadi Hassan and Gianmarco Ottaviano.

It is productivity that’s the problem.

ottaviano fig1 29 nov

It’s not the labour market. This chart shows a measure of “Strictness of overall employment protection”.

ottaviano fig4 29 nov

It might be the banks, or if not banks, finance. This chart compares the change in investment and the change in productivity in detailed sectors of manufacturing, between Italy and Germany.

ottaviano fig3 29 nov

It may also be to do with computers. This chart shows the percentage of non-residential investment made up by information and telecommunications technologies.

ottaviano fig5 29 nov

Hassan and Ottaviano think Italian human resources managers are at fault.

ottaviano fig7 29 nov

The basis of this scoring is as follows:

  • Italian firms promote workers primarily on tenure, rather than actively identifying and promoting top performers;
  • Managers tend to reward people equally, irrespective of performance level, rather than providing targets with performance-related accountability and rewards;
  • Poor performers are more rarely removed from their positions;
  • Senior managers, rather than being evaluated on the strength of talent pool they actively build, are more likely to not see attracting and developing talents as a priority

The first seems to conflict with the second chart, as does the third, and the second is arguable. The fourth, though, reminds me of Diego Gambetta on Italian professors and incompetence as a costly-signalling mechanism. I wrote about him here and here.