A couple of weeks back we had a great post by Christoph Zwick on current account rebalancing in the Eurozone. In the comment section I mentioned I had my doubts on what the variables are that we should look at in order to determine which countries are most vulnerable to experiencing “sudden stops” of capital inflows, thus triggering a financial crisis, which is in essence what happened in the southern Eurozone periphery. In particular I found the argument unconvincing that debt ratios are of much use in this discussion, my thoughts on which I attempted to summarize in a follow-up post I did back then.
I don’t mean to pick on this, but I feel it is important since it is a fairly widespread view that excessive debt ratios (both public and private) are a large part of the reason why some countries fared so badly in the financial crisis while others did much better. The subsequent calls for austerity, often based on this flawed analysis, are also what is destroying the future of an entire generation of young people in the affected economies.
I just happened to stumble on some research by Frankel and Saravelos (.pdf) that seems to address specifically this issue, and I thought it would be a useful addition to the conversation. In essence it is a literature overview that tries to summarize the findings regarding which variables proved to be statistically significant as “early warning indicators” for financial crises. The top 5 indicators they found are as follows (Table 1): foreign exchange reserves, the real exchange rate, GDP growth, growth in credit and the current account. Clearly not all of these are applicable to countries in a monetary union, such as the Eurozone, which essentially by definition have no foreign exchange reserves of their own, for instance. But what struck me the most is the indicator at the very bottom of that list: External Debt. In fact, of the 83 studies reviewed, only 3 found external debt to be a statistically significant indicator to predict a financial crisis. “Budget Balance”, the meaning of which is unfortunately not really defined in the paper, was found to be significant in only 9 of the 83 studies surveyed. Both government as well as external debt simply do not seem to be what we should be looking at here.
P.S.: As a side-note, some economists at Well’s Fargo (.pdf) took these indicators to estimate which of the 30 biggest developing economies in the world are more likely to be subject to crises in the near future. Might be interesting to keep an eye open.
Edit: The survey I quoted in the post relates to pre-2008 crises. The authors then conduct some analysis of their own for 2008-2009 episodes, and for some reason do find external debt to be a significant indicator. I’m not sure how that works, but it does of course change the story I tried to tell.
Following up on my last post on what easy money actually means I would like to offer some options the ECB could, and in my opinion should, pursue to achieve its mandate of getting inflation back in the vicinity of 2%. Whether doing that is enough is another topic, but it would at least be a start. In general, the consensus is that central banks have three types of tools at their disposal once the zero lower bound is reached: first, they can try to shape public expectations about future monetary policy (e.g. forward guidance), second they can expand the size of central banks balance sheets (e.g. quantitative easing) and third they can change the composition of those balance sheets (e.g. operation twist).
All of these measures have, in the vast majority of studies, shown to be able to affect the economy. The view that economic policy is ineffective at influencing the economy at the ZLB is therefore not correct – it might be less effective, and most importantly probably shows decreasing returns, but it does not become impossible. As Bernanke et al. for instance have argued, we should try to avoid such a situation in the first place, but once there we do have options. So let me offer some more concrete ideas on what the ECB might do in particular.
Gerald brought up a really good question in my last post on ECB monetary policy stance since the crisis. I’m afraid Buttonwood got a bit trampled there, which in retrospect seems somewhat one-sided, since a big deal of his post is actually very good. Anyways, to the question:
What do you think a really easy monetary policy by the ECB would look like? Is it mostly about increasing the inflation target? Or would your rather have the central bank buy the debt of troubled economies like Greece?
At first I wanted to rush straight into it, but then I noticed that is pointless without clearing up what my definition of “easy money” is in the first place. I’ve spent quite a bit of time in this blog arguing that monetary policy all around the world, but particularly in the eurozone, is much too tight no matter which way you look at it. Let’s see what the ECB announcement brings today. A big issue i have with a lot of the current discussion, particularly in the Media, is that the currently historically low nominal interest rates are assumed to, by themselves, prove that money is “easy”, which is just wrong. So let me try and clarify some of the issues involved from my perspective.
It is fascinating how much blogging mileage one can get out of the incompetence of the ECB. Call this act 3 in my ongoing series on the delusions of central bankers and one size fits none monetary policy. Or maybe we all just got stuck in a Groundhog Day like world of monetary policy hell.
Scott Sumners links us to The Economist’s Buttonwood, where we find an article on the continuingly low – much too low – level of inflation in many countries around the world, but particularly in the eurozone. Apparently the inflation rate in October fell to a new 4-year low of just 0.7 percent. Obviously this is also absolutely catastrophic from a rebalancing point of view, as nicely described by Max back in his post on eurozone inflation arithmetic. But let as take a look at the Economist article for a second here.
I’ve chosen to start with this topic, because even right after the election several parties still talk about the necessity of a tax reform in favour of the tax payer. Maybe they expect every tax payer to cheer up on that. But even if we ignore the so called debt crisis for a moment, a promise like this one still leaves crucial questions. What can be understood by a tax reform in favour of the tax payer? The easy and myopic answer could be: a tax reduction. But then we still need to know who this favoured tax payer is. And it is clearly not a homogenous everybody, because we individually pay different taxes in different heights. In this sense every serious politician would honestly tell us which voter is overreached and who is getting discriminated in comparison to the status quo. Such concrete information can of course not be found on posters during the election. And the announcement of a flat tax on income in favour of hard working people shows us that they either not know what the word “favour” means, or what a flat tax ceteris paribus would imply for the relative tax burden of “hard working” people. So I rather focus on declaring my own proposal:
I want affordability for the necessities for living at the expense of unnecessary comfort and wealth. That means I do not hesitate to admit that in return to the relief for poor and sparing households I have to tax wastefulness, abundance and excessive luxury. One way to do that is to charge individual consumption instead of income. And this is only one of the reasons why I want a big scale reform towards a direct progressive expenditure tax.
Another reason is that by charging just the purchase of consumables we would expect savings to rise. If these savings are used for investments this should imply economic growth. Of course such investments have to be correspondingly triggered but the first impression leads to the thought that the individual decision process is nudged in a sustainable direction.
In this sense also other forward-looking expenditure for like family, health or education should get even more attractive because they would reduce and avoid taxes. Thereby people could still decide day by day which lifestyle is worth the corresponding burden and are not principally charged for being productive or having a well-paid job.
This raises the topic of another advantage which would be the non-existing discrimination of production factors. It would be irrelevant whether the income is earned out of labour or capital. Once more: Instead of charging the source we would focus on the use. And latter seems to be a pretty good base to estimate what a person is able to give as well as obviously taking from society. So tax it!
There have been some recent changes on the blog and so it seems like a good time to become a bit more active as well. I’m a former KF student who left Graz a while ago and I’m now in the final year of a MSc program that specializes on Economic Development and Growth. This will also be the focus of my blog entries.
On the impossibility of being developed
As a profession we, economists, like clear concepts. When we use a term such as “market”, “capital” or “inflation” we tend to define these terms to get a clear understanding of what we are talking about. Studying a masters in development economics I’ve started to realize that the term “development” has become such a common word in our everyday language that hardly anybody pauses to think about what we actually mean by it.
This blog entry is the first one of a series I am going to write over the next couple of weeks that will deal with the questions of what development is and how we can measure it over time and space. These are obviously important questions, because without a clear idea of what we mean by “development”, “progress” and how we can measure and compare them, most of the things we can say in development economics become quite meaningless.1 In this first part of the series, I focus on discussing “development” and its relation to “progress”.
A series of exciting new developments have played out over the past couple of weeks. Starting with Max’s contributions, the word has spread and the blog is on its way to becoming what it was always intended to be: a true discussion platform for everyone either enrolled in or involved with the Economics program at the Karl Franzens University Graz.
This calls for some changes. First, we have decided to make the blog the official discussion platform of the Economics-Club Graz, which is also reflected in the new choice of title of the blog itself. In order to accommodate a hopefully increasing number of contributors, we have changed the theme of the blog to one that more clearly shows who authored what post and provides easier accessibility to older posts. I am hoping for a lively discussion on this blog, so clear attributability, but also accountability, will be important. Further, in order to allow as many people as possible to actively participate, we have decided to allow for posts both in English, which will continue to be the main language of the blog, and German. Two new categories as well as the updated menu at the top reflect this change, whereas the German tab still rests empty for now.
I am greatly looking forward to what’s in store for this blog in the future, and hope everyone enjoys it as much as I do.