Friday 12 March 2010

EMF, German economy and EU procurement reform

In the following article, Tony barber of the FT asks Two questions. First, whether it is possible for Germany to

: 1) "no longer to be, in the broadest sense of the term, the EU’s paymaster", 2) "impose strict budget deficits in the Eurozone" 3)"remain the EU’s champion exporter and a model of business competitiveness, piling up vast current surpluses as a result"

and secondly, whether this is compatible with European (Economic, I assume) Stability.

Regarding the first question, I believe that this is a coherently proposed set of goals. Again, I go back to the basic open economics: Y=C+I+G+NX, and Y=C+S+T implies that I-S + X-M = T-G. Therefore it is not just possible, but in the absence of a short term disequilibrium between Investment and Savings, if Germany wants to be a big exporter it needs to have a low deficit. What better way to do that than to stop being the EU "paymaster". But is it really the pay master?

Now, the second question is much more tricky. As I said, I'm assuming that he is referring to economic stability. Now the thing one needs to keep in mind is the EU's procurement system. At the moment EU revenue has 4 main sources: VAT, customs and agricultural duties and direct country contributions, based on some GNP proportionality formula. Then there are some other smaller adhoc contributions, but nothing more tha 5-10%. This means that whoever consumes more, whoever participates in more external trade, and whoever has the largest GNP, will always be the EU's paymaster. So Germany is stuck. Even if the EU was to levy some income tax, it would still be germans paying the largest piece of the cake.

Ultimately the point is still that the whole story is a bit inflated. There is no problem with Germany not wanting to pay for greek debt. Moreover, just because it decides that the idea of a EMF is good because it spreads the monetary cost of rescue to everyone, it does not mean that suddenly Germany wants to decrease the bill it pays. I guess it only means it does not want it to increase! Germany is the biggest payer of EU but it is not the majority. It's not worth making a fuss

Tuesday 9 March 2010

The EMF is a very good idea!! The others not so much may be...

France and German officials have voiced their support for an IMF like organisation for the Eurozone. This situation is part of the normal process of surviving a crisis. First you recognise that there's a problem (which is to say that you stop being in denial, because in economic terms the problem does not build up over night, it has been there and it has created a pretty little bubble on which people were happy to feed. Once it blows, then it is this amazing black swan that no one expected.). Then you come up with a short term solution for it (you patch things up), so that you can think of a good way to try and avoid the problem repeating itself. We are now at that stage in Europe, we have taken stock of what happened and are trying to figure what can be done to solve things. Of course it is difficult to sort through the noise of German and Greek nationalistic slur.

We have a number of things on the table:

First we have this idea by the ECB, that it should somehow possess a financial rating agency of its own. My understanding is that this was put forth by the Governor of the Austrian Central bank, but no one has really spoken out in favour or against it. Finance ministers are discussing it apparently...

Then we have also heard of the more serious proposal for a European System of Financial Supervisors (ESFS) within the framework of a European Macroprudential Supervisory Authority (EMSA?), , which has stirred enough interest for there to be hearings at the EP about it. This is a more official idea (details about it can be found here). It was put forth in the Larosière report drafted by a "High level group" on financial supervision, which is to say a group of credible and important MEPs. From what that article seems to describe the ESFS would be divided in three subcommittees:

The Committee of European Banking Supervisors (CEBS),

The Committee of European Insurance and Occupational Pensions Committee (CEIOPS)

The Committee of European Securities Regulators (CESR)

Finally, there's the EMF (European Monetary Fund) proposal, which was first put forth in recent days by the German Finance Minister Wolfgang Schäuble (analysis here). As the name indicates this would be a type of insurance company for European governments. Everyone pays an yearly premium for an "insurance" and then when the getting gets tough, the fund is there to lend money to whoever has not been able to keep its expenses in check. It is there to ensure that governments who mess up their public balance are still able to pay their debts (oddly enough by contracting even more debt, but at a nice rate) and it deflects public outcry from the affected country to the European Commission rather than to Germany

I think that the first idea is not particularly good... Getting a government agency in charge of determining who is worth what sounds too much like centralised price setting, which is inefficient. Public officials lack the self interest that private agents have in their pursuit of information. Secondly public institutions are more constrained in terms of the monetary incentives it can provide (particularly if one assumes that financial crisis will still happen, and that no single system can prevent them or guarantee that their size will be limited. That would be a little PR mess...). Thirdly, it would open the doors for a greater extent of agency capture in the financial sector. Finally, there's the opposite problem of agency capture by governments, who may try to exploit their new found influence by pushing this agency to provide their debt with inappropriately high quality ratings. In other words there would be a potential for selection bias in the value that this rating agency would attribute to government assets rather than to private assets.

So to sum up: lack of self intrest and a limited set of tools to provide incentives exacerbate, or at least fail to solve, the problem of asymmetries of information

agency capture from both private and public agents seems to create fertile grounds for future conflicts of interest and revolving doors. Regarding the second idea, I think further integration is a really good idea. I agree with the author of the Eurozone entry blog, that there is little point in creating this finacial supervisory authority if the structure is going to be overly decentralised. Of course the committees should be separate, but there should be a supervisory point where all financial sectors (Banking, Insurance and Securities) are aggregated for analytical purposes. These industries cannot be regulated separately. Over decentralisation would be tantamount to coordination under a new name, rather than actual integration/delegation of powers. Regarding the problems that I raised with the EU rating agency, these are absent here. In this sense, the ESFS would outsource financial rating to the private sector (Moodys and S&P, etc). My main problem really is about its name. Why call this a European Macro prudential Supervision? It Finance, not macroeconomics... It should be overseen at the EcoFin level, but more than that I can't quite see the Macro point of the ESFS... Finally I think that the last idea is really good. Although it has faced some opposition. Here are some links for further information> Here, der spiegel and business week ft and bbc Note that I think that the EMF would not suffer from any particular problem of Moral Hazard, as it would provide an incentive mechanism based on conditionality. This is not just insurance. It's insurance "if!". So that's good! Moreover, I believe that the risk is in the rigidity of the proposed conditionality. Too rigid and its intellectually dangerous. Too flexible and its economically useless. On the other hand it could be more targetted, taking advantage of the insider knowledge that the EU already has about the functioning of its member states economies, so that conditions could be targetted at certain economic sectors, political reforms and apply in the Longer rather than in the Shorter term, when appropriate. One of the problems of the IMF interventions has always been that its interventions don't have permanent effects. The risk is that once the EMF will be set up it will repeatedly rescue the same countries. This would be problematic, as self selection would propose that those who are not at risk would simply stop contributing, and instead decide to follow policies that minimise their exposure to their neighbours malpractice. If this logic makes sense then it would imply that poorer countries policies would crowd out foreign investment from the EU. Also check this link for some insights on the present discussions about budget and tax coordination.

Saturday 6 March 2010

US recognise Armenian Genocide. Turks should accept and recognise the native american Genocide

For the last couple of days there have been some quiet reports on the tensions between the USA and Turkey caused by a the fact that "the foreign affairs committee in the US Congress narrowly passed a non-binding resolution condemning as "genocide" the First World War killings of 1.5 million Armenians by the Ottoman empire".

I find this a positive step by the USA. I believe that having been the ones that caused this crime to be established, and consequently becoming the poster boys for it, has given Europe the honesty to call exterminations, by their proper contemporary name.

It is a non binding resolution and as such does not carry any consequences. It is tantamount to the USA recognising internationally and domestically that it is their held view that between 1914 and 1918, the Turks tried to get rid of the Armenians. This was obviously a dreadful development in the history of Turkey, but I don't see why they make such a fuss about it and get so offended. The history of mankind is filled with such collective bigotry and scape goating. Spain and then Portugal effectively commit such attrocities against the Jews in the Renaissance, and later towards the indigenous populations of their colonies in the new world. France did the same with the Occitans and the Hughenots, and if you really want to go back, the attitudes of the roman empire to those who unsuccessfully opposed it, were less than compassionate. As Thucydides put it in the History of the Peloponesian war,

“The strong do what they have to and the weak accept what they must.”

Now here is my idea. Turkey should not moan in a corner a nagg about how everyone is making it feel bad. Do what the Chinese do when the americans lecture them about human right! Lecture them back on the hypocrisy of a country that systematically eradicated its indigenous population over the course of 3 centuries lecturing a country that oppresses the sovereignty, the freedom of expression and association of one its minorities.

I am obviously not saying that because the americans treated their native indigenous population bad that it entitles the Chinese to do whatever they want, just because they don't actually want to eradicate the Tibetans or the Turkmen or the Uyghurs(or any other ethnicity for that sake). I'm saying that all this is played out as a shame and blame game in the media, despite the hypothetical presence of actual moral considerations. It's ultimately a cause of pride, which may shift somewhat the political support of the present government. Turkey should rise above, accept that it commited an attrocity that can be (and has been )qualified as a genocide, and then extend an open hand to the USA and say, "Why don't you follow our example? The truth will set you free!" Playing the shame game might just be the politically intelligent thing to do by the Turkish government of the time.

Monday 1 March 2010

A potential macroeconomic interpretation of the last 2 years

I post the image underneath, in the hope that someone will make some comments. I'm not arguing that it is the best or even good description of what has happened, but it is the best I could come up with in a short period of time.

"AD" refers to the Aggregate Demand, "SRAS" refers to Short Run Aggregate Supply, and "LRAS" refers to Long Run Aggregate Supply. This should be thought of in the context of the Mundell-Fleming model, of an (large) open economy. AD corresponds to the equilibrium between the IS curve(representing the goods market Y=C+I+G+X-M, which one may choose to develop into: ) and LM (representing the money or financial market approximated by the function: M/P = L(Y,i) ).

LRAS refers to the long run equilibrium in the labour market, where Y=Y*, meaning when output is at its equilibrium level, and unemployment is at its natural rate (u=u*), given the NAIRU (Non Accelerating interest rate of unemployment also known as the expectations augmented Phillips curve, given by: π = π* -φ(u*-u)+ s)). The SRAS is then given by: Π= (Π^f) + φ (y-y*) +s'

My biggest problem is with the implications of exchange rate regimes particularly because I haven't quite yet gone through the full model for floating exchange rates.

All of these formulas are taken from "Introducing Advanced Macroeconomics", written by Sorensen and Jacobsen. They give a much better explanation of this type of analysis than I do. Nonetheless, as the tittle proposes this is the first draft. It is more intuitive than anything else. Prettier versions in upcoming posts might prove more fitting, as I'll have finished teaching myself this type of analysis...

Anyway, please leave some comments. :)