Archive for the 'Politics' Category

It’s not a fiscal union and Cameron didn’t veto it

Published on 12 December 2011 in Economics, Europe, Finance, Justice/Law and Politics. Tags: , , , . 4 Comments

A fiscal union would have transfers from various parts of the union to various other parts over the business cycle.  A guarantee to stand behind somebody’s debt while simultaneously insisting that you’ll never actually need to cough up a cent because you’ve made them pinky swear is not a fiscal union.

A veto stops a thing from happening (think of the UN Security Council).  The fiscal compact is going to go ahead, just without Britain.  Therefore, Britain did not veto it; they declined to take part.

That is all.

Update:

Okay, that isn’t quite all.  Just to be clear, I think that Cameron did the wrong thing.  I believe that, at a minimum, he should have committed to bringing the proposal to the UK parliament.  It may well have been voted down at that point, but nevertheless it should have happened.  Parliament is sovereign in the UK.  This was a serious proposal with potentially significant consequences from either agreeing to it or walking away from it; the people of Britain deserved to have their elected representatives decide.

I am undecided on whether signing up to the pact would be in the best interests of the UK.

Policy options for the Euro area [Updated]

Published on 30 November 2011 in Economics, Europe, Finance and Politics. Tags: , , , , , , , , , , . 0 Comments

I here list a few policy options for the Euro area that I support, broadly in descending order of my perception of their importance.  Everything here is predicated on an assumption that the Euro itself is to survive and that no member nation of the Euro area is to exit the union.  I don’t claim that this would solve the crisis — who would make such a claim? — but they would all be positive steps that increase the probability of an ultimate solution being found.

  • Immediately establish a single, Euro area-wide bank deposit guarantee scheme.  A single currency must absolutely ensure that a Euro held as money in Greece be the same as a Euro held as money in Germany.  That means that retail and commercial deposits in each should be backed by the same guarantee.  I have no firm opinion on how it should be funded.  The classic manner is through a fee on banks proportional to their deposits, but if Euro area countries ultimately prefer to use a Tobin-style tax on transactions, that’s up to them.  Just get the thing up and running.  Of course, a unified deposit guarantee also requires a unified resolution authority in the event of an insolvent bank collapsing.  There are many and varied forms that fiscal union can take; this is the most urgent of them all.  I am shocked that this does not already exist.
  • The ECB should switch from targetting current inflation to expected future inflation.  The Bank of England already does this.  Accepting that any effect of monetary policy on inflation will come through with a lag (or at least acknowledging that current inflation is backward looking), they “look through” current inflation to what they expect it to be over the coming few years.  This is important.  Current inflation in the Euro area — i.e. the rate of change over the last 12 months — is at 3%.  On the face of it, that might make an ECB policymaker nervous, but looking ahead, market forecasts for average inflation over the coming five years are as low as 0.85% per year in Germany.  They will be much lower for the rest of the Euro area.  Monetary policy in the Euro area is much, much too tight at the moment.  At the very least, (a) interest rates should be lowered; and (b) the ECB should announce their shift in focus toward forward inflation.
  • The ECB should start to speak more, publicly, about forms of current inflation that most affect future inflation.  This follows on from my previous point, but is still logically distinct.  The Fed likes to focus on “core” inflation, stripped of items with particularly volatile price movements.  I don’t much care whether it is non-volatile prices or nominal wages, or even nominal GDP.  I just want the ECB to be speaking more about something other than headline CPI, because it is those other things that feed into future headlines.
  • The ECB’s provision of liquidity to the banking system, while currently large, is not nearly large enough.  The fact that “German Bunds trade below the deposit facility rate at the ECB and well below the Overnight Rate” is clear evidence of this.  I currently have no opinion on whether this ought to be in the form of increasing the duration of loans to Euro area banks, relaxing the collateral requirements for loans or working with member countries’ treasuries to increase the provision of collateral.  I certainly believe (see my second point above) that interest rates should be lowered.  The point, as far as is possible, is to make replacing lost market funding with ECB funding more attractive to banks than deleveraging.
  • A great deal of Euro area sovereign debt is unsustainable; hair-cuts are inevitable and they should be imposed as soon as possible (but, really, this requires that a unified bank resolution authority be established first).  The argument for delaying relies on banks’ ability to first build up a cushion of capital through ongoing profitability.  When banks are instead deleveraging, the problem is made worse by waiting.
  • Credit Default Swaps must be permitted to trigger.  The crisis may have its origins in the the profligacy of wayward sovereigns (frankly, I think the origins lie in the Euro framers not appreciating the power of incentives), but the fundamental aspect of the crisis itself is that various financial assets, previously regarded as safe, are coming to be thought of as risky.  By denying market participants the opportunity to obtain insurance, Euro area policymakers are making the problem worse, not better.  Market willingness to lend to Greece in 2025 will in no way depend on how we label the decisions made in 2011 and 2012.
  • Every member of the Euro periphery should be in an IMF programme.  Yes, I’m looking at you, Italy.  If the IMF does not have sufficient funds to work with, the ECB should lend to it.  All politicians in Euro periphery countries should be speaking to their electorates about multi-decade efforts to improve productivity.  These things cannot be fixed in two or three years.  They can, at best, be put on the right path.
  • For every country in an IMF programme, all sovereign debt held by the ECB should be written down to the price at which they purchase it.   If the ECB buys a Greek government bond at, say, a 20% discount to face value, then that bond should be written down by 20%.  The ECB should not be in a position to make a profit from their trading if Europe finds its way through the overall crisis.  Similarly, the ECB should not be in a position to take a loss, either — they should not be required to take a hair-cut below the price they pay for Euro area sovereign debt.

Note that I have not yet used the phrase “Euro bond” anywhere.  Note, too, that a central bank is only meant to be a lender of last resort to banks.  The lender of last resort to governments is the IMF.

If Euro area policymakers really want to engage in a fiscal union (a.k.a. transfers) beyond the absolutely essential creation of a unified bank deposit guarantee scheme, it is perfectly possible to do so in a minimal fashion that does not lessen the sovereignty of any member nation:  Have a newly created European Fiscal Authority (with voluntary membership) provide the minimum universally agreed-on level of unemployment benefits across the entire area, funded with a flat VAT.  Any member country would retain the ability to provide benefits above and beyond the minimum.  This will have several benefits:

  • Since its membership would be voluntary and it would provide only the minimum universally agreed level, it cannot, by definition, constitute a practical infraction on sovereignty;
  • It will help provide pan-European automatic stabilisers in fiscal policy;
  • It will provide crucial intra-European stabilisation;
  • It will increase the supply of long-dated AAA-rated securities at a time when demand for them is incredibly high; and
  • It will decrease the ability of Euro member countries to argue that they should be able to violate the terms of the Maastricht Treaty at times of economic hardship as at least some of the heavy lifting in counter-cyclical policy will be done for them.

———————-

Update 30 Nov 2011, 13:05 (25 minutes after first publishing the post):

It would appear that the world’s major central banks have announced a coordinated improvement in the provision of liquidity to banks.  This is a good thing. Press releases:

A simple proposal to improve fiscal policy

Published on 10 October 2011 in Economics and Politics. Tags: , , , . 0 Comments

Payroll taxes (a.k.a. Employer’s National Insurance Contribution in the UK) should vary inversely with how long the employee had been unemployed at the time of taking the job.

Or, perhaps, there should be a straight discount on payroll taxes for an employee that was unemployed when hired, but the duration for which the discount applies should be proportional to the length of time they had been unemployed.

Either way, this should be a permanent part of the tax system – thereby providing another automatic stabiliser to fiscal policy, both in boom times and recessions.

This idea is not unique to me.

This idea is conditional on Central Bank policy not reducing the fiscal multiplier to zero.

The US debt-ceiling deal

Published on 1 August 2011 in Economics, Politics and USA. 0 Comments

There’s plenty of detail around the traps. As Tyler Cowen says, Ezra Klein has a habit of producing excellent summaries and analysis on this stuff. Here (pdf) is the CBO’s analysis.

I’m disappointed, but not surprised, at the split between cuts to “discretionary” and “mandatory” spending. I choose to hope that at their big, joint summit on the deficit it’ll mostly be entitlement reform, as Americans like to call it, and tax reform.

I’m also disappointed, but again not surprised, that the cuts are not distributed in such a way as to make them stimulative (or at least not contractionary) in the immediate term. On the other hand, as in Britain, there’s a reasonable political economy argument to be made that fiscal retrenchment, conditional on deciding that it needs to happen, must be front-loaded to minimise the PDV of political pain.

I do in principle like the grim-trigger approach to the bipartisan negotiations on phase two of the whole thing, US politics being what they are. I’m dissapointed that increased taxes aren’t in the trigger, but appreciate why they’re not. I’m not at all sure that the gutting of defense spending in the trigger is as asymmetrically bad for the GOP as the Democrats would have liked.

I very much hope that votes in the joint summit to determine phase two cuts are kept sealed (for, say, at least a presidential term).

Ayn Rand, small government and the charitable sector

Published on 18 April 2011 in Development, Economics, Justice/Law, Politics, UK and USA. Tags: , , , , , , , , . 0 Comments

The Economist’s blog, Democracy in America, has a post from a few days ago — “Tax Day”, for Americans, is the 15th of April — looking at Ayn Rand’s rather odd view of government.  Ms. Rand, apparently, did not oppose the existence of a (limited) government spending public money, but did oppose the raising of that money through coercive taxation.

Here’s the almost-anonymous W.W., writing at The Economist:

This left her in the odd and almost certainly untenable position of advocating a minimal state financed voluntarily. In her essay “Government Financing in a Free Society“, Rand wrote:

“In a fully free society, taxation—or, to be exact, payment for governmental services—would be voluntary. Since the proper services of a government—the police, the armed forces, the law courts—are demonstrably needed by individual citizens and affect their interests directly, the citizens would (and should) be willing to pay for such services, as they pay for insurance.”

This is faintly ridiculous. From one side, the libertarian anarchist will agree that people are willing to pay for these services, but that a government monopoly in their provision will lead only to inefficiency and abuse. From the other side, the liberal statist will defend the government provision of the public goods Rand mentions, but will quite rightly argue that Rand seems not to grasp perhaps the main reason government coercion is needed, especially if one believes, as Rand does, that individuals ought to act in their rational self-interest.

The idea of private goods vs. public goods, I think, is something that Rand would have recognised, if not in the formally defined sense we use today, but I do not think that Rand really knew much about externalities and the ability of carefully-targeted government taxation to improve the allocative efficiency of otherwise free markets.  I think it’s fair to say that she would probably have outright denied the possibility of anything like multiple equilibria and the subsequent possibility of poverty traps.  Furthermore, while she clearly knew about and despised free riders (the moochers  in “Atlas Shrugged“), the idea of their being a problem in her view of voluntarily-financed government apparently never occurred to her.

However, this does give me an excuse to plump for two small ideas of mine:

First, I consider the charitable (i.e. not-for-profit) sector as falling under the same umbrella as the government when I consider how the economy of a country is conceptually divided.  In their expenditure of money, they are essentially the same:  the provision of “public good” services to the country at large, typically under a rubric of helping the most disadvantaged people in society.  It is largely only in they way they raise revenue that they differ.  Rand would simply have preferred that a (far, far) greater fraction of public services be provided through charities.  I suspect, to a fair degree, that the Big Society [official site] push by the Tories in the UK is about a shift in this direction and that, as a corollary, that Mr. Cameron would agree with my characterisation.

Philanthropy UK gives the following figures for the size of the charitable sectors in the UK, USA, Germany and The Netherlands in 2006:

Country Giving (£bn) GDP (£bn) Giving/GDP
UK 14.9 1230 1.1%
USA 145.0 6500 2.2%
Germany 11.3 1533 0.7%
The Netherlands 2.9 340 0.9%

Source: CAF Charity Trends, Giving USA, Then & Spengler (2005 data), Geven in Nederland (2005 data)

Combining this with the total tax revenue as a share of GDP for that same year (2006), we get:

Country Tax Revenue/GDP Giving/GDP Total/GDP
UK 36.5% 1.1% 37.6%
USA 29.9% 2.2% 31.1%
Germany 35.4% 0.7% 36.1%
The Netherlands 39.4% 0.9% 40.3%

Source: OECD for the tax data, Philanthropy UK for the giving data

Which achieves nothing other than to go some small way towards showing that there’s not quite as much variation in “public” spending across countries as we might think.  I’d be interested to see a breakdown of what services are offered by charities across countries (and what share of expenditure they represent).

Second, I occasionally toy with the idea of people being able to allocate some (not all!) of their tax to specific government spending areas.  Think of it being an optional extra page of questions on your tax return.  Sure, money being the fungible thing that it is, the government would be able to shift the remaining funds around and keep spending in the proportions that they wanted to, but it would introduce a great deal more democratic transparency into the process.  I wonder what Ms. Rand (or other modern day libertarians) would make of the idea …

Anyway … let me finish by quoting Will Wilkinson again, in his quoting of Lincoln:

As Abraham Lincoln said so well,

“The legitimate object of government, is to do for a community of people, whatever they need to have done, but can not do, at all, or can not, so well do, for themselves—in their separate, and individual capacities.”

Citizens reasonably resent a government that milks them to feed programmes that fail Lincoln’s test. The inevitable problem in a democracy is that we disagree about which programmes those are. Some economists are fond of saying that “economics is not a morality play”, but like it or not, our attitudes toward taxation are inevitably laden with moral assumptions. It doesn’t help to ignore or casually dismiss them. It seems to me the quality and utility of our public discourse might improve were we to do a better job of making these assumptions explicit.

That last point — of making the moral assumptions of fiscal proposals explicit — would be great, but it is probably (and sadly) a pipe dream.

The origins of ideology

Published on 8 April 2011 in Culture, Economics, Politics and USA. Tags: , , , , , . 0 Comments

With the US Federal Government looking like it might go into a shutdown over budget negotiations (as I type, Intrade puts the chance at 40%), you can expect to see more articles around like this one from the Economist’s Democracy in America.  Here’s the gist of what they’re saying:

As Steve Benen points out, it definitely isn’t (or isn’t just) a function of Democratic legislators’ lack of determination. It’s partly a function of the fact that, as recentNBC/Wall Street Journal, Pew, and Gallup polls show, Democratic voters want their leaders to compromise, while Republican voters don’t. Jonathan Chait argues that what we have here is a structural issue that forces Democratic politicians to be wimpy:

Most people have the default assumption that the two parties are essentially mirror images of each other. But there are a lot of asymmetries between the Democratic and Republican parties that result in non-parallel behavior. The Republicans have a fairly unified economic base consisting of business and high-income individuals, whereas Democrats balance between business, labor, and environmental groups. The Republican Party reflects the ideology of movement conservatism, while the Democratic Party is a balance between progressives and moderates.

The upshot is that the Democratic Party is far more dependent upon the votes of moderates, who think of themselves in non-ideological terms and want their leaders to compromise and act pragmatically. The reason you see greater levels of partisan discipline and simple will to power in the GOP is that it has a coherent voting base willing to supportaggressive, partisan behavior and Democrats don’t. This isn’t to say Democrats are always wimps, but wimpiness is much more of a default setting for Democrats.

The article then goes on to discuss the psychological origins of ideological allegiance.  The upshot is that certain people have certain preferences and the political parties are representations of those groups of people.  There’s an implied assumption that all of this is exogenous to the system at large; that there’s nothing you can do about it, you just need to take it as given in your deliberations.

For anybody interested in this stuff, I strongly encourage you read Steve Waldman’s opposing view:  ”Endogenize Ideology“. Here is his basic point, from quotes arranged in a different order to that in which he provides them:

Many [people] treat ideology or “political constraints” as given, and perform the exercise that economists perform reflexively, starting with their first grad school exam: constrained optimization. Constrained optimization is a mechanical procedure. The outcome is fully determined by the objective function and the constraints.

However …

That’s the wrong approach, I think. Rather than treating ideology as fixed and given, we should treat it as dynamic, as a consequence rather than a constraint of policy choices.

Ultimately, he argues, in a world of hard-nosed ideologues versus constraint-respecting policy wonks …

Rather than two optimizers, one of which has strictly less information than the other, in the real world we’ve seen two satisficers, one of which has adopted the strategy of optimizing subject to fixed constraints and the other of which has neglected pursuit of optimal present policy in favor of action intended to reshape the constraint set. A priori, we would not be able state with certainty which of the satisficers would outperform the other. If the constraint set were, in fact, strongly resistant to change Team Obama’s strategy would dominate. But if the constraint set is malleable (and constraints frequently bind), then Team Bush outperforms.

Just to really kick it home, he pulls out this quote from Karl Rove:

[Probably Karl Rove, talking to Ron Suskind] said that guys like me were ”in what we call the reality-based community,” which he defined as people who ”believe that solutions emerge from your judicious study of discernible reality.” I nodded and murmured something about enlightenment principles and empiricism. He cut me off. ”That’s not the way the world really works anymore,” he continued. ”We’re an empire now, and when we act, we create our own reality. And while you’re studying that reality — judiciously, as you will — we’ll act again, creating other new realities, which you can study too, and that’s how things will sort out. We’re history’s actors . . . and you, all of you, will be left to just study what we do.”

France is set to ban the burqa and niqab

Published on 15 September 2010 in Europe, Justice/Law, Politics and Welfare. Tags: , , , , , . 0 Comments

The French Senate has passed the bill after the General Assembly (lower house) did in July.  From that HuffPo piece in July:

Officials have taken pains to craft language that does not single out Muslims. While the proposed legislation is colloquially referred to as the “anti-burqa law,” it is officially called “the bill to forbid concealing one’s face in public.”

It refers neither to Islam nor to veils. Officials insist the law against face-covering is not discriminatory because it would apply to everyone, not just Muslims. Yet they cite a host of exceptions, including motorcycle helmets, or masks for health reasons, fencing, skiing or carnivals.

I’d really like to read a literal translation of the bill.  I’m curious whether it effectively also bans this sort of thing or this sort of thing.  Do French citizens have a right to privacy?  Wouldn’t this bill violate such a right?

Basel III will help fix the Euro

Published on 13 September 2010 in Economics, Europe and Politics. Tags: , , , , , , . 3 Comments

The Basel III compromise is out.  Via Free Exchange, you can read the text here.  Or you can just look at the BIS’s handy-dandy little chart:

Let me quote Ryan at Free Exchange:

The minimum common equity requirement has been increased from 2% to 4.5%. Common equilty is what is called “core” Tier 1 capital. Regulators have agreed on an additional 2.5% “conservation buffer”. Most large banks will likely maintain such a buffer, as falling below it will lead to additional regulatory scrutiny. The likely impact, then, is a pretty substantial increase in the common equity reserves banks need to hold.

What he said. Anyway …

The asterisk on the countercyclical buffer has this note against it: “Common equity or other fully loss absorbing capital”.  Here’s some more detail, from the press release itself:

A countercyclical buffer within a range of 0% – 2.5% of common equity or other fully loss absorbing capital will be implemented according to national circumstances. The purpose of the countercyclical buffer is to achieve the broader macroprudential goal of protecting the banking sector from periods of excess aggregate credit growth. For any given country, this buffer will only be in effect when there is excess credit growth that is resulting in a system wide build up of risk. The countercyclical buffer, when in effect, would be introduced as an extension of the conservation buffer range.

In other words, the countercyclical buffer is expressly designed to allow for different rates of credit expansion across different countries.  This is excellent news for the Euro area, because (as I mentioned previously) it explicitly allows — heck, even encourages! — individual member countries to re-assert some control over monetary policy.  Remember that the level of credit in an economy is not just affected by demand for the stuff (which is itself influenced largely through interest rates), but also through the supply of the stuff, which falls under the umbrella of macro-prudential regulation (since, it is assumed, banks will generally supply all the credit they can subject to the restrictions of capital adequacy regulations).  The former may remain the remit of the ECB, but the latter can be economy-specific.

This is arguably desirable because, since the Euro-area economies are not perfectly synchronised, we have for many years seen monetary policy be overly tight for low-inflation countries like Germany and overly lax for high-inflation countries like Spain.

To some extent, one might view Germany’s reluctance to accept tighter capital requirements as evidence that they have been tacitly using this logic all along:  that is, they were already compensating for the (to them) overly-high interest rate with relatively lenient policies on the supply side.  To a German’s mind, it may therefore appear that with these higher minimum ratios, a neutral position for the German economy will require lower interest rates on average than previously prevailed.

The risk, from the Germans’ point of view, is that in a Eurozone world with higher capital ratios but lower interest rates, countries like Spain may be tempted to avoid making use of the countercyclical buffer and so may still end up with faster-than-ideal credit expansion.  How to convince the central banks and/or regulatory authorities in Mediterranean countries to be financially conservative, even when their governments aren’t, is clearly the next challenge.

Don’t put a nappy on me just because you’re mollycoddling idiot #8,749

Published on 1 September 2010 in Australia, Justice/Law, Politics, UK, USA and Welfare. Tags: , , , , , , , . 2 Comments

I hereby present the latest iteration of my telling the world how it ought to be run, damn it.  The topic today is:

With (very low) probability, p, event X might occur at location Y, causing offence, harm or even death to a person of type Z.

There are many examples of this sort of scenario.  Here are a few:

  • X:  Fall off a swing
  • Y: A public park
  • Z: A small child
  • X: Trip and fall
  • Y: Footpaths (sidewalks) with cracks in the concrete
  • Z: Old, clumsy or spatially unaware people
  • X: Bringing your dog
  • Y: The outside seating area of a cafe
  • Z: People that are allergic to, or just have an aversion to, dogs

Here is another, eloquently opposed by M.S. at one of The Economist‘s blogs:

  • X: Drown
  • Y: Lakes in Massachusetts state parks
  • Z: A weak swimmer

I’m sure that you, my eager and most imaginative audience, can describe any number of other examples.

What should we do when confronted with these scenarios?  Most people think that the world positions itself along a line separating, at one end, complete government regulation and at the other, zero government regulation and, instead, the use of tort law and civil suits to restrict the “bad” behaviour.  This is poor logic, however, because it is overly simplistic; it presupposes that we need to do anything at all!

I favour a midway point between regulation and tort law, but more importantly, to my mind, we usually don’t need to do anything when confronted with these possibilities. Life inherently has risks and, while we should act to avoid exacerbating those risks, we should not necessarily seek to remove them altogether.  There are three reasons for this:  First, because removing all risk is simply impossible and it is usually the case that reducing risk in one area causes it to rise in another; second, because exposure to some risk is crucial in the development of well-adjusted people and a properly-functioning society; and third, because to restrict people’s choices in order to lower the risk they face is to deprive them of their basic liberty to choose whether to accept that risk for themselves.

Let me summarise my view in this not-even-remotely-to-scale little plot. Think of the horizontal axis as a measure of how easy it is to demonstrate harm to a point of warranting action by “the authorities.”

There are 10 dots of each colour.  Broadly speaking, Australia and the UK have chosen the government regulation approach.  In Australia, every major political party seems to agree that the “solution” is always more (they would say better) regulation.  In the UK, the Lib Dems and Tories make occasional mutterings suggesting that they might agree with me, but for the most part they’re in lock step with Labour (UK), which likes the status quo.

America is a bit more varied.  By and large, they have adopted the approach of letting tort law and the fear of civil suits induce the effect of (remarkably strict) regulation, but when America does use explicit government regulation, it tends to be something of a light touch.  Democrats seem to want to move closer to the British/Australian model, while Republicans seem to either like their status quo or wish to move to the Libertarian ideal.

Small government / Libertarian idealists typically want no government regulation and, to the extent that things need to be dealt with at all, they want everything to happen through the courts.  Although they want small government, what government they do want, they want to be strong (e.g. in the enforcement of the law).

Speaking about America, M.S. in the above-linked-to Economist entry writes:

I would gladly join any movement that promised to do away with this sort of nonsense. For example, Philip K. Howard’s organisation “Common Good” (TED talk here) works on precisely this agenda. Common Good’s very bugaboo is useless, wasteful legal interference in schools, health care, recreation, and so on. But what you quickly note with many of these issues is that they’re driven by legal liability concerns. You have a snowblader in Colorado suing a resort because she crashed into someone. You have states declining to put up road-hazard signs because the signs prove they knew the hazard was there, which could render them liable for damages. You have the war on children’s playgrounds. The Massachusetts swimming ban, too, is driven by liability concerns. The park officials in Massachusetts aren’t really trying to minimise the risk that you might drown. They’re trying to minimise the risk that you might sue. The problem here, as Mr Howard says, isn’t simply over-regulation as such. It’s a culture of litigiousness and a refusal to accept personal responsibility. When some of the public behave like children, we all get a nanny state.

Which is exactly what I’m saying about America in my summary, but I think (at least, from my reading) that M.S. is assuming that the opposite of a litigious society is personal responsibility.  That’s not true, I’m afraid.  The level of personal responsibility is orthogonal to whether your society chooses litigiousness or state regulation.

Nevertheless, I suspect that M.S. (and Matt Yglesis) and I are on the same side in this debate.  Let people decide for themselves; they’re adults, or should be.  Don’t put a nappy (diaper) on me just because you’re mollycoddling idiot number 8,749 over there.

Improving the Euro

Published on 31 August 2010 in Economics, Europe, Finance, Politics and Welfare. Tags: , , , , , , , , , , , . 5 Comments

On BBC Radio 4, Jonathan Charles — the BBC’s European correspondent in the 1990s — has done a special on the Euro and the trouble it’s experiencing.  It’s well worth a listen if you have 40 minutes to spare.

It reminded me that I’d meant to write a post on two things I think ought to be done in improving the long-term outlook for the single currency.  None of this is particularly innovative, but I needed to put it down somewhere, so here it is.

First, a European Fiscal Institution (EFI)

At the start of February, when Greece and her public debt was dominating the news, I wrote:

Ultimately, what the EU needs is individual states to be long-term fiscally stable and to have pan-Europe automatic stabilisers so that areas with low unemployment essentially subsidise those with high unemployment. Ideally it would avoid straight inter-government transfers and instead take the form of either encouraging businesses to locate themselves in the areas with high unemployment, or encouraging individuals to move to areas of low unemployment. The latter is difficult in Europe with it’s multitude of languages, but not impossible.

Let me hang some meat on those not-even-bones.  I like the idea of a partially shared, European Fiscal Institution (EFI) that can conduct counter-cyclical spending, subject to strict limits on its mandate.  I am deliberately avoiding calling it an “authority” because that implies a certain freedom of action, which I oppose.  Instead, I think that an EFI should:

  • be limited to implementing commonly-agreed automatic stabilisers (in particular, a universally-agreed-upon minimum level of unemployment benefits);
  • be able to issue its own “Euro bonds”;
  • have a mandate to retain the very highest regard for the safety of its borrowing; and
  • be funded (and its bonds be guaranteed) by member countries in a manner part way between proportionate to population and proportionate to GDP.

I do not think that membership of such an institution should be required of any European country.  If a non-Euro country wants to be in it, fine.  If a Euro country wants to not be in it, fine.

The unemployment benefits provided would be the absolute minimum that everyone could agree on.  I want to emphasise that this should be extremely conservative.  If it ends up being just €100/week for the first month of unemployment, so be it; so long as it is something.  Member countries would provide additional support above the minimum as they see fit.

This will have several benefits:

  • It will help provide pan-European automatic stabilisation in fiscal policy.
  • It will provide crucial intra-European stabilisation.
  • It will increase the supply of long-dated AAA-rated securities at a time when demand for them is incredibly high.
  • It will decrease the ability of Euro member countries to argue that they should be able to violate the terms of the Maastricht Treaty at times of economic hardship as at least some of the heavy lifting in counter-cyclical policy will be done for them.

Second, country-specific lending standards

A crucial problem with a single currency is that it imposes a one-size-fits-all monetary policy on all member states, even when those states’ economies are not perfectly synchronised.  Synchronisation was, and is, one of the requirements for accession to the Euro, but perfect synchronisation is impossible.  In particular, inflation rates have varied significantly across the Euro-area, meaning that the common-to-all interest rates set by the ECB have been, by necessity, too low for those economies with the highest rates of inflation (e.g. Spain) and too high for those with the lowest rates of inflation (e.g. Germany).

But the (causal) link from interest rates to inflation travels via the extension of credit to the private sector, and the level of credit is determined not just from the demand side (with agents responding to changes in interest rates), but also from the supply side (with banks deciding to whom and under what conditions they will grant credit).  Monetary authorities in individual member countries therefore retain the ability to influence the level of credit through regulatory influence on the supply of the same.

Altering reserve requirements for banks operating in one’s country would be the crudest version of this mechanism. A more modern equivalent would be changes to the minimum level for banks’ capital adequacy ratios.  Imagine if the Spanish banking regulators had imposed a requirement of 10% deposits on all mortgages from 2005.

I suspect that the new “macro-prudential” role of the Bank of England, in addition to its role of more conventional — and, with Q.E., unconventional — monetary policy will grant them the ability to engage this sort of control.  I think it will become more important over time, too, as the British economy continues its (to my mind inevitable) decline relative to the Euro-area, the UK moves closer to the textbook definition of a “small, open economy” and the BoE thus finds itself more constricted in their choice of interest rates.

Update 13 September 2010:

The new Basel III capital adequacy requirements are out and they appear to enable exactly this second idea.  Good!