Are ECB’s Greek bond purchases really irrelevant for the private sector?

Motivated by the current discussions about the Greek debt problems, Paul De Grauwe and Yuemei Ji have a VoxEu column addressing “Why the ECB should not insist on repayment of its Greek bonds”. In a debate that currently is, and has been for a long while, marred by political idiosyncrasies and ethnic stereotypes of the worst kind, it is a sound and healthy contribution based on basic public accounting. In all fairness, however, the authors cannot help contributing to the nationalistic platitude by making snide remarks about “hard-working German tax payers”. Also, in an earlier VoxEu column on the same subject they almost question the intellectual sanity of German economics professors and central bankers.

Their message is simple. The ECB or the citizens in the Eurozone should not worry about Greece not paying back €3.5 billion worth of Greek government bonds which are due on July 20, 2015. Those bonds were acquired by the ECB under the now defunct Securities Markets Programme (where the rule is that these are held to maturity).

They present their idea by a simple one-country example which suffices here. The main thrust of their argument is that when a central bank has purchased a government bond, then at the consolidated public sector level, the government is paying interest to the central bank, which on the other hand rebates those interest payments to the government. I.e., the consolidated public sector has substituted some interest-bearing liabilities (bonds) with non-interest-bearing liabilities (money). From a consolidated public budget perspective one could without problems write off the bonds from the central bank’s balance sheet. It would merely stop the “circular flow” of interest payments back and forth between the public entities. The private sector would be completely unaffected by this. Hence, any fears in the public that, say, extending the maturities on these Greek bonds would necessarily cause more taxation are unwarranted.

This is in itself correct as I see it. But it seriously misses some dynamics. The seigniorage revenues that the consolidated public sector extract in their example (which is not what happened under the SMP which involved sterilized purchases, but let that rest), do not come out of nothing. As the authors make clear: They are saved interest payments on public debt. Well, let us extend the focus beyond the public sector: Look at the private sector. Prior to the purchase of the bonds by the central bank, these bonds were owned by the private sector. They have therefore since the purchase missed out on interest payments. Some call seigniorage an “inflation tax” for a reason. The taxation that is allegedly feared (e.g., by the “hard-working German tax payers”), has already happened—it is not just “an inflation risk” as the authors purport. Those lost interest rate payments are gone for good no matter how long or short time the central bank decides to keep the bonds (and at what value).

So yes, extending the maturity on the Greek bonds will all things equal not necessitate new taxation in the Euro area. The taxation has already occurred. This simple fact could be the reason why some economists (of whatever nationality) raise a flag regarding these types of policies. Adding to the nationalistic mudslinging, I paraphrase the authors (January 15, Conclusion) by saying that I would have expected that London-based economics professors would understand this (whether being a former member of the Belgian parliament is an asset or a liability, I honestly do not know).

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Is Greg getting bailed out by his rich uncle?

I have an old friend, and he probably won’t mind I am telling you this, but for sake of anonymity, I will just call him Greg. He has had some economic difficulties recently, but his family has stepped in at different points. This, I thought, was great for Greg, but the whole sequence of events has led to a lot of animosity within Greg’s family. Even though I am biased, since Greg is my friend, I still can’t help thinking that he somewhat has to blame himself. But I’ll let you be the judge.

The background is that Greg and his family found their dream house some years ago, and Greg took out a mortgage. Everything went fine for a while. Greg had a well-paid job, and every quarter he could honor the agreed mortgage payments as well as providing for his family. Then bad luck struck: Greg lost his job, and his unemployment benefits could only just about cover the costs of taking care of the family. It became impossible for him to make the mortgage payments. You might say he was in a “debt crisis”.

He was obviously in distress, but Greg has an uncle who is incredible well-to-do, and he stepped in and covered the mortgage payments for the entire year Greg was unemployed. Greg got a new job, and things lightened up for a while. But the family relations had suffered. Greg’s uncle began to talk less favorable about Greg. Apparently, he was annoyed that Greg never thanked him for the economic help he received during the unemployment spell. I couldn’t believe what I heard, and thought that the uncle was probably being unfair. But one evening I was out with Greg and two of his new friends (let’s just call them Paul and Joe), and we came to talk about the recent events. Paul and Joe made it quite clear that they didn’t think Greg owed his uncle any thanks. Their argument was that the uncle hadn’t helped Greg by paying his mortgages, but merely had helped the mortgage company. And since it was a big corporation that didn’t really needed the money anyway, there was no need to thank.

I decided not to play the “I am an economist” card. Not only because it never brings me anywhere, but we were having a nice evening, so I didn’t want to ruin it. I just thought for myself that the net effect of the uncle’s action had been to essentially provide housing utility for Greg and his family in a year. Yes, the money went to the mortgage company, but in effect Greg (and his family) could stay in the house uninterrupted. I actually thought that the uncle helped Greg. But I could feel this was not considered politically correct.

The rest of Greg’s family did not get involved too heavily until last year, when Greg unfortunately lost his job again. Greg’s uncle immediately offered to step in and cover Greg’s mortgages, but this time he would only do so if Greg agreed to pay him back when he got a job again. Greg refused and got mad at him, and the whole situation has now split the family into two equally furious parts. One who thinks that Greg’s uncle is a no-good, money-loving capitalist kicking a man lying down, and one who thinks basically the same but that Greg should swallow his pride and succumb to the uncle’s threat for the sake of the well being of his family.

I am torn here. I somehow do not think the uncle is the bad guy. From an economists’ point of view, he tries to help Greg smooth consumption over time. But those arguments don’t fly with Paul and Joe, who think he should cut any connections to his uncle as they believe he has been exploiting Greg all along.

What do you think?

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Taylor legislation? Rules versus discretion misunderstood

John B. Taylor is one of the profession’s most recognized macroeconomists, and for good reason. He has made numerous contributions to theories on wage and price formation and monetary policy. Many concepts are so central that they carry his name. “Taylor contracts” (staggered nominal wage or price contracts that are a central ingredient in many macroeconomics models), “Taylor curves” (curves that simply illustrate the feasible monetary policy trade offs), and, of course, the “Taylor Rule”, which is a specification of a nominal interest rate rule for a central bank.

Originally mentioned in a 1993 paper, Taylor showed that the simple rule—that recommends that the nominal interest rate adjust to inflation and output deviations from trend—tracked actual policy setting by the Fed for the previous six years quite well. This had an enormous influence on subsequent monetary policy theory where a Taylor rule is often used as a simple way of illustrating monetary policy conduct. Also, tons of empirical papers have examined the empirical relevance of Taylor rules in the US and everywhere else.

Now the rule has entered into a new dimension: the legislative sphere. Republicans want to pass a bill where the Fed is required to specify the rule it follows. John Taylor (an open advisor for republicans) has, not surprisingly, supported the idea. Such “Taylor legislation” is, however, slightly milder than one would believe, as it should instruct the Fed to follow a rule of its own liking; not necessarily the Taylor rule per se.

Following this, Krugman and Taylor have had their usual blog shoot-out concerning the cons and pros of such legislation. Most disagreement is on whether the Taylor rule was followed or not before the Great Recession, or whether one is talking about the correct Taylor rule, or whether it was or was not (in part) responsible for the crisis. (Tony Yates points out some more academic and practically based views against legislation that are overlapping with mine in many respects.)

Such disagreement in itself shows the danger of committing to even a particular simple rule. Two leading economists can’t even make head or tails about whether the rule has actually been followed or not. And even though Taylor has emphasized that the Taylor Rule should be seem as a normative prescription (and not just a vehicle for describing policy behavior in practice), his original paper is full of qualifiers that states that one should only see such a rule as a benchmark, and that deviations from the rule would be a good thing under various circumstances. And that makes a LOT of sense, showing that for practical purposes a “rule” is a misnomer and never a good thing (unless it can be made contingent on all foreseeable and non-foreseeable events).

But wait a minute. Hasn’t a long literature following Kydland and Prescott (1977), pointed to the desirability of rules over discretion? Would it not be better to “tie the hands” of policymakers? The answer is yes, but one must also remember (and understand) that the “rules” Kydland and Prescott talked about, were those that solved time-inconsistency problems (credibility problems) of optimal policy. I.e., they are policy prescriptions that are optimal and do not succumb to temptations to deviate to reap short-sighted gains. I.e., they are a description of optimal commitment behavior. A Taylor rule does not belong to that family in most of the models in which it is used. So yes, it is a rule in a semantic sense, in the sense of describing a given simple behavioral pattern to follow, but it is not a rule in the Kydland and Prescott meaning. So forget about rules vs. discretion arguments.

If one wants to raise the bar for legislation in monetary policymaking, one should acknowledge that policymakers act discretionary, i.e., on a day-by- day basis trying to achieve its goals. (Janet L. Yellen’s comments on the FOMC press conference December 17, 2014, has discretion written all over it; see p. 12). Therefore one must provide them with clear goals. There is a vast literature on delegation of monetary policymaking that shows how intermediate goals can bring discretionary policymaking closer to the Kydland/Prescott-style commitment-style behavior. Price level targeting or nominal income growth targeting are some of the alternatives. These are alternatives that can work well, since reaching these goals imply that the policymaker takes the past into account. This is beneficial if one believes that credibility is important: When you respond to past events, you can influence future expectations better to your current advantage (because what you do today will affect future policy and thus expectations).

In view of the above, the Taylor rule raises a conundrum: In environments where expectations are unimportant and credibility problems are absent, rendering the rules vs. discretion distinction irrelevant, a Taylor-type rule can be optimal (cf. Svensson, 1997). On the other hand, if expectations are important, the Taylor rule is rarely optimal. It is not a behavioral pattern that solves credibility problems, just because it has the word “rule” attached.

Actually, one of its celebrated implications, the “Taylor principle” (another term that carries Taylor’s name), should not necessarily be observed in optimal and credible policymaking. The Taylor principle states that the coefficient on inflation in the Taylor rule should exceed one, such that inflationary pressures lead to a more than one-for-one increase in the nominal rate, thereby increasing the real interest rate. But if a central bank enjoys credibility and can manipulate expectations to its advantage, it can obtain stable inflation with rather small fluctuations in the nominal rate. Indeed one could then in practice observe a negative coefficient on inflation. I have shown elsewhere that one can estimate Taylor rules with such properties in model economies where the policymaker is performing as good as it gets. On the other hand ,Taylor rules satisfying the Taylor principle could be an indication of discretionary policymaking. To reiterate: “Commitment versus discretion” is not the same as “Taylor rule versus discretion”.

It is not a good idea to require that a central bank should publish a particular behavioral rule. If it should work, it would be way too complicated to specify, and if it should be simple (as the Taylor rule), policy is just being constrained in an arbitrary way. I don’t think there is a meaningful middle way. It would just lead to endless political debates on whether the “rule” has been violated or not, and if so why. And whether actual policy in the past, good times or bad times, can be characterized by a Taylor rule is rather irrelevant for this type of legislation. The US now, may not be as it was in 1987-92.

As in all branches of economics, good policy design is about shaping incentives appropriately. Requiring by law any decision making agent to directly act in a particular way is usually not a good idea.  If it was, then why not solve unemployment problems by requiring all firms to adhere to a hiring rule that secures full employment?


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Partisanship and dismal economics blogging

I haven’t been blogging much lately. Frankly, I got tired of it. Of course, very few read what I write, but I have no problems with that. I blog mostly to maintain some record of my thoughts. I mainly got tired of the whole so-called academic blogosphere. In particular the one originating from the US, which of course tends to be quite dominating.

My problem is the reductive nature of much academic US blogging. Many bloggers are high-profiled academic economists, who through their blogging are simplifying arguments so as to set up a “Them versus Us” feeling in the mind of the reader. Paul Krugman, of course, excels in this. Most discussions are condensed into a matter of being either in favor of “Them” (e.g., idiotic Chicago-neo-classical-rational-expectations people), or “Us” (e.g., sane and reasonable IS/LM-founded Keynesians). And then the ball rolls, and numerous just as prestigious economists praise “Them” or “Us”.

It makes for great debating platforms, and the most successful ones attract huge audiences, where anyone can join in. Very democratic. The problem, as I see it, is that many get a completely distorted picture of economic sciences. They see it as a shouting contest where it is about convincing one’s opponent about his or her shortcomings. There is no middle ground. There is not even a ground slightly closer to one side than the other.  It is either or. This could be a reflection of the two-party political system in US. You are either a democrat or a republican (if you are not, chances are good that you are considered a nutcase). Then you choose your side and engage in battle to win an argument.

Irrespective of the validity of this amateur theory, the result is extremely unhealthy for economic sciences: It is, and has always been, much more broad and encompassing than such “Them versus Us” battles would suggest. As with any science (how “dismal” it may be), economics is about getting smarter all the time. It is not about winning arguments. It is not about proving that your “school” is better than the neighbor’s. It is only children that would think so, and should be playing such games. But the amount of nonsense that adult economists amass for the sake of simplification and game play is often astounding.

Maybe things are better in Europe and elsewhere? Many blogs are more firmly founded in science and discuss important issues with the open minds of a true scientist. Could this reflect that many Europeans are not brought up with a two-party mind? But as in most other dimensions (expect few things as death penalties and gun laws), we cannot escape the influence from the US. Many students of economics therefore develop twisted ideas like if someone says this and that, then she belongs to school A, and must therefore not be taken seriously, as they root for school B. After all, they read it in famous economist X’s blog. (And they only read academic journals if forced to; after all, famous economists on blogs have declared them dead for years.) It is sad to witness.

I therefore think it is time to hail that middle ground where most sensible and open-minded scientists should operate. It is time to abandon the two-party m.o. in economics blogging and bring back science. Call me a dinosaur, but I believe that it is not necessarily those who shout the loudest that have the deepest thoughts to offer.
PS: Many economics blogs are downright entertaining. But that is a completely different issue.


Edit: I changed the title of this piece from “Bipartisanship. . .” to “Partisanship . . .” as I learned that “Bipartisanship” could mean the exact opposite of what I tried to say; sorry! I gotta watch House of Cards more closely.

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Chris Auld’s 18 signs

Chris Auld really nails some common silly/ignorant ways of bashing economic sciences in his recent blog post. I could not have done it any better, and the funny/sad thing is that the 18 signs he lists which differentiate “crankery from solid criticism” are all signs that I see in my home-country media. Day after day. So these appear to be universal.

Here is the post (and lots of the comments unintentionally prove several of his points)—enjoy:

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The case for negative nominal interest rates and how to attain them: Revisiting the Buiter-Eisler approach

Recently, I discovered that the debate on possibly removing the zero lower bound on nominal interest rates is quite hot in some blog circles in the US. For example, Miles Kimball is writing a lot about it these days, and I thought I would chime in with a piece I did on the issue a few years ago. It was written for a students’ blog at my department in Danish, and took the form of a run through of the arguments as Willem Buiter had presented them. Hence the title “Willem and the negative nominal interest rates”. Actually, Miles Kimball encouraged me to translate the Danish version, and I thank him for providing me with a rough Google-based translation, which I refined.

The piece is a bit heavy on footnotes, so I have chosen to post it as a pdf file. So, with little further ado, here is my piece on Buiter’s three proposals for eliminating the zero lower bound, with particular emphasis on the one drawing on Robert Eisler’s idea of two coexisting currencies: One physical and one virtual. An appropriate exchange rate policy then secures that a negative nominal interest rate rate becomes feasible on the virtual currency. If main transactions in the economy is carried out by virtual currency, expansionary policy can prevail.

Willem and the Negative Nominal Interest Rate (pdf, 200 kb)
© Henrik Jensen, March 2010

 Still seems to me like a great idea.

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No Negative Rates in Euroland (yet)

Today, the ECB decided not to continue their decrease in interest rates implemented on May 8. All rates remained unchanged, so no new territory was explored. In particular, deposit rates remain at zero, so no negative rates were implemented. Apparently the 0.25 basis point cut on main refinancing operations in May was considered sufficient.

It just seem a bit “to little to late” in the current situation, when the ECB simultaneously revised output projections downwards, and stressed that the risks are on the downside. Draghi emphasized at today’s press conference that no measure was set aside permanently, thereby signaling that a further cut cannot be ruled out. He also did offer, in my interpretation, some sort of “forward guidance” on interest rates by stating that the accommodative stance of monetary policy would be maintained as long as necessary.

That latter part is in all likelihood meant as expansive, but I would have imagined that such a non-standard measure should take place when the conventional measures are outplayed. A prolonged recessionary stance such as the one Euroland has been experiencing seems the adequate time to “go all in” with your conventional tools if there ever was one. In other words, I would think that they should have cut more and earlier.

Posted in Macroeconomics, Monetary policy | Tagged , , | 1 Comment

Reinhart and Rogoff’s coding mistake: Much Ado About Nothing

This week saw a wide circulation of recent working paper by Thomas Herndon, Michael Ash and Robert Pollin, “Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff“, Working Paper Series Number 322, Political Economy Research Institute, University of Massachusetts Amherst. The authors challenge the findings in Carmen Reinhart and Kenneth Rogoff’s “Growth in a Time of Debt“, American Economic Review, Papers and Proceedings 100, 573-578. During their efforts to replicate Reinhart and Rogoff’s findings on the relationship between public debt and growth for 20 developed countries post-WWII, Herndon et al. received the original codes from Reinhart and Rogoff. Upon scrutiny, they discovered a coding error in the spreadsheet: Five countries were excluded entirely (the first five in the alphabetically sorted list of countries).

The impact of the mistake is that growth is overstated in two, and understated in one, of the four public debt categories considered by Reinhart and Rogoff. To be precise, the following table shows the difference between Reinhart and Rogoff’s (RR) published growth rates, and the ones using the corrections by Herndon et al. (corrections reported on page 7 in their working paper):

Ratio of public debt to GDP

<30% 30-60% 60-90% >90%
Average GDP Growth, RR (2010)  4.1%  2.8%  2.8%  –0.1%
Average GDP Growth, RR (2010), corrected  4.0%  3.0%  2.8%   0.2%

You may rightfully wonder the fuss is all about. This table show, I my view, that the coding mistake does not change awfully much of RR’s findings. A mistake is unfortunate, of course, but they can happen, and it is great that Herndon et al. found it. RR agree to this in their online comment on Herndon et al. where they thank for the correction. Left here, there would have been no media storm, no explosions in the blogosphere, nothing. It would have been a valid correction of a result in a scientific journal. Not something anybody would notice outside narrow academic circles.

What happened then? a) The RR paper has been used by some politicians as ammunition to put forth austerity measures in high-debt countries. b) Herndon et al. present alternative average growth computations on newer data which bring the 0.2% in the lower right-hand corner of the table up to 2.2% (while adding slightly to the other growth rates). c) Most then conflate “alternative computations”, “new data” and “a mistake” into just “a mistake”. This is after all the most comprehensible concept of the three. And then, of course, there is a fantastic story to be told about famous economists whose incompetence with spreadsheets has led the world into fiscal policy disasters. And it has been told again and again.

Even two of the authors of Herndon et al. got caught up in all the excitement when Financial Times gave Robert Pollin and Michael Ash space to write on “Austerity after Reinhart and Rogoff“. They write:

“When we performed accurate recalculations using their dataset, we found that, when countries’ debt-to-GDP ratio exceeds 90 per cent, average growth is 2.2 per cent, not -0.1 per cent.”

Not so. You performed accurate calculations on another dataset using another method. As shown above the coding mistake is not an issue. But the readers love it, as they can again assert themselves that economists are fools who only manages to use Excel. (This format is of course chosen to make dissemination of the data as wide as possible on RR’s website for their “This Time is Different” book, but let us not spoil the fun.).

Maybe Pollin and Ash just echoed Leonato in “Much Ado About Nothing”:

“A victory is twice itself when the achiever brings home full numbers” – Leonato in Act I, Scene I of Shakespeare, W. (1599): “Much Ado About Nothing”

PS: Their new computations are interesting. Their new data they got from RR (and they thank them by referring to data not deemed reliable in 2010 as “selective exclusion”). Their alternative computations of averages are not more compelling than RR: They take average growth rates of countries in all the years when in a given debt category, and not by averaging countries’ average growth as RR do (there is no “correct” as opposed to “incorrect” here, but RR’s method avoids that some persistently debt-ridden countries get unduly high weight). RR also provide median growth rates, which may be the more relevant measure in such a small sample. It is 1.6% in RR (2010) for the >90% public debt/GDP category. Herndon et al. are silent on medians; cf. RRs response.

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