Knowing and Making

At the end of an otherwise decent article in the Guardian , George Irvin trips over one of the oldest cliches in the left-wing rhetorical manual: Most important, we have not begun to question seriously whether placating the financial markets by means of such cuts is unavoidable. Perhaps it's time to start thinking the unthinkable: namely, that financial markets should be our servants, not our masters. This is a stupid distinction to draw, because markets are neither servant nor master of anybody. They are a place where people (or countries) can choose to go, and where we can each decide on our own participation within the structures available. Greece (more precisely, the people who run its exchequer) can choose whether to borrow money on the international markets. If it wants to, it enters into a two-sided arrangement with consenting investors on terms that both are happy with. If it then wants to default, it does have that option. Exercising that option will bring consequence...

Martin Wolf has described  the eurozone rescue package for Greece, correctly, as "a fudge". However, he thinks this is a bad  thing. Here's why it might not be. One of the key goals in designing a rescue package is to avoid creating moral hazard  - the risk that other countries look at the bailout, assume that they will be rescued too and therefore continue to borrow. If the rules for the bailout are clearly stated, that creates an anchor  which encourages people to trade up to it. The most obvious example is the Maastricht treaty rule which stated that countries in the EU must keep their fiscal deficit below 3% of GDP. Guess what size of deficit most countries ended up with? Around 2.9% was a pretty common figure. So if the rules for the rescue were made explicit, it would give governments very clear guidance on exactly what risks they could take. Inevitably, some would be tempted to push it to the limit - and fall over that limit, in the knowledge that the ...

Paul Krugman (via Niklas Blanchard ) is among many people asserting that: ...when the music stopped, Greece found itself with costs and prices way out of line with Europe’s big economies. (Niklas says this violates the law of one price - but the law of one price applies only when there is one good. In fact, hardly any goods are the same between Germany and Greece - labour is not as productive in Greece, the local tastes are for different products, and many services are non-tradable and not subject to the law of one price. An important example of this is that retailing is a service. Both the cost of retailing and the demand for it (which in Greece is strongly derived from tourism) affect the price of goods sold in shops. So the existence of the euro doesn't by itself imply that wages and prices should equalise quickly.) But that is an aside. In fact, I am unconvinced that Krugman's statement is true at all. According to  this report , Greek unit labour costs last year...

This quite clever proposal from Cavallo and Cottani sounds plausible at first but my immediate reaction is: how can it work? The idea is to eliminate payroll taxes in Greece and instead raise VAT to 25%. This is meant to increase competitiveness while reducing distortions in the economy. It feels like a magic solution - which naturally makes me suspicious. If the economy really needs a devaluation, then how can they miraculously solve the problems without one? But then I realise that magic really can happen . A devaluation is only a nominal change - it simply breaks people's money illusion and affects relative prices. In fact, a devaluation requires no real actions at all, although it does change the pattern of of future real demand. All the benefits of a devaluation can, in principle, be achieved through the coordinated individual choices of all the agents in the economy. Of course such coordinated choices are highly implausible, which is why devaluation is a good short...

Have a look at the following very odd statement from Laurence Kotlikoff in the Economists' Forum . He is suggesting that Greece does not need to devalue, because its prices and wages will quickly adjust regardless: In the US...the past two years has seen essentially zero inflation leaving prices today substantially lower than where they’d be today had there been no recession. This is hardly evidence of sticky prices. I find it difficult to interpret "zero inflation", and prices exactly where they were two years ago, as anything other than evidence for sticky prices. He then goes on to address the important question of sticky wages in exactly the same way: Nor is there strong evidence that wages don’t adjust to market pressures. In the US, median real wages have hardly moved for decades Huh? I haven't seen the new Alice in Wonderland film, but I have the feeling this must be what it's like. Syllogisms whose premises and conclusions point precisely in opposit...

In defence of Greece, I pointed out to a colleague the other day that the cost of a Greek CDS is only 4% for a five year period - meaning that you only need a 0.8% interest premium to make a Greek bond worthwhile, or that the market only gives Greece a 1/125 chance of defaulting each year. He responded with the valid observation that this is all very well, but who's offering this insurance policy and will they be around to pay it if Greece does default? After all, AIG wasn't. In fact, the 4% is not  the spread between the chances of Greece defaulting and a risk-free bond, as it's commonly presented. It is actually the spread between the chances of a Greek default and an  insurance company  default. It's a lot easier for an insurance company to go bust than it was two years ago. Not only have risk conditions deteriorated, but after AIG, Citi and the rest, it would be immensely tough politically to bail out another big insurance company or bank which had issued CDS...

There's a meme around which says that the euro is destined to break up because countries like Greece are fundamentally less productive than countries like Germany. A strategist at Societe Generale has put his name  to this idea, as has the director of the Open Europe (anti-EU) think tank. This argument supposes that the only way to become competitive is to devalue one's currency. But surely this applies within countries too? The southern half of Italy is much less productive than the north, while the reverse is true in Britain. But there are no calls for a London currency and when the lira existed, it was never under the threat of an Italian breakup. Different states in the US are just the same - with widely varying fiscal problems as well as the same diversity of competitiveness. At the individual company scale, Yahoo is less competitive than Google, but does Yahoo need its own currency to devalue? And 22-year-old new college graduate Travis is less productive than his e...

Great interview of Jürgen Stark (chief economist of the ECB) by Spiegel Online. He's a very funny guy for a central banker (maybe I'm revealing too much about my sense of humour). SPIEGEL : You are maneuvering yourself around an answer to the main question: What happens if Greece doesn't make it? Stark : I do not think that is the most important question, but I will answer it with a clear statement: The country must and will make it. More importantly, he is very clear that Federal Reserve-style monetary expansion is not on the cards for the ECB, and that he thinks eurozone governments should be cutting deficits faster. Also: Stark : ...I would like to point to one aspect in this context: Great Britain has a budget deficit of the same magnitude as Greece's. The US budget deficit is also more than 10 percent of GDP. All advanced economies are currently having problems. In fact, it is astonishing to see where most of the criticism of the euro is coming from at the momen...