Knowing and Making

Rising German bond yields over the week since the Irish bailout have been interpreted ( here  and here ) as an increase in default risk to the German government. But surely there is another "risk" much more likely to explain this increase. And that is the simple risk of inflation. The Irish bailout must make inflation more likely - through one of two routes. One : ECB liquidity support, i.e. lending to Irish and other banks, might not be repaid - which will result in an effective increase in money supply unless the ECB then tightens monetary policy to reduce it, which would be politically quite difficult. The ECB lending is secured on bank assets, but we know that those assets might not be worth 100% of their nominal value. So in the case of a bank default, the ECB has printed a billion euros to buy an asset which repays less than a billion euros of principal. Two : monetary policy may be deliberately loosened, either to help reduce the pressure on sovereign borrower...

Robert Peston inadvertently highlights a common journalistic trap today - a trap laid for them by a frequent and annoying habit of economists. David Walker, author of last year's Walker Review on bank governance ,  has written in the FT that: "[A]ny attempt to require banded disclosure for UK banks in isolation would be commercially sensitive vis à vis their non-disclosing competitors elsewhere. It could also stimulate higher executive turnover, and (as a perverse unintended consequence) lead to higher remuneration as a defensive retention measure." [emphasis mine] What exactly do "could" and "would" mean in this context? They have a very specific meaning in economist rhetoric. Would means: is guaranteed to have the following effect on an unobservable variable . Note that Walker can confidently state that this is "commercially sensitive" because there's no way to measure, confirm or deny whether that is the case. Could means...

I thought I'd seen it all. But no. Commenter "zadok" on Robert Peston's blog has discovered the real  culprits behind Britain's economic malaise. From comment 5 on " Can the UK close massive deficit with China? ": The english ( anglo saxons ) are the most inventive people in the world but unfortunately,like everything,the normans highjacked their flair and trashed it. (Punctuation and spelling in the original) I have seen the Americans blamed; the Labour government; the Tory government; the Chinese; the rich; the middle class; the unemployed; the banks; the EU, the IMF, the World Bank, the capitalists, the socialists, the communists, and even the behavioural economists. But it never occurred to me that it could have been...the Normans .

I have no objection in principle to higher taxes on banks. But the IMF's surprising proposal (outlined by Robert Peston here ) may not quite be taxing the right thing. If the goal of the tax is to pay for the externality imposed on taxpayers by bank behaviour, that's fair enough. In line with the principles of Pigovian taxation , the tax should fall on the activities which impose those costs. That way, it's fair and also creates the right incentives, to shrink those activities if they do not benefit society enough to justify them. The first part of the IMF's tax seems to fit this principle. Peston doesn't explain what this "flat rate" would be levied on - I assume it isn't literally a flat rate, otherwise Goldman Sachs or Citigroup would pay the same amount as the Cheltenham Building Society or the Third State Bank of Des Moines. Presumably therefore it will be in line with the recent Obama proposal: a percentage levy either on total assets or on r...

Ofcom, the UK's communications regulator, has decided that mobile phone companies must cut the termination fees  they charge each other from 4.3p/minute to 0.5p/minute. This is the cost paid by, say, Vodafone to T-Mobile when I call a T-Mobile customer using my Vodafone handset. According to Robert Peston , these fees represent 16% of revenues for British mobile phone companies. Therefore, he says, they will try to make it up by increasing charges in other areas. There are a couple of problems with this view, however. The first is that for every Vodafone customer calling T-Mobile, there's likely to be a T-Mobile customer calling Vodafone in return. The numbers won't be exactly the same - perhaps T-Mobile customers are more stingy - but a large part of that 16% of revenues is cancelled out by costs that the telcos incur. These costs will disappear at the same time as the revenue. So instead of charging 15p/minute and paying 4p to another company, then receiving 4p l...

Robert Peston says that RBS is auctioning off Williams and Glyn's - a bank which, I confess, I have never heard of, but which has 2% of the UK's retail banking market. Which, if it doesn't put them in the top ten banks, definitely must be in the top twenty. Although it's not mentioned on this Wikipedia page . Aha - this article explains it - the brand does not really exist any more, but RBS is thinking of reviving it and attaching it to the 300 branches it has to sell off. My view is that competition is the best way to get the banking sector to lend more, reduce the economic rent taken by a few individuals in the sector, and improve the efficiency of the economy. So this is a good first step. Let's hope it is not bought by Santander, though that's looking like a strong possibility, or NAB which owns the Clydesdale and Yorkshire banks. A new independent bank, even a small one, would stimulate competition much better than transferring assets from a big c...

Robert Peston has been working hard reporting on results from RBS and Lloyds the last couple of days. A couple of points. He claims that taxpayer's money has gone down the drain at RBS, because: we as taxpayers put in £25.5bn of new equity into this bank last autumn...but...the equity of this bank has increased by less than £16bn to £80bn. So almost £10bn of the £25.5bn we've only just put into RBS has already been wiped out by losses. Well, that's half true. £10 billion has indeed been wiped out by losses. But it's not £10 billion of our  money, it's £10 billion of the former shareholders'  money. Our £45.5 billion has bought 84% of that £80 billion in equity, a £67.2 billion asset. The reason we're not in profit yet is because the market is still applying a discount due to uncertainty over future losses. We don't know if those losses will happen yet - it depends mainly on economic recovery - but on the book value of the bank, we got a good a...

Robert Peston highlights the Conservatives' idea (I originally wrote 'plan', but it's too vague and too early to be convinced they will actually do it) of moving public service provision into employee-owned, profit-making companies. He points out a few political constraints, in particular: If a John Lewis style primary school were a floperoo, would all the teacher-shareholders be sacked, or only the head? A resolution procedure for failing co-ops that didn't harm pupils - or patients of community nursing teams - would plainly be essential. In fact, this is probably a constraint on all private provision of public services. The co-op structure is not really an issue either way, except that it sounds nicer and less cut-throat than straight privatisation. I'm a fan of market solutions and have generally been well-disposed towards the idea of private companies bidding to do public work - why shouldn't a company be able to offer medical treatment or training...

The interpretation of Hector Sants' resignation announcement seems to be that it's a protest against the Tories' plans to gut the FSA if they are elected. But the Tories haven't been elected. So it's a little odd to make a protest gesture like this. Thus, despite Robert Peston's speculation that this might be bad for the Tories , it actually suggests the converse: that Sants is very confident they will win. And he's putting his money - as it were - where his mouth is. Although this isn't exactly a prediction market, it has some of the same incentive characteristics as one. And looking at a real prediction market (Betfair) the Tories have decimal odds of about 1.5 to win an overall majority (indicating about a probability of about 66%). Not sure I'd leave my job on those odds, but his contract does expire in the summer so it's decent of him to allow some time to find a successor.

In an intriguing example of pricing an externality, Barack Obama has announced a plan to tax American banks based on their reliance on the wholesale finance markets. On a related subject, Nick Rowe has a neat analysis of finance as magic - the magic of borrowing short and lending long, sharing risk and creating liquidity. To make this magic work in a more stable fashion, it's understandable that governments would want to encourage banks to move from wholesale to deposit finance. Assuming it works, what are the effects of this move likely to be? The coordination game between multiple owners of capital will work better, for two reasons. First, because no individual will have as much power as they do now. Second, because the more finance is provided by millions of depositors (instead of a few hundred managers of wholesale capital) the more statistically predictable their behaviour is likely to be. Even when there are herd changes in depositor behaviour, the movement of a larger...

What issue has such purchase on the public imagination that it - at least in the UK - just keeps coming back, again and again, as people's top concern about the financial crisis and the recession? Of course, it's the bonuses paid to bank employees . The psychology of this conversation is revealing. Nobody really notices if RBS makes £6 billion in profits. But when one RBS employee gets a $10 million bonus - that's about 1/1000th of the amount - suddenly it's a big deal. We can relate much better to (relatively) small numbers with people attached to them than we do to huge figures. Clearly the government has a political problem: it doesn't want to be seen to be allowing high bonuses to be paid when the public has paid for the banks to be rescued. But it also has a commercial problem: the rescue is a sunk cost, and the bonuses are part of the bank's strategy to incentivise  future  behaviour. If RBS doesn't pay any bonuses, perhaps their top people wil...

Robert Peston's article today is about the potential for BAE to be prosecuted over alleged bribery. The article itself is interesting but the reader comments are what staggers me. Page after page of comments passionately defend the corruption. "It's just the way things are done"..."do you really think the French and Germans don't do this?"..."it's not as if they were bribing British officials, but foreign ones, which is how you do business in these places". You need to get through 23 comments defending BAE before finding a single one condemning illegal and immoral actions that hurt millions of desperately poor third world citizens (well done to DrDelbert, PorterRockwell and a few others for having a bit of integrity). I am left wondering if this is really how the majority of Peston's readers feel...or is it, in fact, an organised campaign?

Is Lloyds, as Robert Peston suggests , really acting on the instructions of its shareholders in trying to withdraw from GAPS (the Government Asset Protection Scheme)? Or is it, as seems more likely, trying to give its management more power? The EU and Treasury intervention that he refers to will restrict the freedom of Lloyds executives to hang onto the empire they've built; and incidentally, to set their own pay and credit policies. Selling off the Halifax branches might well be in the interest of Lloyds shareholders if not in the interests of the board. What's more: if the government does wish to make more credit available to UK businesses and consumers, one way to do it is to make sure banks have lots of capital available to support lending. If Lloyds really can raise £20 billion of new capital, wouldn't it be better if that can support £100 billion of new lending, rather than just replacing the GAPS scheme without increasing loan capacity at all? With the economy in th...

Scott Sumner has published a couple of good articles about the difficulty of understanding supply and demand, and Robert Peston's posting today may be an excellent illustration of that. Robert says: Here's the great and resonant unknown of the moment. Is the credit contraction a reflection of less demand from you, me and millions of others? Or are the banks rationing much more than they had been doing? The answer is - probably - a bit of both. But does that make any sense? Well, it could - but is it plausible that demand for loans just happens to fall at the same time as the banks tighten their standards? And why would the banks "ration" credit anyway? Professor Sumner might give a simpler explanation. Occam's razor, as you know, says that the simplest explanation is usually the best. So can we identify a single cause of this phenomenon? Yes we can. Imagine that there is a stable market for credit in 2007. Then just one thing happens: the supply curve for loans ...

Robert Peston writes an entertaining, slightly scary, story about BT's pension liabilities . But is this anything to worry about? Not really. He makes a few points that sound striking, but under closer examination are utterly unsurprising. ...in an economic sense, BT's current and future pensioners own this totemic business. True, but any business is "owned" both by its creditors and its shareholders. The creditors always have to be paid off first before the shareholders have clear title to the company's assets. And in most large, old companies, pensioners are among the biggest creditors. Look at General Motors, which has just handed over a majority stake in itself to its pensioners (via their union, the UAW). To put this £8bn chasm in its pension-scheme into an appropriate context, the entire market value of the company is less than £10bn. Also true, but meaningless. The pension deficit - like any other debt that BT has - is already factored into its market value...

The debate between proponents of monetary and fiscal policy remains surprisingly interesting all these months later. Not so much at Robert Peston's blog , unfortunately, where the question is more or less ignored; instead it is reduced to a question - without an answer - about how expensive it will be for the government to finance its debt. But have a look at some of the comments on this Worthwhile Canadian Initiative posting . Adam P in particular makes an intriguing point: Moreover, this really goes to a distinction that people are often not careful about (I was trying to make this point in the discussion of your 'why fiscal policy won't work competition'). We need to decide on what we mean for fiscal stimulus to "work". There are two distinct questions: 1) Can fiscal policy increase output in a liquidity trapped economy? Clearly yes. 2) Can fiscal policy end the recession, break the trap? Only by increasing expected inflation which could also be done by mon...

Robert Peston reports the Conservatives' new proposal for financial regulation . I'm not a fan of the title: "Proposal for sound banking" sounds like a "proposal for secure borders" or "proposal for safe streets after 11pm": the choice of language prejudices the solution. But to be fair, every policy document has to be marketed to the voters. So I will try not to make assumptions about the content. Note that I haven't read the document, as it has not been published yet. But the Tories' embargoes are less strict than the government's [I still have an unpublished draft blog posting from two months ago based on Peston's accidental release, seven hours early, of the Treasury Select Committee's report on the banking sector], so he has been able to outline most of the key details of the document in advance of its release. A simple summary: Macro-prudential regulation transferred from the FSA to the Bank of England, creating a new Fina...

Adam Posen's submission to the Treasury Select Committee - in advance of his appointment to the Bank of England's MPC - are reported by Stephanie Flanders today. Some interesting thoughts. The first is that: The bottom line, he says is that economists just don't understand deflation very well: "I think these facts call for some degree of humility. The Bank of England is right to be engaged in quantitative easing to address our current problem. But I think we should stay away from very mechanistic monetarism that, 'Oh, boy, they've printed a lot of money so at some point that has to turn into inflation.' Or, 'If we do this specific amount of quantitative easing, so it will lead to this result.' Looking at Japan, it is clear that their quantitative easing measures had the right sign, in the sense of being stimulative, but did not have a predictable or even large short-term result, let alone cause high inflation." An intriguing comment and one th...

Robert Peston highlights a nice, rather knotty, little economics problem for Arsenal Football Club . This conundrum highlights a number of areas of economic theory: Generalised agency problem . The interests of the different stakeholders in the club all, potentially, conflict with each other. The fans want maximum money spent on good players so they have a chance of winning something for the first time in years. The management of the club want (I guess) stability and a profitable business, which probably means accepting a lower probability of sporting success. The different shareholders want different outcomes: Usmanov may want an equity issue because, with more cash available than the other shareholders, it would probably allow him to increase his stake. Other shareholders want to preserve their stake relative to him, so they are less keen on the increase in investment. The players and manager presumably want to be successful on the pitch, well-paid and - in Wenger's case - to hav...

What trouble it causes in life when you can't just act directly on your preferences but need to signal indirectly. Chief example at the moment: tomorrow's vote at Marks and Spencer . The shareholders don't really want to get rid of Stuart Rose - he's done a good job - but they do want to tell the M&S directors to stop messing around with corporate governance. So there's a proposal to get him to step down as chairman (not chief executive); but if it passes, or gets significant votes, it's likely to be interpreted as a vote of no confidence in Rose himself. What else? A debate over on Worthwhile Canadian Initiative about the bluntness of the interest rate tool as a way of controlling inflation. If inflation is low anyway, for other reasons, but interest rates are kept low to boost economic activity, price pressures can leak over into asset prices - causing a house price bubble for example. A tool, when not designed directly to address the problem it is meant ...