Hartar Blog

Back in February 2005 Alan Greenspan referred to the abnormal (low) level of US long-term interest rates as a conundrum: "For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum. Bond price movements may be a short-term aberration, but it will be some time before we are able to better judge the forces underlying recent experience." A month later, Ben Bernanke, proposed the idea of a global saving glut as the main reason for low long-term real interest rates. In a world where capital markets are global, interest are determined by global forces and not by domestic macroeconomic conditions. This behavior is also very much related to the discussion around "global liquidity" and the potential influence of monetary policy in the US on monetary policy conditions in emerging markets. The difference is that in this case we are talking about short-term rates where we typically expect more control by the central bank and a stronger correl...

In today's Financial Times, Gideon Rachman discusses the flaws of the Euro and the possibility of failure. He admits that from the beginning he believed that the Euro project would eventually collapsed because "First, a currency union cannot ultimately survive unless it is backed by a political union. Second, there will be no political union in Europe because there is no common political identity to underpin it. And so, third — the euro will collapse." I have always been very skeptical about statements arguing that a currency union needs a political union. The political consequences of sharing a currency (the Euro area) are in many ways much smaller than the political consequences of being part of the European Union, why don't we make the same argument about the European Union? (just to be clear, some make the same argument but clearly it is much less common, as can be seen in the article by Rachman). There are plenty of example where the European Union (EU) requires...

A recent report by the McKinsey Global Institute on the increasing amount of debt among advanced and emerging markets made it to the front page of many financial newspapers yesterday (e.g. the FT ). The report reminds us that in many countries debt is still going up as a % of GDP, that there is limited deleveraging. The Financial Times offers an interesting graphical tool to compare debt evolution for different countries. The data is interesting and it highlights the difficulties in deleveraging but, in my mind, it might lead to readers to reach a simplistic conclusion that is not correct: that everyone is living beyond its means, that we are not learning and that this will not end up well. Let me start with the obvious point: your debt is someone else's assets. The increase in debt as a % of GDP can be rephrased as an increase in assets as a % of GDP. It implies that the size of financial assets and liabilities is growing relative to GDP. That is not always bad. In many cases we ...

As we compare countries' performance since the beginning of the global financial crisis we try to look for patterns that explain differences in behavior and lessons on how to handle the next crisis. When doing that comparison we some times forget that looking at GDP growth does not always give us all the information we need to understand cross-country variation in performance. This variation can be due to demographic, labor market, productivity factors and while these three might be correlated over time, this is not always the case. Here is a quick look at the years 2007-2013 for a group of advanced economies. The charts below plot the level of activity in 2013 measured as a ratio to the level in 2007. We start with GDP. We see the usual suspects at the bottom of the list and we also see on the right hand side the ones that have managed to do better during the crisis years. Japan and the UK sit in the middle of the table.  We now correct for the potential effect of changes in demog...

One more post on Greece, possibly not the last one. Markets are more worried about what is going on and there is more and more talk about the possibility of and exit of Greece from the Euro area. As I have argued in my previous posts, exit will not be the choice of the Greek government, it will be the only solution for Greece as the ECB refuses to provide liquidity to Greek banks as depositors run to avoid capital losses on their Euro deposits in the scenario of Greece leaving the Euro . Let me start by repeating (as I have expressed many times in this blog) that I find that the economic policies followed in Europe have been a disaster, that the suffering that countries such as Greece had to go through during the last years should not have taken place. And I am convinced that in many of these countries, austerity has produced higher debt-to-GDP ratios, as opposed to lower ones. A real disaster. But this is not what this negotiation is going to be about. The reality is that the crisis h...

A follow up to my previous post now that we know that the Syriza party has won the election. What comes next will not be easy. And it is not because the policies proposed by Syriza are that radical or unreasonable and certainly they are not worse that what has been done in Greece since the crisis started. The real issue is that this is a wake up call for the Euro area (and possibly the European Union). A wake up call that without a consensus on what is the purpose and processes of a monetary union, this will be a failed project. The reality is that so far EMU has been built in an asymmetric way: the ECB was designed as a strong anti-inflation central bank with the Bundesbank in mind and that served a purpose (for everyone including Greece). The strict criteria to enter into EMU (low inflation, low budget deficits) were a great excuse for politicians in some countries to do policies that otherwise they could not have done internally. There was no doubt who was in charge and what was the...

An interesting month lies ahead for the Euro area. On January 22 the ECB will meet and they will either announce a QE-style monetary policy action, as most expect by now, or they will disappoint markets with yet another statement suggesting the need to wait for more data and the effects of what has been done so far. On January 25, three days later, elections in Greece will decide whether the first political party with strong views against austerity and with an explicit proposal for a serious haircut on its government debt reaches power in the Euro area. No doubt that the outcome of these two developments will determine the fate of the Euro economy over the coming years but it is also possible that it determines the fate of the Euro area -- at least the current membership. Rumors have started reaching the press that the Germans will not negotiate with Syriza and that they are ready to let Greece leave the Euro.  We have seen this before and we know the outcome: Back in 2011 and 201...

In the current economic policy debate in Europe there seems to be an increasing polarization between the German view and the view of the other countries. How did we end up with such polarized views of the world? What is the basis for the apparent German stubbornness to change their mind about what are the right economic policies for the Euro area? Here is my best attempt to explain the economic logic behind that side of the debate, including a critical view of the arguments whenever is needed. 1. Europe needs structural reforms. Correct, this has always been true and it will be true in the coming years or decades. 2. Some countries/governments will find any excuses they can to avoid reforms. Correct. Without external pressure or a crisis, change will not happen. This was also true for Germany in the post-2000 reforms. 3. Imbalances of spending and debt (and asset price bubbles) were a fundamental cause of the crisis. Correct. 4. The pre-crisis imbalances requires post-crisis sacrifices...

Via Greg Mankiw I read the review of Piketty's book by Deirdre McCloskey . The review reminds me of the conversations I have in my class when I bring up the issue of income inequality. While most people express initial concerns about recent trends of increasing inequality, there tends to be a negative reaction about accepting that this is indeed a failure of our current economic model and most become very defensive when that argument is being made. I do not want to discuss the details of the review but more the overall message. The review presents a strong defense of capitalism relative to alternative economic models potentially proposed by the "left". Very few, including Piketty, would disagree with the merits of capitalism. The fact that all advanced and prosperous economies have reached their current level of income by relying on markets, the fact that the fastest growing emerging markets are those that move closer to that model and by doing so are able to lift a large...

There is very little doubt that housing prices and leverage played a strong role in the global financial crisis that started in 2008. As the effects of the crisis disappear many countries still struggle with the fear that the dynamics of household debt and leverage resemble those of the pre-crisis period (e.g. Sweden ). While I am sympathetic to the idea that increased leverage and debt increases risk , I am less convinced by the theoretical justifications that are commonly used. Typically, there is an assumption that leverage and debt are associated to the notion of "living beyond our means", which makes this behavior and unsustainable. This is not correct and there are plenty of subtleties that should not be ignored that are related to distributional issues. Let's keep things simple. Imagine a world where the stock of housing is not going to change (we have enough houses for everyone). And imagine no population growth either (we do not need more houses). In this world,...

Wolfgang Munchau's FT article today is one of the most complete explanations I have seen about the origin and contradictions of the German economic orthodox dogma. The only issue that he does not address is how these economic views have survived over time despite the increasing evidence that their advice does not deliver the expected results. Here is my guess from what I have learned from many heated discussions over the last years about economic policy in Europe: the resilience (stubbornness) of this view on economic policy comes from a combination of faith and the inability of the economic profession to apply enough real world filters to models. Faith in a certain economic model comes from many years of being trained about the beauty of markets and all the inefficiencies that governments generate. But faith also comes from the belief that only through (individual) hard work and sacrifice (saving) one can achieve any economic progress. In this world (what Wolfgang Munchau refers ...

Hans-Werner Sinn has written a new book with an analysis of the causes and potential solutions of the Euro crisis: "The Euro Trap: on Bursting Bubbles, Budgets and Beliefs". I have not read the book yet but I just went through a video of the presentation he made about a month ago at the Peterson Institute for International Economics. The video of the presentation as well as a transcript are available at the PIIE web site . For those who have followed the writings of Hans-Werner Sinn there should be no surprise in the presentation. His views are very consistent and they put most of the emphasis on the price imbalances that were built prior to the crisis (the periphery becoming uncompetitive, interest rates being too low). These imbalances partly supported unsustainable growth that hid the need for structural reforms that were badly needed. His analysis of the crisis years is very similar: bailouts from the ECB and others, not enough austerity have also supported governments in...

The Swedish central bank just lowered interest rates to zero because of deflation risks. This action comes after ignoring repeated warnings from Lars Svensson who had joined the bank in 2007 and later resigned because of disagreements with monetary policy decisions. What it is interesting is the parallel between Riksbank decisions and ECB decisions. In both cases, these central banks went through a period of optimism that make them raise interest rates to deal with inflationary pressures. In the case of Sweden interest rates were raised from almost zero to 2% in 2012. In the case of the ECB interest rates were raised from 1% to 1.5% during 2011. Also, in both cases, after a significant expansion in their balance sheets following the 2008 crisis, there was a sharp reduction in the years that followed. During 2010 the balance sheet of the Riksbank was reduced by more than 50%. In the case of the ECB it was later in 2013 when the balance sheet shrank by about 1 Trillion Euros. Their polic...

The effect that fiscal consolidation has on GDP growth has probably generated more controversy than any other economic debate since the start of the 2008 crisis. How large are fiscal multipliers? Can fiscal contractions be expansionary? Last year, Olivier Blanchard and Daniel Leigh at the IMF produced a paper that claimed that the IMF and other international organizations had underestimated the size of fiscal policy multipliers . The paper argued that the assumed multiplier of about 0.5 was too low and that the right number was about 1.5 (the way you think about this number is the $ impact on GDP of a $1 fiscal policy contraction). While that number is already large, it is possible that the true costs of fiscal consolidations are much larger. In a recent research project (draft coming soon) I have been looking at the effects that fiscal consolidations have on potential GDP. Why is this an interesting topic? Because it happens to be that during the last 5 years we have been seriously re...

The 2008 crisis has resulted in significant downward revisions of potential growth for most advanced economies. As output collapsed we revised down our expectations of what is feasible in the long-term. This has resulted in estimates of potential output that are much lower than the ones we had before the crisis. There are several interpretations of these revisions, some of which can be very depressing. One interpretation is that we just realized that demographics and technology would not be as favorable as we thought going forward. The crisis might have raised awareness that demographic trends (aging) combined with weaker productivity growth will be unable to deliver the same growth rates as before. This is bad news but if this is what is going on, then we need to accept it or find ways to reverse those trends (increasing retirement age, finding levers for faster innovation,...). But this cannot be the main story behind the revisions of potential output given that most of the revisions...

Charles Wyplosz at VoxEU questions the potential effectiveness of quantitative easing (QE) as recently announced by the ECB. His main concern is that the ECB version of QE is supply driven, as opposed to the one implemented by the other central banks which is demand driven. In the case of the US Federal Reserve or the Bank of England, the central bank buys securities and those securities permanently increase the size of the bank's balance sheet. Liquidity is provided regardless of the actions of commercial banks. In contrast, the ECB so far had always relied on the demand from commercial banks for liquidity. The ECB made loans available to commercial banks, and as long as commercial banks demanded those loans, the balance sheet of the central bank also increased (with the deposits of commercial banks being the liability that appears on the other side). But this means that in many ways commercial banks are driving QE. It is their desire to hold more liquidity the one that determine...

As the US federal reserve might start soon raising interest rates and the ECB is about to being his quantitative easing plans, some see this divergence as a potential source of a large fall in the value of the Euro that might have already started over the last days. Given that we have witnessed in the past similar episodes of divergence in monetary policy (or at least monetary policy moving at very different speeds), it is interesting to check what happened during those episodes. Below is the evolution of the USD/EUR exchange rate since 1975 (click on the picture for a larger version). Of course, the Euro did not exist before 1999 but what I have done is to replace the Euro with the German Mark (converted at the Mark/Euro rate that was fixed at the time the Euro was launched). So the chart is really a combination  of the German/US exchange rate before 1999 and the Euro/US exchange rate post-1999. I will refer to the Euro even in the earlier years for simplicity. The line drifts up ...

Mario Draghi surprised markets last week with a further cut in interest rates and a QE plan to start purchases of assets to expand the ECB balance sheet. These two actions were welcome as well as the change in the content and tone of his comments that are finally make it clear the need for strong policy actions in Europe. Unfortunately, the fear is that this is coming too late and might not be enough. While the ECB plan to buy assets could expand its balance sheet over the coming months, the reality is that this move might just take its size to where it was several months ago. It is true that purchases of certain assets could have a stronger impact than the previous rounds of bank lending, but this might not be enough. And when it comes to interest rates, while the ECB has finally reached zero, it took so long that in the last months the Euro area has seen a dangerous move towards very low inflation. And as inflation went down, real interest rates went up. Below is a chart that compare...

In the economic policy debate in the Euro area it is common to hear a reference to the need for structural reforms in order to improve competitiveness, under the assumption that this is the recipe that Germany has followed so successfully over the  last years. To this logic it is common to add a recommendation for wage moderation. Low wage growth seems to be a necessity in Europe given the increased competition from emerging markets. While there can be some truth to this argument, let me show some evidence that questions some of the facts and then present some additional conceptual concerns with the way wage moderation and competitiveness are normally linked. Below is a chart that summarizes data provided by the OECD on productivity, compensation and unit labor costs. I computed the accumulated change from 2000 to 2013 (except for the US where there was no data for 2013, so the period is 2000-2012). The blue column (real GDP per hour) represents improvements in productivity. This i...

Robert Shiller warns us in the New York Times about the potential risks of high stock market valuations in the US. According to Shiller "the United States stock market looks very expensive right now". Brad DeLong and Dean Baker disagree with Shiller and argue that stock prices might look higher than historical averages but this could be ok given other changes in the economic environment. Here is a restatement of their debate (and I will be repeating arguments I have made before ): Shiller's concern comes from the fact that price-to-earning (PE) ratios in the US are high by historical standards. Using his own measure, they stand at above 25 which is much higher than the 15 level that was common before the massive 2000 bubble that took that ratio all the way to 44. There is no disagreement about this fact. Where Brad DeLong and Dean Baker disagree is in how relevant history is an indicator of what constitutes the right level for the PE ratio. The easiest way to think abou...