Monday, 6 July 2015

After Oxi, what next?

A lot of the commentary on Greece fails to see why the Greek No vote changes anything. This view tends to see the stance of the Eurozone group as simply expressing their own voters’ preferences which will not be changed by what happened yesterday. Here is an alternative reading.

It starts from a simple observation. The Troika will get far less of its money back (if any!) if Greece is forced out of the Eurozone. (I say forced out because Greece does not want to leave, so Greek exit is first and foremost an ECB decision: if you think otherwise read Karl Whelan and Matthew Klein and Paul De Grauwe. [1]) That is why creditors are generally weak in negotiations of this kind. Things are different in this case only because the creditors include the ECB, and Greece wants to stay in the Eurozone. The Troika has played this for all it is worth. They were relying (you could say gambling) on the Greek people, one way or another, deciding that they would agree to the Troika’s demands because they feared Greek exit more.

So far this strategy has failed. First they pushed Tsipras further than he could possibly go, hoping perhaps that Syriza would collapse in recriminations. Tsipras’s response was a unifying referendum. They then gambled that Greece would say no, and they lost that too. Tsipras continues to offer the Troika the chance to be more reasonable. He followed the referendum not with triumphalism but by removing his finance minister. This was both a signal - I really want a deal, even though it will in all probability inflict further (unnecessary) pain on Greece - and a lifeline, because the Troika can now say that an important obstacle to a deal has been removed. (An obstacle, because Varoufakis was too open - something politicians and much of the press hate - and too honest about the other side’s lack of economics.)

Now the Troika seem to face a simple choice. Agree a deal and get a little more heat from your political opponents at home for ‘giving in’, or force Greek exit with the risk that you will get a lot more heat when Greece defaults and people realise you have lost all their money. If they are really just interested in getting as much of their money back as possible, it would seem crazy to throw away their best card by forcing Greece out of the Eurozone.

Of course rationality may not prevail, or interests may be rather different. The IMF may continue to be an unhelpful nuisance. (If you think my criticism of their role was harsh, read this from Peter Doyle.) Some within the Troika will be happy to go for Greek exit because they think nationalist sentiment can overcome any kickback from the subsequent Greek default. Others may fear a deal may encourage anti-austerity sentiment in their own indebted countries.

Unfortunately there is a third possibility, which is probably the worst possible outcome. To prevent any loss of face, the Troika may continue to gamble, waiting for days or even weeks, and watch ECB pressure, together with reluctance by Tsipras to introduce a new currency, gradually bring chaos to the Greek economy. Only then will it negotiate, allowing any deal to be portrayed as the result of desperation by the Greek government. In which case, recent European politics will have reached a new all time low.    

[1] Postscript: Martin Sandbu provides a very clear account.

Saturday, 4 July 2015

Greece and the political capture of the IMF

When governments borrow too much, and cannot repay, it generally falls to the IMF to sort things out. In playing this role, the IMF should be pretty tough on creditors. As Interfluidity so lucidly points out, this is where real moral hazard lies.

So what went wrong with Greece? Remember the Troika made a huge mistake in using their citizens’ money to lend to Greece so Greece could partially repay these private sector creditors - that is where most of the Troika’s rescue package went. The IMF’s own internal analysis was deeply flawed (being predictably wrong in how austerity would impact on the Greek economy), and even then the deal failed its own tests, so special dispensation had to be made.

The IMF should have been very worried about motivations here. After all, many of these creditors were banks from European countries, so the motivations of those bailing out these creditors were conflicted to say the least. They were nevertheless persuaded to go along because of fears of contagion. If the worry was contagion to other countries governments that was an obvious mistake, because it happened anyway but could have been solved ‘at a stroke’ by the ECB (as it eventually was). If the worry was a collapse in the European banking system, then that was the responsibility of the governments concerned, and not the Greek people.

To the present, and the negotiations that failed. Forget all the fluff you read in most papers about this. What is quite clear is the following. A deal could have been done if the Troika had allowed debt restructuring to be part of the package. The IMF agrees that debt needs to be restructured, as do most economists. It has made no secret of this, yet it has consistently soft pedalled when it came to dealing with the rest of the Troika. So it was allowed to be kept off the table in the current negotiations by the Troika: vague promises to look at this after a deal had been agreed would never be enough for Syriza to sell the deal. There are two reasons why Germany might have wanted it to remain off the table. One is that it never wanted a deal; the other is that to include it would have been politically embarrassing for German politicians.

What seems abundantly clear is that the IMF should have had no truck with either concern. It has to be tough on creditors, and in this case the creditors were the European institutions. It clearly had the political power to face down European governments on this issue, and if it had done so a deal could have been achieved. The only conclusion I can come to is that the IMF on this occasion has been captured by the rest of the Troika. [1] [2] [3] As Ashoka Mody puts it, it has become trapped by the priorities of [selective] shareholders, including in recent years the U.K. and Germany.

The following are not really true footnotes - they are too important for that - but I wanted to keep the main text crystal clear.

[1] Peter Doyle has also noted how dubious the IMF’s interventions on essential ‘reforms’ are both in economic and political terms. (If this report is true, it is even worse.) While other parts of the IMF seem to understand multipliers (see [2] below), those in charge of the negotiations seem to take a more German view. [Postscript: Ashoka Mody's verdict on this IMF analysis is restrained but blunt.]

[2] One of the reasons that it is part of the IMF’s job to be tough on creditors is that creditors have no concern for social welfare, by which I mean the aggregate welfare of both creditors and debtors combined. (Although, as Interfluidity says, you might have hoped differently on this occasion.) As this point is hardly ever made in the media let me set it out here (the numbers are based on a FT piece by Martin Sandbu). To achieve a primary surplus of 1% of GDP to transfer to the Troika, the Greek government needs to undertake austerity that will reduce Greek GDP by 3% (assuming a multiplier of 1.5, and a tax/transfer loss from lower GDP of a third). That reduction in GDP is a social loss (the loss to the Greek economy is 3% plus the 1% transfer) - at best pure waste, and probably for some the cause of much suffering.

[3] Here is the former head of the IMF's European department, on the need for both debt restructuring and the dangers of demanding larger primary surpluses.       

Friday, 3 July 2015

The ideologues of the Eurozone

It was all going so well. True, Greek GDP did shrink by 25% over 4 years, unemployment rose to 25% and youth unemployment to 50%, but before Syriza’s election Greek GDP had actually stopped falling. Further austerity was planned so that Greece could start to pay interest on its enormous debts, together with various ‘reforms’ that were so obviously in the interests of the Greek economy, and the consensus forecast was that the Greek economy might start to grow at a pace that would also stop unemployment rising. Who knows, in a decade or so it might even fall below 20%.
 
But then disaster struck. The Greek people went and spoilt everything by electing a government that suggested that there might be an alternative to all this. Of course the Greek people are not really to blame: how can they be expected to understand there was no alternative to their suffering. The real blame must lie with the ‘populist’ politicians who pretended there could be an alternative. The ever patient and understanding Troika negotiators then had to deal with ‘adolescent ideologues’ who were prepared to use the suffering of the Greek people as a means to achieve their own political ends. They were cheered on by pundits and economists on the left in the UK and US who wanted nothing more than to use Greece as part of a ‘proxy war’ to get more Keynesian policies in their own countries.

If you think the above parody is over the top, click on the two links. The hypocrisy of some of the commentary on Greece is amazing. When the ‘adolescent ideologue’ Mr Tsipras shows a statesman-like maturity in being prepared to compromise in an effort to get a deal, he is accused of inconsistency and not being able to make up his mind. When those who he is negotiating with push him further than he is prepared to go, he is accused of ‘taking Greece to the brink’ by having the temerity to ask the Greek people to choose. (Any mature politician knows that in modern Europe you only call a referendum when you know you will get the answer you want, and when that does not happen you ignore the result and call another one.) Mr Tsipras is accused of failing to grasp that other nations too have democracies, as if the Troika had shown huge respect for democracy by acting as if nothing was changed by Syriza’s election.

The OECD estimate that the output gap in Greece is currently well over 10%. In plain English that means that those currently unemployed could be producing something useful and GDP could easily expand by at least 10% without generating any increase in inflation. (Greek inflation is currently around -2%.) That would not only be in the interests of Greece, but also in the interests of Greece’s creditors. It is a way of achieving the primary surpluses that the Troika wants without inflicting more pain. It is also absolutely undeniable that further austerity would tend to reduce GDP, just as past austerity has done. So everyone can be made better off by giving Greece the breathing space so that its economy can recover. But apparently it is childish to try and negotiate for such an outcome.

Why is it impossible for the Troika to agree to such a deal? They say their own democracies would not allow it, but it is part of being a good politician that you can afford to compromise when that compromise is in everyone’s interest. I suspect that in at least some cases this argument is a smokescreen, particularly when you see what Mr Tsipras is being told he should do. There is a pattern here. For the ECB to act as a lender of last resort was impossible, and the only answer was yet more austerity - until that austerity had been put in place and OMT became possible. When the French government tried to meet deficit targets by raising taxes rather than cutting spending, they were told that this was the wrong kind of austerity. When it came to Quantitative Easing (QE) some were quite explicit - a problem with QE is that it might take some pressure off governments to undertake austerity and ‘reforms’. So perhaps only when the Syriza government has fallen and their successor agreed to more austerity and reforms will it turn out that the Troika can after all be flexible about restructuring debt.

One of the charges frequently made against opponents of austerity in the Eurozone is that we are really seeking the failure of the whole Euro project. The opposite is nearer the truth. The problem for the Euro project is that it has become captured by an economic ideology, and austerity is that ideology’s principle weapon. A self-confident and mature Eurozone would be able to tolerate diversity, rather than trying to crush any dissent. A Eurozone captured by an ideology will insist there is but one path, and that the imperative of austerity is too important to accommodate democratic wishes. Pursuing that ideology has brought the Eurozone to the brink, where it is prepared to force out one of its uncooperative members. Critics of austerity are not trying to destroy to Eurozone, but save it from the grip of this self-destructive ideology. 


Wednesday, 1 July 2015

What I did on my holidays

I'm just finishing a short break walking in Scotland, and the fact that I have not posted a blog over the last week tells you the weather has not been too bad. However I did find the time to write a piece for the New Statesman on Greece, which can be found here. My favourite sentence is this:

"That the governments of the eurozone continue to display a macroeconomic understanding of fiscal policy equivalent to that of Angela Merkel’s imagined Swabian housewife is perhaps not surprising – it has been a consistent pattern since the eurozone began."

That sentence is followed by a few on the role of the IMF, which deserve amplification, and I'll hope to do that shortly after I leave Scotland.

Thursday, 25 June 2015

The big picture

I have wasted far too much of my time killing zombies. This is what Paul Krugman calls ideas or alleged facts that, despite being shown to be wrong countless times, keep coming back to life. In terms of anti-Keynesian mythology, the zombie I have spent too much time on is that 2013 UK growth showed austerity works, but I’ve also done a bit on the mistaken idea that US growth in 2013 shows that Keynesian multipliers are zero. (I’ve been told that what I have done in the US case is deficient for a couple of reasons - neither of which I accept - but those saying this have never shown that doing it their way makes any difference. Instead they prefer to stick to gotcha economics. You can draw your own conclusions from that.) But these are particular episodes for particular countries - what about the big picture?

I happened to be using the IMF’s datamapper recently, and it contains the following for GDP growth in the advanced economies.


There was slow growth in the early 80s, but that was followed by years of around 4% growth. Another slow growth period in the early 90s, followed by years of around 3% growth. The same again for the 2000s. We then had the massive recession of 2009, followed by 3% growth in 2010. Then four years of growth below 2%, which would have been classed as a downturn based on previous experience.

Why has there been such a pathetic recovery? There is a simple, entirely conventional answer, which perfectly fits the timing: fiscal austerity. As I set out here, growth from 2010 in the US, UK and Eurozone would have been closer to previous recoveries without cuts in government consumption and investment.

Now of course there are other explanations. The most obvious is that recoveries from financial crises have been weaker and more prolonged in the past. However a point that is not made often enough is that the austerity explanation and the weak finance explanation are quite compatible with each other. In a recession private spending and public spending on goods and services do not compete, so even if private spending has been weak because of difficulties in obtaining finance, austerity in the form of public spending cuts will still reduce GDP. Furthermore, an inability by consumers to borrow can magnify the impact of cuts in transfers or increases in taxes on consumption.

The only theoretically plausible explanation for why austerity in the form of cuts to government consumption and investment will not reduce output in a demand deficient recession is if monetary policy eases to offset the cuts. That explanation suggests weak growth since the recession is a deliberate choice by monetary policy makers, and it gets more implausible as each day passes. Here is consumer price inflation from the same source. Whereas inflation wobbled around 2% during the Great Moderation, in 2013 and 2014 it was below 1.5%, and this year is heading towards zero.





Monday, 22 June 2015

The paranoia of power

A coda to my previous post, where I reported on some simulations presented in the Bank of England’s new blog. My final paragraph started: “The blog does not discuss the policy implications, but they are pretty obvious.” I went on to say what I thought the implications were. Tony Yates thinks that maybe there was a hidden meaning in the sentence I wrote. The hidden meaning was: ‘see how subversive the new blog is: they are allowing staff to communicate that they think the MPC should be overshooting the target’.

When Tony first raised this possibility with me on twitter, I just had to laugh, for two reasons. The first is that I had never imagined what I wrote could be interpreted this way. I am an academic, not a journalist trying to gain kudos by embarrassing the Bank. I am interested in what policy should be, not what some Bank staff think it should be. The second is that Tony’s imagined interpretation of what I had written was a perfect illustration of the kind of old Bank thinking that used to make it such a closed institution.

This kind of thinking subjects each possible release of economic analysis, however technical, to the following test. Could you imagine a malevolent journalist taking this analysis and using it to infer something about what policy might be or what some people in the institution think policy should be? The imagined journalist could be both very knowledgeable and quite stupid. If the answer is yes for any combination of these things, the analysis should not be released.

Now Tony is the last person to support such an attitude, but by imagining I had some hidden meaning, and then putting his imagination into print, he just encourages the old way of thinking. As far as I can see some staff members published a piece of technical analysis, and left those reading it to draw any policy conclusions they wished. Now what on earth is wrong with that! 


Sunday, 21 June 2015

The Bank of England goes Underground

This is a short post to celebrate an important innovation at the Bank. They now have a blog, which not only has a great name (which those who have not been to London may need a subway map to understand), but looks like being an invaluable addition to the UK and economics blogging scene. As I suggested here, this is another in a long line of small innovations made possible by appointing Mark Carney as Governor. Those who experienced previous regimes can hardly believe it.

The blog promises a mix of posts in terms of both content and wonkishness, and to start we have an easily understandable discussion of the implications of driverless cars for the insurance industry, and a more technical piece on macro. The idea behind the macro post is however fairly simple. If interest rates cannot go below some lower bound, the distribution of forecast outcomes will be skewed. If bad things happen, things will be a lot worse than if good things happen. The novelty is to use what are called stochastic simulations of the Bank’s main macro model to quantify this (using, I have to add, a methodology proposed by one of my former Oxford PhD students – well done Tom). Here is a fan chart for inflation which I think is self-explanatory.


The blog does not discuss the policy implications, but they are pretty obvious. As Brad DeLong has recently pointed out (it’s a point that I and others have also made), with non-symmetrical outcomes like this, you should not choose the policy based on what is most likely to happen. Instead you bias your policy to shy away from the very bad outcomes. So in this case instead of aiming for 2% inflation as the most likely outcome, you aim for a policy where the most likely outcome is above 2%, to avoid a situation where the economy hits the lower bound for interest rates. To put it intuitively, when walking along a narrow path beside a cliff, it is natural and probably wise not to walk in exactly the middle of the path.