Posts

Showing posts from November, 2011

Subsidizing youth hiring is wasteful and will yield no positive long-term effects

Image
This post was also published on the Adam Smith Institute blog

The UK Chancellor George Osborne announced his Autumn Statement today, and here are some immediate UK think tank reactions. In summary, the Autumn Statement wasn't surprising; it seems that the taxpayers were bearing the burden of the crisis in order for the government to spend that money on wasteful infrastructural projects, mortgage guarantees (see here), loans to businesses (see credit easing) and essentially is trying to guide (dare I say centrally plan) investment incentives in the economy. 
Within the Autumn statement one proposal in particular caught attention, and it was a policy earlier announced by the LibDem Deputy PM Nick Clegg. The UK government wants to subsidize businesses in hiring young unemployed workers, precisely from the ages of 16 to 24, by offering £1bn to the private sector to take young workers into apprentice schemes. 
Under a typically political decision and explanation, youth unemployment i…

Long live the technocrats!?

Image
Plato would be proud. His idea that philosophers should govern is coming true in Italy and his very own Greece. Even though economists rather than philosophers are in power, economists are today most closely to being the ancient philosophers Plato had in mind. This isn’t at all a biased statement.
The idea itself has its benefits and its flaws. As a non-elected entity, how does this government serve the people? Is the very foundation of democracy at stake if we allow for legitimately elected governments to be replaced by parachuted technocrats? Even if the people have an utmost confidence in these new ‘rulers’ and consider them much more capable of handling the crisis situation, isn’t this necessary an attack on democracy and free choice of the voters? Not necessary.   
The technocratic governments were given legitimacy once approved by Italian and Greek parliaments. The elected members of parliament in both countries agreed upon that a new technocratic leader should step in instead of …

Reusing chewed-up ideas on the housing market

Note: this post was first published on the Adam Smith Institute blog, on Wednesday 23rd November 2011
On Monday, the UK Prime Minister David Cameron announced a new policy on housing designed to partially underwrite mortgage loans for first time buyers in order to make it easier for them to buy and own a house. The idea is to make new buyers provide only a 5% deposit for buying a new home, instead of up to 20% which the banks are demanding now. It is supposed to make the “ home-ownership dream” a reality for young people. The government and the construction firms will together underwrite a part of the loan creating an incentive to the banks to relax lending standards. This is aimed to help 100,000 new possible home-buyers who are excluded from the market due to high loan-to-value ratio’s.
The PM cleverly offered a caveat to potential critics by saying this policy won’t result in another asset bubble like it did in the US, since it is only focused on people buying new houses. It is sup…

Eurozone crisis – analysis of causes and consequences (part 4)

Image
The final part of the eurozone causes and consequences analysis deals with the outcomes of the sovereign debt crisis and how it now threatens to spread contagion back to the rest of Western world and undermine the current sluggish recovery. 
The summary and suggestions on the eurozone sovereign crisis and the critique of the policymakers responses were analyzed on this blog previously and can be found here and here
What were the outcomes?
Italian bond yields. Source: Bloomberg  In the last year every peripheral eurozone government was kicked out of office. Portugal and Ireland changed governments earlier in the year, Italy and Greece most recently got technocratic governments, while Spain held elections this Sunday and saw the victory of the conservatives announcing cuts and fiscal responsibility. The political implication of the crisis was huge, and naturally the politicians needed to pay the price. Governments such as Italy’s Silvio Berlusconi who managed to avoid being removed from o…

Eurozone crisis - Intermezzo (2)

Image
Just a quick look at the daily chart from the Economist.




























Source: The Economist, 22nd November 2011

Observe the obvious differences between the North (Gernmany, France, Netherlands, Belgium, Austria, Ireland) and the South (Greece, Italy, Portugal, Spain) in the eurozone. The set of graphs itself don't necessarily prove any causal relationship (that geography or a relaxed southern lifestyle has something to do with it for example), but they can provide an interesting comparison. They can also provide support for the claim on too large differences between these countries to have a single currency, or the net borrowing effect on the international markets that led to high current account deficits of the 'South'.
The graphs can make an inference on one thing emphasised in the last three posts on the eurozone debt crisis - a welfare state used to fund populist policies cannot lead to a sustainable growth path, only a temporary boom; it will result in increasing existing domestic i…

Eurozone crisis – analysis of causes and consequences (part 3)

Image
After the initial identification of the causes of eurozone contagion in domestic and foreigninstabilities, having in mind the current debt situation we now look at how and why the banks got incorporated into the peripheral contagion, which led to further systemic risk, and finally, how did the collapse take place after a sudden credit stop.
How the banks got caught up buying peripheral debt?
As was already noted in this blog, eurozone banks were buying the peripheral debt as part of their zero risk-weighted assets. While the regulatory requirement on holding a corporate loan was 8%, the capital requirement for holding sovereign debt was just 1,6% (sovereign debt, considered to be a zero risk asset was given a 20% risk-weight, resulting in the total 1,6% of capital requirement for sovereign bond holdings). This meant that if a bank was to lend to sovereigns instead of businesses it could make much more money (leverage on sovereign bonds was 62.5 to one compared to leverage on business lo…

Eurozone crisis - Intermezzo

Image
Here's something to keep it interesting while waiting for the next few posts on consequences and the remedies of the eurozone crisis. 
I 'borrow' this figure from the Economist, depicting debt burdens of eurozone economies:

Source: The Economist

The graph serves as a good reminder on importance of debt levels and the sustainability of these debt levels on investor confidence and country bond yields. Greece, Italy, Portugal and Ireland (4 out of 5 countries analyzed previously) are countries with the highest debt burdens in the eurozone and are the countries most exposed to the threat of default. 
In addition to this I would like to stress out the mechanism of outside contagion described excelently by Reinhart and Rogoff (2009) (I summarize their main findings on the spread of contagion throughout the world financial system):
"Banking crises in advanced economies decrease growth of these economies. This slowing of growth and economic activity will hit exports thus eliminat…

Eurozone crisis – analysis of causes and consequences (part 2)

Image
The second part observes problems inflicted to the eurozone economies from abroad. It then looks at how foreign capital inflows (due to large CA deficits shown in part 1) were used in domestic economies. 
(Regarding the current affairs, the economist offers its own short history of the eurozone crisis, worth reading. In addition, its Free Exchange blog offers two good texts on the current eurozone affairs, one on Spain, the other on Italy. Tyler Cowen offers an interesting summary on what we learned from the euro crisis on his blog Marginal Revolution.)

Instabilities from abroad
Problems with a CA deficit and the common currency
When one country runs a current account deficit, this implies that it runs a surplus in its capital account. A capital account surplus means an inflow of foreign capital (investments) into a country, which is essentially a good thing since money will always flow to where it expects the highest and safest returns. However, the question is where is the money from ab…

Eurozone crisis – analysis of causes and consequences (part 1)

Image
In the next few days I will publish a series of blog posts about the causes and consequences of the eurozone crisis. I will cover the potential reasons why the peripheral eurozone economies suffered a particularly hard hit. The political responses and potential remedies to the eurozone crisis have been published in two previousposts. After publishing all the blog posts, I intend to make a separate page on the eurozone crisis. The topic itself will probably continue for some time as the situation around eurozone currently carries the highest risk for another recession, and so will the page on the crisis be updated. 
Causes of the eurozone contagion
The focus of the first few blog posts will be on the spread of financial contagion onto the peripheral eurozone economies, which include Greece, Portugal, Ireland, Italy and Spain. The reasons why these countries in particular found themselves in such troubles can be separated into three features which they all share. The first are specific lo…

NGDP targeting – a licence for inflation

Image
Last week saw a new idea sprung into economic discussion focused on restoring economic growth – it was proposed that the US Fed should adopt a target growth rate of nominal GDP to 4,5%, or in short NGDP targeting. Nominal GDP is GDP measured with current prices (in a given year). Since it is hard to compare market values of GDP in current prices from one year to another as the value of money changes, economists adjust this nominal value of GDP by including inflation. Therefore, real GDP is nominal adjusted for inflation (or simply GDP measured with constant prices in a given year). 
Source: Data360, http://www.data360.org/index.aspx
On the given graph I compare US nominal and real GDP from 1948 to 2011, using quarterly data, base year 2005. The difference between the two should be obvious from the graph – dollar value of goods and services in the 60s or the 70s isn’t the same as the dollar value today (i.e. in 2005). It is much less and hence nominal GDP has lower values than real GD…

Political economy of eurozone crisis

Image
This is just a short look at how the bond markets reacted on political negotiations and meetings over the eurozone crisis (inspired by the latest reaction on the markets after the call for referendum by the Greek PM, Mr Papandreou):

The Economist brings this interesting graph:

For the full text in the Economist click here.

Observe how the Greek yields in particular reacted to positive or negative reinforcements coming from the politicians. It's not proof but it's a good indication of how markets react to political decisions. For Italy, however, the yield was mostly depended on the ECB buying its bonds earlier this year, but now, after the latest referendum call, even the ECB's actions remained without effect.

Currency devaluation – why is it useless in some cases?

Due to the Tuesday call for referendum by the Greek Prime Minister, George Papandreou, it is becoming more and more likely that Greece will chose its own path out of further bailouts and enforced austerity and into default and exit from the euro. I have covered a more negative scenario (full euro break up), and today I will touch upon the effects of currency devaluation. 
The devaluation of a currency will yield two immediate effects: an increase of exports (since domestic goods are now cheaper for foreigners so they will want to buy more of them) and a decrease of the value of domestic wages in terms of the foreign currency, making domestic workers more competitive on the international markets.
However, there are many other indirect effects that are likely to completely crowd out any positive effects of currency devaluation. Since Greece is the first most likely to exit the euro and devalue its currency, I will look at the effects from a Greek perspective. The Greek people and busines…