Sunday, 28 November 2010

The bright side of the Irish crisis

These days, it is easy to remember why economics used to be known as the "dismal science". The EU finance ministers are meeting today, to put the fine print for the Irish rescue package together. One European bailout is following another; growth is mostly poor, and even where it isn't, output is not returning back to trend; and unemployment is stubbornly high. News that the last big private Irish bank was being nationalized last week seems like a small wrinkle. And yet, one can think of this detail as possibly a first ray of sunlight.

Whenever the future of the Euro is discussed, the practical difficulties of leaving are pointed out. In particular, as soon as there is a good chance that a country might leave, its banks will face a massive run on deposits; converting assets and liabilities into the new national currency will be tricky, as any mismatch will zap bank capital. But how do these problems look in a country whose banks have blown up already? Where the capital injections for the banks are so gigantic that they more or less double the national debt? And where banks mostly live on liquidity support from the rest of Europe? That place is Ireland, and somewhere, someone is hopefully thinking what I am thinking -- this is the time to get out.

The euro was a gigantic mistake in the first place, a vainglorious triumph of politics over sound economics. When the financial crisis broke out, the Queen famously asked during a visit to the LSE - why didn't anybody notice in advance? On this one, for once, many economists were actually acutely aware just how bad an idea the euro was. Barry Eichengreen wrote many articles and a book warning about foisting a new gold standard on advanced economies with massive nominal rigidities. Nobody listened.

Ireland will have to suffer massively in years to come as it is for the folly of its bankers and the stupidity of its housing bubble. It will have to live with IMF-EU imposed austerity. Why not try to get something in exchange for all that pain? A new Irish pound, introduced overnight, would quickly devalue and restore Irish competitiveness. An independent central bank could set appropriate interest rates while anchoring inflationary expectations. The banks would still have to struggle with potential asset-liability mismatches, but the problem cannot be large compared with the capital injections necessary already. And depositors have been taking their money out already. Once the new currency is in circulation, they can put it back in, as there is no uncertainty about the Irish future of the euro left.

What would this do to the rest of Europe? An Irish exit from the nightmare that the euro has become would surely see Greece, Spain, and Portugal leave, too. Depositors there would run on their banks to get euros out while they still can. Banks in some of these countries are healthier than in Ireland; an Irish exit would impose some real costs on the Club Med. And yet, much of the "health" of Spanish banks is illusory anyway, as it depends on fantasy valuations of all the brick and mortar on their balance sheets (something that the Bank of Spain is increasingly concerned and unforgiving about). A quick exit may still be better than a decade of slow, grinding deflation combined with Zombie banks and Zombie household balance sheets being kept on artificial life support before the inevitable rise in interest rates at some point pulls the plug.

When Britain left the gold standard in 1931, the governor of the Bank of England famously declared (having been aboard a ship and out of contact when the decision was made): "I didn't know we could do that." Leaving the euro may seem similarly unimaginable to many, but it may be just as feasible. In the 1930s, cutting the link quickly led to a recovery of demand, by reducing deflationary pressures. Far from the shattering blow to confidence feared by many, exiting the gold standard was actually great for business. Leaving the euro may be every bit as good.

Tuesday, 23 November 2010


too much of everything! First we had Alan Krueger yesterday, who just stepped down Assistant Secretary of the US Treasury for Economic Policy, giving the Inaugural Lecture that officially "opens" our academic year... He spoke on economic policy making - lessons from the US experience... and a good show it was!

Today we had Robin Burgess from the LSE speaking on "Weather and Death in India". Together with his coauthors, he finds that a single day of more than 36 degrees in India raises the annual death rate by about 1%, which is a huge effect... and may bode ill if all the predictions about rising global temperature are right.

A very accurate real estate idiot ranking...

goes live over at IDEALISTA. What is a flat or house worth? Whatever the value of having a roof over your head is... discounted to the present. Economists look at variables like the average rent to average house prices, and if the ratio is very low, you can normally be sure that the adjustment (back to its long-term average) comes through lower prices, not higher rents. The reason is that rents get paid out of current income, and house prices can be sustained by someone selling his house and buying a bit of extra house elsewhere... without ever being able to afford the price of the new one if he had to finance it all. In Spain, rental ratios were laughably low for some time, around the 2% mark. In the US, we are getting back to numbers around 3.5-4.5%, which seems about right; in Germany, the current ratio is 5-7.5%, meaning that rents are high relative to prices (mainly because prices are low).

All these comparisons are normally a bit doubtful because you have to believe that the average house for sale is like the average house for rent. That may or may not be true, and depends on rental law, etc. But sometimes, you can get it 100% right -- if the same house is available for renting or buying. That is what the good folks at Idealista have used to compile their list. Most of the owners listing their properties at these prices are clearly smoking something interesting -- a house in Asturias (listed without pictures) is for sale for 2.5 million €, or 2,500 p.m. Wow, that's a rental yield of 1.2%! Even the house ranked 80th (from low to high) only produces 2.66%. I would say two things. First of all, Robert Shiller must be right -- you have to believe in behavioral explanations to understand these owners. Second, the extra-slow-motion-deflation of Spain's housing bubble has a long way to go...

Saturday, 20 November 2010

Solving the US federal deficit problem

is easy and fun... at least over at the interactive NY Times website:

There, you will encounter a wide range of spending cuts and tax increases. Mix and match to solve the problem. I guess I am a mild fiscal conservative, ending up with a share of 56% spending cuts to 44% tax increases in my preferred plan. Give it a try!

Tuesday, 16 November 2010

It's a dirty job

but someone has to do it... Which student hasn't dreamed of it? One of your professor lying in the dirt before you? That's what our ITFD students got today at lunchtime, when we played a few rounds of beach volleyball. In the first pic, you can see your sincerely after getting up again, admiring the energy and hand-eye coordination of our students. In the second one, Joonas Uotinen gets ready to slam the ball hard as Rachel Lund passes it back. As days in November go, there are worse things to do at midday!
Thanks to ITFD '11 student Kart Siilart for the picture, who, in addition to having a psychology degree from Harvard and an MBA from Insead, also turns out to be a pretty decent photographer...

Friday, 12 November 2010

Good news from the bureaucratic front - we're official!

Why oh why does the EU turn every good idea into a bureaucratic nightmare? When I first heard about the Bologna ideas, I was really excited. Three-year BAs, compatible degrees across Europe, new syllabi - I could already see good education of the snappy, focused, useful variety coming to all of Europe (and not just the UK). Some years later, it's clear that the teaching Taliban have highjacked the undergraduate teaching structure; many ideas entirely unrelated to the basic idea of having compatible ideas across Europe have been tagged on. One of the really idiotic things that the Bologna process gave us is that Master's degrees now need to be certified by the national authorities -- you can get an "official" and "unofficial" master, effectively. In the US, there are universities that are accredited, and those that are not - fine. MIT is accredited, and Abraham Lincoln College in Podunk, Nebraska, is not. But the idea of perfectly well-established universities having to submit each and every course syllabus, etc., for a master to be officially approved (including those that have been taught for decades) is straight out of Kafka.

To cut a long story short, we got there -- the good fairies in the Barcelona GSE office guided us through the whole process, and starting with the class of 2011, our (and all other Barcelona GSE) masters are official - hooray!

Monday, 8 November 2010

The gold bug bites hard...

There I was, innocently trying to explain why my students should learn about the gold standard... and trotted out the "usual suspects" in terms of explanations. It's a bit like EMU, folks! It tells us about what social and political factors matter for running a monetary system! etc. And only two weeks after that problem set on the gold standard, out comes Bob Zoellick, head of the World Bank, arguing for a new gold standard. I have to say, I almost swallowed my gum when I read the headline. It's not Ron Paul, but Zoellick, who made a pretty decent trade negotiator under George W. Bush. We know that a) gold is very good if you want to kill inflationary expectations b) works disastrously if your problem is deflation c) is the worst thing you can do if your labor markets are rigid. Now, let's see what we know about the current crisis. Inflation is NOT the problem -- if anything, Bernanke and friends worry themselves sick over the fact that inflation is too low, and monetary policy doesn't have enough oooomph as a result. Labor markets are pretty rigid everywhere in the developed world. Even after a few decades of "structural reforms", we still have long-term labor contracts, unemployment insurance, etc. (and a good thing, too). The 19C labor market where workers traded their time for cash the way we trade tomatoes is long gone, and nobody except some freaks on the luny fringes of economics wants them back. So why would anyone want a new gold standard? Apparently, Zoellick feels that it would anchor inflationary expectations, etc., but he doesn't have much to say about why this should be a problem when financial markets predict less than 2% on average over the next 10 years. For my money, Keynes' verdict on gold stands - it's a "barbarous relic".

Who is afraid of currency wars?

At the Central Bank of Chile conference the other day, talk naturally turned to the threat of what the Brazilian finance minister Guide Mantega called "currency wars" -- the danger that the world is headed for major conflict over currency movements. All of this is coming from a) unease about the exchange rate of the Chinese currency, which many American politicians feel is too low b) fear in the rest of the world that American pump-priming in the form of quantitative easing will put undue upward pressure on their currencies. On the bus over to the conference restaurant, I had the good fortune of chatting with Olivier Blanchard, currently chief economist of the IMF, and as we talked (without attributing anything specific to him or the IMF) it occurred to me that the current discussion is quite similar to what we used to think about the end of the gold standard during the Great Depression. The standard story used to say - everyone devalued against gold, i.e. against each other, in a bid to improve the competitiveness of their economies. By the end, relative rates were not much changed -- but you had tremendous turmoil in between, and world trade collapsed. That's saying currency wars in the 1930s were really bad, and the implication is gloomy -- we are at it again.

The new view, pioneered by Barry Eichengreen and others, holds that devaluing against gold was good because it broke the grip of deflation. Relative exchange rates may not have moved much, but that wasn't the point -- reflating by getting the money supply up was. In that sense, if we all did a bit of quantitative easing, a bit of "currency war" might be a good thing. It's also an interesting way of aligning incentives. The standard problem in an open economy is that we want our neighbor to stimulate his economy (especially if there is a risk of inflation) - much better than to do it at home. Because QE likely has an impact on exchange rates, this "free rider" problem is mitigated - you may still benefit from your neighbor's QE, but you will pay a price through a higher exchange rate if you don't move as well. In that sense, the non-cooperative policy setting that Mantega described may be a good "second best", provided you believe that Europe is being a bit conservative in terms of monetary policy... The part of the world that really does have a problem is epitomized by Mantega's Brazil, which as been booming and certainly doesn't need more stimulus. But then, perhaps it can live with a higher exchange rate as a price for equilibrating growth around the world.

Congratulations to Fernando Broner, who wins an ERC grant

Fernando Broner, a specialist on international finance and sovereign debt, was deputy director of ITFD for its first two years and is now on the steering committee as well as teaching 2 courses (and co-directing independent study projects). He has just won an ERC starting grant award. I want to congratulate him on this important distinction -- the ERC has been at the forefront of modernizing science funding in Europe, by making it more open, competitive, and all-round sensible (i.e. more like the NSF in the US). But then, I would say that -- I got one, too, in the first round of the advanced grant scheme a few years back. Jaume Ventura, who is in charge of student affairs at ITFD and teaching courses on "contemporary problems in macro" as well as "international finance", got one last year, and so did Nicola Gennaioli, who is teaching for us in the third term... which means that 4 professors involved in running our program got a love letter from Brussels. At least as a percentage, I think this must be higher than in any other masters program in Europe... and UPF economics must have one of the highest concentrations of ERC awards, given that Fernando is bringing our total to 8:
  1. Jordi Gali
  2. Jaume Ventura
  3. Jan Eekhout
  4. Gino Gancia
  5. Nicola Gennaioli
  6. Joachim Voth
  7. Marta Reynal
  8. Fernando Broner