Tuesday, 17 April 2012

Student Guest Contribution: The EU Proposal for a Tobin Tax

As part of the requirements for the ITFD master, our students write a policy memo. Instead of looking at an issue analytically, we ask them to work in teams, and to come up with a concrete policy proposal, assess, and try to convince people of its merit. The students aren't done yet, but they have had to write a first version. This year, I was particularly taken with a contribution by four ITFD students - Alex Hodbod, Daniel Chorzelski, Hannes Timischl, and Lukas Doerfler. Their team is working on the benefits and problems of the Tobin tax, as proposed by the EU commission. Here is their assessment:

Blogpiece – Financial Transaction Tax:Financiers have a lot to answer for. As the architects of the ‘structured products’ that turned into ‘toxic assets’, as the funders of those subprime mortgages, and as the recipients of hundreds of billions in taxpayer bailouts during the crisis, they are blamed by many for the mess the world economy is in. With anti-banker sentiment reaching fever pitch politicians, commentators are looking for ways to tame financial market excesses. One of the more interesting of such proposals is the Financial Transaction Tax, or Tobin Tax. In our Masters project we will investigate whether the introduction of such a policy is a good idea. Here we give some initial insights on the issues raised. We find that the proposal has some merit as a tool to curb trading that is of dubious social value e.g. some high frequency trading and some derivatives activity, but that more targeted interventions might address problems more efficiently.
This idea was initially proposed by John Maynard Keynes in 1936 as a mechanism to reduce uninformed short-term speculative trading and thereby reduce the excessive volatility that the financial sector caused for to the real economy. James Tobin reinvigorated the idea in 1971 with a stronger focus on taxing international trading and maintaining countries‘ economic independence in a floating exchange rate environment. Since then the idea has attracted the support of latter day economic heavyweights such as Joseph Stiglitz (1989), and most recently Paul Krugman (2011).
With such an illustrious list of advocates it does not come as a surprise that policymakers have become interested in this idea. Gordon Brown began this trend by backing an FTT at international meetings in 2009. Support has gradually grown in the European Commission, which recently published a specific proposal for a cross-EU Tobin Tax. The Commission‘s draft proposes a 0.1% tax on the exchange of shares and bonds and 0.01% across derivative contracts. The tax would be levied when one of the trading partner is located within the European Union. Our work will use this proposal as the basis for analysis. We investigate how effective the tax will be at its stated objectives of generating revenue and reducing volatility, and look at the wider negative impact – most notably on the price of and access to funding:
Generating revenue – the EU’s 57 EUR billion estimate is based on a tax of a very broad range of transactions, and involves contentious assumptions about the elasticity of demand for transactions, and the behavioural response of economic agents (who may relocate transactions in order to avoid the tax). In our view the estimate is on the high side of what could be extracted and we see huge political economy problems generated by the uneven geographical distribution of revenue creation from the tax as proposed (with the majority coming from the UK) which makes it unlikely to be agreed.
Reducing volatility – if short term transactions produce more volatility than long term trades, then the tax should reduce overall volatility, as the burden will fall more heavily on shorter term ‘high frequency’ traders. Unfortunately, both the empirical evidence from FTTs in operation, and economic theory generally tends to suggest that decreasing liquidity through an FTT would if anything increase volatility. However, this evidence is generally based on the impacts of equity and debt securities transaction taxes, whereas the EU proposal would fall hardest on derivative activity - as discussed below.
Cost of finance – to the extent that financial markets are competitive the costs of an FTT will at least in part be passed on to the consumers of financial services – most importantly the entrepreneurs in search of finance for projects that will create wealth and employment. In addition, through increasing the illiquidity premium investors demand for holding less liquid assets, an FTT will tend to reduce asset values. This net worth effect can reduce firms’ access to pledgeable collateral and thereby make financing more costly and less available. Estimates of the increase in the cost of capital differ greatly across the literature – Schwert and Seguin find a range of +10 - +180 basis points, Oxera find a range of +66 - +80 basis points.
What is perhaps most interesting about the EU’s proposed FTT is the questions it poses about the value of the huge increase in the volume of derivative activity over recent years. This opaque and ill understood world has exploded in size and importance in the past two decades, and the economic consequences of this remain uncertain. The graph below (taken from Financial Transaction Tax: Small is Beautiful, Darvas & von Weizsacker, 2010) shows the annual turnover of spot and derivatives market trades as a ratio of world GDP.

Total turnover in 2007 had reached almost 70 times total world GDP, 88 per cent of which was accounted for by derivatives trading. This represents a tripling of activity since 1995. Looking at these numbers it is difficult to avoid the instinctive reaction that this market was (and may still be) completely out of control. It is also noticeable that this revolution in the volume (and complexity) of transactions has not been translated into any obvious improvement by the financial sector in its core functions of intermediating credit between savers and borrowers, and allocating resources efficiently. Perhaps a dosage of Tobin’s ‘sand in the wheels’ of this market wouldn’t be the worst thing in the world. 
There is much work to be done to fully understand the different effects of an FTT, not least its application to the derivative market whose value added to the real economy is itself not well understood. Given this, the policy’s most coherent rationale is possibly just that: ‘something must be done’ to slow down the financial sector’s recent tendency to generate ever more transactions and extract ever larger rents whilst failing to improve its service to the real economy. The Tobin tax is a ‘something’ that could fit into this bracket. It may play a useful role as an interim measure to slow some unhealthy tendencies down prior to the introduction of more targeted interventions to address the market failures manifest in excess trading once these are better understood. Meanwhile it could also help to address the public’s concerns about the financial sector’s excessive remuneration and modest tax contributions. However, the question is whether this is sufficiently convincing to justify the potentially significant increase in the cost of capital it would create. As things stand, with Europe still in the midst of a substantial sovereign debt crisis, political leaders seem to have decided that now is not the time to add further to firms’ difficulties in raising funds, and therefore the EU Tobin proposal remains stalled in the EU machinery. Even if that is where it remains this time round, one thing we can be sure of is that the calls for its implementation will resurface somewhere before too long – as the Tobin tax is the idea that will not die.

Saturday, 14 April 2012

My Inet Lecture in Berlin

... due to family reasons, this must have been the shortest trip I ever took, but with 1,600 + hits on youtube on day one, it seems to have hit a nerve:

The whole thing was made more challenging by the (normally highly efficient) INET people not managing to upload my presentation, so that I had to speak without slides or a manuscript. At least, one finds out if one knows one's own stuff...

Monday, 9 April 2012

"What has to be said" - Germany's leading Waffen-SS poet lectures Israel on its right to get nuked - special edition

Günter Grass, German novelist and poet and a Nobel Laureate, is causing a stir with his poem "What has to be said." You can see him read it here. As poetry goes, it is a sad joke; it has no redeeming poetic qualities whatsoever. Instead, it displays every last bit of incoherence and moralistic-condescension-as-politics that makes German left-wing public discourse to sickening to watch, especially for those who (like me) actually can occasionally see some merit in the arguments. This time, however, there are no such redeeming features.

Let's start in the beginning. What is it that Grass feels he has to say? He can no longer remain silent, he says, given that Israel now claims a right for a first strike on Iran. He thinks that this is all wrong. Israel has nuclear weapons, many; and the mean Israelis don't even want those nice Iranians to have a single one! And a pre-emptive strike? How evil. The German involvement, the reason why Grass now has to go public? Selling submarines to Israel. In his book, this is equivalent to collaborating in a crime against world peace. If this all sounds confused and confusing to you, that is because it is. Grass was never very coherent, but old age has not helped. Some of his novels are decent, and form part of German curricula for a reason. 

If you think in abstract categories of "should sovereign states be allowed to decide if they want nuclear weapons", the most you can say is that there a hint of logic here. Almost a century ago, the German economist/lawyer/sociologist Max Weber distinguished two types of ethics - ethics of intent ("Gesinnungsethik") and ethics of responsibility ("Verantwortungsethik"). One cares about feeling superior and good about your own intentions, and consequences be damned; the other thinks through what the results of one's own actions will be, and then decides on a responsible course of action. Tom Lehrer, the American mathematician and comedian, described the left-wing penchant for ethics of responsibility best in his Folk Song Army:
One type of song that has come into increasing prominence in recent months is the folk-song of protest. You have to admire people who sing these songs. It takes a certain amount of courage to get up in a coffee-house or a college auditorium and come out in favor of the things that everybody else in the audience is against like peace and justice and brotherhood and so on. The nicest thing about a protest song is that it makes you feel so good...

We are the Folk Song Army.
Everyone of us cares.
We all hate poverty, war, and injustice,
Unlike the rest of you squares.

If you feel dissatisfaction,
Strum your frustrations away.
Some people may prefer action,
But give me a folk song any old day.

Remember the war against Franco?
That's the kind where each of us belongs.
Though he may have won all the battles,
We had all the good songs.

Grass's so-called poem is ethics of intent at its most maddening. The idea of moral equivalence between Israel and Iran is so troubling that one doesn't really know where to start. Israel is the only more-or-less democratic, open, Western, more-or-less liberal country in the Middle East. Whatever one thinks of occupation policies, the country as a whole has freedom of speech, freedom of assembly, free elections, a free-market economy.  Let's think through where Grass's logic leads. Iraq, accordingly, should have also had a right to build nuclear weapons; Israel was wrong to attack the Osirak reactor in 1981, too. How would a world with an Iraqi nuclear weapon have looked? How much of Tel Aviv would be left after the last Scud missile had rained down on Israel? Not much.

I am not saying that attacking Iran now is a brilliant idea; it may well be very, very stupid, given how advanced the Iranian program is and how hard it will be to degrade Iran's nuclear capability. But the idea that the (not exactly nice) Netanyahu administration should not consider all options, faced with the chance that a madcap regime like the Iranian one might acquire the bomb, is simply bizarre. And it doesn't call for self-absorbed, vacuous and quite frankly bad "poetry" from a former soldier of the Waffen-SS, no less; it calls for considered judgement and hard choices, for responsible pragmatism.

Sunday, 8 April 2012

Austerity and Confidence

Brad Delong has written an excellent VOX piece containing some home truths on austerity, together with a review of the latest writings by Corsetti, Alesina, and Giavazzi:

VoxEUThis column is a Lead Commentary on VoxEU's debate on Austerity:In their recent ‘Lead Commentary’, Alesina and Giavazzi (2012) attack Corsetti (2012) for missing the point:
The European debate on fiscal austerity has gone astray – focusing exclusively on the size of deficit reductions. What policy makers should really be focusing on is the budget tightening’s composition (tax versus spending) and on the accompanying policies. Indeed, the title of this Vox debate – “Has austerity gone too far?” – reflects this inappropriate emphasis…
But as I read further, I feel that Alberto Alesina and Francesco Giavazzi immediately proceed to miss an even bigger point. They say:
…spending-based consolidations accompanied by the right polices tend to be less recessionary or even have a positive impact on growth. These accompanying policies include easy money policy…
But right now in Europe we are not going to have easier monetary policies to offset the contractionary effect of fiscal policies, are we?
Indeed, it is not even clear what, in today's context, easier monetary policies would mean.
The ECB could induce banks to make more loans, and fund more investment and consumption spending by credibly promising to raise its permanent inflation target – but it will not so promise, and it would not be believed if it did. The ECB cannot induce banks to make more loans and fund more investment and consumption spending by swapping bonds for reserves as long as the value of pure liquidity is zero and reserves are as good as – nay, better than – short-term bonds. The ECB could induce banks to make more loans and fund more investment and consumption spending by taking risk onto its balance sheet and so freeing-up scarce private risk-bearing capacity – but is that monetary policy? No, that is fiscal policy, albeit non-standard fiscal policy.
Fiscal policy is the only game in town. If austerity is to boost recovery, it must do so because it in itself is good for recovery – not because it is accompanied by monetary policies that speed recovery.
It is certainly the case that a Europe with shaky credit could boost its economy by pursuing a spending-based reduction in its deficit that boosted confidence in public credit. As Karl Smith (2011) of UNC Chapel Hill noted, one way of seeing this is to look at a neo-Wicksellian equilibrium flow-of-funds condition in financial markets. On the left-hand side place the net flow of private savings into a country's financial market: its domestic private savings which depends on the level of economic activity (i.e. Savings[Y]), minus net exports (NX). On the right hand side place the change in the desired bond holdings of banks and other investors, a function of the riskiness of bonds ρ and the real opportunity cost of money to banks, the difference between the nominal interest rate i and the expected inflation rate π, i.e. i.e. ΔB[i - π, ρ]. The resulting neo-Wicksellian equilibrium condition is:
Savings[Y] - NX = Δ Bond_holdings[i - π, ρ]
This equation tells us that the warranted level of domestic private savings – and thus, via savings, the short-term equilibrium level of economic activity Y – can be boosted by: 1) a depreciation that raises NX, 2) monetary policy that reduces i, 3) a commitment to higher future inflation that raises expected inflation π, or 4) policies to reduce the riskiness ρ of the bond stock – by policies like loan guarantees, forced recapitalization of the financial sector, or adoption of a budget strategy that reduces the risk of holding private or public bonds that may be subject to default, less-than-fully-voluntary exchange, or unexpected inflation.
The only stimulus possibleIn a situation where an economy is at the zero lower bound so that i cannot be lowered, a central bank that will not raise π, and a common currency that rules out depreciation to raise NX, reducing the riskiness ρ of the bond stock is the only game in town.
Now a credit-worthy government like the US would have no problem reducing the average riskiness ρ of the bond stock. It would simply issue more bonds and spend the money on projects of social utility. Because its credit is good, its bonds are automatically less risky than the average, and so the average riskiness of the bond stock falls.
And a government with shaky credit that adopts a credible fiscal plan also has no problem reducing the average riskiness ρ of its bond stock. It adopts its plan. Its plan is credible. And, voila, the average riskiness of the bond stock declines – and so the warranted flow of private domestic savings rises, and so the equilibrium level of economic activity rises as well.
What makes a fiscal plan credible?But what is a credible fiscal plan? It certainly involves in the long-run balancing the funding requirements of the promised social insurance system with taxes. But what does a credible fiscal plan require in the short run? Does it require austerity now, and spending cuts now?
The point of Lawrence H. Summers's and my contribution to the spring 2012 Brookings Institution Panel on Economic Activity was that, as a matter of basic arithmetic, if there is any short-term Keynesian multiplier at all – even one as low as 1/2 – and if there is any long-run shadow cast on potential output by a deeper economic downturn at all – even one as low as 1/10 – then for a country like those of western Europe with a marginal tax-and-transfer share 0.4 and an expected long-run growth rate of 2% per year, short-term spending cuts worsen the long-run fiscal picture as long as the government's real long-term borrowing cost is under 5%.[1]
Thus, unless we believe that the long-term real borrowing costs for western Europe as a whole will be more than 5% per year – that nominal borrowing costs will be more than 7% year – spending cuts now to reduce the deficit are likely to erode rather than bolster the overall fiscal situation. They damage rather than restore confidence. They raise rather than lower the riskiness of the outstanding bond stock. And so they reduce rather than raise employment and production in the economy.
Credible plans and programs for long-run fiscal balance, yes.
Structural reforms to free-up enterprise and increase opportunity, yes.
Reworking the social-insurance state to make it cheaper and less wasteful, yes.
But spending cuts now to lay sacrifices on the altar of credibility in the hope of improving confidence and reducing the riskiness of the outstanding bond stock? No. The arithmetic simply goes the wrong way – unless you believe that Eurozone nominal bond yields will soon normalize to levels above 7% per year.
ReferencesAlesina, Alberto and Francesco Giavazzi (2012). "The austerity question: ‘How’ is as important as ‘how much’", VoxEU.org, 3 April.
Corsetti, G (2012), “Has austerity gone too far? A new Vox Debate”VoxEU.org, 2 April.
DeLong, Bradford and Lawrence H. Summers (2012). “Fiscal Policy in a Depressed Economy”, paper presented at the Spring 2012 Brookings Panel.
Smith, Karl (2011). “More on BL-MP”, blog post on Modeled Behavior, 8 October 2011.

Greece's money supply is

evaporating at a very high rate. The usually excellent Sober Look blog dissects the paradox of the BOG's growing balance sheet on the one hand, and the country's imploding monetary aggregates on the other:

The ECB has completely lost control over the monetary policy for GreeceThe Bank of Greece balance sheet has expanded sharply this year. This of course is part of the ECB's balance sheet expansion on a consolidated basis. But the Greek central bank's balance sheet by itself is now almost €200 billion. That's an unprecedented amount for Greece and represents over 65% of the nation's annual GDP. It is also close to a 50% increase year-over-year.
Bank of Greece balance sheet ( €mm, source: BoG)

One would expect at least some impact on the monetary aggregates from such a dramatic expansion. Yet the money supply measures, both narrow and broad have collapsed. We've seen this before with other periphery nations such as Italy. But nothing on this magnitude.

Greece contribution to Eurozone's money stock year-over-year growth (source: BOG)

This trend shows a massive drain of liquidity out of the system that will result in a total seizure of credit. How can the ECB claim any control over the monetary policy when a 50% increase in the Greek central bank's balance sheet results in a 16% decline in M1 and nearly a 20% decline in M3 money stock?  Greece is now in a  permanent state of extraordinarily tight monetary conditions no matter what the central bank does. In such an environment there is absolutely no hope for any growth, let alone fiscal consolidation. It seems the only possible solution for Greece may be to take control of its own monetary policy, which would require abandoning the euro. An ugly outcome, but given the ECB's inability to stabilize Greece's rapidly shrinking money supply, there may be little choice.

Friday, 6 April 2012

What's being cut in Spain?

You may have read about budget cuts in Spain. Where do they fall? Over at nada es gratis, a great econ blog (in Spanish), FLORENTINO FELGUEROSO has a great post on "Bread and Circus". R+D is going down; this matters for the hard sciences. In the humanities and social sciences? Not sure. Research grants from the Research/Education/add renaming exercise here Ministry were always so small you needed a microscope to see them... largely independent of the merit-points in the academic evaluation, or the amount one requested. Apparently, the time-honored distribution rule was "cafe para todos" (coffee for all). You see, discrimination based on quality is inappropriate. So, to be honest, this won't make much of a difference to the quality of research that I see going on here; funding was a joke long before. All the serious money comes from the ERC anyway these days, at least in economics. Job training is also being cut, clearly part of a cunning plan in a country where unemployment is pushing towards 25%. And what's going up by 13.6%? Payments to the state's sports agency. No joke. Apparently, they are taking on some new responsibilities, too, so this is not quite comparing like with like, but it is still... pretty depressing.

All of this reminds me of an old joke by American comedian Evan Esar, who said "America believes in education: the average professor earns more money in a year than a professional athlete earns in a whole week." Let's do the numbers for Spain. The country's soccer clubs dominate the international leagues largely by paying what it takes, and buying the best, like Cristiano Ronaldo (Brazil) - current pay $17.06 million -- and Lionel Messi ($ 16 million). Average pay at Barca and Real Madrid is now $ 7 million p.a. Most professors would be hard-pressed to earn €45,000 a year. So the equivalent calculation to Esar's quip is even worse: "Spain believes in education: It pays the average professor more money in a year than a soccer player earns in three days of hard work." 

Thursday, 5 April 2012

Suicide in Athens - Remember what touched off the revolution in Tunisia?

That's right, a very public suicide. Mohamed Bouazizi burned himself in December 2010; less than a month later, President Zine El Abidine Ben Ali had fled the country. The Arab Spring got going in earnest. Now comes the news that a pensioner shot himself in Athens, followed quickly by a wave of rioting (via BBC):

Protesters have clashed with riot police in the Greek capital, Athens, hours after a pensioner shot himself dead outside parliament.
The 77-year-old man killed himself in the city's busy Syntagma Square on Wednesday morning.
Greek media reported he had left a suicide note accusing the government of cutting his pension to nothing.
Flowers have been laid at the spot where he died and tributes have been paid online.
Hundreds of demonstrators gathered in the square outside parliament on Wednesday evening, the scene of many large protests in recent months.
Violence erupted, with petrol bombs hurled at police, who fired tear gas in response.
Depression and suicides are reported to have increased in Greece as the country introduces tough austerity measures to deal with huge debts.
 'Dignified end'
The man has not been officially identified but was named in Greek media as Dimitris Christoulas. He was said to be a retired chemist, with a wife and a daughter, who had sold his pharmacy in 1994.
He shot himself in the central square just before 09:00 (06:00 GMT), Athens News reports.
In the alleged suicide note, found by police and reported by Athens News, he said: "The government has annihilated all traces for my survival, which was based on a very dignified pension that I alone paid for 35 years with no help from the state.
"And since my advanced age does not allow me a way of dynamically reacting... I see no other solution than this dignified end to my life, so I don't find myself fishing through garbage cans for my sustenance."
Dozens of people left handwritten messages and flowers at the spot where Mr Christoulas killed himself.
Of course, there is no guarantee that the same course of events will come to pass in Greece... but when people only see their choices as suicide or living out of garbage cans, after paying into the pension system for 35 years, something is VERY wrong. Apparently, the Greek pharmacists' pension fund held a lot of Greek debt, which now got "voluntarily restructured" to be worth 20 cents on the €. 

The News From Spain

can drive you insane...via BBC:

Spain's jobless level hits record 4.75 million
The jobless rate in Spain stood at 23.6% in February, according to EU figures released on Monday.
Meanwhile, Spain has said its public debt will leap more than 10 percentage points this year to 79.8% of GDP.
Of course, if you are Eurocrat or a finance ministry official, you will think that austerity isn't failing, it just hasn't been tried long and hard enough.

Tuesday, 3 April 2012

Dutch boy solves Euro crisis

via bloomberg

The Dutch aren't just the tallest people on earth... they are also amongst the smartest. Now comes the news that a 10-year old Dutch boy, Jurre Hermans entered a suggested solution to the Wolfson Economics Prize for finding an exit to the Euro crisis. It comes complete with a diagram summarizing the idea...