Category Archives: Notes

The Uerdingen Line Replaces The Wall

The Economist discusses the North-South divide in Germany which increasingly replaces the East-West division. The Southern states (Saarland, Rhineland-Palatinate, Hesse, Baden-Württemberg, Bavaria, Thuringia, Saxony) do better along many dimensions.

Germans in the southern states … go to better schools, get jobs more easily, earn more and live longer to enjoy it. Their governments have healthier finances, so they can invest more … crime rates are “strikingly” lower in the south.

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Long-Term Real Rates of Return

More from the recent working paper by Oscar Jorda, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan Taylor (“The Rate of Return on Everything, 1870–2015“). (Previous blog post about the return on residential real estate.)

  • Return data for 16 advanced economies over nearly 150 years …
  • …on the income and capital gains (and thus, total returns) from equities, residential housing, government bonds, and government bills.
  • Real returns average 7% p.a. for equity, 8% for housing, 2.5% for bonds, and 1% for bills.
  • Housing returns are much less volatile than equity returns.
  • Real interest rates have been volatile over the long-run, sometimes more so than real risky returns. Real interest rates peaked around 1880, 1930, and 1990. Current low real interest rates are “normal.”
  • Risk premia have been volatile, but at lower than business cycle frequencies.
  • r − g is rather stable in the long run and always positive. The difference rose during the end of the 19th and 20th century.

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The Residential Real Estate Premium (Puzzle)

On Alphaville, Matthew Klein discusses recent work by Oscar Jorda, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan Taylor (“The Rate of Return on Everything, 1870–2015“) according to which

Residential real estate, not equity, has been the best long-run investment over the course of modern history.

… but they didn’t calculate the returns most homeowners actually experience. Most people borrow to buy housing and most people live in their properties without renting them out. This makes a big difference.

… Net rental income has historically accounted for half of the total returns from owning housing. It’s also far less volatile, dramatically boosting the Sharpe ratio compared to what you would get just by looking at changes in house prices.

Housing has beaten stocks since 1950 because rental income has been better than dividend income, not because house prices have grown more than stock prices.

German Federal Constitutional Court vs. European Central Bank

In the FT, Claire Jones reports about the German Federal Constitutional Court’s decision to refer a case against the European Central Bank’s PSPP program to the European Court of Justice.

“In the view of the [court] significant reasons indicate that the ECB decisions governing the asset purchase programme violate the prohibition of monetary financing and exceed the monetary policy mandate of the European Central Bank.” …

While Germany’s constitutional court said the OMT programme was legal, it stipulated, based on an earlier ECJ judgment, that bond purchases had to meet a number of requirements. On Tuesday the Karlsruhe-based court said there were “several factors” to indicate that one of these requirements — that bonds must be purchased on secondary markets and not directly from governments — was being violated under QE.

From the court’s statement:

… any programme relating to the purchase of government bonds on the secondary market must provide sufficient guarantees to effectively ensure observance of the prohibition of monetary financing. The Senate presumes that the Court of Justice of the European Union deems the conditions which it developed, and which limit the scope of the ECB policy decision on the Outright Monetary Transactions (OMT) programme of 6 September 2012, to be legally binding criteria. Against that background, the Senate further presumes that contempt of these criteria would amount to a violation of competences also with regard to other programmes relating to the purchases of government bonds.

… several factors indicate that the PSPP decision nevertheless violates Art. 123 AEUV, namely the fact that details of the purchases are announced in a manner that could create a de facto certainty on the markets that issued government bonds will, indeed, be purchased by the Eurosystem; that it is not possible to verify compliance with certain minimum periods between the issuing of debt securities on the primary market and the purchase of the relevant securities on the secondary market; that to date all purchased bonds were – without exception – held until maturity; and furthermore that the purchases include bonds that carry a negative yield from the outset.

… the PSPP decision can no longer be qualified as a monetary policy measure but instead must be deemed to constitute a measure that is primarily of an economic policy nature.

… the ECB Governing Council may be able to modify the rules on risk sharing within the Eurosystem in a way that would result in risks for the profit and loss accounts of the national central banks and also threaten the overall budgetary responsibility of national parliaments. Against that background, the question arises whether an unlimited distribution of risks between the national central banks of the Eurosystem regarding bonds in default where such bonds were issued by central governments or by issuers of equivalent status would violate Art. 123 and Art. 125 TFEU as well as Art. 4(2) TEU (in conjunction with Art. 79(3) GG).

Previous, related post.

Economics Journals’ Response Times

In a blog post, Douglas Campbell offers a ranking of economics journals by response times (based on non-representative data). The ranking (with # indicating the rank according to citations):

#    Journal Name    Accept %    Desk Reject %    Avg. Time    Median Time    25th Percent. (Months)    75th Percent. (Months)    N =
1    Quarterly Journal of Economics    1%    62%    0.6    0    0    1    71
12    Journal of the European Economic Association    4%    56%    1.2    0.5    0    2    25
14    Journal of Human Resources    18%    58%    1.3    1    0    2    38
6    American Economic Journal: Applied Economics    3%    33%    1.6    2    0    2.5    36
31    European Economic Review    29%    50%    1.6    1    0    3    34
15    Review of Financial Studies    15%    20%    1.8    2    1    2    20
13    American Economic Journal: Economic Policy    7%    40%    1.8    2    0    3    30
42    IZA Journal of Labor Economics    100%    0%    2.0    2    2    2    1
39    Journal of Financial and Quantitative Analysis    33%    7%    2.1    2    1    3    15
44    Journal of Law and Economics    0%    42%    2.1    2    0.5    3    12
17    Journal of Economic Growth    0%    0%    2.1    2    2    3    7
27    Journal of Financial Intermediation    14%    29%    2.1    3    1    3    7
7    Journal of Finance    0%    32%    2.2    2    0    4    19
16    Economic Journal    20%    46%    2.2    2.5    0    4    41
19    Journal of Financial Economics    29%    21%    2.2    2    1    3    14
34    Journal of Health Economics    14%    57%    2.3    2    0.5    4    28
38    Journal of Population Economics    29%    43%    2.3    3    0    4    7
5    American Economic Journal: Macroeconomics    11%    26%    2.3    2    0    4    19
32    Theoretical Economics    8%    0%    2.3    2    2    2.5    12
49    Econometrics Journal    0%    60%    2.4    0    0    5    5
9    American Economic Review    7%    45%    2.4    2    0    4    71
45    Review of Finance    0%    9%    2.5    3    2    3    11
26    Journal of Urban Economics    19%    19%    2.5    3    1    4    16
35    Labour Economics    12%    35%    2.5    2    1    3    17
24    Journal of Applied Econometrics    0%    42%    2.6    2    0    5    19
4    Econometrica    4%    25%    2.9    3    1    4    24
30    American Economic Journal: Microeconomics    23%    15%    2.9    3    2    4    13
3    Review of Economic Studies    3%    37%    3.1    3    0    5    63
21    Journal of Public Economics    8%    25%    3.2    3    1    4    51
36    World Bank Economic Review    0%    50%    3.4    3    1.5    6    8
11    Journal of Labor Economics    0%    20%    3.5    4    2    6    15
43    Journal of Risk and Uncertainty    0%    75%    3.8    3.5    3    4.5    4
10    Review of Economics and Statistics    2%    50%    3.8    2    0    6    50
23    Journal of Development Economics    14%    33%    3.8    3    1    5    36
25    Journal of Business and Economic Statistics    22%    11%    3.9    3    2    5    9
41    Journal of Environmental Economics and Management    24%    10%    4.0    3.5    2    5    21
22    RAND Journal of Economics    7%    15%    4.1    4    4    5    27
47    Journal of Economic Dynamics and Control    50%    17%    4.2    3    1    4    18
33    Journal of Economic Theory    17%    13%    4.2    4    3    5.5    23
46    Journal of International Money and Finance    41%    6%    4.4    3    2    6    17
50    Oxford Bulletin of Economics and Statistics    23%    38%    4.6    4    2    6    13
2    Journal of Political Economy    0%    60%    4.8    3    1.5    7    25
18    Journal of International Economics    19%    6%    4.8    3.5    2.5    6.5    16
20    Journal of Money, Credit, and Banking    20%    15%    5.1    4    2    8    20
40    Journal of Economic Surveys    0%    40%    5.2    5    0    7    5
28    Experimental Economics    29%    14%    5.9    6    3    9    7
29    Journal of Econometrics    11%    11%    7.0    7    5    10    9
48    Econometric Theory    0%    0%    7.0    5    4    12    3
8    Journal of Monetary Economics    21%    0%    7.7    4    3    9    14

Say’s Law

From The Economist’s economics brief on Say’s Law:

Supply gives people the ability to buy the economy’s output. But what ensures their willingness to do so? According to the logic of Say and his allies, people would not bother to produce anything unless they intended to do something with the proceeds. … Even if people chose to save not consume the proceeds, Say was sure this saving would translate faithfully into investment in new capital …

But what if the sought-after thing was [money] … as a store of value, to be held indefinitely? A widespread propensity to hoard money posed a problem for Say’s vision. It interrupted the exchange of goods for goods on which his theory relied. … And if, as he had argued, an oversupply of some commodities is offset by an undersupply of others, then by the same logic, an undersupply of money might indeed entail an oversupply of everything else.

Say recognised this as a theoretical danger, but not a practical one.

Corporate Governance of Crypto Currencies

The Economist reports about conflicting strategies among important Bitcoin players; the struggle aligns pragmatists against libertarian ideologists. It also reports about attempts by competing crypto currencies to strengthen corporate governance:

Tezos, another blockchain, will … not only have regular votes on competing proposals for how to change the system, but a more scientific approach to evaluating them and a way to compensate the developers for coming up with ideas. If their proposals are accepted, they will get paid in Tezos coins. The approach appears to have resonated within the crypto world: when Tezos closed its ICO earlier this month, it had raised a record $232m.

Bitcoin, Arbitrage, and the Human Side of the Blockchain

On Bloomberg view, Matt Levine discusses the recent bitcoin fork. The handling of long and short positions on Bitfinex, a bitcoin exchange, created an arbitrage opportunity, until Bitfinex changed its mind.

Bitfinex announced a policy to deal with the fork, people took advantage of the policy, and Bitfinex changed its mind after the fact. Each of its decisions was rational, and quite plausibly the fairest option available to it. None of those decisions were required by, like, the nature of bitcoin, or of short selling: There is no single obviously correct solution to these issues. Instead, each decision was sort of weird and contingent and reversible: not the immutable code of the blockchain, but just humans sitting around and trying to figure out which approach would cause the fewest complaints. …

The blockchain has a certain stark logical completeness, but it doesn’t address all of the actual human uses required of it. And so it has become encrusted with other human institutions. And those institutions turn out to be unsurprisingly human.

Limits of Arbitrage and Covered Interest Parity

In a BIS working paper, Dagfinn Rime, Andreas Schrimpf, and Olav Syrstad analyze the apparent breakdown of covered interest parity (CIP). They argue that

CIP holds remarkably well for most potential arbitrageurs when applying their marginal funding rates. With severe funding liquidity differences, however, it becomes impossible for dealers to quote prices such that CIP holds across the full rate spectrum. A narrow set of global top-tier banks enjoys risk-less arbitrage opportunities as dealers set quotes to avert order flow imbalances.

The IMF “In Principle” Approves Funding For Greece

In the FT, Mehreen Khan reports about the IMF’s conditional acceptance to lend to Greece.

The IMF’s “agreement in principle” (AIP) tool draws on a practice where the fund is able to greenlight its involvement in a debtor country, conditional on the government and its creditors agreeing to future debt relief measures.

Of course, the dispute about the merits of debt relief is unresolved. The IMF thinks Greek debt is ‘unsustainable’ and the European creditors should bear more losses, earlier on while some Euro area countries disagree. (For the numbers, see here).

Earlier in July, the European Stability Mechanism had approved a new cash injection (FT). This followed a dodgy compromise in June, as reported by Jim Brunsden in the FT:

Euro area ministers and the International Monetary Fund unveiled a deal … that will … sav[e Greece] … from default this summer. The IMF will join the bailout as a partner but withhold any money until euro area finance ministers give more detail on what debt relief they might offer Athens. …

Euro-area policymakers have been trying to reconcile competing EU and IMF visions of the €86bn programme and, crucially, whether it will make Greece’s debts sustainable.

Programme conditions set by euro area governments in 2015 included budget surplus targets that the IMF said were punishingly ambitious and unlikely to be met. The fund set out a different vision: lower primary surplus targets for Athens, coupled with comprehensive pension and tax reform and, crucially, far-reaching debt relief.

At the centre of the puzzle was Germany’s finance minister, Wolfgang Schäuble, who has insisted that the IMF must join if Greece is going to continue receiving tranches of bailout aid — but has also resisted significant debt relief commitments.

Given that the fund could not join up unless convinced that Greece’s debts were being put on to a sustainable path, the euro area and IMF had to find another solution — and it came in the form of asking Athens to do more.

To give the IMF confidence that Greece could hit budget surplus targets set by the euro area, Athens was asked to widen its income tax base and cut pensions. The measures, adopted in May, are estimated to be worth about 2 percentage points of gross domestic product.

In the meantime, Greece plans to regain market access by 2018 (FT).

The Reformation, Education, and Secularization

In a paper, Davide Cantoni, Jeremiah Dittmar, and Noam Yuchtman argue that the Protestant reformation after the year 1517 triggered major reallocation, due to religious competition and political economy.

[T]he Reformation produced rapid economic secularization. … shift in investments in human and fixed capital away from the religious sector. Large numbers of monasteries were expropriated … particularly in Protestant regions. This transfer of resources shifted the demand for labor between religious and secular sectors: graduates from Protestant universities increasingly entered secular occupations. … students at Protestant universities shifted from the study of theology toward secular degrees. The appropriation of resources by secular rulers is also reflected in construction: … religious construction declined, particularly in Protestant regions, while secular construction increased, especially for administrative purposes. Reallocation was not driven by pre-existing economic or cultural differences.

The Black Death and Atmospheric Lead Concentration

During the black death epidemic (1349–1353), atmospheric lead concentration collapsed as mining ceased. This is the result of a study by Alexander More, Nicole Spaulding, Pascal Bohleber, Michael Handley, Helene Hoffman, Elena Korotkikh, Andrei Kurbatov, Christopher Loveluck, Sharon Sneed, Michael McCormick, and Paul A. Mayevski on lead levels in an Alpine glacier. They write that

[c]ontrary to widespread assumptions, … resolution analyses of an Alpine glacier reveal that true historical minimum natural levels of lead in the atmosphere occurred only once in the last ~2000 years. During the Black Death pandemic, demographic and economic collapse interrupted metal production and atmospheric lead dropped to undetectable levels.

Levels-of-atmospheric-lead-c-geohealth-2017

Connecting Central Bank Payments Systems

In the FT, Martin Arnold reports about a new cross-border payment method tested by the Bank of England. The “interledger” program transfers money “near-instantaneously and without settlement risk.” The Bank of England

set up two simulated RTGS systems on a cloud computing platform, using the Ripple interledger to simultaneously process “a successful cross-border payment”.

This is not necessarily good news for the blockchain community. The Bank of England’s proof of concept is

“about connectivity between central bank systems rather than replacing the central bank systems with the blockchain,” [according to] Daniel Aranda, head of Europe at Ripple.

 

 

 

Arguments Against Strict Monetary Policy Rules

In its July 2017 Monetary Policy Report, the Board of Governors of the Federal Reserve System discusses monetary policy rules. On pp. 36–38, the Board argues that

[t]he small number of variables involved in policy rules makes them easy to use. However, the U.S. economy is highly complex, and these rules, by their very nature, do not capture that complexity. …

Another issue related to the implementation of rules involves the measurement of the variables that drive the prescriptions generated by the rules. For example, there are many measures of inflation, and they do not always move together or by the same amount. …

In addition, both the level of the neutral real interest rate in the longer run and the level of the unemployment rate that is sustainable in the longer run are difficult to estimate precisely, and estimates made in real time may differ substantially from estimates made later on …

Furthermore, the prescribed responsiveness of the federal funds rate to its determinants differs across policy rules. …

Finally, monetary policy rules do not take account of broader risk considerations. … asymmetric risk has, in recent years, provided a sound rationale for following a more gradual path of rate increases than that prescribed by policy rules.

Financial Intermediation and Standardization

On his blog, John Kay speculates about the future of financial intermediation:

The paradox of modern capital markets is that although there is less and less need for market activity from the point of view of either the end users of finance, or the investors who are the ultimate beneficiaries of finance, the volume of market activity has increased exponentially. …

The growth of secondary market trading at the expense of an understanding of the underlying exposure led to disaster in the global financial crisis of 2008, just as it had earlier led to disaster at Lloyd’s. …

Standardisation is not an answer to the problem of information provision in financial markets, nor is pervasive information asymmetry successfully resolved by insistence on the provision of detailed financial information on a standardised basis, whether in company accounts or key features documents.

… it is time to raise question marks over the entire market based model of financial services provision. We should be talking about risk management and capital allocation without any presumption that markets are the best way of handling these issues.