Tag Archives: Credibility

“Elektronisches Notenbankgeld ja, Vollgeld nein (Reserves for All, But no Sovereign Money),” NZZ, 2016

Neue Zürcher Zeitung, June 16, 2016. PDF, HTML. Ökonomenstimme, June 17, 2016. HTML.

  • Vollgeld seems attractive because it decouples the supply of money from intermediation. By enabling everyone to use legal tender for electronic payments, electronic base money would satisfy a need.
  • Vollgeld would prevent bank runs, at least partly; render deposit insurance unnecessary and reduce moral hazard; could help stabilize the credit cycle; and would redistribute seignorage to the central bank.
  • But these objectives can be obtained with less intrusive means.
  • Moreover, a Vollgeld system would be hard to enforce. Banks and their clients would establish new means of payment to circumvent the regulation. And in times of crisis, the central bank would feel obliged to provide liquidity assistance and bail outs.
  • The central problem is not that private money is used for transactions; it rather is that the money’s users rely on the central bank to guarantee the substitutability of private money and base money. In a democracy, the central bank cannot credibly let large parts of the payment system go under.
  • A sudden, forceful change of regime does not offer a credible way out of this trap.
  • But letting the general public access central bank reserves without abolishing private money from one day to the other may open a path towards a new arrangement where the public learns to distinguish between private and base money and where only the latter is publicly guaranteed.

Helicopter Drops of Money

In his blog, Ben Bernanke discusses the merits of “helicopter drops” as a monetary policy tool.

[A] “helicopter drop” of money is an expansionary fiscal policy—an increase in public spending or a tax cut—financed by a permanent increase in the money stock.

… the Fed credits the Treasury … in the Treasury’s “checking account” at the central bank, and those funds are used to pay for the new spending and the tax rebate.

… it should influence the economy through a number of channels, making it extremely likely to be effective—even if existing government debt is already high and/or interest rates are zero or negative. … the channels would include:

  1. the direct effects of the public works spending on GDP, jobs, and income;
  2. the increase in household income from the rebate, which should induce greater consumer spending;
  3. a temporary increase in expected inflation, the result of the increase in the money supply. Assuming that nominal interest rates are pinned near zero, higher expected inflation implies lower real interest rates, which in turn should incentivize capital investments and other spending; and
  4. the fact that, unlike debt-financed fiscal programs, a money-financed program does not increase future tax burdens.

[Debt financed spending programs lack channels 3 and 4.]

[Helicopter drops are subject to various] practical challenges of implementation, including integrating them into operational monetary frameworks and assuring appropriate governance and coordination between the legislature and the central bank.

Longer-Term Interest Rate Pegs

In his blog, Ben Bernanke discusses the merits of longer-term interest rate targeting as a monetary policy tool.

A lot would depend on the credibility of the Fed’s announcement. If investors do not believe that the Fed will be successful at pushing down the two-year rate … they will immediately sell their securities of two years’ maturity or less to the Fed. … the Fed could end up owning most or all of the eligible securities, with uncertain consequences for interest rates overall. On the other hand, if the Fed’s announcement is fully credible, the prices of eligible securities might move immediately to the targeted levels, and the Fed might achieve its objective without acquiring many securities at all.

… A policy of targeting longer-term rates is related to quantitative easing in that both involve buying potentially large quantities of securities. An important difference is that one sets a quantity and the other sets a price. … Concerns about “losing control of the balance sheet” were a factor behind the Fed’s choice of quantitative easing over rate targets while I was chairman.

Conceivably, QE and rate-pegging could be used together … with QE working through reduced risk premiums while the rate peg operates indirectly by affecting the expected path of short-term interest rates. … The principal limitations of rate pegs are similar to those of forward guidance: Both tools are relatively less effective at affecting interest rates at longer maturities, and even at shorter horizons both must be consistent with a credible or “time-consistent policy” path for short-term interest rates.

The German View of The Crisis

On VoxEU, representatives of the German Council of Economic Experts outline the German crisis narrative. In disagreement with the ‘consensus view’ outlined in Baldwin et al. (2015) the German economists including Lars Feld, Christoph Schmidt, Isabel Schnabel and Volker Wieland do not want to

implicate the ‘intra-Eurozone capital flows that emerged in the decade before the crisis’ as the ‘real culprits’. … [Rather] it is the government failures and the failures in regulation and supervision leading to those excessive developments that should take centre-stage in the Crisis narrative.

Consequently, their assessment of the policy response to the crisis is positive:

While the alleged consensus summary concludes that ‘the whole situation was made much worse by poor crisis management’, our view is that the ‘loans for reforms’ rationale underlying the rescue approach was not only sensible, since it was the only way to successfully address the underlying causes of the Crisis. It also worked and substantially improved matters.

Sensibly, the writers favor the

objective of retaining the unity of liability and control in all relevant fields of economic policy.

They promote the ‘Maastricht 2.0’ framework proposed earlier by the German Council.


Europe, Monetary Union and Fiscal Union

In a recent blog post, John Cochrane criticizes the common wisdom that, on economic grounds, the Euro was a bad idea for Europe.

He responds to an earlier New York Times article by Greg Mankiw who argued that conventional wisdom: A monetary union requires (1) cross-subsidization/insurance across regions (“fiscal union”) or (2) significant labor mobility across regions. The US has both, Europe does not; Europe therefore needs regional monetary policy instruments and fluctuating exchange rates to dampen the consequences of adverse regional economic shocks.

Cochrane retorts

I am a big euro fan. … I am also a big meter fan. I don’t think each country needs its own measure of length, or to shorten it when local clothiers are having trouble and would like to raise cloth prices.

Cochrane takes aim at the “deeply old-Keynesian” notion that small regions with fewer inhabitants than the Los Angeles metro area (Greece or Ireland say) are exposed to regional “demand” shocks which require regional fiscal or monetary policy responses. In his view, these are small open economies, and demand shocks arise externally.

Cochrane questions the characterization of the US as “fiscal union.”

In the US, we have Federal contributions to social programs such as unemployment insurance. Europe has the common agricultural policy and many other subsidies. We do not have systematic, reliably countercyclical, timely, targeted, and temporary local fiscal stimulus programs. Just how big is the local cyclical variation in state or local level government spending or transfers? (And why does fiscal union matter so much anyway? If you’re a Keynesian, then local borrow and spend fiscal stimulus should be plenty. The union matters only when countries near sovereign default and can’t borrow.) … Yes, both US and Europe have some pretty large cross-subsidies. But most of these are permanent. … Monetary policy has at best short-run effects, so the argument for currency union has to be about local cyclical, recession-related variation in economic fortunes, not permanent transfers.

He also points out that US monetary union far precedes US “fiscal union.” (And he questions the notion that “tight fiscal policy” lies at the root of Greece’s problems and easy monetary policy would have helped.)

Regarding labor mobility, Cochrane emphasizes again that it is cyclical labor mobility which should matter according to the conventional wisdom. He doubts that there are large differences in cyclical labor mobility between the US and Europe.

Not only are the gains from monetary decentralization in Europe small, according to Cochrane, but the benefits from monetary centralization are large, because of gains in credibility.

When Greece and Italy joined the euro, they basically said, defaulting and inflating now will be extremely costly. They were rewarded for the precommitment with very low interest rates. They blew the money, and are now facing the high costs they signed up for. But that just shows how real the precommitment was.

And Cochrane makes the point that policy should address underlying frictions:

The case for separate currencies is to protect the economy from sticky wages, sticky prices, and sticky people. But none of these stickinesses are written in stone. A plausible answer to my question about pre-new deal US is that prices and wages were not sticky (whatever that means) before the era of regulation. Well, that is a loss, and only very imperfectly addressed by artful devaluation of the currency.  Not every block can have its own currency, so local and industry variation within a country remains hobbled by sticky prices, wages, and people. If sticky wages,  prices and people are the central economic problem, we ought to have a lot of policies to unstick them. We do the opposite, and Europe even more so. The very social programs that Greg implicitly praises for fiscal stimulus tie people to location and undermine labor market flexibility.

He concludes:

So I think a lot of the conventional view seems to think implicitly of fairly closed economies, operating in parallel. But Europe’s economies are open. Moreover, the whole point of the eurozone is to open them further. Small open economies are much worse candidates for their own currency.

“Der starke Franken (Strong Swiss Franc),” SRF, 2015

“Der starke Franken: Des einen Freud, des anderen Leid,” SRF 4 News, July 15, 2015. HTML, AUDIO.

  • Who knows whether the Franc is overvalued.
  • The SNB lost credibility in the short run (and this renders reinstating an exchange rate floor difficult), but not in the long run.
  • Some of the current problems are problems of distribution. The SNB may not be the appropriate institution to address them.
  • Switzerland wants an independent monetary policy. Here are some disadvantages.

“Credibility For Sale,” CEPR, 2013

CEPR Discussion Paper 9562, July 2013, with Harris Dellas. PDF.

We develop a sovereign debt model with official and private creditors where default risk depends on both the level and the composition of liabilities. Higher exposure to official lenders improves incentives to repay but carries extra costs, such as reduced ex-post flexibility. The model implies that official lending to sovereigns takes place in times of debt distress; carries a favorable rate; and can displace private funding even under pari passu provisions. Moreover, in the presence of long-term debt overhang, the availability of official funds increases the probability of default on existing debt, although default does not trigger exclusion from private credit markets. These findings help shed light on joint default and debt composition choices of the type observed during the recent sovereign debt crisis in Europe.

“Die Zukunft des Euros (The Euro’s Future),” FuW, 2011

Finanz und Wirtschaft, February 23, 2011. PDF. Ökonomenstimme, March 1, 2011. HTML.

  • A banking crisis doesn’t imply a currency crisis.
  • Spreads on periphery bonds signal credibility of the ECB.
  • Debt restructuring must not be excluded as a policy option.