Category Archives: Notes

German Banks Send Mixed Signals on Digital Euro

In the FAZ, Christian Siedenbiedel reports that Deutsche Bank questions whether a digital Euro as envisioned by the ECB (i.e., with tight quantity restrictions) would be successful:

Die Argumentation geht so: Die EZB will den digitalen Euro einführen, um auf den verstärkten Währungswettbewerb zu antworten. … Um sich vor solchem Machtverlust sowohl durch Digitalgeld von anderen Notenbanken („Krypto-Dollars“) als auch durch privates Digitalgeld („Global Stable Coins“) zu schützen, treibe die EZB den Digitaleuro voran. Also aus längerfristigen politischen Motiven. Dabei sei unklar, ob der digitale Euro sich international am Markt durchsetzen könne und ob die Menschen in der Eurozone dafür überhaupt Bedarf hätten. “Das Design des digitalen Euros, soweit bisher bekannt, lässt erwarten, dass die potentiellen Nutzer kaum einen Unterschied zu bestehenden Bezahloptionen erkennen werden”.

Update: From the dbresearch document prepared by Heike Mai:

Lifting the limits on how much each user can hold would change the situation entirely, allowing a massive outflow of bank deposits into the digital euro. As a result, lending decisions and money creation would shift from the decentralised, privately owned banking sector to a central, state-run authority: the ECB. In this case, Europe would face the fundamental question of which type of monetary and financial system it wants. The answer to that would have to come from democratically elected representatives.

The German Banking Industry Committee sees a central role for the digital Euro, however, according to a new paper:

In a policy paper, the German Banking Industry Committee (GBIC) for the first time sets out detailed thoughts on the design of a “digital euro”. In this paper, experts from Germany’s five national banking associations draw up an ecosystem of innovative forms of money that extends far beyond the idea of digitalised central bank money, which is referred to as Central Bank Digital Currency (CBDC). The ECB will probably launch the project for a digital euro in mid-July 2021.

“To be successful, the digital euro must do three things: It must be as easy for consumers to handle as cash. It must be viable in the long term for business enterprises, e.g. for automated machine-to-machine payments. And the digital euro must be well embedded in our delicately balanced, carefully secured and highly regulated European financial system because this system guarantees safe and fair access to financial and banking services for everyone in Europe”, notes Dr Joachim Schmalzl, executive member of the Board of Management of the German Savings Bank Association (DSGV), which is currently the lead coordinator for the German Banking Industry Committee.

In the opinion of the experts from Germany’s five national banking associations, issuing money should remain the responsibility of credit institutions in the proven two-tier banking system [my emphasis], even if the digital euro becomes legal tender like cash. For this reason, the ecosystem of digital money which they propose is made up of three key elements:

  • retail CBDC for private use
  • wholesale CBDC for commercial and savings banks
  • tokenised commercial bank money for use in industry

Retail CBDC issued by the central bank is to be used by private individuals in the euro area in the same way as cash for everyday payments, e.g. to retailers or government agencies. It should be possible to use the digital euro like cash, anonymously and offline. For this purpose, credit institutions will provide consumers in Europe with “CBDC wallets”, i.e. electronic wallets.

Wholesale CBDC issued by the central bank is to be used for the capital markets and interbank transfers. The GBIC’s experts are calling for this special form of the digital euro partly because, by adopting this approach, the ECB would be able to include further digitalisation of central bank accounts in its project. The ultimate aim is to achieve improvements which can benefit consumers, enterprises and also the banking sector.

Tokenised commercial bank money, which will be made available by commercial and savings banks, is to complement the two forms of digital central bank money, in particular to meet corporate demand arising from Industry 4.0 and the Internet of Things. Tokenised commercial bank money could facilitate transactions based on “smart” – i.e. automated – contracts and thus increase process efficiency.

“Increasing process digitalisation and automation will provide completely new opportunities for Europe’s enterprises. The banking sector is ready to provide new solutions for its corporate customers by issuing innovative forms of money. The ECB must define the necessary framework that will enable Europe’s banking sector and real economy to make reasonable use of the new opportunities”, Joachim Schmalzl observed on behalf of the GBIC.

I share the skepticism of DB research. And I can understand that banks prefer to maintain the two-tiered system while pushing for broader and more efficient payment options for their business clients.

Green Returns

In the NBER working paper “Dissecting Green Returns,” Lubos Pastor, Robert Stambaugh, and Lucian Taylor argue that excess returns on green assets during recent years are unlikely to predict expected excess returns. At least that’s what theory suggests:

… green assets have lower expected returns than brown, due to investors’ tastes for green assets, yet green assets can have higher realized returns while agents’ tastes shift unexpectedly in the green direction. … green tastes can shift in two ways. First, investors’ preference for green assets can increase, directly driving up green asset prices. Second, consumers’ demands for green products can strengthen—for example, due to environmental regulations—driving up green firms’ profits and thus their stock prices.

In the data

… green stocks significantly outperformed brown stocks in recent years. … green stocks would not have outperformed brown without strengthened climate concerns. …

The bulk of the positive relation between green stock returns and climate-concern shocks evidently occurs with multi-week lags.

Expected returns on stocks are hard to identify, in contrast with expected bond returns. That’s why the authors analyze bond prices and yields:

The inverse relation between a bond’s realized return and the change in its yield to maturity is well understood, and the yield provides direct information about expected return, especially for buy-and-hold investors.

The case of German “twin” bonds illustrates this inverse relation in the context of climate concerns. Since 2020, the German government has issued green bonds, along with virtually identical non-green twins. The green bonds trade at lower yields, indicating lower expected returns compared to non-green bonds. The yield spread between the green and non-green twins, known as the “greenium,” reflects investors’ willingness to accept a lower return in exchange for holding assets more aligned with their environmental values. Since issuance, the 10-year greenium experienced roughly a three-fold widening, presumably due to growing climate concerns. As a result, the green bond outperformed its non-green twin by a significant margin over the same period. However, this outperformance does not imply green outperformance going forward. Rather the opposite is clearly true, given the now wider greenium.

Hermann Hesse’s “Siddharta”

Goodreads rating 4.04.

Seine Wunde blühte, sein Leid strahlte, sein Ich war in die Einheit geflossen. …

Weisheit ist nicht mitteilbar. Weisheit, welche ein Weiser mitzuteilen versucht, klingt immer wie Narrheit. …

Mir aber liegt einzig daran, die Welt lieben zu können, sie nicht zu verachten, sie und mich nicht zu hassen …

 

Swiss Bankers Association on CBDC

In a new working paper the Swiss Bankers Association identifies challenges for banks. Nevertheless it argues that

[a]ny conclusion that the status quo is the least risky option seems premature and shortsighted.

The introduction of digital currencies and design questions regarding payment methods and infrastructure represent strategic business as well as political challenges on which public authorities and business must take a productive position. An informed discussion on the design and implementation of digital currencies is essential. It is time for the general public to consider these issues and drive the opinion-forming process.

Banks’ Response to Reserve Tiering

In a CEPR discussion paper, Andreas Fuster, Tan Schelling, and Pascal Towbin analyze how banks respond to changes in the threshold level above which reserves held at the central bank are charged negative interest:

… exploiting an unexpected decision by the Swiss National Bank in September 2019 to change the threshold calculation without taking any other policy actions. This change led to a large increase in overall exemptions, but with variation across banks. Using a difference-in-differences approach, we find that banks that experience a larger increase in their exemption threshold tend to raise their SNB sight deposit holdings, funded through more interbank borrowing and more customer deposits. The interbank market is important for the funding choice: banks with low collateral holdings (a proxy for market access) use less interbank borrowing and instead grow their customer deposits; they also pass on negative rates on a smaller share of their deposits. Effects on bank lending behavior are moderate; if anything, banks that benefit from a larger increase in the exemption threshold tend to charge higher spreads and take less risk.

Kahlil Gibran’s “The Prophet”

Goodreads rating 4.22.

Your fear of death is but the trembling of the shepherd when he stands before the king whose hand is to be laid upon him in honour.

Surely there is no greater gift to a man than that which turns all his aims into parching lips and all life into a fountain. And in this lies my honour and my reward,—That whenever I come to the fountain to drink I find the living water itself thirsty; And it drinks me while I drink it.

If these be vague words, then seek not to clear them. Vague and nebulous is the beginning of all things, but not their end, And I fain would have you remember me as a beginning.

Working from Home in the Future

In an NBER working paper, Jose Maria Barrero, Nicholas Bloom, and Steven J. Davis argue, based on a survey of 30 000 Americans, that

… 20 percent of full workdays will be supplied from home after the pandemic ends, compared with just 5 percent before. … better-than-expected WFH experiences, new investments in physical and human capital that enable WFH, greatly diminished stigma associated with WFH, lingering concerns about crowds and contagion risks, and a pandemic-driven surge in technological innovations that support WFH.

They predict:

First, employees will enjoy large benefits from greater remote work, especially those with higher earnings. Second, the shift to WFH will directly reduce spending in major city centers by at least 5-10 percent relative to the pre-pandemic situation. Third, … a 5 percent productivity boost in the post-pandemic economy due to re-optimized working arrangements. Only one-fifth of this productivity gain will show up in conventional productivity measures, because they do not capture the time savings from less commuting.

SNB Profit Distributions

The Federal Department of Finance and the SNB have agreed on a new scheme for the distribution of SNB profits. Agreement for the period 2020-2025, Explanations. Some comments in German (also available as PDF):

Profitieren Bund und Kantone finanziell von den höheren SNB-Ausschüttungen?

  • Höhere Gewinnausschüttungen in der Gegenwart bedingen tiefere in der Zukunft.
  • In erster Näherung bleibt das Nettovermögen von Bund und Kantonen unverändert, denn es berücksichtigt auch den Wert der zukünftigen Ansprüche gegenüber der SNB.
  • Siehe z.B. „Die Volkswirtschaft“ 8-9 2020, HTML.

Warum dann die positiven Reaktionen bei Vertretern von Bund und Kantonen?

  • Politiker/Wähler orientieren sich an den ausgewiesenen Schulden des Staates. Höhere Ausschüttungen ermöglichen eine tiefere Schuldenaufnahme. Daher die Reaktionen.
  • Relevanter als ausgewiesene Schulden ist das Nettovermögen. Dieses wird von Ausschüttungen (in erster Näherung) nicht beeinflusst.

Was ist die primäre Wirkung höherer Ausschüttungen?

  • Die Schuldenbremse wird in der Gegenwart gelockert und in der Zukunft angezogen.
  • Falls die Schuldenbremse bindet, erhöhen frühere, höhere Ausschüttungen den Spielraum für staatliche Ausgaben in der Gegenwart, aber nicht in der Zukunft.
  • Hohe Ausschüttungen könnten über ihre Wirkung auf das Eigenkapital der SNB auch deren geldpolitische Entscheide beeinflussen.

Wie ist die neue Gewinnausschüttungsformel ökonomisch zu bewerten?

  • Ausschüttungen sollten die Geldpolitik nicht konterkarieren.
  • Die Geldpolitik setzt Bilanzlänge und -struktur der SNB als Instrumente ein. Ihre Glaubwürdigkeit kann vom Eigenkapital der SNB abhängen.
  • Demnach müssten Ausschüttungen von Bilanzlänge, -struktur und Eigenkapital der SNB abhängen. Nicht vom Gewinn des Vorjahres.

Wie ist die neue Gewinnausschüttungsformel politökonomisch zu bewerten?

  • Problematisch ist, dass der Eindruck entstehen kann, alle paar Jahre würde unter politischem Druck um eine neue Formel gefeilscht. Die Bindung an eine sinnvolle Regel würde diesem Eindruck entgegenwirken.
  • Gleichzeitig reduziert die neue Formel den politischen Druck. Sie signalisiert die Bereitschaft der SNB zur Diskussion.

Wie könnte ein alternatives Ausschüttungsmodell aussehen?

  • Die SNB erklärt periodisch, welche Bilanzlänge und -struktur sie zur Erfüllung ihrer Aufgaben benötigt. Sie stellt sich der Kritik, entscheidet aber eigenverantwortlich.
  • Ausschüttungen sind nicht zweckgebunden. Dadurch wird vermieden, dass sich Interessengruppen bilden, die systematisch auf höhere Ausschüttungen drängen.

Welches Grundproblem bliebe bestehen?

  • Eine ökonomisch begründete Ausschüttungspolitik führt zu fluktuierenden Ausschüttungen. Diese können die Schuldenbremse konterkarieren.
  • Glättet die SNB hingegen ohne geldpolitische Notwendigkeit ihre Ausschüttungen, masst sie sich eine Kontrolle der Fiskalpolitik an, die ausserhalb ihres Aufgabenbereichs liegt.

Peter Bieri’s “Das Handwerk der Freiheit”

Goodreads rating 3.76. An inquiry into language and personal experience.

Bieri analyzes notions of free will, their basis or vacuousness, and their consequences. A powerful dissection of language and experience.

  • Wille ist bedingt durch Historie.
  • Ein unbedingt freier Wille wäre nicht der Wille der Person; er wäre unberechenbar und zufällig — nicht das, nach dem sich Verfechter eines unbedingt freien Willens sehnen. Freier und unfreier Wille sind bedingt.
  • Bedingt freier Wille hat nichts mit Zwang oder Ohnmacht zu tun, denn die Beweggründe liegen nicht aussen; die Person entscheidet.
  • Bedingt freier Wille rechtfertigt daher auch nicht Fatalismus. Nicht Vorherbestimmtheit ist ein Übel, sondern allenfalls das, was vorherbestimmt ist.
  • Verantwortung, Strafe und Moral? “In moralischen Dingen kommt es einzig und allein auf den Inhalt des Denkens an und nicht auf seine Herkunft.” (357) Der moralische Standpunkt ist zumindest eine Konvention, denen Abweichler unterworfen werden. Wir fühlen Reue, daher macht auch Verantwortung intuitiv Sinn.

Some reviews etc.:

  • Sonja Rinofner-Kreidl: Phänomenologische Genauigkeit ist das Ziel, auf das die philosophische Disziplin des Erzählens hinarbeitet (377). Immer wieder findet Bieri prägnante Formulierungen, um die Ergebnisse seiner Überlegungen zu resümieren. Etwa diese: “Ein Wille ist ein Wunsch, der handlungswirksam wird, wenn die Umstände es erlauben und nichts dazwischenkommt.” (41) “Die Freiheit des Willens liegt darin, daß er auf ganz bestimmte Weise bedingt ist: durch unser Denken und Urteilen.” (80) “Wir brauchen kein reines Subjekt, um die Erfahrung von Freiheit und Unfreiheit zu beschreiben.” (272) Bieri betont das Moment der Selbstdistanzierung, welches er zu recht als einen nichtmysteriösen und essentiellen Bestandteil unserer Erfahrung von Freiheit ausweist. Es ist dieses Moment, das die Ausbildung von Wünschen zweiter Ordnung ermöglicht (71, 103f), und uns damit in die Lage versetzt, zu unseren eigenen Wünschen Stellung zu nehmen: nicht Getriebene unseres Wollens zu sein, vielmehr als Urheber und Verantwortliche unserer Handlungen aufzutreten. … Der Wille ist Wille einer bestimmten Person, welche über bestimmte Charakterzüge verfügt und unter bestimmten Umständen denkt und handelt (49ff). Dieser Leitgedanke der Untersuchung ist nicht durch Phänomenbeschreibung gewonnen. Er liegt in der begrifflichen Einsicht, daß ein Wille stets nur bestimmter Wille sein kann (239). Andernfalls wäre er ein leerer Wille, also gar kein Wille. Wer mit diesem Gedanken anfängt, kann nicht dahin gelangen, den Willen als in den Lauf der Welt eingreifend zu denken, ohne diesem selbst unterworfen zu sein, mithin als einen Willen, “der von nichts abhinge: ein vollständig losgelöster, von allen ursächlichen Zusammenhängen freier Wille. Ein solcher Wille wäre ein aberwitziger, abstruser Wille.” (230) … Die Idee eines unbedingten Willens ist, entgegen der Intention ihrer Verfechter, gar keine stimmige Idee. Ein unbedingter Wille, wenn es ihn denn gäbe, wäre ein unfreier Wille — ein sich selbst aufhebender willenloser Wille. … Die Einsicht, daß ein freier Wille nur inmitten von Bedingtheiten wirksam werden kann, eröffnet nach Bieri einen Ausweg aus dem klassischen Dilemma der Willensfreiheitsdebatten: der scheinbaren Unvereinbarkeit von Freiheit und durchgängiger kausaler Bedingtheit alles natürlichen Geschehens (23).
  • Sabine Klomfaß: Bieri zieht mit seinem Konzept des Willens und des Urteilens gegen den Determinismus und einer daraus folgenden Resignation zu Felde. Gebetsmühlenartig legt er dar, dass der Wille “von innen” nur in pathologischen Fällen (wie beim zwanghaften Handeln des Spielers) oder “von außen” erpresst (wie beim Zwang zwischen zwei Übeln zu wählen) wirklich unfrei sei. Im Normalfall aber kommt der zukünftige Wille, so Bieri, “nicht auf dich zu wie eine Lawine. Du führst ihn herbei, du erarbeitest ihn dir, indem du von freier Entscheidung zu freier Entscheidung fortschreitest, bis du bei ihm angekommen bist.” Dabei betont der Philosoph insbesondere die Funktion des Denkvermögens: “In dem Maße, in dem die Aneignung des Willens auf Artikulation und Verstehen beruht, handelt es sich um einen Erkenntnisprozess. Wachsende Erkenntnis bedeutet wachsende Freiheit. So gesehen ist Selbsterkenntnis ein Maß für Willensfreiheit.” Denn erst das Wissen um die Möglichkeiten, die man haben könnte, und dann das Durchdenken und Bewerten dieser Möglichkeiten, formen einen Willen, der wirklich als eigener und verantwortbarer erkannt werden kann.
  • Michael Springer: Freiheit existiert nur als bedingte Freiheit. Unser Wille agiert in einem strukturierten Feld; er hat eine Vorgeschichte. Das enthebt uns nicht der Verantwortung für das, was wir tun – selbst wenn es im Nachhinein aussieht, als ob “alles so kommen musste”.
  • Iris Morad.

See also this on a related book by Julian Baggini.

Comments on Geneva Report 23

Panel with Elga Bartsch, Agnès Bénassy-Quéré, Giancarlo Corsetti, Olivier Garnier, and Charles Wyplosz. Moderated by Tobias Broer.

Elga Bartsch, Agnès Bénassy-Quéré, Giancarlo Corsetti, Xavier Debrun: Geneva Report 23 | It’s All in the Mix: How Monetary and Fiscal policies Can Work or Fail Together.

Event at PSE.

My comments on the report.

Reading List on ‘Free’ or ‘Not-so-free’ Public Debt

Risk, Discounting, and Dynamic Efficiency

In the presence of risk, a comparison of the risk-free interest rate and the expected growth rate is insufficient to assess whether an economy is dynamically efficient or inefficient. Stochastic discount factors—not risk-free interest rates—enter the government’s budget constraint, even if debt is safe.

These points are made, for example, by Andrew Abel, N. Gregory Mankiw, Lawrence Summers, and Richard Zeckhauser (Assessing Dynamic Efficiency: Theory and Evidence, REStud 56(1), 1989),

the issue of dynamic efficiency can be resolved by comparing the level of investment with the cash flows generated by production after the payment of wages … dynamic efficiency cannot be assessed by comparing the safe rate of interest and the average growth rate of the capital stock, output, or any other accounting aggregate,

or Henning Bohn (The Sustainability of Budget Deficits in a Stochastic Economy, JMCB 27(1), 1995),

discounting at the safe interest rate is usually incorrect. … popular fiscal policy “indicators” like deficit levels or debt-GNP ratios may provide very little information about sustainability. … the intertemporal budget constraint imposes very few restrictions on the average primary balance.

Recent work in which these themes appear include papers by Zhengyang Jiang, Hanno Lustig, Stijn Van Nieuwerburgh, and Mindy Xiaolan (Manufacturing Risk-free Government Debt, NBER wp 27786, 2020), Robert Barro (r Minus g, NBER wp 28002, 2020), or Stan Olijslagers, Nander de Vette, and Sweder van Wijnbergen (Debt Sustainability when r−g<0: No Free Lunch after All, CEPR dp 15478, 2020).

Intergenerational Risk Sharing

With overlapping generations the way the government manages its debt has implications for intergenerational risk sharing, see for example Henning Bohn (Risk Sharing in a Stochastic Overlapping Generations Economy, mimeo, 1998), Robert Shiller (Social Security and Institutions for Intergenerational, Intragenerational, and International Risk Sharing, Carnegie-Rochester Conference on Public Policy 50, 1999), or Gabrielle Demange (On Optimality of Intergenerational Risk Sharing, Economic Theory 20(1), 2002).

Long-Run Debt Dynamics and Fiscal Space

Dmitriy Sergeyev and Neil Mehrotra (Debt Sustainability in a Low Interest World, CEPR dp 15282, 2020) offer an analysis of long-run debt dynamics under the assumption that the primary surplus systematically, and strongly responds to the debt-to-GDP ratio such that the government’s intertemporal budget constraint is necessarily satisfied:

Population growth and productivity growth have opposing effects on the debt-to-GDP ratio due to their opposing effects on the real interest rate. Lower population growth leaves the borrowing rate unchanged while directly lowering output growth, shifting the average debt-to-GDP ratio higher. By contrast, when the elasticity of intertemporal substitution is less than one, a decline in productivity growth has a more than a one-for-one effect on the real interest rate, lowering the cost of servicing the debt and thereby reducing the average debt-to-GDP ratio. To the extent that higher uncertainty accounts for low real interest rates, we find that
the variance of the log debt-to-GDP ratio unambiguously increases with higher output
uncertainty. However, uncertainty also has an effect on the mean debt-to-GDP ratio that
depends on the coefficient of relative risk aversion. Higher uncertainty lowers the real
interest rate but this effect may be outweighed by an Ito’s lemma term due to Jensen’s
inequality that works in the opposite direction.

Sergeyev and Mehrotra also consider the effects of rare disasters as well as of a maximum primary surplus which implies that debt becomes defaultable and the interest rate on debt features an endogenous risk premium, generating the possibility of a “tipping point” with a slow moving debt crises as in Guido Lorenzoni and Ivan Werning (Slow Moving Debt Crises, AER 109(9), 2019).

Ricardo Reis (The Constraint on Public Debt when r<g But g<m, mimeo, 2020) analyzes a non-stochastic framework under the assumption that the marginal product of capital, m, exceeds the growth rate, g, which in turn exceeds the risk-free interest rate, r. Reis considers the case where m is the relevant discount rate, for example because r features a liquidity premium:

there is still a meaningful government budget constraint once future surpluses and debt are discounted by the marginal product of capital.

He shows the following:

  • The debt due to a one-time primary deficit can be rolled over indefinitely and disappears asymptotically as long as r<g.
  • With permanent primary deficits that grow at the same rate as debt and output, the government’s intertemporal budget constraint features a bubble component due to r<m. This corresponds to the usual seignorage revenue measure (see p. 173 in Niepelt, Macroeconomic Analysis, 2019).
  • Suppose that from tomorrow on, the primary deficit and debt quotas are given by d and b, respectively. Then, the present value of total net revenues in the government’s budget constraint equals [- d + (m – r)*b] / (m-g). Both m>g and g>r relax the constraint, as does a lower r.
  • Along a balanced growth path, b = [- d + (m – r)*b] / (m-g) and thus, d = (g-r)*b where d is assumed to be positive. Reis argues that b cannot be larger than total assets relative to GDP. Accordingly, the deficit cannot exceed total assets times (g-r).

Reis concludes that most of the bubble component “has already been used.” In addition to developing a model that yields m>g>r in equilibrium he also discusses the role of inflation (stable inflation generates fiscal space because it renders debt safer and thus increases demand for debt) and inequality (more inequality increases fiscal space).

Blanchard’s Presidential Address

In his presidential address, Olivier Blanchard (Public Debt and Low Interest Rates, AER 109(4), 2019) argues that the risk-free interest rate has fallen short of average US growth rate (and similarly, in other countries). Importantly—and implicitly addressing Abel, Mankiw, Summers, Zeckhauser, and Bohn (see above)—he also argues that risk is not that much of an issue as far as the sustainability of public debt is concerned:

Jensen’s inequality is thus not an issue here. In short, if we assume that the future will be like the past (admittedly a big if), debt rollovers appear feasible. While the debt ratio may increase for some time due to adverse shocks to growth or positive shocks to the interest rate, it will eventually decrease over time. In other words, higher debt may not imply a higher fiscal cost.

Most of his formal analysis doesn’t focus on debt though. Instead he analyzes the effects of risk-free social security transfers from young to old in a stochastic OLG economy. (There are close parallels between debt and such transfers to the old that are financed by contemporaneous taxes on the young.) In a steady-state with very low interest rates higher transfers have two effects on welfare, by (i) providing an attractive substitute for savings and by (ii) reducing capital accumulation and thereby lowering wages and raising the interest rate. If the economy initially is dynamically inefficient both effects are welfare improving because (i) capital accumulation with a low return is replaced by higher yielding intergenerational transfers and (ii) lower wages and higher interest rates are attractive, starting from a situation with a low interest rate. In a stochastic economy the first channel yields welfare gains as long as the growth rate exceeds the risk-free rate, and the second channel yields welfare gains (approximately) when the growth rate exceeds the marginal product of capital. Blanchard argues

[b]e this as it may, the analysis suggests that the welfare effects of a transfer may not necessarily be adverse, or, if adverse, may not be very large.

In the corresponding case with debt there is another effect because the intergenerational transfer is not risk-free; the size of this additional effect depends on the path of the risk-free interest rates (Blanchard assumes that the debt level is stabilized which requires net tax payments by the young to reflect the contemporaneous risk-free rate). In the slightly different case where debt is increased once and then rolled over, without adjusting taxes in the future, the sustainability and welfare implications are ambiguous and critically depend on the production function:

In the linear case, debt rollovers typically do not fail [my emphasis] and welfare is increased throughout. For the generation receiving the initial transfer associated with debt issuance, the effect is clearly positive and large. For later generations, while they are, at the margin, indifferent between holding safe debt or risky capital, the inframarginal gains (from a less risky portfolio) imply slightly larger utility. But the welfare gain is small … . In the Cobb-Douglas case however, this positive effect is more than offset by the price effect, and while welfare still goes up for the first generation (by 2 percent), it is typically negative thereafter. In the case of successful debt rollovers, the average adverse welfare cost decreases as debt decreases over time. In the case of unsuccessful rollovers, the adjustment implies a larger welfare loss when it happens. If we take the Cobb-Douglas example to be more representative, are these Ponzi gambles, as Ball, Elmendorf, and Mankiw (1998) have called them, worth it from a welfare viewpoint? This clearly depends on the relative weight the policymaker puts on the utility of different generations [my emphasis].

Blanchard argues that the marginal product of capital may be smaller than commonly assumed, implying that it is more likely that the welfare effects working through (ii) are positive (those working through (i) are very likely positive). Finally, he also presents some additional potential arguments pro and con higher public debt.

Blanchard’s work has attracted substantial criticism, for instance at the January 2020 ASSA meetings (see this previous post). In a short paper presented at the meetings, Johannes Brumm, Laurence Kotlikoff, and Felix Kubler (Leveraging Posterity’s Prosperity?) point out that a negative difference between average interest and growth rates is not necessarily indicative of dynamic inefficiency (see the discussion above) and that Blanchard’s analysis disregards tax distortions as well as the welfare effects from intergenerational risk sharing (again, see above):

To see the distinction between risk-sharing and a Ponzi scheme, modify B’s two-period model to include agents working when old if they don’t randomly become disabled. Now workers face second-period asset income and labor earnings risk. The government has no safe asset in which to invest. If it borrows, invests in capital, and taxes bond holders its excess return, “safe” debt is identical to risky capital. But if the net taxes are only levied on the non-disabled, bonds become a valued risk-mitigating asset and their return can be driven far below zero. This scheme could be, and to some extend it is, implemented through progressive taxation. If, observing this gap between growth and safe rates, the government decides to institute an “efficient” Ponzi scheme with a fixed pension benefit financed on a pay-go basis by taxes on workers, net wages when young will be more variable, raising generation-specific risk and potentially producing an outcome in which no generation is better off and at least one is worse off.

Brumm, Kotlikoff, and Kubler also note that the effective interest rate at which US households are borrowing is much higher than the borrowing rate of the government; this undermines Blanchard’s approach to gauge the welfare implications. And they point out that the scheme suggested by Blanchard could harm other countries by reducing global investment.

Jasmina Hasanhodzic (Simulating the Blanchard Conjecture in a Multi-Period Life-Cycle Model) simulates a richer OLG model and rejects the Blanchard conjecture of Pareto gains due to higher transfers:

It shows that the safe rate on government debt can, on average, be far less than the economy’s growth rate without its implying that ongoing redistribution from the young to the old is Pareto improving. Indeed, in a 10-period, OLG, CGE model, whose average safe rate averages negative 2 percent on an annual basis, welfare losses to future generations resulting from the introduction of pay-go Social Security, financed with a 15 percent payroll tax, are enormous—roughly 20 percent measured as a compensating variation relative to no policy.

Relative to Blanchard’s simulations, her model implies more negative consequences of crowding out on wages, a higher tax burden from the transfer scheme, and more induced old-age consumption risk.

Michael Boskin (How, When and Why Deficits Are Dangerous) offers a broad discussion of potential weaknesses of Blanchard’s analysis. Richard Evens (Public Debt, Interest Rates, and Negative Shocks) questions Blanchard’s simulations on calibration grounds and notes that he couldn’t replicate some of Blanchard’s findings.

On his blog, John Cochrane argues along similar lines as Ricardo Reis: Even if r<g, expected primary deficits are so large that debt quotas will explode nevertheless.

Olivier Blanchard on Markus’ Academy.

More work by Johannes Brumm, Xiangyu Feng, Laurence J. Kotlikoff, and Felix Kubler: When Interest Rates Go Low, Should Public Debt Go High? (NBER working paper 28951), and Deficit Follies (28952).

Note: This post was updated several times.

John Cochrane about CBDC and Me

Writing about CBDC, John Cochrane makes it clear that he is in favor. He links to my work and writes

Dirk Niepelt has written a lot about CBDC theory, including reserves for all in 2015, a recent Vox-EU summary and papers,  here with Markus Brunnermeier a JME paper “CBDC coupled with central bank pass-through funding need not imply a credit crunch nor undermine financial stability,” a follow up including “The model implies annual implicit subsidies to U.S. banks of up to 0.8 percent of GDP during the period 1999-2017.”  Here  “reserves for all” “does not affect macroeconomic outcomes,”

Notions of Liquidity Trap

On Fazit, Gerald Braunberger reviews the concept of “liquidity trap.”

  • Keynes never used the term but Robertson did.
  • Hicks introduced the common notion (represented, e.g., by a flat LM curve).
  • Krugman talks about a different trap. So does Blanchard and he (incorrectly) attributes it to Keynes. So does Sinn.

Not Much Left of “Modern Monetary Theory”

Alberto Bisin (Journal of Economic Literature, December 2020) reviews Stephanie Kelton’s “The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy:”

Never is its logical structure expressed in a direct, clear way, from head to toe. … Some of these statements are literally correct but used for incorrect or misleading implications—plays on words, effectively. They seem taken directly from the book of tricks of the Greek sophists (the ones Aristophanes makes fun of).

John Cochrane (blog post, July 2020) reviews the same book:

Skeptics have called it “magical monetary theory.” They’re right.

Dirk Niepelt (blog post/Neue Zürcher Zeitung (in German), April 2019):

The Macroeconomic Perpetuum Mobile.

The Value of Monetary Units, 1500–1914

K. Kıvanç Karaman, ¸Sevket Pamuk, Seçil Yıldırım-Karaman (2020), Money and monetary stability in Europe, 1300–1914, Journal of Monetary Economics (115).

At one extreme, the Dutch Republic depreciated its monetary unit by about 2.3 times, at the other, the Ottomans depreciated by about 25,000 times. These two numbers correspond to average annual depreciation rates of 0.2 and 2.5% respectively, with the other states falling in-between. … depreciations tended to be episodic. In particular, long periods of constant silver and gold value alternated with episodes of rapid depreciation in consecutive years. … There were also instances of one-off depreciations, but they were few, and at low rates. … monetary stability was not an elusive objective. Some states stabilized their monetary unit early. England did so by the mid-16th century, except for the fiat standard episode during the Napoleonic wars. Dutch Republic stabilized its monetary unit in the early 17th century, with very minor changes in the centuries that followed. France stabilized its monetary unit in 1795 following the fiat money experiment of the Revolution. In contrast to these western European states, in southern and eastern Europe, states continued to depreciate their monetary units until the end of the period.

Central Banks Have Accepted a Future Retail CBDC

Recent indications:

Related recent developments: