Der Bund. March 5, 2019. HTML.
Short newspaper interview about corrective taxes, tackling problems at the root, and equity vs. efficiency.
Der Bund. March 5, 2019. HTML.
Short newspaper interview about corrective taxes, tackling problems at the root, and equity vs. efficiency.
We address five key concerns that are frequently put forward:
1. Aren’t digital currencies just a hype, now that crypto ‘currencies’ like Bitcoin have proved too volatile and expensive to serve as reliable stores of value or mediums of exchange? This confuses things. A central bank digital currency (CBDC) is like cash, only digital; Alipay, Apple Pay, WeChat Pay, and so on are like deposits, only handier; and crypto currencies are not in any way linked to typical currencies, but they live on the blockchain.
2. Doesn’t a CBDC or ‘Reserves for All’ choke investment by cutting into bank deposits? No, because new central bank liabilities (namely, a CBDC) would fund new investments, and this would not in any way imply socialism or a stronger role of government in investment decisions.
3. Wouldn’t a CBDC cut into the profits that banks generate by creating deposits? Less money creation by banks would certainly affect their profits. But if this were deemed undesirable (by the public, not by shareholders and management) then banks could be compensated.
4. Wouldn’t ‘Reserves for All’ render bank runs more likely, undermining financial stability? We argue that, in fact, the opposite seems more plausible.
5. Aren’t deposit insurance, a CBDC, Vollgeld/sovereign money, and the Chicago Plan all alike? There are indeed close parallels between the different monetary regimes. In a sense, “money is changing and yet, it stays the same”.
On his blog, Stephen Williamson discusses the Fed’s plan to maintain a much larger balance sheet in the future than before the crisis. He is not convinced that this plan is a good one.
But what’s the harm in a large Fed balance sheet? The larger the balance sheet, the lower is the quantity of Treasury securities in financial markets, and the higher is reserves. Treasuries are highly liquid, widely-traded securities that play a key role in overnight repo markets. Reserves are highly liquid – for the institutions that hold them – but they are held only by a subset of financial institutions. Thus, a large Fed balance sheet could harm the operation of financial markets. … it would be reflected in a scarcity of collateral in overnight financial markets – in market interest rates. Before early 2018, T-bill rates and repo rates tended to be lower than the fed funds rate, and the fed funds rate was lower than IOER. Now, all those rates are about the same. The Fed thinks the difference is more Treasury debt, but I think the end of the Fed’s reinvestment program mattered, in that it increased the stock of on-the-run Treasuries. Whichever it was, apparently the quantity of Treasuries outstanding matters for the smooth – indeed, efficient – operation of financial markets, and the Fed should not mess with that. My prediction would be that, if we get to the end of the year and the Fed is again buying Treasuries, that we’ll see repo rates and T-bill rates dropping below IOER. Watch for that.
Arnold Kling (2016), Specialization and Trade, A Re-Introduction to Economics, Washington, DC, Cato Institute.
Kling’s central theme in this short book of nine main chapters is that specialization, trade, and the coordination of individual plans by means of the price system and the profit motive play fundamental roles in modern economies. Most mainstream economists would agree with this assessment. Their models of trade, growth, and innovation certainly include the four elements, with varying emphasis.
But Kling criticizes the methodological approach adopted by post-world-war-II economics, which he associates with “MIT economics.” An MIT PhD himself, he argues that economics, and specifically macroeconomics, should adopt less of a mechanistic and more of an evolutionary perspective to gain relevance. In the second chapter, entitled “Machine as Metaphor,” Kling asserts that under the leadership of Paul Samuelson post-war (macro)economics framed economic issues as programming problems that resemble resource allocation problems in a wartime economy. Even as the discipline evolved, Kling contends, the methodology remained the same, pretending controllability by economist-engineers; in the process, the role of specialization was sidelined in the analysis.
I think that Kling is too harsh in his assessment. Economics and macroeconomics, in particular, has changed dramatically since the times of Paul Samuelson. The notion that, given enough instruments, any economic problem can be solved as easily as a system of equations, has lost attraction. Modern macroeconomic models are based on microeconomic primitives; they take gains from trade seriously; they involve expectations and frictions; and they do not suggest easy answers. The task of modern macroeconomics is not to spit out a roadmap for the economist-engineer but to understand mechanisms and identify problems that arise from misaligned incentives.
Kling is right, of course, when he argues that many theoretical models are too simplistic to be taken at face value. But this is not a critique against economic research which must focus and abstract in order to clarify. It rather is a critique against professional policy advisors and forecasters, “economic experts” say. These “experts” face the difficult task of surveying the vast variety of mechanisms identified by academic research and to apply judgement when weighing their relevance for a particular real-world setting. To be useful, “experts” must not rely on a single framework and extrapolation. Instead, they must base their analysis on a wide set of frameworks to gain independent perspectives on a question of interest.
In chapters three to five, Kling discusses in more detail the interplay of myriads of specialized trading partners in a market economy and how prices and the profit motive orchestrate it. In the chapter entitled “Instructions and Incentives,” Kling emphasizes that prices signal scarcity and opportunity costs are subjective. In the chapter entitled “Choices and Commands,” he discusses that command-and-control approaches to organizing a society face information, incentive, and innovation problems, unlike approaches that rely on a functioning price mechanism. And in the chapter “Specialization and Sustainability,” Kling makes the point that well-defined property rights and a functioning price mechanism offer the best possible protection for scarce resources and a guarantee for their efficient use. Sustainability additionally requires mechanisms to secure intergenerational equity.
I agree with Kling’s point that we should be humble when assessing whether market prices, which reflect the interplay of countless actors, are “right” or “wrong.” However, I would probably be prepared more often than Kling to acknowledge market failures of the type that call for corrective taxes. The general point is that Kling’s views expressed in the three chapters seem entirely mainstream. While we may debate how often and strongly market prices fail to account for social costs and benefits, the economics profession widely agrees that for a price system to function well this precondition must be satisfied.
In the sixth chapter, entitled “Trade and Trust,” Kling argues that specialization rests on cultural evolution and learning and more broadly, that modern economic systems require institutions that promote trust. Independently of the norms a particular society adopts, it must implement the basic social rule,
[r]eward cooperators and punish defectors.
How this is achieved (even if it is against the short-run interest of an individual) varies. Incentive mechanisms may be built on the rule of law, religion, or reputation. And as Kling points out societies almost always rely on some form of government to implement the basic social rule. In turn, this creates problems of abuse of power as well as “deception” and “demonization.” Mainstream economists would agree. In fact, incentive and participation constraints, lack of commitment, enforcement, and self-enforcement are at center stage in many of their models of partial or general equilibrium. Similarly, the role of government, whether benevolent or representing the interests of lobby groups and elites, is a key theme in modern economics.
Chapter seven, entitled “Finance and Fluctuations,” deals with the role of the financial sector. Kling argues that finance is a key prerequisite for specialization and since trust is a prerequisite for finance, swings in trust—waves of optimism and pessimism—affect the economy. No mainstream macroeconomist will object to the notion that the financial sector can amplify shocks. Seminal articles (which all were published well before the most recent financial crisis) exactly make that point. But Kling is probably right that the profession’s workhorse models have not yet been able to incorporate moods, fads, and manias, the reputation of intermediaries, and the confidence of their clients in satisfactory and tractable ways, in spite of recent path-breaking work on the role of heterogenous beliefs.
In chapter eight, Kling focuses on “Policy in Practice.” He explains why identifying market failure in a model is not the same as convincingly arguing for government intervention, simply because first, the model may be wrong and second, there is no reason to expect government intervention to be frictionless. I don’t know any well-trained academic economist who would disagree with this assessment (but many “experts” who are very frighteningly confident about their level of understanding). The profession is well aware of the insights from Public Choice and Political Economics, although these insights might not be as widely taught as they deserve. And Kling is right that economists could explain better why real-world policy selection and implementation can give rise to new problems rather than solely focusing on the issue of how an ideal policy might improve outcomes.
To me, the most interesting chapters of the book are the first and the last, entitled “Filling in Frameworks” and “Macroeconomics and Misgivings,” respectively. In the first chapter, Kling discusses the difference between the natural sciences and economics. He distinguishes between scientific propositions, which a logical flaw or a contradictory experiment falsifies, and “interpretive frameworks” a.k.a. Kuhn’s paradigms, which cannot easily be falsified. Kling argues that
[i]n natural science, there are relatively many falsifiable propositions and relatively few attractive interpretive frameworks. In the social sciences, there are relatively many attractive interpretive frameworks and relatively few falsifiable propositions.
According to Kling, economic models are interpretative frameworks, not scientific propositions, because they incorporate a plethora of auxiliary assumptions and since experiments of the type run in the natural sciences are beyond reach in the social sciences. Anomalies or puzzles do not lead economists to reject their models right away as long as the latter remain useful paradigms to work with. And rightly so, according to Kling: For an interpretative framework with all its anomalies is less flawed than intuition which is uninformed by a framework. At the same time, economists should remain humble, acknowledge the risk of confirmation bias, and remain open to competing interpretative frameworks.
In the chapter entitled “Macroeconomics and Misgivings,” Kling criticizes macroeconomists’ reliance on models with a representative agent. I agree that representative agent models are irrelevant for applied questions when the model implications strongly depend on the assumption that households are literally alike, or that markets are complete such that heterogeneous agents can perfectly insure each other. When “experts” forecast macroeconomic outcomes based on models with a homogeneous household sector then these forecasts rest on very heroic assumptions, as any well-trained economist will readily acknowledge. Is this a problem for macroeconomics which, by the way, has made a lot of progress in modeling economies with heterogeneous agents and incomplete markets? I don’t think so. But it is a problem when “experts” use such inadequate models for policy advice.
Kling argues that the dynamic process of creative destruction that characterizes modern economies requires ongoing change in the patterns of specialization and trade and that this generates unemployment. Mainstream models of innovation and growth capture this process, at least partially; they explain how investment in new types of capital and “ideas” can generate growth and structural change. And the standard framework for modeling labor markets features churn and unemployment (as well as search and matching) although, admittedly, it does not contain a detailed description of the sources of churn. The difference between the mainstream’s and Kling’s view of how the macroeconomy operates thus appears to be a difference of degree rather than substance. And the difference between these views and existing models clearly also reflects the fact that modeling creative destruction and its consequences is difficult.
Kling is a sharp observer when he talks about the difference between “popular Keynesianism” and “rigor-seeking Keynesianism.” The former is what underlies the thinking of many policy makers, central bankers, or journalists: a blend of the aggregate-demand logic taught to undergraduates and some supply side elements. The latter is a tractable simplification of a micro-founded dynamic general equilibrium model with frictions whose properties resemble some key intuitions from popular Keynesianism.
The two forms of Keynesianism help support each other. Popular Keynesianism is useful for trying to convince the public that macroeconomists understand macroeconomic fluctuations and how to control them. Rigor-seeking Keynesianism is used to beat back objections raised by economists who are concerned with the ways in which Keynesianism deviates from standard economics, even though the internal obsessions of rigor-seeking Keynesianism have no traction with those making economic policy.
There is truth to this. But in my view, this critique does not undermine the academic, rigor-seeking type of Keynesianism while it should undermine our trust in “experts” who work with the popular sort which, as Kling explains, mostly is confusing for a trained economist.
In the end, Kling concludes that it is the basics that matter most:
[B]etter economic outcomes arise when patterns of sustainable specialization and trade are formed. … It requires the creative, decentralized, trial-and-error efforts of thousands of entrepreneurs and millions of households … Probably the best thing that the government can do to encourage new forms of specialization is to rethink existing policies that restrict competition, discourage innovation, and retard mobility.
This is a reasonable conclusion. But it is neither a falsifiable proposition nor an interpretive framework. It is the synthesis of many interpretive frameworks, weighed by Kling. In my own view, the weighting is based on too harsh an assessment according to which many modern macroeconomic models are irrelevant.
Kling’s criticism of contemporaneous macroeconomics reads like a criticism of the kind of macroeconomics still taught at the undergraduate level. But modern macroeconomics has moved on—it is general equilibrium microeconomics. Its primary objective is not to produce the one and only model for economist-engineers or “experts” to use, but rather to help us understand mechanisms. A good expert knows many models, is informed about institutions, and has the courage to judge which of the models (or mechanisms they identify) are the most relevant in a specific context. We don’t need a new macroeconomics. But maybe we need better “experts.”
The slides (PDF) of a recent presentation of mine at a round table on the future of finance.
In the FT, Robert Armstrong reports about the new “JPM coin” launched by JP Morgan.
“JPM Coins” will be transferable over a blockchain between the accounts of the bank’s corporate clients, who will purchase and redeem them for dollars at a fixed 1:1 ratio, making them “stablecoins” in the crypto-jargon.
The technology will facilitate near-instantaneous settlement of these money transfers and will, according to the bank, mitigate counterparty risk.
According to my reading, the coins are essentially bank deposit that live on a blockchain which is managed by JP Morgan and accessible by the bank’s clients. I doubt that a coin will be redeemable for US dollars issued by the Federal Reserve (as opposed to deposits issued by JP Morgan).
MA course at the University of Bern.
On his blog, JP Koning argues that very short conversion periods rendered it unattractive for Swedes to hold cash. He also suggests that it were the banks that pushed for the short periods.
While digital payments share some of the blame for the obsolescence of paper kronor, the Riksbank is also responsible. The Riksbank betrayed the Swedish cash-using public this decade by embarking on an aggressive note switch. Had it chosen a more customer friendly approach, Swedes would be holding a much larger stock of banknotes than they are now. As long as other countries don’t enact the same policies as Sweden, they needn’t worry about precipitous declines in cash demand.
Recently, the trend decline of kronor cash holdings has reverted. Across the board, the use case for cash seems to change (see also this post).
… even as developed countries are seeing fewer transactions completed using cash, the quantity of banknotes outstanding has jumped. This increase in cash outstanding, which generally exceeds GDP growth, is mostly due to an increase in demand for large-value denominations, as the chart below illustrates:
On his blog, JP Koning reports that
[b]oth the Christmas bump and the sawtooth pattern arising from monthly payrolls are less noticeable than previous years. But these patterns remain more apparent for Canadian dollars than U.S. dollars. Not because Canadians like cash more than Americans. We don’t, and are probably further along the path towards digital payments then they are. Rather, the percentage of U.S. dollars held overseas is much larger than Canadian dollars, so domestic usage of U.S. cash for transactions purposes gets blurred by all its other uses.
On Spiegel online, Christoph Schult reports about “Instrument in Support of Trade Exchanges” (Instex), the new special purpose vehicle founded by France, Germany, and the UK with the task to facilitate legitimate trade with Iran. Instex is not meant to bust US sanctions, but to circumvent the banking sector which the the three countries perceive as “overcomplying.”
Eigentlich dürfen europäische Unternehmen alle Waren, die nicht den Sanktionen unterliegen, weiter in den Iran exportieren. Problem ist allerdings, dass fast alle Banken in Europa ablehnen, den Zahlungsverkehr für solche Geschäfte abzuwickeln. Die Geldinstitute haben Angst, sie könnten in den USA bestraft werden. “Overcompliance” von Sanktionen nennen das EU-Diplomaten – Übererfüllung.
Instex ist eine Art Tauschbörse, in der die Forderungen von iranischen und europäischen Unternehmen miteinander verrechnet werden. Geld, das Iran zum Beispiel für Öllieferungen nach Europa in Rechnung stellt, könnte direkt an europäische Firmen fließen, die Produkte nach Iran verkaufen.
Update (Feb 4): In the FT, Michael Peel discusses the SPV.
Guidelines published by the Swiss Financial Market Supervisory Authority. From the explanations:
The FinTech licence allows institutions to accept public deposits of up to CHF 100 million, provided that these are not invested and no interest is paid on them. A further requirement is that an institution with a FinTech licence must have its registered office and conduct its business activities in Switzerland.
In a press release the Swiss National Bank explains that it
grants access to … [fintechs] that make a significant contribution to the fulfilment
of the SNB’s statutory tasks, and whose admission does not pose any major risks. Entities with fintech licences whose business model makes them significant participants in the area of Swiss franc payment transactions will therefore be granted access to the SIC system and to sight deposit accounts.
The Swiss Financial Market Supervisory Authority is in charge of granting fintech licences.
We propose a generic model of money and liquidity. We provide sufficient conditions under which a swap of private (inside) against public (outside) money leaves the equilibrium allocation and price system unchanged. We apply the results to Central Bank Digital Currency, the “Chicago Plan,” and the Indian de-monetization experiment.
The Economist characterizes the work of who it views as the eight best economists of the decade. Most of their work is empirical. The eight are:
December 2018. PDF. In: Ernest Gnan and Donato Masciandaro, editors, Do We Need Central Bank Digital Currency? Economics, Technology and Institutions, SUERF, The European Money and Finance Forum, Vienna, 2018.
A short version of the CEPR working paper.
The ECB launches its Target Instant Payment Settlement (TIPS) system, which facilitates instant money transfers between banks and allows end users connected to those banks to make instant retail payments across the Euro zone.
From the ECB’s website:
TIPS was developed as an extension of TARGET2 and settles payments in central bank money. TIPS currently only settles payment transfers in euro. However, in case of demand other currencies could be supported as well. …
… a number of national solutions have been developed, or are under development, across the EU. A challenge for the Eurosystem is to ensure that these national solutions do not (re)introduce fragmentation … TIPS aims to minimise this risk by offering a service that can help ensure that any bank account holder in Europe can be reached. …
Participating payment service providers can set aside part of their liquidity on a dedicated account opened with their respective central bank, from which instant payments can be settled. It is only possible to add funds to TIPS accounts during TARGET2 opening hours.
As settlement in TIPS takes place in central bank money, participation in TIPS depends on being eligible to access central bank money. For this reason, in order to open an account in TIPS in euro, an institution needs to fulfil the same eligibility criteria as for participation in TARGET2.
Banks pay at most 0.2 cent per transaction during the first two years of operation.
See also the blog post on the Bank of England’s related, but different “interledger” program.
Central bank digital currency gets closer by the day …
On German TV, stand-up comedian Dieter Nuhr exposes the contradictions of calls for justice and equality that characterize much of the German public debate. His hour-long performance could well serve as a lecture in economics and ethics.
At a conference in Singapore, IMF Managing Director Christine Lagarde has argued that
[w]hile the case for digital currency is not universal, we should investigate it further, seriously, carefully and creatively.
In her speech she emphasizes potential benefits related to financial inclusion; security and consumer protection; and privacy. (Privacy would be limited however.) She sees risks as well, including to innovation. But she de-emphasizes the notion of increased run risk which commentators often stress.
What about the risk of bank runs? It exists. But consider that people run when they believe that cash withdraws are honored on a first-come-first-serve basis—the early bird gets the worm. Digital currency, instead, because it can be distributed much more easily than cash, could reassure even the person left lying on the couch!
In addition, if depositors are running to foreign assets, they will also shun the digital currency. And in many countries, there are already liquid and safe assets to run toward—think of mutual funds that only hold government bonds. So, the jury is still out on whether digital currencies would really upset financial stability.
She also refers to a recent IMF working paper on the subject.
The FT reports.
Almost all working papers on the subject of CBDC claim that the introduction of CBDC would change equilibrium outcomes. Very few papers carefully lay out the reasons; instead most papers make implicit assumptions that are not spelled out although they are crucial for the results. I have argued elsewhere (see this blog post) that the introduction of CBDC could leave equilibrium outcomes unchanged in a benchmark case, and with Markus Brunnermeier we have formally presented the argument.
Laurent Ruessmann and Jochen Beck, FieldFisher, 17 July 2018, International firms caught between US Iran sanctions and EU blocking statute.
Several authors, Gibson, Dunn & Crutcher LLP, 9 August 2018, The “New” Iran E.O. and the “New” EU Blocking Sanctions—Navigating the Divide for International Business.
The “primary sanctions” that limit U.S. companies and persons from engaging with Iran have on the whole never been lifted. The principal sanctions relief provided by the United States [until 2018] have been of “secondary sanctions” that focus on non-U.S. companies’ transactions with Iran. These measures are designed to force non-U.S. firms to choose to either engage with Iran or the United States. …
All of the sanctions and [the EU’s] counter-sanctions are in large part discretionary. …
… the Blocking Statute allows EU operators to recover damages arising from the application of the extraterritorial measures. Though it is unclear how this would work in practice, it appears to allow an EU operator to exercise a private right of action and to be indemnified by companies that do comply with the U.S. laws if in so doing those companies injure the EU operator. …
The United Kingdom has in place a law … which broadly makes compliance with Blocked U.S. Sanctions a criminal offence. … other Member States have also opted for the creation of criminal offences, including Ireland, the Netherlands and Sweden. Other Member States, including Germany, Italy and Spain, have devised administrative penalties for non-compliance. Meanwhile some Member States, including France, Belgium and Luxembourg, do not appear ever to have even implemented the EU General Blocking Regulation …
… element of flexibility in the Blocking Statute is that EU operators will not be forced to continue business with Iran. Rather, the Guidance notes that EU operators are still free to conduct their business as they see fit …
Several authors, Dechert LLP, August 2018, Iran Sanctions—U.S. Reimposes Sanctions After JCPOA Withdrawal, First Measures Come Into Effect.
The practical effect of these developments is to return the U.S. secondary sanctions regime to the status quo pre-JCPOA. However, the New Iran E.O. does expand upon the U.S. primary sanctions regime in one critical respect: U.S. owned or controlled foreign entities … Until now, OFAC’s sanctions have not prohibited a foreign subsidiary from dealing with a non-Iranian SDN. Although many such transactions would likely have subjected U.S. owned and controlled foreign entities to potential secondary sanctions pre-JCPOA (on the basis that they were providing material support to an SDN), they may now result in civil or criminal liability under U.S. law.
For other foreign businesses … The New Iran E.O. does little to clarify the Administration’s current posture, but does grant it significant discretion to target a wide range of activity, effective immediately. Given the Trump Administration’s rapidly shifting approach on other issues relating to international trade and national security, from tariffs to North Korea, businesses should plan for the worst while continuing to strategize and advocate for a more pragmatic approach.
Jeremy Paner, Holland & Hart, 8 November 2018, The Return of All Financial Secondary Sanctions on Iran:
U.S. law currently authorizes OFAC to impose correspondent and payable-through account sanctions on non-U.S. financial institutions that knowingly conduct or facilitate any significant financial transaction involving the following:
- the Central Bank of Iran;
- a designated Iranian individual or entity, other than banks solely designated for being Iranian;
- the automotive sector of Iran;
- the National Iranian Oil Company (NIOC) or Naftiran Intertrade Company (NICO);
- petroleum, petroleum products, or petrochemical products from Iran;
- the purchase or sale of Iran rials; and
- a derivative, swap, future, forward, or other similar contract whose value is based on the exchange rate of the Iranian rial.
Additionally, non-U.S. financial institutions that maintain Iranian rial denominated funds or accounts outside of Iran are exposed to potential correspondent and payable-through account sanctions.
Abstract: I offer a macroeconomic perspective on the “Reserves for All” (RFA) proposal to let the general public use electronic central bank money. After distinguishing RFA from cryptocurrencies and relating the proposal to discussions about narrow banking and the abolition of cash I propose an equivalence result according to which a marginal substitution of outside for inside money does not affect macroeconomic outcomes. I identify key conditions on bank and government (central bank) incentives for equivalence and argue that these conditions likely are violated, implying that RFA would change macroeconomic outcomes. I also relate my analysis to common arguments in the discussion about RFA and point to inconsistencies and open questions.
suspends certain Iranian banks’ access to its cross border-payment network.
According to Peel, SWIFT explains the step as follows:
“This step, while regrettable, has been taken in the interest of the stability and integrity of the wider global financial system.”
This does not only expose SWIFT to punitive actions by the European Union since
… new EU rules … forbid companies from complying with the US Iran sanctions.
It also seems to contradict the explanations that SWIFT provides on its homepage:
[w]hilst sanctions are imposed independently in different jurisdictions around the world, SWIFT cannot arbitrarily choose which jurisdiction’s sanction regime to follow. Being incorporated under Belgian law it must instead comply with related EU regulation, as confirmed by the Belgian government.