Moralizing about money, moralizing about cultures
I’ve been trying to do a sort of Clintonesque triangulation, where I accept a good bit of both sides of the euro-debate, but not all. In other words, the current crisis is caused by both dysfunctional socio-economic systems in the European periphery, and by a dysfunctional ECB. I suppose to some that sounds like a cop out, but I have very good reasons for taking this position.
Let’s start with the conservative position on Europe, which was very ably defended by Tyler Cowen in this post.
Ryan Avent tweeted:
Dear @tylercowen, Germany and the periphery ARE morally equivalent.
How might a response go? Not an argument that German citizens are morally superior to other Europeans; that would be false and indeed repugnant. I mean the kind of “system-wide” moral judgments that progressives offer up when they judge the institutions of Denmark to be superior to the institutions of Mexico, of course without ever judging the residing individuals per se. Let’s play at intellectual Turing test“” with no commitment to endorsing these views “” and draw up a short list of, dare I so label them, (ostensible) German moral superiorities:
Read the whole thing. The post is very impressive, so much so that I’d easily lose an Oxford debate with Tyler. So why do I say; “Yes but . . . ?”
Because of the interwar period of world history. Start with America’s very uneven performance between 1921 and1933. What lessons can we draw? I’d argue that the US circa 1921-29 was close to a conservative paradise, at least as conservatism was defined back then (obviously modern conservatives don’t agree with the racial and gender discrimination of that era.) The economy seemed to have almost no “imbalances,” whatever they are. Fast growth led by huge productivity gains, low unemployment, no inflation, no trade of budget deficits, relatively free markets. And then it all collapsed during 1929-33, as tight money caused NGDP to fall in half. Inevitably some commenters will mention the bad supply-side policies adopted by Hoover (taxes, tariffs, and wage jawboning) but they were far too minor to create the mother of all depressions, and indeed should have led to wage and price inflation, not deflation. Instead, money was the main culprit. But the conservatives of the era could not accept that, so in 1932 they mumbled about workers in the late 1920s living beyond their means, feeling entitled to own cars, radios, and iceboxes. Given what we know about the mass consumer economy after WWII, how likely an explanation is that?
No, the Great Contraction wasn’t a moral problem. The left is wrong in saying it was caused by income inequality, and the right is wrong to portray it as the hangover after an orgy of excess during the 1920s. It was a technical problem, plain and simple. Too little money.
Europe is both, a technical (tight money) problem and a set of structural problems.
Now let’s consider the second half of the problem, the structural weaknesses in the Mediterranean countries. When I did a study of neoliberal policies and cultural valuesof all 32 developed countries back in 2007, I was shocked to find that the “best” cultural values were in Denmark and the “worst” cultural values were in Greece. Why was I shocked? Because Greece was doing quite well in 2007. It had grown rapidly, and its income level was only modestly lower than Germany. Indeed Germany’s income per capita (PPP) was $33,820, lying somewhere between Greece ($32,520) and Iceland ($34,060.) How times have changed! Don’t laugh, but I viewed the success of Greece as a weak point in my argument. So I’m certainly not going to contest Tyler’s cultural argument. But I am going to discuss how it might be misunderstood, and tweak it slightly.
I predict that most readers will have difficulty processing Tyler Cowen’s disclaimer that he is not making invidious comparisons between people, but rather merely describing “cultures,” which have a sort of life of their own. So I’d like to put some meat on the bones of this idea, so that people don’t just assume Tyler is trying to be PC.
1. Some cultural differences do apply to individuals. If I claim the American culture is more gluttonous than the Japanese culture, then I also mean American people are individually more gluttonous than Japanese people. It is an invidious comparison, at least if you consider gluttony a bad thing. (I have no opinion on the subject.)
2. However, cultural characteristics that relate to the organization of society are not as embedded in individuals as it might seem. It almost makes more sense to view culture as something “in the air.” That’s why Greeks and Sicilians do very well in America, and easily blend in to our culture. That’s why Israel is quite different from what one would predict if the only Jewish people you had met were those living in America.
3. When discussing the superiority of a given culture, you always need to identify the context. Superior at what? Producing wealth? Producing equality? Producing peace? Producing strongly knit families and communities? Producing great art or great science? Producing un-neurotic people? Producing joie de vivre? Being fun places to visit?
4. And even if you mean “good at producing successful economies,” it’s still not an easy call. People often see the cultures of Germany, Japan, Korea, and China as being well-suited for economic success. Yet all four countries were economic basket cases in 1945. If an asteroid had destroyed Earth in 1945 the last word on culture would be that Germany had one of the worst societies on earth. Admittedly, pulling out the Nazi example is usually the last refuge of a losing argument. But suppose an asteroid has destroyed Earth as recently as 2002. The last word on Germany would have been that its culture is too “rigid” to adapt well to the post-manufacturing world, and that Catholic upstarts like Ireland and Spain were much more dynamic. There is no last word on culture. All judgments are contextual, and provisional
5. Despite all these provisos, my hunch is that culture is fairly important, and Tyler’s judgments are reasonable. If you don’t agree, consider the following example: Both Afghanistan and North Korea are extremely poor. Which country do you think is more likely to be rich in 2061, fifty years from today? Of course we’ve been wrong before; as recently as the 1950s the small East Asian countries were widely expected to do poorly in the coming decades. We might be wrong again. But right now Korean cultural values seem to be quite useful for the purpose of generating fast RGDP growth.
Bottom line. Europe needs BOTH more NGDP and structural reforms (which may require cultural change.) But not bailouts.
It’s possible that tight money might speed economic reforms, just as economic sanctions on Cuba might speed political reforms. But history suggests that tight money usually leads to bad supply-side policies, and trade sanctions usually fail, as political reform is highly correlated with economic growth. When in doubt, always place your bets with “doing the right thing.” Don’t do bad policies in one area in the hope that they’ll generate good policies in another area. Do good policies in the hope they’ll generate other good policies. That way if you are wrong about spillover effects, at least you have the good policies in one area.
PS. I would quibble with Tyler’s point 9:
9. One clear warning sign of trouble is when you see “trade imbalances” put at the center of the argument, as if “being very productive” and “not being productive enough” were somehow the same kind of disease.
By all means keep “trade imbalances” out of all arguments. Not because they tell us something interesting about productivity, rather because they tell us nothing interesting about anything.
PS. Although I quote Tyler Cowen, this post is not really a rebuttal. I have no idea what he thinks of the views expressed here. Oddly, I find myself agreeing with much of what Tyler says, but also with much of Ryan Avent says in opposition. Are they talking past each other, or am I just a muddled-headed easily impressionable person?
Tags:
2. December 2011 at 10:01
Sorry to sound harsh but morality has no business in economics IMHO. If one is using words like “privilege” “prolifigate” one is not doing economics, it’s political science, or theology.
1. I’ve priced a lot of debt and seen a lot of contracts for various things. There is no “morality” in default. Thats why we have high-paid lawyers who specialize in international law to write tightly worded contracts. Contracts have provisions which include “events of default.” When prices are high a commodities supplier will go to great lengths to mimimize and postpone delivery to maximize revenue; when prices are low they will stuff you with as much as they can at the higher contract price, also to maximize revenue. Most commodities credit analysts have experience with a contract default – large corporations carefully consider the economic cost of a default (usually goes to binding arbitration), impact on reputation, probability/cost of damages, and recourse to recoverable funds. In other words, as a trader once put it “you need to put on your big boy pants.” In the real world, agents are pretty rational actors in my experience. Default is just another potential action with costs and consequences – some quantifiable, some not (like reputational risk). We have quants to attempt to quantify the probability and impact of default, lawyers to write tight contracts, and its all just business with costs and benefits. Goldman Sachs, to pick on someone, puts business in separate legal entities for the express purpose of the ability to declare bankruptcy without recourse to the parent. Heck look at AMR…So to moralize about “default” is not economics, its something else. A rational actor wants to minimize cost and maximize revenue. “Default” is a ruthless business decision made every day with costs and benefits.
2. I think to dicuss the soverign debt crisis in terms of moral hazard is flat out wrong, and not economics either (or at best sloppy). First, empirically, many of the southern countries like Spain have (and still do have) lower debt-GDP ratios than, ahem, Germany. Second, moral hazard entails “risky behavior” the cost of which is borne by someone else and requires information assymmetry. When Germany entered a union with Spain there was no private information about Spanish labor rigidities, pensions, mobility, etc. Many economists warned that the lack of labor mobility made the Euro a bad idea, the union went ahead despite this. Did Germany liberalize employment laws to allow Spanish unemployed to move to Germany?
3. Germany will bear a significant cost of a Euro breakup. period. Germany will bear cost if higher Euro-zone inflation is allowed. Germany will bear a cost of subsidizing euro-zone bonds. In a breakup, exports will drop dramatically, leading to lower tax revenues, and several banks will require bailout, further worsening finances. The real economics question is: is it more costly to allow higher Euro-wide inflation, subsidize Euro -wide bonds, or bear the cost of the breakup.
4. Germany was destined to bear a cost from the day they entered the union. As with any marraige, the cost of divorce escalates with the length of time married. I would argue, even in the case of Greece and Italy, cmon seriously, there is a long long history of tax evasion and corruption. Moral hazard? bad undisclosed behavior? no: Bad prenup. agreement.
5. the far more interesting political question involves a principal-agent issue: Merkel faces a different incentive (the need to maintain power and save face) and that incentive is not aligned with that of Germany. How is that going to work out?
2. December 2011 at 10:46
Scott,
Capital imbalances (and trade imbalances) are very important. Imagine ECB adopts a NGDP level target (the same applies to Trichet’s secret price level targeting regime). At which point do you start to worry about NGDP (or price level) in Greece and start buying Greek securities? Trade imbalances give you a clue.
The problem is very hard. Trichet started buying Greek bonds too soon in 2010, he should have waited until prices drop more.
Perhaps the market monetarist answer is that ECB should always hold a population weighted portfolio of Eurozone sovereign bonds.
2. December 2011 at 12:29
“There is no last word on culture”
I’ve heard it said from historians of economic growth that national GDP in A.D 1000 is a very good predictor of GDP today (obviously english colonies like the U.S, Canada & Australia are more correlated with their historical mother country than the wealth of indigenous peoples). So plenty of totalitarian regimes in the 20th century can be seen as temporary aberrations.
2. December 2011 at 12:41
So what was the deal with those 2007 Greek GDP numbers anyways? Were they cooked, or miscounting debt, or what?
2. December 2011 at 13:22
Scott,
Good post. I’m glad you decided to jump into this with Cowen and Avent. Just one small quibble. With respect to point (5), it seems your example of Afghanistan v. North Korea would suggest that fitting the ‘nation-state’ model is more relevant to economic success than culture specifically (with Pashtuns, Tajiks, Hazaras, etc etc can Afghanistan really be described as having a dominant homogenous culture?).
I think a better example relevant to culture specifically might be China and, say, some of the Islamic nations. Chinese confucian values emphasize saving and a strong work ethic. In a different contrast, Islamic law didn’t allow for the charging of interest and discouraged entrepreneurial activity.
I want to go a step further to double-down and suggest that Chinese culture may even be better equipped than Western values in dealing with current economic issues, like income inequality. As Americans, we’re culturally obsessed with judging our well-being by comparing it to our neighbors. I look at the OWS movement and see how much we still indulge the fallacy that the economy is a zero-sum game. Chinese, on the other hand, are more likely to judge their well-being on an overall absolute sense and, in my view, are culturally adapted to accommodating pareto-optimal outcomes. Depending on successful the OWS movement becomes, the US could potentially be looking at a future with much higher taxes on corporate income and capital as a result. There is a lot at stake that cultural values are determining.
P.S. In the interest of full disclosure I have been married to a Chinese woman for a few years and, admittedly, some of my conclusions are based on generalized observations that are anecdotal.
2. December 2011 at 17:04
dwb, You said;
“Sorry to sound harsh but morality has no business in economics IMHO.”
You can’t do economics without morality. But let’s assume you are right. Your comments on Germany are obviously directed at Tyler Cowen, not me. If I was Tyler, here’s how I would respond:
“You say it’s all cold calculation? Then on that basis Germany should not lift a finger to help the other countries. So I still get the same policy conclusion. Other people have said Germany has an obligation to help the PIGS. I showed they don’t. And if you want to argue that only self interest matters, then it’s not in Germany’s self interest to help the PIGS, Germany is doing fine.”
As for myself, I don’t think any system based on selfishness can work. Capitalism requires altruism, that is, it requires morality.
Germany has given lots of foreign aid to countries like Greece. If Greece defaults, it’s not clear to me why Germany should give foreign aid in the future. Switzerland shows that Germany’s success is not because it’s in the EU.
123, I’m worried about California’s ability to service it’s debt, but not because of trade balances. I don’t even know whether California has a trade surplus or deficit. I do know that Australia has had one of the largest total CA deficits of any developed country over the past 25 years, but I’m not at all worried about Australian sovereign debt, because they hardly have any. Sovereign debts matter, CA deficits don’t.
Wonks, Yes, but not as good predictor of GDP in 1750. China had already fallen behind by that time. And if I’m not mistaken, the Nordic countries trailed places like Italy.
As I said, I do think culture is important, I just don’t see there ever being any last word on the issue. The culture proponents were caught off guard when Ireland became richer than Germany, for instance. There will continue to be surprises–indeed it’s not impossible that Afghanistan will do much better than I assumed.
jj, I’m told they were cooked, but have no first hand knowledge.
TylerG, Yes, but the German, French, and Italian tribes in Switzerland seem to do fine. (Yes, I’m sure that’s a horrible comparison, but I thought I’d throw it out there.)
You said;
“I want to go a step further to double-down and suggest that Chinese culture may even be better equipped than Western values in dealing with current economic issues, like income inequality. As Americans, we’re culturally obsessed with judging our well-being by comparing it to our neighbors. I look at the OWS movement and see how much we still indulge the fallacy that the economy is a zero-sum game. Chinese, on the other hand, are more likely to judge their well-being on an overall absolute sense and, in my view, are culturally adapted to accommodating pareto-optimal outcomes.”
Perhaps, but I’ve been to China many times, and that’s not the impression I get. If anything, just the opposite. Lots of Americans are comfortable living a bohemian lifestyle, they’re comfortable not “keeping up with the Jones.” That’s less true in China.
You said;
“P.S. In the interest of full disclosure I have been married to a Chinese woman for a few years and, admittedly, some of my conclusions are based on generalized observations that are anecdotal.”
Me too.
2. December 2011 at 22:18
Interesting post. I happen to think culture trumps even government policies, when it comes economic success. A culture in which honesty and the work ethic are paramount will always beat a corrupt lazy country.
Sweden will always be a nicer place to live than Nigeria, even if Sweden is icebound and socialist and Nigeria has fertile fields and is capitalist.
I guess if the government is rotten enough–N. Korea comes to mind–then government can trump culture, but we are talking gong-show governments.
This comes back to my favorite idea, and that is that in the USA we should print gobs of money. The American culture is freewheeling, risk-taking, boom-loving. Monetary policy that talks about steady two percent inflation trumping all other concerns is death on American culture.
Americans start business and invest when they think there are going to hit a home run. Boom, baby, boom. No one buys a rundown property in the hopes that it will appreciate at a two percent annual rate. Listening to an anal-gnome pettifog about inflation will kill the typical American businessman.
A monetary noose around the necks of Americans is death on our culture and incentive-system to invest. We are not Swedes or Japanese or Germans or some wieners from Austria.
Americans do not play soccer for hours in the hopes of eking out a 2 to 2 tie. We want to hit the home ruin, or spike it in the end zone. The slam dunk at the buzzer.
Tight money will never work in America—we were better off when counterfeiting was rife in the pioneer days. I wish we had successful counterfeiters today. Lots of ’em.
3. December 2011 at 01:53
TylerG/Scott,
Definitely it does depend. Singapore for example is often stereotyped by both Singaporeans and Malaysians as having a “kiasu,” keep-up-with-the-Joneses culture, and this is seen primarily as a Chinese cultural thing. It doesn’t surprise me to hear that something similar may be happening in China.
Re Islam, although it has prohibitions on usury, so did Christianity (or at least Christianity as it was once understood). Islam was founded by a merchant in a mercantile culture; I don’t see anything inherent in Islam which makes it anti-enterprise. Certainly, though, there is path dependency. But Christians eventually overcame cultural resistance to interest, and I don’t see a good reason why Muslims can’t do the same.
3. December 2011 at 07:02
Ben, Yes, those are good points. My sense is that culture is becoming more important over time, as a number of dysfunctional governments in places like China and India gradually adopt market reforms.
johnleemk, Good point, I’m no expert on Islam, but I’m told that things widely associated with Islam (the veil) are actually cultural developments that are unrelated to the religion.
3. December 2011 at 10:56
I think I am in agreement with your middle of road answer. It’s clear culture affects people’s behavior and the societal equilibriums, but economics has a profound affect on the culture, many of the cultural virtues and vices attributed to China have more in common with relatively poor agricultural societies, which China was until ten years ago. And there is also a tendency to reach for ‘just so’ explanations that happen to fit the current circumstances, Confucianism was supposed to be the force holding East Asia back in the first half of the twentieth century.
Ha Joon Chang, a Korean economist, makes the point that stereotypes were almost the opposite of the present day views for Germany and Japan a century ago. (Link below).
I think that you’re probably right about N. Korea and Afghanistan, then again I suspect many people would’ve thought Peru and S. Korea would’ve had very different outcomes this century if asked a fifty years ago. Cesar Hidalgo at MIT and Harvard has developed model that does a good job of capturing growth potential an development by looking at the diversity and complexity of their exports, it predicted Korea’s divergence from Peru without knowing anything about Confucious or Pizzaro.
http://www.sed.manchester.ac.uk/research/events/conferences/povertyandcapital/chang.pdf
http://www.chidalgo.com/papers.html
3. December 2011 at 12:32
Riddle me this: If Germany is so f-n moral, then what of the stories of pressuring Club Med countries’ governments to purchase German weapons? Or the fact that Germany willfully ignored phoney numbers until it actually mattered to the markets?
These moralizing arguments made by Tyler are pure and simple BS (Not that he believes them). If Germany will feel better blaming the coming collapse on the immorality of other cultures, then I am sure we can come up with some incredible moral failings of German culture (past and present).
3. December 2011 at 13:06
Scott,
I don’t agree. Iceland had almost no sovereign debt before the crisis (20% in 2007), but in 2009 they were one of the most risky sovereigns in the world. That’s why I think that the balance of payments data should not be ignored.
3. December 2011 at 20:55
OGT, Thanks for the link.
Pointer, Didn’t you leave this comment at the wrong blog? I have no opinion on German morality.
123, How big was their sovereign debt in 2009? And was it in local currency? And did they default?
3. December 2011 at 22:07
Germany and Texas are morally superior to Greece and California, or there is no such thing as morality.
They are BETTER. They are PREFERABLE. And Tyler is dead wrong.
Everyone does not get a trophy. Those that structure their society to win trophies are morally superior cultures.
The fancy answer is sustainability.
The clearer answer is adaptability. He who adapts (out competes) wins.
To the victor go the spoils is moral precisely because it makes the loser dance, the trophy for the winner is less important than the loser KNOWING and knowing others KNOW – they lost.
After all, the women have to know who to sleep with, or human history ends.
—-
We can barely be sure there is such a thing as society, but if there is it first exists in Team A vs. Team B.
Meaning society only exists because at least two subsets are splitting up, teaming up to defeat each other.
Meaning, when you have only one government, there won’t be one, it will just be how ALL the individuals on the globe that matter decide the rules are going to be.
4. December 2011 at 02:14
O.G.T.
Thanks for the link to the Ha-Joon Chang paper.
His argument is dubious regarding both Japan and Germany.
First he quotes Beatrice Webb on Japan and Korea. But Webb was a terrible witness. Beatrice and Sidney Webb visited the USSR at the height of the Ukrainian famine (1932), yet wrote a book, “Soviet Communism: A new civilisation?”, portraying the place virtually as a paradise. Judging her by her record, if Webb were declaring the Japanese and Koreans lazy and indolent, that’s excellent reason to suspect the opposite was the case. Let’s not forget, at the time Webb was writing, Japan had a naval alliance with Britain. Japan had already achieved a spectacular victory over Russia in the war of 1905, so Britain had good reason to think about this rising, successful potential maritime rival. Webb’s opinion is eccentric at best.
Second, Chang’s quotes about a ‘lazy’ German culture are highly selective. There’s plenty of evidence the more familiar cliche’s of German culture were well-known already in the 18th century.
For instance, Prussian military discipline was widely admired in the 18th century. In the Seven Years War (1754-63) Frederick the Great’s outnumbered Prussian army managed to fend off an alliance of France, Austria, Russia and Sweden, largely because of their superior discipline. The music of J.S. Bach has a rigour, a tightness of construction, which has never been surpassed. Compared to the Goldberg Variations and the Art of Fugue the French and Italian music of Bach’s time often sounds makeshift. And Bach himself said it was hard work that enabled him to write such perfectionist music. What about Immanuel Kant? The German philosopher was so punctual, the townsfolk of Konigsberg set their clocks by his daily walks.
Chang is definitely right that cultures can and do change over time. But, in the cases of Germany and Japan, he’s being selective, presenting outliers as if they held the settled opinion of the time.
4. December 2011 at 13:54
Scott,
the government debt/GDP gross ratio was 88% at the end of 2009 (two thirds in the domestic currency), net ratio was 56%.
In 2007 net debt was 11% of GDP. In 2007 gross debt was 29% of GDP, a bit more than half in domestic currency, the rest in foreign currencies.
Iceland did not default (IMF has helped), but according to credit default swaps, in March 2009 Iceland was sixth riskiest sovereign in the world (at that time Greece was number eight).
4. December 2011 at 14:14
I still must peruse this well, but the problem here is that they did not enforce (or have an automatic enforcement mechanism) for the Maastrict Treaty – right?
This is just what happened with the Articles of Confderation; the lack of federal power and oversight undermined the union of states. They learned from the problems. Europe will sort this out if it’s efficient and it ought to be well done.
4. December 2011 at 15:53
[…] on in the international blogosphere with Tyler Cowen and Ryan Avent as the main participants, and Scott Sumner adding some interesting historical perspective. In my view, Ryan and Tyler are not talking about […]
4. December 2011 at 22:17
Point 2 is dead wrong. Culture is to a large degree innately determined. Sicilians and Greeks in America have not done as well as Ashkenazi Jews, Scandinavians or Han Chinese, even after many generations. They have done better than Scotch Irish, Mexicans and Blacks. If you look at European GDP it is about what you would expect. Culture, i.e. the genetic make up of a given population, does change over time, but over a longer time scale than most people appreciate.
5. December 2011 at 00:34
“In other words, the current crisis is caused by both dysfunctional socio-economic systems in the European periphery”
How is that? I can understand your argument if it’s intended against Greece, but Greece is too small to cause crisis in EU.
Spain and Italy had their public spending in control before 2008. Spain especially had very good debt to GDP ration. Italy had huge debt, but it was in control and shrinking slowly.
It’s seems that the fundamental problem in euroarea is not cultural differences, but economies that are not in sync. Easy money from Germany flowed to Spain and Italy increasing wages and creating private sector bubble that these countries were unable to control because they don’t have their own monetary policy.
Britain would have been completely screwed by current crisis had it been part of euroarea. Now it can survive it easily. The same option is not possible for Spain and Italy.
9. December 2011 at 05:57
Scott,
The topic seems to be quite far removed from the expertise of anyone, let alone Messrs Avent, Sumner & Tyler.. However if we forget to use terms like moral(ity) it appears that there are patterns of behaviour that maybe typical of groups of individuals characterized by things that they share an environment, some specifici culture, education, a language or a taste for food. Etc.
I thought that TC’s post was quite interesting although not necessarily a good reply to RA’s (typica) statement/question-without-a-single-reasonable-answer.
Moral superiority is unmeasurable (and would certainly not a one-dimensional, static, persistent, etc thing as suggested by the clever tweet.
I think TC’s comment, separate from the provocation at the top, are good enough to convince a remore judge to cut the “Germanic avatar” a lot of slack. Anyone familiar with economic development would probably agree that (a) some conutries in the EU would, if assessed by a, say, Korean economic historian be found wanting in the things that cause long term GDP growth, formation of social capital, development of a strong supply side with gvt policies conducive to the formation of a strong, productive and innovative private sector. Or, simply, that they are less developed than they could have been, despite location, climate, resources etc differences, if they had been part of, say Germany (or Ruritarnia, if that place had the right kinds of factor quantuty and quality). Not to say that German institutions are so overwhelmingly good, or German private sector management so superior, or the German people so much qualified for success in the global economy. No country (except Singapore maybe) has tried to be superior and it is my firm belief that democratic electorates will tend towards fairness long before peak efficiency is reached. And dictatorships face an even more difficult job there.
So, it is not a Germany vs the rest sort of thing. We simply have an economic union with a bad structure, no template for something better a vacuum where central national authority should be located, and probably very high break-costs. Hence the only way to go forward with this thing is to leave the EUR alone for a while, regulate financial markets in the EU at the same level as the US’s (that would include a much more transparent gvt bond market and more discipline over primary dealers) and explain to the countries that are “backward” (relative to Sweden, Germany etc) that their gvt policies must be geared towards growth of the private sector.
The main ting that wnet wrong during the past ten years was not only that the EUR facilitated bad fiscal policy in many countries. The really problematic thing was that the flows between “richer” and “poorer” countries were in the wrong form. Instead of FDI/equity for productive, non-residential investment, the main flows were trough financial intermediaries from individuals/funds/banks to the banking and public sectors of the countries that were supposed to foster their private sectors in order to “catch up”. The equity and FDI flows from the “rich” countries went instead to the former CMEU, Asia and the US. As soon as a Portuguese location becomes competitive with Shenzen or Poznan for a German firm wishing to relocate production, e have a chance that the EU may develop into a functional equivalent of the US economy (not to say that the Shenzen jobs should stay in Portugal forever of course, or that all productive investment should be foreign, or that the US does not move production abroad…).
The only good thing of this crisis is of course that the “rich” countries do not suffer from the same currency buoyancy as the Japanese. Good for net exports, good for statistical economic performace. An unintended, unfair consequence, the Japanese would say.
10. December 2011 at 07:48
Morgan, You said;
“Germany and Texas are morally superior to Greece and California, or there is no such thing as morality.”
Is that a comment you would have written in 1945? Or are you merely saying that people are people, but their policies are currently superior? (Something I could agree with.)
123, I still don’t understand how the balance of payments issue got translated into sovereign debt. Did the Iceland government bail out private firms who ran up foreign debts?
As an aside, I would add that tiny countries tend to have much more volatile macro data–something the debate over Estonia and Latvia tends to miss.
Commentator, Are you saying Europe will become a single country like the US?
Peter, I’m no expert on genetics, but it seems to me that most immigrant groups do much better in the US than hteir home country. The Chinese example you cites actually cuts against your argument. Greece is relatively poor, so is China. Yet you claim Chinese do well in America–that suggests Chinese poverty in China is not genetically determined. But if so, then perhaps Greece’s problems are also not genetic.
Nick, You said;
“Italy had huge debt, but it was in control and shrinking slowly.”
I did a recent post on this. It’s levels that matter most, not just the trend up or down.
I agree that the eurozone mismatch is the fundamental problem, but Italy and Spain would have problems even if they weren’t in the eurozone–they’d just be less severe. Spain had 20% unemployment a while back–it’s got chronic problems.
Rien, You said;
“Moral superiority is unmeasurable (and would certainly not a one-dimensional, static, persistent, etc thing as suggested by the clever tweet.”
That’s my post, isn’t it?
I agree with part of your comments, but certainly not the claim that residential investment is “non-productive.” It’s likely to last for much longer than most factories (which quickly become technologically obsolete. House in Europe often last for 100s of years, providing nice housing services. They built a bit too much, that’s the only problem.
11. December 2011 at 11:01
Scott,
Here are the reasons sovereign debt exploded in Iceland after the crisis:
1. recapitalization of the central bank (18% of GDP)
2. automatic stabilizers
3. liabilities related to insured deposits in foreign branches of commercial banks
4. recapitalization of commercial banks (I agree with Krugman that this was not a bailout)
Current account imbalance statistics have provided a good warning signal that these four problems could happen.
You said:
“As an aside, I would add that tiny countries tend to have much more volatile macro data-something the debate over Estonia and Latvia tends to miss.”
While there are some differences, the Icelandic crisis and the crisis in Lithuania, Latvia and Estonia fit the model of the ’98 Asian crisis. I don’t agree that size of the countries was very important in this case.
12. December 2011 at 09:33
123, Obviously those were horrible public policies, but I don’t see the realtionship to the balance of payments. It’s idiotic to insure foreign deposits equal to multiplies of your GDP, I think everyone agrees with that. (Has the issue been resolved yet?) Why recapitalize the banks?
How did the central bank lose so much money?
12. December 2011 at 09:34
BTW, I meant that smaller countries tend to have bigger cycles, because sectoral or regional shocks are less likely to balance out. If you took the average American city, it’s cycle would be more volatile than the US.
13. December 2011 at 10:34
“Obviously those were horrible public policies, but I don’t see the realtionship to the balance of payments. It’s idiotic to insure foreign deposits equal to multiplies of your GDP, I think everyone agrees with that. (Has the issue been resolved yet?) Why recapitalize the banks?”
Two stories can be told here, both are partially true. In the first story the problem is caused by bad regulation and/or mistakes of private sector in the capital exporting country. In the second story the problem is caused by bad regulation and private sector mistakes in the capital importing country.
1. Capital inflows and associated current account deficits cause a debt boom in the capital importing country.
2. Bad regulation or mistakes made by the private sector cause a debt boom, this in turn attracts capital from abroad and this causes a current account deficit.
In the US the first story applies more, it can be argued that current account deficit is an efficient response to the global savings glut.
In Iceland the second story was very important. Implicit state support of the banking sector has created a current account deficit. Icelandic households have made a mistake – they trusted their government too much, they should have tried to mitigate the problem by saving more. I live in a country that had a double digit current account deficit before the crisis, and I have responded to it by saving more, but I can tell you that I was in a tiny minority.
“How did the central bank lose so much money?”
It lent money to commercial banks against the collateral that ex-post went bad. By the way, the problem of the asset side of the central bank is an underdeveloped part of market monetarist view. In 1997 Tyler Cowen said futures targeting will cause the bankruptcy of the central bank, and market monetarists gave no good answer in the following 14 years.
“Why recapitalize the banks?”
I think the decision to accept IMF loan and invest the money to recapitalize the central bank and the commercial banks was a good decision. Central banking can be defended as a public good. In the darkest days of the crisis, IMF was the only feasible provider of the capital to the commercial banking system. Lots of liabilities of the commercial banks were written off during the reorganization process, so I hope that the Icelandic government has received a good price for the shares of the commercial banks.
“BTW, I meant that smaller countries tend to have bigger cycles, because sectoral or regional shocks are less likely to balance out. If you took the average American city, it’s cycle would be more volatile than the US.”
Yes, but it is interesting that we can ignore this. For example, the fiscal cost of the crisis (as a percentage of GDP) was very similar in Iceland and in Indonesia ’97.
13. December 2011 at 14:56
123, I think we are talking past each other. I agree that bad public policies can lead to CA deficits. I just don’t think deficits are in and of themselves bad.
The solution to the problem of central bank losses is very simple—don’t lend money to banks. I’ve always been opposed to the discount window.
I don’t see any logical relationship between NGDP targeting and central bank risk. I doubt any central bank would get into trouble targeting NGDP at 5%, certainly the Fed didn’t during 1990-2007.
I’ve proposed making the futures market several orders of magnitude smaller than the actual OMOs, in which case there is no risk to the central bank. So it’s simply factually inaccurate that we haven’t responded to Tyler.
I really can’t see why you’d want to have the government recapitalize the commercial banks.
Iceland and Indonesia is apples and oranges. Find me a big developed country with a cycle as big as Iceland.
14. December 2011 at 14:34
Scott, I mostly agree about CA deficits. The only difference is that I think in more than a half of cases high CA deficits are caused by bad policies somewhere. So any CA deficit above 7% rings an alarm bell.
“The solution to the problem of central bank losses is very simple””don’t lend money to banks. I’ve always been opposed to the discount window.”
You have to lend money to someone. T-bills are risky too.
In Estonia there are no T-bills or T-bonds (at least this was the case two years ago).
“I don’t see any logical relationship between NGDP targeting and central bank risk. I doubt any central bank would get into trouble targeting NGDP at 5%, certainly the Fed didn’t during 1990-2007.”
In the short run NGDP targeting reduces the risk to the central bank, as Ch. Norris effect does a lot of work. But in the long run, if you make an idiot-proof central bank, the financial system will build a better idiot.
“I’ve proposed making the futures market several orders of magnitude smaller than the actual OMOs, in which case there is no risk to the central bank. So it’s simply factually inaccurate that we haven’t responded to Tyler.”
Both OMOs and futures market create a risk. Collateral policies in the futures market are extremely important. The founders of EMU thought that T-bills are risky so they created a restrictions for the purchase of T-bills.
“I really can’t see why you’d want to have the government recapitalize the commercial banks.”
I agree. Iceland is an exception that proves the rule.
“Iceland and Indonesia is apples and oranges. Find me a big developed country with a cycle as big as Iceland.”
According to Wikipedia, Indonesia is the fourth most populous country in the world. Everywhere big cycles are caused by a single point of failure – either bad monetary policy or mismanagement of financial regulation. That’s why you can put Iceland ’08, Indonesia ’97 and USA ’29 in one table – I have seen such a comparison a couple of days ago in some blog.
Of course sectoral or regional shocks are less likely to balance out in tiny countries, but the governments of such countries should take this into account and run less risky fiscal and regulatory policies.
16. December 2011 at 13:58
123, You are raising false issues:
1. Buy T-bills, don’t lend money to banks. T-bills are not that risky–the Fed can live with it.
2. Estonia can buy US T-bills.
3. I don’t care if idiot banks collapse, unless we insure them.
4. Saying “markets create a risk” does not in any way respond to my point. You were wrong when you said we haven’t responded to Tyler. If you reduce the risk 100 fold, then it’s easily manageable for a big government. Even a 10 fold reduction would be plenty.
5. So you think Indonesia and Germany are equally likely to see a 20% drop in RGDP over the next five years? How about Philippines and France? How about Iran and Canada?
Yes, the US was very unstable in the 1920s, but it’s become increasingly stable (albeit still less than I’d like to see.)
17. December 2011 at 02:51
Scott, management of tail risks is not a false issue. It is an issue that is not important for the US over the next 10 years, but it needs to be examined. T-bills have tail risks.
BTW I think Indonesia and Germany are equally (un)likely to see a 20% drop in RGDP over the next five years. Germany is more diversified, but Indonesia has got its own currency and lower bank asset to GDP ratio.
18. December 2011 at 08:48
123, the fed should accommodate the demand for base money to keep NGDP on target. The safest asset to buy is T-bills. Yes, there is a tiny risk, but much less than the risk of letting NGDP collapse.
I predict that if there were futures markets on German and Indonesian depression, they would agree with me.
19. December 2011 at 12:45
Scott,
On a days when big financial institutions fail, T-bills yield less than reserves (i.e. T-bills yield less than zero). It is possible that the Fed could buy all the T-bills that exist with a bad result – a guaranteed loss for the Fed and NGDP expectations below target. In fact, the Fed sold T-bills in September 2008.
5 year credit default swaps are a good substitute for the futures markets on depression. So far these markets agree with you, and Germany is safer. On the other hand, 5 year cumulative probability of Indonesian default on July 1st 2011 was equal to 10%. It took only three months for Germany reach the same levels of risk. Germany is now a little bit closer to depression than Indonesia was one year ago.
20. December 2011 at 10:14
123, I’ll pass on T-bills because I’m no expert, but doubt the risk is large in the long run.
I’d point out that Germany lacks its own currency, hence default risk is probably larger relative to depression risk than in Indonesia. On the other hand German culture (bills must be paid) might cut the other way.
21. December 2011 at 09:57
Scott,
there are two problems with T-bills:
1. Their value can drop when NGDP expectations return to target from below.
2. You have to do more OMOs to get the same result if you buy T-bills. If the Fed buys riskier assets, it can operate with much smaller balance sheet, and the total risk can be lower.
22. December 2011 at 07:50
123, I don’t agree. The balance sheet depends on the size of currency in circulation, which depends on expected NGDP growth. I doubt the composition of assets has much bearing at all on the size of the base. If the base is “too big,” requiring the Fed to take on undesired risk, simply raise the NGDP target. The current large base is due to low NGDP, nothing more. It has almost nothing to do with the financial crisis.
22. December 2011 at 14:20
Scott,
usually the composition of assets is not important. The exception is during the financial crisis. Let’s assume that the fed operates a regime of NGDP level targeting, and the level of S&P 500 consistent with NGDP expectations being on target is 1500. Suddenly stockmarkets crash because of the financial crisis, and S&P crashes to 1400. As there are huge limits to arbitrage during the financial crisis, the easiest way for the Fed to restore NGDP expectations is to directly intervene by purchasing S&P futures. Due to limits to arbitrage between various markets, the Fed might buy all the T-bills out there without restoring the S&P 500.
p.s. T-bills and S&P 500 futures are both wrong assets for the Fed to hold, I am using them for illustration purposes only.
23. December 2011 at 07:56
123, I have zero confidence in the Fed’s ability to time the market better than investors. I’d prefer they buy long bonds, if the supply of T-bills is exhausted. The EMH says they’ll earn neither profits nor losses in the long run. In any case, with NGDP taergeting I’d expect the demand for base money to be fairly stable, so they wouldn’t have to buy very much.
23. December 2011 at 08:20
Scott, as the price of treasuries includes the insurance premium against deflationary shock, according to the EMH in the long run Fed’s losses will be equal to the cumulative amount of the useless insurance purchased (I am assuming here that the NGDP level peg is successful).
25. December 2011 at 09:24
123, I don’t see why there’d be any losses in the long run. Their liabilities are zero interest and their assets are positive interest.
25. December 2011 at 15:59
According to Milton Friedman, issuing zero interest rate liabilities amounts to a tax. This might be a workable solution, but it is suboptimal.
There is also an issue of financial innovation. During normal times, financial innovation reduces the amounts of the tax that can be collected by issuing zero interest rate liabilities. During financial shocks, financial innovation increases the amount of T-bills that the Fed has to buy an very high prices.
26. December 2011 at 04:27
Scott,
Did you see a Tyler Cowen’s NYT piece “From the Fed, a Shield Against Europe”. He has just switched to my long-held view that IOR have huge benefits for the financial stability.
I don’t agree with Cowen here:
“THE Fed’s stockpiled liquid reserves have met some heavy criticism. “” while proponents of monetary expansion have wished that banks would more actively lend out those reserves to stimulate the economy. That second view assumes that the financial crisis is essentially over, but maybe it’s not. As the euro zone crisis continues, it seems that Ben S. Bernanke has been a smarter central banker than we had realized.”
Bernanke has underestimated the quantity of reserves needed.
Of course, IOR means that market monetarists have to think much harder about the asset side of central bank balance sheet.
31. December 2011 at 08:38
123, I don’t agree that zero-interest liabilities are sub-optimal–the cost of paying interest on currency exceeds the benefits. And during normal times 95% of the base is currency.
I did read Tyler, but his point is unrelated to mine. I asked for a lower IOR, consistent with rapid NGDP growth. Given a base of nearly $3 trillion, that would have to be positive if NGDP growth is on target. So I have no problem with that.
But IOR isn’t going to stop a financial crisis, as we learned in 2008–the two issues are basically unrelated.
1. January 2012 at 03:44
Happy New Year!
Australia is a normal country living in normal times, but starting with 2015 RBA will expand the balance sheet by lending against residential mortgage-backed securities, as the new Basel reserve requirements could create a financial crisis.
2008 was not a good test of IOR. Bernanke wanted to start IOR just after Bear Stearns to fight the financial crisis, and he was unable to do that for legal reasons.
1. January 2012 at 20:33
123, Happy New Year to you as well.
I agree that 2008 was not a good time to test IOR, which can work quite well under most conditions.
Scott