Italian Black Labor and Productivity

Just thought I'd explore further into a Krugman post a couple of days ago. He asks further questions to Italian productivity. Essentially his point is that Italy's labor market has always been characterized by poor enforcement and over-done labor regulation. Naturally, (this is a characteristic of the Indian labor economy too), one should expect to see some sort of rise in shadow-labor, black labor, whatever you'd like to call it. 

What he does, and what I looked at separately is to dig up measures of cost competitiveness - namely REERs based on ULCs and CPIs/WPIs. The divergence in the data seems in sync with what you would expect in the case of overvaluation and underreported productivity. He makes a note of the possible inconsistencies with an economy that has a difference in quality of their composition of exports but the point is still taken. 

The divergence is quite significant. One has to look at BOPs data to know that Italy wasn't really one to run up huge CA deficits. Anyway, what I did is to split the data from 1990-2001 and 2001-present. I'm dealing with indices based to 2005 so in both cases, i based them back to 100 to compare the trend. Here's what they look like:

Post-euro, it's a bit expected but still significant taking into account Italian growth rates and mild/moderate price levels.

More on Carney

Just some more Carney-related stuff - namely that you often (more than often!) hear of bankers and people in finance being poached left, right and center but when have we had central bank poaching at this level? I really really do believe that being a central banker might well be the single most important position in certain countries. 

Matt O'Brien at The Atlantic advocated a global market for central bankers and argued for a removal of the home-grown theory. This was back when news first filtered of Carney being a front-runner. In it, he said 

"Let's try a thought experiment. Say that Lars Svensson -- one of the world's top monetary economists and the current deputy governor of Sweden's central bank, the Riksbank -- could get our economy back to trend in half the time Ben Bernanke could. It's actually plausible-ish. Like Bernanke, Svensson spent his academic career championing unconventional monetary policy as a "foolproof" way to escape a liquidity trap. (Coincidentally, they were colleagues at Princeton). But unlike Bernanke, Svensson's Riksbank has been much more willing than Bernanke's Fed to experiment with these kind of heterodox policies. Perhaps unsurprisingly, Sweden's recovery has been the envy of the developed world. So I ask again: How much is a good central banker worth? Put simply, how much cash should we throw at Svensson to steal him away from Sweden?

That's another way of asking how long it will take the economy to return to trend. Here's where things get really depressing. According to Fed Vice Chair Janet Yellen, we won't get back to full employment until after 2018. If we assume the output gap will steadily shrink until then, that leaves us with roughly another $4 trillion in lost income. Maybe more. If Svensson really could double our recovery speed, he'd be worth $2 trillion to us. Even if that's being wildly optimistic, something on the order of hundreds of billions of dollars probably isn't. Tell me that wouldn't be worth paying Svensson a billion dollars a year. Maybe more.

The above suggestion is obviously a bit tongue-in-cheek ... but not completely. Right now, central bankers are paid almost entirely in prestige. Ben Bernanke is making just $199,700 this year. That's not to say that we need to pay central bankers more to attract the best ones. We don't. Economists really care about prestige.

This doesn't necessarily lead to the most efficient allocation of monetary economists. As Matt Yglesias pointed out, we'd ideally have economists prove their central banking chops in smaller countries before moving up to the big leagues of the Fed or the ECB or the Bank of England. Put a bit less diplomatically: Sweden is important, but it's a relative waste of Svensson's talents not to have him running a bigger central bank. (Not that I have anything against Sweden). Here comes the "to be sure" sentence: It wouldn't be enough just to import Svensson. As L.A. Galaxy fans can tell you, bringing in one (albeit, overrated) superstar like David Beckham doesn't help much if his teammates are only mediocre. We'd need to create a Federal Reserve board equivalent of the Super Friends for Svensson to make the biggest difference. We might even find out that we already have a superstar in Bernanke in that scenario.

Central banking should be a superstar profession. The difference between a top central banker and an average one can be astronomical, particularly when conventional policy is impotent. An efficient market would pay them accordingly. If the United States spent $10 billion assembling a central banking fantasy lineup of Lars Svensson, Stanley Fischer, Adam Posen, and Christina Romer, it would probably be a phenomenal investment. It'd pay for itself many, many times over. The biggest challenge is changing the norms around central banking. We shouldn't just consider the top American economists for the top spots.

We're a nation of immigrants. The Federal Reserve should reflect that."

Now that's some food for thought - assembling a superstar monetary policy team of global talent.

Sid Verma had an eye-opening piece in Euromoney where he notes how 'Finance's New Statesman's signature move in Canada was undoubtedly the 50 bps rate cut he administered one month into power (the ECB raised rates for the record) along with tact use of language and forward-guidance a year later to hold the rate there for a year once the lower-bound had been hit. 

Here's the actual BoC announcement from back then:

"With monetary policy now operating at the effective lower bound for the overnight policy rate, it is appropriate to provide more explicit guidance than is usual regarding its future path so as to influence rates at longer maturities. Conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target. The Bank will continue to provide such guidance in its scheduled interest rate announcements as long as the overnight rate is at the effective lower bound."

For the sceptic in you, Nomura's Philip Rush says, "The only potential negatives we see are ones of perception rather than substance. Specifically, how the proliferation of ex-Goldman's bankers assuming senior policymaking positions around the world may feed popular mistrust, and how Mr Carney's willingness to leave previous posts may reflect a lack of commitment to each job."

Neither a dove nor a hawk and a trend setter to boot (the BoC was the first G7 central bank to introduce the conditional commitment concept), it's clear that big, innovative things are expected from Carney. Perhaps a bit too much. 

But with fiscal gridlock (read: austerity -> read: idiocy), how much can one man get done? It's something Bernanke probably asks himself every single day.

Infrastructure Spending

Sylvain Leduc and Daniel Wilson at the SF Fed have a forthcoming paper that looks at the dynamic effects of public infrastructure spending (namely federal grants to states for highways) on the output of a state. This is really really interesting to me. Estimating multipliers gets extremely tricky because at some points assumptions have to be made (remember the fiscal multiplier saga!) but essentially attempts to construct explanatory models - at least for the most part - point us in a certain direction.

I don't think there's much disagreement on the state of American infrastructure. There was a brilliant column in the NYT a few days ago by Uwe Reinhardt and one in the FT by Ed Luce as well on how public acceptance of sub-par infrastructure has led to a horrible state of things in the present. I'm just surprised there hasn't been a stronger and more forceful consensus (what's the use, nothing would ever be passed!). The best dose of medicine for the US would be massive, forward-thinking infrastructure spending on a grand scale. Anyway, I should get back to this bit. 

The problem with thinking along these lines is that generally, during a crisis, quick-fix measures and solutions are most in demand and the ones that are actually good in the medium-long term tend to be brushed side. Nevertheless, one would still think that approval for infrastructure projects could have a significant short-term impact as well, especially in a depressed economy. 

The goal is to shift AD and Luc/Wilson conclude with an estimated multiplier of about 2! Think about that for a minute, that's huge. It seems a bit too high from any angle - that for every dollar a state receives in federal highway grants, it's output increases by a couple. Also to be noted is that analytically, there's a variable used (constructed) that captures revisions to forecasts of current and future grants to states (seems sensible because actual spending can be far different in an unfavorable climate thus distorting the causal effects on output). Furthermore, (and there must be more of this in the paper) - spending specially on roads has a significant impact on a state's productive capacity as opposed to other government spending (eg: military).

So what are the conclusions?

- "Based on the results shown...we find that multipliers for federal highway spending are large. On initial impact, the multipliers range from 1.5 to 3, depending on the method for calculating the multiplier. In the medium run, the multipliers can be as high as eight. Over a 10-year horizon, our results imply an average highway grants multiplier of about two."

Hopefully I'll get back to this soon but like I said - models and numbers aside - it's the direction that needs to be established. As long as there's gridlock because one side's policy proposals are antithetical to the other, nothing will ever get accomplished. 

On Carney

Not sure how shocking it was beneath the surface but Osborne's courting of Mark Carney has to count as a bold move. After all, this is a central bank that has been in existence since 1694 and is under immense pressure just like the Fed in a world where conventional monetary policy has long since faded. The appointment of a Canadian ex-GS alum with an encouraging blend of banking experience says a lot about the situation. It's an unconventional, if not obvious appointment, for an unconventional era in central banking. 

Dr. Carney is known more recently for a relatively unscathed stewardship of Canada's central bank, a bust-up with the outspoken JP Morgan head Jamie Dimon, and attacks on fellow regulators (among them Andy Haldane, the leader of the simpler-regulation brigade) among other things.

The bottom line is - he has a huge task at hand. 

The overall reaction has been positive but that's also an outcome of the general empathy to change when the status quo doesn't seem to cut it. Martin Wolf lists three immediate issues - namely, the political (that a central bank in a fiat world makes decisions which have a huge impact on society), the organizational (enabling the consolidation of the various sub-authorities) and lastly (and most obviously!), the intellectual - that with a non-existent consensus on fiscal issues, there needs to be a complete re-think on long-term sources of growth etc. 

The devil's normally in the details and Osborne was determined (or desperate!) enough to tweak the details in his candidate's favor - a 60% salary hike, an eight to five year reduction in term and relocation expenses taken care of. 

All this for the man, who had this to say in response to Dimon's tirade, "If some institutions feel pressure today, it is because they have done too little for too long, rather than because they are being asked to do too much, too soon," and this of Haldane and his call for simpler regulation, "(Haldane’s) conclusion is not supported by the proper understanding of the facts."

Good times at the BoE.

Dragon booms

Here's a theory on the Hong Kong housing bubble courtesy Nomura research. Here's what you should know beforehand:

1) Hong Kong real estate is very very expensive.
2) This is the year of the Water Dragon (I'm Earth!) which should imply a noticeable baby boom.

The premise of the note is simply that while real estate prices have always been horribly expensive, what's puzzling is that it's still accelerating in spite of a growth slowdown! A measure of affordability, as the note shows would be a ratio of home prices and income. This is what it looks like over the long run:

And what's happening on the baby front? Boom?

"We are not seeing the usual boom in Dragon babies – Even on the demographic front, we are witnessing something very unusual. In the first eight months of 2012, there were only 60,103 births in Hong Kong. Compared to the same period in 2011, this is down 5.2% y-y. In the past two Years of the Dragon (2000 and 1988), the number of births rose by 6% and 4% even as the marriage numbers declined by 1% and 7%. Thus, the current condition of a 5% drop in births while marriages are up by 5% is highly unusual"

Draw your own conclusion, I've left out the rather obvious one from the note. No link or causality of any sort but it is a bit unusual in a dragon year.

More on the shadows

Here's Gary Gorton's take on the shadows:

"Historically, during a crisis, banks have suspended convertibility, have been bailed out, nationalised, subsidised, covered by blanket deposit guarantees and so on. There is no case where a society intentionally liquidated its banking during a financial crisis. But here’s the rub: saving the banking system means saving the bankers. And that means that debate over reform is overtaken by anger at bankers."

True, but there's also a lovely paragraph that even Mark Thoma mentions which calls for a kind of re-tooling in our data collecting frameworks. 

" Our measurement systems, national income accounting, regulatory filings and accounting systems are useful but limited. Market economies change. The financial system changes. Isn’t it clear that the measurement systems should also change to keep up? National income accounting, one of the greatest achievements of economics, was built largely as part of the second world war effort and intimately involved the government, which had an interest in understanding the capacity of economies to go to war. Now we need to build a national risk accounting system. The financial crisis occurred because the financial system has changed in very significant ways. The measurement system needs to change in equally significant ways. The efforts made to date focus mostly on “better data collection” or “better use of existing data” – phrases that, at best, suggest feeble efforts. A new measurement system is potentially forward-looking in detecting possible risks."

The problem with risk-reform and regulatory reform is that too many cooks spoil the brother. The biggest fallacy lies in thinking that a complex issue needs a complex solution. Nobody elucidates this better than Haldane in his Dog and the Frisbee speech a few months ago. Should it take an FSB report to start fearing the shadows again? As Gorton rightly says:

"One of the findings of the Financial Stability Board report is that the global shadow banking system grew to $62tn in 2007, just before the crisis. Yet we are only now measuring the shadow banking system. How did such a banking system grow without us noticing – and could it happen again? So a second crucial issue is measurement, in the new world of derivatives, off-balance sheet vehicles, securitisation and new forms of money."

Lines of the Day

Thanks to DeLong for this Keynes gem (1939):

"It is not an exaggeration to say that the end of abnormal unemployment is in sight. And it isn't only the unemployed who will feel the difference. A great number besides will be taking home better money each week.

The Grand Experiment has begun. If it works--if expenditure on armament really does cure unemployment--I predict we shall never go back all the way to the old state of affairs. Good may come out of evil. We may learn a trick or two which shall be useful when the day of peace comes.

If we can cure unemployment for the wasted purpose of armaments, we can cure it for the productive purposes of peace."

Well, we know what happened then...

Uncatchy cliques

I'll have to get back to this for want of time but I've thought all along that it's only a matter of time before such issues are brought to light. Gillian Tett from the FT has a good piece on russian-doll finance (isn't that exactly, in a way, what this is?). 

She credits Tucker with raising soft alarms back during the credit boom which would obviously lead you to question why it was only last week that the FSB released a report on the $67 trillion system that creates calamitous levels of systemic risk that barely anyone can measure? 

The main emphasis here is on the internal working of the BoE and how it seems to have finally transitioned from a hands-off approach (really?). As Tett writes:

"Some regulators on both sides of the Atlantic tried to bridge that mental gulf. When Mr Tucker, for example, became head of markets at the BoE a decade ago, he realised the operations of CDOs and SIVs were affecting the flow of credit. He even suggested an analysis of “vehicular finance” should be incorporated into discussions of monetary aggregates, such as M4.

But he faced at least two big obstacles in raising interest.

First, it was unclear who was responsible for analysing, let alone policing, this non-bank world. For while the FSA was watching the micro-level operations of banks, and the BoE was monitoring macro financial stability, CDOs and SIVs fell between the cracks.

Second – and more subtly – the silo mentality was so entrenched that Mr Tucker did not even have the words to communicate his fears. He knew the phrase “non-bank finance” sounded boring, so he tried to come up with alternatives. But they failed to grab attention."

More on shadow banking soon (hopefully). 

Inequal

Robert Skidelsky has a great condensed piece out at PS, on inequality and capitalism - what he's doing is making a common causal statement starting with why greed manifested itself so readily and focusing not on the supply of credit but the demand  for it instead. 

"And what did the relatively poor do to “keep up with the Joneses” in this world of rising standards? They did what the poor have always done: got into debt. In an earlier era, they became indebted to the pawnbroker; now they are indebted to banks or credit-card companies. And, because their poverty was only relative and house prices were racing ahead, creditors were happy to let them sink deeper and deeper into debt."

It's a bit narrow but it's a horribly valid point. What's more important though,is how the article ends.

"In short, recovery cannot be left to the Fed, the European Central Bank, or the Bank of England. It requires the active involvement of fiscal policymakers. Our current situation requires not a lender of last resort, but a spender of last resort, and that can only be governments.

If governments, with their already-high level of indebtedness, believe that they cannot borrow any more from the public, they should borrow from their central banks and spend the extra money themselves on public works and infrastructure projects. This is the only way to get the big economies of the West moving again."

A lot of people have been saying that. And a lot of people look upon such thoughts as blasphemy. That's why there's little hope for problems to be solved. Because a lot of people in power refuse to admit its very existence.

FUNY, not SUNY

I was browsing through the Atlantic on my phone and I came across a piece by Noah Smith from the ingenuous Noahpinion. It was about something I often wondered many times. Why are there no Federal universities in the United States of America? [which is (still is!) the beacon of higher education in the world?]

Is it because the state system works so well, is less complicated and functions without the hassles of bureaucracy? Probably, but what happens when there's a gradual crisis in tuition cost and overall quality?

Drastic measures = Drastic solutions; which is why the probability of something like this happening in such a politically united government (ahem!) is...well...almost zero.

Firstly, Noah says that the rise in tuition that is often talked about is misrepresented because the majority of it has been in the "display price" rather than the "actual cost" [factoring aid/scholarships etc].

Still, the rises are substantial enough to warrant concern and when one throws in the rapidly increasing burden of student debt you start to draw connecting lines by remembering just what household debt did to the economy.

It seems obvious to me that during a crisis period, and in an economy characterized by uncomfortably high unemployment, the increased costs wouldn't serve as a deterrent to one who decides that a college degree is his/her only hope to a secure job.

With a problem of rapidly rising demand, one would look at increasing supply (college seats). And here's where the private/public sector roles play out.

Smith labels the private sector participation (cue: University of Phoenix comparison) as a failure and reminds us of the crucial elements that will always be missing from an online education - human network, mentoring, personal growth etc.

The question then, is why federal instead of state and I think this is where there's a lot of room for constructive discussion. Essentially, Smith says that state spending will focus on the existing university systems and might simply displace funding (alumni or tuition) thereby having a restricted impact.

One need only look at other models of success such as the IITs and the Japanese universities which "annually produce superb graduates in technical fields". A national system would combat the tuition increases and also attract, as well as accommodate, highly skilled immigrant kids/parents. Furthermore, it would provide a way out in terms of research spending which is all too important to ignore.

There's a sense of reality here, however, that not even Smith can deny. A concept like this, which involves significant amounts of will, planning and money (and most importantly, a public good), will be shot down by the right faster than an injured moose on hunting day in Ohio.

But it's an intriguing thought nonetheless.

Balance Sheet Stuff

I'm continually puzzled as to why the fundamental concept of a balance-sheet problem hasn't filtered through the very-important-people-in-power. Is it really so difficult to look at the massive period of private sector deleveraging? If that's not the difficult part, is it difficult to draw a simple conclusion after that?

Goldman's US Chief Economist Jan Hatzius makes a visual point in a note which I've lifted of Business Insider. Essentially what he's stating unequivocally is the importance of monitoring the gaps between spending-income/saving-investment to see whether things are improving:

"...underneath the fiscal drag the fundamentals in the private sector of the US economy are improving. The key force behind this improvement is the gradual normalization in the private-sector financial balance, i.e., the gap between the total income and total spending--or alternatively, the total saving and the total investment--of all US households and businesses, from levels that remain very high. When the private sector balance is high, the level of spending is low relative to the level of income. A normalization then means that spending rises relative to income, providing a boost to demand, output, and ultimately employment and income. The induced improvement in 
income then has positive second-round effects into spending."

Krugman might be pleased. It is aggregate demand after all!

Ostriches vs Emus

Lisa Pollack at FT Alphaville has a gem of a summary on Super Mario in Milan. I'm not going to read the whole speech and the excerpts won't probably tell you all that much but it's still amusing to read. 

Now I don't quite know what Draghi really thinks. If he was fed a strong dose of veritaserum, what would he really say? That the traditional monetary transmission mechanism is broken? That we need a banking union (single supervisor); a fiscal union that can effectively prevent unsustainable budgets; an economic union that can guarantee sufficient competitiveness to sustain high unemployment; and a political union that can deeply engage euro area citizens? 

That's what Mr. Draghi did say (do keep in mind that he's addressing students after all!). But this is just politically correct stuff consistent with the kicking-can attitude that policy makers have had forever. After all, is a fiscal union just one that "prevents unsustainable budgets"? We might as endorse the austerity brigade then. What about effectively transferring resources, encouraging labor mobility and broader economic integration? 

Pooh, who cares. The goal of a fiscal union is to prevent unsustainable budgets. Gospel truth.

Here's the amusing thing (I have to copy and paste this in order to make you smile):

Background Blurb: If there's a father of the euro, it might well be Tomasso Pado-Schioppa who, in the early 80's recognized the inconsistency (much like the trinity) of free trade, a fixed exchange rate, independent monetary policies and free capital mobility. He also advocated eliminating the third to attain the other three.

"

All well and good. But, one more thing…As you know, in recent months I have repeatedly stressed the irreversibility of the euro. This was precisely the sentiment of one of Tommaso’s most noted quips. Speaking in 2004 about the “EMU”, an abbreviation for Economic and Monetary Union, he remarked that it was also the name of an Australian bird rather like an ostrich. And he added: “Neither of them can go backwards”.

Clever!

Know who’s also clever? That Gary Jenkins over at Swordfish Research: Yes Mr Draghi but a cynic might say that the real resemblance between Economic and Monetary Union and an Ostrich and Emu is that it sticks its head in the sand at the sign of trouble and in its current format has little chance of taking off…

                                                                                                                                                     "

EU-IP

Bleak, bleak, bleak. 

September's Industrial Production numbers (excluding construction) are worse for the Euro Area. One line is the EU 15 and the other is the broadest EU-27, both dropped a good couple of points from last month. The data is seasonally adjusted and a simple percentage corresponding to the IP index value the previous year.

It's only since the beginning of last year though, might this get even worse?

Poor - the four letter word

A well-researched piece from The Economist's print edition (it's available online) that tries to pose fundamental questions on America's attitude to its poor. Lots of gems in here, including two charts that I've lifted from the article:

"A child from a family in America’s bottom quintile of earners is markedly less likely than a child born into the top quintile to be ready for school at five. He is less likely to graduate from high school with decent grades; he is more likely while still of school age to become a parent or be convicted of a crime. Degrees and high earnings are even less probable."

And this is what's scary about the crisis-induced unemployment rate:

"As well as declines in wages, the crisis brought a sharp reduction in the proportion of the population of working age in the workforce. In the early 2000s the proportion was between 62% and 63%. By 2010 it was below 59%. The longer someone is out of work the harder it becomes to get back in, which could turn the temporary macroeconomic problem of high unemployment in the slump into a structural shift towards poverty."

This reminds me of an article I read today on how economists got income inequality wrong despite all the attention it had garnered in recent years. But that's wrong. There's a lot of work still being done and more importantly, income inequality isn't an economic problem without being a social one that draws us back to moral roots at times. That's why it's hard to consider it a problem to be straightforwardly solved.

Praise the FT!

Why must the Financial Times exist?

Read on...

From Weisenthal at Business Insider, this is from the Nomura Research Institute's Chief Economist Richard Koo (and speaking of Koo, here's a must read), 

"Seeing that the dangers of balance sheet recessions had not been mentioned in any of the televised presidential debates, I made a point of writing an introductory article about them for a major US newspaper. However, the article was rejected as being too difficult for a general readership.

I then submitted the piece to another major US daily, with the same result.

Soon after, I was fortunate enough to receive a request from the Financial Times for just such an article, and this time it was quickly accepted. The article was published in last Monday’s paper under the title “Explain the disease, then US citizens will feel better.”"

I find this quite ridiculous, even though I have no idea which two newspapers are being referred to. What I find hard to believe is the difficulty of the concept. Much more believable is the denial of what accepting a balance-sheet recession would mean - i.e: the role of government to complement private sector deleveraging...which means that one of the dailies should definitely be the Wall Street Journal. The other one is anyone's guess!

More on India's Fiscal Situation

This is from the Kelkar-chaired "Roadmap for Fiscal Consolidation", I finally skimmed through most of the report. India is very very different and a lot what the report states is undeniably and uncomfortably true. For example,

"...a growth slowdown is inefficient, inequitable, and potentially politically destabilizing. It is the poor and the unemployed who will suffer the most in the event of sluggish growth and consequent political instability."

and

"Cross-country benchmarking suggests that India is clearly an outlier in terms of major fiscal indicators and currently has the least room for counter-cyclical fiscal policy response if conditions take a turn for the worse in global markets, second only to Egypt among 27 major emerging markets, measured in terms of inflation, real interest rates, exchange rates, current account deficits, cyclically adjusted budget balances and general government debt levels."

Perhaps the most important bit, and credit to the committee for seeming doomsdayish in their analysis, is:

"The twin deficits hypothesis implies that, given a certain level of private savings, an increase in the government deficit will have to be balanced by either a reduction in private investment or an increase in the Current Account Deficit (CAD.) The CAD then needs to be financed through external capital inflows, government external debt or drawdown of foreign exchange reserves. Government’s funding of the deficit through domestic sources tends to be inflationary. Even when the government does not explicitly use seigniorage, if the central bank has to auction government bonds and have adequate takers it needs to create enough liquidity. The RBI indicates that it has been doing so in recent years. This increase in liquidity can be inflationary….

Growth is faltering and inflation seems to be embedded. The external payment situation is flashing red lights. The global economy is likely to be more turbulent, making financing of the large external payment deficits very challenging. Potentially, if no action is taken, we are likely to be in a worse situation than in 1991 for several reasons. Energy prices are at much more elevated levels while our import dependence is now even greater. The Indian economy now is much more open and global developments have greater impact than before. India’s “demographic bulge” demands higher growth to meet the rising aspirations of our young generation. In order [sic] words, our economy may be encountering a 'perfect storm.'"

What Indian policy needs is a technocratic invasion, followed by a paradigm shift in power. But, demographics don't allow this and neither does the overall parliamentary structure and process. Moreover, political entrenchment has long since been a way of life and will continue to be so; foresight is frowned upon and comes with the risk of a loss in power that no one wants to take. One can only remember that if voluntary fiscal adjustment seems painful and inequitable, imagine how bad involuntary consolidation could be.

The Name's Bond, Vigilante Bond

I don't see where exactly the line is drawn with respect to bond vigilantism. After all, what it comes down to is the premise that investors can have an impact on economic policy by selling off bonds and refusing to buy them, thus sending prices plummeting and yields soaring.

That's been the fear from a significant portion of the think tank and it hasn't really garnered enough opposition as far as I've noticed. Let's be clear though, do 'vigilantes' set bond prices? I would say no, Cullen Roche at Seeking Alpha plays it safer with an 'it depends'. In fact, he likens the situation to a person walking an untrained dog. The dog tries to lead the walker (investors/traders) lead the Fed (front-running), but the Fed "as supplier of reserves to the banking system, can ALWAYS control the price of bonds".

In any case, Krugman is most vocal about this and he brings us back to basic macro and the IS-LM model. He seems to insinuate that the chorus coming from the fearful ones is clouded by the impression that the US has a fixed exchange rate and a simple macro model illustrates the difference.

The key here, as mentioned above, is the difference in the floating and constant exchange rate. Krugman goes on to argue that if the exchange rate is free to float, a 'vigilante attack' is in fact, expansionary.
Here are the basics (though it's hard to explain it easier than he does!):

The first equation is a simple linear function relating the demand for domestically produced goods and services to the interest rate and the exchange rate. Thus,

y = -ai + be (where y is real GDP, i is the interest rate, and e is the log(exch. rate) in terms of foreign currency - rise = depreciation (expansionary)

Immediately, one would point out the use of nominal terms and the convenient inflation ignoring that goes on here but simplicity is the key here and inflationary expectations...well...don't make things simpler.

If the exchange rate is fixed, then the second term of the equation above is constant and i is automatically a function of the willingness of international investors to hold securities. If i* is a riskless foreign security, then the domestic i = i* + p where p is the risk premium demanded.

On a downward sloping curve of real GDP versus interest rate, a rise in i automatically leads to a drop in y - i.e: economic contraction. But this is with a fixed exchange rate. 

If i is set by Fed policy (according to a phantom Taylor-rule for example) - i = r*y, then there will be expected arbitrage across borders that can be expressed by:

i = i* + d(e*-e) + p; where d(e*-e) [think of d as delta] expresses the expected 
depreciation. Rearranging gives us:

e = e* + (i* - i + p)/d.

It's simple now, put this expression for e back into the original linear function and you get:

y = -ai + be* + (b/d)(i* - i + p)

Clearly, the interest rate changes AD by:
a) raising domestic demand
b) depreciating the exchange rate and increasing net exports

On the IS graph with a constant policy-rule upward sloping curve, the IS curve shifts to the right outward over a loss of confidence, increasing the risk premium, depreciating the exchange rate and increasing demand - there's the expansion. 

Summarily, a loss of confidence wouldn't cause a rise in rates but a fall in the dollar (better competitiveness). That's not an easy sell but it's an undeniable factor when looking at the bond market. What about the distinction in short and long-term rates? Take a guess. 

Krugman thinks it's still difficult to imagine a contraction. Moreover, there's no issue of foreign denominated debt so it's hard to see where the fear comes from. 

Of course there are numerous other factors at play here (depreciation isn't the end-all solution to economic woe!) but first instinct would tell anyone with common sense that vigilante fears are almost unwarranted in the short-term. 

Fear in the long-run however, is a different matter altogether.

Below Zero

This from Quartz from Mankiw from an anonymous graduate student of his - on the zero bound and ineffectiveness of monetary policy - why can't the Fed go below zero in ways other than going below zero?

Like picking a random number out of a hat and announcing that all currency with a serial number ending with that number would cease to be legal tender. On a whole, the expected return on existing currency would be -10% (0 to 9) and the Fed could set at -2% which is far more attractive than the former. 

Anyway, I'm not getting into why this wouldn't work apart from the obvious reasons. But this is a theoretical thought that is absolutely inapplicable in a fiat world. I suppose for good reason did Mankiw leave the name unrevealed!

The M's

Through all the doomsday inflationary forecasts coming over from the right on QE, something made me remember (though I don't recall it at the time) - the Fed stopped tracking/publishing/releasing M3 data back in 2006. A bit of background details on the money supply definitions for the US - 

M0 is basically your physical currency including coins. (Fed Reserve notes + US Notes + Coins)

The Monetary Base (MB) is M0 + Fed Reserve Deposits

M1 is M0 + demand deposits, traveller's cheques and checkable deposits

M2 is M1 + Savings Accounts, Money Market Accounts, Retail MMFs and small CDs

M3 is M2 + all CDs (includes institutional mmf balances), eurodollar deposits and repos

M4 includes the above as well as commercial  paper

In any case, the Fed's reasoning was that the benefit of what M3 provided wasn't enough to offset the cost of tracking it or something like that. John William's at Shadowstats however, has a compilation of M3 estimates. I have no idea what assumptions have been made or whether any constants have been used to estimate data from eurodollar deposits or for that matter, how repurchase agreements were factored in. But here's what it looks like:

That's what's there to know about the financial sector money multiplier - a deep contraction clearly observed for broader forms of money. Clearly, M3 growth has been much lower since Oct 2008 than before that. Indeed, the monetary base almost triples in size and M1 almost doubles, but M2 growth averaging the past five years has been about the same as before, and M3 growth much less than before. 

One would automatically think that euro-data will look similar. Atleast a straightforward inference of direction could be made. You wouldn't be wrong: 

M1 and M3 definitions are broadly similar - 

• M1: Currency in circulation + overnight deposits
• M2: M1 + deposits with an agreed maturity up to 2 years + deposits redeemable at a period of notice up to 3 months.
• M3: M2 + repurchase agreements + money market fund (MMF) shares/units + debt securities up to 2 years

From '08 onwards, there's perfect asymmetry in the y-o-y growth rates uptill '10 before M1 growth normalizes, so to speak. 

But coming back to the US money supply, it's clear that official M3 measures might not be that useless after all.

Glasner on Currency Manipulation

David Glasner has a winding but ultimately interesting read about currency manipulation including this stinger, 

"...Mary Anastasia O’Grady’s assertion that Ben Bernanke is guilty of currency manipulation, ...based on the fact that Bernanke is expanding the US money supply, is clearly incompatible with Max Corden’s exchange-rate-protection model. In Corden’s model, undervaluation is achieved by combining a tight monetary policy that sterilizes (by open-market sales!) the inflows induced by an undervalued exchange rate. But, according to Mrs. O’Grady, Bernanke is guilty of currency manipulation, because he is conducting open-market purchases, not open-market sales! So Mrs. O’Grady has got it exactly backwards.  But, then, what would you expect from a member of the Wall Street Journal editorial board?"

And for a follow-up, here's more on the PBC reserve requirements and sterilization talk.