Thursday, July 19, 2012

Common sense from France

Today's WSJ has a lovely editorial from Pascal Salin, professor emeritus of economics at the Université Paris-Dauphine. It echoes many of the things I've said about the euro crisis, but with deeper political insight....and it's from France.

A few tidbits with comment
Contrary to what is claimed daily in the media by politicians and many economists, there is no "euro crisis." The single currency doesn't have to be "saved" or else explode.
The present crisis is not a European monetary problem at all, but rather a debt problem in some countries—Greece, Spain and some others—that happen to be members of the euro zone. ... there is no logical link between these countries' fiscal situations and the functioning of the euro system.
A currency union can work just fine without fiscal union.
..the deficits now plaguing these countries were, in large part, justified only a few years ago as necessary to initiate so-called "recovery policies."  But it is always an illusion to believe that governments could increase total demand and thereby induce producers to produce more....The present state of affairs in countries that engaged in stimulus blowouts in 2008 and 2009 should serve as proof of the failure of the Keynesian model.
A letter from Europe that rejects the confusion between common currency and sovereign default, and  sees the abject failure of stimulus? There is still hope. 

I found Prof. Salin's view of the political situation most interesting:
The "euro crisis" is a pure political construction without any economic content. It could even be said that the crisis is a splendid opportunity for many politicians to impose some of their longstanding goals on everyone else. For instance, before the introduction of the euro, many politicians who called themselves Europeans considered monetary union a stepping stone to political union....
So, in Prof. Salin's view, the Euro worthies are deliberately linking sovereign default to breaking up the euro zone in a deliberate effort to scare wary voters into accepting fiscal union. 
This process has begun and continues to develop. Politicians now argue that "saving the euro" will require not only propping up Europe's irresponsible governments, but also reinforcing and centralizing decision-making. This is now the dominant opinion of politicians in Europe, France in particular.
It's really the "centralizing decision-making" that is the problem not "political union." The US at least historically had a political union without requiring the rules on provenance of prosciutto to be written by bureacrats in Brussels.
There are a few reasons why politicians in Paris might take that view. They might see themselves as being in a similar situation as Greece in the near future, so all the schemes to "save the euro" could also be helpful to them shortly....
Yeah, but the Germans may not have any money left by then!

What to do instead? Someone else likes "shock liberalization:"
The real solutions to Europe's debt problems lie in tax cuts and deregulation, and it's here that national politicians should turn their attention. Pan-European cooperation won't deliver any government from its fiscal or economic crises. Only national governments, each working independently to implement the best possible policies, can hope to achieve that.
What a breath of fresh air.

I can't wait to read Prof. Salin's next letter on France's 75% tax -- especially in the face of the UK's disastrous and quickly repealed experience with a 50% tax.  (16 billion pounds forecast revenue turned in to two.) 


  1. Two questions:
    1) Is there a demonstrable relationship between "stimulus blowouts in 2008 and 2009" and debt crises now?
    2) Other than Ricardian equivalence and/or Say's law, what's the argument that stimulus in a depressed economy can't work?

    1. in response to 2) :

    2. I guess it isn't necessarily applicable in a depressed economy though...just something else to think about

    3. It is not a question of argument. It is a question of fact. When it has been tried it hasn't worked. It is theory that must fit facts, not facts that must fit theory.

  2. The sooner we move to the SDR the better, but how much devaluation must the west go through before the Chinese will join. Zhou Xiaochuan said he wants a world currency but the assets (which are not money) of the west must first be marked down drastically. The Chinese recognize that an asset is not money, as in LEGAL currency, but legal currency is an asset. Why is it that ALL western professors refuse to acknowledge this. Do they need to be innitiated as Fisher said. Why do our professors persist in this charade. There will be no economic union between east and west until the Literati start selling the truthe. The lies that are taught to children so they won't protest at being FORCED to get loans from COUNTERFEITERS. It is truly shameful what goes on in western universities. Revolving doors. We know that stealing is wrong but our teachers just can't understand this simple civilized rule. When you steal from others they tend not to like it. This the long standing rift between east and west.

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  4. ax cuts . . .

    silly me . . . I seem to recall that the problem with Greece was its defacto tax cuts---it has deficits because it doesn't collect taxes due under current law.

    The we learn, "The present crisis is not a European monetary problem at all, but rather a debt problem in some countries. . ."

    That is true, but then he gets the countries wrong.

    He thinks the debt problems are in "Greece, Spain and some others," but of course they are in Germany and France, whose banks will be insolvent if Greece, Spain and some others default on their loans.

    Apparently, someone skipped class in Econ 101 where those of us in the real world learned that if I owe the bank $10,000, I have a problem, but that, if I owe the bank $1,000,000, the bank has a problem.

    Last, Keynes cannot be wrong.

    Gretta just reported on Fox News that, if the Fed Gov't moves into balance and starts collecting taxes and cuts spending this fall that we will lose 5% of GDP and 4 million jobs.

    John, you are missing the Team Republic message: We are all Keynesian, now.

    And, BTW, Federal Taxes as a percent of GDP are at their all time low since the beginning of at last recent history (post WWII). High taxes are not our problem.

    1. An economist looks at overall marginal tax rates, not average federal income taxes. A perverse system like ours manages high marginal rates (disincentives) together with low federal revenue.

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    3. I deleted a 90% sensible comment with rude political insults. It's my blog, and I can do what I want to. This will not become a forum for partisan mud slinging.

    4. John,

      Marginal tax rates matter only for choices at the "intensive margin". Few employees, I believe have the luxury to decide on how many hours to work each day. When choices instead are made on the "extensive margin" average taxes matter instead.

  5. A currency union can't work if the central bank is strangling the economy with ultra-tight monetary policy. Why is this point not obvious to you Professor?

    1. I'm not getting this. What part of the ECB is ultra-tight? German (i.e. without credit risk) interest rates have actually been negative! And the ECB is printing trillions of euros to buy insolvent sovereign debt, and to lend to banks who buy more. I thought the monetary issue was: a currency union can't work if the central bank bails out sovereign debt! A currency union needs fiscal union or to countenance sovereign default.

    2. I don't think it is correct to discuss whether money has been tight by looking at interest rates. If anything the relationship is the reverse. As Milton Friedman put it:

      "That is the standard pattern and explains why it is so misleading to judge monetary policy by interest rates. Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy."


    3. This debate over whether money (or monetary policy) is tight and what Milton Friedman meant normally ends up in a confusing battle of the tenses with each side talking past the other. The discussion also often does not draw the necessary distinction between "tight (or easy) money* and tight or easy *monetary policy*. The latter is also a reflection of the problem with tenses and semantics.

      ChargerCarl started the discussion by referring to "ultra-tight monetary policy". Presumably, this is current policy, i.e., he speaks in the present tense. But, current monetary *policy* does not say anything, per se, as to whether *money* is currently tight. This is particularly due to the normal lag between the time monetary policy is implemented and the time monetary policy actual produces the result that policy is targetting. Thus, I think ChargerCarl is wrong to refer to current *policy* as being tight. Clearly, current *policy* calls for easier, not tighter money.

      Professor Cochrane then asks in reply "what part of the ECG is ultra-tight (present tense) and then notes that interest rates have actually been negative (here present tense and presumably the recent past but both the recent past and today constituting *present policy*)." This is more or less consistent with the original comment which referred to policy, but it strikes me as a more accurate statement of what current *policy* is. Neither statement says much, though, if anything, as to whether *money* is currently tight or easy.

      Unconventional Wisdom then comes along and quotes Friedman: "Low interest rates are generally a sign that money *has been tight...high interest rates, that money *has been* easy.

      Very few people pay close attention to the fact that Friedman was talking about the past, not the present. What he presumably meant was that *current* low interest rates (or other central bank tools such as QE designed to create easier money in the future), in other words, current policy, are a sign that *money* had been too tight *in the past* and therefore that current *policy* cannot be judged by the level of current interest rates. Although Friedman did not say so explicity, I think the necessary implication of his quote (made in relation to Japan's situation at the time) was that money in Japan had been too tight and as a result that past tightness spilled over to the present. The tight money in the past was likely also a result of a too tight monetary policy going even before that. Those past events then required a current loose money *policy*.

      It strikes me that the main lesson of Friedman's comment is that current central bank policy is often reactionary---the bank is reacting to past events and quite likely its own past mistakes. He also correctly draws the distinction as to whether *policy* is "tight" and whether *money* is tight.

      Monetary policy is confusing enough as it is. Discussions like this would be a lot more understandable if those involved paid closer attention to their tenses and whether they are talking about the state of money or the state of monetary policy.

    4. Monetary policy is 99% expectations. There is no lag. When Bernanke hints at QE3 or further easing the market soars immediately.

    5. ChargerCarl,

      We are not talking here about the stock market or the bond market, but rather the effect of monetary policy on money supply and inflation--where money is (or has been 'tight'). The *markets* are perhaps anticipating these *future effects* of monetary policy. That's why Friedman said that current low interest rates may be evidence that money was too tight *in the past*. If there were no lag in effect, he would not have needed to use the past tense.

      Since you are quoting Friedman, what better person to cite for the proposition that there *is* a lag with respect to monetary policy on inflation, etc, than Friedman himself. He actually wrote an entire paper on it in 1961:

      "The central empirical finding in dispute (he was responding to Culbertson) is my conclusion that monetary actions affect economic conditions only after a lag that is both long and variable".

      Understanding Friedman's views in respect to this is, in fact, crucial to understanding the very quote you've selected from Friedman. Friedman later adjusted his views a little bit from that 1961 paper; however, his view was clear: there is a lag, and not an insignificant one, between the time monetary policy is initiated and the time it has actual effect on the actual economy (as opposed to forward-looking markets).

  6. Dear Prof. Cochrane,

    Thank you for pointing out to Prof. Salin's op-ed. I am french and admire P. Salin. I think you are both right about the euro crisis. The majority keeps saying that the euro is in jeopardy because of the crisis, without explaining how. I think the euro is in danger, but not because a economic link from default to the euro, but because the politicians are prone to easy solutions, i.e. exiting the euro to inflate the new currency - the devaluation mantra you denounce (or exiting the euro to avoid a inflationary currency in case the ECB buys State-debt or the "contribution" to bail out eurozone members keeps growing - see recent declaration from Finland's prime minister or finance minister, I don't remember). The politics is endangering the euro.

    A final note : I think it was Milton Friedman who said he didn't like schools of economics, because there are good economics and bad economics. Salin was a monetarist until the late 1970's and is now an Austrian. But that should not count, if his reasonning is sound, like yours (or faulty as many comments here suggest).

    I am looking forward for a more formal paper from you about that subject, it is badly needed. By the way, I came accross, two days ago, an interview of Prof. Sargent, in the Minneapolis Fed review, in august 2010. The last part is about the eurozone's troubles, and his reasonning is similar to Salin's and yours. It is here :

    Best regards,
    Olivier Braun

    1. Thanks. Tom Sargent's Nobel Prize speech, comparing the early US experience with the eurozone is also great.

    2. Brother John will join the moral scientists eventually. All morally decent "economists" do. Then we will call him a superstar. Shining bright championing freedom. But till then he must satisfy his owners.

  7. David Glasner has a critique of Salin's op-ed.
    You reference low interest rates as proof that ECB monetary policy is loose. But haven't we known for a loooooong time that interest rates are not a good indicator of monetary policy? As Scott Sumner has repeatedly pointed out, rates were low during the Great Depression and Japan's lost decade but high during hyperinflationary periods like Weimar Germany (so the Post Keynesian Joan Robinson denied there was loose money then). The ECB has prided itself on keeping inflation low, which appears to be its only priority. Inflation targetting may not be the best monetary policy (it responds terribly to supply shocks or a Value Added Tax), but it's more relevant than interest rates.

    1. Interesting critique. Point granted on interest rates. Low does not necessarily mean loose, though one cannot argue that the ECB is deliberatly strangling europe with high rates.

      I'm just wondering how anyone can think ECB policy tight when the ECB is monetizing southern debt as fast as the printing presses can run.

      Glasner seems to be measuring monetary policy by nominal GDP. I don't agree that central banks can control that in the 1-2 year horizon.

      Interesting that we can't really agree whether monetary policy in Europe is wildly expansionary or grumpily tight, replaying US 1932

      We're a little off topic now... I see we'll have to come back to nominal GDP.

    2. This argument about interest rates is weak. If interest rates reflect a certain premium for inflation then a deflationary economy will feature low interest rates and an overheating economy will feature high rates, but that it deceptive. The salient point is where are those rates "Relatively" when you remove the inflation premium?

  8. There are two differences, I believe.

    1) EU is not as culturally homogeneous as USA. The idea that if one state fails people can just move somewhere else (like what happened to Detroit) is not acceptable within the sovereign nations framework. While certain unbalances can be solved in USA by simple massive internal migration, Europe doesn't seem to have the same option as telling Greeks "your nation is doomed, leave your islands and come become all Germans" is impossible.

    2) The pension system is funded by states. If such massive migration happened (and arguably it is happening to some extent) it´d only put even more pressure on the failed states and a spiraling situation of ever increasing motivation to move on and leave your home state in ruins.

    Therefore some transfers from more successful to less successful European states is probably necessary in order to keep them livable. And that might justify some level of centralism, I´d argue for cetralised social net and services.

  9. One retired European professor isn't going to make much of a difference, especially when so many others (like Paul De Grauwe) have switched sides and given up on 'perfectly self-regulated markets' (completely missing the point that abandoning faith in 'perfect' markets isn't reason enough to put faith in 'perfect' government).

    I have been searching, but haven't found any discussion of the fact that the European Commission's 2006 Q4 report on the euro area (QREA) very officially acknowledged the build-up since the beginning of the EMU of imbalances in the periphery, and that euro zone governments, knowing very well that if something cannot go on forever it has to stop one day, simply waited three more years for this day to come before getting into a lasting frenzy over 'rescueing the euro' and 'blaming markets'.

    The other point I haven't found any answers on is this "experience with government bond markets [which suggests] that the disciplining role of financial markets may become less effective in EMU as investors have lost their most effective mechanisms for pricing default risk, namely the exchange rate premium. In particular, there is a possibility that country risk premia might respond in a non-linear way (i.e. responding sharply but late) to possible insolvency problems in a Member State." (From the QREA 2006 Q4.) As the no-bailout threat and the disciplining role of financial markets were central to the functioning of the EMU in a non-optimal currency area, I find it strange that this point is left out in the current debate on the 'constitutional flaws' of the EMU.

    I suspect of course that the answer will point to a 'political flaw' in the functioning of financial markets that cannot simply be cured by the 'political remedy' of fiscal union.

    Olivier Blanchard had also written on Portugal in 2006, I found out during my search:


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