We are ***! People are withdrawing funds from fixed income mututal funds (which hold ARS 300 billion of CB short term debt). Yestedary alone people withdrew 4% from those funds and ran to the dollar today. Peso falls 5% to $24.00 ARS/USD. Next step is a ran against term deposits in banks. Next tuesday the CB has to roll over ARS 680 billion of short term debt. A conservative estimate is that ARS 150 billion will not be rolled over and will ran immediatelly to the dollar. No IMF bailout will stop the crisis but it will definitively help us in the aftermath.Coincidentally, as Argentina started this spiral, I was at the Hoover conference on "Currencies, Capital, and Central Bank Balances," and thinking about it especially during the session on "Capital Flows, the IMF’s Institutional View and Alternatives" featuring Jonathan Ostry, who bravely came to defend the IMF's Institutional View, Sebastian Edwards, and John Taylor, moderated by George Shultz.
PS: If you want to know what interest rates are now (like if anyone cares about them anmore)
maturity APR 5 days 81% 41 days 45%
PS2: CB trying to control the FX as I write email. Down to $23.00 ARS/USD.
Briefly, in the good old days, the IMF was solidly for the Postwar Order that viewed capital restricitons -- laws stopping people from investing in a country or taking their investments out -- were bad things and to be avoided at all times.
That changed, and the new view, as summarized compactly by John Taylor, is much more friendly toward "capital flow management":
what is new about the Institutional View is that “capital flows require active policy management,” which includes “controlling their volume and composition directly using capital account restrictions.” (p. 8) The Institutional View document (IMF 2012) defines key terms and gives examples. For example,.. CFMs thus include “capital controls” that “discriminate on the basis of residency” and macro-prudential policies that differentiate on the basis of currency (p. 40). ..[The quotes and page numbers in the next two paragraphs are from Ghosh, Ostry, and Qureshi (2017).]As Ostry explained, the new view also includes a stronger reliant on fiscal stimulus tools to counter domestic difficulties.
My obvious thought, is just how much would Argentina's problems be solved by more capital flow management, currency restrictions, investment restrictions, fiscal stimulus and so forth. And whether the IMF, if it rides to the rescue, will suggest more such dirigisme for its bailout money. The old IMF view -- commit to openness, fix your budget problems, and a somewhat jaundiced view of the ability of even well intentioned central bankers to execute masterstrokes of technocratic "management" -- might have something to go for it still.
(It's worth remembering that capital cannot flow in aggregate. The only way capital can leave a country is on boats. You can sell a factory to a local at a low price, and you can sell the foreign currency for dollars at a low price, but you cannot move a factory once built and someone else has to buy the foreign currency and give you dollars. Capital and trade accounts must balance. Capital cannot flow in the short run. Prices can change.
"Flow management" is one of those soothing NGO acronyms for what is in fact property seizure. You can tell I'm not favorably predisposed)
This is also of interest as it relates to Argentina's woes:
ReplyDeletehttps://seekingalpha.com/article/4172784-argentine-peso-plummeting
From the article:
"To understand the perilous situation of the peso, we must go back to the previous Kirchner administration. Former President Cristina Kirchner basically ***used the central bank as an ATM.*** Her administration robbed the central bank of its foreign exchange reserves. They exchanged reserves for worthless, non-transferable letters of credit (letras intransferibles) and, in effect, told the central bank: 'Give us your dollars and in return we will give you these worthless and non-sellable IOUs.'"
Mykel,
Delete"Former President Cristina Kirchner basically used the central bank as an ATM. Her administration robbed the central bank of its foreign exchange reserves."
Ahem, the whole story:
https://en.wikipedia.org/wiki/Argentine_debt_restructuring
"However, meeting vulture funds' full face-value demands is problematic for Argentina, because although bonds held by vulture funds are a small share of the total (1.6%), such a settlement would lead to lawsuits from other bondholders demanding to be paid on similar terms under the agreement's rights upon future offers (RUFO) clause, effectively unwinding the settlement by allowing all bondholders payment in full, and creating an unaffordable liability of up to $120 billion more than at present."
"As a result, Argentina has still not been able to raise finance on the international debt markets for fear that any money raised would be impounded by holdout lawsuits; their country risk borrowing cost premiums remain over 10%, much higher than comparable countries. Consequently, Argentina has been paying debt from central bank reserves, has banned most retail purchases of dollars, limited imports, and ordered companies to repatriate money held abroad. Nevertheless, between 2003 and 2012 Argentina met debt service payments totaling $173.7 billion, of which 81.5 billion was collected by bondholders, 51.2 billion by multilateral lenders such as the IMF and World Bank, and 41 billion by Argentine government agencies. Public external debt denominated in foreign currencies (mainly in dollars and euros) accordingly fell from 150% of GDP in 2002 to 8.3% in 2013."
Hi Frank,
DeleteAll interesting stuff. Ha.
My point, and I didn't explicitly say it in the first post, had to do with what happens when the fiscal side tinkers or manipulates the monetary/CB side. Institutions matter, as do the policies that emerge from its foundations. No central bank is perfect, but CB independence has a role in preventing these sorts of messes. Yes, sometimes economic woes are self-inflicted wounds, but I have found it's rarely the case when it's not. See the time inconsistency problem and temporal discounting, even if T.D. tends to be more micro on the behavioral economics side. To me, they're very much connected.
Dr. Cochrane, do you have a position on whether the IMF telling countries unrestricted capital flows were a good thing was smart in the first place? There is a lot of backlash warranted or not against that position, either way it seems the Washington Consensus builders have lost significant credibility on these issues. Is that your perspective as well?
ReplyDeleteCurious as to your thoughts.
All these sharpie economists and economic commentary. But where is the analysis, not to mention, - mention - of the percentage of Argentina's debt denominated in a currency other than its own. THAT is the relevant number and question. A discussion on why and how this debt was incurred would also be interesting and relevant. Everything else is nonsense.
ReplyDeleteDoDeals,
DeletePerhaps you should do your own research:
https://en.wikipedia.org/wiki/Argentine_debt_restructuring
Bad Move #1:
"In 2001, Argentina defaulted on its foreign debt. In January 2005, the Argentine government offered the first debt restructuring to affected bondholders... The majority of the Argentine bond market thereafter became based on GDP-linked bonds, and investors, both foreign and domestic, netted record yields amid renewed growth."
And you wonder why Argentina is struggling with inflation? GDP linked bonds make payments based upon nominal GDP (Real GDP + Inflation Rate). The higher the inflation rate, the higher the government expenditures in the form of interest payments. In this case, monetary policy becomes totally ineffective in curtailing either inflation or fiscal largesse. Higher inflation begets larger fiscal largesse which begets even higher inflation.
Bad Move #2:
"During the restructuring process, the International Monetary Fund was considered a privileged creditor..."
Bad Move #3:
"Because Argentina had been historically so unstable, it would have been difficult for it to solicit investors to buy bonds in Buenos Aires under Argentine jurisdiction, as few external investors trusted Argentina courts to enforce bonds against their own government. This consideration led Argentina to transfer the issue of bonds to New York, under United States law, on April 20, 1976, as were most subsequent bond issues. The bonds were therefore issued under a special kind of bond contract, a Fiscal Agency Agreement that was drafted by Argentina's U.S. attorneys under the law of the state of New York. The FAA stipulated that the repayments on the bonds were to be made by Argentina through a trustee, The Bank of New York Mellon, which meant that the U.S. courts did have jurisdiction over that party to issue injunctive relief."
"In the Fiscal Agency Agreement, Argentina's attorneys included a boilerplate pari passu clause, but neglected to include a collective action clause. Pari passu is a term generally used to signify equal priority or treatment, and a collective action clause would have obligated any holdouts to accept the generally offered terms if enough other bondholders agreed to accept them."
So the government of Argentina (to be able to sell bonds) agrees to have them sold in the state of New York so that U. S. law would provide protections for creditors but neglects to include some form of collective bargaining / action if Argentina would need to restructure the debt - talk about lack of foresight.
Again: What % of total debt s denominated in foreign currency? Why did they borrow in a foreign currency? That was the original sin. As any dummy should know by now: A sovereign (Treasury combined with the Federal Reserve Bank), like the US, that:
Deletea. issues,
b. borrows in, and
c. floats
its own currency, can NEVER run out of cash.
Read the freakin' article. It's there is plain black and white.
DeleteYou seem to be implying (though I could be easily misinterpreting your view) that as long as debt is issued in domestic currency, it can avoid a run.
DeleteJames: Of course.
DeleteCapital flow management certainly cannot solve all of Argentina's problems, but it would be nice to remove the flaws from the international system that make blame-shifting possible at all. The interest in managing flows is based on practical experience, which should be respected as we wait for theory to catch up. The problem with the previous commitment to openness is that the Bretton Woods institutions have not yet restored the anchor for international finance that we once had.
ReplyDeleteAs an asset-pricing guy, you tend to assume a nominal anchor as given, and your thinking proceeds from that. The same is true of Robert Shiller, who is still advocating Trills as a solution to problems of the type discussed in this post. He apparently doesn't think very much about the currency used for the Trill contract and what effects it has.
Perhaps designers of financial systems will turn to designers of electronics for ideas on reducing oscillations, which in economics we call "cycles". We want a system that transmits meaningful information, and not buzzes and hums as it reacts to itself. To get there we need a stable reference point, which in electronics might be compared to a ground wire. Without something like that, prices are less effective in regulating allocation. That's why you've proposed a few inflation-targeting systems on this blog, but you haven't really extended that thinking to the international level.
Anwer,
Delete"The same is true of Robert Shiller, who is still advocating Trills as a solution to problems of the type discussed in this post...Perhaps designers of financial systems will turn to designers of electronics for ideas on reducing oscillations, which in economics we call cycles."
Trills (and other GDP linked securities) are the exact opposite of what you want to "tame cycles". The reason is that the coupon payments / dividends are pro cyclical.
Instead you want zero-coupon securities risk bearing securities with the following features:
1. Potential return on investment (set administratively) rises during recession and falls during economic boom - this is the countercyclical aspect.
2. Realized return on investment rises during economic boom and falls during recession.
Notice that with a potential rate of return set administratively (similar to monetary policy), the upside (realized rate of return) on the securities is limited. Contrast that with Trills (or other nominal GDP linked securities), 100% inflation (assuming no fall off in Real GDP and a 100% rise in tax revenue) yields 100% returns.
What type of risk might / should these securities carry? I can think of several possibilities:
1. The securities are non-transferrable (liquidity risk).
2. The securities are only redeemed in fulfilling a tax liability (redemption risk)
3. The securities cannot be rolled over by the purchaser (loss of principle risk)
Anwer,
DeleteLet's play a little bit of political economy with NGDP linked bonds / Trills and see where it get's us.
U. S. Treasury begins selling Trills (as Shiller advises). The U. S. Treasury must get authorization from Congress for each dividend that it pays.
The U. S. Constitution - Article 1 - Section 8 - delegates Congress as having the power of the purse. Shiller must demonstrate that the payment of those dividends constitutes "Providing for the General Welfare of the United States". Note that interest payments on U. S. debt do not fall under the "Providing for the General Welfare" clause. Instead they are covered under the 13th amendment.
So, Mr. Shiller and his millions of Trill long investors call their Congressmen / Congresswomen to encourage them to make the dividend payments. I myself and my millions of Trill short investors call our Congressmen / Congresswomen to advise them to not make the dividend payments.
Because spending requires positive action by Congress, even a stalemate vote (50-50) is a vote against the expenditure - me and my millions of Trill short investors win.
So Mr. Shiller wants people with fixed lifetimes to buy perpetual securities where the returns on investment are left to the voting public?
Frank you are arguing against the NGDP-targeting community, who have formal models showing that we want debt contracts that work basically like Shiller's Trills. The principal disagreement is whether to use actual Trills and have the central bank target inflation (Shiller) or have the central bank simulate the return on Trills with the perpetual securities (i.e. money) that it issues. Prof. Cochrane is quite close to Shiller in advocating a conversion of government debt to floating-rate perpetual securities, with Cochrane using an auction mechanism to determine coupons rather than Shiller's reliance on national accounting data.
ReplyDeleteWhat is widely overlooked by all sides - apparently including Prof. Cochrane above - is that the international allocation of capital is subject to sunspots of the type studied by Roger Farmer, and that we need a multilateral system to choose a good equilibrium out of the many possible ones, rather than simply accepting these oscillations as part of an ostensible commitment to openness. This means that there is a theoretical basis for the management of flows that is becoming accepted by many policy advisers.
Anwer,
Delete"Frank you are arguing against the NGDP-targeting community, who have formal models showing that we want debt contracts that work basically like Shiller's Trills."
I am not included in the "we" that you refer to. I - unlike you, John, Shiller, and whoever else is included in your "we" -won't live forever and have no interest in perpetuaI securities. I believe that there is too much government debt of all types (TIPs, GDP linked bonds, conventional bonds, floating rate perpetuals, you name it). I believe that interest paying debt of all types sold by governments is an entitlement that should be constrained.
I believe that government should sell securities where the impetus lies with the buyer to realize the returns on investment.
Please read the article below.
https://en.wikipedia.org/wiki/Argentine_debt_restructuring
"In 2001, Argentina defaulted on its foreign debt. In January 2005, the Argentine government offered the first debt restructuring to affected bondholders... THE MAJORITY OF THE ARGENTINE bond market thereafter became based on GDP-LINKED BONDS..."
And yet still, Argentina is in fiscal trouble. And do you know why?
1. Because bond holders of all types are paid out of tax revenue not out of GDP. Set all tax rates to 0% and then it doesn't matter what GDP is - bond holders won't get paid.
2. Because quantities matter. Argentina government sells $10 Trillion in GDP linked bonds while Argentinian GDP is around $100 billion. Guess what, some of those (okay most) GDP linked bondholders won't get paid back.
I agree with Shiller that governments should rely less on fixed interest paying bonds. I disagree with his (and John's) proposed solutions.
Anwer,
ReplyDeleteI apologize if I come on too strong. But getting back to your statement:
"Perhaps designers of financial systems will turn to designers of electronics for ideas on reducing oscillations, which in economics we call cycles."
Those cycles are often tamed by countercyclical efforts by the federal government - increase spending / lower taxes during downturns, raise taxes / decrease spending during booms - emphasis on countercyclical.
The dividends that Shiller recommends on his Trills are by definition pro cyclical - government expenditures rise during periods of high GDP and fall during periods of low / negative GDP - the exact opposite of what you want to tame cycles.
In electronics parlance, GDP linked bonds create a positive feed back loop.
Shiller (and Mark Kamstra) on Trills:
https://cowles.yale.edu/sites/default/files/files/pub/d17/d1717.pdf
And some counter arguments:
http://blogs.reuters.com/felix-salmon/2012/02/22/gdp-bonds-are-a-really-bad-idea-part-3/
"Which, of course, is the whole reason that Shiller is pushing this idea so aggressively. Shiller is a principal in a company called MacroMarkets, which exists to create innovative financial instruments to facilitate investment and risk management — a/k/a volatile new derivatives."
"If Trills existed, you can be quite sure that MacroMarkets would immediately create futures and options based on Trills, trying to make money off their volatility. The volatility would depress the price that governments could sell the Trills for, but at the same time it could make a fortune for Bob Shiller. Bob’s experience in the markets is that if there isn’t enough volatility in the price of the contract, the speculators lose interest in the contracts, says Kamstra."
Frank I'm starting to understand your criticism of floating-rate debt which you are describing here as "pro-cyclical", perhaps following Minsky. Your thinking outlined in the comments above shares a lot in common with the policies advocated by the MMT community: pay zero on national debt, use fiscal policy for stabilization, and perhaps don't rely so much on external creditors for funding.
DeleteBut the MMT community has a system to establish a nominal anchor: the jobs guarantee. In order to stabilize, you also need a nominal target. I don't know if you like the jobs guarantee as an anchor, but it isn't really in keeping with the type of small government and support for entrepreneurial spirit that is advocated here on this blog.
In John Cochrane's proposals to establish a nominal anchor, he aims for something nearly automatic, or at least highly predictable, and much more hands-off than anything we see from the MMT crowd or even the central banking establishment. I generally like that orientation, except for the one neglected point about the need to select a good sunspot for the international portfolio held in equilibrium. A good anchor for international finance helps us get there, and would also make free traders very happy.
Anwer,
Delete"Your thinking outlined in the comments above shares a lot in common with the policies advocated by the MMT community: pay zero on national debt, use fiscal policy for stabilization, and perhaps don't rely so much on external creditors for funding."
I am not saying "pay zero on national debt". I am saying set the amount of national debt to zero - meaning, governments don't borrow / sell bonds.
"I don't know if you like the jobs guarantee as an anchor, but it isn't really in keeping with the type of small government and support for entrepreneurial spirit that is advocated here on this blog."
I am not a member of the MMT crowd looking for a job guarantee. A government can perform countercyclical economic policy without making guarantees of any type other than contract / property rights.
"In John Cochrane's proposals to establish a nominal anchor, he aims for something nearly automatic, or at least highly predictable, and much more hands-off than anything we see from the MMT crowd or even the central banking establishment."
Bear with me. Consider these two rules:
Monetary Policy Rule (Modified Taylor Rule)
i(t+1) = Inf% (t) + alpha1 * ( Inf% (t) - InfTarg% (t) ) + beta1 * dD/dt
i(t+1) = Short Term Interest Rate
Inf%(t) = Inflation Rate Observed
InfTarg%(t) = Target Inflation Rate
dD/dt = Credit Growth Rate
Notice that I have eliminated the economic growth rate from the Taylor rule, kept the inflation rate term, and added a credit growth rate term - remember what I said about quantities mattering?
Notice also that the central bank reaction function raises the policy rate in response to increasing credit growth (Supply and Demand).
The old Taylor rule has some glaring problems
1. The total stock of debt (and how it grows / shrinks) is not addressed nor is how the central bank should adjust policy to changes in the stock of debt.
2. The central bank (in it's reaction function) is caught between raising it's policy rate to curtain inflation and lowering it's policy rate to promote growth.
Fiscal Policy Rule (Restly Rule)
f(t+1) = Y% (t) + alpha2 * ( YPot% (t) - Y% (t) ) - beta2 * dF/dt
f(t+1) = Return on Security Sold by Government
Y%(t) = Growth Rate Observed
YPot%(t) = Potential Growth Rate
dD/dt = Government Security Growth Rate
Notice that the returns on my government securities rise in the face of an output gap and fall as the output gap closes - AHAH, countercyclical fiscal policy. Contrast that with the pro cyclical nature of Trills.
Notice also, that the government decreases the returns on my government securities as demand for them increases (Again Supply and Demand).
When you use two levers in steering an economy, you get to shoot for two targets - both an inflation target (monetary policy) and a economic growth target (fiscal policy).
What keeps that from happening is central bankers (and most economists) insisting that governments borrow / sell bonds.
If we can agree that two lever policy making based upon rules is the way to go, then I can explain further.
If I have lost you at this point then please ask questions.
Anwer,
DeleteP. S. Minsky (I believe) was concerned with credit bubbles of all types - not just those that lead to headline inflation. If you notice from the above Modified Taylor Rule, I allow the central bank to increase interest rates in the face of rising inflation AND/OR rising credit demand.
This follows from simple supply / demand economies - if demand for credit is heavy, the price should be increased. If the demand for credit is soft, the price should be decreased. It also follows from Walter Bagehot - "Lend freely at a penalty rate against good collateral".
Typo correction:
DeletedF/dt = Government Security Growth Rate
Frank I definitely have an appreciation for those who want to regulate quantities, like Prof. Richard Werner, and those like you who are concerned about the positive feedback systems in finance that were discussed by Minsky. I also believe that limiting the positive feedback is more effective for economic stabilization than attempts to govern the system using only global negative feedback (such as the Taylor principle, or NGDP targeting).
DeleteThe specific positive feedback mechanism that I tend to focus on is connected to speculative portfolio flows across borders, and I believe there is a solid case to manage these flows. Respected members of the establishment like John Taylor are starting to discuss this position in conferences.
Anwer,
Delete"The specific positive feedback mechanism that I tend to focus on is connected to speculative portfolio flows across borders, and I believe there is a solid case to manage these flows."
I am just a novice at economics, and have little experience in international finance. However, I have run across this:
https://en.wikipedia.org/wiki/Impossible_trinity
The impossible trinity (also known as the trilemma, or the unholy trinity) is a concept in international economics which states that it is impossible to have all three of the following at the same time:
1. A fixed foreign exchange rate
2. Free capital movement (absence of capital controls)
3. An independent monetary policy
It is entirely possible for a fiscal authority to add / remove liquidity from an economic system to tame speculative portfolio flows while still permitting capital to flow freely across borders.
Frank by invoking this impossible trinity you might be suggesting that management of capital flows and exchange rates prevents us from using monetary policy for stabilization. But the latest thinking on this problem includes work by Hélène Rey, who participates in these international macro conferences - though perhaps not the one at Hoover that Prof. Cochrane discusses in this post. You might look up her paper on "Dilemma not Trilemma".
ReplyDeleteThere are some academics who advocate a completely passive tie of the local currency to the USD via a currency board. The trilemma criticism applies mostly to them and their 20th century thinking. We do want some degree of flexibility in exchange rates - more than they have in the Eurozone. But we also want countries to have firm ground to stand on when they make these adjustments, and not be buffeted by global financial cycles due to an excessive commitment to openness, and the dilemma discussion explains the difficulty of resisting these cycles without actual management of flows. Due to positive feedback effects, the current international system has excessive volatility, or in modeling terminology: multiple equilibria. We need a cooperative system that selects a good one.
Anwer,
Delete"There are some academics who advocate a completely passive tie of the local currency to the USD via a currency board. The trilemma criticism applies mostly to them and their 20th century thinking."
The 20th century thinking that is still in play is the thinking that governments must borrow / sell bonds. Look at my fiscal policy equation above and replace Potential / Actual GDP with an exchange rate policy:
Fiscal Policy Rule (Restly Rule - Exchange Rate Stabilization)
f(t+1) = ExchRate(t) + alpha2 * ( ExchRateDes(t) - ExchRate(t) ) - beta2 * dF/dt
f(t+1) = Return on Security Sold by Government
ExchRate(t) = Exchange Rate Observed
ExchRateDes(t) = Echange Rate Desired
dF/dt = Government Security Growth Rate
Notice that governments can sell non-debt securities to stabilize exchange rates rather than using coercive tax rates. That leaves monetary policy available to stabilize the inflation rate / credit growth rate.
Remember what I said, two independent levers (monetary policy lever #1 and fiscal policy lever #2) in an economy let you hit two policy goals.
Positive inflows of capital could be offset through the sale of non-debt securities by the fiscal authority. Positive outflows of capital could be offset through the repurchase of the same securities by the fiscal authority.
"We do want some degree of flexibility in exchange rates - more than they have in the Eurozone."
The flexibility in exchange rates is achieved through public choice - the public can choose to buy government securities at the advertised price or they can choose not to. Contrast that to direct changes in tax rates / tax policy where individual choice is not preserved.
Frank you don't tell us what the desired exchange rate should be. The global financial cycle requires international cooperation between central banks to prevent. They must decide mutually on a good set of exchange rates, as they have in previous monetary accords. And then they will need to manage flows somehow to implement such an agreement. If you're on Twitter you can look up people like Sean Rushton providing more details on this - and note that he has the same free-markets orientation as Prof. Cochrane.
ReplyDeleteAs a free trader, Prof. Cochrane is a fan of the common currency in Europe. Though note that in the Eurozone when they committed to par exchange rates, they had a really bad pattern of flows as a byproduct. Lots of capital went to the periphery, where it could not be used effectively, and they could not make adequate payments on those loans. In addition to full employment, we also need a policy goal of bidding for only as much of the world's capital as we can use well, and not (for example) absorbing it by building unnecessary housing or unsustainable patterns of consumption.
Anwer,
ReplyDelete"Frank you don't tell us what the desired exchange rate should be."
"The global financial cycle requires international cooperation between central banks to prevent."
"They (central banks?) must decide mutually on a good set of exchange rates, as they have in previous monetary accords."
"And then they (central banks?) will need to manage flows somehow to implement such an agreement."
In my model (Restly Rule - Exchange Rate Stabilization), the desired exchange rate is for the fiscal (not monetary) authorities to decide. The realized exchange rate is still ultimately determined by market participants.
Let me repeat myself, to achieve multiple independent policy objectives you need multiple independent policy tools.
Using monetary policy to try to achieve both economic stabilization as well as currency stabilization is like trying to use a hammer for both driving nails and turning screws (hence the trilemma / dilemma).
"In addition to full employment, we also need a policy goal of bidding for only as much of the world's capital as we can use well, and not (for example) absorbing it by building unnecessary housing or unsustainable patterns of consumption."
You can set all the goals that you would like. Unless you have the tools available to achieve those goals, they will forever remain out of reach. And that is what I am describing here - a rules based, predictable fiscal policy tool (in line with John Taylor's rules based, predictable monetary policy).
To manage the price level, I really like the Neo-Fisherian thinking regarding interest on reserves. If full employment is also an objective I will grant you the use of fiscal policy as a tool to close economic slack. But I also have an objective to manage the share of the world's capital allowed into the country, as we've been discussing above.
ReplyDeleteFiscal policy is clearly not adequate for this third task. To see why, it might be useful to reflect on the Richardian equivalence critique of fiscal policy, which argues that government spending mostly just changes the share of economic activity between public and private - though it might be able to close some economic slack if it exists.
So if the world offers capital at a low interest rate, the government could borrow spend some of it - let's say on generous pensions to current retirees (Greece). Or the private sector could use it for a housing boom (Spain). Citizens could even take home loans to finance an unsustainable pattern of consumption (USA). But it will be difficult to pay back these loans because none of these uses is productivity-enhancing. Indeed BIS points out that the global financial cycle produces misallocation towards low-productivity sectors (home construction) that does lasting harm to economic growth.
We can't simply assume that opening ourselves to capital flows will give us good, productivity-enhancing investments and economic convergence. Large amounts of capital should only be allowed in if the other requisite reforms (of the type discussed on this blog: institutions, regulations, etc) are also happening. Otherwise we might be better off with an agreement between central banks to raise global rates and have less saving. They certainly want this for China.
In terms of actual implementation, we could start with an exchange rate between the core of Europe and the periphery. To see more details, perhaps the best source is Miles Kimball's blog post from 2013: "How the Electronic Deutsche Mark Can Save Europe".
Anwer,
ReplyDelete"To manage the price level, I really like the Neo-Fisherian thinking regarding interest on reserves."
https://www.stlouisfed.org/publications/regional-economist/july-2016/neo-fisherism-a-radical-idea-or-the-most-obvious-solution-to-the-low-inflation-problem
The Neo-Fisherian thinking is incomplete in that the inflation rate is arrived at by only looking at the nominal interest rate (assuming a fixed real interest rate). I will keep saying it until it gets through to you - QUANTITIES MATTER.
"But I also have an objective to manage the share of the world's capital allowed into the country, as we've been discussing above. Fiscal policy is clearly not adequate for this third task."
Clearly it is, you haven't been paying attention.
"To see why, it might be useful to reflect on the Richardian equivalence critique of fiscal policy, which argues that government spending mostly just changes the share of economic activity between public and private - though it might be able to close some economic slack if it exists."
I am NOT talking about fiscal policy in terms of government expenditures.
I am talking about fiscal policy in terms of the sale of securities.
You look at interest paying government bonds as strictly a means for the cost of an investment made by the government to be shared by all taxpayers over time. That is not entirely accurate because a lot of those taxpayers are also government bond holders. I look at interest paying government bonds as an entitlement (not unlike Social Security, Medicare, or Medicaid).
There is no Ricardian equivalence between debt and equity. Each form of security has a different risk profile.
With government bonds / debt, the risk lies with the seller of the security (taxpayers as a whole).
With government equity, the risk lies with the buyer of the security. That is the fiscal tool that I am describing - government equity.
"We can't simply assume that opening ourselves to capital flows will give us good, productivity-enhancing investments and economic convergence."
Perhaps not, however, the sale of equity in lieu of debt will insure that the holders of government securities are not given a free pass irregardless of whether those productivity-enhancing investments come to pass.
"In terms of actual implementation, we could start with an exchange rate between the core of Europe and the periphery."
Greece had the Drachma, Italy had the Lira, etc. What makes you this time will be different?
Frank you are touching on an important issue with the comparison of debt and equity and the differences in risk properties. The commentary I find most interesting on monetary innovation is looking for some hybrid form that navigates the monetary trilemma / dilemma better than we have done in the past, when we made choices at corners (pegged exchange rates, or completely free-floating ...).
ReplyDeleteThis discussion has perhaps drifted beyond what Prof. Cochrane intended in this post (simply commenting on the Hoover conference) but you might like to join the conversation on Twitter, where I am as well. I will leave you with a tweet describing a recent blog post from the World bank on whether money should be treated as national debt or as equity. Hopefully the link will be allowed to post.
https://twitter.com/BJMbraun/status/999309939939135488
Anwer,
ReplyDeleteThe blog link is here:
http://blogs.worldbank.org/allaboutfinance/accounting-view-money-money-equity-part-i
By Biagionne Borsone, Coauthored by Massimo Costa
"Coins circulating as legal tender in national jurisdictions worldwide are treated as debt liabilities of the issuing states and reported as a component of public debt under national accounting statistics (ESA 2010). Similarly, banknotes issued by central banks and central bank reserves are accounted for as central bank debt to their holders."
Currency is a liability of the central bank in the sense that the central bank defines the uniform set of weights and measures that currency is valued in. Meaning that $1.00 in San Francisco is exactly the same as $1.00 in New York or Chicago. Also, under most jurisdictions currency is sufficient to discharge an existing public / private sector debt liability.
When the central bank "creates" money, it in fact lends it into existence:
1. Central bank maintains a loan as an asset and the corresponding money that it lends as a liability.
2. Borrower receives the lent money as an asset and has a loan outstanding as a liability.
I really cannot stand when economists talk about central banks "Issuing" or "Printing" money. Central banks lend money either directly or by purchasing loans that have already been made.
The article continues:
"Money accounted as the issuer’s equity implies ownership rights. These rights do not give money holders possession over the entity issuing the money (as shares giving investors ownership of a company or residual claims on the company’s net assets). Rather, they consist of claims on shares of national wealth, which money holders may exercise at any time. Those who receive money acquire purchasing power on national wealth, and those issuing money get in exchange a form of gross income that is equal to its nominal value."
NO. INCORRECT FOR TWO REASONS.
Reason #1: Owners of currency lent into existence by central banks are not guaranteed purchasing power of any sort. Owners can always pay down their debts and pay taxes in that currency. Read the fine print on any dollar bill:
"THIS NOTE IS LEGAL TENDER FOR ALL DEBTS, PUBLIC AND PRIVATE"
I as an owner of some resource or good am in no way obligated to accept Dollars, Pesos, or Yen in exchange for the goods in my possession when I go to sell them. If I put my car up for sale and demand payment in the form of gold or silver or seashells, I am not obligated to accept dollars (or any other currency) as a substitute.
Reason #2: Some currencies (like the Euro) extend beyond the lines that distinguish individual nationalities / sovereignties. What does "national wealth" mean in the context of a Euro being used in both Italy and France?
All that being said, there is nothing to preclude a sovereign government from selling equity claims on it's tax revenue. That is exactly what I describe above.
Frank I'm glad you looked at the Euro system because the blog writer overlooked that as an interesting hybrid. I'd say that TARGET2 balances should be regarded as debt, and Euros are a great unit for denomination, for anyone who likes the facilitation of international trade. But we need a better form of obligation for sovereign members of the Euro - one that accommodates fluctuations in growth rates, so that it acquires risk characteristics closer to equity. Naturally - and like equity - it would have lower priority than TARGET2 obligations.
ReplyDeleteI already mentioned Miles Kimball proposal for a managed exchange rate between contract units in the core (or Germany in particular) and the rest of the zone. This wouldn't be quite the same as all of the nations borrowing in their own currencies, but it would provide more flexibility than there is now. The proposal that is currently ascendant is Robert Shiller's NGDP-linked debt, with plenty of discussion at central bank conferences organized by Euro members, with Banque de France taking a leading role. Compared to Kimball, the adjustments to Shiller's contract units would be automatic (based on national accounting data). Shiller was the one who got me started in thinking about hybrids and new forms of debt, and it seems that he's influencing quite a few others as well.
Anwer,
Delete"But we need a better form of obligation for sovereign members of the Euro - one that accommodates fluctuations in growth rates, so that it acquires risk characteristics closer to equity."
Agreed. Here is what I believe the risk profile of equity sold by a sovereign should look like:
1. Equity sold by a sovereign should be non-transferrable and should be extinguished upon demise of the purchaser.
Contrast that with bonds that are purchased, re-sold, and rolled over. That is how countries go from debt to GDP ratios in the single digits to triple digits. Compare that also with Trills - I don't know what Shiller has in mind with regard to transferability though he has indicated that they (Trills) should be perpetual.
2. Equity sold by a sovereign should be fixed duration.
This is similar to existing government debt, though dissimilar to the Trills that Shiller describes.
3. Equity sold by a sovereign should accrue returns rather than making regular interest / dividend payments.
This makes cash flow management at the fiscal level much easier. This also steps around legislative hurdles since no cash payments are made on the securities.
4. Equity sold by a sovereign shall only be redeemed when used to satisfy a tax liability. No central bank purchases.
This (along with non-transferability) makes sovereign equity decidedly less liquid than bonds and currency. This also places the risk / rewards solidly on the shoulders of the individual that purchases the security. Compare that to GDP linked bonds where all purchasers share commensurately in the risk / rewards.
5. Equity sold by sovereign governments should offer countercyclical returns. Meaning that the returns should be linked to the output gap (Potential GDP - Actual GDP) rather than GDP itself.
Contrast that with GDP linked bonds that offer larger returns in times of higher growth and lower / negative returns in times of weak growth.
Frank your proposal of non-transferable equity that is extinguished on demise of the purchaser, and used to fulfill tax liabilities, is very similar to a proposal by Dean Baker. You might want to look up his op-ed: "An Honest Approach to Simplifying Corporate Income Taxes". The state owns a piece of every corporate, and the aggregate of these shares might be understood as sovereign equity. It is indeed a way of funding a sovereign that automatically adjusts for growth rates, the way that Shiller's trills attempt to do.
DeleteTrills have been criticized by futures traders I know, because it relies on accounting data that is revised multiple times, thus is a poor basis for futures contracts that need to be settled at a fixed date. Of course Dean Baker's proposal isn't affected by this problem. Until now I didn't think of it as an alternative to Shiller's idea - it doesn't accommodate external funding of national infrastructure - but it does have similar risk properties.
Anwer,
DeleteI have always taken issue with taxing corporate income differently than taxing personal income since it's easy enough for an individual to incorporate himself / herself.
And so, it seems unrealistic to think that a government would seek equity financing only from the corporate sector.
"Until now I didn't think of it as an alternative to Shiller's idea - it doesn't accommodate external funding of national infrastructure - but it does have similar risk properties."
I don't quite understand the necessity of seeking external funding for national infrastructure - but then again, I am not well versed in the finances of developing countries.
P. S. I have read some of Dean Baker's stuff but from what I have read, he seems to construe government bonds as claims on national property (collateralized loans so to speak). Argentina was able to successfully fight this proposition (sovereign immunity) - see:
https://en.wikipedia.org/wiki/Argentine_debt_restructuring
"After defaulting, Argentina continued to pay its renegotiated bondholders, but not the holdout bondholders who had rejected settlement. As Argentina refused to pay the holdout creditors at full value, the holdouts initially resorted to lawsuits to seize Argentine government assets abroad – notably Central Bank deposits in the Federal Reserve Bank of New York, the presidential airplane, and the ARA Libertad. The Libertad, an Argentine Navy training frigate, was arrested (though not seized) at the behest of NML Capital for ten weeks in late 2012 in the port of Tema, Ghana, until the International Tribunal for the Law of the Sea ruled unanimously that it be released. Eventually this approach proved fruitless. The holdout bondholders soon discovered that due to a number of sovereign immunity laws, it was impossible to actually enforce their judgments by seizing the handful of Argentine assets still within the reach of U.S. jurisdiction."
Anwer,
DeleteI just read the article that you refer to:
https://www.huffingtonpost.com/entry/an-honest-approach-to-simplifying-corporate-income_us_5a0a4f8be4b060fb7e59d359
???
I don't know what Baker hopes to achieve here. Government ownership of equity put's the government's finances at risk and makes a sovereign default more likely. Government accepts $100,000 in equity from a company to fulfill a tax liability, but market value of that equity collapses to $50,000.
That is the exact opposite of what I am talking about.
Equity sold by a government puts the finances of the buyer at risk.
Equity purchased by a government puts the government's finances at risk.
Frank, I personally am a skeptic of income taxation, after having been persuaded through blog posts here and elsewhere that it is better to tax consumption. You point out one specific problem with taxation of corporate profits that Baker doesn't solve with his proposal, and also that it doesn't accommodate capital inflows (since the shares are non-transferable - one of your stipulations).
ReplyDeleteBut even if it's not my first choice, Dean Baker's proposal is still one of the best for corporate taxation. He mentions his desire for bipartisan appeal. Our conversation should be comparing the best options proposed by each side, and not straw men.
Regarding external funding of infrastructure investment: you are definitely not the only skeptic! Some appraisals of the track record have been written up recently, and the empirical record is disappointing. Quite a few heterodox economists are quite happy to follow Keynes and have an international currency that is limited to trade, not finance. There are others who would allow external funding as long as the flows are controlled. I have tried to think through this later possibility and how best to make it work for everyone.
On the other hand, the neoliberal economists working for central banks in Europe seem to have no problems with free movement of capital within the continent, and their preferred form of external funding of sovereigns is via Shiller's trills - judging by published conference output. If this is the best compensation for the lack of monetary policy within a union, then let us compare this best (trills) with the best option for managing flows without such a union. I still haven't been able to track down any videos from the Hoover conference, but it would be great to hear what those economists (including Prof. Cochrane) had to say on this matter!
Anwer,
Delete"Frank, I personally am a skeptic of income taxation, after having been persuaded through blog posts here and elsewhere that it is better to tax consumption."
I am quite the opposite for several reasons.
Actually taxing consumption means that the purchaser of a good pays the taxes for that transaction. Is the government going to accept a portion of the bananas that I buy to settle a tax liability?
I believe that you actually mean some sort of national sales / value added tax.
In that case I would say that there are several problems:
1. How does a government maintain an operational cash flow without withholding income on a regular basis?
2. National sales taxes tend to be regressive. Attempts to add progressiveness to a national sales taxes create bad incentives.
3. There isn't a single government that I am aware of that limits taxation to a VAT and no income tax (including Argentina, the original subject of this article). And so, in everywhere that it has been instituted, a VAT was lopped on top of existing income taxation.
"But even if it's not my first choice, Dean Baker's proposal is still one of the best for corporate taxation. He mentions his desire for bipartisan appeal."
As a follower of economics, bi-partisan appeal is not all it's cracked up to be.
The twin wars in Iraq / Afghanistan had "bi-partisan" appeal even though they made little sense on economic grounds. I prefer non-partisan (central bank technocratic style) to bi-partisan any day of the week.
"Our conversation should be comparing the best options proposed by each side, and not straw men."
What "sides" are you referring to? So far, I seem to be the only individual offering a conservative approach to government financing. And so far, I seem to be the only non-economist doing it.
In my mind, the conservative ideal for government equity is this:
1. Risk should lie with the individual, not with the government / taxpayers as a whole (scratch Baker's idea).
2. Individual effort should be emphasized and rewarded (scratch Shiller's Trills).
Of course, opinions can (and should) vary on what government equity should look like.
However, if we consider a government using a mix of both debt and equity in it's financing decisions, then from simple portfolio theory we can conclude that equity sold by a government should carry very few of the properties that debt does.
Whereas debt should be extremely liquid, equity should be illiquid.
Whereas debt should carry shared risk, equity should carry individual risk.
Whereas the returns on debt should be guaranteed, the returns on equity should not.
Whereas the returns on debt fall should during a recession, the returns on equity should rise during a recession.
With both debt and equity (as I describe) in the mix, any risk profile can be achieved.
"Quite a few heterodox economists are quite happy to follow Keynes and have an international currency that is limited to trade, not finance."
As far as facilitating international trade, the best idea that I have heard is creating a global electric grid that allows countries to settle international trade by selling / buying electricity on the grid. It puts even small, resource constrained countries on a more even footing with their larger brethren.
It's not perfect, I agree. But it doesn't have the "luck of the draw" issues that precious metals or other scare resources have. You can put in solar, wind, or hydrodynamic generators virtually anywhere in the world.
A couple more WhereAs:
DeleteWhereas debt should make regular coupon (cash) payments, equity should accrue returns to be paid out on redemption (Again nix Shiller's Trills).
Whereas debt should be a liability of the Legislative branch of government, equity should be a liability of the Executive branch of government.
Frank, while we have delved somewhat on the best way for the government to fund itself, I think the focus of conferences like the one here is how the international monetary system can perform well. We want money to be as liquid as possible. So far, the best we've come up with is government debt, precisely because it is diversified over the human capital of so many citizens.
DeleteThis was the objection that I had when I first encountered Prof. Cochrane's 100% equity proposal for banking: how would these equity shares be better as money, when the bank debt we use now trades at par (due to its wonderful information properties, during good non-crisis periods). But then I realized that these national currencies like the one discussed above need to be valued against each other every day, and that this is a design choice.
If instead of trading debt at par within national banking systems, we have management of rates between central banks and floating NAV for our deposit accounts at MMMFs, that arguable leads to fewer crises and better performance for the international system as a whole. I am trying to think about ways to reduce positive feedback loops. I believe this is very close in spirit to Prof. Cochrane's aim for a "run-free" system.
Anwer,
Delete"Frank, while we have delved somewhat on the best way for the government to fund itself, I think the focus of conferences like the one here is how the international monetary system can perform well."
The international monetary system can perform well when central banks cease to become financing arms of their respective governments.
Let me add another WhereAs:
Where debt can be purchased by a central bank, equity cannot be purchased by a central bank.
Anwer,
Delete"So far, the best we've come up with is government debt, precisely because it is diversified over the human capital of so many citizens."
It is not diversified enough when international considerations are added.
More on modern portfolio theory:
ReplyDeletehttps://en.wikipedia.org/wiki/Modern_portfolio_theory
"Diversification"
"An investor can reduce portfolio risk simply by holding combinations of instruments that are not perfectly positively correlated (correlation coefficient −1 ≤ ρ(ij) < 1. In other words, investors can reduce their exposure to individual asset risk by holding a diversified portfolio of assets. Diversification may allow for the same portfolio expected return with reduced risk."
Key phrase - "Not perfectly positively correlated".
Now apply that phrase to government securities.