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Número 102.3 ANEXO XI

Alvaro Espina 24 Noviembre de 2014 Entre 19 de octubre y el 5 de Noviembre

Republished with permission from Bloomberg View Read also on Italy:// Austerity Tales: the Netherlands and Italy/ Why does Italy not grow?/ "It's true, Italy breaks your heart" A Crazy Idea About Italy - Italy needs growth in nominal GDP to stop its debt burden from rising any further. To do so it needs Germany's help. by Jim O‘Neill on 5th November 2014

NASA's Marshall Space Flight Center I've spent a good deal of my 35 years as an economic and financial analyst puzzling over Italy. Studying its economy was my first assignment in this business -- as a matter of fact, Italy was the first foreign country I ever flew to. I'm just back from a vacation in Puglia and Basilicata. Over the decades, the question has never really changed: How can such a wonderful country find it such a perpetual struggle to succeed? Tweet This Italy has pitted weak government against a remarkably adaptable private sector and a particular prowess in small-scale manufacturing All the while, Italy has pitted weak government against a remarkably adaptable private sector and a particular prowess in small-scale manufacturing. An optimist by nature, I've generally believed these strengths would prevail and Italy would prosper regardless. In the days before Europe's economic and monetary union, though, it had one kind of flexibility it now lacks: a currency, which it could occasionally devalue. These periodic injections of stronger competitiveness were a great help to Fiat and other big exporters, and to smaller companies too. The rest of Europe had mixed feelings about this readiness to restore competitiveness through devaluation -- meaning at their expense. When discussions began about locking Europe's exchange rates and moving to a single currency, opinions divided among the other partners, notably Germany and France, on what would be in their own best interests. Many German conservatives, including some at the Bundesbank, doubted Italy's commitment to low inflation, which they wanted to enshrine as Europe's chief monetary goal. On the other hand, leaving Italy outside the euro would leave their own competitiveness vulnerable to occasional lira devaluations. In the end, of course, the decision was made to bring Italy in. The fiscal rules that were adopted at the same time -- including the promise to keep the budget deficit below 3 percent of gross domestic product -- can be seen as an effort to force Italy to behave itself. Now and then I wondered if some saw them as a way to make it impossible for Italy to join at all. In any event, Italy found itself doubly hemmed in, with no currency to adjust and severely limited fiscal room for maneuver. Tweet This Between 2007 and 2014 Italy has done better than most in keeping its cyclically adjusted deficit under control, yet its debt-to-GDP ratio has risen sharply The results haven't been good. It's ironic that between 2007 and 2014 Italy has done better than most in keeping its cyclically adjusted deficit under control -- yet its debt-to- GDP ratio has risen sharply. The reason is persistent lack of growth in nominal GDP, itself partly due to an overvalued currency and tight budgetary restraint. Italy is the euro area’s third-largest economy and its third-most populous country. Given this, the scale of its debts and everything we've learned about Europe's priorities during the creation of the euro and since, I've always presumed that, in the end, Germany would do whatever was necessary to protect Italy from the kind of financial blow-up that hit Greece in 2010. Now I am starting to wonder. Italy needs growth in nominal GDP to stop its debt burden from rising any further. Yes, it also needs to reform its economy, raise its productivity and boost its labour force to do this in a lasting way. But as long as it remains a member of the euro system, there'll be no aid from a devalued currency. Tweet This Italy needs Germany's help not just through greater fiscal flexibility but also through a rise in euro-area inflation back to the ECB's target This means it needs Germany's help -- not just through greater fiscal flexibility, which is essential, but also through a rise in euro-area inflation back to the European Central Bank's target of "below, but close to, 2 percent." It will be almost impossible for the euro area to do this unless Germany itself sees consumer-price inflation rise to that rate or higher. As I travelled around Italy on this latest trip, I imagined a different kind of Germanic rigidity. How about a zero-tolerance approach to inflation that falls below target?

Perhaps German citizens should pay an extra tax each year the country experiences inflation that is below but not close to 2 percent -- with the penalty increasing in proportion to the shortfall? The proceeds could be distributed to countries with a cyclically adjusted fiscal deficit of less than 3 percent and less-than-trend GDP growth. Come to think of it, perhaps Italy could impose a punitive tax on German tourists? I know. That would be crazy. But would it be any crazier than insisting on an arbitrary fiscal-deficit rule, unadjusted for the economic cycle -- or letting demand fall so low that Europe misses its inflation target by a mile, and in a way that condemns Italy and others to endless recession? I'd say it's a close call. http://www.bruegel.org/nc/blog/detail/article/1475-a-crazy-idea-about-italy/

A Greek programme for Greece Written by Christian Odendahl, 05 November 2014 Greece is currently negotiating its exit from the various programmes and ‘bailouts’ with its European and international creditors. Greece is still too weak to stand on its own, financially. But the problem is not the debt level alone, which is manageable over the short term because debt servicing costs are relatively low. The main issue is how to make Greece a prospering economy within the euro, after an epic economic depression and in the face of waning public support for further reforms. The country’s growth prospects will ultimately determine how much of Greece’s debt will get repaid. Of course, European policy-makers and the IMF could continue to muddle through, and Greece is unable to force them to change course. But with a crucial presidential election looming in early 2015 that could end the current government’s term and bring Syriza, the far-left party, to power, it is time to take stock. The Greek programmes had severe shortcomings that proved costly, both in terms of economic damage and in terms of popular legitimacy. What is needed is Greek ownership of further reforms, and a focus on long-term economic growth. Taking stock Over the last four years of crisis, Greece has never been the only – or even the main – problem in the eurozone. As a result, the eurozone’s Greek programmes have served other purposes: they have set a tough example for other countries, so they did not seek European money lightly; they have sought to prevent contagion to other countries and hence blocked a restructuring of Greek debt for a long time; by being tough, they have tried to preserve the political support in Europe’s northern core that might be needed if the crisis were to spread; and they have aimed to spare the fragile European banking system from ‘another Lehman’ because the Europeans failed to fully restructure and recapitalise their banks after 2008. At the same time, Greek society and its political leadership were ill-prepared for the crisis. They have struggled to collaborate with the IMF and the Europeans, neither of which knew the country well, in order to design an effective and inclusive reform programme. The resulting programmes focused on cutting back spending and on sparing European and Greek private bondholders from losses. These wrenching fiscal cut-backs, together with the threat of a euro exit, predictably led to an economic depression: Greek GDP is currently 20 per cent below its 2009 level and hardly growing; unemployment stands at 26 per cent, three quarters of which is long-term unemployment. Greek public finances do show a primary surplus, that is, a surplus before the costs of servicing public debt have been subtracted. But with crumbling nominal GDP, Greek public debt has risen to 176 per cent of GDP – despite a massive haircut on private bondholders in 2012.

Importantly, the depression has eroded the initial public support for an overhaul of the Greek economy and governance. Structural reforms, meanwhile, focused on issues that were seen as crucial for Greece’s public finances: tax collection, cuts to public sector jobs, salaries and welfare, and privatisation. Some of these reforms were certainly needed, and Greece has been one of the OECD’s busiest reformers, according to the Paris organisation’s ‘reform responsiveness indicator’. But they did little to raise Greece’s growth potential: public bureaucracy, regulation, the judicial system and land rights issues continue to weigh heavily on the Greek economy. • This recent EU Commission paper found that these constraints hold Greek exports back rather than uncompetitive prices or wages; • Earlier this year, the OECD argued that Greek business could save €3.3 billion euro annually if the government removed unnecessary administrative burdens. • The OECD also identified 555 regulations that severely hamper competition in the Greek economy.

Thus, the goal should be an overhaul of the way in which the political system and public bureaucracy works, which requires the support of the whole political spectrum, the public and the bureaucracy itself. It also requires action to reduce clientelism, which to a large extent is currently just on hold because there is very little public money to spend, or public jobs to fill. These crucial reforms could take a decade – some even a generation – rather than a couple of years to implement. The current state of the programmes Overall, therefore, the limited political capital in Greece was not spent on what was most critical for the long-term success of its economy, and hence, its public finances. As a consequence, Greece’s European creditors are less likely to be repaid, despite extending loan maturities and pretending that Greece could grow strongly and run politically unrealistic budget surpluses for years. The current round of negotiations between the Greek government and the ‘troika’ of the European Commission, the IMF and the ECB over the final review of the second adjustment programme could now be the breaking point. The government cannot agree to the troika’s demands – a highly unpopular pension reform and making it easier to lay off workers collectively, among other things – in return for the final tranche of €7.2bn. In addition, the government would like to exit the programme entirely before the elections, foregoing further IMF funds pencilled in for 2015 and 2016, a plan that the troika rejects. Finally, it would like to reduce the amount of intrusive monitoring and outside interference, despite needing at least a precautionary credit line from either the Europeans or the IMF before it can safely return to markets – credit lines that usually come with significant outside monitoring. The reason is clear: politically, the government has its back against the wall, ahead of the presidential election in February 2015. Under the Greek constitution, the president is elected by the parliament, and the winning candidate will need a three-fifths majority (180 votes). At present, the government only has 154. The remaining 26 votes need to 5

come from either the former coalition partner DIMAR or independent MPs, both of which loath to help the government. If the parliament fails to elect a new president, there will be snap elections, one year ahead of time. The current government coalition is highly unlikely to win: the far-left Syriza is leading in the polls with roughly 33 per cent, compared to the main governing party, New Democracy, at just 26 per cent and PASOK, the junior coalition partner, down to 6 per cent. If Greece elects Syriza, the eurozone would be back in unchartered territory. Syriza has vowed to reverse cuts to public spending, wages and pensions, and to cancel or at least substantially renegotiate the agreement with the troika. Given that Greece cannot stand on its own, financially, unless it defaults unilaterally on its debt, both sides would be on a collision course. Greece would be destabilised and less likely to repay its debt. It also might spook investors beyond Greece. Of course, the ECB has made it clear that it intends to prevent contagion from spreading across the eurozone. But the collision with Greece might come at a bad time. If eurozone growth continues to disappoint, the ECB has to use further unconventional measures (thereby enraging the German public), and Italy challenges the current policy course more openly, a collision with Greece might add fuel to the fire. What Europe should do The widely respected mayor of Thessaloniki, Yiannis Boutaris, has recently called for a national unity government of all the major parties. The EU should take the cue and try to find a long-term solution to Greece’s economic woes and its public debt that has broad support across the political spectrum; that ensures Greek ownership of further reforms; and that, based on local knowledge, removes the most binding constraints that currently hold Greek growth back. One way would be to create a Greek reform council, consisting of Greek experts and representatives of Greek civil society, which would draft a long-term reform programme that the major parties in parliament – and the Greek public – can agree on. This programme should, at the same time, leave enough room for democratic decisions on policies. Europe and the IMF should continue to offer their technical help but mandate the Greek reform council with the monitoring of its new reform programme. In addition, a clear agreement should be made: that after a successful completion of the programme, Greek debt will be written down to a sustainable level. How much debt is sustainable is impossible to predict and depends on Greek growth, but it would be an effective incentive to make sure the reform council is a success. In the meantime, the European Stability Mechanism (ESM), Europe’s main bailout fund, should extend a precautionary credit line that the Greek government can draw on in case the markets are not willing to fund it at reasonable rates, conditional on the progress of the reforms. Why would the current leader in the polls, Syriza, agree to such a Greek reform programme and reform council, just before the opportunity to come to power? Syriza’s problem is that it has to prove to the Greek public that it would not further destabilize the Greek economy. The threat of a euro exit scares the public. According to the latest Eurobarometer poll, 59 per cent of the Greek population still approve of the euro – which, strikingly, is above the eurozone average, and considerably above Italy’s 43 per cent. A genuinely Greek reform programme and a stable, long-term agreement with the rest of the eurozone and the IMF might give Syriza the credibility it needs. If early 6

elections in the summer of 2015 were part of the agreement, Syriza’s chance of winning an outright majority might actually be higher than it is now. What is more, Alexis Tsipras, Syriza’s leader, could use this Greek reform programme to discipline his party, which is a loose association of various socialist groups. At the same time, he would have enough leeway to push through some Syriza policies. Finally, Tsipras would preside over a light-touch monitoring of a genuinely Greek reform agenda, rather than having intrusive troika visits every couple of months; and he could avoid a stand-off with the EU that deep down he knows he cannot win without causing further short term damage to the Greek economy. The eurozone would gain from a realistic long-term strategy for Greece that ensures a maximum amount of useful reform and economic growth. Such a long-term solution would also, despite writing down Greek debt, ensure that Greece’s official debt would get repaid as much as possible, and end the current charade of extend and pretend. If eurozone policy-makers continue to muddle through with Greece against a fading momentum for change, the Greek economy will remain half-reformed and continue to struggle inside the euro. Eventually, the political tension might spread beyond Greece. Christian Odendahl is chief economist at the Centre for European Reform. - See more at: http://www.cer.org.uk/insights/greek-programme- greece#sthash.aQ1cMEk4.dpuf

Tax avoidance Luxembourg tax files: how tiny state rubber-stamped tax avoidance on an industrial scale Leaked documents show that one of the EU’s smallest states helped multinationals save millions in tax, to the detriment of its neighbours and allies • What do you want to know about Luxembourg’s tax secrets? • The $870m loan company above a stamp shop Simon Bowers Wednesday 5 November 2014 21.01 GMT An unprecedented international investigation into tax deals struck with Luxembourg has uncovered the multi-billion dollar tax secrets of some of the world’s largest multinational corporations. A cache of almost 28,000 pages of leaked tax agreements, returns and other sensitive papers relating to over 1,000 businesses paints a damning picture of an EU state which is quietly rubber-stamping tax avoidance on an industrial scale. The documents show that major companies — including drugs group Shire, City trading firm Icap and vacuum cleaner firm Dyson, who are headquartered in the UK or Ireland — have used complex webs of internal loans and interest payments which have slashed the companies’ tax bills. These arrangements, signed off by the Grand Duchy, are perfectly legal. The documents also show how some 340 companies from around the world arranged specially-designed corporate structures with the Luxembourg authorities. The businesses include corporations such as Pepsi, Ikea, Accenture, Burberry, Procter & Gamble, Heinz, JP Morgan and FedEx. Leaked papers relating to the Coach handbag firm, drugs group Abbott Laboratories, Amazon, Deutsche Bank and Australian financial group Macquarie are also included. The Luxembourg tax files 1. Introduction 2. How it works 3. Case study: Shire 4. Case study: ICAP 5. Case study: Dyson 6. Analysis by Richard Brooks 7. Find out more or get in touch A Guardian analysis has found:

A Luxembourg unit of Shire, the FTSE-100 drug firm behind attention deficit pill Adderall, received more than $1.9bn in interest income from other group companies in the last five years, paying corporation tax of less than $2m over four of the years despite minimal overheads. Vacuum and hand dryer firm Dyson set up companies in the Isle of Man and Luxembourg to pour £300m of internal loans into its UK operations in 2011. Interest payments made on those loans slashed Dyson’s UK tax bill and were instead taxed at only around 1% in Luxembourg, saving Dyson companies millions in tax. Icap, the financial trading firm run by leading Conservative party donor Michael Spencer, lent $870m from Luxembourg to its US business for seven years. Interest paid out from US companies on those loans was £247m, which was taxed at a fraction of official corporation tax rates in the US and UK. Stephen Shay, a Harvard Law School professor who has held senior tax roles in the US Treasury and who last year gave expert testimony on Apple’s tax avoidance structures in a Senate investigation, said: “Clearly the database is evidencing a pervasive enabling by Luxembourg of multinationals’ avoidance of taxes [around the world].” He described the Grand Duchy as being “like a magical fairyland.” "Luxembourg is like a magical fairyland" Stephen Shay, Harvard professor There is growing political pressure in the UK and abroad to stop companies exploiting international tax rules to slash their tax bills. In January last year David Cameron told business leaders gathered at the World Economic Forum in Davos he would not tolerate big multinationals avoiding tax. In particular, he criticised how “companies navigate their way around legitimate tax systems ... with an army of clever accountants”. Chancellor George Osborne has pledged to reveal new measures next month to stop global corporations diverting profits offshore. Barack Obama has condemned tax avoiding companies as “unpatriotic” and the G20 group of nations is working on new rules to rein in aggressive tax planning. The revelations will be embarrassing for the new president of the European Commission, Jean-Claude Juncker, who was prime minister of Luxembourg between 1995 and 2013. In a speech in Brussels in July, Juncker promised to “try to put some morality, some ethics, into the European tax landscape.” He has insisted that the country is not a tax haven. Pressure is already building on Luxembourg after the European Commission launched a formal investigation into whether Amazon’s tax arrangements in the Grand Duchy amount to unfair state aid. The Luxembourg tax arrangements of Italian carmaker Fiat’s finance unit are also under official scrutiny by Brussels. Asked recently if such a crackdown risked damaging the economy of Luxembourg, one senior figure closely involved in the G20 reform programme said: “I don’t care. It is like saying: ‘If you fight drugs there will be no jobs in certain parts of Mexico.’”

Recent scrutiny by politicians and media organisations of aggressive structures used by technology groups such as Apple, Google and Amazon have suggested US digital firms are at the vanguard of cross-border tax avoidance. But today’s revelations show many European multinationals in non-digital industries have also made extensive use of tax engineering. More than 80 journalists in 26 countries, working in collaboration through the International Consortium of Investigative Journalists, have spent six months scrutinising the leaked papers - after a small number of the documents were first revealed by French TV journalist Edouard Perrin. The papers largely relate to clients of PricewaterhouseCoopers Luxembourg. PwC is one of the largest tax advisory groups in the world.

The leaked papers show Luxembourg acting as a go-between, both enabling and masking tax avoidance, which always takes place beyond its borders. The documents are mainly Advance Tax Agreements - known as comfort letters. The leaked papers include 548 of these private tax rulings. These ATAs are typically schemes put to the Luxembourg tax authorities which, if implemented, reduce tax bills substantially. If the Luxembourg authorities approve the scheme they provide a comfort letter which is a binding agreement. The EC’s Amazon and Fiat investigations were launched after Brussels officials demanded that Luxembourg hand over certain ATAs.

"[I will] try to put some morality, some ethics, into the European tax landscape." Jean-Claude Juncker Less than a third of the tax deals brokered by PwC in the 28,000 pages of documents include a figure for the sums multinationals planned to move into Luxembourg schemes. However, these deals still amounted to more than $215bn of loans and investments using the Grand Duchy between 2002 and 2010, many to massage down tax bills. Given that many more leaked papers did not disclose sums involved, and that PwC was just one of several accounting firms which secure deals with the Luxembourg tax authorities, the full scale of financial flows through Luxembourg, facilitated by comfort letters from the Grand Duchy’s officials, is likely to be much higher. PwC said questions put to it by ICIJ journalists were based on “outdated” and “stolen” information, “the theft of which is in the hands of the relevant authorities”. 10

But analysis of public filings with company registries around the world indicate many of the leaked tax deals remain in force, sapping tax revenues from public coffers today. The Guardian’s detailed findings were put to Shire, Icap and Dyson. All three declined to answer questions. They issued statements saying that they do not engage in tax avoidance and that they pay tax in the countries where profits are made. Dyson stressed that its Isle of Man and Luxembourg structure was unwound in 2013. Icap said it had started a process of winding down its Luxembourg financing companies last month as part of a wider reorganisation. Many papers in the leaked tax correspondence do not reveal enough information to clearly show tax consequences of each group’s corporate structuring. And some corporations will have sought comfort letters from Luxembourg for reasons other than tax avoidance. Many large private equity investments are also the subject of Luxembourg ATAs. Well known buyout firms such as Blackstone and Carlyle appear in the leaked documents, and Luxembourg investment vehicles are commonplace in such investment firms. A 2008 joint venture between private equity group Apax Partners and Guardian Media Group, which owns the Guardian, also used a Luxembourg structure after it invested in magazine and events group Emap, now called Top Right. A spokesman for GMG said: “We partnered with a private equity company which regularly used such structures. A Luxembourg entity was used because Apax already had that structure in place. The fact that the parent company is a Luxembourg company does not give rise to any UK corporation tax savings for GMG.” How it works The documents reveal a number of financial structures which were approved by the Luxembourg tax authorities, and which led to substantial tax savings for the companies involved. One of the more common is based on cross-border lending within a group of companies, and a mismatch between the perceptions of Luxembourg and overseas tax authorities. How Shire’s internal lending cuts its tax bill A tiny Luxembourg-based unit of Shire, a multinational drug firm specialising in treatments for ADHD, Crohn’s disease and rare genetic disorders, has become one of the most profitable outposts of the pharmaceutical empire. Shire is a £24bn transatlantic drugs group with big operations in the UK town of Basingstoke, and Pennsylvania and Massachusetts in the US. It shifted its corporate head office from the UK to Ireland for tax purposes in 2008 and is registered in the tax-friendly island of Jersey. The majority of its sales are in north America. One of Shire’s Luxembourg units has made $1.87bn in profits in the last five years, largely from making loans to sister companies, as it charged interest rates of up to 9% on those loans. With what appears to be the consent of the Luxembourg authorities, the enormous profits generated by this unit were taxed at a fraction of 1%.

Shire’s tiny Luxembourg finance company in an office with dozens of other corporate occupants — Shire Holdings Europe No2 Sarl, or SHES2 for short — has lent out a total of more than $10bn. Away from Luxembourg, more than two-thirds of Shire’s $5bn in annual revenues came from the sale of prescription drugs in the US and Canada last year. But group profits around the world were taxed at an average of 16.4% — less than half the official tax rate for most big businesses in America. Somehow, the FTSE 100 firm had hit upon the holy grail of tax management: a structure that allowed it to access some of the most profitable healthcare markets in the world while keeping its tax bill low at the same time. The main factor pushing down its tax bill is explained in the smallprint of the group’s annual report as “intra-group items”. That is, the tax consequences of investments and transactions between Shire group companies around the world. Leaked letters from PwC, Shire’s tax advisers, reveal how far Shire was prepared to go to conjure up tax advantages through highly artificial tax structures. The confidential papers reveal the critical role in group tax planning played by SHES2 — one of seven Shire companies incorporated in Luxembourg. Over the last five years this business received $1.91bn of interest income from loans it made to other Shire companies, including more than $580m last year alone. By the end of 2013, sister companies within the Shire group owed SHES2 more than $10bn in loans and interest — equivalent to more than two years’ sales for the entire group. The Guardian asked Shire why it had such large internal loans when the overall group had few borrowing needs. Shire declined to comment. The borrower companies and where they operate remains unknown. It is likely however that the vast interest payments have created huge tax deductions for these sister units, whose profits are lowered by the cost of paying the interest on the Luxembourg loans. With minimal operating costs — including staff wage bills of less than $55,000 a year — SHES2 appears to be one of Shire’s most lucrative business units with profits over five years of $1.87bn. But Shire’s annual report makes mention of SHES2 only once, in an appendix that lists the group’s subsidiaries. Meanwhile, accounts for SHES2, filed in Luxembourg, show that, despite its towering profits, the company recorded no corporate income tax charge at all. The Guardian sent a reporter to the offices of SHES2 in Luxembourg but found few of the trappings to be expected of a multi-million-dollar enterprise. Watch footage of Rupert Neate attempting to find a SHES2 employee in Luxembourg: Company filings show SHES2 had just four official managers, two of whom were senior figures in Shire’s tax department, working at UK head office in Basingstoke, England. Among them is Fearghas Carruthers, the group’s head of tax. The key to solving the riddle of how SHES2 appears to have made $1.91bn of interest income almost disappear for tax purposes is found in leaked Luxembourg letters from

tax advisers at PwC to the local tax office. They offer a rare glimpse into the group’s labyrinthine corporate structures. Company filings show SHES2 had just four official managers, two of whom were senior figures in Shire’s tax department, working at UK head office in Basingstoke, England. Among them is Fearghas Carruthers, the group’s head of tax. The key to solving the riddle of how SHES2 appears to have made $1.91bn of interest income almost disappear for tax purposes is found in leaked Luxembourg letters from tax advisers at PwC to the local tax office. They offer a rare glimpse into the group’s labyrinthine corporate structures.

A diagram provided by PwC to help the Luxembourg tax authority to understand the corporate structure of Shire. The Guardian has picked out SHES2 and an Irish company called Shire Holdings Ireland No.2 Limited in yellow. The circle labelled “LuxPE” is the Irish company’s Luxembourg branch.Photograph: Guardian The answer lies in Ireland, where Shire moved its corporate headquarters from the UK in 2008 after the Labour government had attempted a crackdown on UK multinationals using internal financing companies in aggressive tax planning structures. Among a cluster of Irish-registered Shire firms is a holding company Shire Holdings Ireland No.2 Limited, or SHIL2 for short. This Irish company has for years been charging itself interest on billions of dollars of loans — to itself. More specifically, the 13

interest has been charged on loans from SHIL2’s head office registered near Dublin to a SHIL2 branch office in Luxembourg. Rupert Neate returned - to the same office block on the outskirts of Luxembourg city - to enquire about SHIL2. Leaked papers show that Shire’s tax advisers told the Luxembourg tax authorities that this unusual lending within the same legal entity had transformed the drug group’s wider activities in the Grand Duchy into a lending conduit: pushing one large loan from Ireland, through two Luxembourg units (SHIL2 and SHES2), and onwards to Shire companies around the world. Such a chain of back-to-back lending, advisers from PwC argued, effectively meant Shire’s intra-group loans were only passing through Luxembourg. Therefore, the local taxman did not need to conduct a rigorous assessment of Shire’s tax liabilities. The full Luxembourg corporate tax rate should still apply, but only on a notional amount of profit. In Shire’s case, PwC suggested, the Grand Duchy should be satisfied taxing just “1/64%” — that is 0.0156% — of the billions in loans and interest owing to SHES2. A letter of consent from the Luxembourg tax office does not appear in the cache of leaked files, but it is clear from publicly available filings elsewhere that the avoidance structure was set up in 2008 and appears to have remained active at least as recently as the end of 2013. By the end, the complex structure had created a multi-billion-dollar lending chain, bearing no relation to Shire’s overall borrowing needs. The structure appeared to have little commercial benefit other than a tax conjuring trick: tax bills have been lowered for Shire borrower companies around the world while the group’s Luxembourg operations had all but escaped corresponding tax on the interest income. In a statement, the group said: “Shire Holdings Europe No.2 Sarl, is part of our overall treasury operations. We have a responsibility to all our stakeholders to manage our business responsibly; this includes managing our tax affairs in the interest of all stakeholders.” Icap’s skeleton-staffed multimillion dollar office Above a stamp shop, behind closed office blinds, on the first floor of a terrace building overlooking a park on Boulevard Prince Henri in Luxembourg City, the lights appear to be out. When the Guardian pressed the buzzer one October afternoon a male voice, with what seems a Dutch accent, sounds over the crackly intercom. The speaker confirmed this was, indeed, the Luxembourg offices of Icap, the London-listed financial trading group. Polite and good humoured, he chuckled and apologised for having to catch his breath, explaining he has just run down some stairs to answer the buzzer. He said little else about Icap’s Luxembourg lending operations, however, and wouldn’t let the Guardian in the building. Watch footage of our reporter, Rupert Neate, trying to make contact. Official filings show two Icap companies at this address. Together they have sucked hundreds of millions of dollars in interest income out of the high-tax US and, with the help of a third Icap unit, and made them all but disappear for tax purposes.

Together they had lent a total of $870m to Icap operations in America by March 2008. Annual accounts since then show these loans remained on the companies’ books unchanged every year. They were still outstanding at the end of March this year. Last week the Guardian approached Icap with the findings from its investigation into the broker firm’s Luxembourg activities. In response, Icap explained that the loans had just recently been repaid in full by the group’s US operations, and that a process to wind down its Luxembourg unit had begun only last month. No such information was relayed by the voice on the intercom, though Icap’s local manager has since explained that Luxembourg secrecy laws meant he could not offer explanations. Company accounts suggest neither of the two Icap lending firms had much commercial activity - other than the holding of large loans to the US. The companies’ names are as long as they are uninformative — Icap Luxembourg Holdings (No.1) Sarl and Icap Luxembourg (No.2) Sarl. In leaked tax correspondence they are abbreviated to generic terms “LuxCo1” and “LuxCo2”. Over the last seven years, the two each had just one employee — paid an annual wage of less than $15,000 — while other costs of operating above the stamp shop have also been consistently small.

A detail from one of the documents shows part of Icap’s corporate structure, as it relates to Luxembourg. Photograph: Guardian It is a far cry from Icap’s busy trading desks in New York and London, scenes from which every year appear in the newspapers as a string of celebrities take over the

dealing phones as part of a charity day. Last year the Duchess of Cornwall and Strictly Come Dancing’s Craig Revel Horwood manned the lines. Offering services in many of the busiest financial markets — foreign exchange, credit, interest rates and equities — the group has a busy role at the heart of the City of London, Wall Street and other financial centres. The chief executive, Michael Spencer, has the best political connections, serving as treasurer of the Conservative party between 2006 an 2010. His donations to the party have totalled nearly £5m. But no celebrities or cabinet ministers have ties to Icap’s quiet Luxembourg offices. LuxCo1 and LuxCo2 are not mentioned among the 22 main subsidiaries listed in Icap’s annual report. Yet together the two companies received a total of $248m in interest on their loans to the US in the last seven years. And thanks to modest overheads - the pedestrian office, the single employee - almost all of the interest income converted into profit, making LuxCo1 and LuxCo2 among the most lucrative subsidiaries within the Icap empire. The tax position on the Luxembourg lending profits is less than clear from company accounts, which record both LuxCo1 and LuxCo2 as having no income tax to pay at all for the seven years reviewed by the Guardian. The true position, however, is discoverable with the help of leaked tax approvals given to Icap, in private, by the Luxembourg taxman. These show that LuxCo1 and LuxCo2 were treated in their tax returns as part of a lending chain. Although neither company had any borrowings themselves, another ICAP unit, registered to the same address on Boulevard Prince Henri did. The Icap borrower company in question has an innocuous sounding name — ICAP US Holdings No2 Ltd, or ICAP US2 for short — but it is a truly exotic corporate creature. Despite having just one employee, paid $12,000 in Luxembourg, this UK tax-resident company has three registered addresses: a law firm in Gibraltar; Icap’s international headquarters on Broadgate in the City of London; and the office above the stamp shop on Boulevard Prince Henri. A clue as to its importance to Icap’s finance and tax affairs comes from the list of directors at Icap US2. These include Stephen Caplen, deputy financial director for the Icap group, and David Ireland, Icap’s head of tax. In the Luxembourg branch office, meanwhile, the sole “représentant permanent” is the non-board member Paul de Haan. Watch the video to learn more about Mr de Haan’s role. A leaked Luxembourg tax deal, covering all three Icap financing units, shows these units were treated collectively as a the middle link in a lending chain: a conduit rather than a lender. As a result, the local tax office agreed, the borrowing activities of Icap US2’s Luxembourg branch was generating tax deductions that could be neatly offset against the tax liabilities on almost all interest income earned at LuxCo1 and LuxCo2.

The resulting near-zero tax bill in Luxembourg could hardly be seen as controversial — so long, of course, as the millions paid out in interest by Icap US2 in the Grand Duchy was taxed when it became income for the lending company. And therein lies the twist. The lender to ICAP US2 was, in fact, ICAP US 2 itself. More precisely, ICAP US2 was lending hundreds of millions of dollars to its Luxembourg branch. In an exotic arrangement — one seen elsewhere repeatedly in the leaked tax files — the group was effectively paying interest to itself. Meanwhile, in Britain, tax inspectors scrutinising this arrangement recognised there was something unusual afoot. But there was not much they could do to block it, because the UK does not recognise such internal company lending as taxable. The result was that Icap’s interest payments - paid by Icap US2’s Luxembourg branch to another part of Icap US2 in a different country - almost disappeared, for tax purposes. The saving ran into many tens of million of dollars. That said, the UK taxman was not entirely without powers to act. HMRC was able to use its anti-avoidance powers, under the so-called “controlled foreign companies” regime, to winkle out a relatively small amount of tax from Icap US2. Over the last five years for which there are available accounts, Icap US2 appears to have paid an average corporate income tax of $3m a year to HMRC and $83,500 to Luxembourg. While the precise effective tax rate achieved on Icap’s interest income is hard to calculate, it is clear that it is a fraction of the headline corporate tax rates in the US and UK over the last seven years. In a statement to the Guardian, Icap said: “Icap is a British company, which has always paid more tax than the UK corporation tax rate, and we do not engage in aggressive tax avoidance. We pay all taxes due on the profits earned in the countries in which we operate. Our Luxembourg financing operation was created to support a series of acquisitions Icap made in the US in the 2000’s, and is now being wound down to reduce costs. Its profits were taxed in the UK. It is an entirely standard financing method and was agreed by HMRC.” Dyson sweeps away profits from the taxman Up until 2010 the corporate structure behind Dyson, the hand dryer and vacuum cleaner group, was as functional as its products. Shares in Dyson James Ltd (DJL), the main business, based in Malmesbury in Wiltshire, were owned by inventor and entrepreneur Sir James Dyson, with the founder’s three children each holding minority stakes. Official filings show two Icap companies at this address. Together they have sucked hundreds of millions of dollars in interest income out of the high-tax US and, with the help of a third Icap unit, and made them all but disappear for tax purposes. Together they had lent a total of $870m to Icap operations in America by March 2008. Annual accounts since then show these loans remained on the companies’ books unchanged every year. They were still outstanding at the end of March this year.

Last week the Guardian approached Icap with the findings from its investigation into the broker firm’s Luxembourg activities. In response, Icap explained that the loans had just recently been repaid in full by the group’s US operations, and that a process to wind down its Luxembourg unit had begun only last month. No such information was relayed by the voice on the intercom, though Icap’s local manager has since explained that Luxembourg secrecy laws meant he could not offer explanations. Company accounts suggest neither of the two Icap lending firms had much commercial activity - other than the holding of large loans to the US. The companies’ names are as long as they are uninformative — Icap Luxembourg Holdings (No.1) Sarl and Icap Luxembourg (No.2) Sarl. In leaked tax correspondence they are abbreviated to generic terms “LuxCo1” and “LuxCo2”. Over the last seven years, the two each had just one employee — paid an annual wage of less than $15,000 — while other costs of operating above the stamp shop have also been consistently small. It is a far cry from Icap’s busy trading desks in New York and London, scenes from which every year appear in the newspapers as a string of celebrities take over the dealing phones as part of a charity day. Last year the Duchess of Cornwall and Strictly Come Dancing’s Craig Revel Horwood manned the lines. Offering services in many of the busiest financial markets — foreign exchange, credit, interest rates and equities — the group has a busy role at the heart of the City of London, Wall Street and other financial centres. The chief executive, Michael Spencer, has the best political connections, serving as treasurer of the Conservative party between 2006 an 2010. His donations to the party have totalled nearly £5m. But no celebrities or cabinet ministers have ties to Icap’s quiet Luxembourg offices. LuxCo1 and LuxCo2 are not mentioned among the 22 main subsidiaries listed in Icap’s annual report. Yet together the two companies received a total of $248m in interest on their loans to the US in the last seven years. And thanks to modest overheads - the pedestrian office, the single employee - almost all of the interest income converted into profit, making LuxCo1 and LuxCo2 among the most lucrative subsidiaries within the Icap empire. The tax position on the Luxembourg lending profits is less than clear from company accounts, which record both LuxCo1 and LuxCo2 as having no income tax to pay at all for the seven years reviewed by the Guardian. The true position, however, is discoverable with the help of leaked tax approvals given to Icap, in private, by the Luxembourg taxman. These show that LuxCo1 and LuxCo2 were treated in their tax returns as part of a lending chain. Although neither company had any borrowings themselves, another ICAP unit, registered to the same address on Boulevard Prince Henri did. The Icap borrower company in question has an innocuous sounding name — ICAP US Holdings No2 Ltd, or ICAP US2 for short — but it is a truly exotic corporate creature. 18

Despite having just one employee, paid $12,000 in Luxembourg, this UK tax-resident company has three registered addresses: a law firm in Gibraltar; Icap’s international headquarters on Broadgate in the City of London; and the office above the stamp shop on Boulevard Prince Henri. A clue as to its importance to Icap’s finance and tax affairs comes from the list of directors at Icap US2. These include Stephen Caplen, deputy financial director for the Icap group, and David Ireland, Icap’s head of tax. In the Luxembourg branch office, meanwhile, the sole “représentant permanent” is the non-board member Paul de Haan. Watch the video to learn more about Mr de Haan’s role. A leaked Luxembourg tax deal, covering all three Icap financing units, shows these units were treated collectively as a the middle link in a lending chain: a conduit rather than a lender. As a result, the local tax office agreed, the borrowing activities of Icap US2’s Luxembourg branch was generating tax deductions that could be neatly offset against the tax liabilities on almost all interest income earned at LuxCo1 and LuxCo2. The resulting near-zero tax bill in Luxembourg could hardly be seen as controversial — so long, of course, as the millions paid out in interest by Icap US2 in the Grand Duchy was taxed when it became income for the lending company. And therein lies the twist. The lender to ICAP US2 was, in fact, ICAP US 2 itself. More precisely, ICAP US2 was lending hundreds of millions of dollars to its Luxembourg branch. In an exotic arrangement — one seen elsewhere repeatedly in the leaked tax files — the group was effectively paying interest to itself. Meanwhile, in Britain, tax inspectors scrutinising this arrangement recognised there was something unusual afoot. But there was not much they could do to block it, because the UK does not recognise such internal company lending as taxable. The result was that Icap’s interest payments - paid by Icap US2’s Luxembourg branch to another part of Icap US2 in a different country - almost disappeared, for tax purposes. The saving ran into many tens of million of dollars. That said, the UK taxman was not entirely without powers to act. HMRC was able to use its anti-avoidance powers, under the so-called “controlled foreign companies” regime, to winkle out a relatively small amount of tax from Icap US2. Over the last five years for which there are available accounts, Icap US2 appears to have paid an average corporate income tax of $3m a year to HMRC and $83,500 to Luxembourg. While the precise effective tax rate achieved on Icap’s interest income is hard to calculate, it is clear that it is a fraction of the headline corporate tax rates in the US and UK over the last seven years. In a statement to the Guardian, Icap said: “Icap is a British company, which has always paid more tax than the UK corporation tax rate, and we do not engage in aggressive tax avoidance. We pay all taxes due on the profits earned in the countries in which we operate. Our Luxembourg financing operation was created to support a series of acquisitions Icap made in the US in the 2000’s, and is now being wound down to reduce

costs. Its profits were taxed in the UK. It is an entirely standard financing method and was agreed by HMRC.” Dyson sweeps away profits from the taxman Up until 2010 the corporate structure behind Dyson, the hand dryer and vacuum cleaner group, was as functional as its products. Shares in Dyson James Ltd (DJL), the main business, based in Malmesbury in Wiltshire, were owned by inventor and entrepreneur Sir James Dyson, with the founder’s three children each holding minority stakes. The billionaire industrial designer, who came up with the bagless vacuum cleaner and built a company with a £1bn turnover, has become a figurehead and spokesman for UK engineering and science. In the late 2000s a rash of businesses moved their headquarter operations abroad. Shire, UBM and WPP had moved to Ireland. Ineos switched to Switzerland. Dyson did not approve. “We don’t have any plans to do that [move tax domicile],” he said in 2008. “I think it’s wrong to direct your business for tax reasons. Your business should be where you can do it best.” However, his company went on to use elaborate tax structures after he made those comments. At the start of 2010, new tiers of holding and finance companies began sprouting into life above DJL. Shares in DJL were now owned by a new UK holding company: Dyson James Group Ltd (DJG), which in turn became a subsidiary of Clear Cover Ltd, a parent company incorporated in Malta. Two group financing companies were also established: one in the Isle of Man called Silver Cyclone, one in Luxembourg called Blue Blade. Leaked details of tax deals with the Luxembourg tax office show these were to be the vehicles for a £300m injection of loans into DJG in the UK. Like all good corporate manoeuvres it was given a muscular-sounding code name: Project Ajax. In a matter of months, the simple corporate architecture that existed before had been swept aside. Dyson and his children remained the ultimate owners but their immediate interest was now in a company registered to an address on Tingé Point in the Maltese costal town of Sliema, the site of a former British barracks. Back in Britain, financial transactions that bore little relation to breaking new ground in product design began to take place. Instead of product engineering, this was financial engineering. In 2010 DJG had to meet new interest costs of £5.37m that were paid to newly-created sister company Blue Blade, filings in Luxembourg show. These costs are thought to have been largely or entirely tax-deductible - meaning they lowered profits at DJG, and thus its tax bill.

Dyson declined to confirm this, saying only that tax matters were commercially sensitive. Accounts for Blue Blade show the group’s corporation tax for 2010 was just £55,037 — an effective tax rate of just under 1%. Somehow the business had escaped tax at anything close to the then headline rate of over 28% in Luxembourg. Only in leaked tax papers is an explanation to be found. In a 2009 letter to Marius Kohl, one of Luxembourg’s top taxmen, Dyson’s tax advisers at PwC argued the case for Blue Blade to be charged tax on only a small fraction of its interest income. The letter makes clear PwC had met with Kohl to discuss the matter a month earlier. At the heart of the tax advisers’ case was a claim that Blue Blade should pay almost no tax because although it had lent £300m to DJG, it had also borrowed £299m from Isle of Man-based Silver Cyclone. PwC make no secret of the fact that the loan from the Isle of Man was interest-free. Nevertheless, it suggests, Blue Blade should properly benefit from a tax deduction as if it had been required to pay interest to Silver Cyclone. “[Blue Blade] will be allowed to deduct a deemed interest on its interest free debt involved in the financial on-lending activity”, PwC wrote. Rather than taxing all of Blue Blade’s lending profits, Luxembourg should only tax a tiny fraction of the sums borrowed. The nine-page PwC letter was sent to Kohl on 11 November. On the same day, the Luxembourg taxman sent back a two-paragraph reply: “Further to your letter... relating to the transactions that [the Dyson group] would like to conduct, I find the contents of said letter to be in compliance with the current tax legislation and administrative practice.” With these words, Kohl provided official sanction for the Dyson scheme to go ahead as PwC had described. The Guardian asked the Dyson group why Blue Blade should qualify for a tax deduction over “deemed interest” costs when, in reality, this company had almost no borrowing costs thanks to the interest-free loan from Silver Cyclone. Dyson did not answer. In a statement it said: “Advice a number of years ago was that a non-UK holding structure would aid growth further, however, that has not turned out to be the case and the holding structure of Dyson group is now entirely in the UK.” For reasons unknown, the £300m loan from Blue Blade was repaid in less than a year. But analysis of Dyson filings in the UK, Luxembourg, Malta and Isle of Man show that in 2011 the group rebuilt a near identical structure. This time, however, millions of pounds in interest payments from UK operations went to a Luxembourg company called Copper Blade. And the payments were higher as the Malmesbury holding company had borrowed £550m. This large loan was partly repaid in 2011 and again in 2012, with all debts and the entire structure unwound last year.

Dyson told the Guardian: “The Dyson family business paid £330m in UK tax over the past three years, clearly not the act of a company avoiding its fair share of tax. Dyson’s success means that over 85% of its technology is sold overseas ... At no time did the [group’s former] non-UK structure deliver any significant tax advantage and, of the entities in question all have been dissolved or are in a liquidation process.” Analysis: Havens make for a global race to the bottom Richard Brooks writes: “Occupying a damp 1,000 square miles where the French, German and Belgian borders meet, the Grand Duchy of Luxembourg is a far cry from the palm-fringed tropical island tax haven of popular imagination. “In fact the country owes its status as the world’s premier corporate tax haven to its position at the heart of Europe. A founding member of the European Economic Community in 1957, Luxembourg enjoys all the freedoms governing investment in what is now the European Union. These and a network of taxation agreements with all the world’s leading economies ensure the Grand Duchy is accepted in a club of leading nations that share basic principles on how to tax corporations operating across national borders.

Office buildings in Luxembourg’s financial district. A far cry from the Caribbean island vision of tax havens.Photograph: Graeme Robertson/Graeme Robertson “Such a privilege would never be afforded to island-in-the-sun tax havens. Large economies, such as the US and UK, typically block multinationals from shifting profits to low-tax territories by imposing ‘withholding taxes’ on payments leaving their borders. Luxembourg, by contrast, is a respected member of the international economic club, and assumed therefore to tax its companies fully; it even has a corporate income tax system with a 29% rate that is now relatively high by international standards. So money flows into the country tax-free. “Secretly, however, Luxembourg is a tax haven, offering a range of ways in which payments that reduce a multinational’s taxable profits in a country such as the UK or US can escape tax when received in the Grand Duchy. These include: exempting income diverted to foreign branches of Luxembourg companies in places like Switzerland and Ireland, tax relief for paper investment losses, and the approval of 22

complex ‘hybrid’ financial instruments and corporate structures within its borders. Top FTSE 100 firms like Vodafone and GlaxoSmithKline are known to have exploited these opportunities to channel billions through Luxembourg companies. “When a multinational approaches the Luxembourg tax authorities with a scheme employing one of these tactics, after a meeting or two to chew over the details a senior official rubber-stamps the plan and the company walks away with a big tax break. In this way the Grand Duchy behaves like the club member who enjoys all the benefits of membership while quietly pilfering from the kitty. "Luxembourg is like the club member who enjoys all the benefits of membership while quietly pilfering from the kitty" Richard Brooks “It might be an underhand way to run a tax system, but it serves Luxembourg well. The country has the highest levels of foreign investment inflows and outflows in the EU, taking a small but valuable tax levy as the money washes through. Corporate income taxes, at 5% of GDP, consequently form a far greater share of Luxembourg’s finances than they do in other EU countries. “As the world cottons on to Luxembourg’s tax poaching, pressure for reform grows. So does embarrassment for the new president of the European Commission, Jean-Claude Juncker, who as prime minister of the Grand Duchy for 18 years until 2013 presided over the activity. Revelations of precisely how its corporate tax avoidance factory works give the lie to Juncker’s repeated protestations that the country is not a tax haven. “Investigations by the European Commission into deals offered by Juncker’s government to Amazon and Fiat might or might not conclude that they constituted anti- competitive ‘state aid’. But these inquiries concern the possibility of ‘sweetheart deals’ for favoured companies, when the bigger problem is that Luxembourg offers major tax breaks to all companies – as long as they have enough money. “Neutering Luxembourg as a tax haven at the heart of Europe requires an overhaul of its corporate tax law and administration. A concerted effort coordinated by the OECD aims to bring many of the tax structures facilitated by Luxembourg to an end. But, even if its proposals are technically sufficient, it will take intense political pressure to force Luxembourg to implement them. “In the meantime, despite his claims to be spearheading the OECD’s work, George Osborne has enhanced the allure of Luxembourg’s tax breaks. In 2012 he drastically scaled back anti-tax avoidance laws targeted at multinationals’ so-called ‘controlled foreign companies’. These are tax laws that since 1984 have caught profits diverted by UK multinationals into tax havens. In a move specifically aimed at favouring finance companies established in Luxembourg, Osborne reduced the tax on their profits to no more than 5%. “Osborne’s changes are designed to make the UK an attractive place for multinationals to base themselves. They do so by accommodating predatory tax practices, in response to opportunities provided by countries like the Netherlands and Luxembourg. Other widely publicised tax breaks such as the ‘patent box’ special tax rate for income from intellectual property mimic concessions elsewhere.

“This is the real harm that tax havens like Luxembourg cause. They turn ‘tax competition’ into a global race to the bottom, depleting the contributions of major corporations and leaving citizens to pick up the tab.” Richard Brooks is the author of The Great Tax Robbery – How Britain became a tax haven for fat cats and big business. Find out more or get in touch The full set of documents has been published by the ICIJ. On Thursday November 6, the writer of this report, Simon Bowers, will be answering your questions between 1pm and 2pm GMT. Or you can email the Guardian financial desk at [email protected].// http://www.theguardian.com/business/2014/nov/05/-sp-luxembourg-tax-files-tax- avoidance-industrial-scale?CMP=EMCNEWEML6619I2

ft.com Markets Capital Markets

November 5, 2014 4:58 pm German borrowing costs fall to record low Elaine Moore Germany sold a tranche of five-year debt at a record low rate on Wednesday as markets wait and see whether the European Central Bank will expand its stimulus programme. The €4bn Bund sale was priced to yield just 0.12 per cent to investors. More ON THIS TOPIC// Irish debt sale to pay down IMF loan/ UK to repay tranche of perpetual war loans/ Global bankruptcy law comes back to life/ Funds buckle up for redemption surge IN CAPITAL MARKETS// Investors search for high-yield bargains/ HK banks compete for offshore renminbi/ Hedge fund nightmare turns into a dream/ Bank of China targets US with $3bn bond Across the rest of the eurozone, government borrowing costs rose slightly ahead of the ECB’s Thursday meeting. Debt market commentators said they were not expecting the ECB to shock markets with an unexpected government bond-buying programme announcement this week, but pointed out that the language it used would be scrutinised and had the power to change yields. “There may be a moderate disappointment trade on Thursday if nothing is explicitly mentioned about QE [quantitative easing],” said Patrick O’Donnell, investment manager at Aberdeen Asset Management. “But markets are willing to roll their QE expectations to the end of the year or beginning of next year, so if the language is neutral it may not have an impact.” Debt analysts say the case for jump-starting the eurozone economy via a fresh bond- buying scheme remained strong. This week the European Commission revised down its 24

growth expectations, forecasting a slower economic recovery in the largest countries and growth of only 0.8 per cent for the region as a whole in 2015. Eurozone retail sales were also revealed to have sunk 1.3 per cent in September, the biggest drop since April 2012. However, in spite of demand for German bonds pushing yields down to all-time lows, research by Rabobank revealed that four out of Germany’s last five debt auctions had failed to attract sufficient investor interest to cover the targeted amount sold. Bids for Wednesday’s auction amounted to €4.23bn – 1.06 times the amount offered. Lyn Graham-Taylor at Rabobank called the recent auctions lacklustre and said investors appeared reluctant to buy Bunds on primary markets. “Occasionally Germany will have auctions that are uncovered and this isn’t necessarily a problem because Germany still sells the debt,” he said. “But it’s interesting because obviously the huge demand for German paper is why yields are so low, and yet primary issuance isn’t attracting large demand.” European government borrowing costs have been fluctuating as investors wait and see what the ECB has to say. Italy’s borrowing costs, which had jumped above Spanish costs during the recent period of volatility across markets, have begun to regain lost ground. The yield on Spain’s benchmark 10-year debt rose 2 basis points on Wednesday to 2.19 per cent while the equivalent Italian bond yield rose to 2.44 per cent. Greek bond yields, which climbed towards 9 per cent as uncertainty surrounded the country’s politics and its intention to exit its bailout programme, are hovering around 8 per cent. The yield on Ireland’s benchmark bonds remained steady at 1.75 per cent following the country’s successful sale of €3.75bn this week to repay part of the bailout it received from the International Monetary Fund during the eurozone crisis. http://www.ft.com/intl/cms/s/0/387af67c-64da-11e4-bb43- 00144feabdc0.html#axzz3IHL81cjm

ft.com Comment Opinion November 5, 2014 5:39 pm Rajoy must go if Spain is to confront the threats it faces Luis Garicano Solving the political problems is impossible while the prime minister remains, says Luis Garicano

©AFP Mariano Rajoy, Spain's prime minister A stable two-party political system has been among Spain’s greatest strengths in the post-Franco era. But since 2008 the brutal economic crisis – together with growing evidence that large sections of both parties have operated as engines of patronage, graft and influence peddling – has undermined the legitimacy of the system and allowed two existential threats to the constitutional order to flourish. The first, in Catalonia, seeks to fragment the existing state. The second seeks to turn the entire country away from its post-1975 shift to modernity and towards a “national- populist” system similar to that of Venezuela and other Latin American countries. The conflict over Catalonia’s self-determination is fuelled by the belief among many Catalans that the northeastern region pays a disproportionately large share of Spain’s bills, along with a perception that the central government is trying to curtail Catalan autonomy on language and education. More ON THIS STORY// Podemos surges to poll lead in Spain/ Catalans to defy Spanish court/ Editorial Spain’s political scandals/ Global Insight The furious but forgiving Spanish voters/ Spain’s recovery boosts labour market ON THIS TOPIC// Global Insight Rajoy follows fish through shark-infested waters/ Catalan leader to sign decree calling independence referendum/ Spain scraps plan to tighten abortion law/ Roula Khalaf Catalan fact and friction IN OPINION// Washington gridlock cannot get any worse/ Jacob Weisberg Washington gridlock/ Philip Bobbitt Data and due process/ Thant Myint-U Economy key for Myanmar Moreover, in the current depressed climate it is easy for Catalan nationalists to cultivate the perception that – although corruption, high public and private debt and unemployment are as endemic as in the rest of Spain – Catalonia can do better on its own. Intelligently, rather than agitating for independence (historically never desired by a majority), nationalists have rallied a large majority of the population around a “right to choose” that is incompatible with the current constitution. Even Catalans who would rather see Catalonia continue to be part of Spain demand the right to vote on their own destiny.

The conflict comes to a head this Sunday in a pseudo-referendum on independence that was ruled illegal by the constitutional court in Madrid on Tuesday. The confrontation is growing increasingly dangerous as it is plagued by mutual misunderstandings about beliefs, bargaining power and threats. Radical Catalan nationalists believe pressure from the debt markets and global public opinion will make Madrid yield. They ignore the fact that for many in Spain the integrity of the constitution and of the country is an existential (not an economic) question. Rather than a negotiated settlement, the Spanish government is relying on two things. The first is perceived contradictions between moderate and more radical Catalan separatists. The second is the rule of law according to the constitution. To make things worse, the economic crisis and the political scandals mean leaders on both sides are too weak to negotiate. Regardless of the outcome of the referendum clash, the war of attrition will continue beyond November 9. As in the global war of attrition that began 100 years ago, the first world war, each side thinks optimistically that the only possible outcome is victory for its cause. And, as in the Great War, the only outcome outsiders can envision is one where both players lose heavily. Wars of attrition are long and costly, not for psychological reasons alone (both players hate to lose face) but also because at each step the costs incurred are irrecoverable and the incremental cost of holding out for a bit longer are relatively small. The spirit of disgust with the current system that fuels the Catalan independence movement is also inflicting a shock on the political system nationwide. Podemos, a party created by a few professors only nine months ago, is now the most popular grouping in the country, the choice of fed-up Spaniards across the entire spectrum wishing to punish corrupt politicians. Sadly for the nation, Podemos is not a reformist group nor a disorganised, festive, progressive collective in the image of Italy’s Five Star Movement, but a revolutionary party, tightly led by a compact cadre of tough, smart, pragmatic intellectuals in the best (or worst) Leninist tradition, hardened through their work as advisers to Hugo Chávez, Evo Morales and other Latin American socialists. Since Prime Minister Mariano Rajoy was directly responsible for every appointment in the highly centralised Popular party, dealing with Spain’s twin political challenges is impossible while he remains in place. Soraya Sáenz de Santamaría, his deputy prime minister, is professional, well regarded and appears untainted by corruption. With her in charge of the party and the government, a reform of the Spanish constitution and judiciary process can be agreed by the main parties with the aim of tackling corruption, introducing much-needed accountability and openness into the patronage-based party system and transforming Spain into a multinational state with increasing recognition for Catalan (and Basque) identity. It is Mr Rajoy’s duty to fall on his sword to allow Spain to defuse these existential challenges. // The writer is professor of economics and strategy at LSE and author of ‘El Dilema de España’ http://www.ft.com/intl/cms/s/0/e2362e6a-64e5-11e4-ab2d- 00144feabdc0.html#axzz3IHL81cjm

Proyecto Europeo// Impacto Social// Nueva Política// Reforma Constitucional//Quiénes somos El nuevo votante de Podemos y sus circunstancias

Pau Marí-Klose 06/11/2014 - 07:16h Los nuevos datos publicados por el CIS indican que Podemos está consolidando sus apoyos sociológicos. Además, está avanzando en segmentos progresistas centrales del electorado más proclives a votar críticamente en función del clima político del momento. Está por ver si estos grupos mantendrán la lealtad a 28

Podemos si mejora la situación económica, o si el PSOE es capaz de articular una oferta atractiva capaz de recuperar el electorado perdido. Tras la encuestas de la última semana a nadie le queda duda ya que Podemos ha venido para quedarse. El avance de resultados publicado ayer por el CIS confirma con pequeños matices el empuje de esta fuerza Política avanzado por la encuesta de Metroscopia para El País, aunque las pócimas secretas de la cocina del CIS y de Metroscopia nos situen las estimaciones de voto en niveles bastante distintos (27,7% y 22,5%). Podemos acredita su avance en el indicador de intención directa de voto, el punto de partida de cualquier buena estimación, que salta de 11,9% en julio a 17,6% en octubre. Antes del dato de julio, habíamos tenido elecciones el 25 de mayo, que representan el momento de la irrupción de Podemos en escena. Con motivo de esas elecciones, Agenda Pública sacó un análisis de urgencia radiografiando socialmente los apoyos a Podemos en base al recuerdo de voto declarado en la encuesta postelectoral del CIS. A continuación ponemos al día ese análisis.

Lo primero que destacamos en ese primer análisis es que, en contraste con la ideas que se había extendido en los primeros momentos, Podemos no era un partido que recabara apoyos solo en las clases más desfavorecidas de la sociedad. Podemos no debía ser catalogado como un partido de clase al uso que se nutría de sectores castigados por la crisis. Esa primera idea se afianza en el barómetro de octubre. Podemos se convierte en la primera fuerza política de la clase alta y media alta, con 8,6 puntos de intención de voto probable más que el PP (23,2% y 14,6% respectivamente). La composición de esta clase social es el resultado de agrupar bajo una misma categoría condiciones sociolaborales distintas, desde empresarios y altos funcionarios a profesionales técnicos. En el otro extremo, Podemos avanza entre obreros cualificados (19,8% ahora, 11,9% en recuerdo de voto en mayo), pero apenas logra hacerlo en obreros no cualificados, donde el PSOE sigue manteniendo su principal nicho de apoyos En esta línea, Podemos se configura como el partido de los segmentos más bien formados del electorado, tanto entre la población con estudios postobligatorios como superiores. En cambio tiene muy baja penetración en los grupos con menor nivel de estudios. 29

Respecto a mayo, Podemos también se reafirma como el partido preferido por los más jóvenes. Pero ahora se refuerza su condición de partido de partido hegemónico en edades intermedias (desde los 35 a los 55). Aunque tiene un apoyo escasísimo entre mayores de 65 años, sí experimenta un ascenso considerable entre personas de 55 a 65 años (del 9,2% al 18%). Frente a Podemos, PP y PSOE mantienen inabordables para Podemos a los votantes de más de 65 años.

A diferencia de mayo, Podemos ya no es un partido que cosecha sus votos primordialmente en municipios de más de 50.000 habitantes. El barómetro de octubre permite vislumbrar avances significativos en municipios más pequeños, aunque pueda existir una asignatura pendiente en los pueblos de menor tamaño.

El mayor damnificado del ascenso Podemos es IU, que pierde el 45,6% de sus votantes de 2011, acentuándose claramente las fugas ya considerables observadas en las elecciones de mayo (26%). El PSOE pierde el 24,7% de sus antiguos votantes, algo más que en mayo (16,1%). Y, aparentemente (y con las debidas cautelas a que obliga la muestra), Podemos pesca cada vez más votos entre antiguos votantes UPD (27%). En cambio, apenas existe evidencia de trasvases de antiguos votantes del PP a Podemos. El panorama que dibujan estos cambios apunta a una consolidación de los apoyos sociológicos de Podemos, acompañado de un avance sustancial en segmentos progresistas centrales del electorado, más proclives a votar críticamente en función del clima político del momento. Está por ver si estos grupos mantendrán la lealtad a Podemos si mejora la coyuntura económica, y el PSOE (que compite claramente en su mismo espacio sociológico e ideológico) es capaz de articular una oferta atractiva que le permita recuperar parte un electorado progresista e ilustrado todavía enfurecido con los últimos años de gobierno de Zapatero y el bienio perdido de Rubalcaba. Si eso no ocurre, Podemos podrá. http://www.eldiario.es/agendapublica/nueva-politica/nuevo-votante-Podemos- circunstancias_0_321617879.html

España BAROMÉTRO DEL CIS » Podemos se mantiene como tercera fuerza política, según el CIS La formación de Pablo Iglesias se alza en el primer puesto en intención directa de voto DESCARGABLE Barómetro del CIS del mes de octubre ANABEL DÍEZ MADRID 5 NOV 2014 - 12:43 CET1987

GRÁFICO Podemos se mantiene como tercera fuerza política por detrás del PP y del PSOE, según la encuesta de intención de voto realizada por el Centro de Investigaciones Sociológicas (CIS). La encuesta desvela que el PP obtendría un 27,5%, el PSOE un 23,9% y Podemos alcanzaría el 22,5%. Estas cifras desvelan un descenso de más de dos puntos del PP y un ascenso del PSOE de 2,7 puntos, en el que ha sido el primer examen de

Pedro Sánchez desde que fue elegido secretario general de los socialistas. Además, la distancia entre ambos partidos se reduce de los 8,8 puntos de julio a los 3,6 actuales. Sin embargo, la formación de Pablo Iglesias se alza con el primer puesto en voto directo, ya que obtendría un 17,6% de los sufragios, a 5,9 puntos del PP (11,7%) y a una distancia más corta del PSOE (14,3%), que se quedaría a 3,3 puntos de Podemos.

MÁS INFORMACIÓN// Encuesta Metroscopia: Podemos supera a PSOE y PP y rompe el tablero electoral/ Podemos recibe “con mucho cuidado” los resultados de la encuesta/ Podemos: el gigante de cien cabezas coge impulso/ La mejor nota de un ministro: 2,90/ Escenario insólito por el profundo malestar ciudadano/ Podemos, siete momentos clave / Cinco meses de ascenso impulsado por la indignación, por F. MANETTO La diferencia entre el voto directo y la estimación de voto estriba en que mientras que las cifras del primero tienen en cuenta la respuesta espontánea del encuestado, la de estimación de voto refleja un porcentaje estadístico, elaborado, teniendo en cuenta diferentes variables. Nunca un partido con ocho meses de vida había conseguido un ascenso similar. Podemos ya consiguió un resultado espectacular en las elecciones europeas de mayo y ahora consolida su despegue a siete meses de las autonómicas y municipales (a las que no se presenta con marca propia) y a un año de las generales. El CIS pregunta también por fidelidad de voto. El PP es el partido que aglutina un mayor porcentaje de personas que "con toda seguridad, no le votaría nunca", seguido de UPyD. Entre los que han contestado "con toda seguridad, le votaría siempre" destaca Podemos y ERC entrelos encuestados en Cataluña. En el anterior barómetro con estimación de voto —elaborado en julio—, Podemos irrumpió como tercera fuerza política y como segunda en intención directa, adelantando ya al PSOE y quedándose a menos de un punto del PP. En la fecha en la que se hizo la consulta, a 2.500 personas, del 1 al 13 de octubre, aún no se había producido la redada contra dirigentes del PP y empresarios, que se produjo la última semana de octubre, pero sí había salido a la luz la utilización opaca de tarjetas, a espaldas de Hacienda, de consejeros y directivos de Bankia. Además, la crisis del ébola, estaba en pleno apogeo. El paro sigue siendo la primera preocupación para el 52,5% de los encuestados, seguido de la corrupción, que lo es en primer lugar para el 16,4% y los políticos y la política, en tercera posición, para el 8,7%. Tan solo hace tres meses el PP estaba en primer lugar con una intención de voto del 12,8%, que se convertía en el 30% una vez hecha “la cocina”, es decir, la propia estimación del CIS, con todos los ingredientes que introducen los investigadores para tratar de aproximarse lo más posible a la realidad de lo que podría ocurrir. Le seguía el PSOE con el 10,6% y un 21,2% en estimación del CIS. Podemos estaba en el tercer lugar con un 11,9 y un 15,3% después de las ponderaciones. IU – ICV, estaba en un 8,2% y UPyD en un 5,9.

La encuesta del CIS no difiere en el resultado de intención de voto directo de la realizada por Metroscopia y publicada el domingo por EL PAÍS, que señalaba al partido de Iglesias como la que podría ser la lista más votada, con un 27% de los sufragios. En este sondeo Podemos sacaría 1,5 puntos al PSOE y 7 al PP, que se hundiría hasta caer al 20,7% de resultado estimado sobre voto válido. http://politica.elpais.com/politica/2014/11/05/actualidad/1415183511_675346.html

España BARÓMETRO DEL CIS » Ningún ministro logra el aprobado La máxima nota es el 2,90 de la vicepresidenta Soraya Sáenz de Santamaría Podemos se mantiene como tercera fuerza, según el CIS EL PAÍS MADRID 5 NOV 2014 - 13:23 CET22

La encuesta del Centro de Investigaciones Sociológicas (CIS) evalúa, como otros meses, la valoración de los miembros del Gobierno. En esta ocasión, ni uno de los integrantes del Ejecutivo de Mariano Rajoy logra el aprobado. La máxima nota es el 2,90 que obtiene la vicepresidenta Soraya Sáenz de Santamaría, a la que sigue el ministro de Exteriores, José Manuel García Margallo, con un 2,73, y la de Fomento, Ana Pastor, con un 2,54. Entre los peor valorados, el responsable de Educación, José Ignacio Wert, que se queda en un 1,47, el nuevo titular de Justicia, Rafael Catalá, que obtiene un 1,54 y la ministra de Sanidad, Ana Mato que se queda con una valoración de 1,78 tras la crisis del ébola. El CIS pregunta además por líderes políticos con representación en el Congreso. Tampoco hay ni un solo aprobado aunque la portavoz que más se acerca al cinco es la

representante de Geroa Bai, Uxue Barkos, que ha alcanzado un 4,12. Entre las fuerzas mayoritarias, Mariano Rajoy se queda con un 2,31; Pedro Sánchez con un 3,85; y Cayo Lara con un 3,48. En esta valoración no hay ningún miembro de Podemos puesto que no tienen representación en el Parlamento. En la valoración sobre la gestión del Gobierno, una mayoría de los encuestados, el 41,2%, la califica de "muy mala". La nota mejora solo un poco para el PSOE cuya gestión, según el 37,8% de los encuestados, es "mala". HTTP://POLITICA.ELPAIS.COM/POLITICA/2014/11/05/ACTUALIDAD/14151 90201_134091.HTML

España ANÁLISIS Escenario insólito por el profundo malestar ciudadano PP, PSOE y Podemos se reparten tres cuartas partes del voto La "cocina" del CIS matiza la voluntad de castigo a las grandes opciones El CIS sitúa a Podemos como tercera fuerza política tras PP y PSOE FERNANDO GAREA 5 NOV 2014 - 13:37 CET45 Nunca antes tres fuerzas políticas se habían repartido casi de forma similar las tres cuartas partes de la estimación de voto. Esa circunstancia es la que hace visible el cambio evidente en el tablero electoral, fundamentalmente como consecuencia de los escándalos y el deterioro de los partidos tradicionales. El tablero cede porque más del 80% de los encuestados por el CIS ve mala o muy mala la situación política, mientras que los españoles no perciben la mejora económica que proclama el Gobierno. Podemos recoge ese malestar y el consiguiente deterioro de la política tradicional.

El barómetro del CIS y la encuesta del domingo de Metroscopia para EL PAÍS coinciden y dejan claro que PP, PSOE y Podemos se pueden repartir cada uno el 25% aproximado de los votos y, a partir de ahí, hay matices por la metodología, la ponderación de recuerdo de voto o de simpatía, el margen de error o la coyuntura que puede hacer que uno de ellos suba al 27% y que otro quede en el 22%.

MÁS INFORMACIÓN// Podemos, siete momentos clave/ Nueve claves de un CIS que refleja el malestar ciudadano/ Escenario insólito por el profundo malestar ciudadano Lo importante, por tanto, no es si Podemos gana, sino si tiene opciones de ganar. Lo espectacular es si puede competir con PP y PSOE y eso es un cambio impensable hace un año, porque nunca había pasado nada parecido. En las encuestas es más cierto y veraz el "trazo grueso" o la tendencia que el porcentaje exacto. Otro 25% queda para otras opciones como IU, UPyD, nacionalistas o grupos minoritarios, según todas las encuestas. En todo caso, el bipartidismo se confirma como hundido porque hasta ahora el PP y el PSOE sumaban como mínimo el 70% de los votos en todas las elecciones o en la estimación en las encuestas. Ahora, a duras penas llegan los dos al 50%, aunque el PSOE suba respecto al mes de julio. La conclusión global es que cualquiera de los tres partidos está en condiciones de ganar, o lo que es lo mismo, Podemos, solo ocho meses después de su nacimiento tienen posibilidades de ser la primera fuerza política. Para ello tiene que mantener la tensión hasta las elecciones y el PP y PSOE tienen que continuar en su tendencia a la baja, sin reaccionar al deterioro. O la segunda que ya sería un salto sustancial, o la tercera con un porcentaje que nunca ha alcanzado el tercer partido en unas generales. Hay una variable fundamental y es que el trabajo de campo del CIS se hizo entre el 1 y el 13 de octubre, es decir, cuando ya había estallado el escándalo de las tarjetas negras de Caja Madrid, pero antes de la operación Púnica y la explosión de otros casos de corrupción. Por el contrario, el sondeo de Metroscopia es posterior y sí medía esas variables que afectan al voto de Podemos y que hunde a PP y PSOE. Esa variable temporal es muy importante, porque según la breve serie histórica de encuestas con Podemos las circunstancias políticas son fundamentales para su ascenso, especialmente la percepción ciudadana sobre los escándalos. Podemos empezó en las europeas con el 7,97% de los votos y ahora según el CIS está en el 22,5% en estimación de voto según el CIS y el 27,7% según Metroscopia. La distancia con PP y PSOE se invierte si se tienen en cuenta el voto directo, es decir, la respuesta espontánea sin cocina. Normalmente, la intención directa es menos significativa, pero en este caso sí lo es porque no hay posibilidad de ponderar variables como el recuerdo de voto que no existe en el caso de Podemos. El PP tiene un voto directo de solo el 11,7% que se convierte en una estimación del 27,5%, porque el CIS pondera de forma muy significativa y quizás elevada o desproporcionada su recuerdo de voto. La cocina que debe tener toda encuesta es arriesgada en este caso. En este momento, según detectó Metroscopia, un porcentaje cercano al 20% de votantes del PP está molesto, desmovilizado y apuntado a la abstención y eso hunde el voto directo al partido de Mariano Rajoy. Sin embargo, el CIS pondera el recuerdo de voto y lo incorpora a la estimación para llevarlo al 27,5%. Porque incluso en voto más simpatía gana Podemos con el 19%, el PSOE es segundo con el 18% y el PP tercero con el 14%. Es decir, de nuevo el orden de los tres cambia según las variables, con opciones para que gane cualquiera de ellos.

En esa desmovilización del electorado del PP opera a la inversa que en Podemos el factor del hartazgo por los escándalos. Desde que apareció el partido de Pablo Iglesias hasta ahora se ha manifestado un ascenso notable en los sondeos, especialmente los del CIS, de la preocupación ciudadana por la corrupción. Es el principal problema para el 42% de los españoles, en coherencia con el resultado en castigo a los principales partidos. No hay correspondencia, en cambio, entre el optimismo del Gobierno por la recuperación económica y la estimación de voto al PP. En este sondeo, por ejemplo, el 45,3% ve igual la situación económica, mientras que el 96,6% ve la situación política igual o peor que hace un año. Es decir, en todas "las tripas" del sondeo subyace el malestar social que da a tres fuerzas políticas distintas la posibilidad de ganar las elecciones y fragmenta el mapa político. IU y UPyD eran antes opciones refugio y ahora parecen quedarse cortas para el electorado molesto. Otra muestra de ese malestar ciudadano reconducido hacia Podemos es que esta formación recoge votos de la abstención según el CIS, mientras que es el PP el que fundamentalmente nutre el porcentaje de ciudadanos dispuestos a dar la espalda a las urnas. http://politica.elpais.com/politica/2014/11/05/actualidad/1415189914_023465.html

España

EL ASCENSO DE PODEMOS » Podemos cree que “hay posibilidad de cambio pero queda mucho camino” El PP destaca que seguiría siendo el partido más votado, según el CIS El CIS sitúa a Podemos como tercera fuerza política tras PP y PSOE FRANCESCO MANETTO MADRID 5 NOV 2014 - 15:20 CET3 Podemos ha recibido con prudencia los datos del barómetro del Centro de Investigaciones Sociológicas que le sitúan como tercera fuerza en estimación de voto, mientras el análisis del PP, primer partido, destaca que seguiría siendo el partido más votado. Los socialistas aseguran que no se conforman con situarse como segunda fuerza e Izquierda Unida toma nota de los resultados. La formación de Pablo Iglesias, que logra la primera posición en intención directa de voto, considera que la encuesta confirma la tendencia de los últimos meses, que refleja "un gran desgaste del PP y el crecimiento de Podemos". Esta circunstancia confirma, en palabras de Íñigo Errejón, que "hay posibilidad de cambio político en España", aunque a ese cambio "le queda todavía mucho camino y mucho trabajo". El partido valora "con humildad" esos datos, aunque Errejón destaca "la situación política y económica que dibujan". Los encuestados creen que dentro de un año el escenario empeorará, lo que demostraría que "la gente no se cree el relato de que estamos saliendo de la crisis y el relato de la regeneración". Una situación, en su opinión, que más allá de "la carrera de caballos", deja patente el "profundo hartazgo" de la sociedad.

El PP, primera fuerza en estimación de voto, resalta en cambio los aspectos positivos. El vicesecretario de Organización y Electoral, Carlos Floriano, señala que “el Partido Popular seguiría siendo el partido más votado”, lo que según la dirección nacional supone un respaldo mayoritario al proyecto político de Mariano Rajoy. Floriano, al igual que la mayoría de los dirigentes populares, está convencido de que antes de las elecciones lograrán movilizar a sus votantes habituales. "Habrá más españoles dispuestos a apostar por la estabilidad que proporciona el PP, frente a determinados experimentos que pueden ser apoyados en una encuestas pero que, seguramente, no vayan a serlo en el momento en que depositen su voto", manifiesta el partido a través de un comunicado. “Con trabajo, rigor y transparencia, nuestro objetivo en este final de legislatura irá encaminado a recuperar la confianza de esos ciudadanos que ahora no nos apoyan", ha afirmado Floriano. El secretario general del PSOE, Pedro Sánchez, ha asegurado por su parte que no se conforma con el sondeo que avala su liderazgo ni con la segunda posición que logra su partido en estimación de voto. Sánchez considera "insuficiente" el crecimiento que le otorga el CIS, puesto que su objetivo es "salir a ganar las elecciones", informa EP. http://politica.elpais.com/politica/2014/11/05/actualidad/1415197252_298108.html

España PODEMOS EN BARÓMETRO DEL CIS » Las nueve claves de un CIS que refleja el malestar ciudadano Rajoy es el político peor valorado El barómetro no pregunta por Pablo Iglesias El CIS sitúa a Podemos como tercera fuerza política tras PP y PSOE EL PAÍS MADRID 5 NOV 2014 - 15:29 CET32 El Centro de Investigaciones Sociológicas (CIS) ha presentado este miércoles el Barómetro de Opinión del mes de octubre, un estudio de 2.480 entrevistas personales realizadas en 239 municipios de 50 provincias, que incluye intención de voto y cuyas entrevistas se realizaron a principios del mes de octubre, en pleno escándalo de las tarjetas opacas de Caja Madrid y en los primeros días de la crisis del ébola en España. Estos son los nueve aspectos clave de la encuesta: 1. ¿Quién ganaría hoy las Elecciones Generales? El PP ganaría las elecciones generales si se celebraran hoy con el 27,5 % de los votos, seguido del PSOE con un 23,9, mientras que Podemos sube con fuerza en el tercer puesto con un 22,5, aunque es el partido con más apoyos (17,6%) en intención directa de voto—la respuesta inmediata que los encuestados dan a la pregunta—. Lea aquí la diferencia entre intención de voto directo y estimación de voto. 2. Ningún ministro aprueba y la nota más alta es un 2,90

La vicepresidenta del Gobierno, Soraya Sáenz de Santamaría, vuelve a ser el miembro del Ejecutivo más valorado por los ciudadanos, 2,90, en un ránking en el que el titular de Educación, José Ignacio Wert, 1,47, repite con la peor nota y en el que no aprueba ningún ministro. La ministra de Sanidad, Ana Mato, está en décimo primer lugar, con 1,78 puntos— esta encuesta se elaboró en plena crisis del ébola—.

Asamblea Ciudadana de Podemos. Juan Carlos Monedero y Pablo Iglesias / Claudio Alvarez (EL PAÍS) 3. Principales problemas para los españoles: El paro y la corrupción La corrupción sigue siendo el segundo problema para los españoles después del paro. El sondeo apenas refleja variaciones respecto al del mes anterior y muestra un leve aumento de la preocupación por el paro, mencionado por el 76 % de los ciudadanos, siete décimas más que en la encuesta de septiembre. 4. Rajoy inspira poca o ninguna confianza para el 86,1% de los encuestados La pérdida de confianza del presidente del Gobierno, Mariano Rajoy (PP), continúa a la baja. Un 86,6% dice tener "poca" o "ninguna" confianza en el presidente del Gobierno frente al 67,8 que manifiesta lo mismo por el nuevo líder Pedro Sánchez, que se estrena en la encuesta. 5. Rajoy es el político peor valorado por los ciudadanos, Uxue Barkos la mejor y el CIS no pregunta por Pablo Iglesias. La diputada Uxue Barkos (Nafarroa Bai) es la política mejor puntuada por los ciudadanos con un 4,12. En segundo lugar se sitúa el nuevo lider socialista, Pedro Sánchez con una nota de 3,85 mientras que Rajoy es el peor con 2,31. Tras Barkos y Sánchez los líderes que reciben mejor calificación son el portavoz de ERC, Alfred Bosch, con 3,75; la líder de UPyD, Rosa Díez (3,63), y el líder de Izquierda Unida, Cayo Lara (3,48). El Barómetro del CIS no ha preguntado por Pablo Iglesias, cabeza visible de Podemos.

5. La situación económica para las familias españoles en 2015 será igual o peor que en 2014 para el 75,4% Para el 27,3 de los encuestados su situación económica en 2015 será peor que en 2014. Casi la mitad (48,2%) cree que será igual. Solo el 11,6% cree el año que viene será mejor que este. 7. Para los parados: ¿Cree probable que en los próximos 12 meses encontrará empleo? El CIS también ha preguntado exclusivamente a los parados. Para el 37,9% es poco probable encontrar trabajo en los próximos doce meses y el 19,7 lo ve nada probable. Sin embargo, el 26,7% ve bastante probable encontrar un empleo en 2015 y el 6,6% cree que es muy probable. . 8. El 61% casi nunca acude a misa u otros oficios religiosos. A la pregunta ¿con qué frecuencia asiste usted a misa u otros oficios religiosos, sin contar las ocasiones relacionadas con ceremonias tipo social, por ejemplo, comuniones o funerales? El 61% responde que casi nunca acude a misa, el 13,9% varias veces al año, el 10,1 alguna vez al mes, el 12,% casi todos los domingos y festivos y solo el 1,9% varias veces a la semana. 9. El independentismo llega al 11,5%, récord de la serie histórica El sondeo afirma que los partidarios de que el Estado reconozca a las comunidades la opción de la independencia pasa del 11,1 % de septiembre al 11,5 % de octubre. Por contra, los partidarios de un Estado con un único Gobierno central sin autonomías descienden del 19,5 % al 18,7 % y quienes prefieren que el modelo territorial se mantenga como está aumentan al 36,1%, por un 33,5 % del mes anterior. Los favorables a que las comunidades autónomas tengan más autonomía de la que disfrutan ahora son el 13,3 % de los españoles, cinco décimas más que en la última encuesta. El 52,1 % de los consultados se siente tan español como de su comunidad autónoma, el 17,7 % se considera únicamente español —1,2 puntos más que en septiembre— y el 8,5 % sólo de su comunidad autónoma —un punto más que el mes anterior—. http://politica.elpais.com/politica/2014/11/05/actualidad/1415193285_936500.html

España ENCUESTA CIS » Podemos, última hora La formación de Pablo Iglesias se mantiene como tercera fuerza, según el CIS EL PAÍS MADRID 5 NOV 2014 - 19:20 CET

Pablo Iglesias en la asamblea de Podemos. / LUIS SEVILLANO El barómetro de opinión del CIS sobre el mes de octubre publicado hoy mide, entre otras cuestiones, el ascenso de Podemos, que se convierte en la tercera fuerza política del país. Un resultado muy esperado tras conocer los datos de la encuesta de Metroscopia publicada el domingo por EL PAÍS que le situaba como la primera fuerza. En ese momento, la formación liderada por Pablo Iglesias recibió los resultados con prudencia y consideró que reflejaban la sensación de que “lo viejo no va a dar más de sí”. Los datos del CIS se recogieron en pleno escándalo de las tarjetas opacas de Caja Madrid y en los primeros días de la crisis del ébola en España.

Caerán todos: Podemos celebra con este vídeo los resultados del CIS Tan solo un par de horas después de que se conociera el resultado del barómetro, la formación política ha publicado un vídeo con un 'sutil' titular

Podemos, siete momentos clave La formación de Pablo Iglesias, desde su creación hasta los últimos datos del CIS

“Este CIS tiene mucho dato oculto del PP” El periodista de EL PAÍS Joaquín Prieto cree que el PP tiene muy dificil remontar el vuelo y que el PSOE está en un "veremos", con Podemos mordiendo parte de su electorado

Podemos: “Hay posibilidad de cambio pero queda mucho” El PP destaca que seguiría siendo el partido más votado y Sánchez no se conforma con la segunda posición

Cinco meses de ascenso impulsado por la indignación ciudadana Podemos se afianza en un escenario de crisis del bipartidismo y de las instituciones

Pablo Iglesias, del ajedrez a la batalla política El líder de Podemos se propone medirse con Rajoy y Sánchez tras 10 meses en el tablero

Podemos se mantiene como tercera fuerza, según el CIS La formación de Pablo Iglesias se alza en el primer puesto en intención directa de voto

Escenario insólito por el profundo malestar ciudadano El barómetro del CIS deja claro que PP, PSOE y Podemos se pueden repartir cada uno el 25% aproximado de los votos Consulte toda la información sobre la fomación Desde su nacimiento hasta su ascenso en las encuestas electorales, todas las noticias publicadas en EL PAÍS http://politica.elpais.com/politica/2014/11/05/actualidad/1415177358_757539.html?rel= rosEP

España Sánchez acusa a Rajoy y la cúpula del PP de convivir con la corrupción El líder del PSOE pide la dimisión de la ministra Mato por el brote de ébola y dice que los populares han de regenerarse en la oposición Un retraso ferroviario altera los actos de Pedro Sánchez en Valencia ADOLF BELTRAN VALENCIA 5 NOV 2014 - 15:15 CET1

Pedro Sánchez y Ximo Puig, este miércoles en Valencia. / Mònica Torres No solo no habrá pacto bilateral entre el PSOE y el PP para la regeneración democrática, sino que el líder de los socialistas, Pedro Sánchez, ha pasado a exigir que asuman sus reponsabilidades sobre la corrupción el presidente del Gobierno, Mariano Rajoy, y la dirección del PP. "Estoy convencido de que la mayoría de los militantes del PP son gente honrada. Sus votantes viven escandalizados e indignados lo que están viendo", ha dicho el secretario general del PSOE, que ha reunido a su ejecutiva en Valencia para aprobar una declaración sobre la regeneración democrática. "El problema son sus dirigentes, una cúpula que ha convivido con la financiación irregular y con la corrupción durante años". Sánchez ha personalizado en Rajoy la crítica de que los dirigentes del PP no han asumido ninguna responsabilidad, ha añadido que es necesario que ese partido se regenere y ha concluido: "Donde tiene que regenerarse es en la oposición". "El cambio se hace andando", ha apuntado el líder socialista, que ha añadido que "Rajoy lleva demasiado tiempo inmóvil". "Cree que los problemas se solucionan dándoles la 43

espalda", ha continuado sus reproches al presidente del Gobierno, y se ha referido a la "grave fractura social" que puede producirse en Cataluña. De la situación creada con la convocatoria de consulta del próximo 9 de noviembre ha responsabilizado a "la impotencia del señor Mas y del señor Rajoy". Ante la salida del hospital de la ayudante de enfermería contagiada de Ébola, Sánchez ha mandado "un abrazo a Teresa Romero y su familia", ha felicitado a los profesionales sanitarios que la han atendido, pese a los efectos del desmantelamiento de la sanidad pública, y ha anunciado que pedirá la comparecencia del presidente del Gobierno en el Congreso para explicar la gestión de la crisis. "Es la hora de las responsabilidades", ha asegurado, para añadir que la primera de esas responsabilidades implica "la dimisión de la ministra Mato". De esta manera, una vez acabada la crisis por el contagio, durante la cual se negó a hacerlo, el líder del PSOE pide que dimita la ministra de Sanidad. Acompañado poro el secretario general de los socialistas valencianos, Ximo Puig, el líder del PSOE ha comentado los resultados de la encuesta del CIS para explicar que revela cómo el PP cae y "experimenta un deterioro muy fuerte", cómo incrementa su fuerza Podemos y cómo su partido "ha frenado el golpe, la sangría de votos, para empezar a recuperar apoyos". Sin embargo, Sánchez ha advertido: "No me conformo. Somos la primera alternativa al PP y lo vamos a demostrar".. En relación con la atribución al Supremo de la investigación del caso de los ERE en Andalucía, que afecta a su partido, se ha declarado respetuoso con la justicia y ha anunciando que, en función de lo que vaya deparando la instrucción, "el PSOE va actuar de manera implacable, con la máxima contundencia y celeridad". El líder socialista ha tenido un accidentado viaje a Valencia, dado que ha perdido el AVE, a causa de un retraso por problemas de tráfico y el tren Alvia que ha cogido a continuación ha sufrido una avería. La llamada Declaración de Valencia que ha aprobado la ejecutiva federal incluye, como ha explicado Ximo Puig, "una parte de principios" y otra de medidas que los socialistas llevarán al Congreso y abordarán con agentes sociales y fuerzas políticas. Sánchez ha destacado entre esas medidas la reducción de 120.000 euros a 50.000 del límite para que se considere que una defraudación es delito fiscal y la propuesta de que la Agencia Tributaria certifique que los cargos públicos están al corriente en sus obligaciones y haga pública su evolución patrimonial. Esta última iniciativa plantea que pueda sancionarse hasta con tres veces el incremento de patrimonio que no pueda ser justificado. http://ccaa.elpais.com/ccaa/2014/11/05/valencia/1415196943_799818.html

Stumbling and Mumbling An extremist, not a fanatic Chris Dillow: November 04, 2014 Stagnation: noise vs signal A commenter on my previous post invites me to bet on the idea that economic growth is slowing. I'm going to decline the offer. This isn't (just) because I'm an empty blowhard: I was only raising the possibility of slower growth. Nor is it just because I'm risk- averse: in being scarred by memories of the early 80s recession, I am one of Malmendier and Nagel's Depression Babies (pdf). Instead, I reject the bet because facts might not suffice to prove or disprove the secular stagnation hypothesis. Even over a period as long as ten years - to take Matt's suggested time period - average GDP growth will be due in part to luck as well as to fundamental forces. For example, if a recession hits us in 2025, growth will look much better over the next ten years than it would if the recession comes in 2024. We can quantify this luck by measuring the standard error, which (under some assumptions) is simply the standard deviation divided by the square root of the number of years in our sample. The idea here is that if growth is very volatile then observed average growth over a period is more likely to be due to good or bad luck than it would be if growth were more stable. So, let's say that GDP grows by an average of 1.5% a year over the next ten years, with a standard deviation of GDP 2.2 percentage points, its volatility since 1973. What would this tell us? One possibility is that growth has been lower than the 2% per cent per year we saw between 1973 and 2013. This would be evidence for secular stagnation. But once we consider the standard error, things get complicated. Over a ten year period, the standard error is 0.7 percentage points. Our 1.5% growth might therefore mean simply that true growth was the same between 2014 and 2024 as it was between 1973 and 2013 and that we got unlucky, in drawing more bad years than good out of the hat. Or it might mean that there really has been secular stagnation and the growth rate has halved*. We can't tell for sure. Such is the volatility of growth that even over longish periods there's lots of noise relative to signal. This problem is actually even greater if we consider equity returns rather than GDP; a standard deviation of 20 percentage points makes it almost impossible to measure true returns even over long periods.

This doesn't mean the secular stagnation hypothesis is unfalsifiable; if growth averages (say) 3% per year or more over the next ten years, we can be fairly confident it was wrong. My point is simply that facts often don't tell us much. My point here isn't merely a statistical one, but a political one. When John Landon-Lane and Peter Robertson argued that national government policies couldn't alter long-run growth, they were relying upon this reasoning; the standard error around growth estimates is so big that it's quite possible that most developed economies grow at much the same rate, implying that (except in a very few cases) the effect of national policies is undetectable. Their point generalizes. Once we consider the noise-signal ratio, claims that government policies have made a big difference for good or ill must be accompanied either by very robust theory or by a big dose of scepticism. * Over ten years, a drop in the growth rate from 2% to 1% is a big deal. It's a difference of £229 per month to someone with a monthly income of £2000 now. The fact that such a big difference is hard to detect is therefore troubling. Chris Dillow: http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2014/11/stagnati on-noise-vs-signal.html (4 Nov., 2014)

A Coordinated Fiscal Response to Revive the Euro Area Economy Author: Bernard Delbecque · November 4th, 2014 · The worsening of the economic situation in the euro area raises serious questions about the capacity of policymakers to get the situation under control. Member States have limited room of manoeuvre to implement a counter-cyclical budgetary policy under the Stability and Growth Pact (SGP). The European Central Bank (ECB) is confronted the zero bound interest rate and the political challenge of engaging into an ambitious program of quantitative easing. Structural policies to liberalize the good, services and labor markets are unlikely to accelerate economic growth in the short term. A limited fiscal capacity for the euro area The challenge would be less severe if the euro area had a fiscal capacity to adjust to economic shocks. However, there is very limited appetite among member states to create a European fiscal union. In the name of realism, a growing number of economists are trying to develop mild forms of common fiscal policy mechanism that could improve the functioning of the euro area (see in particular Wolff 2012 and IMF 2013). One example of such mechanism is described in Delbecque (2013). Under this proposal, the net contributions to a euro area stabilization fund (ESF) would be based on the country’s position in the economic cycle and the relative size of the economy. Euro-area countries would benefit from a disbursement from the ESF during economic downturns, and they would make a contribution to the ESF when they are in a strong cyclical position. Thanks to payments received from the ESF, a country could take fewer austerity measures in the face of a negative economic shock. Depending on the overall economic situation, the ESF would accumulate reserves if the contributions received from high-growth countries exceed the payments made to low- growth countries. And it would borrow from financial markets during hard economic hard times if the reserves accumulated during times of economic boom are not sufficient to transfer resources to member countries. At the institutional level, the ESF could be managed by the European Stability Mechanism (ESM). An empirical illustration Chart 1 illustrates how the ESF would work using the following equation to calculate each member country’s annual net contributions to the ESF: d = α (y – y*), where d is the net contribution expressed as a percentage of GDP, α = 0.5, (y – y*) is the output gap, i.e. the difference between the output of an economy (y) and its potential output (y*). The output gap data used are from the International Monetary Fund (IMF) World Economic Outlook October 2014 database. We can see how the total net contributions would have varied with the ups and downs of the euro area economy. Overall, all other things equal, the EFS would have

accumulated a total debt of EUR 283 billion or 2.8% of the euro area GDP. It should be recognized, however, that this amount corresponds exactly to the ESF disbursements in 2014-2015. This finding highlights the severity of the current economic downturn, and the need to take action.

The calculated net ESF disbursements for 2015 are shown, by country, in the table below. It can be seen that all countries would benefit from ESF support. Greecewould be the biggest receiver of funds (3.4% of GDP in 2015, or EUR 6.4 billion), whereasGermany,LuxembourgandMaltawould receive the smallest relative amount (less than 0.5% of GDP).

At first glance, the disbursements in favor ofGreeceseem high. However, they have to be compared with the overall evolution of the net contributions ofGreecesince 1999. Overall, all things being equal,Greecewould have been a net contributor to the EFS, for a total amount of EUR 5.4 billion (2.9% of GDP). In contrast,Germanywould have benefited from an overall net contribution of EUR 52 billion (1.8% of GDP). These different outcomes mostly reflect the different average output gaps in 1999-2008, i.e. 0.2% forGermanycompared to 2.3% forGreece. It should be noted, however, that the 48

existence of the ESF would have allowed smoothing both positive and negative shocks, and therefore reduce the size of the net contributions to the ESF. It is also interesting to note the modest size of the ESF disbursements to Germany. This result indicates that the room for manoeuvre to support the euro area’s economy is relatively small when measured against its current output gap. This finding is at odds with the numerous calls for Germanyto increase government spending. These calls refer to the low budgetary deficit ofGermany, which makes it possible to relax its budgetary policy in a significant way without breaching the 3% deficit rule of the SGP. From an output gap perspective, however, Germany has a more limited space to act. It should also be noted that the euro area countries with a rather high negative output gap tend to have no room of manoeuvre because of their budgetary deficits and the rules of the SGP. Indeed, ten of the eleven euro-area countries with a negative output gap greater than 2% are expected to have a budget deficit greater than 2.5% of GDP in 2014; Finland is the only exception, with a budget deficit very close to 2.5% (see Chart 2). These countries represent 64% of the GDP of the euro area. Clearly, if they continue to take austerity measures in 2015, and if the other countries are doing the same thing because their deficit is too close to 3% of GDP (this is the case for Austria, Belgium and Malta) or if they give preference to maintaining a deficit close to zero as is the case for Germany, it is not surprising that real GDP growth in the euro area will be barely above 1% in 2015, in the best case scenario.

The case for action The creation of a mechanism similar to the ESF would create the conditions for stronger growth in Europe. Beyond this general observation, the ESF would have the following advantages: • It would allow keeping the rules of the SGP. The principle of budgetary discipline would remain as a corner stone of the euro area. The member countries which have included the principle of balanced budget in their constitutions could continue to target this objective. The support given by the ESF in adverse economic conditions such as the ones we are experiencing at present would help these countries to achieve their objectives more easily.

• The ESF would give the means to euro area countries to coordinate a coordinated fiscal response to the current economic downturn. This could be implemented without triggering negative movements in the financial markets against some high-debt countries because the ESF disbursement would be funded by ESM borrowing under very favorable financing conditions. • The entry into force of the ESF would not be a free lunch for member countries. They would receive support during difficult economic times in exchange for paying an “insurance premium” when their output gap becomes positive. They would therefore enter into a contractual agreement with other member countries and the ESF, based on shared responsibility and mutual accountability. This framework would ensure that the overall potential increase in the euro area common debt would be capped at a very low level. • In the absence of a mechanism like the ESF, the euro area will have to rely almost entirely on the European Central Bank (ECB) to return to growth. However, the zero-interest bound and the ban on monetary financing of budget deficits reduce very much the scope for further action by the ECB. The ESF would therefore contribute to reduce the pressure on the ECB. • The creation of the ESF would also strengthen the credibility of the commitment made by the new President of the European Commission, Jean-Claude Juncker, to implement a EUR 300 billion investment package to boost growth and employment. Indeed, it could be agreed that the ESF disbursements should be used for the financing of long-term investments. According to recent IMF research, during periods of low growth, a 1 percent of GDP permanent increase in public investment in advanced economies increases output by about 1.5 percent in the same year and by 3 percent in the medium term (see IMF 2014). Public investment increases also bring about a reduction in the public-debt-to- GDP ratio during periods of low growth in countries with high public investment efficiency. Under the proposed mechanism, the reduction in the debt ratios would be all the more significant as the investments would be financed by ESF disbursements.

Unconventional fiscal stimulus against deflation

When the economy is stuck in a liquidity trap, there may be an argument for relying on fiscal policy intervention to avoid any serious threat of deflation. Werning (2012) confirms that there is a role for government spending during a liquidity trap. Following this approach, it could be considered to increase the level of ESF transfers to the countries where the inflation rate would smaller than a certain level. For instance, it could be considered that the transfers could be increased by an amount equal to 0.5 (1.5% – π) when the inflation rate π is less than 1.5%.[1] The chart below compares the total net contributions to the ESF that would result from this approach with those presented in Chart 1. In 2015, the ESF would disburse EUR 151 billion (1.5% of GDP) rather than EUR 122 billion (1.2% of GDP), if the disbursements were linked to both the output gap and the inflation gap. Conclusion The euro area economy can be compared to a car that has come to a standstill. Its tank is full of gas. The problem is with the brakes which prevent the car from moving off. In other words, it is not the fault of monetary policy that the economy is in contraction mode at this juncture. To paraphrase President Clinton, one could say “It’s the fiscal policy, stupid”! There is today a real risk that some passengers will decide to leave the car. The expected general election in Greece in February could be a trigger. Rather than waiting to see whether the ECB be able to do whatever it takes to save Greece and the euro, it would be wise to explore available alternatives to revive growth in the euro area, including through the establishment of a limited fiscal capacity such as the ESF. References Delbecque, B. (2013), “Proposal for a Stabilisation Fund for the EMU”, CEPS Working Document, N°385, October 2013. IMF (2014), “Is it time for an Infrastructure Push? The Macroeconomic Effect of Public Investment”, Chapter 3, IMF World Economic Outlook, October 2014. IMF (2013), “Toward a Fiscal Union for the Euro”, IMF Staff Discussion Note 13/09, September 2013. Werning, I. (2012), “Managing a Liquidity Trap: Monetary and Fiscal Policy”, MIT, March 2012. Wolff, G. (2012), “A Budget for Europe’s Monetary Union”, Bruegel Policy contribution, Issue 2012/22, Bruegel, Brussels, December.

[1] In principle, it could be proposed to implement a symmetric mechanism to collect payments from high inflation countries. However, this would require taking into account the fact that the equilibrium inflation rates in less advanced euro area countries tend to be somewhat higher than 2%. Moreover, it should remain the task of the central bank to preserve inflation stability when inflation is above target.

November 4, 2014 7:24 pm José Manuel Barroso: ‘Not everything I did was right’ Peter Spiegel On his final day, the former European Commission president explains his actions during two terms

Friday broke sunny and warm in Brussels, a rarity for late October in the Belgian capital. But as José Manuel Barroso exited the imposing wrought-iron front gate of his home, a three-storey townhouse in the central Etterbeek neighbourhood, his face was sour. The night before had been the second late one in a row for the outgoing European Commission president, brokering an ultimately successful deal between Kiev and Moscow to ensure gas deliveries would continue to Ukraine this winter, and he appeared tired. Plus, he had awoken with an upset stomach. “Yesterday I did not eat,” he lamented. “I just had those canapés for the Russians, and I don’t know what our people prepare for the Russians.” More ON THIS STORY// Russia and Ukraine reach gas deal/ Brussels seeks compromise in budget row/ Brussels cash Who knew what and when?/ UK ‘irrelevant’ without EU, warns Barroso ON THIS TOPIC// Barroso upbeat as political winds change/ Lunch with the FT José Manuel Barroso IN THE BIG READ// Norway Braced for a new wave of investment/ South Korea Sparks fly over the chaebol/ US politics Eyes on the prize/ Middle East Walled in But it was not just his digestion fouling his mood. As he sat in the back of a black BMW taking him to the commission’s headquarters in the Berlaymont building for the final time, Mr Barroso admitted to experiencing saudade, or melancholic nostalgia. “It’s a mix. On the one side, I’m looking forward to my new life. I think it’s great at 58 to have the ability to restart,” he said, as his driver steered the car into the tunnel that leads to the Berlaymont’s underground parking lot. “At the same time, there is a sadness . . . If I was 10 years younger, I would do it again. This is the kind of job I would pay to do.” The Financial Times was given exclusive access to Mr Barroso during the last day of his 10 years in office, accompanying him as he wound up what is almost certainly the stormiest tenure of any man who has held the job since the “high authority” of the European Coal and Steel Community, as the post was first known, was created more than 60 years ago.

Not only did Mr Barroso head the EU executive through the bloc’s first truly existential crisis – the near break-up of the eurozone – but he also spearheaded the so-called “Eastern Partnership”, the commission’s outreach programme to ex-Soviet republics which has unwittingly sparked the conflict in Ukraine. As a result, any verdict on Mr Barroso’s legacy will have to wait. The EU’s common currency did not collapse under his watch, as so many market analysts had predicted. But it may yet find its future threatened by anti-EU parties of the far left and right that have found continent-wide support in the wake of the crisis. Similarly, the Ukrainian conflict unleashed by then-president Viktor Yanukovich’s eleventh-hour decision to renounce a Barroso-backed EU integration treaty last November has receded into a smouldering ceasefire. But while the uneasy stand-off could see Ukraine land safely into a western embrace, the conflict could just as easily reignite at the instigation of Russian President Vladimir Putin – and even spread, agitating Russian minorities in ex-Soviet republics that are already EU members. “Frankly, for me my conscience is enough. I did my best during these years and this I think even my critics recognise,” Mr Barroso, now seated in an office of empty bookshelves and voids on the wall where Portuguese modern art once hung, says when asked about his legacy. Facing his critics After a decade in office, Mr Barroso’s critics are legion. Many accuse him of acting too cautiously in the face of the eurozone brushfire, of failing to stand up to the big EU member states on critical issues, of naïveté in his outreach to Ukraine. Mr Barroso is fully aware of the criticisms – many of the loudest of which have come from Berlin, where German officials often lost faith in the commission’s ability to manage the eurozone at the height of the crisis – and acknowledged his tenure has not been without its failings. “I’m not going to pretend everything I did was right,” Mr Barroso says. Putin has told me that he would not have an objection in principle regarding membership of Ukraine to the EU - Barroso on Putin’s view of Ukraine-EU ties Tweet this quote But in a series of interviews throughout the day, he vigorously defended his actions during the crisis – he proudly recalled a Berlaymont dinner with chief economists from several banks where all but one predicted a Greek exit from the euro – and ticked off a litany of issues where he locked horns with EU powerhouses: fighting Paris on international trade, Berlin on auto fuel efficiency standards, London on the EU budget. “It’s a very common comment here in Brussels: the time of [François] Mitterrand, [Helmut] Kohl and [Jacques] Delors, that was the golden age. That is a typical optical illusion,” he says, recalling that he sat through EU summits with those leaders as a young Portuguese foreign minister and prime minister. “I can tell you those moments with Kohl, Mitterrand and Delors . . . were not so glorious as people today tend to present.”

His comments defending Brussels’ euro crisis policies have been voiced before, and they sounded scripted. But it was when Mr Barroso was asked about the EU’s talks with Ukraine, which have been portrayed by some in Washington as having recklessly provoked Mr Putin, that he became emotional. “We were perfectly aware of all of the risks,” he said, his voice rising with pique. “I spoke with Putin several times, and he told us how important for him was the customs union, the Eurasian Union, and the specific role he saw for Ukraine. But should we have given up? Should we say, ‘OK, Vladimir, Ukraine is yours, do whatever you want?’ That is the logical consequence of what they are saying. That’s perfectly unacceptable.” His devotion to the emerging democracies of central and eastern Europe – a stance heavily coloured by his own political awakening as a young activist against Portugal’s dictatorship – put Mr Barroso on the wrong side of Mr Putin. A 2009 diplomatic cable from the US embassy in Moscow, made public by WikiLeaks, asserted Mr Barroso even then was viewed by Mr Putin “as the ‘Trojan horse’ of the new EU states, whose message that ‘family is closer than friends’ had worn thin in Moscow”. But unlike Angela Merkel, the German chancellor who reportedly said Mr Putin has become “irrational”, and his own trade commissioner Karel De Gucht, who recently told reporters Mr Putin “is somebody who doesn’t like Europe”, Mr Barroso said Mr Putin understands his country’s future lies to the west and should not be shunned. The show must go on. Why? [Pessimists] underestimate the level of economic interdependence - Barroso on European integration Tweet this quote He has met the Russian president more than two dozen times, and recalls their first meeting: a dinner lasting nearly four hours at Mr Putin’s dacha outside Moscow, in which Mr Putin depicted the EU and Russia as two members of a team of Christian nations facing terrorism from abroad. “One of the first things he said to me was, ‘How many are we,’ and by ‘we’ he meant the Christians,” Mr Barroso said, recalling the conversations that took place as the Kremlin was fighting Muslim separatists in Chechnya. “In terms of identity, Putin presents himself as a Christian, and this is certainly European; it’s not the Muslim world or China . . . [which is] why I cannot agree with those that present him in opposition to Europe.” But Mr Barroso says understanding the Russian leader’s motivations is not the same as accepting them, and argues Mr Putin has moved the goalposts since he reassumed the presidency two years ago. “Putin has changed and Russia has changed,” he said. “They were opposed to Ukraine’s membership in Nato. But Putin has told me several times – so I’m not quoting second hand – that he would not have an objection in principle regarding membership of Ukraine to the EU. Membership!” Mr Barroso is equally confident that what George Osborne, the UK finance minister, once called “the remorseless logic” of the eurozone – that a single currency requires

even more centralisation of economic policy making in Brussels – was still achievable despite rising anti-euro sentiment in core EU countries. Stalled integration Voter backlash and market calm have stalled efforts towards further economic and political integration, a fact even the powerful Ms Merkel learnt the hard way when her push to require binding economic reform contracts for all 18 eurozone governments fell short at an EU summit this spring. But Mr Barroso said he believed that failure was merely another temporary setback that occasionally befalls EU integration, much like the French and Dutch rejections of an EU constitution in 2005 – which was followed by a treaty to overhaul the EU that was almost as ambitious just four years later. The [EU] institutions are much stronger than before. But the peoples, the old prejudices, are still there - Barroso on North-south divisions Tweet this quote “One of the lessons of the crisis is that the forces of integration are stronger than the forces of disintegration,” he insists, arguing that even as voters revolt against Brussels, leaders know they cannot now reverse course – lest they risk a return to the days where markets openly questioned the euro’s existence. “The show must go on. Why? [Pessimists] underestimate the level of economic interdependence and the centripetal forces in political integration.” Still, he had occasional pangs of doubt and disillusionment during three years living on the brink of euro extinction. For a man who once viewed joining the EU as Portugal’s path to an equal seat at the table of free and democratic states after five decades of autocracy, the sniping between the north and south – his home country was a besieged bailout member – disheartened him. “For me, the EU was something of an ideal,” he said, recalling his first visit to Brussels as a law scholar in the 1970s. “During the crisis, I saw some national egoisms and prejudices coming to the forefront, very strongly. That brought me to the conclusion that we have not yet been able to unite the people of Europe.” For Mr Barroso, it is the central paradox of the eurozone crisis. Brussels and Frankfurt have emerged more powerful than ever, signs that integration – what those in Brussels universally refer to as “the European project” – continues unabated. But even as the EU pulls together at the top, on the ground the trend is in the opposite direction. Mr Barroso said he saw leaders exhibiting “petty consideration of only the national interest without considering the common good”. And within countries, he worries about Catalans and Flemings advocating independence rather than supporting poorer Spanish and Belgian countrymen. “The [EU] institutions are much stronger than before,” he said. “But the peoples, the old prejudices of the north to the south, and the prejudices of the south to the north, are still there. Of course, I’m not naive; I knew perfectly well the basic political community

reference is the nation state. But I would have liked to see more instinctive solidarity, and it was very hard work.” ‘Same enthusiasm for Europe’ Mr Barroso is not one to dwell on failures or doubts, however. He declares himself as having “the same enthusiasm for Europe” as he did as a young idealist, and by late afternoon – following phone calls from current and former world leaders to wish him well, and a handful of final media appearances – his mood had improved markedly. Those moments with Kohl, Mitterrand and Delors . . . were not so glorious as people today tend to present - Barroso on a ‘golden age’ for the union Tweet this quote He regaled a klatch of aides that had gathered in his office with tales of his attempts to learn to drive again, which included a recent weekend session in the parking lot of a Brussels Ikea. He admitted that the thing he worries most about in civilian life is the intrusive airport screenings he will have to undergo when he visits the US. Indeed, he was enjoying his long farewell so much that his office assistants worried they still did not know when he planned on departing. “He has to leave here by 8 o’clock,” fretted one nervously, noting that electricians were due to begin rewiring the offices for his successor, Jean-Claude Juncker. But at 6.30pm, his desk remained covered by stacks of papers. So in his final hours as president of an institution that represents more than 500m Europeans, Mr Barroso took off his suit coat, loosened his tie and, aided by his chief of staff, German lawyer Johannes Laitenberger, began boxing up papers or dumping them into yellow garbage bags. By 9pm, it was done. An enterprising aide procured some bubbly. Mr Barroso picked up a nearly-full tumbler from a tray and raised it. “Thank you, friends,” he said to his aides. Then, as he had done hundreds of times before, he put a few folders and his iPad – this time, a new personal one – under his arm and marched purposefully down the hall that connects the president’s suites to the lifts. Back in the basement, he gave hugs and handshakes to the four aides that remained, some brushing back tears. With barely a word spoken between them, he climbed into the same BMW that had brought him to work that morning. And then he was gone. Timeline: highlights and low points of a decade in power July 2004: Surprise choice as European Commission president, a compromise after countries could not agree on Guy Verhofstadt, prime minister of Belgium, or British commissioner Chris Patten May/June 2005: The Netherlands and France reject new EU constitution, at the time the most serious setback to integration in the bloc’s history January 2007: Accession of Bulgaria and Romania to the EU, the last of the “big bang” enlargement from the former communist bloc

December 2007: EU members sign the Lisbon treaty, creating a new European Council president to rival commission president’s supremacy June 2009: Chosen overwhelmingly to serve another five years as president after opposition social democrats fail to back a challenger December 2009: EU fails to win global limits to greenhouse gas emissions at UN climate conference in Copenhagen May 2010: First Greek bailout agreed; start of eurozone crisis November 2013: Ukrainian President Viktor Yanukovich rejects integration treaty with EU at summit in Vilnius, setting off months of protests November 2014: Succeeded by Jean-Claude Juncker http://www.ft.com/intl/cms/s/0/4624563a-640b-11e4-8ade-00144feabdc0.html#slide0

Why Don’t We See More Macroeconomic Populism? November 4, 2014 3:06 amNovember 4, 2014 3:06 am130Comments As I’ve been noting recently, there’s a lot of opposition within Japan to the Bank of Japan’s policy of printing more money; there’s also a lot of pressure on the government to raise taxes. And that’s not really very different from what has been happening in the rest of the advanced world: central banks that have pursued quantitative easing have done so despite political pressure, not because of it, and fiscal austerity has been imposed almost everywhere. The funny thing is that when you ask for justifications for pursuing hard money and tight budgets in a depressed, low-inflation economy, the answers you get often start from the presumption that money-printing and deficit finance are immensely tempting to politicians, so that you don’t dare let them get even a slight taste of these addictive drugs. This is often said in a tone of great wisdom, and presented as the lesson history teaches us. Now, as Simon Wren-Lewis points out — and as I’ve pointed out in the past — history actually teaches us no such thing. Fiscal stimulus in the United States, far from becoming permanent, has always faded out fast, indeed too fast; monetary retrenchment has also tended to come too quickly, at least sometimes. And even when things did run away from us in the 1970s, it was not at all the story conservatives now like to tell, in which central banks printed money to cover deficit spending; deficits weren’t actually big, and inflation took off because of oil shocks and macroeconomic misjudgments, not populist temptation. But why don’t these things happen in advanced countries? After all, the story — populist politicians should love it when people tell them that printing money and running big deficits is OK — seems plausible. And things like this have happened in Latin America — indeed are happening again today in Venezuela and Argentina. So why don’t they ever happen in America, Europe, or Japan? Why, in a time of deflationary pressure, have calls for belt-tightening dominated the political scene? I actually don’t know, although I continue to think about it. But it is a puzzle worth pondering. http://krugman.blogs.nytimes.com/2014/11/04/why-dont-we-see-more- macroeconomic-populism/?_r=0

mainly macro Comment on macroeconomic issues Sunday, 2 November 2014, Simon Wren-Lewis Fighting the last war It is often said that generals fight the last war that they have won, even when those tactics are no longer appropriate to the war they are fighting today. The same point has been made about macroeconomic policy: policymakers cannot avoid thinking about the dangers of rising inflation, and in doing so they handicap efforts to fully recover from the Great Recession. Another military idea is the benefit of using overwhelming force. In the case of inflation we have two legacies of the last war that are designed to prevent inflation reaching the heights of the late 1970s: inflation targets and in many countries independent central banks. Do we need both, or is just one sufficient? I think this question is relevant to the debate over helicopter money (financing deficits by printing money rather than selling debt). Why are helicopter drops taboo in policy circles? Why is it illegal in the Eurozone? The answer is a fear that if you allow governments access to the printing presses, high inflation will surely follow at some point. Many of those who worry about helicopter money are fairly relaxed about Quantitative Easing (QE), which involves much more money creation than would be involved in a helicopter drop. (Of course some are not relaxed, and (still) think that QE is about to produce rapid inflation - I will ignore that group here.) The key reason they are more relaxed is that central banks are in control of QE, whereas governments would initiate money financing of deficits. [1] Take the recent interchange between Tony Yates and myself on helicopter money (TY, SWL, TY), and consider the following hypothetical. The economy needs a fiscal stimulus, but for some irrational reason the government will not allow debt to rise. It therefore instructs the central bank to create money to fund a fiscal stimulus (i.e. a helicopter drop). However it also tells the central bank that this action should not compromise its inflation target (which is currently being undershot), and the central bank agrees that the helicopter drop will not compromise its ability to stop inflation exceeding the target, but instead it will help inflation rise to meet that target. Tony’s problem with this is in the instruction. In these particular circumstances the actions are not a problem, and will do some good (given the government’s irrational fear of debt). However we have crossed a barrier - the government is telling the central bank what to so. The fact that in my hypothetical example the inflation target remains is not enough: he writes “the inflation target in the UK is a very fragile thing”.He goes on: “So I don’t view the inflation target as a cast iron protection against helicopter drops undermining monetary and fiscal policy. There’s a good reason why monetary financing is outlawed by the Treaty of Rome. Allowing yourself tightly regulated helicopter drops is not time-consistent. Once government gets a taste for it, how could it resist not helping itself to more?”

I think it is possible to take two quite different views to Tony on this. The first is that, in most OECD economies today where macroeconomic understanding is better and information more available, inflation targets are more than sufficient to prevent us experiencing the inflation rates of the 1970s again. The hypothetical to think about here is a government that has direct control over the inflation target, but asks the central bank to vary interest rates to achieve that target. Of course we do need to imagine this - it is the UK set-up. Would such a government happily raise the inflation target in order to finance a bit more spending? Such a move would be highly unpopular, because most people think higher inflation means lower real wages. In the UK no political party has even hinted that raising the inflation target might be a good idea, despite obvious fiscal incentives to do so. Suppose a government pretended repeated money creation would not breach the inflation target, even when the central bank advised otherwise. Would that government survive when inflation took off? A second view is that we have the story of the 1960s and 1970s all wrong. We did not get high inflation in advanced economies because governments wanted to monetise their own profligacy. There were, after all, independent central banks in the US and Germany. Inflation occurred because of the combination of a number of specific factors: trade union pressure in the face of shocks that tended to reduce real wages, underestimation of the natural rate (and a poor understanding of how monetary policy should work), and placing too great a priority on achieving full employment. The latter might have been a legacy of the 1930s: policymakers were also fighting the last war, except in the 1970s the last war was about unemployment, not inflation. I think both views are probably correct. As a result, I’m much more relaxed about money financing of deficits in the current situation. However in one crucial respect I do agree with those who say we have no need for helicopter money today, because there is no reason for governments to have a fear of rising debt if their central bank can undertake QE. However irrational fear of rising debt in a recession has similar characteristics to fighting the last war: deficit bias is a problem, but a recession is not the time to worry about it. I think this is why I am not persuaded by this article by Ken Rogoff: yes, in the grand scheme of things we should worry about inflation and debt, but right now we are worrying about them too much and therefore failing to deal with more pressing concerns. [1] Some people imagine the central bank could itself initiate a helicopter drop, independently of government. That is simply not possible given current institutional arrangements, but as I noted in my earlier post (point 7) I think it is interesting to explore institutional changes that give the central bank some role in countercyclical fiscal policy. A simpler confusion is that helicopter money involves giving money to everyone, while tax cuts just go to taxpayers. Helicopter money is really about financing a fiscal stimulus of any kind using money: the form of that fiscal stimulus is a separate matter. http://mainlymacro.blogspot.in/2014/11/fighting-last-war.html

Eurointelligence RSS Feed Hoy, 05 de noviembre de 2014 , Hace 4 horas Draghi vs the minions -Insurrection reaches ECB Governing Council

Hoy, 05 de noviembre de 2014 , Hace 4 horas Our colleagues at Reuters have a cracker of a story this morning - about a revolt by the minions in the ECB's governing council, who are complaining that they do not get enough love from Mario Draghi, who apparently does not listen to them when they speak up. The article does not mention any names, but the anonymous sources quoted in the article include a group of disaffected national central bank governors, and possibly members of the executive council as well, who are finding themselves in a minority as the ECB is inching towards QE. There seem to have two concrete triggers for this outburst. The more important one was the announcement by Draghi in September to raise the balance sheet total back to the level of early 2012 - which gave rise to expectations of €1bn target in asset purchases. That was apparently not agreed by the Governing Council. The other was a reference to the fall in the 5y-5y inflation expectations during his Jackson Hole speech. We thought the following comments by the quoted anonymous central banks quite hilarious: "We specifically agreed at the meeting... not to put any numbers on the table…Draghi's reference to the balance sheet of 2012 irritated a lot of colleagues. So he has had to backtrack a bit ... to compensate." What also seems to have upset several of the sources is that they are no longer in the loop, as the ECB no longer circulates market-sensitive policy papers as the ECB governors have a habit of leaking information anonymously to the press - as this story itself demonstrates. Some also seem irritated that Draghi does not listen to them when they speak, and spends more time sending SMS messages during the meetings, or even makes phone calls. The story also mentioned that Draghi and Jens Weidmann had a meeting recently, but failed to resolve their differences. The ECB is now convinced that whatever they have to do now, they will have to do it against Weidmann, according to one of the sources quoted. Reuters puts the number of governors opposed to QE as between 7 and 10, among a total 24. That number includes two member of the ECB's executive committee - Yves Mersch and Sabine Lautenschlager.

Our other stories We also have extensive coverage of the European Commission's forecasts - especially the sections that interest us the most - on investment and deleveraging; we also have an extensive review of the French forecast; on the latest social security statistics in Spain; on the now informal "consultation" in Catalonia; on an Irish plan to pay back IMF money, on producer prices; on a German strike and two columns comparing Japan and Europe. http://www.eurointelligence.com/rss.xml Los bancos centrales desafían el estilo de liderazgo de Draghi martes 4 de noviembre de 2014 18:04 CET FRÁNCFORT/PARÍS (Reuters) - Los bancos centrales en la eurozona se plantean desafiar el miércoles al presidente del Banco Central Europeo, Mario Draghi, ya que consideran opaco su liderazgo y errático su estilo de comunicación, y le urgirán a actuar de forma más consensuada, según dijeron fuentes del BCE. Los banqueros están especialmente molestos con la decisión de Draghi de fijar un objetivo para aumentar el balance del BCE inmediatamente después de acordar en una reunión de política económica del Consejo de Gobierno no hacer pública ninguna cifra, afirman las fuentes. "Esto ha creado exactamente las expectativas que queremos evitar", dijo una fuente en el BCE. "Ahora todo lo que hagamos se medirá con el objetivo de aumentar el balance un trillón de euros". El malestar entre los gobiernos nacionales que poseen una mayoría en el Consejo podría limitar el espacio de Draghi a la hora de maniobrar con políticas más contundentes en los próximos meses, a medida que el banco se enfrenta a decisiones cruciales sobre si comprar deuda soberana para combatir la inflación decreciente y el estancamiento económico. Según las fuentes entrevistadas por Reuters, algunos miembros intentaron hacer partícipe a Draghi de sus preocupaciones en la tradicional cena de trabajo celebrada el miércoles, antes del mítin mensual para fijar los índices el jueves. Mucha gente en el banco central, que administra una sola moneda para dieciocho miembros de la Unión, agradeció la informalidad de Draghi cuando recibió el cargo de manos del francés Jean Claude Trichet en 2011. Sus esfuerzos por acortar los encuentros, delegar tareas y buscar nuevas ideas con mayor frecuencia fue recibido entonces como un soplo de aire fresco. En cualquier caso, a medida que las decisiones destinadas a suavizar la política monetaria y recurrir a medidas extraordinarias se han vuelto más polémicas, fuentes dentro del BCE afirman que el italiano ha actuado cada vez más por su propia cuenta o con sólo un puñado de asesores, dejando de lado incluso a figuras clave del departamento. 62

"Mario es más reservado (...) y menos dado a la toma de decisiones conjunta. Los gobernadores nacionales a veces sienten que están en la oscuridad, ignorados", dijo un miembro veterano del BCE. "Jean-Claude solía consultar y comunicar más", dijo otra fuente del BCE. "Trabajaba más para construir consenso", agregó. (Información de Eva Taylor y Paul Taylor; Traducido por Gabriel Sánchez en Madrid) http://es.reuters.com/article/businessNews/idESKBN0IO1OE20141104

Exclusive: Central bankers to challenge Draghi on ECB leadership style BY EVA TAYLOR AND PAUL TAYLOR FRANKFURT/PARIS Tue Nov 4, 2014 10:18am EST Mario Draghi, president of the European Central Bank (ECB), addresses the media during the ECB's monthly news conference in Frankfurt in this September 4, 2014 file photo. CREDIT: REUTERS/KAI PFAFFENBACH/FILES RELATED NEWS// European Commission cuts forecasts, euro zone recovery delayed / FOREX -Dollar dips, oil's drop hits Norwegian crown, Canadian dollar / Merkel says euro zone extremely fragile / From firebrand to PM-in-waiting, Greek leftist smells power /ECB's Coeure presses euro zone governments to reform economies ANALYSIS & OPINION//EU forecasts put France, Italy under the microscope / Draghi can only dream of moving like BOJ’s Kuroda (Reuters) - National central bankers in the euro area plan to challenge European Central Bank chief Mario Draghi on Wednesday over what they see as his secretive management style and erratic communication and will urge him to act more collegially, ECB sources said. The bankers are particularly angered that Draghi effectively set a target for increasing the ECB's balance sheet immediately after the policy-making governing council explicitly agreed not to make any figure public, the sources said. "This created exactly the expectations we wanted to avoid," an ECB insider said. "Now everything we do is measured against the aim of increasing the balance sheet by a trillion (euros)... He created a rod for our own backs." Irritation among national governors who hold a majority on the 24-member council could limit Draghi's space for bolder policy action in the coming months as the bank faces crucial choices about whether to buy sovereign bonds to combat falling inflation and economic stagnation.

Some members intend to raise their concerns with Draghi at the governors' traditional informal working dinner on Wednesday before their formal monthly rate-setting meeting on Thursday, the sources interviewed by Reuters said. Many people at the central bank, which manages a single currency for 18 European Union member states, welcomed Draghi's greater informality when he took over from Jean-Claude Trichet of France in 2011. His efforts to keep meetings short, delegate and brainstorm more, were received as a breath of fresh air. However, as decisions to loosen monetary policy and resort to further unconventional measures have become more contentious, insiders say the Italian ECB chief has acted increasingly on his own or with just a handful of trusted aides, sidelining even key heads of department. "Mario is more secretive... and less collegial. The national governors sometimes feel kept in the dark, out of the loop," said one veteran ECB insider. "Jean-Claude used to consult and communicate more," another ECB source said. "He worked a lot to build consensus." The ECB sources, like other central bankers interviewed for this report, declined to be identified because of the confidentiality of the bank's highly market-sensitive deliberations. BOARD IN THE DARK Even members of the ECB's executive board - the six-member inner circle that runs the bank - were not informed in advance about two key recent policy announcements, two sources said. Those were a key passage inserted into Draghi's speech at the U.S. Federal Reserve's Jackson Hole conference in August, in which he highlighted falling euro zone inflation expectations and vowed to act to counter them, and his Sept. 4 comment during a question-and-answer session that the ECB aimed to expand its balance sheet "towards the dimensions it used to have at the beginning of 2012" at the peak of the euro zone crisis. That particularly rankled with council members since they had just agreed not to put any price tag on the "sizeable" plan decided that day to buy bundled loans known as asset-backed securities (ABS) and covered bonds, the sources said. "We specifically agreed at the meeting... not to put any numbers on the table," one central banker. "Draghi's reference to the balance sheet of 2012 irritated a lot of colleagues. So he has had to backtrack a bit ... to compensate." The ECB declined comment on the matter. Several ECB sources said Draghi had cut back on circulating policy papers in advance of council meetings, apparently out of concern that opponents, notably in the German Bundesbank, were leaking them to try to block or discredit decisions. Draghi's relationship with Bundesbank chief Jens Weidmann hit a low point in October after the German publicly criticized ECB policy and each side briefed against each other at the annual IMF session in Washington.

An ECB source said German Chancellor Angela Merkel, who met Draghi at an EU summit on Oct. 24, had privately urged both men to mend their relationship. Merkel went out of her way to praise Draghi publicly that day when asked about a Reuters report on the tensions between the ECB chief, Berlin and the Bundesbank. After her intervention, Draghi and Weidmann met last week to try to clear the air but they did not resolve all their policy differences, the source said. Merkel's office declined comment on her reported meeting with Draghi, and neither the ECB nor the Bundesbank would comment on whether Draghi and Weidmann met last week. "We now know that the further we go, it will be without Jens," said a central banker who has tried to build bridges between them. "He's clearly not going to change his position." One of the few national chiefs whom Draghi takes into his confidence is Bank of France governor Christian Noyer, an elder statesman who was on the Governing Council when the euro was launched in 1999, one ECB source said. That did not stop Noyer voting against Draghi's plan to buy asset-backed securities and covered bonds, which Noyer thought ill-prepared and technically flawed, another source said. At times, Draghi has appeared to pay little attention to national governors' comments in the monthly rate-setting meeting after chief economist Peter Praet and board member Benoit Coeure report on the economic situation and financial markets. "He sits there with these three mobile phones in front of him and sometimes he’s sending text messages or going out to make or take phone calls," one source usually in the room said. On at least one occasion, a national governor has skipped his turn to speak because Draghi was not present. "This has got a bit better. He’s paying a bit more attention now," the source said. The ECB's governing council is currently deeply divided over suggested policies to tackle too-low inflation - though it is difficult to say whether these differences have been a cause of Draghi's more tightly held leadership style or are exacerbated by it. At least seven and possibly as many as 10 of the 24 council members are against U.S.- style quantitative easing - creating money to buy euro zone government bonds - if inflation falls further below the ECB target of just below 2 percent, the sources said. Opponents include executive board members Yves Mersch and Sabine Lautenschlaeger as well as governors from Germany, the Netherlands, Luxembourg, Estonia, Latvia and possibly Slovakia, Slovenia and even Austria. While a unitary state like Japan can make a radical monetary policy change with a slim majority, the ECB sources said it would be politically explosive for Draghi to try to force QE through in the multinational euro zone by such a narrow margin. He would need to consult national governors more and work harder to build a broader consensus for QE to become feasible in the euro area, they said. http://www.reuters.com/article/2014/11/04/us-ecb-governors-exclusive- idUSKBN0IO1GY20141104

Warning: Stocks Will Collapse by 50% Tuesday, 04 Nov 2014 07:57 AM It is only a matter of time before the stock market plunges by 50% or more, according to several reputable experts. “We have no right to be surprised by a severe and imminent stock market crash,” explains Mark Spitznagel, a hedge fund manager who is notorious for his hugely profitable billion-dollar bet on the 2008 crisis. “In fact, we must absolutely expect it." Unfortunately Spitznagel isn’t alone. “We are in a gigantic financial asset bubble,” warns Swiss adviser and fund manager Marc Faber. “It could burst any day.” Faber doesn’t hesitate to put the blame squarely on President Obama’s big-government policies and the Federal Reserve’s risky low-rate policies, which, he says, “penalize the income earners, the savers who save, your parents — why should your parents be forced to speculate in stocks and in real estate and everything under the sun?” Billion-dollar investor Warren Buffett is rumored to be preparing for a crash as well. The “Warren Buffett Indicator,” also known as the “Total Market Cap to GDP Ratio,” is breaching sell-alert status and a collapse may happen at any moment. So with an inevitable crash looming, what are Main Street investors to do? One option is to sell all your stocks and stuff your money under the mattress, and another option is to risk everything and ride out the storm. But according to Sean Hyman, founder of Absolute Profits, there is a third option. “There are specific sectors of the market that are all but guaranteed to perform well during the next few months,” Hyman explains. “Getting out of stocks now could be costly.” How can Hyman be so sure? He has access to a secret Wall Street calendar that has beaten the overall market by 250% since 1968. This calendar simply lists 19 investments (based on sectors of the market) and 38 dates to buy and sell them, and by doing so, one could turn $1,000 into as much as $178,000 in a 20-year time frame. Editor's Note: Sean Hyman Reveals His Secret Wall Street Calendar in This Controversial Video, Click Here. “But this calendar is just one part of my investment system,” Hyman adds. “I have also designed a Crash Alert System that is designed to warn investors before a major correction as well.”

(The Crash Alert System was actually programmed by one of the individuals who coded nuclear missile flight patterns during the Cold War so that it could be as close to 100% accurate as possible). Hyman explains that if the market starts to plunge, the Crash Alert System will signal a sell signal warning investors to go to cash. “You would have been able to completely avoid the 2000 and 2008 collapses if you were using this system based on our back-testing,” Hyman explains. “Imagine how much more money you would have if you had avoided those horrific sell-offs.” One might think Sean is being too confident, but he has proven himself correct in front of millions of people time and time again. In a 2012 interview on Bloomberg Television, Hyman correctly predicted that Best Buy would drop down to $11 a share and then it would rally back up to $40 a share over the next few months. The stock did exactly what Hyman predicted.

Then, during a Fox Business interview with Gerri Willis in early 2013, he forecast that the market would rally to new highs of 15,000 despite the massive sell-off that was haunting investors. The stock market almost immediately rebounded and hit Hyman’s targets. “A lot of people think I am lucky,” Hyman said. “But it has nothing to do with luck. It has everything to do with certain tools I use. Tools like the secret Wall Street calendar and my Crash Alert System.” With more financial uncertainty than ever, thousands of people are flocking to Sean Hyman for his guidance. He has over 114,000 subscribers to his monthly newsletter, and his investment videos have been seen millions of times. In a recent video, Hyman not only reveals the secret Wall Street calendar, he also shows how his Crash Alert System works so that anybody can follow in his footsteps (click here to watch it now). Read Latest Breaking News from Newsmax.com http://www.Moneynews.com/MKTNewsIntl/stock-market-crash-warren-buffett- indicator/2014/10/03/id/598461/#ixzz3ICMpCUR9 Urgent: Should Obamacare Be Repealed? Vote Here Now! http://nws.mx/1x7EdFU

What Quantitative Easing Did Not Do: Three Revealing Charts Author: Ed Dolan · November 4th, 2014 · Comments (2) The Fed has declared an official end to quantitative easing. It is a logical time to ask, did QE work? Danielle Kurtzleben gives the honest answer in a recent post on Vox: “It’s very, very hard to know.” Still, we do know three things that QE did not do. These are worth pointing out, especially since back when QE was just getting under way, there were people who expected that QE 2 would do all of them. 1. QE did not work according to the textbook model One thing was never in doubt. As the Fed added massively to its assets, QE would cause an equally massive increase in the monetary base—the sum of bank reserves and currency that accounts for the bulk of its liabilities. Some economists used to refer to the base as high powered money. It got that name from a familiar textbook model, according to which two simple ratios link the monetary base to the rest of the economy. One is the money multiplier, which is the ratio of ordinary money (M2) to the monetary base. The other is the ratio of nominal GDP to the M2 money stock, known as the velocity of circulation of money, or just velocity, for short. If the money multiplier and velocity were constants, then the monetary base would be high-powered indeed. Any increase in the base (which the Fed can manipulate at will) would cause a proportional increase in nominal GDP. The only thing left to determine would be how much of the change in nominal GDP would express itself as an increase in real output and how much as inflation. The idea of treating the money multiplier and velocity as constants is not completely silly. There have been times in recent history when one or both of those ratios were, in fact, reasonably stable. For example, for the whole period from 1959 to 1992, the velocity of M2 stayed in a narrow range between 1.7 and 1.9, with ups and downs from year to year but no obvious trend. Similarly, for most of the 1990s and 2000s, the M2 money multiplier stayed in a narrow range of about 8.0 to 8.4. (Is it a coincidence that the periods of maximum stability for the ratios did not overlap? Probably not, but I’ll save that rather technical issue for another post.) When QE came along, though, and when short-term interest rates fell effectively to zero, all hell broke loose with those deceptively stable ratios. Take a look at the following chart, which shows data for the monetary base, the M2 money stock, and nominal GDP. To make it easier to compare their trends, all three series are plotted with their value as of the first quarter of 2008 is set equal to 100.

Before mid-2008, the three series move closely together, as we would expect them to if the money multiplier and velocity were textbook-stable. Then, as soon as the Fed undertakes QE1, beginning in the second half of 2008, the series diverge. The monetary base soars as the Fed buys up vast quantities of financial assets, but the money stock barely budges. The divergence of those two series indicates a precipitous decrease in the money multiplier. Meanwhile, nominal GDP continues to fall for a year or so, and even after that, it grows more slowly than the money stock. The divergence of the money stock and nominal GDP indicates a decrease in velocity.

In short, the chart shows that in a deep slump, expansionary monetary policy is, as the saying goes, like “pushing on a string.” The Fed pushed and pushed, but the only thing it had the power to push was the monetary base, and that had very little effect on nominal GDP. 2. QE did not cause inflation The sluggish reaction of nominal GDP to an increase in supposedly “high powered” money can be viewed as either a good or a bad thing, depending on your perspective. Back at the start of QE, not a few observers warned that QE would quickly lead to hyperinflation. That did not happen, and we can be glad it did not. However, it would have been nice if QE had boosted the growth of GDP by enough to bring inflation at least up to the Fed’s modest 2 percent target and, at the same time, to pull real output back to its potential and the job market back to full employment. Instead, as the next chart shows, what we got was a painfully slow recovery of the real economy. The unemployment rate is still not all the way back to the 5.25-5.75 percent range that the Fed considers “full employment.” Meanwhile, inflation, as measured by the Fed’s preferred indicator, the deflator for personal consumption expenditures, peaked three years ago. Since then it has fallen well below its 2 percent target. When it looks at these data, the Fed sees enough progress to call an end to QE, but it is not as much or as fast as many of us would have liked. 69

3. QE was not powerful enough to overcome fiscal restraint The policy experiments of recent years have given us a test of the relative strength of monetary and fiscal policy. Expansionary monetary policy and contractionary fiscal policy have gone at it head to head, with the outcome pretty much a draw. Fiscal policy has not been restrictive enough to derail the recovery completely, but neither has quantitative easing proved powerful enough to break decisively through the fiscal restraint.

Just how tight has fiscal policy been? The next chart shows the best overall indicator of the stance of fiscal policy, the structural primary balance, shown as a percentage of GDP. The structural primary balance is the deficit or surplus of the consolidated budgets of all levels of government as they would look at full employment, under current law and excluding interest on government debt. The current budget deficit—the indicator political discussions usually focus on—can be misleading, since it tends to increase automatically in a recession and decrease in an expansion even if there is no change in policy. The structural primary balance filters out cyclical effects to reveal underlying policy changes. A movement toward deficit shows added fiscal stimulus, while a movement toward surplus shows fiscal tightening. If we compare this chart with the first one, we see that monetary and fiscal policies were pulling in the same direction during the downturn of the Great Recession, up to the middle of 2009. We can be thankful for that. Without QE1 and the combined fiscal stimulus programs of the late Bush and early Obama administrations, the recession would have been even deeper than it was. However, at about the same time the economy began to recover, fiscal policy shifted toward restraint, and has continued to move in that direction through this year. What Ben Bernanke said a couple of years ago remains valid: “Monetary policy cannot achieve by itself what a broader and more balanced set of economic policies might achieve.” The bottom line This brief look at what QE did not do helps us understand why it is so hard to know what it did accomplish. It was an uncontrolled experiment. There was no way to apply QE to half of the economy and a placebo to the other half. Furthermore, for most of its life, the expansionary effects of QE were fighting against the contractionary effects of fiscal policy. It was a standoff, but there is no way to tell if that is because both policies were weak, or because both were equally strong. The most widely accepted conclusion about QE—that things would have been even worse without it—remains plausible, but since that is a counterfactual hypothesis that can never be conclusively tested, the debate will undoubtedly continue. Related posts Quantitative Easing and the Fed: A Tutorial (Slideshow) Whatever Became of the Money Multiplier? As We Move into Fiscal Chaos, Just How Bad is Our Fiscal Policy, Really? http://www.economonitor.com/dolanecon/2014/11/04/what-quantitative-easing-did-not- do-three-revealing-charts/

Eurointelligence RSS Feed Hoy, 04 de noviembre de 2014 , Hace 4 horas The return of pro-cyclical austerity

Hoy, 04 de noviembre de 2014 , Hace 4 horas We did not think much of the confidence surveys and official economic forecasts when they were optimistic during the first two quarters. Nor are we particularly shaken by their current pessimism. On an otherwise quiet newsday for the eurozone, we noted three economic reports - one for the eurozone, two for Italy - all of which contain some interesting information - though you would not see that in the headlines, which are, as so often, the least interesting bit. What we thought was interesting in Istat's semiannual forecast for the Italian economy was not the GDP estimate, which is close enough to those of other organisations, but the estimate on the impact of Matteo Renzi's budget on the Italian economy next year. According to Istat, the budget is going to be severely contractionary. The fall in government consumption exactly offsets the increase in household consumption. The projected rates of GDP growth next year will thus depend entirely on investments and net exports. Here are the relevant numbers for 2015. Annual Growth in % GDP 0.5 Domestic demand 0.4 Household consumption 0.6 Government consumption -0.6 Investment 1.3 Trade balance 2.9% of GDP Also note that these numbers contain some fairly benign assumptions about inflation. The GDP deflator is put at 0.6%, and the household consumption deflator at 0.7%. That would assume that the ECB is getting some traction with its policies. The second report of note is a statement by Italy's Corte dei Conti, the national audit court, in the Italian parliament yesterday. It contained two warnings according to Ansa. The first is that the cuts in regional spending could drive the quality of local services down, and taxes up. If so, this would be a contractionary fiscal measure. The second warning relates to the revenue assumptions. The auditors warned against "risks inherent in allocating funds recovered from the fight against tax evasion, whose amount is uncertain, to cover known expenses and tax cuts".

remains insipid and beset by lackluster domestic conditions, slowing export growth and ongoing economic uncertainties. “National growth disparities also remain a concern, as solid expansions in Ireland, the Netherlands and Spain provide a marked contrast to the downturns in Italy, Greece, France and Austria. The German industrial Rob Dobson, Senior Economist at Markit said: engine is also achieving only modest growth. “The performance of eurozone manufacturing remained “Not surprisingly, this is forcing broadly flat at the start of the final quarter, as the sector firms to focus on cost-cutting and struggles to recover the traction lost following its mid- competitiveness, at the expense of year slowdown. Manufacturing is therefore unlikely to employment and margins, as they provide any meaningful boost to the currency union’s strive to boost sales volumes. This anaemic GDP growth. is likely to hold up the alreadyhigh “Perhaps most worrying is the trend in new orders, a key unemployment rates across much bellwether of future output growth, which declined for the of the currency union, as firms lack second month running. It is hard to see any significant the profitability and demand near-term boost to performance while market demand requisite to expand capacity.”

Meanwhile, Markit's eurozone manufacturing PMI also contained an interesting bit of new information. We noted that industrial orders had fallen for the second consecutive month, which points to further weakness in industrial output ahead. Germany is still 74

doing relatively well overall, slightly ahead of the average, but German new orders are now falling as well. This tells us that the manufacturing downturn in Germany has continued into the fourth quarter. The overall headline number of the PMI is largely irrelevant, as it confirms what we already know. The ECB, meanwhile, published the latest details of its covered bond purchase programme. After purchases of just €1.7bn in the first week of the programme, the total now stands at €4.8bn. It's neither here nor there. Our other stories We also have stories on the plans by Podemos, on the plans of Syriza, on a property tax for second homes in France, on a rise in the floor of SDR interest rates, on the next round of sanctions against Russia; on the return of Helmut Kohl, and a particularly acidic comment on Germany. Why inflation did not go up in October

Ayer, 03 de noviembre de 2014, 9:00:39 Don't believe those knee-jerk news reports saying that the increase in the headline inflation rate from 0.3% to 0.4% have reduced the pressure on the ECB to act. First, the core rate of inflation has fallen from 0.8% in September to 0.7% in October. The core rate gives a much better reading of underlying trends. It has been fluctuating in a narrow band of 0.7-0.9% over the last year. We are now back to the lower end of that range. We also noted from Eurostat's release that non-energy industrial goods are in outright deflation - at -0.1%. Unemployment, meanwhile, remained sticky at 11.5% in September, unchanged from August. Another important development on Friday was the narrow vote by the Bank of Japan's policy board to increase the annual size of asset purchases from a range of Y60-Y70tr to Y80tr(€570bn). This triggered a weakening of the Yen from a range of Y137 to the euro by the middle of last week to over Y140. While the euro's exchange rate to the dollar has also fallen, the combination of a weak yen and mostly stable European currencies means that the effective exchange rate of the euro is relatively sticky. We noted a comment by Ignazio Visco, who is quoted by Reuters as making two taboo- breaking points. The first is that the risk of deflation is real. The second is that an ambitious deficit reduction "could worsen the very imbalances which it is intended to contain." Both statements are true, of course, but they are not usually made in polite company. A more conventional comment came from Ewald Nowotny, who said QE was possible in theory, but not right now. Paul Krugman noted that Japan has done reasonably well, compared to what the western economies did since 2008. At least Japan managed to keep unemployment low, which did not happen here. Swaha Pattanaik of Reuters Breakingviews writes that Mario Draghi would not be able to pass a policy on the basis of a single-vote majority. He noted that European policy decisions are taken either with unanimity, or an "overwhelming majority", a “significant majority” or a “comfortable majority.” Part of the problem is that the ECB is still viewed from a national perspectives, and some nations count more than others. 75

Other than that, there is probably not much that divides the ECB from the Bank of Japan. In both central banks there is a small majority in favour of more policy action. Our other stories We have a special reports on insurrection in Spain, France and Ireland; In Spain, Podemos now tops the polls; in France, a killing of a young protester has led to violent demonstrations; Ireland saw large demonstrations against water charges; we also take a look at whether the Portuguese constitutional court may have to revise its position, and whether Greece can succeed to renegotiate its relations with the eurozone; plus comments on investment and OMT.

EDITORIAL Credibilidad Para que la regeneración sea sincera, es preciso que los partidos aborden en serio su depuración EL PAÍS 4 NOV 2014 - 00:00 CET Acuciados por el monumental enfado de la ciudadanía, los partidos políticos con mayor número de implicados en casos de corrupción reiteran las promesas de limpieza en el futuro. Pero la primera condición para que sus reacciones sean verosímiles es la credibilidad. Cumplir esa circunstancia exige depurar las estructuras ejecutivas o representativas en las que se hayan colado los corruptos, no hayan cuidado con rigor el comportamiento ético o hayan permitido el crecimiento a su alrededor de enriquecimientos abusivos. Editoriales anteriores// Seísmo político (02/11/2014)/ No es suficiente (29/10/2014)/ Crisis no solventada (02/08/2013) La actitud de la justicia y la actividad de la Fiscalía Anticorrupción y de las fuerzas de seguridad prueban que se equivocan los que predican la debilidad del Estado o dan por liquidado “el régimen del 78”, en expresión de los populistas. Esas instituciones están llevando a cabo vigorosas investigaciones, como se está comprobando. Es cierto que no lo parece tanto porque en España se tarda mucho tiempo en llegar a establecer la verdad judicial, debido a una mezcla entre complejidad de las investigaciones y aplicación rigurosa de las garantías del Estado de Derecho, que retrasan las decisiones. Sin embargo, no cabe aceptar la lógica de aquellos responsables políticos que durante años han sostenido que sus conmilitones son víctimas de oscuros ataques cuando se hurga en la razón de decisiones discrecionales o en sus patrimonios, o que pretenden aplazarlo todo hasta que haya sentencias judiciales. María Dolores de Cospedal, secretaria general del PP, insistió ayer en la línea de que los dirigentes políticos no pueden meter a la gente en la cárcel. Cierto, pero sí pueden conducir indagaciones internas o aceptar comisiones de investigación parlamentaria para casos importantes. Calificar de “cobardes” a los que plantean anónimamente la renovación de la dirección del PP o un congreso para dar paso a una nueva generación

implica que la cúpula del partido gobernante sitúa el problema en términos de mantenimiento del poder, y no de regeneración. Los partidos pueden excluir de sus filas a los sospechosos de abusos o actuaciones ilegales —solo muy recientemente han empezado a hacerlo— y, por supuesto, dejarles fuera de las candidaturas electorales. Ha ocurrido demasiadas veces que personas implicadas en investigaciones penales son reconducidas al fortín de las listas electorales cerradas y bloqueadas, para buscar así “el blanqueo” de conductas presuntamente oprobiosas. Hora es de poner fin a tales prácticas. Es verdad que la política se encuentra sometida a un escrutinio muy intenso, pero eso se corresponde con su enorme presencia en la vida pública. Partidos de los que dependen estrechamente las instituciones son hoy el centro de las preocupaciones de muchos ciudadanos. Ayer mismo, los miembros del Instituto de Empresa Familiar expresaron su inquietud al respecto. Tiene razón Joaquín Almunia, vicepresidente saliente de la Comisión Europea, cuando indica que el problema está menos extendido de lo que parece, pero la salud de la democracia exige enfrentarse a una crisis política que no deja de crecer. Bien está que el PSOE prepare una declaración contundente para que se le perciba como un partido intransigente hacia la corrupción, y que el PP insista en algunas reformas legales, anunciadas numerosas veces y aplazadas en busca de un pacto con los socialistas que no se ha materializado. No sobran; pero hay que tomar medidas ejemplares, que hagan creíble la voluntad de adoptar una actitud mucho más firme contra cualquier desviación de los principios éticos exigibles a los políticos. No debería olvidarse que los partidos canalizan la representación de los ciudadanos y viven esencialmente de los contribuyentes. http://elpais.com/elpais/2014/11/03/opinion/1415043897_106771.html

ft.com/markets MARKETS INSIGHT November 4, 2014 2:21 am Japan cannot rely on corporate governance push Henny Sender Attempt to lift return on equity for shareholders unlikely to succeed

©EPA Shinzo Abe, Japan's prime minister E very day it seems the Government Pension Investment Fund of Japan posts notices on its website inviting fund managers to apply to manage mandates for a variety of both fixed income and equity strategies. Under the government of Shinzo Abe, the GPIF, the largest pension fund in the world with Y127tn, has become far more active. On October 31, the Bank of Japan announced an intensification of its asset purchases, while the GPIF said it would roughly double its allocation to domestic stocks to 25 per cent, briefly sending the Nikkei stock index above 17,000 for the first time in seven years on Tuesday. More ON THIS TOPIC// Abenomics sends equities soaring/ Editorial Kuroda sticks to inflationary promises/ The Short View Japan goes bold in deflation fight/ Dollar soars after BoJ stuns markets MARKETS INSIGHT// How to read the Dow’s ups and downs/ Rescue measures for stagnant eurozone/ ‘Coffin corner’ threat to stability/ Corporate cash hoarding has to end Come December, a new third-party report on governance of the fund with an expected emphasis on making it more independent, more transparent, more activist and more risk taking, will be made public. Believers in Abenomics regard the GPIF as a catalyst for change for both the Japanese financial markets and for corporate Japan as a whole. Their critics believe what was meant to be a technocratic shift has become a move to make the government even more intrusive in financial markets. They see it as a replay of the Koizumi emphasis on postal savings reform, which ultimately failed to work a huge transformation of the investment landscape. In any case, regardless of which viewpoint is correct, the GPIF has become the best reason to hold Japanese equities today. The government and Yasuhisa Shiozaki, its assertive new Minister of Health, Labour and Welfare, wish to improve corporate governance and raise the return on equity for shareholders. After 20 years of a deflationary mindset, they believe Japan Inc is too conservative and is hoarding too much cash, rather than investing and contributing to Japanese growth. (This despite the fact that most economists believe the maximum

potential growth rate of Japan is well below 1 per cent, far less than government estimates of more than 2 per cent.) If the GPIF puts its money into the shares of well managed Japanese companies, reinforcing best corporate governance practices, it is likely that a host of other public pension funds and private pension funds will follow. Also, since the return on government bonds is paltry and becoming more so since the BoJ began buying massive quantities of Japanese government bonds, it is true that Japanese pension funds must aspire to higher returns than 1 per cent or 1.5 per cent in real terms. The government is also trying to encourage risk-averse retail investors to come back into the market with new Nippon Individual Savings Accounts that offer tax incentives. But can the GPIF really work such a dramatic transformation in the corporate landscape? For a start, Japanese managers with their emphasis on seniority, consensus and incremental change may not have the skill set to initiate bolder moves. For example, Japanese electronics companies’ return on equity is half of, say, a Siemens, according to one frustrated financial official, precisely because of their reluctance to hive off less profitable operations in favour of more lucrative business lines. At the same time, it is not clear where the competitive advantage of Japanese companies lies in a digital world. So far, the emphasis on return on equity has resulted in more short-term fixes in the form of share buybacks than the much harder task of altering business mixes that involve so many diverse activities. It is precisely because of such doubts that foreign hedge funds have increased their short positions dramatically in recent months. “The only reason to be bullish is to front run GPIF and that is a sort of version of the greater fool theory,” says the head of prime brokerage of one major investment bank in Hong Kong. There are other doubts as well. Is this really the right time to go into the market? And if the answer is yes, the reasons may be questionable. Some managers say, for example, that the government has to win upcoming regional elections and needs a buoyant stock market to vindicate its actions. Of course, the world today is all about relative value. Japan may be more attractive than, say, a shrinking Europe. Still, the irony is that in the name of independence, the government’s hand in the economy is getting heavier not lighter. Government-ordered risk taking has rarely led to happy endings. http://www.ft.com/intl/cms/s/0/68db835e-6025-11e4-98e6- 00144feabdc0.html#axzz3HzdhcOeQ

ft.com World UK Politics & Policy Last updated:November 3, 2014 8:35 am Merkel warns Cameron over freedom of movement within EU Helen Warrell in London and Jeevan Vasagar in Berlin

©EPA Angela Merkel, the German chancellor, is reported to have warned the UK prime minister that she is prepared to consider a British exit from the EU if there is a move to change the rules on freedom of movement. According to the news magazine Der Spiegel, Ms Merkel fears that David Cameron is leading the UK to the “point of no return”. She is said to have made clear to him that any attempt to restrict immigration from fellow member states will result in Germany withdrawing support for efforts to keep Britain in the union. More ON THIS TOPIC// Osborne seeks rule change over £1.7bn bill/ Inside Business Business quest for standard on EU reform/ EU bill not out of control, says Treasury/ Robert Shrimsley Cameron opts out to stay in IN UK POLITICS & POLICY// Lib Dem minister quits Home Office/ North gives cautious welcome to devolution/ Tory focus on migration fails to stop Ukip/ Tech groups aid terror, says UK spy chief Citing sources in the chancellor’s office and the German foreign ministry, Der Spiegel reported that Berlin now regards a British exit as a possibility. The prime minister, under pressure from rightwing Conservatives and the anti-European UK Independence party, has consistently promised Britons that he will bring forward 80

measures to curb immigration from within Europe. He is expected to set out his position in a speech before Christmas. David Davis, former shadow home secretary, said that while the debate still had two years to run, Mr Cameron should set out his position definitively. “If you’re going to get the Europeans to take you seriously, you’ve got to hold out the prospect of recommending leaving,” he told the BBC on Monday. He added that Ms Merkel’s comments were no surprise. “These blood-curdling comments from leaders in Europe were to be expected. They’re often being driven by domestic considerations.” However, it emerged over the weekend that Mr Cameron might now be modifying his initial plans to impose quotas on low-skilled EU migrants to appease Ms Merkel. The Sunday Times newspaper reported that Downing Street was focusing instead on stretching existing commission rules “to their limits” by deporting migrants from member states unless they are able to support themselves within three months of arrival. Nigel Farage, the Ukip leader, responded gleefully to the reports of Ms Merkel’s warning on Sunday, suggesting this undermined the prime minister’s strategy of negotiating a new deal with the EU, rather than leaving the bloc. “German paper Der Spiegel reports Berlin wants UK EU exit if we try and limit immigration. Still think you can renegotiate, Mr Cameron?” Mr Farage tweeted. Speaking after a meeting of the European Council last month, Ms Merkel said Germany would not interfere with the basic principle of freedom of movement, but emphasised “that doesn’t mean that there aren’t various problems”. The chancellor added that she had discussed these problems with Mr Cameron, including benefits for unemployed EU migrants. She said at the time: “However, it is my view that this must be resolved in a way that on the one hand allows us to tackle abuses, but on the other, does not deviate from the basic principle of freedom of movement in Europe.” High quality global journalism requires investment. Please share this article with others using the link below, do not cut & paste the article. See our Ts&Cs and Copyright Policy for more detail. Email [email protected] to buy additional rights. http://www.ft.com/cms/s/0/da16f51c-6287-11e4-aa14- 00144feabdc0.html#ixzz3I5UiB6Ta Responding to the Der Spiegel report, Ms Merkel’s spokesman Steffen Seibert said: “Everything there is to be said on the part of the federal government, on the question of immigration, has been said by the chancellor at her press conference in Brussels.” Downing Street would not confirm that Mr Cameron had received a warning from the German chancellor, saying only that the prime minister would do “what is right for Britain, as he has repeatedly made clear”. Meanwhile, Tory grandee Ken Clarke, a pro-European who left the cabinet in the summer reshuffle, said it was impossible to control net migration and that fears of EU migrants abusing UK benefits had been exaggerated.

“The Europeans who come here are coming here for jobs,” Mr Clarke told the BBC. “They’re filling skills we haven’t got and they’re working in our economy. There’s less of abuse of benefits amongst the Eastern Europeans than there is amongst the native British population here.” Additional reporting by John Aglionby http://www.ft.com/intl/cms/s/0/da16f51c-6287-11e4-aa14- 00144feabdc0.html#axzz3HzdhcOeQ

11/03/2014 02:29 PM Approaching Brexit? Merkel Fears Britain Crossing a Red Line on Immigration By Nikolaus Blome, Christoph Scheuermann and Gregor Peter Schmitz David Cameron is furious about the EU Commission's demand that the UK make a back payment of €2.1 billion. But it is the British prime minister's stance on immigration that has German Chancellor Merkel more worried. She fears he may be crossing a red line. Two adjectives best describe the British prime minister in recent days: shrill and loud. Late last month in Brussels, an angry David Cameron vented over the surprise €2.1 billion ($2.62 billion) back payment being demanded by the European Commission. "I am not going to pay that bill on Dec. 1," he fumed to the press. The charge, he said, was "completely unacceptable." Despite his vehemence, German Chancellor Angela Merkel took Cameron's outburst in stride. To be sure, it cast a shadow over the October EU summit, which reached what Merkel sees as a successful agreement on new climate protection goals. But when it comes to disagreements over money, the EU has always managed to find a solution. A compromise appears even more likely given that the European Commission has a bad conscience for the way it blindsided Cameron with the bill, which represents a recalculation of Britain's dues based on higher-than-expected economic growth. Brussels had only informed lower-level officials in London prior to announcing the payment request. Merkel was much more worried about a different development. For the first time, according to an assessment by the Chancellery and the Foreign Ministry, Cameron is pushing his country toward a "point of no return" when it comes to European Union membership -- a point at which Germany would cease doing all it can to convince Britain to remain a member of the EU. Were Cameron to continue insisting on an upper limit for immigration from EU member states, Berlin sources said "that would be that." Sources say that Merkel left no doubt about where she stands on the issue during a private meeting with the British prime minister on the sidelines of the recent EU summit. The sources said that the surprise bill from Brussels was hardly mentioned.

'Every Effort to Control Migration' It seems doubtful that Merkel's message has been sufficiently understood. Just days after he met with the German chancellor, a red-faced Cameron once again addressed the issue of immigration, this time venting his anger in the House of Commons. "The British people know we are making every effort to control migration," he said on Oct. 29 in response to a question from Labour Party leader Edward Miliband. In the 12 months ending in March 2014, Britain saw net immigration of 243,000 people and Cameron's government has pledged to drastically reduce that figure. But significant restrictions on immigration from non-EU countries could hurt the UK's economy. So Cameron is evidently considering rejecting the immigration of certain groups from within the EU's 27 member states. The plan likely calls for upper limits on the immigration of less prosperous, less educated migrants. And such a plan is one that Merkel finds unacceptable. In recent years, the chancellor has sought several times to find common ground with the British, most recently on the issue of London's bitter opposition to Jean-Claude Juncker's candidacy as European Commission president. In June, the crisis saw Merkel joining Cameron in Harpsund, Sweden together with the Swedish and Dutch prime ministers. The images of the quartet in a small rowboat were useful as a signal to the rest of the EU that Merkel was not going to leave the British isolated with their demands that Brussels change course in the interest of economic competitiveness. It was also in Merkel's interests to do so. But demands to establish quotas for EU migration call into question one of the European Union's "four freedoms" -- the free movement of people, goods, services and capital -- that form a significant part of the foundation for European unity. Though Merkel is famous for her willingness to compromise, she is not willing to budge on the issue. UKIP's Greatest Desire Indeed, as Britain's conservative government is rapidly approaching a red line, it looks from Berlin as though Cameron is neither willing nor able to apply the brakes. Should Cameron move to establish numerical limits on immigration from EU member states, "there will be no going back," say sources in Berlin. First, they say, Cameron's proposal would be torpedoed in Brussels by Germany and several other EU countries and then he would return home and lose the referendum on Britain's exit from the EU. Cameron, however, seems to have lost all sense of moderation. He has made a series of public pledges regarding the competencies he would like to reclaim from Brussels. In particular, he is focused on the judiciary and domestic policy -- and on parliamentary elections scheduled for next May. Polls show his Conservatives are even with the center-left Labour Party while the anti-EU UKIP party isn't far behind, with between 13 and 19 percent support. An upcoming by-election could see UKIP winning a second lower-house seat in a district that used to belong to the Conservatives. Last week, members of the Foreign Affairs Committee in German parliament traveled to London for meetings with British lawmakers and government ministers. The atmosphere was cool. Norbert Röttgen, a member of Merkel's Christian Democrats and chair of the committee, expressed surprise about the amount of influence EU opponents 83

now have in Britain. "UKIP dominates political discourse in Great Britain," Röttgen says. "The Conservative strategy of imitating UKIP doesn't seem to be working very well." Should Cameron continue on his current path despite the resistance, sources in Berlin believe, he will unwittingly fulfill UKIP's greatest desire: Britain's exit from the European Union. URL: • http://www.spiegel.de/international/europe/merkel-fears-cameron-crossing-red- line-on-immigration-a-1000743.html Related SPIEGEL ONLINE links: • Cameron's Empty Threat: Britain Risks Losing an Ally in EU Feud (06/04/2014) http://www.spiegel.de/international/europe/cameron-risks-losing-merkel-as-ally-in- eu-feud-a-973389.html • Ex-Premier Blair: 'British Understand the Folly of Leaving the EU' (06/03/2014) http://www.spiegel.de/international/europe/interview-with-former-british-premier- tony-blair-on-eu-and-reform-a-973226.html • Decision Time: Britain Must Choose Now If It Will Stay in Europe (06/03/2014) http://www.spiegel.de/international/europe/spiegel-editorial-argues-britain-must- determine-future-in-eu-a-972903.html • Lurching Right: UKIP Win Creates Pressure for Cameron and Europe (05/27/2014) http://www.spiegel.de/international/europe/ukip-wins-big-in-britain-and-creates- challenge-for-cameron-and-europe-a-971968.html

11/03/2014 01:38 PM Monetary Fallacy? Deep Divisions Emerge over ECB Quantitative Easing Plans By Anne Seith To prevent dangerous deflation, the ECB is discussing a massive program to purchase government bonds. Monetary watchdogs are divided over the measure, with some alleging that central bankers are being held hostage by politicians. At first glance, there's little evidence of the sensitive deals being hammered out in the Market Operations department of Germany's central bank, the Bundesbank. The open- plan office on the fifth floor of its headquarters building, where about a dozen employees are staring at their computer screens, is reminiscent of the simple set for the TV series "The Office". There are white file cabinets and desks with wooden edges, there is a poster on the wall of football team Bayern Munich, and some prankster has attached a pink rubber pig to the ceiling by its feet. The only hint that these employees are sometimes moving billions of euros with the click of a mouse is the security door that restricts access to the room. They trade in foreign currencies and bonds, an activity they used to perform primarily for the German government or public pension funds. Now they also often do it for the European Central Bank (ECB) and its so-called "unconventional measures." Those measures seem to be coming on an almost monthly basis these days. First, there were the ultra low-interest rates, followed by new four-year loans for banks and the ECB's buying program for bonds and asset backed securities -- measures that are intended to make it easier for banks to lend money. As one Bundesbank trader puts it, they now have "a lot more to do." A Heated Dispute Ironically, his boss, Bundesbank President Jens Weidmann, is opposed to most of these costly programs. They're the reason he and ECB President Mario Draghi are now completely at odds. Even with the latest approved measures not even implemented in full yet, experts at the ECB headquarters a few kilometers away are already devising the next monetary policy experiment: a large-scale bond buying program known among central bankers as quantitative easing. The aim of the program is to push up the rate of inflation, which, at 0.4 percent, is currently well below the target rate of close to 2 percent. Central bankers will discuss the problem again this week. It is a fundamental dispute that is becoming increasingly heated. Some view bond purchases as unavoidable, as the euro zone could otherwise slide into dangerous deflation, in which prices steadily decline and both households and businesses cut back their spending. Others warn against a violation of the ECB principle, which prohibits funding government debt by printing money.

Is it important that the ECB adhere to tried-and-true principles in the crisis, as Weidmann argues? Or can it resort to unusual measures in an emergency situation, as Draghi is demanding? A Mixed Record in Japan and the US The key issues are the wording of the European treaties, the deep divide in the ECB Governing Council and, not least, the question of what monetary policy can achieve in a crisis. Is a massive bond-buying program the right tool to inject new vitality into the economy? Or does it turn central bankers into the accomplices of politicians unwilling to institute reforms? The question has been on the minds of monetary watchdogs and politicians since the 1990s, when a German economist working in Tokyo invented the term "quantitative easing." Its purpose was to help former economic miracle Japan pull itself out of crisis after a market crash. The core idea behind the concept is still the same today: When a central bank has used up its classic toolbox and has reduced the prime rate to almost zero, it has to resort to other methods to stimulate the economy. To inject more money into the economy, it can buy debt from banks or bonds from companies and the government. The Bank of Japan finally began to implement the concept, between 2001 and 2006, but the country sank into years of deflation nonetheless. After the financial crisis erupted, central bankers in Tokyo tried a second time to acquire government bonds on a large scale, in the hope that earlier programs had simply not been sufficiently forceful. Between 2011 and 2012, the central bank launched emergency bond-buying programs worth €900 billion ($1.125 trillion). Finally, in 2013, the new prime minister, Shinzo Abe, opened up the money supply completely when he had the central bank announce a virtually unlimited bond buying program. A Higher Debt-to-GDP Ratio than Greece But the strategy, known as "Abenomics," worked only briefly. After a high in 2013, in which Abe proudly proclaimed that Japan was "back," industrial production declined once again. With a debt-to-GDP ratio of 240 percent, much higher than that of Greece, investments declined again, despite the flood of money released under Abenomics. Businesses and private households were simply too far in debt to borrow even more, no matter how cheap the monetary watchdogs had made it. The banks, for their part, still failed to purge all bad loans from their books, because the central bank was keeping them artificially afloat. "For decades, the Japanese government did not institute the necessary structural reforms," says Michael Heise, chief economist at German insurance giant Allianz. Ben Bernanke, the former chairman of the US Federal Reserve, demonstrated that under different circumstances quantitative easing could indeed work. After the collapse of investment bank Lehman Brothers, Bernanke, a monetary theorist, spent close to $1.5 trillion to buy up mortgage loans, corporate bonds and US Treasury bonds. A second program was launched in 2010, followed by a third in 2012. This time the Fed decided that the program would continue until unemployment had declined to 7 percent.

Bernanke's successor, Janet Yellen, only put an end to the latest round of quantitative easing last week. During this period, the Fed, through its emergency measures, has inflated its balance sheet by about $1 trillion to $4.5 trillion, and the economy is now falling into step once again. Unemployment has dropped from 10 to 6 percent, and the annualized growth rate in the third quarter was 3.5 percent. Many observers believe that this alone proves that Bernanke's mega-experiment was a success. Relatively strong consensus only exists over the fact that the Fed, with its massive intervention, quickly returned many credit markets to normality after the crisis erupted by buying up securities that suddenly no one else wanted. But have the quantitative easing programs also stimulated the economy in the long term? In a study, the Fed itself concludes that its programs reduced the unemployment rate by 1.5 percent in 2012. Other studies found that long-term interest rates on government and corporate bonds declined significantly as a result of the Fed's buying spree. Still others question the efficacy of the programs, especially more recently. So who's right? "It's nearly impossible to measure that," says Clemens Fuest, president of the Center for European Economic Research, "if only because we don't know what would have happened without the programs." Strong Side Effects The lack of certainty has led many economists to believe that the effects of the bond buying programs were not all positive. On the contrary, the longer the central bank pumps up the markets with its injections of liquidity, they warn, the stronger the policy's side effects get. Because yields on many investments declined along with borrowing rates, more and more market players ignored the risks associated with many halfway lucrative business opportunities. In Europe, for example, bond traders and other investors began buying up Greek, Spanish and Italian government bonds after the debt crisis had subsided, so that some of the former crisis-ridden countries are now paying even lower interest rates on new borrowing than before. Meanwhile, in the United States, corporate debt securities known as junk bonds became the latest trendy investment. Junk bonds come with an enormous risk of default, but they are also considered very high-yield investments. The market blossomed, at least until recently. But what this means for the US economy may not become apparent for several years. More than $700 billion in junk bonds will mature by 2018, and "a large number of companies will suddenly have great trouble finding follow-up financing," warns Allianz economist Heise. On the global exchanges, the mood among investors was long delirious. In June, the Bank for International Settlements, an international organization of central banks, noted a "puzzling disconnect" between the boom and actual economic developments. Because debt has also been growing worldwide, the financial system is, in a certain sense, even more fragile than before the crisis, said Jaime Caruana, the bank's general manager.

Whether this is true could become apparent in the next few weeks. Once the Fed has stopped its ongoing injection of liquidity into the economy, many observers fear severe withdrawal symptoms in markets and exchanges. Growing Pressure for ECB President to Act Nevertheless, ECB President Draghi is coming under growing pressure to hazard the risky experiment in the euro zone. The region's economy is stagnating and inflation continues to decline. "If the central bank did nothing to counteract the threat of deflation, it would be like withholding treatment from a patient with pneumonia because of the potential side effects," argues Joachim Fels, chief economist with investment bank Morgan Stanley. The only problem is that the recipe for cheap money is no longer showing much effect in Europe today. In September, ECB President Draghi offered banks four-year loans at ultra-low interest rates, under the condition that the institutions would pass on the funds to the economy through lending. But the amount of borrowing that ensued -- €82.6 billion -- was significantly less than anticipated. The demand for credit is simply too low in many places. The economy is ailing as a result of a lack of investment and low consumption rates, because households and businesses in a number of countries are still in too much debt. Countries like Italy and France are also dragging their feet with important reforms that could make their industries competitive once again. A 'Largely Pointless Exercise' If the ECB does launch a buying program for government bonds, another problem arises. To avoid coming under the suspicion of trying to provide funding primarily to crisis-ridden nations, it will probably have to acquire the bonds of all euro-zone countries. For the ECB itself, the most likely approach is to simply base its bond- buying program on each country's initial contribution to the ECB, known as the capital key. But then the central bankers would also have to buy large numbers of German bonds, which would be a "largely pointless exercise," as Willem Buiter, the chief economist at US bank Citigroup, puts it. Interest rates on some German government bonds are already in the negative range. Buiter can readily be described as a proponent of active monetary policy, and yet he too believes that this approach only works if accompanied by structural reforms. Monetary policy alone isn't enough to combat persistent stagnation, he says, "which is what the euro zone is heading for." It's no surprise that the ranks of skeptics are also growing within the ECB. Bundesbank President Weidmann has long warned that the central bank cannot be allowed to become a "sweeper" for policymakers. Now German ECB Supervisory Board member Sabine Lautenschläger is coming to his defense, saying that the purchase of government bonds could only be a "last resort" in the event of a deflationary spiral, essentially the final ammunition of monetary policy. The critics of further quantitative easing measures also include the Executive Board members from Luxembourg, Austria, the Netherlands and Estonia.

It was US economist Melvyn Krauss who proposed a compromise in the German financial newspaper Handelsblatt last week that many central bankers read with interest. According to Krauss, the ECB could exclude from a bond purchasing program countries that Brussels had admonished for deficit violations. In this way, quantitative easing would become an "enticement" for politicians to institute reforms. Will Krauss's proposal produce a consensus? Europe's central bankers remain skeptical. "I don't see the south accepting this," one of them said, referencing to Southern European countries. Translated from the German by Christopher Sultan URL: • http://www.spiegel.de/international/business/deep-divisions-emerge-over-ecb- quantitative-easing-plans-a-1000713.html Related SPIEGEL ONLINE links: • The Zombie System: How Capitalism Has Gone Off the Rails (10/23/2014) http://www.spiegel.de/international/business/capitalism-in-crisis-amid-slow-growth- and-growing-inequality-a-998598.html • EU Banking Stress Tests: 'Far-Reaching Reforms Are Needed' (10/23/2014) http://www.spiegel.de/international/business/stress-tests-in-europe-interview-with- mohamed-el-erian-a-998612.html • 'Poets and Alchemists': Berlin and Paris Undermine Euro Stability (10/20/2014) http://www.spiegel.de/international/europe/euro-stability-threatened-if-france-flouts- stability-rules-a-997995.html • Out of Balance? Criticism of Germany Grows as Economy Stalls (10/14/2014) http://www.spiegel.de/international/germany/germany-and-finance-minister- schaeuble-under-fire-as-economy-slows-a-996966.html • Bungle Bungle: Italy's Failed Economic Turnaround (10/06/2014) http://www.spiegel.de/international/europe/matteo-renzi-struggling-to-solve-italian- economic-crisis-a-995558.html • German Central Bank Head Weidmann: 'The Euro Crisis Is Not Yet Behind Us' (09/24/2014) http://www.spiegel.de/international/business/interview-with-bundesbank-head-jens- weidmann-on-euro-crisis-and-ecb-a-993409.html • Germany's Ailing Infrastructure: A Nation Slowly Crumbles (09/18/2014) http://www.spiegel.de/international/germany/low-german-infrastructure-investment- worries-experts-a-990903.html

globalinequality

Monday, November 3, 2014 For Whom the Wall Fell? A balance- sheet of transition to capitalism

As I was leaving Berlin less than a week before the 25th anniversary of the fall of the Wall, and as celebrations there were going strong, I decided to look at the balance sheet of transition countries (even if the term is no longer fully adequate) over the past quarter century. I am originally from one of them, I worked on most of them in the 1990s, and I discussed and documented the Great Depression there in my 1998 book ”Income, inequality and poverty during the transition to market economies.” So, I was going back to a familiar terrain. What naturally comes to mind to an economist is to look first at how these countries have done in terms of economic growth. To fix the ideas, let’s call the counties that are yet (in 2013) to reach the level of real income of 1990, measured by real GDP per capita, clear failures. Then, let’s call the countries that grew more slowly than the average of rich OECD counties, that is at less than 1.7% per capita per year, relative failures. They are so because they are not converging to the rich countries’ income levels. The third group consists of countries that are just about keeping up with the rich world and have been growing at between 1.7 and 2 percent per capita. Finally, we come to the success cases, countries that grew by at least 2% per annum per capita over the 25-year period. Note that the requirement of growing by 2% per year during quarter a century is not particularly onerous, nor is such an achievement very stirring: you would need 35 years, almost two generations, of such growth to double per capita income. (All growth rates are in per capita terms, derived from GDPs, based on 2011 International Comparison Project PPP data, and downloadable from the World Bank World Development Indicators.) How does the picture look? In the bottom group, of absolute failures, we have seven countries with a combined population of almost 80 million (20% of the population of all “transition” countries). They are, in order of the extent of their failure: Tajikistan, Moldova, Ukraine, Kyrgyz Republic, Georgia, Bosnia and Serbia. All except Ukraine (note that our data end in 2013) have been involved in civil or international conflicts. None is likely to reach its 1990 income any time soon. Basically, they are countries with at least three to four wasted generations. At current rates of growth, it might take them some 50 or 60 years— longer that they were under Communism!—to go back to the income levels they had at the fall of Communism. The relative failures include four countries (Macedonia, Croatia, Russia and Hungary). They, because of the large size of Russia, comprise 160 million people and represent the dominant of our four groups. Some 40% of transition countries’ populations live there. Their growth rates have been less or around 1% per capita. Those that are managing not to fall further behind the rich capitalist world are five: Czech republic, Slovenia, Turkmenistan, Lithuania and Romania. They include 40 million people

(10% of transition countries’ total). Their growth rates have been between 1.7 and 1.9 percent per capita annually. Finally, we come to the success cases, those that are catching up with the rich world. There are 12 countries in this group., and in increasing order of success they are: Uzbekistan and Latvia (average growth rate of 2%), Bulgaria (2.2%), Slovakia and Kazakhstan (2.4%), Azerbaijan, Estonia, Mongolia and Armenia (around 3%), Belarus (3.5%), Poland (3.7%) and Albania (3.9%). The population living there amounts to 120 million (almost a third of the total). If we concentrate on success cases, several of them (Azerbaijan, Kazakhstan and Uzbekistan) are resource-rich economies whose success is entirely explained by the exploitation of hydrocarbons, gold or other minerals. The real capitalist successes are only five: Albania, Poland, Belarus, Armenia and Estonia, having grown by at least 3% per capita per annum, almost at twice the rate of rich countries, and without an obvious help of natural resources. Armenia is particularly remarkable since its original period of transition was rocky due to the war with Azerbaijan. If in addition to growth, we broaden our gaze to income inequality, there we have extremely high increases in some countries like Russia (which, with a rather sluggish overall growth produced very modest decreases in poverty), the three Baltic countries, and Georgia. In all of them, inequality, measured by the Gini index, increased by more than 10 points, which is twice as much as it increased in the US between mid-1980s and today. On the other hand, central European countries registered rather small Gini increases and currently have stable low-to-moderate inequality levels, very much in line with the rest of OECD. The data for Central Asian countries are not reliable, but they most likely underwent a significant increase in inequality. Further, if we require that a successful tradition to liberal capitalism should in addition to the catch-up with the rich world and rather moderate increase in inequality imply also a consolidation of democracy, and we go back to our list of five success cases, we must, on account of unconsolidated or inexistent democracy, drop Belarus and Armenia. (In 2012, Belarus’s Polity score for democracy, on a scale from minus 10 to plus 10 is -7, and Armenia’s +5.) That leaves us with only three successes: Albania, Poland and Estonia.Albania had a somewhat less than exemplary transition to democracy, and it still may not be included in the list of the fully consolidated democracies (although its current Polity score, like Estonia’s, is a high +9). Data on pre-transition inequality are inexistent for Albania, so we really do not know how much inequality increased there. Most people’s expectations on November 9, 1989 were that the newly-brought capitalism will result in economic convergence with the rest of Europe, moderate increase in inequality, and consolidated democracy. They are fulfilled most likely in only one country (Poland), and at the very most in another, rather small, two. Their total populations are 42 million, or some 10% of all former Communist countries. Thus, 1 out of 10 people living in “transition” countries could be said to have “transitioned”to the capitalism that was promised by the ideologues who waxed about the triumph of liberal democracy and free markets. In this short piece, obviously, I cannot go into political developments which were also much worse than expected, nor into wars that continue and have cost, conservatively estimated, 250,000 lives so far (from Nicholas Sambanis’ database on ethnic conflict), nor into major declines in life expectancy in Russia and Ukraine, nor into sluggish or negative population

growth rates in most European former socialist countries, nor into all pervasive corruption and kleptocracy. Let me just focus on one often overlooked fact. It is most strikingly illustrated with respect to Russia. Russia, probably for the first time since the early 1800s, has gone through a quarter of a century without leaving any trace on the international world of arts, literature, philosophy or science. One does not need to mention Russia’s “Silver Age” of the early 1900s, nor a number of writers who, often in the opposition to the regime, produced some of the best literature of the 20th century (Akhmatova, Pasternak, Grossman, Sholokhov, Solzhenitsyn, Zinoviev); one does not need even to dwell on scientific progress, indeed limited to the military or military-used production, in the USSR, to realize that nothing similar happened in the past 25 years, which is indeed a sufficiently long period to draw conclusions. Capitalism was not kind to Russia’s arts and sciences. The same is true for smaller countries like Poland, Hungary, Yugoslavia and Czechoslovakia who, between 1945 and 1990, produced important poets, writers, philosophers and artists. I might not have followed fully the current intellectual trends, but I really cannot recall, with a few exceptions (and there I confess to my own bias) anyone from Eastern Europe who has made an intellectual or artistic imprint on the world in the past 25 years. The exceptions, in my opinion, are almost all from the former Yugoslavia (here is my bias): Emir Kusturica (film), Goran Bregović (music), and Slavoj Žižek (political philosophy). Interestingly, all have roots in the non-aligned Titoist Yugoslavia and often draw inspiration from it; e.g. Bregović’s music would not exist if he had to limit it to one of the new countries (i.e., former republics). To that very subjective short list I might add the Bulgarian political scientist Ivan Krastev. (Obviously, I am not including researchers who might have done excellent work on their own countries. I am interested in those who had influence beyond their borders, some international impact.) Another glaring absence is that of interesting and important political leaders. I do not include here Putin who is obviously important but whose influence while, in my opinion, positive in the first 5-6 years of his rule, has been increasingly negative since. Political leaders of the new states are hardly known to their own populations, much less to the others. I think it is a fair guess that, other than for Putin, 90% of the population in transition countries would be unable to name a president or prime minister of any other transition country than theirs. Midget countries have produced intellectual midget leaders who either rule by iron hand (Nursultan Nuzerbayev in Kazakhstan, Islam Karimov in Uzbekistan), or have created a dynasty (Aliyevs in Azerbaijan), or have been in power for some 30 years (as in Central Asia and Milo Djukanović in Montenegro) or just mindlessly repeat mantras coming from Brussels or Washington. So, what is the balance-sheet of transition? Only three or at most five or six countries could be said to be on the road to becoming a part of the rich and (relatively) stable capitalist world. Many are falling behind, and some are so far behind that they cannot aspire to go back to the point where they were when the Wall fell for several decades. Despite philosophers of “universal harmonies” such as Francis Fukuyama, Timothy Garton Ash, Vaclav Havel, Bernard Henry Lévy, and scores of international “economic advisors” to Boris Yeltsin, who all phantasized about democracy and prosperity, neither really arrived for most people in eastern Europe and the former Soviet Union. The Wall fell only for some. Posted by Branko Milanovicat5:34 PM http://glineq.blogspot.com.es/2014/11/for-whom-wall-fell-balance-sheet-of.html

Discussion: Jeff Madrick, Ylan Mui, Josh Bivens, Brad DeLong: Lightly-Edited Transcript: Jeff Madrick EPI Event: http://delong.typepad.com/2014-10-22-jeff-madrick.pdf How Mainstream Economic Thinking Imperils America: Focus by Posted on November 3, 2014 at 2:53 pm Share Ylan Mui: I want to kick it off with a question to you Josh. There have been a lot fingers pointed when it comes to blame for the financial crisis–Wall Street greed, predatory lending, et cetera–but rarely has a finger been pointed at the economists themselves. Do you think your profession deserves blame? Josh Bivens: The one word answer is yes. Jeff’s book is entirely right: most the ideas covered in his book have indeed been put to damaging use in US policy debates. But we should be careful to also say that a lot of the ideas actually contain useful nuggets. They are bad and dangerous ideas when they are improperly invoked—-when the people who invoke them cannot differentiate when one of the ideas should be taken as a description of how the world works versus a prescription for how we should make it work. That is one big way that they can be put to dangerous use. I can say more about that later. But I think, even more importantly, they are really bad and dangerous when they are mobilized by people… It’s tough to say this nicely… By people with either really weak minds or with old and ideological political motivations. Let’s get specific: macroeconomics and recession-fighting. Jeff’s second chapter is about the claim that economies have self-correcting properties that keep recessions short and shallow. If it were true, we would not have too much to worry about as far as fighting recessions. This is obviously a dangerous idea. Get really complacent about fighting recessions, and you know what happens: We see the past five years. We see millions of people unemployed and underemployed. We see sluggish wage growth. It is really obvious that the DC policy-making class has been way too complacent about fighting the recession. I can go off for a long time about the fiscal-policy side as well. In terms of the question about who deserves the blame: Where are the channels by which bad ideas infect the policy-making process? It is much more than the monetary policy front. The actual monetary policymakers with PhDs have done a much better job than almost anybody else in the US scene in responding to the crisis. mean Ben 93

Bernanke and Janet Yellen have not been excessively complacent. You–we–may have wished they had been more aggressive, that they had seen that the economic world in more of a crisis and had taken stronger action to keep the world economy from being even more engulfed in flame than it has been over the past five years. But they have not been complacent. They have been pushing really hard to do something about the economic crisis. It is the policymaking backseat drivers–the congressional committees–that summon them and chastise them for setting the stage for hyperinflation. It is the regional Federal Reserve Bank presidents who do the same thing. They are the ones who have been arguing aggressively for more complacence. This divergence between the actions of actual PhD policymakers and others on this front illustrates the channel through which these bad ideas actually infect the policy making process. Have they really hypnotized the minds of professional economists? Have they just become an easy cover for policymakers who do not want to take what professional economists tell them about how to make good policy? I wish I could say professional economists were totally off the hook–that we are all giving good advice; that it is just Paul Ryan and Rand Paul who are perverting the policy. But we know that is not the case. There are enough economists to keep the water muddy. I’ll end really quickly here: I was asked by a reporter, “Can we now take… people who deny that fiscal stimulus at zero interest rates helps an economy recover, can we treat people who deny that like climate change deniers? Can we just say “all experts , and they are completely beyond the pale”? Sadly, no. We cannot. I mean, I think the evidence says we should. There is just not a bigger slam dunk that I have seen in actual evidence as a social scientist. But we can’t. You’ve got people like Greg Mankiw, who defended the Bush tax cuts of 2001 and 2003 on purely stimulative macroeconomic arguments, who then in 2009 when the Obama stimulus is being debated links to every anti-stimulus argument there is. He does not actually endorse each one specifically. But: come on, every day he links to five of crazy ideas why the stimulus is bad. While I would love to say that Jeff’s bad ideas have not hypnotized economists–that they have just provided a cover for those who want to block the translation from economist wisdom to policy. I cannot. It is just not true that these bad ideas have only provided a useful cover for non-economists going to bat for bad policies. A last thought: Part of the missing ingredient here–why economists are not useful actors in policy debates–is not just that they hve been suckered by the big big ideas Jeff is talking about. Their is lots of conscious and unconscious class bias among economists that affects how they enter policy debates. I think this is a missing ingredient. I’m sure we can talk more about that later. Ylan Mui: Brad what do you think? Is the problem the academics or the policy, the description or the prescription? Brad DeLong: Do you want me to talk about monetary policy, about fiscal policy or about finance? I can do all of them, or one of the three.

Ylan Mui: Why don’t you start with monetary policy? [Laughter] Brad DeLong: I see four big gaps between where we should be and where we are: 1. The gap between what real economists should be saying about monetary policy, and what I think they do say. 2. The gap between what I think real economists do say and what Jeff thinks real economists do say. 3. The gap between what Jeff thinks real economists do say and what the Washington policymaking and the global policymaking community take real economists to be saying. 4. The enormous gap between what the Washington and the global community thinks real economic wisdom is and the policies that are actually being followed. All four of those gaps are large. I would say the fourth is the largest. I would say the third is the next to largest. And the first two gaps–well, it seems to me that they are actually not all that huge. We do not know what Milton Friedman would be saying in this particular conjuncture if he were here with us. He was an unpredictable guy. He was a very smart guy. He was smart both at finding insights into how the world worked and also, unfortunately, finding clever arguments so that he did not have to listen to evidence about how the world worked when it disturbed his beliefs. It is an occupational hazard of people who are a little too book-smart, a little too intellectually-talented. They can get away with plausible rationalizations too easily. But when Friedman was confronted with a situation like that of the US today, that of Japan in the late 1990s, his policy prescriptions were very clear. Up until then he had counted on the velocity of money to be a relatively stable variable–if not greatly disturbed by extraordinary financial distress. And so he believed that if you simply kept the money stock of the economy on track that would keep total spending on track and would keep the economy stable near its “natural” rate of unemployment. In Japan in the late 1990s Friedman found himself faced with a situation in which keeping the money stock’s growth path on track did not keep spending in Japan on track. His answer was that in such a case you should throw overboard his constant money stock growth rule. What Japan should do, Friedman said in the 1990s, is print money, Keep printing money. Print more money. Do not care that the short-term interest rates are “too low”. Do not care that long-term interest rates are “too low”. Low interest rates, he said, do not tell you whether money is improperly easy. Only the total level of spending tells you whether money is too easy. Thus Friedman’s policy advice for Japan in the 1990s was: Massive quantitative easing. If that does not get spending and employment back to where you want it to be, do some more. And if that does not work, do even more. Helicopter drops. Now it is a fact that there is not one single person on the Board of Governors of the Federal Reserve or in a Federal Reserve Bank President’s job who is right now as far to the “left” as Milton Friedman was in monetary policy [except, perhaps, for the Federal Reserve Bank of Minneapolis's Narayana Kocherlakota]. They all talk about vague

“risks” of excessive quantitative easing. They talk about the importance of the taper and of avoiding excessive growth in the balance sheet. They talk about how their models show convergence to something like full employment over the next three or four years– during which they plan to continue to fail to hit their 2%/year inflation target. They talk about the relatively-rapid soaking-up of excess labor supply through various structural changes in the labor market–which so far have no support anywhere in the wage data. If Milton Friedman with his opinions of monetary policy in a liquidity trap of 1999– Milton Friedman without his name–were nominated to the Board of Governors of the Federal Reserve right now, I donot think he could get 50 votes. I think he would be regarded as too much of a crazy left-winger. This is an extraordinary situation we find ourselves in. It is one that makes me wake up at night in a cold sweat about one day a week. Ylan Mui: So, Jeff, do you have any comments or response to their thoughts? Jeff Madrick: Yeah, sure. I mean I’m sure Brad has a lot of thoughts about other people besides [Inaudible] Ylan Mui: [Laughter] The other nights of the week he wakes up in cold sweat. Jeff Madrick: I always remember reading Robert Solow’s criticism of the Friedman and Schwartz Monetary History book, and Solow said: “Well, it’s an odd book that says velocity is one thing during one decade and something totally different in another decade.” It was a little bit hard for him to square this constant-velocity idea with Friedman’s claims about money. I tend to think of money as more endogenously created by business activity than exogenously created. Finally, in terms of Friedman as a left winger, left-wing is not only about stepping on the interest-rate pedal–lowering rates– it’s about regulations. Janet Yellen, I’m very glad to see, as Fed Chairman is talking about how lower interest rates alone might lead to risk but there are other ways to deal with speculative risk that were neglected badly, not just under Greenspan but to some degree under Bernanke, who I have a lot more respect for than for Greenspan. There are regulatory tools, and I doubt if Friedman would be in favor of this kind of capital controls. Ylan Mui: Well, Jeff, let’s get to a broader question. What exactly are you considering “mainstream”? In your book you cite Stiglitz and Shiller as people who called it right. Certainly they are part of the mainstream economic consensus. So how are you defining this term? There are plenty of people outside the mainstream who I would suggest that you would disagree with too, hardly including these folks of the [Indiscernible] [Cross- talk] Jeff Madrick: Well, the point of the book is to talk about how the preponderance of economists who teach in major universities–not only on the right but on the left–came to a consensus on these views, and that in effect was my definition of mainstream. By and large it’s the acceptance of neoclassical economics for the most part, with some variation among them. Let me point out that these economists came together in believing in the great moderation. Blanchard was slightly left the center. Bernanke was probably slightly right of center. They both believed in the Great Moderation. They manufacture thed measure of their own success. Economists on the left and the right

believed in low and stable inflation as the primary policy objective. That’s what I’m talking about when I talk about “mainstream economics”. It was a very strong consensus on a lot of issues, I believe. While they did not have their hands literally on the policy levers all the time, very few decisions were made by a president or a Fed Chairman without talking to the economics departments. Economists had a lot of control: their ideas seep through the media and into the general population. Ylan Mui: We have a question from the audience, which is asking each of the speakers to address the ideal role of government in markets and in national economics. Brad, you want to start with you? Brad DeLong: Let me start with a parenthesis: In 1992 Larry Summers and I wrote a paper, stood up in front of the assembled Federal Reserve, and said that in our judgement reducing the target inflation rate below 5%/year ran risks that probably should not be run–as shown by the fact that had the inflation rate been significantly lower than the 4%/year or so that it had been in the late 1980s, the Federal Reserve would not have been able to do the expansionary policies it needed to do to fight the 1992 S&L crisis recession. That was a relatively small macroeconomic shock. There were and are large chunks of the mainstream that did not buy into 2%/year as the proper inflation target. Even though you can interpret Olivier Blanchard as not dissenting strongly from that target before 2008, since he has gotten into his post at the IMF has has been dissenting from 2%/year more strongly than anyone else. Olivier Blanchard and his boss Christine Lagarde are now the left-most people on monetary policy in any public-sector organization today. If there is an equivalent of the Sixth Socialist International today, they are it. On the question of the proper rule of government… There are stringent requirements for market effectiveness for anything like the invisible hand to actually work well. We need to have the distribution of wealth we start with to correspond to fairness and utility for lots of reasons–straightforward utilitarian reasons, and also that equality of opportunity is a joke without substantial equality of result to support it behind it. We need to have aggregate demand matched to potential supply. We need to have competition. We need to have calculation–that is people need to know what their options are, be able to assess them accurately. Goods and services need to be rival, in the sense of no public goods or no increase in returns so it actually makes sense to charge prices for them because in consuming a good you are using up some scarce resource. Goods and services need to be excludable,so that you can actually make price-taking markets function. There need to be no information asymmetries–no situations in which one side of the market knows a great deal more about what they are buying or selling that the other does. If those requirements are not all met, then the invisible hand theorem simply fails. Jeff talks about Arrow, Debreu, and Hahn building up the enormous edifice of modern 97

general equilibrium theory. He talks a little less than I would about how the lesson all the three of them drew from it was that these requirements were extraordinary stringent–not to be found very much in the real world. If we take a look at the world out there, I think we can see decreasing relevance of the Smithian model. As we live longer, we find that more of our economy has to go into pensions and healthcare finance in which problems of miscalculation and myopia on the one hand and of information asymmetry on the other are absolutely enormous. We also are spending a lot more on education. We are spending more on infrastructure as the average lifespan of the goods and services we produce increases, and as interdependencies increase. Research and development and information goods in more general are the heart of where any kind of Smithian invisible hand theorem will fail. So not only are the requirements for market effectiveness extremely stringent, but they will apply to a smaller share of the economy in the future than they have in the past. If we are going to right-size the market over the course of the next century, we economists really do need to think very hard. Mostly what we need and what other social scientists need is a grammar of alternative forms of organization. Markets are not the only way to organize things. We have command, we have bureaucracy, we have charity, we have cooperatives, we have Wikipedia, we have regulated monopolies, we have yardstick competition, we have a whole bunch of other things. And if we had a better grammar of where each of these succeeds and where each fails, we would have a much better discussion. As it is though, we have a bunch of people who yell that government is not competent and fails always. We have some other people who whimper that sources of market failure are relatively strong. Some other people say all you have to do is to cut property rights at the joints in the correct Coasian way. None of those three positions seem to meet to come close to doing the job. Ylan Mui: Josh, what do you think? Josh Bivens: Let me focus on just the narrow part of it because I’m narrow minded and to bring it back to Jeff’s… Ylan Mui: Like a mainstream economist? Josh Bivens: Yes… Jeff’s second chapter. The proper role of government is huge question. But it seemed like the one that should be pretty much non-ideological and non-partisan. We should at the very least not let the economy founder well below fall employment for a long periods of time. There is no conservative or liberal case for: “Yes, really high rates of unemployment are somehow good”. The minimum government should do macroeconomic management There’s no reason why the response to the big shortfall in demand in 2008 couldn’t have been—were going to zero out payroll taxes for three years. It would’ve worked. It wouldn’t been the most efficient, but it would’ve done something to stimulate the economy. Yet a serious absence of anything like a serious sort of proposal from the right anywhere near the scale of the demand shortfall has led to the five years of just terrible times. I think that’s a little bit of an indication for Jeff’s thesis…

Brad DeLong:& And not just from the right. It was Barack Obama who stood up in his 2010 State of the Union address and said that the time for expansionary fiscal policy is over. That because American households had to tighten their belts so the government needed to tighten its. Christina Romer was out there trying to nail the Obama administration to the position: “No 1937s–no premature withdrawal of expansionary fiscal support from the economy until the recovery is well established.” But right now, if you go over to the White House briefing room, they are talking about how wonderful it is that the deficit has fallen by so much. It has fallen from a level that was appropriate to the state of a macroeconomy to a level that I think is at most a third of what it should be, given the state of the macroeconomy, given the extraordinary shortfall of output below what it ought to be according to any serious measure of the trend of potential, and given the extraordinarily good terms on which the government can borrow right now. That is: any private organization–any market organization–that could borrow on the terms the US government can borrow right now would be borrowing like mad, and investing and making every single long-term capital investment it was going to make over the next 30 years right now. We ought to do that. Ylan Mui: I want to get–I want to get Jeff a moment to respond ,but also I want to let you guys know that if you have questions, if you want to challenge Brad or Josh or Jeff you can come up to mic and ask your questions as well. Jeff, what’s your response? Jeff Madrick: I just think I seriously disagree with Brad on this issue. Not that Obama prematurely withdrew. In my own writings, I was arguing about that all the time. Christina wrote a very good essay, I wrote about it many times about multipliers over one, it was an excellent piece of work but the fact is a large proportion of the economics community battle that idea. Many supported the first Obama stimulus. I haven’t seen evidence about whether they would’ve supported a second Obama stimulus or still bigger one after that which I think we both agree would’ve been desirable. I think Brad’s talking about an ideal wish list that economists for the most part are not talking about. There’s enormous pressure not to increase healthcare spending but to control Medicare and Medicaid spending and so forth. There’s enormous pressure not to invest in R&D. Let me name names of the major mainstream economists. There’s an extraordinary assumption that government R&D was not the significant or even the most significant factor in technology advance in America even the Post-World War II period. I love Bob Gordon, but he gave a talk about how the stagnation of technology and then somebody asked him questions about future technology. He said, “Well, that’s been through private capital not government. That’s not government.” Well, that ain’t so. It’s been government all the major venture capital has got into areas where government has been the leading investor. I think Brad gave a beautiful wish list, but it’s a wish list. There’s a lot of decent stuff. I mean in my own defense, regarding Arrow and so forth, I would never say that Arrow defends market optimality. I think he spends his whole career showing how the extreme assumptions may had make it highly unlikely. Ylan Mui: Any questions from the audience? While we wait for someone to be brave enough to ask the first question I have another one for you Jeff, which is: You said that part of the reason you wrote the book because

you don’t want us to repeat the mistakes of the past. To what extent do you think that mainstream economics has incorporated lessons from the financial crisis and is shifting? When we talk about unemployment now as the problem, not inflation, the IMF has spoken many times about the need for infrastructure investment et cetera. So are you seeing some of these ideas start to shift? Jeff Madrick: Yeah, I’m seeing some of it start to shift. Brad brought this up also. I mentioned very explicitly that Olivier Blanchard changed his mind. But after you get wounded you begin to believe in God. He got wounded. He now believes in God. Thank goodness. He did and then a guy named Daniel Leigh, I did a little conference on this long before Blanchard sponsored the research with Daniel Leigh on demand and growth. It was hard to get that stuff out there. And who is knocking heads together? Alesina of Harvard, not the Chicago guys but Alesina… Brad DeLong: He was born in Italy, and has the Italian’s view of the effectiveness of government having watched the Christian Democratic party run Southern Italy like feudalism for forty years. Jeff Madrick: Well in any case, Alesina was knocking heads together proposing that austerity works and it was… Brad DeLong: But he was the only one of the 40 people on the Chicago Business School panel of expert economists, right? Nobody else agrees with him, right? Jeff Madrick: But he had the year of George Osborne. 20 LSE economists wrote in favour of the Osborne budget. They were all–it’s not as if the Germans don’t have the school of thought, it is, we think, a perverse school of thought, but they have an economic school of thought. They don’t represent the mainstream here so much, obviously. My point is there’s has been a lot of economic influence in the wrong direction and I fear I’m not answering your question. [Laughter] Ylan Mui: Josh, Josh, what are your thoughts here? I mean do you feel like there’s been a shift in mainstream thinking? Josh Bivens: It’s pretty early to tell. I mean let me step back. I think, again, this discussion is about where does the breakdown happen between in the policymaking process. Why do we get so many bad policy outcomes> Is the problem economist who generated that the front-end of the chain? Or do they somehow get messed up along the way, and it’s the policy makers on the ground who garble the ideas and get it wrong? And I think there’s blame to go around for sure. In Jeff’s book I think it’s mostly about that top of the food chain where the ideas come from. I will say I think Brad does have some points in that. We’ve got a lot of economists saying some sensible things, and yet we’re doing almost nothing sensible these days in economics. And so I would like as much attention as Jeff has put in his book on how to make sure economists have better ideas–and this is really self-serving because I work in a policy institute–but I think we need a lot more attention and resources aimed at places to figure out how to make that translation so that the good ideas in economics actually make it unscathed through the policymaking process. I see lots of people who want to throw a lot of money to change how economists think and that’s worthy goal. But there’s also this other really important channel that doesn’t

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get enough attention: How to make sure that the good ideas that the economists have find good shepherds in the policymaking process. I have to argue EPI is a pretty good shepherd of such things and there’s lots of… Ylan Mui: So you’re saying the problems aren’t diversity of thought it’s transmission of thought. Josh Bivens: It’s not the only problem. Transmission is a problem. Brad DeLong: The Council on Foreign Relations can put on absolutely the worst conference on the macroeconomy back in March 2009. Even at retrospect I can only marvel at the total incompetence and irrelevance of the people chosen to speak. In fact, as long as I live, at the end of March I am going to make it part of April Fool’s Day on my weblog to make fun of them. Ylan Mui: Questions… Brad DeLong: EPI has a hard time getting stuff out… Ylan Mui: A question from the audience. Audience 1: Yes. May be Josh’s comments were particularly good. I think to set up the question that I had and that is on a question of currency manipulation. Of course I’m operating under the disadvantage for not having read your book. You mentioned that you have a chapter on globalization. My view and I think that the institute is confusing itself with the importance of if there’s one thing that one could try to change to help setup a better international economic system would be counteract currency manipulation but we don’t see this. Just a few weeks ago yet again the Treasury Department says no currency manipulation. The question I have for our guest, for you Jeff is to what extent–maybe you can help us unpack this, to what extent is that an economic question, let’s say from a point of view of some economists, is it a–to what extent is it a question of that it’s sort of that not getting into that area is something that business people whose business model depends on not dealing with that issue? How do they perpetuate this? What about the politics at this, the hill politics, all of that? Maybe we could get to Josh’s question in that particular area. How do we move from this stagnation and obviously outdated policies to something better? Jeff Madrick: It was directed at me and I guess everybody will speak on that. Obviously, currency manipulation is a major political issue. It’s a very old free trade issue. We do one thing and they retaliate with some other policy that under minds what we do. I would like to see a different evaluation for the dollar. I would like to see them stop doing that. Partly they started manipulating the currency when they joined the WTO because they were forbidden from doing some other things that help their exports. So I think it’s—one of the major problems we face is the fact I did a little piece where I included this, in New York Times, a worldwide agreement on how to set exchange rate policy. Now we, long time ago in the 1970s, decided we just let the market decide. And here I’m probably—they’re two issues of course. You can manipulate the market but also specially with the dollar, the dollar price is trying to settle two different kinds of 101

markets who reserve currency market and the trade market so it seems implausible to me that one price would solve both problems but I don’t have the easy answer for that but I do think some economist, Peter Tanman for example are talking about having there is a priority in dealing with the balancing of trade deficits and trade surpluses in the world. It can’t be forever that the only grow—reasonable growth model is export growth. But by and large historically, export growth has been the launching pad for most economists so you raised probably the most difficult question for which there is only not an easy answer. Ylan Mui: Josh? Josh Bivens: I really agree with that question. Of all the policy debates, in terms of starting from some kind of consensus among economist, I don’t really think it exists on that issue so much. And then there are all of the barriers to getting anything like a consensus expressed in policy. There are administration officials who will say: we have a lot of things to worry about our relationship with China and a lot of this sort of currency managing countries, and why does this one go to number one? I’m definitely of the mind that if we can convince these countries to stop ploughing tons of money into our economy rather than their own that would be a really good thing for both countries in the long run. But one has a lot of hurdles going from consensus through the policy making. So that one I think is the hardest to generate what exactly the breakdown is. Other ones are a little easier: like why our congress people who have no say over monetary policy have been hearings for the scream at Federal officials. They think they have a stake in a not-very-good economy for the time being. I mean I think it’s pretty much simply that crude. Brad DeLong: You don’t think they’ve been listening to the wrong people–having dinner with Cliff Asness and John Cochrane? Josh Bivens: I don’t think they believe—-I think those people will tell them something entirely different if all of a sudden Republicans were seen as in charge of the economy and responsible for bad economic outcomes. Brad DeLong: I don’t think Asnes and Cochrane would. Josh Bivens: Naah, okay. But they would stop talking to them. Brad DeLong: And they would be having dinner with Greg Mankiw instead? Josh Bivens: Yeah… Brad Delong: Right… Ylan Mui: Larry Mishel Larry Mishel: Thanks. I think it is interesting to think about the problems at two points of the food chain. One is where the economists are a weakness. The other is then what happens even beyond that. Just getting to the whole issue of the Great Recession and the inadequate response which shapes this debate, one of the things that surprised me so much–I was a little shocked about the complete rout of Keynesian economics in the academy. There was

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very little–there’s a group, but outside of Berkeley and some people at Princeton and whatever, it was a pretty thin group to support the idea of an active fiscal policy. We also have to think about, even given that, why was there the bad turn in the Obama administration? The giving-up of the stimulus, and part of it is that the whole idea stimulus was defeated in the public marketplace ,in part because there was this stimulus and the unemployment rate didn’t seem to get to where people wanted it to be. Jeff Madrick: Or was promised. Larry Mishel: It was promised–well, that was a mistake, but part of that is that we just had a really, really, really deep recession and has really hard to do almost everything that you could to get the unemployment rate back to full employment within a year or two. It’s just not going to happen. Brad DeLong: Well, if your problem is a disruption of the housing finance credit channel, actually doing something to fix the housing finance credit channel might help. Audience 2: I’m very sympathetic to the fact that there has been a major defeat in the academic world for activist fiscal policy. That was pretty clear. It’s not all of our problems. I guess it’d be useful to think about what are the range of problems that we are confronted with, even if you were to get to the point where academia is correct. Part of it is that we are not talking about the incredible power of money in politics and policy, and the role of Wall Street in both the democratic party and in the Republican party. Maybe we should comment a little bit about that. Brad DeLong: As I said, I see economists somewhat differently. I see 38 of 40 of the Chicago Business School Panel’s contributors saying: yes, expansionary fiscal policy does produce benefits. Even though we are only, I think, at 32 out of 40 saying the stimulus was a good cots-benefit idea–the other seven plus Alberto Alesina saying that the debt was already too high for the benefits to be worth it. The rout in the academy was—-if it was there–extremely short-lived. It was tied to a momentary boomlet behind Giavazzi-Alesina ideas of expansionary austerity because it would somehow summon the Confidence Fairy. It was coupled with the very smart Ken Rogoff and Carmen Reinhart’s greatly overselling their evidence about the potential risks run by running up high national debt due to (a) an analytical mistake in terms of choosing the wrong baskets into which to sort their data, and (b) failing to properly distinguished between sovereigns that have exorbitant privilege in that they issue reserve currencies and sovereigns that do not. It looks to me like it’s recovered to pretty much where it was back in 2007. Jeff Madrick: You knowm what I was always struck by the Christina Romer essay ,in which she did empirical work or some rise empirical work on whether there’s a multiple, and she said specifically like she’s just defending herself, “I am not a Keynesian. I am simply an empiricist.” Now that to me suggested something. That to me suggested something’s going on in academia that being labelled a Keynesian made you something: being a Keynesian made you something of a pariah. I think that’s probably still the case of most of the empirical argument. But we’re not talking about a simple yes or no on the Obama 103

stimulus. Most people say yes. Mark Zandi’s model said yes, and he’s by and large a Republican. We’re talking about do we continue with the stimulus? Do we stop worrying about the deficit, on which there is so much pressure coming from the economics community I believe. It’s not a simple short term issue. I think the economics community thinks of it as so. I do think Larry’s right. I think the Keynesian argument was by enlarged routed. It’s still an embarrassment in some circles still call yourself a Keynesian, and that has to have an impact. And we should talk a little bit about EPI–one of EPI’s major issues which is what cause inequality. Do we really—and is there really economic—a correct economic consensus about that? I don’t know if he wants to talk about that. Larry doesn’t want to talk about that. Larry Mishel: That’s actually my question. Ylan Mui: Josh, do you have a point—a point you want to add? What do you want to say to your boss? Josh Bivens: We have a whole project on what calls the equality called Raising Americas Pay. You should check it out on our website. I mean I would say yeah, I think it’s an illustration I think of Jeff’s chapter one. For way too long the conventional wisdom was that labor is just like a commodity. There is supply and the demand for it, so if inequality rises something must’ve shifted those supply and demand curves. People go on about the race between education and technology. The work of Larry specially over the years has shown just not a lot of evidence that education or the increase in technology has been the big driver of inequality. Economists need to broaden out and actually look at the policy changes we’ve under taken over the past couple of decades that have intentionally shifted bargaining power from low and moderate wage workers to corporate managers and owners. I think one thing that keeps economist from looking there is that I don’t think their policy patrons are all that interested in looking too hard there. I also do think there’s a class bias among our economist. I mean look at the Chicago survey that Brad’s been talking about. They survey 40 economists of the Chicago Business School. They asked them basically a question, “Do you like Uber?” and the idea that they love Uber. They love the idea shaking up monopolies when the people are going to be hurt by that are taxi drivers. They asked them: do you think the US software patent system is doing well? Most of them said–a third well, a third badly, a third I don’t know. Brad: Somebody thinks software patents are doing well? Josh Bivens: Because there are some really rich people making money off software patents. They’re a lot harder to kick than taxi drivers. And so I really do think when it comes to applying the simplistic theory of chapter one of Jeff’s book. It matters a lot…. Brad DeLong: And I have an email from a student saying: I think the evidence is that while there are a lot of good ideas in intellectual scaffolding of economics, the Friedmanite socialization of economist is one that makes them (a)

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epistemologically blindfolded by naïve positivism which leads them to believe technocrats that believe themselves above the fray of democratic politics, (b) too willing to believe the great glass bead game of model building and finding natural experiments, (c) too inclined to treat the decisions of capitalists as forces of nature rather than sociological constructions, and (d) too slavish to finance in business schools. Jeff Madrick: Berkeley is a good school. Ylan Mui: We have our last question. Audience 3: I would like to follow up the issue of inequality. Jeff, when you opened your remarks you talked about the difference between inequality in opportunity and inequality in outcomes. Josh just talked about how the foundations of inequality and growth have shifted over the years that it’s no longer a strict trade off. The research is showing that inequality can actually lead to lower growth rather than higher growth. We just had the Boston Fed meeting where inequality of outcome was shown to affact inequality opportunity. Ifs you don’t have equality of outcomes you don’t get to the inequal—you don’t get to the equality of opportunity. This morning, one of your other organizations here in town, the American Enterprise Institute just blasted Janet Yellen for mentioning the fact that inequality of outcome might be important, basically called her a leftist politician. Parti—excuse me, a partisan leftist politician. Do you see any hope here? Jeff Madrick: Thank you for asking that. This is another area in which from my point of view mainstream economists have by and large failed, with exceptions. By and large they say inequality of outcomes is not our interest. William Buiter now at Citicorp would say that. Bernanke said it–that inequality of distribution is not really our issue. Yellen grabbed so much attention is because it’s not stated by somebody in Yellen’s position and it’s about time it should be stated. It is not—nothing quite peace me as much and it comes from the left and the right. The answer to all our problems is education. Just get kids, make it cheaper to go to college. We have so much deeper problem than education. It’s not at all obvious that education and skills attainment are identities, but the economics profession does regression analyses as if attainment level of schooling is exactly equal to skills identity. The OECD did a comprehensive study and found that skills are considerably higher in Europe at the same level of education compared to the level of education in the US. That doesn’t stop economists from doing these regression analyses. It’s an area for me of misinformation. There is nothing easy. It’s apple pie and motherhood. What’s wrong with you? I have some apple pie, go home and see your mom. Educate people. It is so much more difficult a problem–while there are lots of exceptions, Heckman for example, talks a lot about early childhood education. We need interventions, we now realize, at zero. We need serious public investment. Not just public investment that meets a rather tech—narrow technical definition of what public is. We know that there’s neurological damage for kids from zero to three, neurological damage not only from being hit in the head but just from neglect. There are major issues here to face and we’re just not doing it. We are suppressing this, with the help of some economists.

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I think many economists are suppressing social spending in America. It’s haunting us already. It’s going to continue to haunt us. People talk about secular stagnation. If this is true, why would you be surprised? Our infrastructure stinks, our education system stinks, we have the highest child poverty rate in the world, 25 to 30 per cent of kids under five or six are by and large lost to the system. That’s a huge chunk of the population. Why should we have a glorious future? Economists should be asking themselves whether they should devote themselves to that or more—-let me be kinder about this, more fully. [Laughter] Brad DeLong: The interesting thing is that if you actually will listen Janet Yellen’s speech. It wasn’t the partisan speech. It wasn’t the political speech. It was very much the standard just-the-facts manner that Janet has adopted since the Clinton administration picked her for her first go-round at the Fed in 1994. Here are the important facts about this situation. You analyse them as you like. I think it speaks a great deal about the American Enterprise Institute as an institution that it now thinks that learning about facts and trying to analyse them is itself a leftist partisan political thing. Is it John Stewart or was it Stephen Colbert who says the problem is that reality has a liberal bias. I think the only way to read the AEI attack on what’s very weak tea is as confirming that that, indeed, seems to be the case in America today. That makes me a lot less certain that if the Republicans were in power that people who still retain some anchor to reality would have positions of influence. Jeff Madrick: In agreement with Brad, Janet Yellen’s strength is that she does stick to the facts. Now, humans are imperfect beings. Bias will always enter somehow. But by and large she’s going to succeed, and the reason is–to say she does her homework is an understatement. So I always worry about the old boys club. My guess is Obama worried about it when he seemed to be resisting Yellen’s appointment. She fights it by being by and large the best or at least the best informed economist in and among her peers in decision making capacity. Ylan Mui: And Jeff we’ll let you have the last word here. Thank you so much to you for being here. The book is Seven Bad Ideas. I think it’s going to be for sale outside this room. Thank you to Josh and to Brad for joining us as well… http://equitablegrowth.org/2014/11/03/discussion-jeff-madrick-ylan-mui-josh-bivens- brad-delong-lightly-edited-transcript-jeff-madrick-epi-event-mainstream-economic- thinking-imperils-america-focus/

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Proyecto Europeo// Impacto Social// Nueva Política/ Reforma Constitucional/ Quiénes somos Nueva Política Tripartidismo: el nuevo escenario de (in)gobernabilidad La encuesta de ayer confirma el fin de una época y el inicio de otra en la que Podemos es protagonista del mapa político. Josep Lobera 02/11/2014 - 20:15h Es la primera vez. La encuesta publicada ayer por El País estima que Podemos sería la fuerza más votada en unas elecciones generales. Según Metroscopia, la formación de Pablo Iglesias obtendría hoy el 27,7% de los votos, mientras que PSOE y PP obtendrían 26,2% y 20,7%, respectivamente. Desde 1982 ningún tercer partido político se había colado en el bipartidismo mantenido por PP y PSOE. Es un hecho que rompe, en tan solo ocho meses, la dinámica electoral de los últimos treinta años en España. ¿Quiere decir que Pablo Iglesias será el próximo presidente del Gobierno? No. Quiere decir que la mesa tiene tres patas. Y eso es una novedad de dimensiones enormes. A estas alturas, es imposible predecir cómo va a evolucionar la dinámica electoral hasta las próximas elecciones. Pero si Podemos llegase a ser la lista más votada en las próximas elecciones generales (o el PSOE o el PP), cualquier posibilidad de formar gobierno pasaría hoy por el pacto. ¿Coalición PSOE-PP? ¿Pacto Podemos-PSOE? ¿Podemos-PSOE-IU? ¿Coalición arcoíris? ¿Escenario “a la italiana”? Estas especulaciones son las que van a llenar más minutos de tertulia política hasta las elecciones. El nuevo debate se llama problema de gobernabilidad. Falta todavía mucho para el 13 de diciembre de 2015 (la fecha más probable para las próximas elecciones generales). Son precisamente los meses después de las elecciones municipales, donde se sitúa el principal reto para Podemos, cuando las baterías políticas y mediáticas van a estar dirigidas a analizar con lupa las decisiones electorales de aquellos consistorios gobernados por personas militantes o simpatizantes con este partido. Acierto mayúsculo, el de no presentarse a las elecciones en ocho mil municipios. Pero, aun así, el flanco está abierto y habrá militantes de Podemos que formarán parte de varios gobiernos municipales a los que se les va a escrutar cada decisión. Inevitablemente, más de una noticia y más de dos van a aparecer. Y será en ese espacio temporal entre las municipales y las generales donde se cristalizarán las nuevas estrategias electorales. A tres bandas (para variar).

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El PP, salvo sorpresa mayúscula, tejerá una comunicación dirigida a evitar la hemorragia de votantes esgrimiendo el miedo al “neo-chavismo”, esgrimiendo ejemplos de decisiones de gobiernos locales con vinculaciones con Podemos que puedan ser utilizables con este fin. Y recordará lo malo que era Zapatero y los ERES de Andalucía.

En ese nuevo escenario interelectoral, Podemos seguirá con el discurso de crítica al bipartidismo (que tan buen resultado le está dando y que todavía no se ha agotado). Pero, además, tendrá que defenderse de algunas polémicas en los próximos gobiernos locales. Muy probablemente, subrayando la línea que separa el equipo de Pablo Iglesias de todos aquellos militantes que gobiernan en los municipios y de los que no se puede responsabilizar. Es quizás la estrategia que minimice los daños, pero incluso con la amputación de responsabilidades perderá algunos votos. Ya sabemos que el que se defiende está, solo por defenderse, en posición de pérdida electoral. El PSOE tiene tres opciones estratégicas. Dirigirse hacia un escenario postelectoral en el que pueda pactar con el PP o con Podemos, acercando la línea discursiva a la coherencia

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con uno de los dos posicionamientos. O mantenerse en la ambigüedad. Esta última opción tiene muchas desventajas, el ciudadano de a pie percibe rápidamente el juego ambiguo y lo sanciona. Y a medida que nos vayamos acercando a diciembre de 2015 será cada vez más difícil de sostener. Sin embargo, esta es la opción que parece que va a adoptar el PSOE. Y cuando llegue el momento de elegir (momento que llegará): ¿pactarán con el PP o con Podemos? Obviamente no lo van a decir antes de las elecciones, pero se diría que Sánchez-Díaz parecen más cerca de lo primero que de lo segundo. La encuesta de ayer (y la del CIS, que aparecerá en breve) confirma el fin de una época y el inicio de otra. Podemos es, ya, un actor de primera fila en el escenario electoral, a pesar de no disponer de ningún parlamentario ni de representación alguna en las instituciones en España. Ha roto la baraja, ha desplazado a Izquierda Unida y UPyD, que ahora esperan poder ser necesarios para pactar en un Parlamento fragmentado y que alguna eventualidad haga que Podemos se desplome tan rápidamente como ha subido. Podemos, hoy, podría ser la lista más votada; pero, en el nuevo escenario de tripartidismo que se perfila, esa no es condición suficiente para poder gobernar. Pero el tripartidismo virtual que hoy se constata es una situación dinámica y los elementos que han aupado a Podemos todavía no se han detenido. Las encuestas muestran que la insatisfacción política busca sus cauces. Y Podemos tiene un aspecto y ocupa un lugar que lo convierte en la vaguada natural por el que baja buena parte del agua de la insatisfacción política, por los motivos que comenté en este blog hace quince días. La capitalización del descontento por este nuevo partido tiene mucho que ver con sus decisiones pero también con el contexto. La miríada de casos de corrupción política, como una percusión incesante, agrieta, caso a caso, la ya muy mermada confianza que los españoles en el funcionamiento político (no solo erosiona el apoyo específico sino, también, a niveles más difusos del sistema). Sectores empresariales y políticos parecen haberse emparejado obscenamente a costa de los impuestos y los recortes en el bienestar de (casi) todos. Tarjetas black, paraísos fiscales, dinero b, regalos, favores. Lo peor (o lo mejor, según se mire) son los detalles; el morbo de ver en qué se gastan el dinero es un motor poderoso para el descreimiento y el resentimiento. La corrupción no parece ya una borrasca sino como algo generalizado desde hace tiempo, como “la verdad de la vida” que nadie nos había contado. Hay quienes creen que PP y PSOE pueden ser los instrumentos que permitan una regeneración de la política. Pero cada vez son menos. Podemos tiene el campo abonado para seguir creciendo. Pero, ahora que está en primera fila, va a recibir un fuego más intenso por parte del resto de actores políticos. Especialmente cuando haya elementos concretos a los que agarrarse, cuando en algún lugar alguien que dice que estuvo una vez en un círculo tome decisiones y gobierne. A partir de mayo, Podemos recibirá una confrontación directa más intensa, aunque no quiera. Por otro lado, la estrategia que adopte el PSOE frente al tripartidismo será clave y marcará la dinámica política de los próximos años. Cuando deje de poder ser equidistante, cuando tenga que elegir, ¿se acercará más a Podemos o al PP? Esa decisión generará nuevos discursos y marcará la dinámica política en el futuro. http://www.eldiario.es/agendapublica/nueva-politica/Tripartidismo-nuevo-escenario- ingobernabilidad_0_320218267.html

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ft.com/comment November 2, 2014 7:13 pm Central bankers are caught in their own trap Their power to change expectations relies on their power to make them real, says Martin Sandbu

©Bloomberg You can almost hear the great wheels of global monetary policy making turning: change is afoot in each leading central bank. The US Federal Reserve has bought its last long- term bond. The Bank of England is talking down the prospect of rate rises (after talking it up not long ago). The Bank of Japan is speeding up money creation. Even the European Central Bank is creeping towards asset purchases. This is not a bad time to assess how much we can demand from central banks. It is fashionable to say monetary policy is “overburdened” and only fiscal policy can help depressed economies out of their rut. I do not dispute the importance of using fiscal policy where there is room for manoeuvre (as in the eurozone as a whole, where the fiscal deficit is only 2.5 per cent of output). Structural reforms are needed, too. But we should take issue with the idea monetary policy has done as much as it can. More ON THIS TOPIC// Global Market Overview Euro slips after manufacturing data/ Markets Insight How to read the Dow Jones ups and downs/ Mix of data to include UK and US PMIs/ Long View BoJ shows central banks have firepower IN COMMENT// Kevin Feige/ Stephen Foley The fiendish bond market/ Patrick Pouyanné/ Oil markets - Where’d the floor go? The notion that developed economies are in a “liquidity trap” – where printing money no longer has any effect – is treacherous. The problem is partly semantic but semantics can shape politics. A trap is hard to spot and difficult or impossible to escape. The implication is that monetary policy makers have done everything possible. In liquidity trap models of the economy, the central bank is impotent. Although it can create money at will, this power no longer provides influence over interest rates or the ability to give the economy a boost. The reason this is said to happen is a supposed “zero lower bound” on interest rates. Central banks stimulate spending and investment by increasing the money supply. With more liquidity in the economy than people want to hold, they try to buy profitable assets for their cash. This drives market interest rates down. But when nominal rates are (near) zero, investors can hold all the liquidity the central bank throws at them without missing

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out on returns elsewhere, so money printing loses its power to pull market rates further down – even if that is what the economy needs fully to employ its resources. If that is the situation we have been in, we can hardly blame central banks for failing to deliver more monetary stimulus. The best they can do is promise higher inflation in future, so as to make real interest rates – which take account of inflation and shape people’s decision whether to borrow or save – fall further below zero. But who would believe such a promise from a bank unable to create inflation now? A central bank’s power to change expectations relies on its power to make them come true. This situation has not happened in the present crisis. Look beyond short-term rates and it is evident that the longest-term rates are everywhere significantly positive. Even if zero is a “lower bound”, central banks cannot be said to have hit it. The big ones (with the exception of the ECB) have admittedly used asset purchases to influence these rates – but not in the most effective way. They could have declared how low they wanted long-term rates to fall, and promised to buy as much debt as necessary to bring them to the target. Instead, they committed to buy a specific quantity of debt – and let the resulting long-term cost of borrowing be what it may. Bringing long-term rates towards zero could have required large purchases so long as short-term rates stayed positive: investors typically insist on a rate differential between shorter and longer-term (or otherwise riskier) assets. But it is wrong to think interest rates cannot fall below zero. The rate most immediately under central banks’ control – the deposit rate on reserves – can be made as negative as one wishes. There are technical questions involving incentives to hoard physical cash, but these are solvable. And with the rate on reserves sufficiently negative, the rate on other assets can be made negative as well. The only zero lower bound is one central banks impose on themselves. That is particularly true in the eurozone. That is partly because of the politically paralysing opposition between the interests of creditor and debtor nations. It is also because of the way the ECB operates. It typically changes the money supply by offering loans to banks rather than buying financial assets – making monetary expansion dependent on banks’ willingness to take up the offer. That is no excuse for the ECB not to have adapted much faster. It should look to the BoJ, whose all-hands-on-deck approach to money printing includes buying corporate bonds and shares in investment funds. There is a lesson for Frankfurt, with its qualms about bond buying. It is: buy anything – but, whatever you do, buy something. [email protected] http://www.ft.com/intl/cms/s/0/2af44544-604d-11e4-88d1- 00144feabdc0.html#axzz3HzdhcOeQ

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ft.com Comment The Big Read

November 2, 2014 2:59 pm South Korea: Sparks fly over the chaebol Simon Mundy in Seoul Investors have trained their focus on the unchallenged family control and complex structures of the country’s largest companies, by Simon Mundy

©Bloomberg Chung Mong-koo could not resist sounding a triumphal note after Hyundai Motor Group sealed a $10bn deal for a prime piece of real estate in Seoul’s glitzy Gangnam district. “This is an investment for the next 100 years,” the Hyundai chairman reportedly told executives after his company had beaten Samsung Electronics to secure the site, where it plans to build new headquarters. More ON THIS STORY// Hyundai looks to placate angry investors/ Kia Motors blames slowdown on strong won/ Small-caps in focus in South Korea/ S Korea probe highlights governance woes IN THE BIG READ// US politics Eyes on the prize/ Middle East Walled in/ Russian oil Between a rock and a hard place/ Fracking In the path of the ‘shale gale’ Investors did not share his excitement. The value of the three companies that will fund the purchase – Hyundai Motor, Kia Motors and Hyundai Mobis – plunged by a combined $8bn immediately after the deal’s announcement on September 18, as shareholders recoiled at the extravagant use of company funds on a trophy asset.

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“The size of this transaction is quite shocking,” says Mark Mobius, executive chairman of Templeton Emerging Markets, calling it a “violation of shareholder rights” and symptomatic of “an incredibly backward looking system”. The deal was a bitter disappointment for the investors, governance experts and reform- minded politicians who have been pressing for change at South Korea’s chaebol business groups, famed for their unchallenged family control, miserly dividends and staggeringly complex structure. And it fanned the flames of one of the country’s most vital debates: is the unique chaebol model sustainable? Any account of South Korea’s economic rise over the past 60 years must acknowledge the central role played by the chaebol. Under Park Chung-hee, the military ruler who seized power in 1961, scarce capital was channelled to a small group of businessmen with the proviso that they succeed in the export market to qualify for continued funding. The US capital market used to be controlled by the Ford family, the Rockefeller family . . . None of them are in charge now This concentrated, conditional support yielded outstanding results, as the elite chaebol groups drove a rapid industrialisation that brought a 13-fold increase in output per capita between 1960 and 2000. It laid the foundations for a country that now stands as the world’s 10th-largest trading nation by volume, the leading exporter of products from cargo ships to smartphones. But it also resulted in an economy reliant on a small number of huge, family-controlled groups – a situation that lawmakers from across the political spectrum are vowing to change, by toughening restrictions on big business or fostering smaller companies. The handling of the Hyundai land bid reinforced concerns about the lack of accountability offered by the family-centred chaebol model. The Hyundai Motor board discussed the bid in two meetings each lasting less than two hours, according to two people familiar with the process. It granted full authority over the bidding process to a special “task force”, and was not privy to the bid price until after it was submitted. Investor outrage intensified as Korean media published leaked remarks by Mr Chung. The Hyundai chairman reportedly told directors during the bidding process that “money is no problem”. After the offer was accepted, he remarked that the “huge sum” was Hyundai’s way of contributing to the nation: the seller was Korea Electric Power Corp (Kepco), the financially troubled national utility. Protecting the cash pile The continuing dominance of the chaebol founding families has begun to chafe with outside investors, who want them to return more of their healthy cash piles to investors. While it is denied by the companies, some analysts say the families view high dividends as an unnecessary leakage of cash, despite their own status as large shareholders. “The founders don’t care much about cash inflow,” says Chanik Park, an equity strategist at Barclays. “They feel like the whole company is theirs.” Investors in the Korea Exchange (KRX), the country’s stock market, could afford to be sanguine about stingy dividends and shaky governance during the years of rapid profit growth, as the likes of Samsung Electronics and Hyundai Motor grew into global giants.

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The Kospi’s all-time peak in April 2011 was more than four times the level of the South Korean benchmark index 10 years earlier. But growth on KRX has stalled, with the Kospi meandering well below its peak level. Deprived of capital growth, investors are now agitating for higher direct returns from companies with slowing profit growth and limited opportunities to invest their cash piles. “These days, the benchmark interest rate is only 2 per cent, and the economy is slower than before,” says Choi Kyung-soo, KRX chairman and chief executive. “In the past, investors had more interest in capital growth, but now they want dividends.” Mr Choi recently oversaw the creation of a “dividend growth index” consisting of companies, including Samsung Electronics and Hyundai Motor, with the potential for substantial dividend increases.

The new index reflected some investors’ anticipation of a future increase in South Korean dividend payout ratios, which hover around 10 per cent, according to the brokerage CLSA – by far the lowest level of any major market. These stingy cash returns are widely seen as the main reason for the “Korea discount”, which leaves companies in the country trading at lower price-earnings ratios than foreign peers. Optimists were encouraged this summer when Choi Kyung-hwan, the new finance minister, announced tax proposals aimed at discouraging cash hoarding by corporations. But these expectations only heightened the dismay when Hyundai’s land deal was announced. Hyundai has defended the transaction, arguing it is not aimed at generating short-term profits but will boost the company’s brand image in the long term and that the headquarters will house 30 group affiliates. The company proffered some consolation to shareholders on October 23 by mooting an increased dividend, and the possible introduction of an interim dividend. Samsung Electronics increased its dividend payout ratio for last year to 7 per cent from 5 per cent in 2012. Yet these increases are unlikely to satisfy investors, with the companies’ payout ratios set to remain very low relative to those offered by foreign peers, and to the cash they have accumulated.

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Korean companies’ conservative cash management stems partly from the 1997-98 Asian crisis, says Daniel Kim, an analyst at Macquarie. The crisis caught the chaebol light on cash and highly indebted, pushing some to the brink of insolvency and others – notably the once-mighty Daewoo – over the edge. The founding families’ continuing grip on the chaebol comes with some benefits, argues Rahul Chadha, co-chief investment officer of Mirae Asset Management, South Korea’s second-largest fund management group. “A lot of managers hesitate to take radical decisions,” he says. “These decisions can be best made by the founding family.” As an example of this strength, analysts point to Samsung’s hugely successful assault on the smartphone market, which gathered pace in 2010 – soon after Lee Kun-hee returned as chairman following his resignation over a tax evasion lawsuit, telling employees: “It’s a real crisis now . . . We must begin anew.” Maintaining control Yet the complex structures through which the families maintain control can be a daunting sight for investors. Though often described as a conglomerate, Samsung Group – according to the Samsung Electronics website – is in fact “not a legal entity [but] a term to conveniently refer to a group of companies tied together by their corporate history”. They are also tied together by a dizzying web of cross-shareholdings. The Lee family’s direct ownership of Samsung Electronics, for example, is less than 5 per cent. Its control is exercised partly through its 46 per cent stake in the theme park operator Cheil Industries, which holds a 19 per cent stake in Samsung Life Insurance. Samsung Life in turn is the largest shareholder in Samsung Electronics, which is indirectly invested in Cheil Industries. “If you draw lines connecting the companies it’s like a bowl of spaghetti – it’s unbelievable,” Mr Mobius says. While all Samsung Group companies are legally distinct entities with different sets of shareholders, they follow a co-ordinated strategy set by the chairman’s office. “Samsung’s founding family has a vital role in management by providing long-term vision and responsible leadership for sustainable growth, and they work in concert with highly qualified professional managers,” says a group spokeswoman. But the pursuit of a group strategy by nominally independent companies can bring risk for investors. In February the Swiss group Schindler Elevator brought a lawsuit against the directors of Hyundai Elevator, in which it holds a 35 per cent stake, and which is part of Hyundai Group but distinct from Hyundai Motor Group. Schindler alleges that Hyundai Elevator destroyed around $600m of shareholder value through investments aimed at protecting the control of Hyundai Group’s chairwoman, Hyun Jeong-eun, over an affiliate company. This was denied by a spokesperson for the group, who said that its constituent companies pursue “their own interests”. “The circular shareholding structure is unique to Korea [and] it’s important to know that there are clear risks that go together with such a structure,” Schindler chairman Alfred Schindler said after announcing the lawsuit, which is ongoing. “If one company gets into problems, the whole group gets into problems as well.”

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The government has responded to such concerns with a ban on new cross-shareholdings between large chaebol affiliates, which took force in July, although existing structures will be tolerated. Some investors hope this will encourage a change to more transparent shareholding structures – a process that may already be under way at Samsung. This year has brought announcements of the flotations of Cheil Industries and Samsung SDS, two of the companies in which the Lee family hold large stakes. Samsung says the listing plans are unrelated to the handover of control to Mr Lee’s son Jae-yong – a prospect that has assumed growing urgency, with the chairman, 72, confined to hospital since a heart attack in May. Welcome restructuring But most analysts view this as part of a broader reorganisation that will allow the Lee family to retain control of Samsung even after an inheritance tax bill that could amount to more than $4bn. Shaun Cochran, head of Korea research at CLSA, expects Samsung to switch to a new structure based around three holding companies. While some investors voice concerns about the succession to the younger Mr Lee, 46, the prospect of a simpler shareholding structure is broadly welcomed. “A neat, understandable ownership structure will be appraised as an improvement,” says Lee Jisoo, a lawyer at the Seoul-based Center for Good Corporate Governance. “But while it may look better externally, there could still be the ‘emperor’ style of management.”

Such warnings are reflected by the recent history of SK Group, the third-largest chaebol, which was reorganised into a holding company structure in 2007. Chey Tae- won, SK’s chairman and scion of its founding family, was sent to prison for four years in January last year for stealing $42.5m from companies under his authority. Despite his incarceration, Mr Chey’s fellow directors rewarded him with an annual pay package of Won 30.1bn, including bonuses worth Won 20.7bn, making him the best-paid South Korean executive of the year. Mr Chey subsequently resigned the chairmanship and promised to donate last year’s pay to charity. But news that he had received 1,778 visits during 17 months in prison strengthened suspicions that his authority over the group would remain intact.

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Meanwhile, both the justice and finance ministers recently voiced sympathy towards the idea of pardoning jailed executives in the interests of economic growth. This sparked concern about a return to a practice well-established under the government of former president Lee Myung-bak, who was blamed for enabling chaebol leaders to flout fiduciary duty with near impunity. But the family dominance of the chaebol will erode over time, argues Lee Wonil, a former head of Allianz Korea who established an activist hedge fund to target flawed corporate governance. “The US capital market used to be controlled by the Ford family, the Rockefeller family . . . None of them are in charge now,” he says. “As time goes by, professional management will take over. That’s the inevitable history of capitalism. It will happen.” Governance: Long-term focus offers strengths and weaknesses As debate boils in the west over how to make corporate leaders less focused on short- term returns, investors in the chaebol face an opposite problem. “The founding families think of the company first above everything else,” says Michael Oh, a fund manager at Matthews Asia. “They want the company to survive for generations to come – they think of a much longer time horizon than the outside shareholders.” This long-term focus has held down the dividends, and consequently the share prices, of South Korean companies – but some see it as a vital strength of the chaebol system. In a recent book on Samsung Electronics, professors Song Jae-yong and Lee Kyung-mook argue that family control of the company has enabled it to make expensive investment in research and development that might not have happened under “professional managers, whose compensation is based on their short-term performance”. The chaebol now have to contend with an investor wielding unprecedented clout: the South Korean National Pension Service, with total assets that have grown rapidly to $400bn, including a stake of more than 6 per cent in the entire stock market. Some investors hope the NPS will put pressure on companies to increase returns as it battles to meet its growing liabilities – although its chairman Choi Kwang played down such suggestions this year, warning of the dangers of “pension socialism”. In the meantime, shareholder frustration is reflected by an average 12-month forward price/earnings ratio of 9.7 for Kospi companies, against 13.8 for those on the MSCI World index. Yet this weak valuation represents an opportunity for investors, provided they are prepared to be patient, says Mark Newman, an analyst at Bernstein who previously worked for Samsung. “If you’re in it for the long term, the corporate governance looks fantastic. But if you have a mandate to make money by the end of the year, it doesn’t look good.” http://www.ft.com/intl/cms/s/0/9d84d488-5f90-11e4-8c27- 00144feabdc0.html#axzz3HzdhcOeQ

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The Opinion Pages| Op-Ed Columnist Business vs. Economics NOV. 2, 2014 Inside

Paul Krugman TOKYO — The Bank of Japan, this country’s equivalent of the Federal Reserve, has lately been making a big effort to end deflation, which has afflicted Japan’s economy for almost two decades. At first its efforts — which involve printing a lot of money and, even more important, trying to assure investors that it will keep printing money until inflation reaches 2 percent — seemed to be going well. But more recently the economy has lost momentum, and last week the bank announced new, even more aggressive monetary measures. I am, as you might guess, very much in favor of this move, although I worry that the policy might nonetheless fail thanks to fiscal mistakes. (More about that later.) While the bank did the right thing, however, it did so amid substantial internal dissent. In fact, the new stimulus was approved by only five of the bank board’s nine members, with those closest to business voting against. Which brings me to the subject of this column: the economic wisdom, or lack thereof, of business leaders. Some of the people I’ve spoken to here argue that the opposition of many Japanese business leaders to the Bank of Japan’s actions shows that it’s on the wrong track. In saying this, they’re echoing a common sentiment in many countries, including America — the belief that if you want to fix an ailing economy, you should turn to people who have been successful in business, like leaders of major corporations, entrepreneurs and wealthy investors. After all, doesn’t their success with money mean that they know how the economy really works? Actually, no. In fact, business leaders often give remarkably bad economic advice, especially in troubled times. And I think it’s important to understand why. About that bad advice: Think of the hugely wealthy money managers who warned Ben Bernanke that the Fed’s efforts to boost the economy risked “currency debasement”; think of the many corporate chieftains who solemnly declared that budget deficits were the biggest threat facing America, and that fixing the debt would cause growth to soar. In Japan, business leaders played an important role in the fiscal mistakes that have

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undermined recent policy success, calling for a tax hike that caused growth to stall earlier this year, and a second tax hike next year that would be an even worse error. And on the other side, the past few years have seen repeated vindication for policy makers who have never met a payroll, but do know a lot about economic theory and history. The Federal Reserve and the Bank of England have navigated their way through a once-in-three-generations economic crisis under the leadership of former college professors — Ben Bernanke, Janet Yellen and Mervyn King — who, among other things, had the courage to defy all those tycoons demanding that they stop printing money. The European Central Bank brought the euro back from the brink of collapse under the leadership of Mario Draghi, who spent the bulk of his career in academia and public service. Obviously there are business leaders who have gotten the economic analysis right, and plenty of academics who have gotten it wrong. (Don’t get me started.) But success in business does not seem to convey any special insight into economic policy. Why? The answer, to quote the title of a paper I published many years ago, is that a country is not a company. National economic policy, even in small countries, needs to take into account kinds of feedback that rarely matter in business life. For example, even the biggest corporations sell only a small fraction of what they make to their own workers, whereas even very small countries mostly sell goods and services to themselves. So think of what happens when a successful businessperson looks at a troubled economy and tries to apply the lessons of business experience. He or (rarely) she sees the troubled economy as something like a troubled company, which needs to cut costs and become competitive. To create jobs, the businessperson thinks, wages must come down, expenses must be reduced; in general, belts must be tightened. And surely gimmicks like deficit spending or printing more money can’t solve what must be a fundamental problem. In reality, however, cutting wages and spending in a depressed economy just aggravates the real problem, which is inadequate demand. Deficit spending and aggressive money-printing, on the other hand, can help a lot. But how can this kind of logic be sold to business leaders, especially when it comes from pointy-headed academic types? The fate of the world economy may hinge on the answer. Here in Japan, the fight against deflation is all too likely to fail if conventional notions of prudence prevail. But can unconventionality triumph over the instincts of business leaders? Stay tuned. http://www.nytimes.com/2014/11/03/opinion/paul-krugman-business-vs- economics.html?rref=opinion&module=Ribbon&version=context®ion=Header&acti on=click&contentCollection=Opinion&pgtype=article

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Oct 28 3:07 pmOct 28 3:07 pm66 Notes on Japan I’m going to Japan soon, and have been putting some numbers and thoughts together, both about Abenomics and the longer-term lessons from the Japanese experience. Here are some notes on the way. First, can we stop writing articles wondering whether Europe or the United States might have a Japanese-type lost decade? At this point the question should be whether there is any realistic possibility that we won’t. Both the US and Europe are approaching the 7th anniversary of the start of their respective Great Recessions; the US is far from fully recovered, and Europe not recovered at all. Japan is no longer a cautionary tale; in fact, in terms of human welfare it’s closer to a role model, having avoided much of the suffering the West has imposed on its citizens. Part of the impression that Japan has been a bigger disaster comes, of course, from Japanese demography: if you look at total GDP, or even GDP per capita, you miss the fact that Japan’s working-age population has been declining since 1997. I’ve tried to update the numbers on real GDP per working-age adult, defined as 15-64; I start in 1993 because of annoying data problems, but it would look similar if I took it back a few more years. Here’s a comparison of the euro area, the US, and Japan:

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Credit So even in growth terms Japan doesn’t look much worse than the US at this point, and is actually slightly ahead of the euro area. That doesn’t mean Japan did OK; it just means that we’ve done terribly. What about Abenomics? The decision to go ahead with the consumption tax increase — which some of us pleaded with them not to do — dealt a serious blow to the plan’s momentum. There has been some recovery in growth:

But losing momentum is a really bad thing here, since the whole point is to break deflationary expectations and get self-sustaining expectations of moderate inflation instead. For what it’s worth, the indicator of expected inflation I suggested, using US TIPS, interest differentials, and reversion to long-run purchasing power parity, is holding up:

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But I still worry that Japan may fall into the timidity trap. The whole business with the consumption tax drives home a point a number of people have made: the conventional view that short-term stimulus must be coupled with action to produce medium-term fiscal stability sounds prudent, but has proved disastrous in practice. In the US context it means that any effort to help the economy now gets tied up in the underlying battle over the future of the welfare state, which means that nothing happens. But even where that isn’t true, talking about fiscal sustainability when deflationary pressure is the clear and present danger distracts policy from immediate needs, and can all too easily lead to counterproductive moves — as just happened in Japan. When I see, say, the IMF inserting into its latest Japan survey (pdf) a section titled “Maintaining focus on fiscal sustainability” my heart sinks (and so, maybe, does Abenomics); it’s hard to argue against sustainability, but under current conditions it means taking your eye off the ball, and Japan really, really can’t afford to do that. More notes as my cramming for the coming quiz continues. http://krugman.blogs.nytimes.com/2014/10/28/notes-on-japan/

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España SONDEO METROSCOPIA » Podemos supera a PSOE y PP y rompe el tablero electoral Pablo Iglesias se convierte en el líder más valorado según el sondeo de Metroscopia El nivel de abstencionistas entre los votantes populares es del 20% GRÁFICO Clima político en España: intención de voto y valoración de líderes FERNANDO GAREA MADRID 2 NOV 2014 - 19:26 CET11439

Pablo Iglesias posa junto a su equipo en la asamblea ciudadana de Podemos. / CLAUDIO ÁLVAREZ Podemos ya ha provocado un seísmo sin precedentes en la política española y está en condiciones de hacer saltar por los aires el tablero electoral. La formación que lidera Pablo Iglesias podría incluso ser la lista más votada, con un 27% de los sufragios, según el resultado de la encuesta de Metroscopia para EL PAÍS. En este sondeo Podemos sacaría 1,5 puntos al PSOE y 7 al PP, que se hundiría hasta caer al 20,7% de resultado estimado sobre voto válido. Nunca antes una formación recién creada había alcanzado una expectativa de voto tan alta como la que Podemos ha logrado en solo ocho meses de vida. Ya consiguió un resultado espectacular en las elecciones europeas de mayo y ahora consolida su despegue a siete meses de las autonómicas y municipales y a un año de las generales. A las municipales no concurrirá con su marca, sino integrada en otras candidaturas. El dato explica la conmoción en el Gobierno, que la próxima semana se confirmará con una encuesta del CIS, aunque el trabajo de campo del sondeo oficial se realizó antes de la semana negra de la corrupción que se ha vivido en los últimos días.

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La serie de los últimos meses, coherente con otros sondeos, permite atisbar un fin de ciclo en la política española, si llegaran a confirmarse las predicciones. A este insólito resultado habría que aplicarle algunas prevenciones que en ningún caso mitigan la importancia del vuelco político que se apunta. La primera es metodológica, porque la irrupción de Podemos cambia el panorama de dos partidos consolidados como PP y PSOE que se disputaban siempre las elecciones y una tercera fuerza a mucha distancia de ambos. Ahora es más difícil ponderar criterios demoscópicos imprescindibles para la 124

“cocina” o aplicación de criterios estadísticos y subjetivos como el del recuerdo de voto que, obviamente, no existe en el caso de Podemos. Hay que tener en cuenta también que la encuesta muestra un hundimiento del apoyo al PP por el profundo malestar de sus votantes, que se manifiesta en un índice de abstención de sus electores próximo al 20%. UPyD e IU retroceden como refugio de los indignados Mientras que Podemos moviliza a anteriores abstencionistas y nuevos votantes, casi la cuarta parte de los del PP pasan a dar la espalda a las urnas. Ese efecto abstencionista dificulta la estimación porque puede ser coyuntural y podría mitigarse con la proximidad de las elecciones. El propio hecho de que Podemos esté en condiciones de ganar podría servir para movilizar a votantes molestos del PP. Ese empeño movilizador es el que ocupa al PP de aquí a las próximas elecciones y está detrás de la estrategia de los populares contra el nuevo partido. Votantes tradicionales del PP no perdonan en este momento que se olviden puntos esenciales de su programa, aunque en este sector la ventaja para Rajoy es que no compite con otras opciones en su espectro ideológico. Juega en contra del partido de Mariano Rajoy la acumulación de escándalos y el hecho de que los ciudadanos aseguren que no perciben la mejora económica. El Gobierno apostó casi todo a la carta de la recuperación y la reforma fiscal, pero no parecen ahora factores catalizadores por sí mismos. O no se percibe la mejora o esta no sirve para llevar ciudadanos a las urnas. Que un porcentaje próximo al 8% de votantes del PP pueda plantearse votar a Podemos explica por sí solo el nivel de malestar de sus electores. Y también ayuda a entender la estrategia de transversalidad ideológica hacia la que muta Podemos en los últimos meses. Ya no hablan de izquierda ni derecha para intentar ser una formación de amplio espectro ideológico y con las menos aristas posibles. Otro factor a tener en cuenta es el de la conmoción por la crudeza de la realidad. A lo que supuso el escándalo de las tarjetas negras de Caja Madrid se han sumado estos días el avance del caso Gürtel y la Operación Púnica. (http://elpais.com/elpais/2014/10/27/media/1414432785_062399.html) Ese tipo de acontecimientos de gran impacto emocional actúan a veces como seísmos coyunturales y es preciso esperar a que se asienten en los siguientes meses. Los escándalos de corrupción actúan a veces como seísmos coyunturales En todo caso, Podemos recoge ese efecto, mientras que UPyD e Izquierda Unida retroceden como opciones refugio de indignados. El bipartidismo puede ser una reliquia dentro de un año y se aventura un Parlamento fragmentado, pero en favor sobre todo de Podemos y no de las formaciones que lideran Rosa Díez y Cayo Lara. Otro factor claro en la encuesta es que Podemos se alimenta sobre todo de los errores de los otros. Por eso una mayoría no ve realistas las propuestas del partido de Iglesias y no cree que tengan ideas claras, pero inclina la balanza el hecho de que los demás ya hayan demostrado, según los ciudadanos, que no se puede confiar en ellos. Un 42% de los encuestados atribuye su éxito a la decepción y el desencanto de los demás. Sin minimizar el éxito de haber logrado capitalizar ese descontento, el gran reto de Podemos es el de mantener un año esa sensación de desafección y el factor novedad.

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Tiene que lograr que se prolongue la tensión de los descontentos, que permite obtener el voto de los que inicialmente pueden no ser muy próximos pero los prefieren a las otras opciones por las que se sienten decepcionados. Recogen nuevos votantes y sectores que nunca fueron a las urnas y tienen también la ventaja de la valoración de su líder, Pablo Iglesias. Es el único de los siete dirigentes de partidos políticos por los que se pregunta en la encuesta que tiene nota positiva (es decir, un saldo positivo entre los que le aprueban y los que le desaprueban). El índice de Rajoy, el peor evaluado, es de -63 y, muy cerca de él, Soraya Saénz de Santamaría obtiene -45. La mejor puntuación, muy por encima de los líderes políticos, la obtienen los Reyes de España. A poco más de cien días de haber asumido la Corona, Felipe VI tiene un saldo 127

de +52 puntos, y doña Letizia, de +44, lo que supone un cambio radical de tendencia frente al deterioro de la imagen de la Casa Real registrada en anteriores encuestas. Lo socialistas, más movilizados Los socialistas mantienen la cabeza fuera del agua aunque, como es obvio, les perjudica notablemente la fragmentación del voto de la izquierda. Y Podemos provoca una fragmentación en ese sector ideológico como nunca antes se había producido, porque nunca antes ninguna otra formación procedente de la izquierda había discutido la hegemonía de los socialistas. Ni el PCE en sus mejores tiempos pudo acercarse al resultado del PSOE. Ahora, según el sondeo, los socialistas tienen dificultades para mantener el 28,7% sobre voto válido que tuvieron en las elecciones generales de 2011. El partido que ahora lidera Pedro Sánchez mantiene una tendencia a la baja y ya están más de dos puntos por debajo de ese resultado. Le arrastra el hundimiento del bipartidismo y en esa tendencia a la baja van inexorablemente unidos al PP. Por más esfuerzos que haga, a Sánchez le resulta sumamente difícil diferenciarse de los populares. Eso explica su rechazo a firmar cualquier acuerdo con el Gobierno de Rajoy. La realidad no le ayuda porque, por ejemplo, en la trama de la Operación Púnica se incluye un destacado alcalde socialista, el de Parla (Madrid). Ante la opinión pública, los dos grandes partidos son parte del problema. La diferencia con el PP está en el nivel de movilización. Los socialistas pierden voto en favor de otras opciones, especialmente de Podemos, pero su nivel de abstención en este momento es de la mitad del de los populares. Los simpatizantes que mantienen al PSOE parecen estar más decididos a ir a votar pese a todo, probablemente, por reacción contra el Gobierno del PP. Sánchez es el más valorado tras Pablo Iglesias, aunque no apruebe. Los datos sobre la evaluación de su gestión entre los votantes del PSOE, los que en definitiva deben juzgarlo, son buenos. El 75% le ve capaz de renovar el partido y darle aires nuevos y el 72% cree que podrá atraer antiguos votantes socialistas. http://politica.elpais.com/politica/2014/11/01/actualidad/1414865510_731502.html

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EDITORIAL Seísmo político El catastrofismo de Podemos arrastra a una ciudadanía harta; motivo de reflexión para todos EL PAÍS 2 NOV 2014 - 00:00 CET No hay certeza de que España se encamine hacia un vuelco electoral, pero es seguro que la opinión pública vive ahora bajo los efectos de un tsunami político, según se deduce del sondeo de Metroscopia publicado hoy por este periódico. La intención de voto al Partido Popular cae con fuerza, el PSOE se sostiene con dificultades y la bolsa de ira social que se ha formado en los últimos años cree haber encontrado en Podemos la mejor oferta para propinar a los partidos tradicionales el castigo demandado por el fracaso en el enderezamiento de la situación económica y política. La foto del presente refleja el monumental enfado de la ciudadanía y arroja incertidumbres respecto a las aún lejanas elecciones de 2015. Editorial anterior// Podemos se organiza (19/10/2014)/ Bienvenidos al sistema (19/09/2014)/ El recién llegado (30/05/2014) Aunque el trabajo de campo ha coincidido con un periodo negro para el Partido Popular, es evidente que esta fuerza acumula desgastes respecto al enorme depósito de confianza recibido en 2011 en los diferentes niveles políticos. El PSOE sale mejor librado y se observa una valoración de su nuevo líder, Pedro Sánchez, claramente por encima de la de Mariano Rajoy; no obstante, su recorrido es corto para considerarle una alternativa y verificar si los simpatizantes de este partido resistirán la opa electoral que Podemos le ha lanzado a las claras, como a IU, a los partidos nacionalistas e incluso al PP. Nada menos que 9 de cada 10 personas creen que la situación política es mala o muy mala, y eso es un dato clave para comprender la razón de que parte de la población compre el discurso de Podemos como la opción catalizadora de la ira. En todo caso, este éxito traduce el fracaso de las organizaciones principales del sistema político y delata el peligro latente de ruptura. Los graves defectos demostrados por el paso del tiempo se deberían haber corregido con altura de miras, reformas políticas de envergadura y un combate abierto contra la corrupción. Por eso es incomprensible que el PP, con mayoría absoluta en las Cortes, se haya dedicado a ningunear al Parlamento y a confiar la resolución de la mayor parte de los problemas políticos al simple paso del tiempo. Su agarrotamiento es tal que incluso se niega a debatir sobre la corrupción en un pleno monográfico del Congreso, a sabiendas de que el asunto preocupa muy seriamente a la opinión pública y que la responsabilidad de los dirigentes sobre las fechorías o los abusos de sus militantes no puede despacharse con un yo no sabía. Todo esto no justifica dejar a la sociedad en manos de Pablo Iglesias y de Podemos, es decir, de un grupo de diagnóstico catastrofista y voluntad descalificadora, que niega ser de izquierdas ni de derechas para ocultar lo que en realidad es: simple y vulgar populismo como el que, con otras apariencias ideológicas, aparece en diversas partes de Europa. El sondeo muestra que los votantes potenciales de otros partidos, por críticos que sean hacia estos, tampoco creen en Podemos como la única opción en que se puede 129

confiar. Una cosa es criticar y otra muy distinta ofrecer soluciones solventes y realistas a una sociedad necesitada de buena gestión. Hasta el momento, las únicas recetas que hemos escuchado en boca de los líderes de Podemos son viejas, fracasadas o delirantes. La opinión pública aparece hoy más dividida que en el último decenio. De la alta concentración de votos en torno a dos partidos estatales —más algunos nacionalistas— se ha pasado a una fragmentación de opciones. El futuro no está escrito, pero hay que prepararse para un posible escenario de Gobiernos de más de un partido, también al frente del Estado. Y una de las condiciones necesarias es evitar crispaciones gratuitas y no polarizar a la sociedad en opciones irreconciliables. Para reparar los efectos de un terremoto no basta con la táctica de jugar a Casandras anunciadoras de desgracias; al contrario, se requieren muchos esfuerzos constructivos. http://elpais.com/elpais/2014/11/01/opinion/1414871207_412263.html

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The Opinion Pages| Op-Ed Contributor Underwriting the Next Housing Crisis By PETER J. WALLISONOCT. 31, 2014

Credit Scott Menchin WASHINGTON — SEVEN years after the housing bubble burst, federal regulators backed away this month from the tougher mortgage-underwriting standards that the Dodd-Frank Act of 2010 had directed them to develop. New standards were supposed to raise the quality of the “prime” mortgages that get packaged and sold to investors; instead, they will have the opposite effect. Responding to the law, federal regulators proposed tough new standards in 2011, but after bipartisan outcries from Congress and fierce lobbying by interested parties, including community activists, the Obama administration and the real estate and banking industries — all eager to increase home sales — the standards have been watered down. The regulators had wanted a down payment of 20 percent, a good credit record and a maximum debt-to-income ratio of 36 percent. But under pressure, they dropped the down payment and good-credit requirements and agreed to a debt-to- income limit as high as 43 percent. The regulators believe that lower underwriting standards promote homeownership and make mortgages and homes more affordable. The facts, however, show that the opposite is true. In the late ’80s and early ’90s, down payments were 10 to 20 percent. The homeownership rate was 64 percent — about where it is now — and nearly 90 percent of housing markets were considered affordable (that is, home prices were no more than three times family income). By 2011 only 50 percent were considered affordable, and 131

by 2014, just 36 percent — even though down payments as low as 5 percent are now common. How could this be? Consider this: If the required down payment for a mortgage is 10 percent, a potential home buyer with $10,000 can purchase a $100,000 home. But if the down payment is dropped to 5 percent, the same buyer can purchase a $200,000 home. The buyer is taking more risk by borrowing more, but can afford to bid more. In other words, low underwriting standards — especially low down payments — drive housing prices up, making them less affordable for low- and moderate-income buyers, while also inducing would-be homeowners to take more risk. That’s why homes were more affordable before the 1990s than they are today. Back then, when traditional standards for “prime” mortgages prevailed, homes were smaller; they had fewer bathrooms, and the kitchens were not appointed by Martha Stewart. A family could buy and live in a “starter home” for several years before selling it and using the accumulated equity to buy a bigger or better appointed home. In a competitive housing market not subsidized by lax standards, home builders would similarly adjust by reducing the size and amenities of new homes to meet the financial resources of home buyers entering the market. Home prices would stabilize and not rise faster than incomes. Low- and moderate-income families and millennials might have to wait to save for a first home, but they would be able to afford it. (Higher down payments are not the only way to limit excessive borrowing. The “standard” 30-year mortgage is a subsidized, archaic result of our government’s distorted housing policies; very few home buyers stay in a home for 30 years. A 15- year fixed-rate mortgage means higher monthly payments, but the homeowner starts to accumulate equity sooner, reducing the lender’s risk.) If the government got out of the way, would sound underwriting standards come back? History suggests yes. Although Fannie Mae and Freddie Mac were government-backed, they were shareholder-owned, profit-making firms. They adopted strong underwriting standards to avoid the credit risk of subprime and other high-risk mortgages. But after Congress enacted affordable-housing goals, administered by the Department of Housing and Urban Development, in 1992, underwriting standards declined. Republicans generally favor eliminating the government’s role in housing finance, while Democrats worry that without government support, mortgages would be too expensive for low- and moderate-income families. Although it runs counter to the current Washington view, good underwriting standards can satisfy the objectives of both parties. It’s clear that today’s policies create winners and losers. The winners include real estate agents and home builders, who want to increase borrowing and sell ever- larger and more expensive homes. The losers, as we saw in the financial crisis, are borrowers of modest means who are lured into financing arrangements they can’t afford. When the result is foreclosure and eviction, one of the central goals of homeownership — building equity — is undone. After the financial crisis, Representative Barney Frank — the Massachusetts Democrat who led the House Financial Services Committee during the crisis, and a champion of

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credit programs for low-income buyers — admitted, “It was a great mistake to push lower-income people into housing they couldn’t afford and couldn’t really handle once they had it.” Policy makers who support homeownership would be wise to consider who is hurt and who is helped when we abandon traditional underwriting standards. Peter J. Wallison, a senior fellow at the American Enterprise Institute, is the author of the forthcoming book “Hidden in Plain Sight: What Really Caused the World’s Worst Financial Crisis and Why It Could Happen Again.” http://www.nytimes.com/2014/11/01/opinion/underwriting-the-next-housing- crisis.html?emc=edit_tnt_20141103&nlid=64395644&tntemail0=y&_r=0

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Eurointelligence RSS Feed viernes, 31 de octubre de 2014, 9:01:18 German inflation falls again

viernes, 31 de octubre de 2014, 9:01:18 A stressful week ended on a quiet newsday for the eurozone. After the bank stress tests and the associated hype, reality returned to the eurozone as Germany reported yet another fall in inflation rates. Annual HICP inflation fell from 0.8% in September to 0.7% in October, according to the German statistical office. The more detailed German national measures holds up 0.8% yoy, but shows a mom decline by 0.3% from September. The breakdown of the data shows that the weakness stems entirely from energy and manufactured goods prices, both of which are negative. A Reuters article sampled some opinion among traders, according to which the latest marginal improvements in confidence indicators and bank lending would be enough to hold off further monetary policy action for a while. The eurozone inflation data for October will come out this morning. The market consensus is for a small increase in the headline rate. With Germany HICP headlines rates falling, that would imply rising HICP rates elsewhere in the eurozone. In Spain, HICP inflation was -0.2%, after -0.3% in September, while the national measure was - 0.1%. The rates have been oscillating around zero for the past 13 months. Unlike other eurozone countries, Spain has managed to achieve some modest GDP growth. The 3rd quarter GDP advanced estimate, one month before the full analysis, puts the yearly growth rate at 1.6%. This is the 4th consecutive quarter of positive yoy growth rates, and the 7th quarter of accelerating growth. The picture that emerges from these indicators is that the Spanish economy started a year ago on a trajectory of accelerating growth but with flat prices and consumption. We have no inflation figures for Italy, but we noted a couple of other statistics this morning, which give us a sense of a stabilisation – at a very low level. Istat reports that the number of people at risk of poverty or social exclusion fell from 29.9% in 2012 to 28.4% in 2013. There was a relative shift in risks – we presume due to policies – as the situation of elderly people improve while the situation worsened dramatically for families with many children. Corriere della Sera reports that, the percentage of families that managed to put aside some savings had risen from 29% to 33% in the last twelve months. Our other stories We also have stories on how Spain rescue foreign creditors; on the discussion of a precautionary credit line for Greece; on whether the BES scandals will have macroeconomic consequences for Portugal; on a language problem in European supervision; on German paranoia about QE, and a hilariously funny comment on the stress tests.

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Eurointelligence RSS Feed jueves, 30 de octubre de 2014, 9:01:50 Signs on insurrection in Rome and Madrid

jueves, 30 de octubre de 2014, 9:01:50 barometer that puts Podemos in first place in voter intent; The mood in Rome and Madrid is tensing up as austerity and depression are finally taking their political toll. The mood in Rome was sombre yesterday after an incident in front of the German embassy in Rome. A group of workers, faced with dismissal by a ThyssenKrupp factory, demonstrated peacefully when they were attacked by police. Five demonstrators were hospitalised with head injuries. The police justified the action on the grounds that they received information that the demonstrators were planning to occupy Rome central railway station – which the demonstrators deny. The incident raised all sorts of mostly unsubstantiated speculation in the Italian media this morning about the involvement of the government, and the usual who talked to whom and when. What is important to note, however, is that there are signs of insurrection on the streets of Italian cities, as trade unions are stepping up their national protests against both actual job losses and against the proposed labour reforms. There will also be a general strike in November. In Brussels, meanwhile, Jyrki Katainen felt the need to emphasise a procedural point – that the interim clearance of the Italian and other budgets does not prejudice the final outcome. This is technically correct, but clearly, the interim stage was the critical step because the old Commission was still in charge, and because we are now moving into the more technical, and less political aspects of the analysis. As La Repubblica reminds us this morning, the final judgement will be influenced by the Commission’s autumn economic forecast, due next month, by the macroeconomic imbalances procedure, and by an analysis of debt sustainability. And while there is still room for haggling, the big political decision seems to have been taken. La Repubblica quotes Pierre Moscovici, speaking in Paris, saying “Europe is not a penalty machine. Deterrence is there ??to convince. Sanctions are always a defeat. " Also in La Repubblica, Federico Fubini has a comment in which he compares the favourable market conditions in Spain to those of Italy. He said it is perfectly plausible that relative market perceptions reverse again, as next year’s election season in Spain may produce a similar outcome with Podemos, compared to the rise of the Five Star Movement in Italy at the last election. 135

In Spain, meanwhile, the commentariat was abuzz about a rumour relating to the latest political barometer of the national sociological institute CIS, to be published next week. According to El Confidencial, which quotes unnamed sources in the PP leadership, the poll will show that Podemos for the first time leads in direct voter intent. This refers to the raw data before they are “cooked” to produce an election vote estimate. The latter puts Podemos in close second place to the PP, and well ahead of the PSOE. According to the senior PP source the major private polling firms have been sitting on unpublished polls but once the CIS’ cat is out of the bag one can expect the release of further private polls confirming the rise of Podemos and the lack of traction of the new PSOE leader. Our other stories We also have reports on Spanish productivity, on a proposal to fund Juncker’s €300bn investment programme; on a warning by the Greek parliament’s budgetary office; on a childish proposal by Portugal’s prime minister; on a collapse in German exports to Russia; on a mild improvement in lending conditions; and on a number of euro crisis fallacies.

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Eurointelligence RSS Feed White Flag over Brussels

miércoles, 29 de octubre de 2014, 8:45:12 After a noisy stand-off now comes the truce. The Commission cleared five countries – France, Italy, Austria, Slovenia and Malta - of serious non-compliance with the Stability and Growth Pact after these member states have “responded constructively” to initial concerns. France and Italy had tweaked their budgets to get closer to EU targets, and presented some €3.6bn and €3.3bn respectively in extra measures the day before. Whether or not these measures are considered to be effective will be part of the more detailed examination over the coming weeks until the final verdict is given end of November by the new Juncker Commission. France in particular is thus not yet out of the woods. France will need to obtain another permission for a delay to achieve a deficit below the 3% of GDP – after being granted already a two-year delay in 2013. For France to get another waiver the commission must determine the French government has implemented significant economic reforms to justify the miss. Any waiver would also require approval from other eurozone countries, including Germany. But opinions are divided even inside the Commission, writes Peter Spiegel in the FT. In a meeting with a small group of reporters on Monday night, Karel De Gucht, the outgoing trade commissioner, called the French explanations for missing EU targets “simple bullshit”. Other officials expressed relief that both governments amended their submissions to avoid the politically explosive decision. The decision by the Commission to yield, in part, to demands by Italy and France for a more flexible treatment has given rise to some commentary. One is by Giuseppe Guarino, who was an Italian finance minister in the late 1980s, and who is quoted by Corriere della Sera as saying that Matteo Renzi has bulldozed the fiscal compact. He also gave an unorthodox legal interpretation of the existing rules. He said that council regulation 1466/97, which was one of the components of the original stability pact, constituted a violation of the Maastricht Treaty, by changing the objective from sustainable growth to a balanced budget. The 3% deficit limit was no more than a reference value in the Maastricht Treaty, and Italy could easily have invoked a force majeure argument, given its growth performance since 1999. He noted that there were no references to structural reforms in the treaties or to structural deficits. What Renzi has achieved in the last few days is an increase in Italy’s deficit limit from zero to 3%. Ashoka Mody asks the question whether the fiscal rules are dying. He said the outcome of the recent negotiations with France and Italy were unseemly, but economically welcome. Forcing austerity on weak economies is counterproductive. The French and Italian revolt may encourage similar challenges from others. In his essay, he goes in the history of the fiscal rules, and the more recent embrace of structural targets, noting the difficulty of the underlying assumption. 137

“Once centralized surveillance and enforcement of fiscal rules is consigned to the dustbin of history, there is only one way ahead: more-orderly recourse to debt restructuring combined with the forceful exercise of ECB powers to prevent financial contagion... Although applying this principle to the problems inherited from this crisis will require considerable improvisation, it is the only logically-consistent and politically feasible system for the future. All other approaches will continue to run into political and economic cul-de-sacs.” Our other stories We have an extensive discussion on the European Commission’s decision to clear the budgets of the five countries it questioned – including a debate on whether this is the beginning of the end for the fiscal rules. We cite two commentators who think so. We also have further details on the French and Austrian budgets; more on corruption in Spain; on a stress test for German insurers; further commentaries on the bank stress tests; and about an intra-German power struggle.

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Are the Eurozone’s fiscal rules dying? - if so: good riddance by Ashoka Mody on 28th October 2014 1219131754

Stephen Mcsweeny The European Commission and European Council have blinked.1 Reprimanding France and Italy for their transgressions of the fiscal rules was too risky. With face-saving measures, France and Italy will now break the eurozone’s prized fiscal rules.2 While unseemly in the eurozone context, this is a good economic outcome. Forcing deeper austerity upon fragile economies is destructive. Yes, sure, the French and the Italians could have better managed the balance between taxes and spending. But fine- tuning those through a collective process is absurd. Despite the small victory for economic good sense, it is too early to cheer. Indeed, the eventual agreement with France and Italy may well entail excessive austerity: we have no good way of knowing because the discussion has been focused on numerical targets rather than on economic considerations. Regrettably, the economic mythology of austerity lives on. When Hans-Werner Sinn asserts that the reduced austerity is a license to run up fresh debts, he speaks for many who insistently disregard the empirical evidence. The evidence is overwhelmingly clear. Single-minded austerity caused growth to stall; as a

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consequence, the debt/GDP ratios increased rapidly, leading to the onset of a cycle of rising debt and deflation in the most distressed member states (Mazzolini and Mody, 2014). But no matter, the instinct remains that the rules must be respected. The reason to be cautiously optimistic is that the French and Italian revolt may encourage new challenges from other countries. Such a momentum would politically discredit the rules, leaving them to atrophy. True, such optimism is premature. Germany and France did flout the rules in 2003, undermining their credibility. But instead of withering away, the rules reasserted their grip at precisely the wrong moment, when— amidst the crisis—the distressed economies needed the oxygen of fiscal stimulus. German interests were central to the reassertion of the fiscal rules. Germany relishes its role as Europe’s hegemon but has no appetite to pay for that privilege. So the crisis forced to the surface the central dilemma in the construction of the eurozone: Tweet This The Commission and the Council have blinked. Reprimanding France and Italy was too risky • Germany is unwilling to pay for the “mistakes of others.” • But the option of restructuring sovereign debt has been ruled out. • Hence, everyone is agreed on the need for more austerity, even though unending austerity makes the debt repayment burden greater, not less. To be clear: Germany’s unwillingness to pay was part of the contract at Maastricht in 1992 and remains so in the Lisbon Treaty. Those who now fret that Germany should do more must not forget that they signed on to the deal with open eyes; presumably the hope was that Germany would see good sense when it became necessary. But that hope did not incorporate the views of the German taxpayer or the ability of a new generation of German leaders to persuade the German taxpayer. With the passage of time, the German taxpayer is less likely to be compliant. Tweet This Germany relishes its role as Europe’s hegemon but has no appetite to pay for that privilege For this reason, the resolute German opposition to such concepts as Eurobonds should not be a surprise to anyone. Indeed, if the European Stability Mechanism (ESM) had to be considered now—knowing that official loans to Greece will be largely forgiven—it is possible that the German authorities would be less forthcoming in their support and, more seriously, the European Court of Justice (ECJ) would find it illegal under the Lisbon Treaty. The ECJ judgment requires that the loans be paid back, otherwise they violate Article 125, the so-called no bailout clause. 1 Eurointelligence Professional Edition, October 23, 2014. 2 Analysts have described the changes in response to the Commission’s demand as “cosmetic.” Article 125 did imply— and even encourage—the idea that private creditors would bear the costs of imprudent lending to eurozone sovereigns. But as soon as the crisis began,

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this option was ruled out on the grounds that the ensuing mayhem would have catastrophic costs. This folklore has persisted despite the historical evidence that, notwithstanding the temporary hiccups, the cleansing effect of debt restructuring benefits both debtors and creditors (Mody, 2013a). The damage inflicted by denying this evidence was manifest when Greek debt was eventually restructured. Sovereign debt attorney Lee Buchheit remarked: “I find it hard to imagine they will now man up to the proposition that they delayed – at appalling cost to Greece, its creditors and its official sector sponsors - an essential debt restructuring …” Thus, the response to the crisis was a patchwork of financial safety nets (which arguably contravene the Treaty), the presumption of no debt restructuring (which the Treaty encourages), and an extraordinary political compromise on counter-productive austerity rules. Tweet This This outcome was extraordinary because the economics and politics of the eurozone’s fiscal rules were always known to be flawed and potentially corrosive This outcome was extraordinary because the economics and politics of the eurozone’s fiscal rules were always known to be flawed and potentially corrosive. As Eichengreen (2003) bluntly pointed out, there never was an economic basis for the fiscal rules. Jean Tirole, the most recent recipient of the Economics Nobel Prize, wrote a similarly scathing critique in 2012. There is limited contemporary commentary on the political evolution of the rules. Of German origin, they were defined by the Delors Committee’s Report in 1989 and reaffirmed in the deliberations leading to the Maastricht Treaty in 1992. Interestingly, however, Charles Grant, Delors’ biographer, recounts that Delors himself was unhappy with the rules. In the months before Maastricht (Grant, 1994, pp. 183-184): “The Germans continued to argue for sanctions against countries with ‘excessive deficits.’ Only the strange alliance of Delors and [Norman] Lamont [the British Finance Minister] argued against centralization of fiscal policy. Delors claimed that EC sanctions would breach subsidiarity and be unnecessary. …Lamont argued that markets would discipline profligate governments by demanding higher rates of interest.” Tweet This The fiscal rules persisted along with the equally stupid idea—one that has never been invoked—that countries in economic distress need to be helped along with sanctions But that fight went nowhere. In October 1991, two months before the summit at Maastricht to sign the Treaty, Delors and Lamont “conceded defeat.” Delors had come so close to the monetary union that he had so desperately wanted; he was willing to make an essential compromise. From then on, the history is well known. Romano Prodi, as president of the European Commission, pronounced the rules (recast in 1997 as the Stability and Growth Pact) to be “stupid.” But they persisted along with the equally stupid idea—one that has never been invoked—that countries in economic distress need to be helped along with sanctions.

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Hence, after the onset of the crisis, the search for a more “scientific” approach offered a ray of hope. The intention was to downplay the requirement that budget deficits could not exceed 3 percent of GDP and target instead the “structural deficit.”3 The structural deficit is more apt because it sees through to the more permanent underlying deficit by filtering out the deficit due to the temporary decline in revenues and increase in social support during a recession. 3 In an important sense, the 3 percent rule has never gone. The so-called excessive deficit procedure (EDP) continues to specify a date by which the 3 percent needs to be reached. So, while there may be agreement on and adherence to a structural adjustment path (with automatic stabilizers allowed to operate), if the country under scrutiny does not observe the EDP date for the 3 percent target, there is a problem. But this “scientific” approach was always fraught with difficulty. The simple truth is that measuring the depth of a recession—and isolating it from a more durable decline in an economy’s potential output—is an art, not a science. Plausible approaches come up with completely different estimates. For example, Robert Gordon of Northwestern University has proposed “a surprisingly simple” new method of estimating potential output, which leads him to conclude that the estimates of the Congressional Budget Office are “too optimistic.” For this reason, I wrote a year ago (Mody, 2013b, p. 18): “[…] the shift from the SGP’s three percent of GDP budget deficit target to the ‘structurally’-balanced budget deficit is technically appropriate. But that requires assessment of a country’s potential output, a nebulous concept especially during periods of economic stress. The risks are high that the assessment to be conducted by a committee of member-country representatives will be politicised. The actions that follow from the assessment also remain subject to discretion.” Since then, things have played out much as predicted. The various groups and committees set up to assess a country’s fiscal position have taken the traditional refuge in process, while the real debate has occurred in the political arena. Hence, Italian Prime Minister Mateo Renzi’s call for greater flexibility in the application of rules met with the anticipated retort from the German Chancellor Angela Merkel. She told the German Bundestag that the rules permitted sufficient flexibility: “The German government agrees that the Stability and Growth Pact offers excellent conditions for that, with clear guard rails and limits on the one hand and a lot of instruments allowing flexibility on the other." To good effect, she added, "We must use both just as they have been used in the past." In other words, she said, “What exactly is the problem?” Even ECB President Draghi, whose speeches have been viewed as calling for more fiscal stimulus, has been cautious: “[…] we are operating within a set of fiscal rules – the Stability and Growth Pact – which acts as an anchor for confidence and that would be self-defeating to break.” Tweet This The call for exempting “investment” from the fiscal rules has resurfaced. That once again makes economic sense, but it is easy to see why the idea goes nowhere Predictably also, the call for exempting “investment” from the fiscal rules has resurfaced. That once again makes economic sense, but it is easy to see why the idea goes nowhere. Over a decade ago, one commentator noted that investment is a 142

“wonderfully elastic concept” (Righter, 2002). Even serious scholars, however, have been seduced by the possibility. Blanchard and Giavazzi (2004) offered a proposal for encouraging investment within the SGP framework but note, without irony (p. 9): “Such rules would need to deal with the incentive to re-deﬁne current spending as public investment, and this may not be easy.” These observations are not an argument against “flexibility” in rules or greater incentives for investment. They are argument for the political improbability of centrally applying rules to a collection of sovereign nations with widely differing economic capabilities and trajectories. Inevitably, exceptions will be needed, but they will create a sense (often incorrectly) that some nations are cheating and free-riding. The political debate will continue to be poisoned. For this reason, the hope that France and Italy are in the vanguard of rendering these rules obsolete should be a matter of cheer. Delors was right: centralization of fiscal rules makes neither economic nor political sense. Persisting with centralized fiscal rules despite their evident costs—because all other options have been ruled out—is a grievous error. Once centralized surveillance and enforcement of fiscal rules is consigned to the dustbin of history, there is only one way ahead: more-orderly recourse to debt restructuring combined with the forceful exercise of ECB powers to prevent financial contagion (see Mody, 2013b). Although applying this principle to the problems inherited from this crisis will require considerable improvisation, it is the only logically-consistent and politically feasible system for the future. All other approaches will continue to run into political and economic cul-de-sacs. 4 The current Bundesbank President, Jens Weidmann has recently reiterated this proposal. Central to the new architecture must be system of more automated debt-restructuring. The idea was first proposed in 2011 by then Bundesbank President Axel Weber and his colleagues. Whenever a country applied to the European Stability Mechanism for financial assistance, private creditors would be required to automatically extend the maturities of all bonds issued by that country.4 This, in principle, is the right idea because it removes the discretion in sovereign debt restructuring. That discretion is always used to postpone needed restructuring because, despite all evidence to the contrary, the fear of wild contagion is invoked. Although an important step in the right direction, the trigger for maturity extension proposed by Weber et al. is not the right one. Since an ESM program is intended to kick in as “a last resort” (when the eurozone’s financial stability is threatened), the distress by then would be acute; and because the timing of the program remains uncertain, the trigger would be difficult to price. Hence, I recently outlined a proposal for automated restructuring using risk spreads as triggers. Tweet This Being wedded to an ingrained way of doing business, Berlin, Brussels, and Frankfurt may prefer to find accommodation with Paris, Rome, and others that come after them The symbiosis between automated debt restructuring and ECB’s lender-of-last resort functions is clear: with the burden of insolvent sovereigns on the ECB eliminated, the 143

concerns of the German Court will be reduced (Mody, 2014). And a politically legitimate and transparent commitment to an ECB safety net should then be possible. Those who are persuaded by this agenda—which entails discarding fiscal policy centralization, making debt restructuring integral to the policy framework, and creating a politically legitimate financial safety net—may yet argue that the task is too hard to achieve. Being wedded to an ingrained way of doing business, Berlin, Brussels, and Frankfurt may prefer to find accommodation with Paris, Rome, and others that come after them. A new normal in the rules may allow some modest, hard-fought exceptions. That will be an unfortunate response. A continued reliance on centralized fiscal policy will be like searching for lost car keys under the lamppost because it is easiest to look where the light is. Without implicating them, I am grateful to Ajai Chopra and Guntram Wolff for their comments and suggestions. http://www.bruegel.org/nc/blog/detail/article/1468-are-the-eurozones-fiscal-rules-dying/

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World Affairs

Wolfgang Schäuble Wolfgang Schäuble has been Germany’s Federal Minister of Finance since 2009, helping to engineer the country’s remarkable post-crisis growth. He previously served as Minister of the Interior during the governments of Angela Merkel (2005-09) and Helmut Kohl (1989-91), and has been Chairman of Germany’s ruling Christian Democratic Union. OCT 30, 2014 Why Taxation Must Go Global BERLIN – We are witnessing profound changes in the way that the world economy works. As a result of the growing pace and intensity of globalization and digitization, more and more economic processes have an international dimension. As a consequence, an increasing number of businesses are adapting their structures to domestic and foreign legal systems and taxation laws. Thanks to technical advances in the digital economy, companies can serve markets without having to be physically present in them. At the same time, sources of income have become more mobile: There is an increasing focus on intangible assets and mobile investment income that can easily be “optimized” from a tax point of view and transferred abroad. Tax legislation has not kept pace with these developments. Most of the tax-allocation principles that apply today date back to a time when doing business internationally primarily meant transporting goods across a border to a neighboring country. But rules that were devised for this in the 1920s and 1930s are no longer suitable for today’s international integration of economic processes and corporate structures. They need to be adapted to the economic reality of digital services. In the absence of workable rules, states are losing revenue that they urgently need in order to fulfill their responsibilities. At the same time, the issue of fair taxation is becoming more and more pressing, because the number of taxpayers who make an adequate contribution to financing public goods and services is decreasing. The resulting tensions between national fiscal sovereignty and the borderless scope of today’s business activities can be resolved only through international dialogue and uniform global standards. Within the European Union, permitting groups of states to

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forge ahead with joint solutions to issues that can be addressed only multilaterally has worked well in the past. If such measures prove successful, other states follow. This approach can also serve as a global governance model for resolving international problems. In today’s world, even large states cannot establish and enforce international frameworks on their own. Groups of countries still can. This has been demonstrated in the context of financial-market regulation; it is starting to become clear with regard to the regulatory framework for the digital economy; and it is now being confirmed in the area of taxation. The Seventh Meeting of the Global Forum on Transparency and Exchange of Information for Tax Purposes took place in Berlin this week, bringing together representatives from 122 countries and jurisdictions, as well as the EU. A joint agreement on the automatic exchange of information on financial accounts was signed on Wednesday. The joint agreement was originally an initiative by Germany, France, Italy, the United Kingdom, and Spain. Roughly 50 early-adopter countries and territories decided to take part, while other countries have indicated their willingness to join. The agreement is based on the Common Reporting Standard, which was developed by the OECD. Under the CRS, tax authorities receive information from banks and other financial service providers and automatically share it with tax authorities in other countries. In the future, virtually all of the information connected to a bank account will be reported to the tax authorities of the account holder’s country, including the account holder’s name, balance, interest and dividend income, and capital gains. Various measures are in place to ensure that banks can identify the beneficial owner and notify the relevant tax authorities accordingly. The CRS thus expands the scope of global, cross-border cooperation among national tax authorities. In this way, we can establish a regulatory framework for the age of globalization. The automatic exchange of information is a pragmatic and effective response to the perceived lack of global governance regarding international tax issues. By making taxation fairer, governments will have a positive impact on people’s acceptance of their tax regimes. This great success in the fight against international tax evasion would have been unthinkable only a few years ago. Now it is important to continue the efforts of the OECD and the G-20 in the area of corporate taxation. We need to make sure that creative tax planning in the form of profit-shifting and artificial profit reduction is no longer a lucrative business model. A “beggar-thy-neighbor” taxation policy, by which one country pursues tax policies at the expense of others, is just as dangerous as beggar-thy- neighbor monetary policies based on competitive currency devaluation. It leads to misallocations – and will ultimately reduce prosperity around the world. That is why we need to agree on uniform international standards in order to achieve fair international tax competition. The progress achieved in Berlin on the automatic exchange of tax information shows that, by working together, we can realize this goal.

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https://www.project-syndicate.org/commentary/taxation-international-standards- regulation-by-wolfgang-sch-uble-2014-10

Business & Finance

Stephen S. Roach Stephen S. Roach, former Chairman of Morgan Stanley Asia and the firm's chief economist, is a senior fellow at Yale University’s Jackson Institute of Global Affairs and a senior lecturer at Yale’s School of Management. He is the author of the new book Unbalanced: The Codependency of America and China. OCT 28, 2014 Last Chance for Japan? NEW HAVEN – Japan is the petri dish for the struggle against the secular stagnation that is now gripping most major developed economies. And, notwithstanding all of the fanfare surrounding “Abenomics,” Japan’s economy remains moribund. In the six quarters of Shinzo Abe’s latest stint as prime minister, annualized real GDP growth has averaged just 1.4% – up only slightly from the anemic post-1992 average of 1%. Abenomics, with its potentially powerful combination of monetary and fiscal stimulus, coupled with a wide array of structural reforms, was supposed to end Japan’s “lost decades.” All three “arrows” of the strategy were to be aimed at freeing the economy from a 15-year deflationary quagmire. Unfortunately, not all of the arrows have been soaring in flight. The Bank of Japan seems well on its way to delivering on the first one – embracing what it calls quantitative and qualitative easing (QQE). Relative to GDP, the BOJ’s monetary-policy gambit could actually far outstrip the efforts of America’s Federal Reserve. But the flight of the other two arrows is shaky, at best. In recent days, Abe has raised serious questions about proceeding with the second phase of a previously legislated consumer-tax hike that has long been viewed as the linchpin of Japan’s debt- consolidation strategy. Abe has flinched because the economy remains weak, posing renewed risks of a deflationary relapse. Meanwhile, the third arrow of structural reforms – especially tax, education, and immigration reforms – is nowhere near its target. Abenomics, one might conclude, is basically a Japanese version of the failed policy combination deployed in the United States and Europe: massive unconventional

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liquidity injections by central banks (with the European Central Bank apparently now poised to follow the Fed), but little in the way of fundamental fiscal and structural reforms. The political expedience of the short-term monetary fix has triumphed once again. Such a gamble is especially problematic for Japan. With an aging – and now declining – working-age population, it has limited scope for reviving growth. Japan must either squeeze more out of its existing workforce by boosting productivity, or uncover new sources of demand at home or abroad. At home, that could mean adding workers, either by boosting female participation in the work force, which, at 63%, is among the lowest in the developed world, or relaxing immigration restrictions. Unfortunately, there has been little progress on either front. Moreover, even if the political will to launch third-arrow structural reforms were suddenly to strengthen – a dubious proposition – any productivity payback would most likely take a long time to materialize. That leaves external demand, which underscores what is perhaps Abenomics’ most serious strategic flaw: It does not take into consideration some of the biggest changes that are likely to occur in the global economy. That is a great pity, because Japan is well positioned to take advantage of one of the most powerful global trends – the coming rebalancing of the Chinese and US economies. China appears to be more committed to restructuring than the US – at least for the foreseeable future. Its Third Plenum reforms provide a cohesive framework for a pro- consumption transformation. Though America currently remains intent on resurrecting a tired growth model, there is good reason to hope that it, too, will eventually rebalance. Japan cannot afford to squander these opportunities. As the main driver of Chinese growth shifts from external to domestic demand, who could benefit more than Japanese exporters? China is already Japan’s largest export market, leaving it ideally situated to capture additional market share in the coming surge of Chinese demand for consumer products and services. Likewise, Japan stands to benefit from its technological prowess in environmental remediation – an urgent priority for China in the years ahead. Japan already has great expertise in many of the solutions to some of China’s toughest problems. Japan is also likely to gain from a long-overdue rebalancing of the US economy. A shift in the US – from excessive consumption of goods largely sourced in low-wage developing countries to the capital equipment that an increasingly investment-led economy will require – would play to Japan’s greatest strengths. As a global leader in sophisticated machinery and the earth-moving equipment needed for infrastructure investment, Japan should be able to to seize these opportunities. In looking to external demand, Japan should not lose sight of its earlier achievements. In the 1970s and 1980s, Japan was the envy of the world, owing to an all-powerful export machine that tapped the demand of a rapidly growing global economy. “Japan, Inc.” still has a good institutional memory of what it takes to draw support from external demand.

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It is time to recapture that memory. Failure to do so would leave Japan, the world’s third largest economy, at risk of being further marginalized by transformations in the world’s two largest, the US and China. There is one obvious and important caveat: Poor Sino-Japanese relations, owing to unresolved historical grievances, could prevent Japan from realizing the economic benefits implied by China’s economic rebalancing. The interplay between economics and politics lies at the heart of the rise and fall of great powers. In a rapidly changing world, underscored by likely shifts in the economic structure of China and the US, Japan cannot afford to lose sight of that fact. Just as the US and China have much to gain by transforming their economies, Japan is running out of time. In the grip of two lost decades and counting, this could be Japan’s last chance. https://www.project-syndicate.org/commentary/china-us-rebalancing-benefits-japan-by- stephen-s--roach-2014-10

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Culture & Society

J. Bradford DeLong J. Bradford DeLong is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau of Economic Research. He was Deputy Assistant US Treasury Secretary during the Clinton Administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies, and cemented his stature as a leading voice in economic-policy debates. OCT 29, 2014 American Wellbeing Since 1979 BERKELEY – The story goes like this: Since 1979 – the peak of the last business cycle before the inauguration of Ronald Reagan as President – economic growth in the United States has been overwhelmingly a rich-only phenomenon. Real (inflation-adjusted) wages, incomes, and living standards for America’s poor and middle-class households are at best only trivially higher. While annual real GDP per capita has grown 72%, from $29,000 to $50,000 (in 2009 prices), almost all of this growth has gone to those who now occupy the highest tier of the US income distribution. All of this is true, but there are a few important caveats. One is found in the Distribution of Household Income and Federal Taxes, published by the US Congressional Budget Office (CBO) last year. After-tax real income for the lowest quintile of US households was 49% higher in 2010 than in 1979, growing at an average rate of 1.3% annually. After-tax income for the middle three quintiles in 2010 was 40% higher – equivalent to 1.1% average annual growth. To be sure, households in the 81st to 99th percentiles gained 64% in after-tax income, with the top 1% up by 201%, representing an average annual growth rate of 3.6% – far ahead of any other income group. And, by now, with the recovery concentrated among the rich as well, the top 1% of Americans are highly likely to be approaching a cumulative 300% gain since 1979. But real income gains of 1.3% per year for the middle quintiles and 1.1% for the bottom are not exactly chopped liver, are they? The gap with 1.6% average annual growth rate for per capita GDP is small, isn’t it?

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Well, yes and no. An optimist (or an apologist) could argue that, though market income has indeed become grossly more unequal since 1979, with the slots in the bottom half of the income distribution losing absolute ground in real income, and with taxation becoming less progressive, welfare-state growth substantially moderated this increase in inequality. But when one looks at the 1.3% annual growth rate of after-tax real income that the CBO calculates for the bottom quintile, 0.9 percentage points comes from the growth of the health-care financing programs Medicare, Medicaid, and the State Children’s Health Insurance Program. The CBO counts all of that growth as an increase in poor US households’ after-tax real income. But that is not money that America’s poor can spend, so some downward adjustment should be applied. Moreover, only half of those expenditures show up as more health care received by program beneficiaries; the other half flow into the general US health-care financing system and cover care that was previously uncompensated. And America’s health-care financing system is uniquely inefficient: other OECD countries get more in terms of health and healthcare services from every dollar they spend than America gets from every $2 it spends. As a result, a better estimate of the contribution of expanded US public health-care programs to the material wellbeing of America’s poor is just 0.2 percentage points per year. Hence the necessity of something like the individual health-insurance mandate of the 2010 Patient Protection and Affordable Care Act (“Obamacare”), or of biting the bullet and adopting a single-payer system for financing health care. Either way, America needs to gets something comparable to other OECD countries’ value out of its enormous health-care expenditures. Frankly, I am of two minds on the relationship between growing government health- care financing programs and inequality. On odd days, my bottom line is that material wellbeing since 1979 has grown at 0.5% per year for America’s poor, compared to 4% per year for America’s rich (and 6% per year for its super-rich). This is because most of the expansion is not the equivalent of a greater income for America’s poor in any reasonable sense, and because America gets relatively little value for its health-care financing. On even days, however, my bottom line is very different. America’s poor in 1979 lagged so far behind normal OECD social democracies in terms of health and health care that even though each extra dollar produced only $0.25 of real health-care services, that $0.25 was worth about one dollar to the poor in terms of material wellbeing. On this reading, the expansion of America’s health-care programs has kept the properly measured material wellbeing of its poor on an upward path since 1979 at a rate not much less than that of real per capita GDP. But the health-care coverage and financing gaps that existed in America in 1979 made it a much more unequal place than the income-distribution data showed. https://www.project-syndicate.org/commentary/us-households-wellbeing-poor-and- middle-class-by-j--bradford-delong-2014-10

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VOX, CEPR’s Policy Portal Research-based policy analysis and commentary from leading economists Reflections on the new 'Secular Stagnation hypothesis' Lawrence Summers30 October 2014 The notion that Europe and other advanced economies are suffering secular stagnation is gaining traction. This column by Larry Summers – first published in the Vox eBook “Secular Stagnation: Facts, Causes and Cures” – explains the idea. It argues that a decline in the full-employment real interest rate coupled with low inflation could indefinitely prevent the attainment of full employment. Related// Secular stagnation: Facts, causes, and cures – a new Vox eBook Coen Teulings, Richard Baldwin Just seven years ago all seemed well in the field of macroeconomics. The phrase 'great moderation' captured the reality that business cycle volatility seemed way down from levels of the first part of the post war period. A broad methodological consensus supported the use of DSGE (dynamic stochastic general equilibrium) models to understand macroeconomic fluctuations and to evaluate macroeconomic policies. There was widespread support for the idea that the primary concern of independent central banks should be maintaining appropriate inflation targets and reacting to cyclical developments to minimise the amplitude of fluctuations. Economic crisis has led to crisis in the field of macroeconomics. The idea that depressions were a concept of only historic interest has been belied by the financial crisis and “Great Recession”. Figures 1a and 1b depicts the gap between actual and potential output estimated as of various dates for both the US and the Eurozone. It is apparent that output is far short of where its potential was expected to be as of 2008. Even more troubling is the observation that most of the gap is expected to represent a permanent loss as potential output has been revised sharply downwards. For the Eurozone, GDP is almost 15% below its 2008-estimated potential and potential output has been written down by almost 10%. As Figure 2 illustrates Europe’s output shortfall is almost identical to the one Japan experienced when the bursting of its ‘bubble economy’ triggered a financial crisis. The experience of Japan in the 1990s and now that of Europe and the US suggests that – for the purpose of understanding and combating important fluctuations – theories that take the average level of output and employment over a long time period as given are close to useless. Unfortunately almost all work in both the New Classical and New Keynesian tradition has focused on the second moment (the variance) of output and employment. This thinking presumes that with or without policy intervention the workings of the market will eventually restore full employment and eliminate output gaps. The only questions go to the volatility of output and employment around their normal levels. What has happened in the last few years suggests that the second moment is second-order relative to the first moment – the average level of output and employment through time. 152

Figure 1a. Actual and potential GDP in the US

Sources: Congressional Budget Office, Bureau of Economic Analysis Figure 1b. Actual and potential GDP in the Eurozone

Sources: IMF World Economic Outlook Databases, Bloomberg

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Figure 2. Japan and Eurozone, forecast vs. reality

Sources: OECD 1992 “Long Term Prospects For The World Economy”, IMF 2007, 2007 & 2014 WEO Database The “new secular stagnation hypothesis” responds to recent experience and the manifest inadequacy of conventional formulations by raising the possibility that it may be impossible for an economy to achieve full employment, satisfactory growth and financial stability simultaneously simply through the operation of conventional monetary policy. It thus provides a possible explanation for the dismal pace of recovery in the industrial world and also for the emergence of financial stability problems as an increasingly salient concern. Plan This column focuses on the idea of secular stagnation. After noting the apparent difficulty that industrial economies are having in achieving financially stable growth with full employment, I explain why a decline in the full employment real interest rate – FERIR, for short – coupled with low inflation could indefinitely prevent the attainment of full employment. I argue that even if it were possible for the FERIR to be attained, this might involve substantial financial instability. Having made the case that a decline in the FERIR would explain much of what we observe, I then adduce a variety of factors suggesting that the FERIR has declined substantially over the last several decades in the industrial world. I conclude by discussing the relationship between the secular stagnation and hysteresis, global aspects and policy implications.

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1. The secular stagnation hypothesis and recent events It has now been more than 5 years since the US economy reached its trough in the second quarter of 2009 and close to 5 years since evidence of systemic financial risk as reflected in LIBOR spreads or the need for government bailouts or elevated risk premiums on bank debt has been pervasive. Yet US economic growth has averaged only 2% over the last 5 years despite having started from highly depressed state. In a similar vein, credit spreads in Europe have come way down and fears of the dissolution of the Eurozone have been sidelined, yet growth has been glacial over the past several years and is not expected to rapidly accelerate. Upon reflection, these patterns should be surprising. If a financial crisis represents a kind of power failure one would expect growth to accelerate after its resolution as those who could not express demand because of a lack of credit were enabled to do so. Trouble masked by unsustainable finances Unfortunately it appears that the difficulty that has arisen in recent years in achieving adequate growth has been present for a long time but has been masked by unsustainable finances. Here it is instructive to consider the performance of the US and Eurozone economies prior to onset of financial crisis in 2007. Start with the United States. It is certainly fair to say that growth was adequate perhaps even good during the 2003- 2007 period. It would not be right to say either that growth was spectacular or that the economy was overheating during this period. And yet this was the time of vast erosion of credit standards, the biggest housing bubble in a century, the emergence of substantial budget deficits and what many criticize as lax monetary and regulatory policies. Imagine that US credit standards had been maintained, that housing had not turned into a bubble and that fiscal and monetary policy had not been simulative. In all likelihood output growth would have been manifestly inadequate because of an insufficiency of demand. Prior to 2003, the economy was in the throes of the 2001 downturn and prior to that it was being driven by the internet and stock market bubbles of the late 1990s. So it has been close to 20 years since the American economy grew at a healthy pace supported by sustainable finance. Making judgments for Europe is more difficult because of the problem of evaluating structural constraints on growth. But in retrospect it is clear that much of the strength of the economies of the periphery prior to 2010 was based on the availability of inappropriately cheap credit and that much of the strength of the economies of Northern Europe was derived from exports that were financed in unsustainable ways. Understanding anaemic growth absent unsustainable financing How might one understand why growth would remain anaemic absent major financial concerns? Suppose that a substantial shock took place – for reasons that I will describe subsequently – and that this tended to raise private saving propensities and reduce investment propensities. How would growth be affected? The normal answer to this question is that one would expect interest rates to fall (driven either by market forces or policy actions) until the saving and investment rate were equated at the full employment level of output. That is to say, changes in saving and investment propensities, or for that

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matter, in government deficits might be expected to impact an economy’s FERIR but not its level of output and employment. But this presupposes full flexibility of interest rates. In fact, in modern economies short term safe interest rates cannot fall appreciably below zero because of the possibility of currency substitution. So interest rates are not fully flexible in modern economies. Note that interest rates that include term or credit premia will never fall to zero but only to a level that reflects these premia. Hence the possibility exists that no attainable interest rate will permit the balancing of saving and investment at full employment. This is the secular stagnation hypothesis first put forward by Alvin Hansen in the 1930s. Notice that as Keynes, Tobin and subsequently Brad Delong and I have emphasized, wage and price flexibility may well exacerbate the problem. The more flexible wages and prices are, the more they will be expected to fall during an output slowdown leading to an increase in real interest rates. Indeed there is the possibility of destabilizing deflation with falling prices leading to higher real interest rates leading to greater output shortfalls leading to more rapidly falling prices and onwards in a vicious cycle. Low rates and financial instability Even if the zero interest rate constraint does not literally bind, there is the possibility that the positive interest rate consistent with full employment is not consistent with financial stability. Low nominal and real interest rates undermine financial stability in various ways. They increase risk taking as investors reach for yield, promote irresponsible lending as coupon obligations become very low and easy to meet, and make ponzi financial structures more attractive as interest rates look low relative to expected growth rates. So it is possible that even if interest rates are not constrained by the zero lower bound, efforts to lower them to the point where cyclical performance is satisfactory will give rise to financial stability problems. Something of this kind was surely at work during the 2003-2007 period. 2. What has happened to the FERIR? So far I have argued that if the FERIR declined substantially one might expect to see an unfortunate combination of unsatisfactory cyclical performance and financial instability, much like what has been observed recently. Is it reasonable to suppose that FERIR levels have declined in major industrial countries? A variety of structural changes summarized in Summers (2014) suggest that FERIR levels may have declined substantially. These include: • Slower population and possibly technological growth means a reduction in the demand for new capital goods to equip new or more productive workers. Throughout the industrial world levels of labor force growth are way down with labor force shrinkage already under way in Japan and soon to come in large parts of Europe. • Lower priced capital goods means that a given level of saving can purchase much more capital than was previously the case. Information technology continues to decline rapidly in price and to account for a larger share of total capital investment. It is revealing that the iconic cutting edge companies have traditionally needed to go the market to support expansion. Today leading edge companies like Apple and Google are attacked for holding on to huge cash hoards.

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• Rising inequality operates to raise the share of income going to those with a lower propensity to spend. Closely related a rising profit share operates to transfer income to those with a lower propensity to spend. • Increasing friction in financial intermediation associated with greater risk aversion in the wake of the financial crisis and increased regulatory burdens operates to raise the wedge between safe liquid rates and rates charged to borrowers. In general equilibrium this drives down safe rates. The same effect is present if debt overhangs or increased uncertainty discourages borrowing. • A rising desire on the part of central banks and governments to accumulate reserves coupled with conservative investment strategies operates to raise the demand for safe assets driving down safe interest rates. This effect is reinforced by requirements that encourage pension funds and insurance companies to hold their assets in safe bonds as to best match liabilities. • Ongoing disinflation which means that at any given real interest rate, real after- tax interest rates are higher. To the extent that it is after-tax real interest rates that matter for investment decisions (as for example with tax deductible mortgages), this operates to shift investment demand inwards, resulting in a pretax real interest rate lower than it was before.[1] Figure 3. World average real interest rate

Sources: Mervyn King “Measuring the World Real Interest Rate”

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Evidence from FERIR estimates The importance of these considerations is suggested by the available empirical evidence on actual real rates and on estimates of the FERIR. Figure 3 shows trends in indexed bond yields for a number of countries. It is clear that they have trended down over the last 15 years. Even more relevant for the US economists at the Fed, Laubach and Williams (2003) have attempted to estimate the FERIR – using data on actual real interest rates and measures of where the economy is relative to its potential. While many issues can be raised with respect to their calculations, Figure 4 illustrates their estimate of a substantial long term decline in the FERIR. The IMF in its most recent World Economic Outlook has examined trends in real interest rates in industrial countries and has also considered a variety of factors bearing on real rates. They have reached conclusions similar to the ones I have reached here – that the FERIR has likely declined in recent years. This observation, together with the observation that lower US inflation – and in Europe declining rates of inflation – make it more difficult than previously to reduce real interest rates. This in turn suggests that the zero lower bound and secular stagnation are likely to be more important issues in the future than in the past. At a minimum the analysis suggests that if full employment is to be maintained in the years ahead, real interest rates in the industrial world will likely be lower than they have been historically – a development that may have important implications for financial stability. Figure 4. US natural rate of interest

Sources: Thomas Laubach and John Williams “Measuring the Natural Rate of Interest” 3 Conclusions and implications The case made here, if valid, is troubling. It suggests that monetary policy as currently structured and operated may have difficulty maintaining a posture of full employment 158

and production at potential and that if these goals are attained there is likely to be price paid in terms of financial stability. A number of questions come to mind: • How great are the risks? Alvin Hansen proclaimed the risk of secular stagnation at the end of the 1930s only to see the economy boom during and after World War II. It is certainly possible that either some major exogenous event will occur that raises spending or lowers saving in a way that raises the FERIR in the industrial world and renders the concerns I have expressed irrelevant. Short of war, it is not obvious what such events might be. Moreover, most of the reasons adduced for falling FERIRs are likely to continue for at least the next decade. And there is no evidence that potential output forecasts are being increased even in countries like the US where there is some sign of growth acceleration. • What about Hysteresis? On their own, secular stagnation ideas do not explain the decline in potential output that has been a major feature of the experience throughout the industrial world. The available evidence though is that potential output has declined almost everywhere and in near lockstep with declines in actual output; see Ball (2014) for a summary. This suggests a way in which economies may equilibrate in the face of real rates above the FERIR. As hysteresis theories which emphasize the adverse effects of recessions on subsequent output predict, supply potential may eventually decline to the level of demand when enough investment is discouraged in physical capital, work effort and new product innovation. Perhaps Say’s dubious law has a more legitimate corollary – “Lack of Demand creates Lack of Supply”. In the long run, as the economy’s supply potential declines, the FERIR rises restoring equilibrium, albeit not a very good one. • What about global aspects? There is important work to be done elucidating the idea of secular stagnation in an open economy context. The best way to think about the analysis here is to treat it as referring the aggregate economy of the industrial world where – because of capital mobility – real interest rates tend to converge (though not immediately because of the possibility of expected movements in real exchange rates). If the FERIR for the industrialized economies were low enough one might expect capital outflows to emerging markets which would be associated with a declining real exchange rates for industrial countries, increased competitiveness and increased export demand. The difficulty is that this is something that emerging markets will accept only to a limited extent. Their response is likely to be either resistance to capital inflows or efforts to manage currency values to maintain competitiveness. In either case the result will be further downward pressure on interest rates in industrial countries. 4.What is to be done? Broadly to the extent that secular stagnation is a problem, there are two possible strategies for addressing its pernicious impacts. • The first is to find ways to further reduce real interest rates.

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These might include operating with a higher inflation rate target so that a zero nominal rate corresponds to a lower real rate. Or it might include finding ways such as quantitative easing that operate to reduce credit or term premiums. These strategies have the difficulty of course that even if they increase the level of output, they are also likely to increase financial stability risks, which in turn may have output consequences. • The alternative is to raise demand by increasing investment and reducing saving. This operates to raise the FERIR and so to promote financial stability as well as increased output and employment. How can this be accomplished? Appropriate strategies will vary from country to country and situation to situation. But they should include increased public investment, reduction in structural barriers to private investment and measures to promote business confidence, a commitment to maintain basic social protections so as to maintain spending power and measures to reduce inequality and so redistribute income towards those with a higher propensity to spend. References: Summers, Lawrence (2014). “U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound”, Business Economics, Vol. 49, No. 2, National Association for Business Economics. Laubach, Thomas and John C. Williams (2003). “Measuring the Natural Rate of Interest”, Review of Economics and Statistics 85(4), 2003, pp 1063-1070. http://www.voxeu.org/article/reflections-new-secular-stagnation-hypothesis

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mainly macro Comment on macroeconomic issues

Simon Wren-Lewis Wednesday, 29 October 2014 The untold story of the Eurozone crisis Everyone knows that the Eurozone suffered a crisis from 2010 to 2012, as periphery countries could no longer sell their debt. A superficial analysis puts this down to profligate governments, but look more closely and it becomes clear that the formation of the Euro itself led to an excessive monetary stimulus in these periphery countries. This is widely understood. But this is not the whole story. It leaves out one key element that is vital if we are to understand the situation today. Here is a chart of nominal wage growth (compensation per employee) in the Eurozone and selected countries within it before the Great Recession.

Percentage change in compensation per employee (annual): source OECD Economic Outlook

Between 2000 and 2007 German wages increased by less than 10% compared to over 20% in the Eurozone as a whole (which of course includes Germany). This difference was not primarily caused by excessive growth in the periphery countries: wages in France, Belgium, the Netherlands, Italy and Spain all increased by between 20% and 30%. The outlier was Germany. Of course growth in nominal wages of less than 2%, and sometimes less than 1%, is not consistent with a consumer price inflation target of close to 2%. It was for this reason that the ECB lowered short term interest rates from 4.4% in 2000 to 2.1% in 2004. 161

They were not worried by excessive inflation in the periphery - they had to lower rates to counteract the effect of low nominal wage growth in Germany. [1] So the reason why Germany seems to have largely escaped the second Eurozone recession of 2012/3 is that it pursued (perhaps unintentionally) a beggar my neighbour policy within the Eurozone. Low nominal wage growth in Germany led to lower production costs and prices, which allowed German goods to displace goods produced in other Eurozone countries both in the Eurozone and in third markets. This might make sense if Germany had entered the Eurozone at an uncompetitive exchange rate, but my own analysis suggests it did not, and Germany’s current relative cyclical position and its current account surplus confirm this. As I argued in an earlier post, I do not think this divergence in cyclical position is the main reason why Germany resists expansionary measures in the Eurozone. But it is a lot easier to take up these obstructive positions when you are benefiting from this beggar my neighbour policy, and other countries that have suffered as a result appear not to understand what you have done. Notes [1] One of the comments on my earlier post tried to justify this beggar my neighbour policy using the following argument. Although the ECB's inflation target was close to 2%, they suggested that inflation below this was clearly desirable. What the Eurozone provided was an incentive system to try and achieve below target inflation by becoming more competitive. Germany had successfully risen to this challenge, and now it was up to other countries to try and do the same. Now if this competitiveness had been achieved by improvements in productivity, then this idea - although still mistaken - would be worth discussing. When it is achieved by cutting nominal wages (such that real wage increases are below productivity growth), it is not clear what efficiency gains are being achieved. http://mainlymacro.blogspot.com.es/2014/10/the-untold-story-of-eurozone-crisis.html

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ft.com Comment Opinion October 29, 2014 5:45 pm Largest economies must fix the eurozone Olli Rehn and Jean Arthuis Only peer pressure, opprobrium and fear will shake leaders up, write Olli Rehn and Jean Arthuis

©EPA Not long ago, before the euro existed, French politicians would have felt uncomfortable presenting a budget in deficit. The devaluation of the franc against the Deutschmark was unpalatable at home and would have provoked a costly reaction from the markets. The single currency appears to have worked since as an anaesthetic. On the eve of the European Commission’s scrutiny of its 2015 budget – and after overshooting its deficit- reduction targets for a third time – France displays a disconcerting air of nonchalance. So, three years after the eurozone reinforced its economic governance and brought in the fiscal compact – the treaty that strengthens the terms of the EU’s stability and growth pact – where are we, and where do we go? More ON THIS STORY// Brussels clears France and Italy’s budgets/ Martin Wolf Europe’s banks are too feeble/ Smaller companies face funding freeze/ Eurozone business activity expands in October/ Martin Wolf Eurozone needs more than reform ON THIS TOPIC// Gavyn Davies stress tests are not enough/ EU leans on big banks for bailout fund/ Wolfgang Münchau Italian debt/ Europe’s lenders urged to raise capital now IN OPINION// Towers that cast a shadow on New York/ What dandruff can teach us about funding the NHS/ Days of impulse and quiet repression in Orban’s illiberal democracy// Lorenzo Bini Smaghi Germany needs to spend

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The fear of a euro break-up has gone, and the days of make-or-break summits are over. But now the spectre of deflation haunts a highly unstable geopolitical climate. Some member states at the periphery underwent reform programmes that have broadly succeeded. Today it is the largest economies – France, Germany and Italy – that hold the answer to the European recovery conundrum. If persistent high fiscal deficit and increasing public debt resulted in rapid economic growth, then France and Italy would be European champions; Japan would be the world’s leading economic power; and Finland would be running the show in the Nordic area. What these countries have in common is a lack of appetite for structural reforms. When Germany broke the terms of the stability and growth pact in 2003-04, it did so to implement a bold reform agenda that is unanimously applauded today. Should structural reforms be implemented in France and Italy, the European Central Bank would be reassured that its monetary stimulus was being channelled effectively through to the real economy to boost lending to enterprises and households. But genuine reforms in France are still pending. The reshuffled government does not have the support of its Socialist majority. The republic’s rigid institutional system prevents Prime Minister Manuel Valls and Emmanuel Macron, economy minister, from co-operating with like-minded elements in the opposition, making it impossible to abandon the 35-hour working week or suffocating taxes on producers and companies. Ultimately, without reforms, the social system cannot continue to be financed by salaries; the burden must be shifted to consumption, in the form of a “social value added tax”, for instance. Rallies in Rome this weekend were a reminder that Matteo Renzi, the prime minister, is still struggling with factions in his Partito Democratico, despite its victory in the European elections. Rome and Paris should not wait until they have lost all their political capital before taking decisive action Tweet this quote Should the Rome-Paris axis implement genuine reforms, Germany would be inclined to boost its own domestic demand, particularly by increasing public and private investment. In return, a clear signal from Berlin that it is ready to boost internal demand would be welcomed in Paris and Rome. At the same time, the ECB should go all the way down the road of monetary policy. Quantitative easing would help fell the spectre of deflation and assure leaders in France and Italy that economic reform is worth the political cost because it would keep up stronger economic activity and domestic demand. The reinforced economic governance of the eurozone and the decisive actions of the ECB have helped to stabilise the economy. Now member states must do their bit. European economic governance is not in the first instance about sanctions but about a partnership for reform orchestrated by the member states themselves and helped by the commission. Any successful strategy to boost growth requires the member states concerned to take ownership of reforms. The Commission’s chief role is to help

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identify the most significant reforms to underpin growth. The euro group, comprising eurozone finance ministers, must push for this too. Only peer pressure, opprobrium and fear of losing influence will shake leaders up. Still, Rome and Paris should not wait until they have lost all their political capital before taking decisive action. The year 2017 will be crucial. The fiscal compact will have to be integrated into EU treaties; the EU budgetary framework for 2014-20 will be revised; and the UK will hold a referendum on a renegotiated membership which, given public opinion, will be hard to escape, even if the opposition Labour party wins the 2015 general election. At the same time, Germany and France will go to the polls. All the stars are aligned for big changes in Europe. The writers, Liberal MEPs, are respectively former Commission vice-president for economic and monetary affairs; and chair of the European Parliament budgets committee and French finance minister, 1995-97 http://www.ft.com/intl/cms/s/0/045fbf5a-5f7e-11e4-a882- 00144feabdc0.html#axzz3HMcg3THv

ft.com/markets MARKETS INSIGHT October 30, 2014 6:01 am Willem Buiter Four rescue measures for stagnant eurozone Willem Buiter Bank stress tests an unconvincing fudge and big problems remain L ast week, 25 banks failed the asset quality review (AQR) conducted by the European Central Bank for 130 of the eurozone’s largest banks. In the stress test performed by the European Banking Authority on 123 of the EU’s largest banks, 24 failed. These latter had a capital shortfall under the adverse macroeconomic scenario amounting to €24.6bn – 0.09 per cent of assets worth €28tn, 70 per cent of the EU total. After allowing for capital raised or converted since the beginning of 2014, 14 banks remained short by €9.5bn – about 0.03 per cent of assets, according to the stress test. More ON THIS TOPIC// Martin Wolf Europe’s banks are too feeble/ Inside Business Alternative stress test hits French banks/ Italy rules out public money for banks that failed stress tests/ Stress tests fail to tackle deflation spectre MARKETS INSIGHT// ‘Coffin corner’ threat to stability/ Corporate cash hoarding has to end/ EU must avoid ‘lost decade’/ Eurozone crisis fears re-emerge On October 27, Professors Viral Acharya and Sascha Steffen published an alternative estimate, using a different methodology, for 39 publicly listed eurozone banks with a 165

combined balance sheet of €12.5tn (a subset of the banks in the EBA stress test and the ECB’s AQR). They calculated a shortfall of €450bn at the end of 2013 – about 3.6 per cent of assets. Both capital shortfall numbers are point estimates. Both are therefore bound to be wrong. Which one is likely to be closer to the true figure? I put greater faith in the estimate of Profs Acharya and Steffen. The EBA has a long record of stress tests that grotesquely underestimate the capital holes in EU banks. Both the AQR and the stress test relied heavily on national regulators and supervisors – the very entities on whose watch the excesses that led to the financial crisis were allowed to fester and compound. They were in charge of the regulatory leniency that permitted the banks in their jurisdictions to engage in lender forbearance (extend and pretend/delay and pray) and to overstate the fair value of their assets. The adverse scenario was not particularly stressful – no deflation, for instance. In addition to still-hidden legacy losses from the financial crisis, new losses are bound to have piled up as a result of the miserable economic performance of the eurozone during the past five to six years. So my money is on Profs Acharya and Steffen as better guides to the capital that would have to be raised by the EU banking sector to put it on a sound footing. If this is correct, more AQRs and stress tests – this time without the assistance of the national authorities – are required. In the meantime, the zombification of much of the eurozone banking system continues. Even if private domestic demand were to revive, either spontaneously or through external shocks or expansionary monetary and fiscal policy and supply-side reforms, the banking sector will not be able to support any incipient demand growth. The Japanification of the eurozone would result in a lost decade following the lost half-decade just experienced. To avoid the cyclical stagnation in the eurozone turning into secular stagnation, four policies are required. The first is a proper AQR and stress test followed by a speedy recapitalisation of the capital-deficient banks and a wave of consolidation in the eurozone banking sector to bring higher profitability, and efficiency, to a banking sector with too many undersized banks. Cross-border consolidations would create more effective competition in each member state. Such radical measures might even boost confidence and optimism in the real economy. The second measure is a temporary fiscal stimulus (say 1 per cent of eurozone GDP per year for two years, concentrated in the countries with the largest output gaps, that is, in the periphery), which is permanently funded and monetised by the ECB. To make the mechanics of this helicopter money drop more transparent, the ECB could cancel the sovereign debt it purchases. This third measure would be economically equivalent to buying and holding the debt forever (rolling it over as it matures), but rather more dramatic. Finally, to achieve debt sustainability for the eurozone sovereigns, radical supply side reforms are required that boost the growth rate of potential output to at least 1.5 per cent in Italy, Portugal and other sclerotic countries.

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The eurozone’s ‘no monetary financing of sovereigns’ fetish hamstrings the ECB. The instinctive anti-Keynesianism of the Teutonic fringe emasculates countercyclical fiscal policy. Domestic political paralysis inhibits structural reform. The AQR stress test was a fudge. Good luck, eurozone. Willem Buiter is chief economist at Citigroup http://www.ft.com/intl/cms/s/0/987e237c-5f81-11e4-a882- 00144feabdc0.html#axzz3HMcg3THv

ft. com World Europe October 29, 2014 5:02 pm German exports to Russia tumble as sanctions bite Jeevan Vasagar in Berlin and Roger Blitz in London German exports to Russia tumbled by more than a quarter in August, underlining the impact of sanctions on Europe's biggest economy. But it is not just Germany that is suffering. Tourism across Europe and North America has taken a knock, too. In August, Germany exported goods to the value of €2.3bn to the Russian Federation, a decline of 26.3 per cent on August 2013, Germany’s federal statistical office said on Wednesday. More ON THIS TOPIC// Fast FT Rouble touches new record low/ UK blocks €5bn Russian North Sea deal/ No ‘untouchables’ for Putin, says Pugachev/ Russia – sifting in the rouble IN EUROPE// Spanish recovery lays bare social crisis/ Nato jets intercept Russian aircraft/ Eurozone lending conditions improve/ The furious but forgiving Spanish voters Between January and August 2014, German exports to Russia declined by 16.6 per cent to €20.3bn compared with the same period a year earlier. The EU imposed sanctions in finance, defence and oil equipment in July, following Russia’s annexation of the Crimea and the suspected shooting down of a Malaysia Airlines flight by pro-Russian separatist forces in eastern Ukraine. The US and Canada imposed sanctions, too, and both have seen sharp drops in arrivals from Russia. Before the Ukraine crisis, the number of Russian trips to the US had been growing substantially – up 36 per cent in January compared with the same month in 2013, and by 30 per cent across the first three months of 2013. But growth in trips to the US slowed in the second quarter to13 per cent. Russian arrivals in Canada deteriorated even further. In July arrivals were down 17 per cent. In Europe, Poland, Italy, Germany and Spain suffered a sharp fall in arrivals. Before the annexation of Crimea, Russia was becoming one of Europe’s most important source 167

markets, accounting for 6 per cent of all arrivals in the continent, said Oxford Economics. Turkey, Greece and Cyprus, however, decided against imposing sanctions and all three countries saw an increase in Russian tourists. With Germany’s export-dependent economy slowing, the EU restrictions have hit Mittelstand companies particularly hard. Brussels blog

Notes on the EU’s capital: Our Brussels blog looks at the EU’s foreign and economic policies Russia is the fourth most important export market for German machinery manufacturers, many of which are small and medium-sized. German manufacturers fear the sanctions will jeopardise their reputation as reliable suppliers, and will lose business to Chinese rivals. The data released on Wednesday show that exports of German motor vehicles and vehicle parts were hardest hit, dropping 27.3 per cent between January and August, compared with the same period in 2013. Exports of machinery dropped 17.2 per cent and chemical products dropped 5.9 per cent. Although Russia accounts for less than 3 per cent of Germany's exports overall, the crisis – coupled with a slowdown in other emerging markets – has rattled German business confidence. Economists predict Germany's GDP growth could be as low as 1.5 per cent for 2014, compared with earlier estimates of 2 per cent. http://www.ft.com/intl/cms/s/0/45eea262-5f72-11e4-a882- 00144feabdc0.html#axzz3HMcg3THv

ft.com Comment Blogs Andrew Smithers Fiscal stimulus – is it just a sugar rush? Andrew Smithers Oct 30 10:043Share The following comment on my blog post about quantitative easing and the eurozone struck a chord: “The unaddressed and unanswered question about fiscal stimulus in the eurozone is about why it will be anything other than another short-term sugar rush?”

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I like the way this is expressed and it is a very important issue that economists frequently ignore or assume away. Economists tend to use a different terminology. A weakness in demand should respond to fiscal stimulus, but that stimulus will only provide a solution if the weakness in the economy is cyclical not structural. In recent years the vast majority of calls for more fiscal stimulus ignored this important proviso. They have assumed that it would not be “another short term sugar rush” but have often seemed unaware that this assumption was central to their argument. (Imagine an engineer, a biologist, a chemist and an economist are marooned on board a raft with plenty of canned food but no can opener. The economist is the only one who can think of a way to prevent starvation. His solution is simple: “Let’s assume we have a can opener.”) If demand is weak for cyclical reasons then, in John Maynard Keynes’ words, the animal spirits of entrepreneurs are temporarily depressed. Given a dose of fiscal stimulus sugar, they return to their normal enthusiasm and boost their investment spending, causing demand to bounce back. The fiscal deficit can then fall through a combination of economic recovery and renewed fiscal prudence. The boost to spending does not have to come from business (although this is more likely) — it can also come from households. Keynes’ preference for entrepreneurs seems to be justified by the strong correlations between business net lending and fiscal deficits, at least in Japan, the UK and the US (chart one).

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If I have understood the reader’s comment on my previous blog correctly, the sugar rush question is the same as the cyclical vs structural question. The answer I have been expounding in several posts is that demand weakness is cyclical in the eurozone and structural in Japan, UK and the US. I have sought to justify the structural nature of the problem in those three countries and have quoted abundant evidence to support this view. I have found no evidence to justify taking a similar view of the eurozone and therefore assume that the weakness of demand there is cyclical. The absence of evidence in favour of the problem being structural makes it probable, though not certain, that it is cyclical. The model on which the case for fiscal stimulus rests, points out that if intended savings exceed intended investment this creates demand weakness, which will result in falling incomes and output until the intentions to save more are thwarted by the fall in incomes from which the savings can be made. To avoid this, the intended savings are reduced by fiscal deficits which are “intended dissaving”. The model is logical but the question is whether it works in practice. Economists are, I think, divided on this issue. The case in favour lies in our experience. We have not had a repetition of the depth and breadth of the 1930s slump, even after the recent financial crisis, and it seems reasonable to me to think that the willingness of governments to use fiscal stimulus has been responsible. The case against is the difficulty that economists have had in seeking to show that it has worked in a statistically robust way. This, however, may be evidence that cyclical downturns are not the sole cause of weak demand. We then need a definition of cyclical, which Keynes did not provide and which has made it hard to make sense of what he wrote. Forecasts of world output have recently been cut by the International Monetary Fund and other international bodies, leading to rational concerns that this is the start of a series of further revisions and that the world may now be sliding towards another recession. I don’t know if this is true and I don’t think anyone else does either. It has been said that economists were invented to make weather forecasters look competent. Both simple extrapolations and complicated forecasts often fail because financial markets have a large effect on the economy, and to forecast the economy you therefore need to forecast when markets are going to start falling. This is logically impossible because the ability to forecast such timing would stop markets becoming overpriced or underpriced. An added problem is that weak markets do not invariably forecast recessions. As Paul Samuelson put it, the stock market has forecast nine of the last four recessions. Nevertheless, our inability to forecast should not deter us from having policies ready to respond to events. I am not therefore making a forecast when I say that, if the world economy falls back into recession, we should be prepared with policy action to get it back on track. What should this policy be? There seem to be four main views. More QE, more fiscal stimulus, structural reform and “grin and bear it”. Although I think the fiscal deficits of Japan, the UK and the US are currently structural, they would have an important cyclical element if the world were to fall back into recession, and so my objections to fiscal stimulus would not apply to the changed circumstances. Faced with a new world recession, it would be much better to use fiscal policy rather than monetary policy. First, it is much more likely to be effective, and second, it is less dangerous. The famous analogy that monetary policy is in today’s conditions likely to be no more effective than pushing on a string strikes me as valid. 170

There are dangers in both fiscal and monetary policy. The key danger lies in their impact on asset prices at a time when world debt levels are high. Fiscal policy considered in isolation increases cash flow. For the world as a whole this means increased flows either to households or business, but for individual countries it may simply increase their trade deficits. Both households and companies are highly leveraged; it is therefore desirable they use the extra cash to invest. This will improve their balance sheets by increasing their assets without increasing their liabilities. A bad outcome would be a repetition of recent events in which companies have not used their strong cash flows either to invest or to reduce debt, but to increase their leverage through equity buybacks. Ideally, therefore, any additional fiscal stimulus should be accompanied by measures to deter buybacks. But this is sadly unlikely as the problem seems little understood. The risk that fiscal stimulus will drive up share prices is, however, likely to be modified by the fact that profits would otherwise be falling in the event of a worldwide recession. A further bout of QE seems to me altogether more dangerous. Assuming that profits will be falling, it is likely to have less effect on share prices than on other assets and will exacerbate the current drive to ignore risk in pursuit of income. The dangers that this poses have been admirably set out in two recent articles in the FT. James Grant expressed concern about the way that QE had distorted the signals that markets should provide about risk, adding that “bankers strain to make money on good credit. Not a few accordingly turn to discredit.” Amir Sufi followed this by quoting Ben Bernanke, who claimed in 1983 that “the real service provided by the banking system is the differentiation between good and bad borrowers”. Dr Bernanke now knows this process no longer works as he has been unable to refinance his own mortgage. Banks today lend against real estate rather than to companies to finance capital equipment. Real estate becomes more dangerous as its price rises and at the same time appears less risky to those who lend. Calls for structural reform are simply beside the point when cyclical demand is weak. Structural reform is badly needed but its impact is by definition structural rather than cyclical. It will improve supply and therefore our long-term future, but is rather more likely to depress short-term demand than to boost it. Today, there is probably greater opposition to fiscal policy than when the financial crisis broke. This is partly because government debt and fiscal deficits are much higher, and partly due to disillusion with its apparent lack of success. There is also an increasing awareness of the dangers of QE as the two quotations above illustrate. There is a growing risk therefore that in the event of a new worldwide recession, the chosen policy option may be “grin and bear it”. In Japanese, the word is gamanshimasho and is often used to express the view that we must accept our fate. There is also a Buddhist principle that all action leads to suffering. I fear that this is increasingly accepted by policy makers. In the event of a recession I expect inaction to be a more likely cause of suffering than action. I therefore hope the recent rise in fears about a world recession will subside soon with justification. Alternately, I hope my pessimism about the willingness of governments to revert to fiscal stimulus proves wrong. http://blogs.ft.com/andrew-smithers/2014/10/fiscal-stimulus-is-it-just-a-sugar-rush/

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ft.com/markets October 29, 2014 6:18 pm How the Fed got from eternity to here

John Authers in New York

©AP Infinity, it turns out, lasted a little more than two years. In September 2012, the Federal Reserve administered one of the greatest market shocks of recent years by announcing that it would buy $40bn of mortgage-backed securities every month (subsequently raised to $85bn, including Treasury bonds), and do so indefinitely. This was unprecedented. The third dose of “QE” bond purchases was soon dubbed QE Eternity, or QE∞. As the market was not signalling any great concern over deflation at the time, and bond yields were low, the complaints were that QE∞ was unnecessary, and meant the abandonment of the dollar. The Fed was telling investors to buy gold, avoid paper money, and invest anywhere in the world but the US.

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It has not worked out that way. Now that eternity is over, inflation expectations are lower than when QE∞ started. As QE is generally justified as a means to push up inflation expectations and fight deflation, this is the exact opposite of what might hvae been expected.

Meanwhile, ten-year bond yields are higher. Gold has tanked. The dollar stayed weak against its main trading partners until June this year; since then it has appreciated by about 7 per cent as the end of bond purchases nears. Benchmark mortgage rates, about 2 per cent at the time, briefly dipped, but are now about 3 per cent.

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Rather than the assets the Fed was buying, those that profited most were equities. The S&P 500 is up 42.75 per cent over the infinity era, trouncing every other major stock market. Again, this is the exact opposite of what might have been expected.. Even more dramatically, given the hype about gold when QE∞ was announced, the S&P’s value in terms of gold has doubled.

Even if its effects on financial markets were counter-intuitive, however, the QE∞ period overlapped with some of the improvements in the economy that the Fed most desired. House prices were still in the doldrums in September 2012. Since then, judging by the

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S&P Case-Shiller indices, they have made a meaningful recovery - which in turn means relief for many consumers, and far less concern for banks’ balance sheets. Also, and by far the most important, employment has moved in the right direction. As of September 2012, a gradual improvement in the unemployment rate had stalled at 8.1 per cent. It has since fallen to a politically conscionable 5.9 per cent. More ON THIS STORY// Fed eyes first rate rise after end to QE/ Fed’s slow march to first rise continues/ Brazil raises rates to three-year high/ FT Alphaville Highlights from the Fed statement/ From September to October Fed statement changes When announcing QE∞, the Fed said it would carry on “if the outlook for the labour market does not improve substantially”. Whether or not QE was sufficient, or even necessary for this to happen, the latest period of aggressively loose monetary policy has seen the labour market log the kind of improvements that the Fed was hoping to achieve. Now, however, comes the reckoning. Eternity is over. The dollar is rising, now that investors expect US rates to start rising, and this puts pressure on US exporters, while pressing down on inflation. There are also QE’s other consequences. Stocks look overvalued and bubbly, just as the bond market is signalling concern about an economic slowdown. http://www.ft.com/intl/cms/s/2/b03663b4-5f8e-11e4-986c- 00144feabdc0.html#axzz3HMcg3THv

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ft. com World Europe October 30, 2014 8:49 am Spanish recovery lays bare a social crisis Tobias Buck in Madrid

©Getty The number of Spaniards who rely on the country’s 55 food banks has risen to 1.5m For many of the poorer residents of Madrid, the daily struggle to put food on the table ends in a vast red-brick warehouse on the northern fringes of the Spanish capital: the central food bank. Stacked to the ceiling with crates of mandarins and bell peppers, along with staples such as pasta, rice and biscuits, the bank is the main source of supply for soup kitchens and other food charities that have sprung up across Spain’s principal city. Fifty thousand kilos of food and drink leave the warehouse every day.

More ON THIS STORY/ Global Insight The furious but forgiving Spanish voters/ Spain’s recovery boosts labour market/ Spanish ghost town shows signs of life Staff point out that donations have risen sharply since the start of the Spanish crisis, but that demand has grown faster still. Over the past five years, the number of Spaniards

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who rely on the country’s 55 food banks has soared from 780,000 to 1.5m, and – despite growing signs of economic recovery – their numbers continue to rise. “On the macroeconomic level you see that things are going better. But our people see no change,” says Nicolás Palacios, the president of Spain’s food bank federation. “There are more and more people whose unemployment benefits have run out, and who have used up all their financial reserves. And even if they have some income, a few hundred euros are just not enough to feed a family.” His observation offers a poignant riposte to the recent surge in optimism about Spain’s economic prospects. The country emerged from recession more than a year ago, and is expected to post the fastest growth rate of all large eurozone countries next year. Unemployment is falling at last, and Spain’s financial sector – for so long a source of Europe-wide concern – came out squeaky-clean from the European Central Bank’s recent stress tests. Even the International Monetary Fund has lavished praise on Spain’s faster-than-expected economic turnround. In depth/ Euro in crisis

News, commentary and analysis of the eurozone’s debt crisis and its faltering recovery as it struggles with austerity and attempts to regain competitiveness/ Further reading Back in Spain, however, economists and analysts warn that the recent recovery is doing little, if anything, to alleviate a searing social crisis. There is particular concern over the fate of Spain’s rapidly-swelling ranks of long-term unemployed, and over the more than 700,000 households that generate no income from work and have no claim to any form of government support either. Another great fear is that many of the individuals worst- affected by the crisis are so poorly-skilled – and so detached from the labour market – that they will struggle to find new employment even if the economic recovery accelerates in the years ahead.

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“Spain is growing again, but there are a lot of people who still face a bleak future,” says Marcel Jansen, a professor of economy at Madrid’s Autónoma University. “It is actually quite easy to reduce unemployment at the start. We have a huge stock of people with recent work experience who are now very cheap to hire. The problems start when you have absorbed all the people who are actually easily employable.” Data from Spain’s latest labour market survey show that the chances of finding a new job have already improved notably for short-term unemployed. For those who have been out of a job for more than a year, however, the odds are just as poor as they were at the height of the crisis: only 13 per cent found a new job in the three months to September; for those who left the labour market two or even four years ago, the chances are slimmer still. Already today, there are more than 2.4m Spaniards who have been out of work for more than two years – the period after which unemployment benefits run out. Some minor programmes aside, there is currently no other government support to replace the jobless payments. Organisations such as Caritas, the charity branch of the Roman Catholic Church, try to fill the void, but they too are sounding the alarm. “The tremors of the earthquake may have stopped, but the people are still buried underneath the rubble,” says Francisco Lorenzo, head of research at Caritas. The number of people receiving emergency aid from Caritas has leapt from 350,000 in 2007 to 1m today. Even one year after the end of the recession, the organisation says it sees no sign that the recovery is reaching the most vulnerable sectors of Spanish society: “We hear that economic growth is back, we hear that the banks are doing well. But people are desperate,” says Sebastián Mora, the secretary-general of Caritas España. To back up their analysis, Caritas and its Foessa research arm this week published the most detailed study yet of Spain’s social crisis. Running to almost 700 pages, the report made for sobering reading. It found that close to 12m Spaniards suffer “social exclusion”, which means they lack access to at least some basic rights and services that are taken for granted by the rest of society. It also noted a sharp jump in poverty, inequality and the emergence of a relatively new class of working poor. Back in the Madrid food bank, Mr Palacios says his ultimate ambition would be to make his organisation obsolete. Yet, as Spain’s recovery enters its second year, he sees little chance that his dream will be fulfilled: “Unfortunately, our clients will stay for us a long time to come.” http://www.ft.com/intl/cms/s/0/bbdfb1fe-5f96-11e4-8c27- 00144feabdc0.html#axzz3HMcg3THv

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FEDERAL RESERVE Fed's Lack of Conviction Is Warranted

By Mohamed A. El-Erian Oct 29, 2014 4:30 PM EDT The Federal Reserve delivered today what I and many others expected, in both actions and words. Rather than sending a well-telegraphed signal for going forward, it is keeping its options open in an unusually fluid economic, political and global environment. As anticipated, the Fed completed its exit from the large-scale purchases of securities (or QE3). In ending this extraordinary phase, the Fed understandably sidestepped any comprehensive assessment of, to use former Chairman Ben Bernanke’s famous phrase, the “benefits, costs and risks” of its highly experimental policy tool. Instead, it just noted the “substantial improvement in the outlook for the labor market” since the inception of the policy. Also, as expected, the Fed reaffirmed its position on maintaining low interest rates for a “considerable time.” In doing so, it delivered a rather open-ended assessment of recent economic developments and, therefore, of its possible policy course down the road. Fed officials welcomed the continued improvement in the economy, particularly signs that the underutilization of labor resources is gradually “diminishing,” though only “gradually” despite “solid gains and a lower unemployment rate.” On the second element of its dual mandate -- stable inflation -- the central bankers acknowledged the fall in market measures of forward inflation but played down the risk of damaging deflation by also pointing to other metrics of inflationary expectations. This apparent lack of conviction, while frustrating to many, is understandable and warranted. Because it faces a historically unusual mix of cyclical, structural and longer-term issues, the behavior of the U.S. economy isn't easy to capture well with existing models, including those used by the central bank. The nation’s policy response has fallen well short of the “first best” given the constraints imposed by the political polarization in Congress on virtually every policy-making entity other that the Federal Reserve; and the central bank doesn't have sufficient instruments to compensate for this.

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Finally, the global economy is far from accommodating, given the challenges facing Europe, Japan and a number of emerging economies (in some cases accentuated by geopolitical tensions). In short, the Fed ended up taking the approach that was suggested in last week’s column -- that is, to muddle through a complicated situation, including minimizing the risks of a short-term policy mistake and of a market accident. The longer-term issues, including the consequential ones, were left for another time. http://www.bloombergview.com/articles/2014-10-29/fed-s-lack-of-conviction-is- warranted

Fed's Lonesome Dove Dissents as Brighter Outlook Appeases Hawks By Jeff Kearns and Christopher CondonOct 29, 2014 10:01 PM GMT+0100

Photographer: Andrew Harrer/Bloomber U.S. Federal Reserve chair Janet Yellen has just one more meeting with the current FOMC roster before the committee’s annual rotation brings on more like-minded voters in 2015. Close U.S. Federal Reserve chair Janet Yellen has just one more meeting with the current FOMC... Read More U.S. Federal Reserve chair Janet Yellen has just one more meeting with the current FOMC roster before the committee’s annual rotation brings on more like-minded voters in 2015. Related// Kocherlakota: Fed Stimulus Hasn't Offset Recession/ Fed Ends QE: What This Says About the Economy To understand the direction that the Federal Reserve is taking in its new policy statement released today, look at who dissented -- and who didn’t. Minneapolis Fed President Narayana Kocherlakota cast a dovish dissent, saying policy makers should have continued their asset purchases and done more to ensure inflation gets up to their 2 percent target. Last time it was hawkish Presidents Richard Fisher of 180

Dallas and Philadelphia’s Charles Plosser, who voted against the September Federal Open Market Committee statement as being too downbeat about strength in the economy. “If you go by the dissents, we’re now leaning more to one side of the bird cage than the other,” said Beth Ann Bovino, chief U.S. economist at Standard & Poor’s Ratings Services in New York. “We’re now seeing dissent from someone considered dovish.” Today’s statement emphasized “solid job gains” as the FOMC ended its third round of asset purchases and kept mute about slowdowns in China and Europe. It maintained a commitment to keep interest rates low for a “considerable time.” Kocherlakota’s dissent, which echoed comments he’s made in recent speeches, cited falling inflation expectations. “The Committee should commit to keeping the current target range for the federal funds rate at least until the one-to-two-year ahead inflation outlook has returned to 2 percent and should continue the asset purchase program at its current level,” he said, according to today’s FOMC statement. Inflation Goal The personal consumption expenditures index, the central bank’s preferred price gauge, increased 1.5 percent in August from a year earlier and hasn’t exceeded the Fed’s 2 percent target since March 2012. The shift in FOMC dissents also illustrates how hard it is for Chair Janet Yellen to make everyone around the table happy, said Brian Jacobsen, who helps oversee $236 billion at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin. “Yellen is trying to bring peace to the committee and really trying to build consensus, but that might be impossible to do with the current cast of characters,” Jacobsen said. “It’s like a Teeter-totter. She shifted a little bit to the hawkish side to accommodate Plosser and Fisher but in doing so alienated Kocherlakota.” Yellen has just one more meeting with the current FOMC roster before the committee’s annual rotation brings on more like-minded voters in 2015. Next year brings a dove, Charles Evans of Chicago; dovish-leaning John Williams of San Francisco; one consistent hawk, Richmond’s Jeffrey Lacker; and centrist Dennis Lockhart of Atlanta. 2-1-1 http://www.bloomberg.com/news/2014-10-29/fed-dissents-shifting-from-hawks-to- dove-signal-new-path.html

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Fed Unshaken by Global Market Turmoil Bets on Job Gains By Craig Torres - Oct 30, 2014 Federal Reserve officials dismissed recent turmoil in global financial markets, and focused instead on “solid” employment gains that will keep them on a path toward an interest-rate increase next year. A majority of U.S. policy makers at their meeting yesterday also set aside concerns, both among their own members and in financial markets, about too-low inflation, voting to proceed with plans to end their third round of asset purchases. “The FOMC is making a pretty bold call here,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. “The economy’s momentum is strong enough to push through the headwinds of slower world growth.” While bond and commodities markets have signaled concern about a global slowdown since Fed officials last met Sept. 16-17, U.S. central bankers decided to go with the facts in hand, said Paul Mortimer-Lee, chief economist for North America at BNP Paribas in New York. “They have concentrated on what they are sure of: the labor side of the economy is improving,” Mortimer-Lee said. On inflation, the message was, “We are going to take our time and look.” The Federal Open Market Committee maintained its commitment to keep interest rates low for a “considerable time.” The committee cited “solid job gains and a lower unemployment rate” since its last gathering in September. It said “underutilization of labor resources is gradually diminishing,” modifying earlier language that referred to “significant underutilization.” Payroll Gains Non-farm payroll gains have averaged 227,000 this year, heading for the best showing since 1999. That has helped push the unemployment rate down to 5.9 percent in September, just 0.4 percentage point above the top end of a range Fed officials consider full employment. Such indicators of a strengthening economy outweighed policy makers’ concerns about decelerating inflation. Oil prices are down about 17 percent this year, partly due to weaker global growth prospects. Inflation expectations, measured by yield differences on U.S. Treasury notes and government inflation-linked bonds, signal inflation could remain below the Fed’s 2 percent target for several more years. The personal consumption expenditures price index rose just 1.5 percent in August from a year earlier, the 28th month in a row it has been below 2 percent. Policy makers want to maintain a minimum level of inflation, because falling prices can encourage

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businesses and consumers to delay spending in the expectation of further price declines, reducing demand. Energy Prices “Although inflation in the near term will likely be held down by lower energy prices,” the FOMC said in its statement, policy makers determined that the risk of inflation remaining “persistently below 2 percent has diminished somewhat.” Money-market investors in recent months had been giving more weight to the possibility that inflation won’t increase, forcing the Fed to raise interest-rates more slowly. That view may have changed after yesterday’s FOMC announcement. Yields on two-year Treasury notes rose one basis point to 0.495 percent at 9 a.m. in London today. Fed funds rate futures show the probability of a rate increase by the September 2015 FOMC meeting is about 60 percent, up from a 42 percent chance yesterday. “You can’t blame the markets for taking this as hawkish,” said Michael Pond, head of global inflation market strategy at Barclays Capital in New York. If investors needed proof that the FOMC had shifted, it was in where the dissents came from, Pond said. Missing Target // This time around the dissenter was Narayana Kocherlakota, president of the Minneapolis Fed, who has raised concerns about the Fed missing its inflation target for too long. Kocherlakota wanted the Fed to continue asset purchases and commit to holding the benchmark lending rate near zero until inflation expectations rose back toward 2 percent. That contrasts with the September meeting when Fed presidents Richard Fisher of Dallas and Charles Plosser of Philadelphia dissented. Both pointed to strength in the economy that in their view didn’t square with the committee’s expectation to hold rates near zero for a “considerable time.” U.S. central bankers forecast growth of 2.6 percent to 3 percent next year, fast enough to bring the unemployment rate down to 5.4 percent to 5.6 percent in the final quarter. That is about in line with private forecasters surveyed by Bloomberg News. Rate Outlook // FOMC participants’ interest rate outlook for next year also fits with a scenario of a June rate increase that proceeds at quarter-point increases for the next several meetings. Their median forecast for the federal funds rate was 1.375 percent for the end of 2015. The Fed’s statement in effect endorsed that forecast and brushed aside fears in the financial markets that such an outlook is at risk. “It was obvious how much the Fed did not address the risks of external shocks, a stronger dollar, and fears of slowing growth and deflation abroad,” said Diane Swonk, chief economist at Mesirow Financial Holdings Inc. in Chicago. “It was a calculated move, a roll of the dice that they will have lots of time” to see how the U.S. and world economy develop over the next couple of months. http://www.bloomberg.com/news/2014-10-29/fed-unshaken-by-global-market-turmoil- bets-on-job-gains.html 183

EU provisionally clears French, Italian budgets after tweaks BY BARBARA LEWIS AND JULIA FIORETTI BRUSSELS Tue Oct 28, 2014 8:53pm GMT

European flags are seen outside the European Commission headquarters in Brussels September 10, 2014. CREDIT: REUTERS/YVES HERMAN RELATED VIDEO/ France & Italy face budget showdown/ RELATED NEWS/Italy cuts 2015 deficit goal to win EU approval for budget BRUSSELS (Reuters) - The European Commission provisionally accepted the budgets of France and Italy, saying on Tuesday that no euro zone states had submitted deficit plans for next year that seriously breached EU rules for fiscal stability. A day after Paris and Rome amended their 2015 budgets in the hope of avoiding censure from the European Union executive, the economics commissioner said no national budget had been so out of line it need be rejected by an initial deadline of Wednesday. Detailed analysis will continue next month, Commissioner Jyrki Katainen added.

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Noting intensive discussions with some governments since budgets were filed to Brussels two weeks ago, Katainen said: "I want to welcome the fact that these member states have responded constructively to our concerns. "After taking into account all of the further information and improvements communicated to us ... I cannot immediately identify cases of 'particularly serious non- compliance' which would oblige us to consider a negative opinion at this stage. "Our services will now work to complete their detailed assessment of the draft budgetary plans and the new Commission will adopt its opinions on these in November," Katainen added. "Any shortcomings or risks will be clearly highlighted at that point. Any possible further steps under the Stability and Growth Pact will be assessed at a later stage." France's finance minister Michel Sapin welcomed the Commission's decision, saying the "constructive dialogue" with the European Commission on the 2015 budget would continue. He reiterated French calls for more to be done at EU level to kick-start growth. "We must collectively find the means to drive an economic recovery in the whole euro zone," he said. On Monday, Italy and later France published letters to Katainen outlining adjustments to next year's budgets that would further trim their deficits and bring them closer to the levels set out in agreements among member states. Italy on Tuesday cut its 2015 deficit goal to 2.6 percent of gross domestic product from 2.9 percent following the announcement of its 4.5 billion euro adjustment . Italian Economy Minister Pier Carlo Padoan told parliament the changes represented "a very considerable step for a country in its third year of recession" but said they would not have an appreciable impact on Italy's prospects of economic recovery. He rejected charges from opposition lawmakers that the government had "surrendered" to the Commission and said a compromise had been reached that "reflects the principle of flexibility in the framework of the rules." France and Italy have been arguing with Germany and its conservative Chancellor Angela Merkel to be allowed not to cut their spending as sharply as EU rules dictate in order to prevent the euro zone economy slipping back into recession. Berlin has insisted both need to make more effort to reduce their structural deficits, which are adjusted for swings in the business cycle, for example by reforming welfare and other systems in line with demographic change. But German leaders want to avoid an all-out clash with Paris in particular, or risk fanning anti-EU sentiment in France, long Germany's key partner in forging closer European integration. Failure to satisfy the Commission could result in one or both governments being asked to make further changes to their budgets and ultimately facing fines if they refuse. Officials have been involved in intensive negotiations to find a compromise since the plans were lodged two weeks ago.

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CREDIBILITY At issue is both the development of the euro zone's second and third biggest economies -- although European officials point out that the budget adjustments involved are barely of economic significance -- and the political credibility of the currency. Smaller euro zone states, such as Ireland, Portugal and Greece, which have put voters through tough austerity programmes to meet EU rules, are angry that France is trying to bend them. Italy said on Monday it would scrap some 3.3 billion euros of planned tax cuts. France said that its additional 2015 resources would come from lower-than-expected interest payment costs and contributions to the European Union's budget, which with other cost savings are worth some 1.5 billion euros. Along with other measures, that should allow France to reduce its structural deficit, which is closely watched in Brussels, by more than 0.5 percentage points of GDP, French officials say. That is more than twice the originally planned reduction of 0.2 percentage points. Italy's structural deficit should fall some 0.3 percentage points under its revised plan, compared to an originally proposed 0.1 point reduction. France faces a tougher hearing from Brussels than Italy because its 4.3 percent budgeted deficit is well above an EU ceiling of 3 percent of GDP, while Rome is running a total deficit that is below the permitted limit. Nonetheless, the politics of Europe mean few expect the EU to embark on an outright confrontation with French President Francois Hollande. "Tough punitive action against France remains unlikely," wrote Berenberg Bank economist Christian Schulz. "Although it is unfair, large countries have more power than small ones. France enjoys a special relationship with Germany which protects it against the Commission and financial markets." Other EU countries are also in the spotlight. Austria said on Tuesday it will cut its 2015 budget deficit by up to another 0.3 percent of GDP, responding to pressure from Brussels to justify a shortfall higher than the EU rules allow. (Additional reporting by Ingrid Melander in Paris, Gavin Jones in Rome; Writing by Alastair Macdonald; Editing by Catherine Evans) http://uk.reuters.com/article/2014/10/28/uk-eu-budgets-idUKKBN0IH19D20141028

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ft.com GlobalEconomy US Economy October 29, 2014 2:49 am Fed’s grand experiment draws to a close Michael Mackenzie in New York A grand experiment in US monetary policy is coming to an end. When the Federal Reserve releases the statement from its October meeting on Wednesday afternoon, the moment is almost certain to mark the end of the liquidity and stimulus programme known as quantitative easing. Investors are already prepared for the Fed’s last $15bn of monthly bond purchases to cease. Now, they are betting that it will replace its extraordinary actions with soothing words to limit the volatility markets have seen earlier this month. More ON THIS STORY// beyondbrics Farewell QE3, but what’s next?/ Trading Post Markets position for Fed’s next move/ Fed set to halt asset purchases/ The Short View Worse ahead, but do cyclicals beckon?/ Monetary policy An unconventional tool ON THIS TOPIC// Global Market Overview Stocks advance on hopes Fed stays dovish/ Fears grow over QE’s toxic legacy/ Trading Post ‘Draghi put’ doubt places spotlight on Fed/ Rate expectations change faster than data IN US ECONOMY// Corporate America starts to spend again/ Democrats battle sour economic mood/ Boston Fed chief urges end of QE/ St Louis Fed chief calls for taper delay Interactive Tracking the US market benchmarks

September 12, 2014 9:33 pm/ Tracking the US market benchmarks/By Mike Mackenzie, US markets editor Investors focus on two major benchmarks in the US: the S&P 500, tracking the world’s largest equity market and the 10-year Treasury note yield. Against the backdrop of the Federal Reserve’s quantitative easing policy that began in 2009, the S&P 500 has nearly tripled in value from its financial crisis nadir, while government bond yields, which move inversely with price, have been confined to historically low levels. Now as the Fed aims to end QE in October and the normalised interest rate policy during 2015 looms, a matter for debate among investors is whether the strong performance of both equities and Treasury debt in recent years has peaked. Charting the historical divergence in the S&P 500, the world’s largest equity market, and the 10-year Treasury note yield The hope is for language that suggests any tightening of monetary policy remains a story for the latter half of 2015, defusing any return of that kind of market turmoil. In mid-October the S&P 500 briefly erased all of its gains for 2014 and Treasury yields plunged. But since then the focus on the Fed’s next statement has helped markets stabilise, with shares prices and junk bonds rebounding smartly.

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The question facing investors after nearly six years of large scale bond purchases that have swollen the Fed’s balance sheet to $4.45tn, is whether the US economy can prosper sufficiently to justify the large appreciation seen in asset prices. As the curtain closes on the Fed’s third instalment of quantitative easing – QE3 – this month’s market turmoil provides a glimpse of what may lie ahead for investors with the central bank no longer pumping liquidity into the financial system. Some believe the end of QE will reveal which of those asset classes have been lifted by their own fundamental strength, and which of them have merely been floating on the tide of US dollar liquidity. “We have never seen such an extraordinary experiment in monetary policy and markets and the Fed are both worried about the exit from QE,” said Win Thin, global head of emerging markets strategy at Brown Brothers Harriman. Such a backdrop supports the general view that the Fed will provide markets with a friendly or dovish statement on Wednesday and in effect wait to see how forthcoming data unfolds. The S&P 500 rose 1.2 per cent on Tuesday ahead of the Fed meeting, and the broad benchmark has recovered nearly 7 per cent from its low in mid-October. “With domestic economic growth momentum beginning to leak lower, and the medium term outlook for the recovery and inflation becoming less certain, we expect the statement to be tweaked sufficiently to reflect a more dovish bias towards the near term monetary policy stance,” said Millan Mulraine, strategist at TD Securities. Within the Fed, however, there are policy officials who believe interest rates should start to rise relatively quickly once QE ends – and that could open the possibility of a less dovish statement. “The risk, however, is that the statement fails to live up to the overly dovish tone that the market may be expecting,” Mr Mulraine added. Another factor supporting asset prices as the Fed ends QE comes from other central banks borrowing from the Fed’s playbook. The Bank of Japan continues ramping up its bond-buying programme, as speculation rises that the European Central Bank will follow suit. Moreover, the Fed’s balance sheet will remain elevated for some time and economists say that another bout of market turmoil and weaker US data could well spark another QE programme.

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ft.com comment Columnists October 28, 2014 6:37 pm Europe’s banks are too feeble to spur growth

Martin Wolf One doubts whether the capital in eurozone institutions is enough to drive the economy forward

Will the asset quality review and stress tests conducted by the European Central Bank and the European Banking Authority mark a turning point in the eurozone’s crisis? Up to a point. They are an improvement on what has gone before. But they are not a complete fix for the banking sector, still less for the economy’s wider problems. More ON THIS STORY// Editorial Better check on health of Europe’s banks/ Lex European banks – life after the AQR/ Bank shares slide after ECB stress tests/ Gavyn Davies stress tests are not enough/ Audio ECB stress tests ON THIS TOPIC// Inside Business Alternative stress test hits French banks/ Italy rules out public money for banks that failed stress tests/ Stress tests fail to tackle deflation spectre/ European bank stocks feel stress of tests MARTIN WOLF// Eurozone needs more than reform// UK fiscal policy has no simple rules/ World can do better/ An extraordinary state of ‘managed depression’ The optimistic assessment is that the ECB has at least done enough to mend the banking system. There are two things to be said for this judgment: first, the ECB has taken a close look at the quality of assets in the system; and, second, the “stresses” imposed in the tests are tough. They seem comparable to those imposed by the Federal Reserve on US banks. The ECB concluded that 25 institutions, nine of them Italian, would need to add a total of €25bn in capital. This number has already fallen to €13bn because of capital-raising undertaken this year. Perhaps the most important possibility omitted by this assessment is that of sovereign default. This bears on a fundamental concern: risk-weighted capital requirements, on which the analysis is based, involve making judgments about the safety of different types of assets. This is especially problematic in the eurozone, where the lack of a unified fiscal backstop for banks means that national governments are responsible for 189

rescuing troubled institutions. Moreover, the solvency of the eurozone’s highly indebted members is more doubtful than that of countries with their own currencies. Since a banking crisis would be even harder to deal with in the eurozone than elsewhere, it would be wise for its banks to have bigger capital buffers that stand a better chance of preventing one. This is particularly important when actual leverage is so much higher than the risk-weighted capital ratios suggest. (See chart.)

Fortunately, banks with the smallest amount of equity relative to actual assets are located in relatively solvent countries, such as the Netherlands, France and Germany. Nonetheless, leverage is 20 to 1 in Spain and Italy; 25 to 1 in Germany and France; and 30 to 1 in the Netherlands. It is questionable whether this is enough loss- absorbing capital. High leverage also impairs the ability of banks to finance growth. A responsibly managed yet highly leveraged institution would seek to make heavily collateralised loans, against property, for example; or to hold highly rated assets. This is likely to militate against the productive investment the eurozone needs. For these reasons, one must doubt whether the capital in eurozone banks is enough to drive the economy forward. But this is just one part of a still bigger problem: the dramatic weakness of aggregate demand and the slow slide into ultra-low inflation and, quite possibly, deflation. Sounder banks do not necessarily generate faster growth in demand. Indeed, causality goes far more in the opposite direction. Two former ECB officials have expressed sharply different views about how policy makers should respond. Otmar Issing, the bank’s former chief economist, argues that monetary policy is already too loose from a German point of view and that it would be a mistake for Berlin to loosen fiscal policy, too. Lorenzo Bini Smaghi, a former member of the executive board, argues that stronger demand is needed in Germany to prevent the European economy from falling into deflation. The vital point is that the eurozone has a single monetary authority, which should take a view of the entire eurozone economy. Between the first quarter of 2008 and the second quarter of this year, eurozone nominal demand rose by a mere 2.5 per cent (see chart). Nominal gross domestic

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product grew by 5 per cent over that period. Now assume trend real growth was a mere 1 per cent and inflation 2 per cent (in line with ECB targets). In that case, nominal GDP should have been growing at 3 per cent a year. By the second quarter of 2014, nominal GDP was 13 per cent below this objective. Under Mr Issing, the ECB looked at monetary aggregates as well. In the six years to September 30 2014, broad money (M3) increased by 9.6 per cent, a compound annual rate of 1.5 per cent. On both measures, the ECB has failed.

The same goes for inflation. Suppose the ECB intends to hit its inflation target of close to, but below, 2 per cent. When a number of important member countries need to improve their competitiveness, their inflation should be well below German levels. If that is to happen while the average remains close to 2 per cent, core inflation needs to exceed 3 per cent in Germany (and other surplus countries). In fact, it is just 1.2 per cent in Germany. This suggests domestic demand is far too weak in the eurozone as a whole, including in the surplus countries, the most important of which is of course Germany. The question, however, is how to achieve higher demand growth in the eurozone and creditor countries. Experience in the US and UK suggests that unconventional monetary policy might work. But the ECB is hampered by the constraints (perceived and actual) on purchases of government debt. If Germany is opposed to such purchases, then its opposition to active fiscal policy as well, even when it is able to borrow at close to zero real interest rates over 30 years, ensures continued eurozone stagnation. That just cannot make sense. It is essential not to make too much of these stress tests and asset quality review. Yes, they are real improvements. But they do not mean that eurozone banks will now drive growth. They still have too little capital for that. More important, the eurozone lacks a credible strategy for reigniting demand. If much of the German policy elite continues to deny this is even a problem, the crisis of the eurozone must remain unresolved. That is a disaster. http://www.ft.com/intl/cms/s/0/cb939e1a-5dc7-11e4-897f- 00144feabdc0.html#axzz3HMcg3THv 191

ft.com/markets MARKETS INSIGHT October 29, 2014 5:56 am ‘Coffin corner’ threat to financial stability By Satyajit Das Post-crisis regulation makes markets more vulnerable to shocks Modern financial markets increasingly operate at what aviators term “coffin corner”, flying at the edge of structural integrity. This is because the nature of risk within markets has changed. Exogenous risk, exposure to external shocks such as economic or political events, is increasingly exacerbated by endogenous risk. New institutional arrangements and banking regulations have altered market structures in ways likely to amplify shocks in a future financial crisis. Designed to address problems exposed by the global financial crisis and to reduce instability, new initiatives may have done the reverse. Higher liquidity reserves for banks, more stringent calculations of risk in derivative transactions and increased bank holdings of government bonds are now the potential source of problems, helping transmit losses across markets. Correcting inadequate pre-crisis levels of liquidity, regulators now require banks to hold larger quantities of government securities to boost their ability to withstand funding disruptions. More ON THIS TOPIC// Markets Insight Corporate cash hoarding has to end/ Markets Insight Market nerves do not portend global slump/ Loans to buy US shares at record levels/ Comment Upheaval bound to recur MARKETS INSIGHT// EU must avoid ‘lost decade’/ Eurozone crisis fears re-emerge/ Stakes high for Europe bank stress tests/ Emerging markets foster gloom Addressing previous underestimation, regulators require banks to record higher credit risk in derivatives transactions, which now incorporate both any potential loss and the risk that the counterparty may default (known as credit value adjustment or CVA). Banks are incentivised to collateralise these exposures with government securities to lower capital requirements. The new regulations increase bank exposure to sovereign bonds, adding to existing exposures to government securities via repurchase transactions, investments or trading inventories. This coincides with a deterioration in the quality of government securities and unprecedented low interest rates. Increased exposure to government bonds is now an increasing source of instability. A future crisis is likely to unfold as follows. Rating downgrades or deteriorating credit quality of a sovereign result in falls in the value of government bonds held by banks, triggering losses. Where the securities are used as surety for funding or derivatives, banks face calls for additional collateral, draining liquidity from markets.

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The deterioration in a sovereign’s credit quality will affect the CVA calculation for derivative transactions, not only with the sovereign but entities in that jurisdiction. This will require additional capital as well as collateral. Banks may be forced to hedge their CVA risk, usually by purchasing default protection on the sovereign or shorting government bonds. This will exacerbate losses as the sovereign bonds’ value falls further. Market constraints may necessitate use of proxies for the sovereign, including shorting or buying insurance on equity indices or major stocks. Banks may short sell the currency as a de facto hedge. Proxy hedges transmit the volatility into other asset markets. This creates additional risk as volatility spikes sharply and correlation between major asset classes becomes unstable, especially in a risk-on risk-off trading environment. Second round effects flow from the increasing financial risk of banks adversely affected by losses on government bond investments and the reduced ability of the government to provide emergency support. The increased default risk of affected banks sets off a chain reaction of CVA increases and actual losses in the inter-bank markets, requiring further hedging, compounding the negative spiral. Trading liquidity declines. The reduced demand for the affected sovereign’s bonds results in higher funding costs and reduced market access, which is transmitted to banks and other borrowers in the country. Higher counterparty risk or downgrades trigger more collateral calls. The problems are amplified by uniform rules, similar risk models and herding behaviour, where participants have similar positions and strategies. Financial shocks then flow into the real economy, affecting the supply of credit, growth, investment and employment. In turn, this flows into further sovereign and financial sector weakness. Once this sequence of events starts, it will be difficult to control the negative feedback loops. With the risk of instability now ever present in markets, any breakdown will result in the rapid spread of losses and problems. This will affect ordinary savers and investors, ultimately undermining the stability and integrity of financial markets, destroying capital formation and efficient intermediation. Satyajit Das is a former banker and author of Extreme Money http://www.ft.com/intl/cms/s/0/d53c3588-4e0b-11e4-bfda- 00144feab7de.html#axzz3HQAPZVip

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Read more on the ECB's "comprehensive assessment Monday blues for Italian banks - Italian Banks get a red scorecard in the ECB stress test and a rude awakening on Monday morning by Silvia Merler on 28th October 2014 71 On Sunday, the ECB and EBA published the results of their comprehensive assessment of banks balance sheets, and Italian banks where the worst performers. The stress tests singled out 25 banks that would be falling short of the 5.5% minimum CET1 threshold, based on data as of end 2013. But once the measures already enacted in 2014 are taken into consideration, the number of banks failing the test is reduced to 13. Of these, 4 are Italian. Banca Monte dei Paschi di Siena, Banca Carige, Banca Popolare di Vicenza and Banca Popolare di Milano will need to raise respectively 2.1bn, 0.81bn, 0.22bn and 0.17bn, for a total of 3.31bn. It is the largest share of the total net (of capital raised in 2014) shortfall of 9.5bn identified from the test. Tweet This 13 banks are found to effectively fail the ECB stress tests. 4 of them are Italian Markets gave Italy a very rude awakening on Monday morning. Milan stock exchange closed on Monday at -2.4%. By the end of the trading session MPS had lost 21.5% and was valued at 0.79 euros, whereas Carige ended the trading day down by 17% at a value of just under 0.08 euros per share. But leaving the market reaction aside, the truth is that beyond capital some long-lived problems of the Italian banking sector have by now been known for a while but not addressed. In this respect, the comparison with a country like Spain - where the banking system has been subject to a deeper monitoring and restructuring during the financial assistance programme of 2012-13 - may yield striking insights. First, the Italian banking system is still keeping in place a strong liason dangereuse with the (huge) government debt. This is not at all a special feature of Italian banks (as Figure 1 shows) but with almost 80% of their sovereign long direct gross exposures concentrated on Italy, Italian banks are found in this supervisory exercise to be among the most exposed to the sovereign debt issued by the domestic sovereign. Actually, if one excludes the countries that have been or are under a EU/IMF macroeconomic adjustment programme, Italian banks are the most exposed in the Eurozone (Figure1 and Figure 2 left). Note: Long Direct Gross Exposure EBA 2014

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Tweet This Sovereign debt accounts for 10% of Italian banks asset on average and the home bias in debt portfolio seems to have increased since the last EBA test More interestingly, the exercise shows that this “home bias”, which is deeply at the root of the sovereign-banking vicious circle that characterised the euro crisis, has even worsened over the last three years. Domestic exposure has grown (rather than decreased) as a percentage of total sovereign exposure on the books of all those banks that were already tested in 2011 with the exception of UniCredit (Figure 2).

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Sovereign debt accounts by now for around 10% of total assets of Italian banks, on average. The carry trade on these holdings might have kept banks afloat over the last 3 years, but these gains are actually concealing deeper structural issues that Italian banks have - until now - never been forced to facein full. One such long-known problem of the Italian banking system is profitability, which is (and has been for quite a while now) very low. According to ECB data, average return on equity has been negative over the period 2010-2013 and the comparison with Spanish banks is especially striking. After the huge drop in return on equity during 2012, Spanish banks recovered, whereas Italian banks seemed to have never done it (Figure 2). Tweet This After the huge drop in return on equity during 2012, Spanish banks recovered, whereas Italian banks seemed to have never done so

ECB consolidated banking statistics Differences between Italy and Spain are evident also in the reliance on Eurosystem liquidity and the pace of reimbursement, which until very recently has been significantly slower in Italy than in Spain (Figure 3 right). Italian banks have borrowed less - in absolute terms - from the ECB facilities, but have been sticking to the central bank liquidity for longer, accelerating reimbursements only in recent months. This may be explained by the fact that their alternative funding is relatively more expensive than it is for Spanish banks. Interest rates paid by Italian banks on retail (households’) deposits is in fact still significantly above those paid by their Spanish equivalents, not to mention German banks. More interestingly (and worryingly) deposit interest rates in Italy have only very recently started to drift downwards, contrary to Spain, where convergence has started earlier and moved faster. These few elements depicts a gloomy Italian banking system which has been spared - until now - from the deeper monitoring and restructuring that have been undergoing in Spain and other programme countries, but at the cost of finding itself stuck in a limbo where lack of capital (in some cases), low profitability (in general) and rising bad loans are hindering credit and therefore further harming the potential recovery. 196

ECB and national central banks Tweet This Even if the economic cycle were to improve and bad loans to subside, the low profitability will stick due to structurally high costs and inefficiencies As pointed out, among others, by RBS’ Alberto Gallo, this is not a sustainable situation. Even if the economic cycle were to improve and bad loans to subside, the low profitability will stick due to structurally high costs and inefficiencies (such as Italy’s very high concentration of bank branches and length of the judicial process, for example). One possible answer to these issues could be consolidation, which has been important in Spain but basically absent in Italy. This is partly due to specific features of the Italian banking structure, which make such reform very difficult. In particular, as shown in figure 4, banks are closely bound together by equity cross holdings in which bank foundations play often a significant role. And bank foundations are often dominated by local politics (see for example this summary account of professional politicians presence in Italian banks’ foundation boards), which may hinder consolidation on the bases of various (not necessarily economic) interests. This suggests that a meaningful reform process in the Italian banking system can hardly go separate from a deep restructuring of this governance structure. Tweet This Needed consolidation is made difficult by a corporate governance structure that is strongly tied with local politics All these problems are long known, but have not yet been addressed. In our (Italian) language, there exists a fascinatingly peculiar expression: La Bella Figura. While it is impossible to appropriately convey all the nuances of its meaning, it could be broadly translated with “nice appearance” and it fits well also to the attitude that has until now been kept about the Italian banking system’s need for reform. Hopefully the stress test results will act as a wake up call, forcing some to finally acknowledge the importance of substance over form

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Collections from disclosure in annual reports http://www.bruegel.org/nc/blog/detail/article/1469-monday-blues-for-italian- banks/?utm_source=Bruegel+Fact+of+the+Week&utm_campaign=69c43c7b10- Bruegel+Fact&utm_medium=email&utm_term=0_397314f092-69c43c7b10-277671613

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ft.com/global economy EU Economy October 28, 2014 8:53 am Sweden’s central bank cuts rates to zero Richard Milne, Nordic CorrespondentAuthor alerts

©Dreamstime Sweden’s central bank cut interest rates to zero – a record low – as it stepped up its increasingly desperate fight against deflation. The Riksbank cut its repo rate by more than markets were expecting as it moved from 0.25 per cent to zero, reversing a series of rises that had brought interest rates up to 2 per cent at the end of 2011. The Swedish krona hit a fresh four-year low after the rate cut, falling by 0.7 per cent to 7.354 to the US dollar. More ON THIS STORY// Trading Post Krona weakness shows Riksbank dovishness/ Sweden slides further into deflation/ Sweden cuts interest rates to 0.25%/ Scandinavian policy makers test resolve/ Swedish krona slides after rate cut ON THIS TOPIC// Business attacks Sweden’s new government/ Swedish sub hunt ends in farce/ Sweden abandons submarine hunt/ Utilities companies search for new business models IN EU ECONOMY// France bows to EU pressure on deficit/ Gloomy forecasts sap hopes for German economy/ Spain’s recovery boosts labour market/ ECB urged to make more dangerous moves The world’s oldest central bank is in the global spotlight as it seeks to combat deflation which has seen Sweden’s headline inflation figures negative in 16 of the past 24 months. Stefan Ingves, the Riksbank’s governor, has come under pressure from the likes of economist Paul Krugman for lifting rates in 2010 and 2011 to counter what Sweden’s central bank saw as a risk of a housing bubble. Mr Krugman called that policy “sadomonetarism”, as unemployment remained above the historical average and inflation was weakening. The Riksbank justified the cut by citing the weak outlook for prices with both core inflation – its preferred measure – and long-term inflation expectations below its target of 2 per cent.

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“The Swedish economy is relatively strong and economic activity is continuing to improve. But inflation is too low. The executive board of the Riksbank has therefore decided that monetary policy needs to be even more expansionary for inflation to rise towards the target of 2 per cent,” it added. The central bank said rates needed to stay low until inflation “has clearly picked up”. It added that slow increases in interest rates would now be likely to begin in the middle of 2016, a delay from the previous guidance that they would start at the end of next year. The Riksbank said rates should reach 175 per cent by the end of 2017. “It’s a problem for the Riksbank’s credibility that they have to make these adjustments,” said Robert Bergqvist, chief economist at SEB, the Swedish bank. “But they are not alone. We can see many other central banks and countries that are facing similar challenges.” Some analysts have suggested the Riksbank’s next move could be to cut interest rates to below zero or launch asset purchases along the lines of the quantitative easing policy used in the US and UK. But economists at Nordea, the pan-Nordic bank, said it did not expect unconventional measures as the Swedish economy was working well. “If unconventional measures were to become relevant, in contrast to our expectations, a floor for the krona exchange rate against the euro is the most likely choice,” Nordea said. The Riksbank itself said it did not envisage using what it called “complementary monetary policy measures” alongside zero interest rates. But it added: “If conditions were to change the Riksbank has the same possibilities as other central banks to take further measures to increase the monetary policy stimulus.” Mr Bergqvist said the situation was not yet critical as Sweden’s economy continued to record growth and inflation expectations remained positive, albeit below the Riksbank’s target. But he added that the Swedish central bank has shown that it lacks understanding of inflationary dynamics. “The Riksbank has been too slow to adjust its economic models and maybe too backwards looking. It seems it has not understood the impact of globalisation on inflation,” Mr Bergqvist said. The Riksbank continued to fret about the impact of low interest rates on a strong housing market although it has conceded that other regulators should fight against household indebtedness using so-called macroprudential measures such as stricter borrowing limits. The ratio of household debt to income stands at 174 per cent. “With this low repo rate for a long period of time, it becomes increasingly urgent for other policy areas to manage the risks associated with household indebtedness and developments on the housing market,” the central bank added. http://www.ft.com/intl/cms/s/0/3033b236-5e7e-11e4-a807- 00144feabdc0.html#axzz3HMcg3THv

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ft.com Comment The A-List

Lorenzo Bini Smaghi// October 28, 2014 Here’s why Germany needs to start spending

A store offering discounts in Berlin © Bloomberg In a recent article in the FT, Otmar Issing suggested that there are no good reasons for a country like Germany — which enjoys near-full employment and has a balanced budget, a debt “far above target” and an extremely loose monetary policy — to embark on an expansionary budget policy. He asks: “Where is the economic textbook that argues that such a country should run a deficit to stimulate the economy?” The argument may sound convincing but one key variable is missing: Germany’s national savings exceed national investment by more than 6 per cent of GDP. This long- running current account surplus derives from Germans’ desire to accumulate wealth, in particular in view of their retirement. The problem is that the German economy does not produce enough assets to satisfy this wish. If Germany was a closed economy, the excess of savings over investments would lead to a sharp fall in interest rates to levels even lower than the current ones and to a protracted deflation. Fortunately for Germany, its economy is not closed and several other countries are willing to sell assets to German savers. However, while Germany’s desire to accumulate wealth seems infinite – the foreign asset position of Germany is approaching 100 per cent of GDP – the ability of other countries to borrow and issue debt assets is not. In fact, the external debt of several peripheral countries has risen above 100 per cent of GDP and has become unsustainable, forcing them to sharply cut spending. German savers could decide to shift their investments to other parts of the world, but the memories of the losses incurred after the Asian crisis of the 1990s and the US subprime crisis of the last decade still hurt. Given that Germans as a nation are one of the world’s largest net savers, by definition they have to invest abroad and it is no surprise that they are therefore badly hit when financial crises erupt somewhere around the world. Europe is thus in a Catch-22. On one hand, Germany and a few other countries want to continue to save a high portion of their income and accumulate assets through record

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current account surpluses. On the other hand, peripheral countries cannot, and do not want to, borrow more from abroad because they have to deleverage in order to put their own houses in order and reduce their excessive debt. This ends up in an overall excess of savings in Europe which, as described above, produces deflationary effects. Germany has so far escaped the recession because it has been able to compensate for the lower demand coming from the rest of Europe with a strong export performance in the emerging markets. However, the recent slowdown in China, Russia and the Gulf show the fragility of the German economy. In fact, for an economy as large as Germany to depend for nearly 50 per cent of its GDP on exports is a sign of extreme weakness. How can Europe escape from deflation? There are two avenues. The first is that German savers stop investing their savings in fixed income debt instruments (which is what they prefer), and move instead towards foreign stocks and direct investments, as China is increasingly doing. This would avoid excess debt accumulation in peripheral countries and help stimulate growth in those countries too. The other solution is that Germany itself issues more assets in which its savers can invest. How would this work? One possibility is to increase the country’s public debt, but this option is not favoured by German economists and politicians. An alternative is to encourage private investment. Why doesn’t the private sector invest more in Germany? Entrepreneurs answer that there is not enough demand for their goods to justify an increase in investment. Indeed, foreign demand is slowing and domestic demand is sluggish. What should German policy makers do under these circumstances? Implement policies that stimulate domestic demand, be it through higher consumption or investments. One way to achieve this, for instance, is to cut the VAT rate, which is high at 19 per cent, and discourages household spending. Another example is to encourage private investments through preferential tax treatment. If domestic demand does not rise and compensate for the slowdown in world demand, the huge excess of German savings over investment will drag the European economy into a deflationary spiral. That is what standard economic analysis suggests, and that is actually what happened in the 1930s and led to the economic and political disasters of which we all know. If we want to avoid repeating the same mistake we just need to pick any standard macroeconomic textbook from the shelf of a university library and, if needed, translate it. The writer is a former member of the executive board of the European Central Bank and currently visiting scholar at Harvard’s Weatherhead Center for International Affairs and at the Istituto Affari Internazionali in Rome http://blogs.ft.com/the-a-list/2014/10/28/heres-why-germany-needs-to-start- spending/

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Agenda Pública / /Impacto Social "El Estado de bienestar contribuye tanto a la justicia social como a la eficiencia" Jorge Galindo y José Luis Cives entrevistan a Nick Barr, experto en el diseño de políticas sociales. Su último trabajo, La reforma necesaria. El futuro de las pensiones, constituye según Luis Garicano "una excelente guía para entender los retos que se avecinan". En esta entrevista Barr analiza algunos de estos retos.

Jorge Galindo / José Luis Cives 28/09/2013 - 20:26h

Gran parte de su trabajo se ha dedicado a la economía del estado de bienestar. Nos gustaría empezar por conocer un poco más sobre lo que motivó su trabajo y cómo cree usted que nos ayuda a aumentar nuestra comprensión de las políticas sociales. Mi motivación original era tratar de proteger el estado de bienestar de los ataques ideológicos, por ejemplo, por Ronald Reagan y Margaret Thatcher, y del apoyo ideológico ciego como, por ejemplo, bajo el comunismo. El argumento central que presenté (basado en la entonces nueva literatura sobre la economía de la información) es que el Estado de bienestar que existe no sólo por razones de distribución conocidas, en particular para proteger a los pobres, sino que también tiene una función importante de eficiencia -el Estado de bienestar hace cosas que los mercados privados, por razones

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técnicas, harán mal o no harán en absoluto. Este último argumento era nuevo cuando lo utilicé por primera vez en la década de 1980. Uno de los argumentos de su libro The welfare state as a piggy bank fue que el habitual equilibrio eficiencia-igualdad que es común en el debate público se ve muy diferente cuando se observa a través de la lente de la teoría de seguros y de economía de la información. ¿Cómo explicaría a nuestro lector medio su visión de cómo este equilibrio es modificado por su trabajo? El Estado existe para proteger el bienestar de los pobres. Pero también existe para hacer las cosas que los mercados privados harían mal o no harían. Los mercados privados funcionan bien cuando una serie de condiciones técnicas los sostienen. Entre esas condiciones se encuentran las siguientes: Los consumidores deben estar bien informados. Esa condición se cumple, en términos generales, para cosas como la comida, pero no para, por ejemplo, los medicamentos. Así que si compramos alimentos en los supermercados a precios de mercado, el sistema de mercado funciona. Por el contrario, no se nos permite comprar cualquier producto farmacéutico que nos gusta, dado que la producción y venta de esas drogas están muy fuertemente reguladas. Los vendedores de seguros deben saber qué tan arriesgado es el comprador del seguro. Esto funciona bien para cosas como el seguro del automóvil, pero mucho menos para los riesgos como el desempleo o la salud. Así las cosas, como el seguro social y la asistencia sanitaria, el Estado de bienestar contribuye tanto a la justicia social como a la eficiencia. Reforma de las pensiones Su último libro, que fue traducido al español, trata sobre la reforma de las pensiones y ha sido escrito con el premio Nobel Peter Diamond. ¿Cuál diría usted que es el mensaje principal del libro acerca de las opciones que el bienestar se enfrentan los estados con el envejecimiento? El libro consta de varios mensajes: Primero, los sistemas de pensiones tienen múltiples propósitos, incluido el alivio de la pobreza, el seguro y lo que los economistas llaman la suavización del consumo, es decir, la redistribución en el tiempo, o de uno mismo en la juventud a esa misma persona en la tercera edad. Segundo, un sistema de pensiones bien diseñado ha de tener en cuenta todos esos objetivos. Tercero, la estabilización del consumo efectivo: se entiende que un sistema de pensiones tiene que ser (a) estable y (b) sostenible financieramente en el largo plazo. Cuarto, para lograr la estabilidad y la sostenibilidad del sistema éste debe adaptarse a las tendencias a largo plazo, como la prolongación de la vida. Y quinto, el ajuste al envejecimiento de la población puede tener lugar en diversas formas, pero es improbable que tenga éxito sin un incremento en promedio de la vida laboral.

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Como usted sabe, la reforma de pensiones en España hará que las pensiones se actualicen en función del equilibrio a medio plazo del sistema, en lugar de acuerdo al poder adquisitivo. ¿Cuál sería su punto de vista sobre esta solución? No hago ningún comentario sobre la propuesta específica, porque no sé lo suficiente sobre ella. Mi respuesta general es que si un sistema de pensiones no es sostenible en el largo plazo se producirá un error para lograr sus objetivos. Si un sistema de pensiones está gastando demasiado, entonces o bien (a) las contribuciones han de incrementarse o (b) los beneficios percibidos tienen que reducirse. Puesto que (a) probablemente no es una opción en este momento la opción que queda es la (b). Es posible reducir los beneficios ya sea mediante la reducción de lo percibido mensualmente (por ejemplo, al cambiar la fórmula de indexación) o empezando a pagar las pensiones a una edad más tardía. Muchos países han hecho ambas cosas. Teniendo en cuenta las tendencias en la esperanza de vida, el aumento de la edad de jubilación es un elemento esencial en la reforma de pensiones en casi todos los países. En el debate sobre la reforma de las pensiones, algunas personas, incluso instituciones internacionales, a menudo sugieren que el envejecimiento es un problema en los sistemas de reparto que no existiría con un sistema de capitalización. Esta es una idea que ya contradecía en 1979 en su pieza Myths my Grandfather taught me, pero que muchas personas educadas encuentran intuitiva y atractiva. ¿Cuál es exactamente el problema? La intuición es obvia y clara. Y es correcta si se piensa en las pensiones como el simple hecho de acumular dinero para el futuro. Si acumulo lo suficiente para el ahorro en mi vida laboral, la idea es que ese dinero proporcionará mi pensión, aunque no haya muchos trabajadores en activo después de que me haya retirado. Pero el argumento es erróneo si estoy preocupado no por el mero dinero (por ejemplo, tener X euros al mes), sino por la capacidad de consumo después de haberme retirado. Si una generación de pensionistas tiene un gran montón de dinero va a poder gastar ampliamente, pero si no hay muchos trabajadores no habrá mucho que poder comprar para los primeros. Como resultado, los precios de los bienes van a subir, habrá inflación. Así, los pensionistas recibirán su dinero de manera segura, sí, pero no la capacidad de consumo. Reforma de la educación superior Un debate en el que estaba bastante activo fue el tema de la reforma de la educación superior en el Reino Unido. ¿Podría decirnos cuál fue su contribución al debate y las lecciones que España podría aprender del Reino Unido? Mis principales argumentos son que en primer lugar, los países necesitan la educación masiva y de calidad superior para ser competitivos; pero los contribuyentes no pueden permitirse el lujo de pagar el costo total, por lo que el gasto público debe ser complementado por el gasto privado. En segundo lugar, la financiación de la educación superior debe aumentarse mediante el cobro de derechos de matrícula. Sin embargo, los estudiantes generalmente no pueden permitirse el lujo de pagar los derechos de matrícula. Lo que se necesita es un sistema bien diseñado de los préstamos estudiantiles para cubrir gastos de matrícula y costos de vida. Una de mis contribuciones fue precisamente una propuesta de diseño para dicho 205

sistema: los préstamos deben (a) tener pagos supeditados a los ingresos (es decir, la devolución del préstamo ha de consistir en reembolsos de x% de los ingresos del prestatario hasta que él / ella pague el préstamo); (b) cobrar una tasa de interés relacionado con el costo de endeudamiento del gobierno. Al igual que con Myths my Grandfather Taugth Me, esta es un área con un resultado contrario a la intuición. Todo el mundo "sabe" que las tarifas en la universidad disminuyen la capacidad de acceso. Esto es, en realidad, erróneo. Varios países sin matrícula general tienen una baja participación de las personas procedentes de entornos desfavorecidos. Lo que perjudica el acceso es la falta de logros en la escuela, por lo general, por razones que se remontan a la primera infancia. El ministro de Educación británico dijo una vez: "Si yo fuera un socialista real, no gastaría un centavo en la educación superior-me gustaría pasar todo en la educación infantil." Aunque no quiso decir eso literalmente, la declaración tiene un grano muy importante de verdad. Gastar dinero público en garantizar el acceso gratuito la educación superior no ayuda al acceso en sí, sino que lo perjudica al desplazar el gasto que debería hacerse en la parte del sistema correspondiente a las primeras etapas de educación, que es la verdadera manera de mejorar la movilidad social. La educación superior gratuita es políticamente popular como un subsidio de clase media, pero es política social regresiva. Por último, un sistema de tasas y préstamos, si están bien diseñados, libera recursos para ampliar la participación en la educación superior de los estudiantes procedentes de entornos desfavorecidos, es decir, es posible argumentar a favor de tasas y préstamos como parte de la política social progresista (otra de mis contribuciones) . El Gobierno español ha propuesto recientemente reforzar las condiciones de elegibilidad para becas en la educación superior argumentando que esto aumentará los incentivos y la eficiencia de los estudiantes. ¿Usted cree que esto es un argumento sólido? Sí, especialmente si se combina con las políticas para mejorar la consecución anteriormente en el sistema. http://www.eldiario.es/agendapublica/impacto_social/bienestar-mercados- privados-tecnicas-haran_0_180232081.html

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ft.com Markets MARKETS INSIGHT October 27, 2014 5:56 am Europe must act now to avoid ‘lost decade’ Scott Minerd None of the tools currently on the table will get the job done

©Reuters Investors’ confidence in ECB president Mario Draghi has taken a knock in recent months I n recent conversations – whether with the US Federal Reserve, the European Central Bank, the US Treasury or the International Monetary Fund – one theme is playing large and loud: things in Europe are bad and policy makers appear already to have fallen behind the curve. Quantitative easing in Europe is coming, but too slowly to avert a severe slowdown and perhaps even a hard landing. The depreciation of the euro, while welcome, will not be enough to lift the economy out of the doldrums and more must be done both in terms of monetary policy and fiscal reforms. The European Investment Bank stands ready to support infrastructure investment, but at a scale that currently appears too small to make much of a difference. More ON THIS TOPIC// Record outflows from Europe-focused ETFs/ Martin Wolf Eurozone needs more than reform/ Market turmoil tests investors’ nerves/ Reza Moghadam Break Europe’s taboos MARKETS INSIGHT// Corporate cash hoarding has to end/ Eurozone crisis fears re- emerge/ Stakes high for Europe bank stress tests/ Emerging markets foster gloom In the meantime, the ECB will work as quickly as it can to expand its balance sheet. The problem is simply that there may not be enough assets to buy. Mario Draghi, ECB president, has made it clear that the ECB must increase its balance sheet by at least €1tn – a tough mandate as the balance sheet will continue to shrink in the coming year as the earlier longer-term refinancing operation (LTRO) assets roll off. The reality is the ECB will need to purchase at least another €1.5tn in assets, and even that may not be enough.

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The much heralded asset-backed securities purchase programme will only yield about €250bn-€450bn in assets over the next two years. More LTRO (or the newer targeted LTRO) will prove a challenge as sovereign bond yields in Europe are so low that a large balance sheet expansion through this means seems impractical. Perhaps there is another €500bn-€750bn to do over the next year or two. Outright purchases of sovereign debt would prove politically difficult, as many would interpret such purchases as violating the ECB’s mandate and the matter would probably end up in the European courts. The bottom line is that none of the tools currently on the table will get the job done. There are not enough assets to purchase or finance and the timetable to get anything done is too long. Policy makers do not have the luxury of a year or two to figure this out. The ECB balance sheet shrinks virtually daily and as it shrinks, the monetary base of Europe is contracting and putting downward pressure on prices. Europe is clearly in danger of falling into the liquidity trap, if it is not already there. The likelihood of a “lost decade” like that experienced in Japan is rapidly increasing. The ECB must act and act quickly. How is this affecting the markets? The recent rally in US fixed income is materially different than when rates last approached 2 per cent. Previously, the Federal Reserve was actively managing the yield curve to reduce long-term borrowing costs in order to stimulate the economy. The current rally is caused by a massive deflationary wave unleashed upon the US by beggar-thy-neighbour policies in Europe and Asia. The precipitous decline in energy and commodity prices and competitive pressures on prices for traded goods will probably push inflation, as measured by the Fed’s favoured personal consumption expenditures index, back down toward 1 per cent. This raises the likelihood that any increase in the policy rate by the Fed will be pushed into 2016 or later. With inflationary expectations falling and the relative attractiveness of US Treasury yields over German Bunds and Japanese government bonds, US long- term rates are likely to continue to be well supported with limited room to rise and a dynamic that could push them lower from here. In the real economy, the decline in energy prices should offset the effect of reduced exports, which is supportive of US growth in the near term. This will help equities recover from the recent storm of volatility as we move deeper into the fourth quarter, which is a time of seasonal strength for the stock market. However, this may prove to be the rally to sell. Results from currency translations for large, multinational companies will weigh heavily on S&P 500 earnings in the first half of 2015. It is too early to be making decisions for next year, but the events overseas provide ominous portents of things to come. If we do get a sign of a bear market in US equities, it could be that the events in Europe presage what lies ahead for the US. Is it too late to change these shadows of dark foreboding? It is hard to tell but time is not on our side. Scott Minerd is global chief investment officer and chairman of investments at Guggenheim Partners http://www.ft.com/intl/cms/s/0/cf718a1c-5a0a-11e4-be86- 00144feab7de.html#axzz3HMcg3THv

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ft.com/global economy EU Economy October 27, 2014 12:42 pm Fears grow over QE’s toxic legacy By Tracy Alloway in New York

©Bloomberg US Federal Reserve building in Washington “Bankruptcy? Repossession? Charge-offs? Buy the car YOU deserve,” says the banner at the top of the Washington Auto Credit website. A stock photo of a woman with a beaming smile is overlaid with the promise of “100% guaranteed credit approval”. On Wall Street they are smiling too, salivating over the prospect of borrowers taking Washington Auto Credit up on its enticing offer of auto financing. Every car loan advanced to a high-risk, subprime borrower can be bundled into bonds that are then sold on to yield-hungry investors. More ON THIS TOPIC// Trading Post ‘Draghi put’ doubt places spotlight on Fed/ Rate expectations change faster than data/ After QE Taking off the stabilisers/ Policy makers worry that investors are underpricing risk IN US ECONOMY// Corporate America starts to spend again/ Fed set to halt asset purchases/ Democrats battle sour economic mood/ Boston Fed chief urges end of QE These subprime auto “asset-backed securities”, or ABS, have, like a host of other risky assets, been beneficiaries of six years of quantitative easing by the US Federal Reserve, which is due to come to an end this week. When the Fed began asset purchases in late 2008 the premise was simple: unleash a tidal wave of liquidity to force nervous investors to move out of safe investments and into riskier assets. It is hard to argue that the tactic did not work; half a decade of low interest rates and QE appears to have sparked an intense scrum for riskier securities as investors struggle to make their return targets. Wall Street’s securitisation machine has kicked back into gear to churn out bonds that package together corporate loans, commercial mortgages and, of course, subprime auto loans. At $359bn sold last year, according to Dealogic data, issuance of junk-rated corporate bonds is at a record as companies take advantage of low rates to refinance debt and investors clamour to buy it.

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The question now is whether the rebound in sales of risky assets will prove to be a toxic legacy of QE in a similar way that the popularity of subprime mortgage- backed securities was partly spurred by years of low interest rates before the financial crisis. “QE has flooded the system with cash and you’re really competing with an entity with an unlimited balance sheet,” says Manish Kapoor of West Wheelock Capital. “This has enhanced the search for yield and caused risk appetites to increase.” The subprime auto loan market is a case in point. Lured by the higher returns on offer from investing in subprime auto ABS, investors have flocked to buy the securities. Sales of the bonds total $17.4bn so far this year – on course to reach the highest annual level since the credit boom. Washington Auto Credit, just one of many similar companies in a burgeoning industry, helps would-be car owners find financing for their vehicle purchases by connecting them with a growing crop of subprime car lenders. On its website, it lists Flagship Credit Acceptance, a relatively new auto lender backed by the private equity firm Perella Weinberg, as one of its partners.

Like other subprime auto lenders, Flagship has been able to grow its business by tapping strong investor demand for subprime auto ABS. So strong is that demand that Flagship has been marketing ABS with a “prefunding” feature – in effect selling securitised bundles of auto loans before the loans have even been made. Such prefunding features were a hallmark of securitisation markets before the crisis, when demand for residential mortgage-backed securities was so high that it outstripped supply of new loans. Now a similar dynamic appears in play, prompting concerns that investors’ relentless search for yield will once again end poorly. Such features hint at a major worry over QE: that the liquidity unleashed by the Fed has stimulated demand in financial markets more than in the real economy. “It’s not the underlying economics that’s driving things, it’s central bank liquidity,” says Matt King at Citigroup. Unconventional monetary policies are “very good at driving up asset prices but the trickle-through to things like inflation is very weak”. In larger markets there are worries over frothiness too. US regulators last year issued new guidelines to govern banks’ lending to companies with weak balance sheets. Sales of these leveraged loans reached a record $607bn last year, according to S&P Capital IQ. Sales of collateralised loan obligations, which bundle together such loans, have helped fuel the boom, reaching a record $100bn. 210

Still, proponents of such securitisations say they have history on their side. CLOs defaulted at a rate of less than 0.5 per cent during the crisis. The housing bust taught many investors that Americans would sooner lose their homes than their cars, giving further impetus to post-crisis sales of subprime auto ABS. Crucially, issuance of securitisations is still far below levels seen in the run-up to the crisis. Yet there remains a lingering unease that investors are being herded into asset classes that may not be adequately compensating them for the risks involved. Some are already leveraging their portfolio and using derivatives to help amplify their returns during a period of unprecedented low interest rates. “If you tell [investors] we’re in a low-growth environment and add on top of that the central banks are your best friend . . . [they] will lever every single risk factor [they] can find,” says Mohamed El-Erian, Pimco’s former chief investment officer. http://www.ft.com/intl/cms/s/0/aad9b71c-4d83-11e4-9683- 00144feab7de.html#axzz3HMcg3THv

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The Importance of Being Europe October 27, 2014 “The truth is rarely pure and never simple.” Oscar Wilde, The Importance of Being Earnest If Oscar Wilde were still around, he could write a wonderful comedy about European Economic and Monetary Union (EMU). Like the life of his protagonist, Ernest John, the evolution of EMU is rarely pure and never simple. But it would take a Wilde imagination to see exactly how EMU gets to a happy ending. Despite its name, EMU was not and is not primarily an economic endeavor. Introducing the euro lowered transactions costs and facilitated the flow of trade and finance within the euro area. It also reduced inflation in Europe’s formerly high-inflation periphery. However, a common currency is neither necessary (think Canada and the United States) nor sufficient (think northern and southern Italy) for closer economic integration. Nor is it necessary to keep inflation low and stable (think United Kingdom). Instead, its founders viewed EMU as a profound step toward a more perfect political union in Europe (see, for example, here). Helmut Kohl famously elevated the importance of European integration to a question of war and peace in the 21st century. Some (and perhaps many) EMU advocates understood that a common currency would lead to stresses – financial, economic and political. Yet, their experience with the disaster of 20th century European nationalism (and with the policy developments that led up to the euro) led them to expect that these stresses would cause future European leaders to make greater sacrifices of sovereignty to save and advance political union. That outcome remains possible, but it was never pre-ordained. Moreover, recent trends are not favorable. In the absence of acute financial crisis, even the sporadic progress toward greater risk-sharing among euro-area sovereigns slows or comes to a halt. While Europeans generally support the euro, “they show no appetite to delegate more power to the European Union (EU).” Instead, the persistent economic stresses in the member 212

states – including high unemployment, fiscal incapacity and impaired banking systems in many countries, combined with the public perception in several core countries that they are being unfairly (and even secretly) taxed – are nurturing the strongest anti- European political reactions since efforts to promote integration began in the 1950s. Polls show a sizable loss of trust in European institutions since the global financial crisis began in 2007 (see chart). And political parties opposed to European integration are clearly on the rise. In Greece, the poll-leading Syriza party opposes existing fiscal agreements with the European Commission and the IMF. In Britain, popular support for the Independence Party (UKIP) that wishes to exit the EU (not the monetary union, which Britain never joined) reached a record 25% in a recent poll. In Germany, the AfD party (launched in 2013), which objects to transfers to the euro-area periphery, recently entered three state parliaments for the first time. Most ominous for EMU and the EU, polls in France show the leader of the right-wing anti-EU Front National atop the array of potential candidates for the next presidential election in 2017. Trust in European Institutions (Share of respondents expressing trust)

/> Source: Eurobarometer. For more than 60 years, the partnership of France and Germany has been the key driver of European integration. The key product of that partnership – the European Union (not the monetary union) – has contributed enormously to the welfare of more than 500 million people, expanding the free flow of goods, services, capital, and people across European borders. Its success has made another war in the center of Europe unthinkable for generations of Europeans. Yet, it is hard to imagine today how any German

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chancellor would work with a nationalist President of France to preserve the gains of European integration, let alone advance them. European politicians were certainly warned about the instability of a monetary union that includes such an economically diverse group of countries. History does not provide an example of such a broad currency union that survives in the absence of fiscal and financial union. Fiscal union means sharing sovereignty over tax and spending decisions. Financial union means sharing sovereignty over (and fiscal burdens resulting from) banking regulation, supervision, resolution, and deposit insurance. The simple contrast of EMU with the U.S. monetary union – which has enjoyed fiscal and financial union since the Great Depression and political union for much longer – makes these differences clear. Leading economists highlighted the risks. Two examples suffice. In 1997, Martin Feldstein famously argued in “EMU and International Conflict” that “the adverse economic effects of a single currency on unemployment and inflation would outweigh any gains from facilitating trade and capital flows among the EMU members.” In 1999, future Nobel Laureate (2011) Christopher Sims warned about “The Precarious Fiscal Foundations of EMU,” stating “it is unlikely that EMU can long survive with the degree of vagueness and weakness in the associated fiscal structure that currently characterize it.” He argued that the incentive to leave EMU – say, on the part of one country in fiscal distress – could fuel a destabilizing spiral of higher interest rates and financial contagion. He also warned that adherence to the Maastricht fiscal rules – needed to enforce fiscal discipline in normal times – can undermine economic stability in a world of zero interest rates and deflation. In short, euro-area institutions would need to adapt substantially to preserve EMU. Yet, in the absence of acute financial crisis, institutional adaptations have remained grudging over the 15 years of monetary union. Recently, euro-area members have strengthened mutual fiscal surveillance, but without creating incentives for the relatively healthier countries to use their fiscal capacity in the current zero-bound world anticipated by Sims. Following the October 26 ECB assessment of the capital of 130 euro-area banks, the euro area will soon transfer the regulation and supervision of its largest banks to the Single Supervisory Mechanism inside the ECB. It also has developed an institution – the European Stability Mechanism – to aid in their resolution. But it has not ended the “doom loop” that links euro-area banks and their sovereigns (through the banks’ impaired domestic assets and the national sovereign’s contingent liability for resolving the banks). Finally, a serious discussion of euro area-wide deposit insurance is simply not on the table because of the enormous expansion of risk sharing that it would entail. Domestic economic adaptations have remained similarly grudging. Compelled by a fiscal and banking crisis, Spain has moved relatively faster than other euro-area economies to make its economy more competitive, but still suffers like much of the region both from institutional rigidities and an enormous shortfall of aggregate demand. Italy and France have implemented few (if any) significant labor or product market reforms despite their poor economic performance. And Germany has continued to tighten its fiscal stance even as it remains the only large euro-area economy with meaningful capacity to do otherwise. 214

Against this worrisome background, the burden of maintaining financial stability has fallen mostly on the European Central Bank – easily the euro area’s strongest institution. Considering the context, the ECB has been extraordinarily effective. Absent President Mario Draghi’s 2012 commitment to do “whatever it takes” to save the euro – combined with the critical backing of German Chancellor Angela Merkel – it is doubtful that EMU today would have 18 members (soon to be 19 when Lithuania joins in January 2015). Reflecting Draghi’s credibility, investors never tested the ECB’s promise to undertake “outright monetary transactions” (OMT) in the debt of fiscally distressed countries. Instead, European bond yield spreads collapsed. To preserve price stability – its primary mandate – the ECB will need to go much further, expanding its balance sheet massively. (See our earlier post on the mechanics.) Current purchases of private assets (such as covered bonds and asset-backed securities) almost surely won’t suffice. Yet, the alternative of buying government debt – without the fiscal conditionality of the as-yet-untried OMT program – once again raises the specter of large transfers from the healthier economies to those in fiscal distress. If such sovereign debt purchases are needed to meet the ECB’s mandate, they may prove consistent with the Maastricht Treaty, but the subject already is a source of political conflict and any implementation would surely be court-tested. Ultimately, even if the ECB achieves its price stability objective – a necessity for the preservation of EMU – it is merely buying time. Ironically, its success in tempering the euro-area financial crisis diminishes the incentives of countries and policymakers to adjust. Yet, the crisis has shown that EMU is an unstable regime and that preserving it will entail greater sharing of risk and sovereignty across borders. Stabilizing EMU (and preserving the broader EU) will require Europeans to compromise more, precisely when the will to do so has diminished sharply. The staggering cost of policy failure does not ensure success. Effective compromise will involve politically unpopular sacrifices by virtually everyone. As Wilde might say, the result will be neither “pure” nor “simple.” The architects of the Maastricht Treaty probably wanted a strong political union, not just a monetary union. Had it been politically feasible in 1992 when the Treaty was signed, they might have endorsed the issuance of commonly backed euro-area debt by a European Parliament empowered to tax and spend and to operate a banking union. However, it has never been clear that Europe’s citizens want such a federal regime. Today, they still appear to like the euro, but not its economic or political consequences. Europeans will need Oscar Wilde to write a happy ending. http://www.moneyandbanking.com/commentary/2014/10/27/the-importance-of- being-europe

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ft.com/management THE ART OF PERSUASION October 27, 2014 11:49 am Ronald Reagan’s career-making speech still shines 50 years on Sam LeithAuthor alerts

©Getty What were the great turning points of the cold war? You could make a case that one was 50 years ago on Monday when Ronald Reagan gave a speech, “A Time For Choosing”, in support of the Republican presidential candidate Barry Goldwater. The speech – or The Speech, as it became known – helped make Reagan’s political career. Shortly afterwards he was nominated to run for governor of California – which led on to the White House, the partnership with Margaret Thatcher, detente with Mikhail Gorbachev, perestroika, impromptu wall-demolition in Germany, and all that jazz. More ON THIS STORY// The Art of Persuasion On tense and rhetorical time-travel/ The Art of Persuasion Memory matters/ Nixon great orator but still a crook/ The Art of Persuasion Gain in translation/The Art of Persuasion A classic way to give orators rhythm ON THIS TOPIC// Letter Reagan doctrine is at the heart of US’s credit problem THE ART OF PERSUASION/Scottish vote lessons/ Is it worth asking a rhetorical question?/ Ukip gets it badly wrong/ Treats or threats

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So what made “the Great Communicator” such a great communicator? There are abundant examples in this speech. Wherever you stand on Reaganomics, here is a lucid, cogent and fiercely persuasive statement of the case for small government and market freedoms, and a refusal to accommodate with communism. One thing any business communicator can learn from is how it deals with statistics. It is packed, at least in the first half, with facts and figures: a turn-off in unskilled hands. They are given persuasive life by Reagan. Here is folksy style; aphoristic wit; and above all a clever use of metaphor – which provides an easily grasped interpretive framework for the statistics. The most quoted passage is the pivot: “You and I are told increasingly we have to choose between a left or right. Well I’d like to suggest there is no such thing as a left or right. There’s only an up or down – [up to] man’s old-aged dream, the ultimate in individual freedom consistent with law and order, or down to the ant heap of totalitarianism.” Here, introduced with that seductively informal “you and I” (inviting us into collusion against the bossy “they”), is a spatial metaphor that cunningly loads the dice: reframing right versus left as up versus down. “Left” and “right” are relatively un-loaded terms – they articulate a political disagreement; whereas “up” and “down” carry universal connotations. The gutter is down and the stars are up. And – as Reagan hints with his ant heap image – we talk of the Ascent of Man. Also, instead of attacking the Democrats as a threat, he treated them as idiots who missed the point of a greater threat. His sonorous high style was reserved for the communist menace; the Democrats, he patronised. In fact, he made fun of them. That’s far deadlier. In a splendid reductio ad absurdum, he quoted an optimist on the $298bn hole in the Social Security budget: “He said there should be no cause for worry because as long as they have the power to tax, they could always take away from the people whatever they needed to bail them out of trouble.” Another gem: “For three decades, we’ve sought to solve the problems of unemployment through government planning, and the more the plans fail, the more the planners plan.” One more: “Well, the trouble with our liberal friends is not that they’re ignorant; it’s just that they know so much that isn’t so.” What did this brilliant speech do for Goldwater? He lost the election by miles. People concluded that someone had the vision thing; and that someone was Reagan rather than Goldwater. Which offers an extra lesson: don’t – figuratively speaking – pick a bridesmaid who’s much prettier than the bride. The writer is the author of ‘You Talkin’ to Me?’ Rhetoric from Aristotle to Obama [email protected] http://www.ft.com/intl/cms/s/0/c5557294-593f-11e4-9546- 00144feab7de.html#axzz3HMcg3THv

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The Washington Post Wonkblog Even the ECB thinks Germany needs to start spending more By Matt O'Brien September 22

But spending more is strictly against the rules! (Clemens Bilanclemens Bilan/AFP/Getty Images) Europe is stuck in a depression worse than the 1930s, and the ECB has finally noticed. It's about time. Eurozone inflation has fallen to just 0.4 percent, which makes it harder for the crisis countries to regain competitiveness, and real debt burdens higher than they would otherwise be. This, as Japan can tell you, is how a lost decade (or two) begins. The ECB has belatedly responded by introducing negative interest rates, offering banks even more cheap loans, and promising to buy asset-based securities—a kind of QE-lite. It's a good start, but only that. Indeed, the new funding-for-lending scheme's lower- than-expected uptake is a reminder that—at least as long as 3 percent inflation is verboten—it's not so easy for central banks to gain traction when interest rates are zero. It's Keynes' world, in other words, and we're just living in it. That's why, after years of preaching fiscal rectitude, the ECB is now speaking out against austerity, and even, in some cases, in favor of further investment. (Just don't call it stimulus.) Here's what the ECB's Benoît Cœuré and his former colleague Jörg Asmussen said about it last week: Germany can use some of its budgetary room of manoeuvre to support investment and reduce tax wedges, while preserving its sound fiscal position. In doing so, it would tackle some its own future economic challenges. Countries without margins of manoeuvre should not undo the progress made on fiscal consolidation. How can we rebuild mutual trust if we renege on our commitments? Thus, countries lacking fiscal space should instead aim to achieve a more growth- friendly mix of fiscal policies by simultaneously cutting unproductive spending and distortionary taxes. Translation: countries that can afford stimulus should do it, and countries that can't should at least cut taxes as much as they cut spending to stop any more tightening. It's remarkable that the same ECB that has been Europe's budget enforcer, basically kicking then-Italian Prime Minister Silvio Berlusconi out of office for not being 218

committed enough to austerity, is now calling for more spending to fight their slump. And it's even more remarkable that a German—Asmussen—is joining this Keynesian chorus. Berlin, of course, was not pleased. It insists that it invests "significantly," and that these attacks are "unfounded." It wasn't much different from what it said last year when the U.S. Treasury criticized excess German saving—some 7 percent of their GDP—for sapping demand from the rest of the world. But, as Cœuré and Asmussen point out, it's not about Germany doing what's best for everyone else. It's about Germany doing what's best for itself. And, on that score, it's failing. Take a look at the chart below from Christian Odendahl, the chief economist at the Center for European Reform. Once you account for depreciation, Germany's public investment on construction and equipment has actually been negative the past decade. It spends substantially less than other countries on education, too.

Source: Christian Odendahl This is fiscal insanity. Germany has plenty of worthwhile projects to spend money on after systematically underinvesting in its people and infrastructure for 20 years. And, even before inflation, it can borrow for less than nothing. That's because, as crazy as it sounds, investors are actually paying Germany to borrow over two years. But out of some misplaced sense of fiscal self-righteousness, it refuses to do what will help itself grow and save money over the long-term: namely, borrow in the short-term. It's letting your nose fall off to spite your face, just because you made a rule against catching it. Even the ECB thinks that's absurd. Matt O'Brien is a reporter for Wonkblog covering economic affairs. He was previously a senior associate editor at The Atlantic. http://www.washingtonpost.com/blogs/wonkblog/wp/2014/09/22/even-the-ecb- thinks-germany-needs-to-start-spending-more/

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ft.com Markets Capital Markets October 27, 2014 6:03 pm Eurozone bonds brush off ECB stress tests Elaine Moore Europe’s government debt markets have barely registered the results of a test designed to ensure the region’s lenders can withstand adverse economic conditions. Across the eurozone, 25 banks were revealed to have capital shortfalls under the European Central Bank’s health check, nine of which were in Italy. Trading in the shares of the worst performer, Banca Monte dei Paschi di Siena, were suspended on Monday morning after falling 20 per cent. More ON THIS TOPIC// Lex European banks – life after the AQR/ MPS shares tumble 20%/ Analysis Analysts comb bank data for clues/ ECB says banks overvalued assets by €48bn IN CAPITAL MARKETS// Funds buckle up for redemption surge/ Leveraged loans come under pressure/ Big hedge funds suffer brutal October/ Markets brace for ECB stress tests Yet Italian government bonds appeared to rally on the news, pushing down yields slightly on 10-year bonds. By Monday afternoon prices had fallen again, pushing up the yield by about 3 basis points to 2.55 per cent. In Greece and Portugal government bonds told the same story, rising slightly by mid- afternoon. Spain, whose banks all passed the test, outperformed the rest of the market and yields on 10-year Spanish debt fell by 5 basis points to 2.14 per cent. “The results haven’t set the European government debt markets alight,” said David Owen, an economist with Jefferies investment banking. “Investors came in, saw the results and moved quickly on. We are generally heading towards more action by the ECB, and on that expectation Bunds are falling and spreads are coming in.” In depth ECB stress tests

The central bank’s Asset Quality Review is aimed at restoring investor faith in European banks ahead of the launch of a unified banking supervisor in Frankfurt / Further reading Germany’s government bonds, the eurozone’s largest and most liquid bond market, rallied, pushing down the yield on 10-year Bunds by 3 basis points to 0.86 per cent, following data that showed German business confidence down for the sixth consecutive month. The Ifo institute’s business climate index, which is collated from a survey of 7,000 executives, fell to 103.2 from 104.7 in September, a larger drop than expected. 220

“The ECB stress test is more of an equity story than a sovereign credit one,” said Peter Goves, European rates strategist at Citi. “The results aren’t being read as negative for sovereign credit. They don’t affect the macro fundamentals like sovereign debt sustainability. The movements in Bunds are more related to the weak data from Germany.” Weak growth and low inflation across the eurozone has raised the possibility of further bond purchasing programmes by the ECB to spur growth. Last week the ECB began its programme of covered bond purchases, part of a plan to help stimulate lending across the region. “Overall there’s been a muted response in government bond markets,” said Carl Norrey, co-head of European rates trading at JPMorgan. “You could reasonably have expected far greater movements but it’s been really quiet.” http://www.ft.com/intl/cms/s/0/7ee02502-5dc7-11e4-897f- 00144feabdc0.html#axzz3HMcg3THv

ft.com/ companies Financials Banks INSIDE BUSINESS Last updated: October 27, 2014 10:38 pm Alternative stress tests find French banks are weakest in Europe Tom Braithwaite Measure based on market capitalisation says they are most risky On Sunday, Christian Noyer, governor of the Banque de France, was crowing about the “excellent”performance of French banks on the European stress tests Many of their Italian and Greek counterparts might have flunked but France could be proud of its banking sector. “The French banks are in the best positions in the eurozone,” said Mr Noyer. More ON THIS STORY// Editorial Better check on health of Europe’s banks/ Lex European banks – life after the AQR/ Bank shares slide after ECB stress tests/ Gavyn Davies stress tests are not enough/ Audio ECB stress tests ON THIS TOPIC// Italy rules out public money for banks that failed stress tests/ Stress tests fail to tackle deflation spectre/ European bank stocks feel stress of tests/ Rome bankers protest at stress tests INSIDE BUSINESS// Sainsbury’s to open Netto-branded stores/ Tech companies split on cloud computing/ Norway consumed by Yara soap opera/ Corporate India frets over debt levels Not so fast.

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Two days earlier, a different test found that the French financial sector was the weakest in Europe. The team with the temerity to deliver this bucket of cold water to Paris works at the wonderfully named Volatility Institute at New York University’s Stern school and presented its findings from a safe distance – a financial conference at the University of Michigan. The chief architect, Viral Acharya, has worked on systemic risk ever since the last crisis, attempting to design a bank safety test that can be run all the time – not at the whim of regulators. Using his methodology, which he calls SRISK, Mr Acharya found that in a crisis French financial institutions would have a capital shortfall of almost $400bn, worse than the US and UK despite their much bigger financial sectors. Looking just at the French banks tested in the ECB stress tests, which found zero capital shortfall, SRISK came up with €189bn. Mr Acharya did not have access to the 6,000 officials who scoured balance sheets across Europe to gauge the health of the continent’s banks. But his results, which have implications for other countries, including China, should not be ignored.

How big is the crisis hole?

Country SRISK shortfall (€bn) ECB shortfall (€bn)

France 189 0 Germany 102.4 0 Italy 76.3 7.6 Spain 37.9 0 Belgium 26.6 0.3 Austria 6.7 0.9 Greece 4.4 8.7 Portugal 3.8 1.1 Ireland 3.1 0.9 Cyprus 0.2 0.3 Total 450.3 19.8

Source: NYU Stern/European School of Management and Technology

Take Société Générale. France’s second-biggest bank by market value did fine on the ECB’s stress test. But on Mr Acharya’s measure, the bank has a large capital shortfall in a crisis.

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There are a couple of big reasons for the difference. First, SRISK takes into account the banks’ total balance sheet without regard for risk: unlike the ECB, it does not attempt to distinguish between €1m of German Bunds and a €1m loan to a dipsomaniac farmer with a rusty tractor. Second, it does not care what banks’ book value of equity is; it uses what the stock market says it is. Under the ECB’s methodology, SocGen has €36.6bn of equity today and, in a crisis, would have €30.7bn of equity against €377bn of risk-weighted assets. That equates to a passable 8.1 per cent capital ratio even in a deep recession. According to Mr Acharya’s methodology, the bank has only €30bn of market equity today against €1,322bn of assets for a much weaker capital ratio of 2.3 per cent. In a crisis, when market values would plunge further, SocGen would be left with a shortfall of more than €60bn.* Using the stock market to compute a bank’s equity makes SRISK vulnerable to irrational optimism or irrational pessimism of investors. But Mr Acharya finds three good reasons to use it. “Markets told us that subprime MBS [mortgage-backed securities] had become poor in quality and liquidity; book values and regulatory risk weights did not,” he says. “Market values are also harder to manipulate by management through understatement of losses or provisions. Finally, banking crises are caused by drying up of credit by financiers. Financiers are not interested in book values or regulatory capital per se, but whether the firm can raise capital if needed to repay them. This is best captured by market value.” It is not just France’s regulators and banks that might be well-advised to stop patting themselves on the back and consider other measures of systemic risk. Europe’s aggregate SRISK has fallen since 2011, with the deleveraging of balance sheets following the eurozone crisis. Systemic risk in the US has also fallen by half since 2008. But risk in China has picked up significantly and now surpasses the US. If anything, Mr Acharya notes, the problem is likely to be understated because of the amounts of off- balance sheet debt in China. In the US, JPMorgan Chase’s leverage might be much better than its French counterparts, but its SRISK is bigger: a $98.4bn shortfall in a crisis. MetLife, which is considering suing the US government over its designation as a systemically important company, is found to pose a bigger systemic risk than Goldman Sachs. If you believe that financial companies always appropriately value their assets and never try to massage the value of their equity and if you believe that officials are always diligent in examining banks’ accounting then SRISK is a waste of time. But if you believe this you haven’t been paying attention for the last decade. [email protected] * This article has been amended since initial publication to correct Société Générale’s assets and capital ratio. http://www.ft.com/intl/cms/s/0/fad2c772-5dd7-11e4-b7a2- 00144feabdc0.html#axzz3HMcg3THv

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ft.com Comment Opinion October 27, 2014 6:33 pm Stress tests alone will not bring the eurozone back to health Gavyn Davies A dysfunctional banking system should no longer be fatal for growth

©EPA ECB president Mario Draghi T he examination is over. For more than a year the European Central Bank has been shining a light on the books of the eurozone’s banks; this weekend it reported its conclusions. The balance sheets of 25 institutions were found wanting; the ECB concluded that they need an extra €25bn between them to be able to withstand a nasty economic surprise. Two crucial questions remain. Has enough at last been done to fix the European banking system? And will this on its own be enough to ward off the threat of deflation that is hanging over the eurozone? The answer to the first question is “probably yes”. But the answer to the second is “certainly no”. The ECB has taken a necessary, but far from a sufficient, step to fix the low-growth, low-inflation condition that has become the norm in the European economy. More ON THIS STORY// Editorial Better check on health of Europe’s banks/ Lex European banks – life after the AQR/ Bank shares slide after ECB stress tests/ Audio ECB stress tests/ Inside Business Alternate stress test hits French banks ON THIS TOPIC// EU leans on big banks for bailout fund/ Wolfgang Münchau Italian debt/ Europe’s lenders urged to raise capital now/ Foundations for banking union laid but bricks still to fall in place GAVYN DAVIES// Stress tests alone will not bring the eurozone back to health/ Is economic growth permanently lower?/ China’s slowdown is secular, not cyclical/ What is market turbulence telling us? The stress tests have been criticised for being insufficiently tough. If this becomes the general view, confidence in the banking system will not return. But the criticisms seem unfair. The economic conditions modelled in the “adverse scenario” are injurious indeed: real output growth in the eurozone is marked down by 6.6 per cent over three years relative to the baseline, an enormous shock; there are big falls in house prices; and consumer prices are also lower than expected. 224

Critics have complained that the ECB did not model the effects of a deflationary scenario. Vítor Constâncio, the ECB vice-president, said at the press conference on Sunday that this was because deflation simply would not happen. With headline inflation already as low as 0.3 per cent, this is not exactly convincing. But the current levels of inflation are being temporarily depressed by weak commodity prices; and inflation expectations, though falling, are far from consistent with outright deflation. It is unreasonable to expect the main adverse case to be premised on several years of continuous deflation – which would amount to a further, unprecedented policy failure. Another complaint is that the tests are based on capital ratios, which attempt to take account of risk by attaching a higher value to assets whose value is believed to be most certain. Some observers believe that the methodology used to adjust for risk is flawed, and prefer to judge a bank’s health by looking at the leverage ratio, which is a simpler measure. This is an approach that the US Federal Reserve has used. But not all of the problems of a diverse banking system can be fixed at once. The crucial point is that the ECB will be in charge of regulating the systemically important banks of the eurozone after November, and the central bank is not likely to risk its credibility by doing shoddy work. There is much greater transparency in the new system than there has ever been before. Mr Constâncio said at the weekend that these measures would essentially unblock the eurozone’s credit system and restore credit growth to the economy. This is optimistic. Private-sector capital flows between the banking systems in different countries of the eurozone need to be fully restored, and loan-to-deposit ratios need to be reduced markedly. That will not happen instantly. Furthermore, banks need to restore their risk appetite, having spent several years preferring to build their capital buffers than lend to risky small businesses. Most bank analysts say more work is likely to be needed here. There is also the lingering worry that credit growth is being held down as much by a lack of demand for loans as a lack of supply. Calculations by Malcolm Barr of JPMorgan Chase show the likely rise in credit growth will boost gross domestic product by less than a quarter of a percentage point next year. The experience in Japan after the banks were cleaned up in 1997 was that credit growth was never really restored to full health. In the US, after the bank clean-up in 2008-09, there was slightly more success, but even now credit growth there is fairly subdued. The lesson is that the effects of credit shocks can last an extremely long time, even if they are cleared up more quickly than the eurozone has managed. Mario Draghi, the ECB president, told European leaders on Saturday that a combination of fiscal, monetary and structural reforms are needed, on top of the banking measures. He is right on all counts. The best that can now be said is that a dysfunctional banking system should no longer be a fatal impediment to growth, on the optimistic assumption that the other measures he has promised – including a sizeable monetary stimulus – come on stream. The writer is chairman of Fulcrum Asset Management and writes a blog for the Financial Times at FT.com/gavyndavies/ http://www.ft.com/intl/cms/s/0/63f168e2- 5dee-11e4-b7a2-00144feabdc0.html#axzz3HMcg3THv

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ft.com Comment Opinion October 27, 2014 5:58 pm Transatlantic trade negotiators should own up to their ambition Pascal Lamy Consumers fear the transatlantic pact will cost them their safeguards, writes Pascal Lamy

©Getty American cars have bigger bumpers than European ones. That may sound like a trivial detail but it, and others like it, have big ramifications for diplomats charged with negotiating a trade agreement between the US and the EU. Opening up markets once meant removing barriers that protected domestic producers from foreign competition. Authorities in Europe and America have given the impression that the Transatlantic Trade and Investment Partnership is just another trade agreement of that kind. In fact, the proposed agreement is a different beast. Most old-fashioned barriers have already disappeared. Trade negotiators are focusing instead on removing discrepancies between the regulations in force in the American and European markets. These talks are no longer about removing protections; they are about harmonising precautions that prevent harm to consumers. More ON THIS STORY// EU states warn Juncker over trade deal/ German concern at US/Canada trade deals/ US trade agenda awaits midterm elections/ ExIm warns US of export risk from China/ EU and China agree truce on trade spats ON THIS TOPIC// Pacific Rim ministers positive after talks/ Editorial Juncker plays with trade deal future/ Canada accuses US of protectionism/ Ukraine conflict overshadows New Silk Road IN OPINION// Here’s why Germany needs to start spending/ Gavyn Davies stress tests are not enough/ Rebecca Liao China’s legal contortions/ Robert Zoellick Germany and freedom The political economy of this sort of endeavour differs from those of past negotiations. When you work to reduce tariffs, consumers praise you for lowering prices while producers complain that you have stripped away their protections. Things are different when we start talking about regulatory harmonisation. Producers are excited by the prospect of such measures, which could have serious implications for medicine, food, 226

financial products, vehicles – everything. But they make consumers anxious because they fear it means giving up the precautionary safeguards from which they benefit. How do we come up with a mutually acceptable approximation of American and European regulations that have the same purpose but do not always safeguard consumers to the same extent or in the same way? This is serious politics – far more difficult than horse-trading over tariffs. The Europeans have been dealing with this challenge ever since they set about creating the single European market in the mid- 1980s. Failing to make clear that the TTIP negotiations, too, are about regulatory harmonisation was a huge blunder. Negotiators need to be transparent if they are to calm public suspicions. Another political obstacle lies in the plan to allow investors to sue governments under the pact if they feel local laws threaten their investment. The negotiators seem to have forgotten about the anti-globalisation activists. This loud minority is managing to convince consumers they will have to eat chlorinated chicken and genetically modified food, and that US data privacy laws will be foisted on them. Introducing potential investor-state disputes to the mix adds to this sense of distrust. Both sides also underestimated the change in German public opinion. When I was the EU trade commissioner, from 1999 to 2004, the German public could be counted on to support greater trade openness. But recent polls suggest that Germans trust America far less than they did – a bad omen for a pact that would require them to put their faith in US regulators. How can we put TTIP back on track? We need to embrace transparency. We must explain, frankly and openly, that 80 per cent of these negotiations deal with a realm of regulatory convergence. We must recognise that, while we might reap some early harvests, this is a long-haul project. If investor-state disputes are to be allowed, a much better case for them must be made. When there are differences in regulation, negotiators should say either that they will not touch each other’s rules or that they will both adopt the most stringent of the existing safeguards. Finally, both sides should leave open the possibility of TTIP being widened to include other interested states. If the EU and the US overcome these obstacles and put the agreement back on track, then they stand to establish global regulatory benchmarks that will help to achieve the promise of open trade. The writer is a former director-general of the World Trade Organisation and European commissioner for trade http://www.ft.com/intl/cms/s/0/d69d4496-5a07-11e4-8771- 00144feab7de.html#axzz3HMcg3THv

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Budget : la France devrait échapper à l'avis négatif de Bruxelles Le Monde.fr | 27.10.2014 à 20h26• Mis à jour le28.10.2014 à 07h44 |Par Cécile Ducourtieux (Bruxelles, bureau européen) Les efforts de Paris ont payé. Selon les informations obtenues par Le Monde de sources européennes concordantes, la Commission européenne ne devrait pas sanctionner d'un avis négatif la France sur son projet de budget 2015, suite à l'envoi par Bercy lundi 27 octobre d'un courrier annonçant des efforts supplémentaires de l'ordre de 3,6 milliards d'euros. Cette modification budgétaire faite sous la pression de Bruxelles devrait permettre à la France d'afficher l'année prochaine une baisse de son déficit structurel – hors effet de la conjoncture – de 0,5 point, selon le ministre des finances français, Michel Sapin. C'était précisément ce que la Commission était prête à accepter de Paris pour transiger. Mais lors de l'envoi de son budget, la France avait initialement proposé un effort de seulement 0,2 % du PIB, un chiffre jugé indécent par une source haut placée à la Commission. Cette dernière avertissait encore la semaine dernière : si la France ne revient pas sur ce chiffre, c'est l'avis négatif assuré. Paris s'était en effet engagé pas plus tard qu'en juin à un effort de 0,8 % du PIB. « REVENIR DANS LES CLOUS » Entre temps, la France a réussi à faire valoir que la faible inflation rendait encore plus difficile de tenir cet objectif. Paris a aussi obtenu que la Commission tienne compte d'un changement de procédure comptable dans le calcul du CICE, qui permet à la France de gratter 0,1 point d'effort structurel. Enfin, la France a bénéficié d'un recalcul de sa contribution au budget de l'Union européenne, dégageant un milliard providentiel. La partie n'est pas pour autant gagnée avec Bruxelles. S'il n'y a pas d'avis négatif, cela ne veut pas dire pour autant que le projet de budget hexagonal – qui ne prévoit pas de retour à un déficit sous le plafond de 3 % du PIB – convient à la Commission, qui doit rendre entre le 15 et le 30 novembre un avis détaillé sur tous les budgets des 18 pays de l'euro zone. Il va falloir tout au long de novembre que Paris arrache un délai supplémentaire d'un ou deux ans pour « revenir dans les clous », comme l'a promis le ministre de l'économie, Michel Sapin. La Commission a déjà prévenu : pas de délai de grâce sans engagement clair sur un agenda de réformes structurelles. >> Lire le décryptage des Décodeurs : La France a-t-elle perdu sa souveraineté budgétaire ?// Sous la pression de Bruxelles, la France modifie son budget58// Budget de l'UE : malgré la menace de sanctions, Cameron refuse de « sortir le chéquier »14// Budget : l'Italie répond à Bruxelles en proposant plus d'efforts sur le déficit6 http://www.lemonde.fr/europe/article/2014/10/27/budget-la-france-devrait-echapper-a-l- avis-negatif-de-la-commission-europeenne_4513282_3214.html

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Budget : l'Italie répond à Bruxelles en proposant plus d'efforts sur le déficit

Le Monde.fr avec AFP | 27.10.2014 à 12h49• Mis à jour le27.10.2014 à 13h27

L'échange de courrier continue entre Rome et Bruxelles sur la question budgétaire. Une semaine après avoir reçu une lettre très directe du commissaire européen à l'emploi et à la croissance le sommant de s'expliquer sur les raisons qui l'ont conduit à ne pas respecter les objectifs de réduction des déficits dans son projet de budget 2015, le gouvernement italien a renvoyé sa réponse par écrit, lundi 27 octobre, proposant des « mesures supplémentaires ». L'Italie avait présenté le 15 octobre un projet de budget prévoyant un déficit de 2,9 % du PIB après 3 % en 2014 ainsi qu'un report de 2015 à 2017 de l'objectif d'équilibre du déficit structurel. La Commission avait vivement réagi, qualifiant ce report de « déviation importante » par rapport aux engagements initiaux. Dans sa lettre, le ton de Jyrki Katainen, le commissaire à l'emploi et à la croissance, était alors très direct : « Je vous écris pour vous demander les raisons qui ont conduit à ce que l'Italie prévoit de ne pas se conformer au Pacte de stabilité et de croissance en 2015. Je voudrais également savoir comment l'Italie pourrait respecter ses objectifs relatifs au Pacte de stabilité et de croissance en 2015 ». Le ministre de l'économie italien, Pier Carlo Padoan, lui répond en détail, lundi. Dans son courrier, il souligne que la loi de finances italienne a « pour objectif de relancer l'économie italienne après de longues années de crise qui ont coûté au pays une contraction de 9 % de son PIB par rapport au niveau de 2008 ». >> Lire le récit (édition abonnés) « Je voudrais savoir comment l’Italie pourrait respecter ses objectifs » Italie: manifestation contre la réforme du marché du travail Des centaines de milliers de personnes ont manifesté samedi 25 octobre dans les rues de Rome pour dénoncer le projet de réforme du marché du travail de Matteo Renzi et rappeler au chef du gouvernement qu'il devait compter avec les syndicats. 00:54 « EFFORT DE RELANCE » Cet « effort de relance » se fera en maintenant le déficit public sous la barre des 3 % et en corrigeant le déficit structurel (hors impact de la conjoncture sur la situation des finances publiques) de 0,3 point de PIB, tout en « finançant simultanément l'effort extraordinaire [requis] pour les réformes structurelles attendues de longue date », précise le ministère. 229

« L'économie se trouve actuellement dans sa troisième année de récession et fait face à un sérieux risque de déflation ou de période prolongée de très basse inflation et de stagnation. Une quatrième année de récession doit être évitée par tous les moyens car il serait très problématique de hisser le pays hors d'une telle conjoncture. De plus cela rendrait beaucoup plus difficile le maintien de la soutenabilité de la dette. » Pour financer les mesures supplémentaires, le gouvernement italien prévoit d'utiliser 3,3 milliards d'euros de fonds initialement destinés aux baisses d'impôts et une baisse des ressources destinées aux fonds de cohésion de l'UE, selon la lettre. La France, qui prévoit de son côté un déficit à 4,3 % du PIB en 2015, fait également l'objet de fortes pressions européennes. François Hollande a expliqué que Paris répondrait « à la fin de la semaine ». La Commission doit formuler un avis sur les budgets des Etats de la zone euro – il est seulement consultatif – d'ici à la fin novembre. Il s'agit d'un document circonstancié, qui, pour chaque pays, évalue ce qui va bien et moins bien, au regard des engagements pris pour redresser les finances publiques. Depuis la signature du Pacte de stabilité, en 1997, aucun pays ne s'est jamais vu infliger de sanction pour non-respect des règles de dette et de déficit. >> Lire le décryptage des Décodeurs : La France a-t-elle perdu sa souveraineté budgétaire ? http://www.lemonde.fr/economie/article/2014/10/27/budget-rome-propose-plus-d- efforts-sur-le-deficit_4512851_3234.html

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Europe’s Banking Union starts on an encouraging note - the results of the ECB's “comprehensive assessment” of the euro area’s 130 largest banks, including an Asset Quality Review (AQR) and stress tests, announced by Nicolas Véron on 27th October 2014 Sunday, October 26 was D-Day for Europe’s banks: at noon in Frankfurt, the European Central Bank (ECB) announced the results of its “comprehensive assessment” of the euro area’s 130 largest banks, including an Asset Quality Review (AQR) and stress tests. Simultaneously in London, the European Banking Authority (EBA) announced the results of these stress tests for a larger sample of banks, including the largest banks headquartered in the EU but outside the euro area. Tweet This The comprehensive assessment is intended to draw a line over years of unsatisfactory oversight by national watchdogs, and allow the ECB to start from a high level of trust

More on banking union//Europe's half a banking union / A realistic bridge towards European /banking union/ The European Central Bank in the age of banking union/ Supervisory transparency in the European banking union/ The neglected side of banking union: reshaping Europe’s financial system/ The fiscal implications of a banking union

This was meant as a cathartic watershed that would allow the ECB to take over its new role as the licensing authority of all the euro area’s banks and direct supervisor of the largest ones, a transfer of authority from national supervisors that will occur on Tuesday next week, November 4. The comprehensive assessment is intended to draw a line under years of unsatisfactory oversight by national watchdogs, and allow the ECB to start from a high level of trust.

On the face of it, these objectives appear to have been met, even though a definitive assessment will only be possible several months from now. The ECB identified 25 banks as having been undercapitalised as of end-2013; of these, 12 have raised enough capital this year to be technically compliant with capital requirements, but the other 13 need to submit recapitalization plans to the ECB within two weeks. Four of these are in Italy: Monte dei Paschi di Siena (MPS), which may have to lose its independence, Carige in Genoa, Banca Popolare di Milano, and Banca Popolare di Vicenza: this puts a cloud above the Bank of Italy’s reputation as a supervisor, especially as several other Italian banks also appear fragile. Farther west in Lisbon, Banco Comercial Portugues (BCP) is among the other institutions asked to strengthen their balance sheet, or else. In total, the assessment identified slightly more “problem banks” than expected, but did not uncover problems so massive that they may trigger systemic instability. 231

Perhaps more importantly, the ECB (and EBA) flooded the market under a deluge of data, the full analysis of which will take several more days. One not-so-hidden nugget of information is how the banks would have fared if a more rigorous yardstick of capital, known as fully-loaded Basel III, had been used instead of the current “phased- in” measure which it will replace in the EU in a few years. In that case, a few significant German banks would have failed the test as well. They include HSH Nordbank, a Northern German Landesbank that provides wholesale services to local savings banks (Sparkassen), in spite of the guarantees it has received for up to EUR10bn from the local governments that are also its main shareholders. This group also includes DZ Bank and WGZ Bank, the two wholesale institutions that serve Germany’s system of local cooperative banks (Volksbanken and Raiffeisenbanken) – possibly the biggest surprise of today’s entire disclosure package. The fact that Germany and Italy, two of the euro area’s biggest countries, are not immune to the ECB’s inquisitiveness suggests that the assessment has been kept reasonably independent from political pressure. In the two other largest countries, France and Spain, most banks have passed the test successfully.

Tweet This Investors and the public will need to be persuaded that there are no more skeletons hiding in the banks’ cupboards

Crucially, this exercise must be seen as the beginning of a sequence of policy actions by the ECB – even as, to the thousands of professionals who participated in the process, it may feel like the endpoint of a long hard slog. To start with, investors and the public will need to be persuaded that there are no more skeletons hiding in the banks’ cupboards. This is likely to take a few months: the credibility of the EBA-led stress tests whose results were announced in mid-July 2011 was later ruined by the problems of Dexia in October 2011, then of Bankia in May 2012. Moreover, some of the AQR’s consequences will only be felt in the banks’ financial statements as of end-2014: for example, more of the EUR136bn of additional non-performing loan exposures identified in the AQR may be written down at that time. Overall, the definitive assessment on the robustness and credibility of the comprehensive assessment, and specifically of the AQR, will probably have to wait until the first quarter of 2015.

Furthermore, the ECB has a lot of follow-up work on its plate, on a number of issues it has signalled it will address gradually after its assumption of direct supervisory authority on November 4. It should gradually tighten the definition of capital to make it fully compliant with the Basel III framework, including on the contentious question of insurance subsidiaries of diversified banking groups (a point on which even today’s “fully-loaded” disclosures are based on a laxer standard than the international accord, and which is particularly sensitive for several large French banks). It should put an end to the widespread practices of geographical ring-fencing of capital and liquidity by national supervisors within the banking union area, an aim that may eventually require legislative changes in Germany and elsewhere. It should vigorously encourage those banks which keep a high home-country bias in their sovereign debt portfolios to reduce it, something that ECB top supervisor Danièle Nouy has already announced. It should encourage cross-border bank acquisitions, and investment in banks by international 232

private equity funds, to decrease the sector’s current fragmentation along national lines. Finally, it should gradually bring smaller (mostly German, Austrian and Italian) into its supervisory fold, as Ms Nouy’s deputy Sabine Lautenschläger has indicated.

Tweet This Overall, this debut of Europe’s banking union comes five years too late, but better late than never

The full economic impact of the comprehensive assessment will depend on these developments still to come. If all goes according to plan, it may unlock some of Europe’s repressed growth, by allowing most banks to lend more freely now that their creditworthiness has been duly checked – even though this will not resolve a number of other problems in Europe’s anaemic economy that contribute to depressed credit demand. Overall, this debut of Europe’s banking union comes five years too late, but better late than never. It is an encouraging start for the most transformative policy initiative that has emerged from Europe’s crisis so far. http://www.bruegel.org/nc/blog/detail/article/1466-europes-banking-union-starts-on-an- encouraging- note/?utm_source=Bruegel+economic+blogs+review&utm_campaign=f23752771e- Bruegel+BEBR&utm_medium=email&utm_term=0_14a9e32a9c-f23752771e- 277483461 mainly macro Comment on macroeconomic issues

Sunday, 26 October 2014 Why the Eurozone suffers from a Germany problem 26 Simon Wren-Lewis When, almost a year ago, Paul Krugman wrote six posts within three days laying into the stance of Germany on the Eurozone’s macroeconomic problems, even I thought that maybe this was a bit too strong, although there was nothing in what he wrote that I disagreed with. Yet as Germany’s stance proved unyielding in the face of the Eurozone’s continued woes, I found myself a couple of months ago doing much the same thing (1, 2, 3, 4, 5, 6), although at a slightly more leisurely pace. Now it seems the whole world (apart from Germany, or course) is at it: here is a particularly clear example from Matt O’Brien. I’m not going to review the macroeconomics here. I’m going to take it as read that

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< !--[if !supportLists]-->1) ECB monetary policy has been far too timid since the Great Recession began, in part because of the influence of its German members.

< !--[if !supportLists]-->2) This combined with austerity led to the second Eurozone recession, and austerity continues to be a drag on demand. The leading proponent of that austerity is Germany. < !--[if !supportLineBreakNewLine]--> < !--[endif]--> < !--[if !supportLists]-->3) Pretty well everyone outside Germany agrees that a Eurozone fiscal stimulus in the form of additional public investment, together with Quantitative Easing (QE) in the form of government debt purchases by the ECB, are required to help quickly end this second recession (see, for example, Guntram Wolff), and the main obstacle to both is the German government.

The question I want to raise is why Germany appears so successful in blocking or delaying these measures. At first the answer seems obvious: Germany is the dominant economy in the Eurozone. However that is too easy an explanation: while Germany’s GDP is less than a third of the Eurozone total, the combination of French, Italian and Spanish GDP is nearly one half. Now it could be that in the past France, Italy and Spain have failed to coordinate sufficiently to oppose Germany, in part because France has placed a high value on the French-German bilateral relationship. But that seems less of a problem today. The puzzle remains if we just view these debates as being about national interest, rather than a battle over ideas. Germany is virtually unique in the Eurozone in not currently having a large negative output gap, and having low unemployment. So, you could argue, it is not in Germany’s national interest to allow Eurozone demand to expand, and inflation to rise. But Germany achieved this position because it undercut its Eurozone partners by keeping wages low before 2007. If political discourse was governed by basic macroeconomics, you would expect every other country to be very annoyed that this had happened, and be demanding that Germany put things right by restoring a sustainable relative competitive position through additional inflation. These last two sentences contain a clue to resolving this puzzle. While nearly everyone recognises the internal competitiveness problem within the Eurozone, hardly anyone describes this as a problem caused by German policy. Instead, as Edward Hugh suggests for example, they believe “Germany’s unit labour costs are low not because Germans aren’t paid much, but because they are very productive, and at the end of the day, despite all the bleating about the current account this is the model other members of the Euro Area (including France) not only need to but are compelled to follow: high pay and high productivity”. I suspect many would agree with that sentiment. Unfortunately it misses the point. International differences in productivity occur for a variety of reasons, and they are slow to change. The Eurozone’s current problem arises because one country - Germany - allowed nominal wage growth well below the Eurozone average, which undercut everyone else. (This postshows how real wage

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growth in Germany was below productivity growth in every year between 2000 and 2007.) Within a currency union, this is a beggar my neighbour policy. In other words, as Simon Tilford suggests, Germany is viewed by many in the Eurozone as a model to follow, rather than as a source for their current problems. (He also plausibly suggests that Germany’s influence immediately after 2010 reflected its creditor position, but he argues that the importance of this factor should now be declining.) Of course in general terms Germany may well have many features which other countries might well want to emulate, like high levels of productivity, but the reason why it’s national interest is not currently aligned with other union members is because its inflation rate was too low from 2000 to 2007. That in itself was not a virtue (whatever the rights or wrongs of why it came about), and so if they had any sense other union members should be complaining bitterly about the German position. I think the current Eurozone problem makes much more sense if we focus less on divergent national interests, and more on different macroeconomic points of view. The German perspective which sees the Eurozone problem in terms of profligate governments and lack of ‘structural reforms’ outside Germany is utterly inappropriate in understanding the Eurozone’s current position. Yet it is a point of view that too many outside Germany also share. This is beginning to change. As this Reuters reportmakes clear, relations between Draghi and the Bundesbank have steadily deteriorated, as Draghi begins to understand the macroeconomic reality. (While I still have problems with the ECB’s current position, set out clearly in this speech by Benoît Cœuré, it makes much more sense than anything coming from the Bundesbank or German government.) Yet, as Simon Tilford notes, it is still not clear whether this will end in a significant departure from current policies, or just more of the minor adjustments we have seen so far. It may well come down to the position taken by countries like the Netherlands. They have sufferedas much as France in following the Eurozone’s fiscal rules to implement damaging fiscal contraction. As Giulio Mazzolini and Ashoka Mody note, “For the Netherlands …. less austerity would have been unambiguously better.” Yet until now, politiciansin the Netherlands (and the central bank) appear to have taken the German line that this medicine is for their own good. If they can eat a bit of humble pie and support a kind of ‘grand bargain’ that would see fiscal expansion rather than contraction in the Eurozone as a whole, and a comprehensive QE programme by the ECB, then maybe some real progress can be made. Ultimately this is not the Eurozone’s Germany problem, but a problem created by the macroeconomic vision that German policymakers espouse. http://mainlymacro.blogspot.com.es/2014/10/why-eurozone-suffers-from-germany.html

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VOX, CEPR’s Policy Portal

Research-based policy analysis and commentary from leading economists A 100-year perspective on sovereign debt composition in 13 advanced economies S. M. Ali Abbas, Laura Blattner, Mark De Broeck, Asmaa El-Ganainy, Malin Hu27 October 2014 There has been renewed interest in sovereign debt since the Global Crisis, but relatively little attention has been paid to its composition. Sovereign debt can differ in terms of the currency it is denominated in, its maturity, its marketability, and who holds it – and these characteristics matter for debt sustainability. This column presents evidence from a new dataset on the composition of sovereign debt over the past century in 13 advanced economies. Related// Sovereign-debt relief and its aftermath: The 1930s, the 1990s, the future? Carmen M Reinhart, Christoph Trebesch/ Private and public debt in crises: 1870 to now Òscar Jordà, Moritz Schularick, Alan Taylor// Restructuring sovereign debt, 1950– 2010: From process to outcomes Udaibir S Das, Michael G. Papaioannou, Christoph Trebesch Why sovereign debt composition matters Academic, policy, and market interest in sovereign debt has spiked since the 2008 Global Crisis. Researchers have sought to place the post-Crisis synchronised build-up in sovereign debt ratios in advanced economies within a longer-term/historical context, drawing comparisons with debt surges during the Great Depression, debt consolidations in the aftermath of World War II, and more.1 However, this literature has largely abstracted from a discussion of sovereign debt ‘composition’, which, both theory and experience tell us, is central to questions of debt sustainability/management, optimal taxation, monetary policy, and even financial regulation.2 For instance, an inability to issue term debt in local currency is often described as ‘original sin’ (Eichengreen and Hausmann 2002, Eichengreen et al. 2003), which drives the high cost/riskiness of (higher yields on) emerging-market sovereign debt. Arslanalp and Tsuda (2012) have linked the holder profile of sovereign debt to countries’ ability to weather financial market stress. Reinhart and Sbrancia (2011) highlight the amenability of non-marketable debt to ‘liquidation’ during periods of financial repression. The recent wave of European sovereign debt crises has underscored the importance of debt maturity – countries with longer debt duration registered lower sovereign risk premia than others, despite higher debt and deficit levels (Abbas et al. 2014a). The biggest obstacle to a proper historical treatment of sovereign debt composition, in our view, has been a lack of data. Debt structure data are simply not available in an easily accessible format across countries over long stretches of time. Our recent paper (Abbas et al. 2014c) seeks to address this data gap. Using official sources for individual 236

countries – as well as some published cross-country datasets – we assemble a debt structure database spanning the period 1900–2011 and 13 advanced economies: Australia, Austria, Belgium, Canada, France, Germany, Ireland, Italy, the Netherlands, Spain, Sweden, the UK, and the US. The dataset slices the sovereign debt pie along four dimensions: currency (foreign vs. local); maturity (local currency debt subdivided into short-term and medium-to-long- term); marketability; and holders (non-residents, national central bank, domestic commercial banks, and the rest). Because this is a first effort, we still report a number of gaps in our data, which reflect, in most cases, the lack of coverage on certain categories of debt (such as debt held by non-residents) or during certain stress periods (such as around the World Wars). Notwithstanding the gaps, the dataset offers insights into the evolution of debt structure over the past 11 decades, including around major sovereign stress events. What the historical debt structure data reveal A bird’s eye view of key debt composition ratios over time offers some intuitive patterns. Around 90% of advanced economies’ debt is and was denominated in local currency. Still, six of the 13 countries saw the foreign currency debt share rise above 50% at some point – post-WWI France and Italy are notable cases in point. The share of local currency medium-to-long-term debt in total debt has averaged 68% over the sample (or three-fourths of local currency debt) and exhibits an intuitive pattern – governments issued longer-dated paper in good times and compensated for the higher riskiness of their debts during bad times by shortening issuance maturities. Cross- country variation in the maturity structure of debt mirrors differences in, inter alia, a country’s vulnerability to fiscal/military crises, reserve currency status, and debt management preferences. Before WWI, almost all central government debt was issued in the form of marketable securities. The share of such securities declined during post-WWI consolidations, before falling precipitously (to as low as around 55%) during and after WWII – an era characterised by financial repression and captive financial markets. The share recovered starting in the mid-1970s and now stands at about 80%. The holder profile data reveals an average share in debt for national central banks of about 10%,3 and almost double that for domestic commercial banks. Moreover, the two shares appear to be substitutes for much of the 1920–1970 period – central banks were clearly picking up the tab from commercial banks (and other holders) around/after WWII. Both shares fell in tandem after the 1970s, as just non-resident participation in sovereign debt markets soared. The non-residents’ share of debt increased from 5% to 35% over 1970–2011, and reflected a number of underlying factors: financial innovation and globalisation; stronger sovereign debt management; independent central banks committed to low inflation; the introduction of the euro, which led to the de facto elimination of currency risk within the Eurozone; and the accumulation of ‘safe’ foreign sovereign securities by emerging Asian economies, especially China. Figure 1. Central government debt composition by instrument and currency

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Figure 2. Holder composition of central government debt

Source: Authors’ calculations. We also provide a more ground-level view of how debt composition of individual sovereigns responded to major episodes of debt accumulation and consolidations during 1900–2011. We recover some broad common patterns. Large debt accumulations – essentially, large increases in debt supply – were typically absorbed by increases in short-term, foreign currency-denominated and banking- system-held debt (Table 1 provides an illustration from WWI). Table 1. World War I: Maturity and currency (% of GDP for debt/GDP; otherwise, % of central government debt)

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This pattern, however, did not hold during the debt build-ups starting in the 1980s and 1990s, which were compositionally skewed toward long-term local-currency marketable debt (see Table 2 below). We attribute this change to similar factors to those that drove higher non-resident demand for sovereign paper. These include the emergence of a large (global) contractual savings sector with long investment horizons, and independent central banks committed to low inflation, thus providing confidence that governments would not inflate away the burden of long-term nominal debt obligations. Table 2. The Great Accumulation: Maturity, holders, and marketability (% of GDP for debt/GDP; otherwise, % of central government debt)

On debt consolidations, we find support for the financial repression-cum-inflation channel during the post-WWII episodes, but are also able to show that this channel did not operate with the same intensity everywhere. Table 3 shows two country groups, categorised according to whether debt maturities lengthened or shortened during the consolidations (debt maturity is used here as a proxy for voluntary investor demand). In the first group, where maturities shortened, resort to central bank financing and inflation was higher, and the debt ratio fell by an average of 152% of GDP. In the second group, where maturities lengthened, the debt reduction was only slightly more modest (145% of GDP), but inflation and central bank financing involvement were much more modest.

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Table 3. Post-World War II consolidation: Maturity, holders, and marketability (% of GDP for debt/GDP; otherwise, % of central government debt)

What it means for debt reduction ahead The foregoing suggests that governments have pursued two broad types of debt reduction strategies in the past: a traditional approach committed to preserving long debt durations, accompanied by fiscal consolidation and, in some cases, moderate inflation (although moderate in earlier decades would be considered high today); and an unconventional strategy that involved reliance on debt holdings (often non-marketable) by fully- or semi-captive domestic investors, accompanied by very high inflation, and at the cost of shortening debt maturities. Given the current environment of low growth and politically challenging fiscal adjustments, it bears asking if the unconventional strategy is feasible. Table 4. Sovereign debt composition, past and present (% of GDP for debt/GDP; otherwise, % of central government debt)

In our own view (not to be mistaken with the view of the IMF), the pre-requisites for pursuing such a strategy – e.g. absence of capital controls, lack of competing investment opportunities – are not met. With 36% of the advanced economy debt now held by non- residents (compared with 3% at end-WWII), and only 21% held by the domestic banking system (compared with 46% at end-WWII), sustaining involuntary demand for sovereign debt offering sub-market returns will be difficult (Table 4). Similarly, recourse to surprise inflation (with or without financial repression) above conservative central bank inflation targets to dent the value of already-issued medium- to-long-term securities will likely present challenges: (i) the current ‘lowflation’ 240

environment in many advanced economies renders engineering significant inflation surprises challenging; (ii) the globally-accepted regime of price stability (as the anchor for monetary policy) does not quite allow for surprise inflation; (iii) the latter could entail significant economic costs, as governments would either have to accept permanently higher inflation with direct costs to efficiency and investment, or, if they wished to return to low inflation, accept the inevitably painful disinflation process (e.g. Fischer 1994, Bordo and Orphanides 2013); and (iv) higher inflation would likely entail a permanent hidden ‘cost’ in terms of departure from a less risky (long-duration) debt structure, or a lower level of sustainable debt (Aguiar et al. 2014). What it means for further analytical work on sovereign debt Further work is needed to develop models that can deal with the observed ‘shifts’ in sovereign debt management objectives over time that our debt composition data capture. For instance, until WWI, sovereign debt management was geared to debt issuance for specific and temporary purposes, such as to finance a war. After WWII, the focus shifted to reducing the debt-to-GDP ratio, including through financial repression and inflation policies. And in recent decades, debt management objectives have been largely cast in terms of minimising expected debt servicing costs, subject to an acceptable level of refinancing risk, which translated into a shift towards longer-term debt denominated in local currency held by a diversified investor base. More work is also needed on how and whether debt structure can help predict crises. An initial analysis based on the paper’s data suggests that changes in the debt composition typically considered to increase exposure to crisis risk, such as maturity shortening, indeed could have these consequences. Similarly, governments’ willingness to default (outright) on their debt may be different if much of the debt were held by non-residents as opposed to domestic investors (especially banks). Disclaimer: The views expressed herein are those of the authors and should not be attributed to the IMF, its Executive Board, or its management. References Abbas, S M A, N Belhocine, A El-Ganainy, and M Horton (2011), “Historical Patterns and Dynamics of Public Debt – Evidence From a New Database”, IMF Economic Review 59(4): 717–742. Abbas, S M A, N Arnold, M De Broeck, L Forni, and M Guerguil (2014a), “The Other Crisis: Sovereign Distress in the Euro Area”, in C Cottarelli, P Gerson, and A Senhadji (eds.), Post-Crisis Fiscal Policy, Cambridge, MA: MIT Press: 193–226. Abbas, S M A, N Belhocine, A El-Ganainy, and A Weber (2014b), “Current Crisis in Historical Perspective”, in C Cottarelli, P Gerson, and A Senhadji (eds.), Post-Crisis Fiscal Policy, Cambridge, MA: MIT Press: 161–191. Abbas, S M A, L Blattner, M De Broeck, A El-Ganainy, and M Hu (2014c), “Sovereign Debt Composition in Advanced Economies: A Historical Perspective”, IMF Working Paper 14/162. Arslanalp, S and T Tsuda (2012), “Tracking Global Demand for Advanced Economy Sovereign Debt”, IMF Working Paper 12/284.

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Aguiar, M, M Amador, E Farhi, and G Gopinath (2014), “Sovereign Debt Booms in Monetary Unions”, American Economic Review, forthcoming. Bordo, M and A Orphanides (eds.) (2013), The Great Inflation: The Rebirth of Modern Central Banking, Chicago: University of Chicago Press. Eichengreen, B, R Hausmann, and U Panizza (2003), “Currency Mismatches, Debt Intolerance and Original Sin: Why They Are Not the Same and Why it Matters”, NBER Working Paper 10036. Eichengreen, B and R Hausmann (eds.) (2002), Debt Denomination and Financial Instability in Emerging Market Economies, Chicago: University of Chicago Press. Fischer, S (1994), “The costs and benefits of disinflation”, in J O de Beaufort Wijnholds, S Eijffinger, and L Hoogduin (eds.), A Framework for Monetary Stability, Dordrecht: Kluwer Academic Publishers. Reinhart, C and K Rogoff (2009), This Time is Different: Eight Centuries of Financial Folly, Princeton: Princeton University Press. Reinhart, C and K Rogoff (2013), “Financial and Sovereign Debt Crises”, IMF Working Paper 13/266. Reinhart, C and B Sbrancia (2011), “The Liquidation of Government Debt”, NBER Working Paper 16893. Sbrancia, B (2011), “Debt and Inflation during a Period of Financial Repression”, Job Market Paper, Department of Economics, University of Maryland College Park. Footnotes 1. See, for example, Reinhart and Rogoff (2009, 2013), Sbrancia (2011), Reinhart and Sbrancia (2011), Abbas et al. (2011), and Abbas et al. (2014b). 2. Notable exceptions are Sbrancia (2011) and Reinhart and Sbrancia (2011), who look at debt maturity and marketability structure for 12 economies (a mix of emerging and advanced) over 1948–1980. However, this dataset is not yet public. 3. As a share of GDP, central bank holdings averaged about 5%, with a peak of 19% during WWII and a recent post-Crisis uptick reflecting large-scale asset purchase programs (as in the UK and the US). http://www.voxeu.org/article/advanced-economies-sovereign-debt-100-years-data

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ft. com World Europe Brussels October 26, 2014 7:35 pm Brussels seeks compromise in budget row Peter Spiegel in Brussels and James Politi in Rome/ ©Reuters When the European Commission sent formal letters to Rome and Paris last week informing them their 2015 budget plans risked violating the EU’s fiscal rules, officials in Brussels privately communicated a more subtle message: give us something to work with. “For us to help them, they have to help themselves,” said one commission official briefed on the discussions, which included informal talks between José Manuel Barroso, the outgoing commission president, and the French and Italian leaders at last week’s EU summit. More On this topic// Berlin and Paris paper over budget cracks/ Gideon Rachman Threats to EU/ UK ‘lighting a fire under EU’, says minister/ Merkel and Renzi clash on growth

IN Brussels// EU energy deal to hurt Putin, says Davey/ Q&A Why is Brussels demanding back-payment?/ EU agrees target to cut gas emissions/ Row between Rome and Brussels heats up

Thus far, Italy has sent strong signals it is willing to deal. According to Italian finance ministry officials, Rome is preparing to resubmit its budget plan on Monday with further cuts to its structural deficit – its budget shortfall when changes in the economic cycle are stripped out – that it believes will allow Brussels to give them a pass. France, however, has given no such signal, raising concerns in Brussels that Paris is ready for a showdown. Commission leaders must decide by Wednesday whether both budgets are in “particularly serious non-compliance” with EU rules, a judgment that would force them to make the politically explosive move of returning them to their national capitals for a rework. At last week’s EU summit, Matteo Renzi, the Italian prime minister, argued that the adjustments the commission were seeking were achievable with little pain. “I don’t think there are any big problems,” Mr Renzi insisted. “We’re talking about €1bn or €2bn.” Italian officials said their new cuts are unlikely to get Rome all the way to the target Brussels had required: shrinking the structural deficit by 0.7 percentage points. But the improvement is likely to be about 0.3 points, which is better than the 0.1 points in the budget Italy originally submitted to the EU on October 15. “We’re confident that the commission will appreciate the three pillars of our economic policy: we keep our finances under control and we cut our deficit; we finance structural reform; and we give a boost to the economy through tax cuts,” an Italian official said. Italy has already set aside €3.4bn for further deficit reduction, so would not have to make new savings or renege on some of its tax cuts in the new budget. 243

François Hollande, the French president, has been far less accommodating, thus far. In public, Mr Hollande has struck a defiant tone even after talks with Mr Barroso at last week’s summit and EU officials said there has been no indication in private that Paris is willing to move. France presents a more difficult call for the outgoing commission. Unlike Italy, whose budget deficit is below 3 per cent of economic output, France has been violating that threshold for six years and is now openly flouting a promise to hit the target by next year. “The details to be provided will enable the commission to understand that we’re asking for as much flexibility as possible to protect growth and employment,” Mr Hollande said when asked on Friday about how his government will respond to the Brussels letter. “We’ve presented a €21bn cut in expenditure. This is historic.” In order to get more time to hit the 3 per cent target, France must show it is implementing significant economic reforms. But, like Rome, Paris has also flouted its structural deficit target – it was supposed to cut it by 0.8 percentage points, but is only promising a 0.2 point improvement – making it difficult to prove it is doing enough for a waiver. According to EU officials, Brussels has signalled to Mr Hollande that, if he could meet them halfway or make additional cuts that would get the figure to 0.5 percentage points, they would be willing to give Paris its second extension in as many years. “Incremental tightening by France and Italy will solve the political confrontation between Brussels, Paris and Rome, allowing the commission to endorse both countries’ budget plans for next year,” said Mujtaba Rahman, head of European analysis at the Eurasia Group risk consultancy. Both countries will still have one final hurdle to clear: the Wednesday deadline is for Brussels to determine whether egregious violations exist. A full evaluation is not due until the end of November, when Jean-Claude Juncker, the incoming commission president, will be in charge. If Mr Juncker gives both a full pass, he may face ire from a different direction: Angela Merkel, the German chancellor, who has been urging the commission to enforce the rules to the letter. “This will smell like fudge to German noses, reinforcing Berlin’s view that the commission is too soft, political and ultimately incapable of credibly enforcing rules,” said Mr Rahman. http://www.ft.com/intl/cms/s/0/5254565e-5d20-11e4-9753- 00144feabdc0.html#axzz3HMcg3THv

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VOX, CEPR’s Policy Portal Research-based policy analysis and commentary from leading economists What drives micro and macro volatility? Cosmin L. Ilut , Matthias Kehrig, Martin Schneider26 October 2014 Heightened economic uncertainty has attracted much recent attention. Policymakers repeatedly emphasise uncertainty as a key factor driving the last two recessions – in particular the depth and length of the Great Recession. This column proposes asymmetric hiring rules as a mechanism that generates endogenous and joint movements in macro and micro volatility of employment growth. Related/ Recoveries: The missing third phase of the business cycle Antonio Fatás, Ilian Mihov// Moving towards a single contract? Pros, cons and mixed feelings Nicolas Lepage-Saucier, Juliette Schleich, Étienne Wasmer If and how increased uncertainty may trigger recessions 1, lower the effectiveness of fiscal and monetary policy, and stifle subsequent recoveries is the main object of a new ‘uncertainty literature’ surveyed in Bloom (2014). The authors typically point to time- varying volatility of both aggregate employment growth – ‘macro volatility’ – and cross-sectional employment growth dispersion, analogously labeled ‘micro volatility’. ‘Micro volatility’ and ‘macro volatility’: The basic facts Figure 1 illustrates the time-varying volatility of aggregate employment growth (“macro volatility”) and cross-sectional employment growth dispersion (“micro volatility”). Macro volatility refers to the fact that aggregate employment fluctuates twice as much in contractionary episodes than in expansionary ones – so employment growth is more “jumpy” in recessions. In addition, manufacturing employment rises on average by a mere 2.1% relative to trend in expansions, but contracts by 3.3% relative to trend in downturns. In contrast, micro volatility refers to the fact that employment growth of individual firms differs more in recessions than in booms, so recessions are more disparate across firms. The firm at the top quartile grows employment by 15.7% more than the firm at the bottom quartile in expansions, but in recessions this difference increases to 20%. Although micro and macro volatility per se reflect two separate phenomena – one describing the differences across firms in a given year, the other describing changes in the aggregate over time – their business cycle properties look strikingly similar. This correlation between micro and macro volatility has been documented in the recent literature,2 but its causes have been little discussed. Existing studies often focus on either the macro or micro level volatility in isolation, and explore the effects of exogenous micro or macro volatility shocks. Deep recessions and meek booms are often interpreted as a result of time-varying volatility of aggregate shocks (see Justiniano and Primiceri 2008, Basu and Bundick 2011, Fernández-Villaverde et al. 2011, and Gourio 2012). Likewise, countercyclical dispersion across firms has been interpreted as a result of a wider distribution of technology shocks to individual firms (see Arellano et al. 2010, Bloom et al. 2012, Schaal 2012, Berger and Vavra 2014, Christiano et al. 2014, and Vavra 2014). 245

We expand these literatures in two ways. • First, we propose a mechanism that gives a unified explanation of both micro and macro volatility. • Second, time-varying volatilities emerge endogenously. Although this does not rule out the presence of exogenous aggregate and cross-sectional uncertainty shocks, it offers a complementary explanation for changing micro and macro volatility. Figure 1 Macro and micro volatility in US manufacturing employment

All figures are taken from Ilut et al. (2014); for detailed description of construction of data and time series, please see the paper. Asymmetric hiring: Firms are slow to hire, but quick to fire In this column, we consider asymmetric behavior by firms as a candidate to explain micro and macro volatility. Many model environments such as a search and matching frictions, hiring adjustment costs, or information processing of ambiguous signals will result in asymmetric firm hiring policy.3 To see how the mechanism works, suppose that a firm’s hiring/firing response to news about profitability is concave: there is less hiring after good news than there is firing after bad news. Suppose further that aggregate shocks shift the mean of all firms’ signals about future profitability: for example, a spell of bad aggregate shocks generates signals that are on average worse. With concave decision rules, the typical firm’s

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response to its signal during this spell of bad aggregate shocks is then stronger than during a spell of good aggregate shocks. It follows that both macro and micro volatility of employment growth are countercyclical. Indeed, firms’ stronger responses to bad signals generate not only stronger average responses – that is, sharper movements in aggregate employment growth – but also stronger responses to idiosyncratic components in signals and hence higher cross sectional volatility. Importantly, changes in volatility here derive only from firms’ endogenous nonlinear responses to mean shifts, not from exogenous changes in volatility. Figure 2 illustrates the qualitative workings of the mechanism: firms are faced with symmetric and homoskedastic signals about productivity (bottom right panel) that are transmitted by a concave hiring rule (top right panel) to employment growth (top left panel). Bad aggregate (red) will now transmit into a more dispersed cross-sectional employment growth distribution, while good aggregate shocks (blue) into a more compressed distribution. Similarly, aggregate employment contractions in bad times will be lower on average than aggregate employment expansions as seen from the differences between the means in the top left graph. Figure 2 How asymmetric hiring leads to micro and macro volatility

Empirical evidence for asymmetric hiring As we just mentioned, asymmetric hiring will lead to countercyclical aggregate volatility in employment growth (macro volatility) and countercyclical employment growth dispersion (micro volatility). Both features are borne out in the data as demonstrated in Figure 1. An additional contribution of this mechanism is that it

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explains micro and macro volatility simultaneously and without assuming exogenous time variation in either common or firm-specific technology shocks. Our proposed mechanism makes sharp additional predictions that we can test in the data. Most notably, employment growth should be negatively skewed across firms in a given year, and aggregate employment growth should be negatively skewed as well. This means that contractions are on average sharper and deeper than booms, which are slow and meek. Furthermore, one should observe negative time series skewness in employment growth of an individual firm over time. We find evidence for all three of these: Figure 3 shows that the distribution of employment growth across firms is more spread-out at the left tail (skewness = -0.5). That means that the typical shrinking firm contracts by 2.2% while the typical growing firm increases employment by only 1.5%. Similarly, the aggregate time-series skewness is -1 and the time series skewness of firm-level employment growth is -0.4. Figure 3 Employment growth is negatively skewed

Asymmetric hiring or asymmetric shocks? The previous analysis begs the question whether firms are asymmetrically responding to symmetric profitability signals as we propose or whether firms face asymmetric shocks and are just responding to good and bad shocks in a similar way. We use establishment- level Census data to construct profitability shocks and non-parametrically estimate the firm hiring rule. Both the distribution of profitability shocks and the non-parametric hiring rule are plotted in Figure 4. Figure 4 Employment growth and productivity shocks 248

As one can see, the distribution of technology shocks is symmetric (skewness = +0.04) while employment growth (right blue scale) is asymmetric: a typical innovation to productivity (+18% output produced with the same inputs) leads to 0.7% hiring while the same negative innovation leads to 1.8% firing. The estimated hiring rule suggests that concavity in firm responses is large enough to account for a significant negative skewness in employment growth and sizable movements in employment dispersion. Table 1 compares the same moments about the employment growth distribution from the data and a simulation obtained from feeding technology shocks to the estimated hiring rule. Table 1 Asymmetric hiring is quantitatively significant

To conclude, our theoretical and empirical results suggest that one mechanism – an asymmetric hiring response of firms to dispersed signals – has the quantitative potential

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to jointly explain a range of cross-sectional and time-series properties of employment growth. Making progress on understanding the underlying causes of the movements in these distributions can be fruitful for setting more informed policy responses. References Arellano, C, Y Bai, and P J Kehoe (2010) “Financial markets and fluctuations in uncertainty”, Federal Reserve Bank of Minneapolis Staff Report. Bachmann, R, and G Moscarini, (2011) “Business cycles and endogenous uncertainty”, Working Paper. Basu, S, and B Bundick (2011) “Uncertainty shocks in a model of effective demand”, Working Paper. Berger, D W, and J Vavra (2014) “Consumption dynamics during recessions”, Working Paper. Bloom, N (2014) “Fluctuations in uncertainty”, Journal of Economic Perspectives, 28(2):153–175, 2014. Bloom, N, M Floetotto, N Jaimovich, I Saporta-Eksten, and S Terry (2012) “Really uncertain business cycles”, NBER Working Paper No. 18245. Carvalho, V M, and X Gabaix (2013) “The great diversification and its undoing”, American Economic Review, 103(5):1697–1727. Christiano, L J, R Motto, and M Rostagno (2014) “Risk shocks”, American Economic Review, 104(1):27–65. Decker, R, P N D’Erasmo, and H M Boedo (2014) “Market exposure and endogenous firm volatility over the business cycle”, Working Paper. Fernández-Villaverde, J, P Guerrón-Quintana, J F Rubio-Ramírez, and M Uribe (2011) “Risk matters: The real effects of volatility shocks”, American Economic Review, 101(6):2530–2561, October 2011. Ferraro, D, (2013) “The asymmetric cyclical behavior of the U.S. labor market”, Working Paper. Gourio, F (2012) “Disaster risk and business cycles”, American Economic Review, 102(6):2734–2766. Ilut, C, M Kehrig, and M Schneider (2014) “Slow to hire, quick to fire: Employment dynamics with asymmetric responses to news”, NBER Working Paper No. 20473. Kehrig, M, (2013) “The cyclicality of productivity dispersion”, Working Paper. McKay, A, and R Reis (2008) “The brevity and violence of contractions and expansions”, Journal of Monetary Economics, 55(4):738–751. Schaal, E, (2012) “Uncertainty, productivity and unemployment during the great recession”, Working Paper. Vavra, J, (2014) “Inflation dynamics and time-varying uncertainty: New evidence and an interpretation”, Quarterly Journal of Economics, 129(1).

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Endnotes 1 For example, the Federal Open Market Committee states in April 2008: “Several [survey] participants reported that uncertainty about the economic outlook was leading firms to defer spending projects until prospects for economic activity became clearer.” In 2009, Chief Economist of the International Monetary Fund (IMF) Olivier Blanchard wrote in The Economist: “Uncertainty is largely behind the dramatic collapse in demand”, while the Chair of the Council of Economic Advisers, Christina Romer, noted in her 2009 testimony to the US Congress Joint Economic Committee: “Uncertainty has almost surely contributed to a decline in spending.” 2 See the survey by Bloom (2014). 3 Indeed, physical adjustment costs to labour are not necessary for asymmetric adjustment. If firm decision makers are averse to Knightian uncertainty (ambiguity) and are uncertain about the quality of signals, then it is also optimal to respond more to bad news. Intuitively, ambiguity-averse firms evaluate hiring decisions as if taking a worst case assessment of future profits. With ambiguity about signal quality, the worst case then depends on what the signal says: for a good signal, the worst case interpretation is that it is noisy, whereas for a bad signal the worst case is that it is very precise. Updating from ambiguous signals thus endogenously generates asymmetric actions. http://www.voxeu.org/article/what-drives-micro-and-macro-volatility

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The Opinion Pages| Op-Ed Columnist |NYT Now Ideology and Investment

OCT. 26, 2014

Paul Krugman

America used to be a country that built for the future. Sometimes the government built directly: Public projects, from the Erie Canal to the Interstate Highway System, provided the backbone for economic growth. Sometimes it provided incentives to the private sector, like land grants to spur railroad construction. Either way, there was broad support for spending that would make us richer. But nowadays we simply won’t invest, even when the need is obvious and the timing couldn’t be better. And don’t tell me that the problem is “political dysfunction” or some other weasel phrase that diffuses the blame. Our inability to invest doesn’t reflect something wrong with “Washington”; it reflects the destructive ideology that has taken over the Republican Party. Some background: More than seven years have passed since the housing bubble burst, and ever since, America has been awash in savings — or more accurately, desired savings — with nowhere to go. Borrowing to buy homes has recovered a bit, but remains low. Corporations are earning huge profits, but are reluctant to invest in the face of weak consumer demand, so they’re accumulating cash or buying back their own stock. Banks are holding almost $2.7 trillion in excess reserves — funds they could lend out, but choose instead to leave idle. And the mismatch between desired saving and the willingness to invest has kept the economy depressed. Remember, your spending is my income and my spending is your income, so if everyone tries to spend less at the same time, everyone’s income falls. There’s an obvious policy response to this situation: public investment. We have huge infrastructure needs, especially in water and transportation, and the federal government can borrow incredibly cheaply — in fact, interest rates on inflation-protected bonds have been negative much of the time (they’re currently just 0.4 percent). So borrowing to build roads, repair sewers and more seems like a no-brainer. But what has actually happened is the reverse. After briefly rising after the Obama stimulus went into effect, public construction spending has plunged. Why? 252

In a direct sense, much of the fall in public investment reflects the fiscal troubles of state and local governments, which account for the great bulk of public investment. These governments generally must, by law, balance their budgets, but they saw revenues plunge and some expenses rise in a depressed economy. So they delayed or canceled a lot of construction to save cash. Yet this didn’t have to happen. The federal government could easily have provided aid to the states to help them spend — in fact, the stimulus bill included such aid, which was one main reason public investment briefly increased. But once the G.O.P. took control of the House, any chance of more money for infrastructure vanished. Once in a while Republicans would talk about wanting to spend more, but they blocked every Obama administration initiative. And it’s all about ideology, an overwhelming hostility to government spending of any kind. This hostility began as an attack on social programs, especially those that aid the poor, but over time it has broadened into opposition to any kind of spending, no matter how necessary and no matter what the state of the economy. You can get a sense of this ideology at work in some of the documents produced by House Republicans under the leadership of Paul Ryan, the chairman of the Budget Committee. For example, a 2011 manifesto titled “Spend Less, Owe Less, Grow the Economy” called for sharp spending cuts even in the face of high unemployment, and dismissed as “Keynesian” the notion that “decreasing government outlays for infrastructure lessens government investment.” (I thought that was just arithmetic, but what do I know?) Or take a Wall Street Journal editorial from the same year titled “The Great Misallocators,” asserting that any money the government spends diverts resources away from the private sector, which would always make better use of those resources. Never mind that the economic models underlying such assertions have failed dramatically in practice, that the people who say such things have been predicting runaway inflation and soaring interest rates year after year and keep being wrong; these aren’t the kind of people who reconsider their views in the light of evidence. Never mind the obvious point that the private sector doesn’t and won’t supply most kinds of infrastructure, from local roads to sewer systems; such distinctions have been lost amid the chants of private sector good, government bad. And the result, as I said, is that America has turned its back on its own history. We need public investment; at a time of very low interest rates, we could easily afford it. But build we won’t. http://www.nytimes.com/2014/10/27/opinion/paul-krugman-ideology-and- investment.html?_r=0

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Oct 27 7:34 amOct 27 7:34 am41 Open Letters of 1933 My friend and old classmate Irwin Collier, of the Free University of Berlin, sends me to an open letter to monetary officials warning of the dangers of printing money and debasing the dollar, claiming that these policies will undermine confidence and threaten to create a renewed financial crisis. But it’s not the famous 2010 letter to Ben Bernanke, whose signatories refuse to admit that they were wrong; it’s a letter sent by Columbia economists in 1933 (pdf): Photo

Credit It’s all there: decrying inflation amid deflation, invocation of “confidence”, a chin- stroking pose of being responsible while urging policies that would perpetuate depression. Those who refuse to learn from the past are condemned to repeat it.

COLUMBIA EXPERTS OPPOSE GOLD PLAN; 38 of Faculty, in Statement, Urge Cessation of Buying to Avert Economic Warfare. INFLATION CRISIS FEARED Stabilization Agreement With Leading Nations for Return to Old Standard Proposed

Demanding the end of President Roosevelt's gold-purchase policy to prevent worldwide economic warfare, thirty-eight educators of Columbia University issued a joint statement yesterday urging an "expeditious" return to the gold standard. http://query.nytimes.com/mem/archive- free/pdf?res=9A02E1DC1431E333A2575BC2A9679D946294D6CF 254

Oct 27 6:05 amOct 27 6:05 am14 When Banks Aren’t The Problem OK, an admission: Sometimes it seems to me as if economists and policymakers have spent much of the past six years slowly, stumblingly figuring out stuff they would already have known if they had read my 1998 Brookings Paper (pdf) on Japan’s liquidity trap. For example, there’s been huge confusion about whether Ricardian equivalence makes fiscal policy ineffective, vast amazement that increases in the monetary base haven’t led to big increases in the broader money supply or inflation; yet that was all clear 16 years ago, once you thought hard about the Japanese trap. And now here we go with another: the role of troubled banks. Europe has done its stress tests, which aren’t too bad; but now we’re getting worried commentary that maybe, just maybe, a clean bill of banking health won’t stop the slide into deflation. Folks, we’ve been there; in the 90s it was conventional wisdom that Japan’s zombie banks were the problem, and that once they were fixed all would be well. But I took a hard look at the logic and evidence for that proposition (pp. 174-177), and it just didn’t hold up. I know, I know — blowing my own horn, and all that. But if I am not for myself, who will be for me? And in any case, it has been really frustrating to watch so many people reinvent fallacies that were thoroughly refuted long ago. Oh, and if people had read my old stuff they might have managed to avoid embarrassing themselves so much in open letters to Bernanke and suchlike. Oct 27 5:49 am Oct 27 5:49 am17 What Secular Stagnation Isn’t Et tu, Gavyn? In the course of an interesting piece suggesting that there has been a sustained slowdown in the trend rate of growth, Gavyn Davies declares that Some version of secular stagnation does seem to be taking hold. He later acknowledges that there are different meanings assigned to the term; but it’s really important not to feed the confusion. To the extent that secular stagnation is an important and perhaps shocking concept, it really has to be distinguished from the proposition that potential growth is slowing down. What I wrote: For those new to or confused by the term, secular stagnation is the claim that underlying changes in the economy, such as slowing growth in the working-age population, have made episodes like the past five years in Europe and the US, and the last 20 years in Japan, likely to happen often. That is, we will often find ourselves facing persistent shortfalls of demand, which can’t be overcome even with near-zero interest rates. Secular stagnation is not the same thing as the argument, associated in particular with Bob Gordon (who’s also in the book), that the growth of economic potential is slowing, although slowing potential might contribute to secular stagnation by reducing investment demand. It’s a demand-side, not a supply-side concept. And it has some seriously unconventional implications for policy.

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This is a really important distinction, because secular stagnation and a supply-side growth slowdown have completely different policy implications. In fact, in some ways the morals are almost opposite. If labor force growth and productivity growth are falling, the indicated response is (a) see if there are ways to increase efficiency and (b) if there aren’t, live within your reduced means. A growth slowdown from the supply side is, roughly speaking, a reason to look favorably on structural reform and austerity. But if we have a persistent shortfall in demand, what we need is measures to boost spending — higher inflation, maybe sustained spending on public works (and less concern about debt because interest rates will be low for a long time). So please, let’s not confuse these issues. This isn’t some academic quibble; we’re trying to understand what ails us, and saying that high blood pressure and low blood pressure are more or less the same thing is not at all helpful. Oct 24 11:41 amOct 24 11:41 am94 The Profits-Investment Disconnect I caught a bit of CNBC in the locker room this morning, and they were talking about stock buybacks. Oddly — or maybe not that oddly, given my own experiences with the show — nobody brought up what I would have thought was the obvious question. Profits are very high, so why are companies concluding that they should return cash to stockholders rather than use it to expand their businesses? After all, we normally think of high profits as a signal: a profitable business is one people should be trying to get into. But right now we see a combination of high profits and sluggish investment :

What’s going on? One possibility, I guess, is that business are holding back because Obama is looking at them funny. But more seriously, this kind of divergence — in which high profits don’t signal high returns to investment — is what you’d expect if a lot of those profits reflect monopoly power rather than returns on capital. More on this in a while. http://krugman.blogs.nytimes.com/?8dpc

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Brad DeLong's Grasping Reality...... with the Neural Network of a Moderately-Intelligent Cephalopod

October 25, 2014 Over at Equitable Growth: Is There Really a Profits-Investment Disconnect?: (Late) Friday Focus for October 24, 2014 Over at Equitable Growth: I think Paul Krugman gets one wrong--or, at least, I need more convincing before I think he gets this one right, in spite of the extraordinary empirical success of my rules (1) and (2):

Paul Krugman: The Profits-Investment Disconnect: "Profits are very high...... so why are companies concluding that they should return cash to stockholders rather than use it to expand their businesses? After all, we normally think of high profits as a signal: a profitable business is one people should be trying to get into. But right now we see a combination of high profits and sluggish investment. What’s going on? One possibility, I guess, is that business are holding back because Obama is looking at them funny. But more seriously, this kind of divergence — in which high profits don’t signal high returns to investment — is what you’d expect if a lot of those profits reflect monopoly power rather than returns on capital. More on this in a while. READ MOAR

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As a result of the housing bubble, the mortgage frauds, the attempts at regulatory arbitrage on their balance sheets by the money-center universal banks, the financial crisis, et sequelae, U.S. real GDP today is now 12% below what we back in 2007 expected it to be now. Since the post financial-crisis trough U.S. real economic growth has proceeded at 2.24%/year, compared to the 3.00%/year growth rate we saw between 1990 and 2007. So far there are no signs anywhere that the gap between today and the pre-2007 trend in levels will be made up. So far there are no signs anywhere that the gap between today and the pre-2007 trend in growth rates will be made up. That means that, come 2024 a decade hence, we can now expect a U.S. economy to be 19.5% smaller than the economy we confidently projected as of 2007 we would have. And, with a capital-output ratio of roughly 3, that means that between 2007 and 2024 cumulative net investment will be lower than projected back in 2007 by 58.5%-point years of GDP--and cumulative gross investment considerably lower. Given this extraordinary shift in our long-run growth trajectory and in the investment requirements consistent with that trajectory, is it really surprising that investment in this "recovery" is not matching previous patterns? Paul Krugman says that because profits are high, the marginal return on capital is high, and that means that firms ought to be eager to add to their capital stocks via investment 258

in order to achieve high returns and further boost their profits. This seems to me to rely on an identification of average-Q with marginal-Q that I have always found suspect. Remember: Profits are not high now because demand is high, throughput is high, and capacity is being fully used. Profits are high now because the labor share is unusually low. Firms almost surely, given the collapse in the labor share over the past fifteen years, operating with too much capital and too little labor along the isoquant to be profit maximizing. Why shouldn't we presume that--just as after 1973 and 1979 they shifted to more energy-intensive mixes, and productivity growth was thus lower than previous experience would have predicted--firms are now shifting to more labor- and information-intensive mixes, and that investment (in everything except real investments in information technology) is lower than previous experience would have predicted? I do see a puzzle needing explanation in the extraordinary shortfall in housing investment--in the now 8 million people who ought to be out on their own in apartments and houses but who are instead living in their sisters' or other relatives' basements. I still have to be convinced that there is any shortfall or puzzle needing explanation in non-housing investment...

UPDATE: Now Paul could respond that my point is really his: that you do not get a wedge between marginal-Q and average-Q in any competitive marketplace with constant-returns-to-scale firms and labor and capital as the factors of production. You need an additional factor of market position or some such that it is difficult to invest in and then profit from for any of a number of reasons. Too that I would say "touché...", but then I would add that I think saying that there are the two and only the two boxes of "return on invested capital" and "monopoly power" is much too simple to be of much use... http://delong.typepad.com/sdj/2014/10/over-at-equitable-growth-is-there-really-a- profits-investment-disconnect-late-friday-focus-for-october-24-2014.html

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Very Rough: Exploding Wealth Inequality and Its Rent-Seeking Society Consequences: (Early) Monday Focus for October 27, 2014 by Brad DeLong Posted on October 25, 2014 at 4:12 pm Emmanuel Saez and Gabriel Zucman: Exploding wealth inequality in the United States: “The share of total income earned by the top 1%… …less than 10% in the late 1970s but now exceeds 20%…. A large portion of this increase is due to an upsurge in the labor incomes earned by senior company executives and successful entrepreneurs. But… did wealth inequality rise as well?… The answer is a definitive yes…. We use comprehensive data on capital income—such as dividends, interest, rents, and business profits—that is reported on individual income tax returns since 1913. We then capitalize this income so that it matches the amount of wealth recorded in the Federal Reserve’s Flow of Funds…. In this way we obtain annual estimates of U.S. wealth inequality stretching back a century. Wealth inequality, it turns out, has followed a spectacular U-shape evolution over the past 100 years…. How can we explain the growing disparity in American wealth? The answer is that the combination of higher income inequality alongside a growing disparity in the ability to save for most Americans is fueling the explosion in wealth inequality. For the bottom 90 percent of families, real wage gains (after factoring in inflation) were very limited over the past three decades, but for their counterparts in the top 1 percent real wages grew fast. In addition, the saving rate of middle class and lower class families collapsed over the same period while it remained substantial at the top…. If income inequality stays high and if the saving rate of the bottom 90 percent of families remains low then wealth disparity will keep increasing. Ten or twenty years from now, all the gains in wealth democratization achieved during the New Deal and the post-war decades could be lost…. There are a number of specific policy reforms needed to rebuild middle class wealth…. Prudent financial regulation to rein in predatory lending, incentives to help people save… steps to boost the wages of the bottom 90 percent of workers are needed…. One final reform also needs to be on the policymaking agenda: the collection of better data on wealth… What I would like to see Emmanuel and Gabriel guess it is the share of wealth that is productive–that boosts the productivity of the working class and that shares those productivity benefits with workers–and the share of wealth that is extractive–that are pure claims on income rather than useful instruments of production, and thus that erode rather than boost the incomes of others. Wealth plays two roles, you see: as useful 260

factors of production that boost productivity, and as extractive social power that is the result, the cause, and the maintainer of the rent-seeking society. Taking off from my Mr. Piketty and the Neoclassicists, once we had such guesses we could build a balanced-growth model… The important quantities would be: (1) The annual rate of population and labor force growth: n. (2) The annual rate of labor productivity growth: g.

(3) The warranted annual rate of accumulation ra = n + g: the rate at which wealthholders’ assets need to grow if their wealth-to-national-income ratio to be constant. (4) The wedge ω between the rates of accumulation and net profit: what share of their current assets the wealth spend, dissipate, lose to Wall Street sharks, consume, give away, and so forth.

(5) The resulting warranted annual rate of net profit rw= n + g + ω: The warranted annual rate of net profit at which wealthholders’ have a constant ratio of their wealth to national income. If the actual average rate of profit r > rw, the rich become richer in relative terms. If the actual average rate of profit r < rw, the rich lose ground in relative terms. If the actual average rate of profit r = rw, the wealth of the rich remains a stable multiple of national income.

From the warranted annual rate of net profit rw, we then need to know: • How the annual rate of net profit r in the productive sector depends on the size of the stock of physical capital–which is rented out to workers at its marginal product– relative to annual income K/Y. • To calculate this we need to know: • What the physical net annual marginal product of capital is at some baseline physical capital-income ratio K/Y, say 3. • What the elasticity of the net rate of annual profit r in the productive sector with respect to the productive capital-income ratio is. • How the annual rate of net profit in the rent-seeking sector depends on the size of the stock of rent-seeking property relative to national income R/Y. • To calculate this we need to know: • What the rate of rent extraction ε is at some baseline rent-seeking property-income ratio, say 3. • What the elasticity of the net rate of rent extraction ε in the rent- seeking sector is with respect to the rent-seeking property-income ration R/Y. If we know all those, we can then calculate: (6) The physical capital-annual income ratio at the warranted rate of net profit: (K/Y)* (7) The rent-seeking capital-annual income ratio at the warranted rate of profit: (R/Y)*

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(8) (W/Y)* = (K/Y): The total wealth-annual income ratio at the warranted rate of profit: (W/Y)

(9) The income-from-wealth share of total income: rw x (W/Y)*, given:

(10) The physical net annual marginal product of capital at K/Y = 3: ρK

(11) The annual net return on rent-seeking capital at R/Y = 3: ρR

(12) The elasticity of the rate of profit on physical capital: λK

(13) The elasticity of the rate of profit on rent-seeking capital: λR Which I believe gets us to this spreadsheet. If you download it and edit it in interesting ways, please send me a copy… For the particular parameters I have chosen, we have the wealthholders cumulatively investing 2.1 times a year’s GDP in productive capital that boosts the wage level, and 0.6 times in year’s GDP in rent-extraction property that subtracts from the wage level. And we have a Belle Epoque and a Future Second Gilded Age in which wealthholders do indeed hold a greater multiple of GDP’s worth of useful, productive, wage-boosting capital–3.4 times a year’s national income–but also hold vastly more rent-seeking property: 5.2 times a year’s national income. In this interpretation of Piketty, thrift on the part of the rich is indeed beneficial to the working class–as long as it is channeled into productive investment. But if it is used to create, politically maintain, and profit from rent-extraction property… well, it is not so nice. http://equitablegrowth.org/2014/10/25/rough-exploding-wealth-inequality-rent- seeking-society-consequences-early-monday-focus-october-27-2014/

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The Growth Economics Blog This blog takes Robert Solow seriously Scale, Profits, and Inequality Posted on October 25, 2014 by dvollrath After my post last week on inequality, I got a number of (surprisingly reasonable) responses. I pulled one line out of a recent comment, not to call out that particular commenter, but because it encapsulates an argument for *not* caring about inequality. “Gates and the Waltons really did probably add more value to humanity than the janitor at my school.“ The general argument here is about incentives. Without the possibility of massive profits, people like Bill Gates or Sam Walton will not bother to innovate and create Microsoft and Walmart. So we should not raise taxes because those people deserve, in some sense, the fruits of their genius. More important, without them innovating, the economy wouldn’t grow. But if we take seriously the incentives behind innovation, then it isn’t simply the genius of the individual that matters for growth. The scale of the economy is equally relevant. In any typical model of innovation and growth, the profits of a firm are going to be something like Profits = Q(Y)(P-MC), where (P-MC) is price minus marginal cost. Q(Y) is the quantity sold, and this depends on the aggregate size of the economy, Y. The markup of price over marginal cost (P-MC), is going to depend on how much market power you have, and on the nature of demand for your product. This markup depends on your individual genius, in the sense that it depends on how indispensable people find your product. Apple is probably the better example here. They sell iPhones for way over marginal cost because they’ve convinced everyone through marketing and design that substitutes for iPhones are inferior. The scale term, Q(Y) does not depend on genius. It depends on the size of the market you have to sell to. If we stuck Steve Jobs, Jon Ive, and some engineers on a remote island, they wouldn’t earn any profits no matter how many i-Devices they invented, because there would be no one to sell them to. People like Gates and the Waltons earn profits on the scale effect of the U.S. economy, which they did not invent, innovate on, or produce. So the “rest of us”, like the janitor mentioned above, have some legitimate reason to ask whether those profits are best used in remunerating Bill Gates and the Walton family, or could be put to better use. There isn’t necessarily any kind of efficiency loss from raising taxes on Gates, Walton, and others with large incomes. They may, on the margin, be slightly less willing to innovate. But if the taxes are put to use expanding the scale of the U.S. economy, then we might easily increase innovation by through the scale effect on profits. Investing in health, education, and infrastructure all will raise the aggregate size of the U.S. economy, and make innovation more lucrative. Even straight income transfers can raise 263

the effective scale of the U.S. economy be transferring purchasing power to people who will spend it. Can we argue about exactly how much of the profits are due to “genius” (the markup) and how much to scale? Sure, there is no precise answer here. But you cannot dismiss the idea of taxing high-income “makers” because their income represents the fruits of their individual genius. It doesn’t. Their incomes derive from a combination of ability and scale. And scale doesn’t belong to individuals. The value-added of “the Waltons” is particularly relevant here. Sam Walton innovated, but the profits of Walmart are almost entirely derived from the scale of the U.S. (and world) economy. It’s the presence of thousands and thousands of those janitors in the U.S. that generates a huge portion of Walmart’s profits, not the Walton family’s unique genius. Alice Walton is worth around $33 billion. She never worked for Walmart. She is a billionaire many times over because her dad was smart enough to take advantage of the massive scale of the U.S. economy. I’m not willing to concede that Alice has added more value to humanity than anyone in particular. So, yes, I’ll argue that Alice should pay a lot more in taxes than she does today. And no, I’m not afraid that this will prevent innovation in the future, because those taxes will help expand the scale of the economy and incent a new generation of innovators to get to work. http://growthecon.wordpress.com/2014/10/25/scale-profits-and-inequality/ The Enlightened Economist Economics and business books

Hume, Keynes and wisdom Posted on October 25, 2014 by Diane Coyle What’s not to like about a book that starts with David Hume’s contribution to economics. In Keynes: Useful Economics for the World Economy by Peter Temin and David Vines begins with a chapter on Hume’s essay ‘Of the Balance of Trade’. They argue that not only was economics born in 18th century Britain, but so too was the first economic model with Hume’s price-specie flow mechanism. This classical tradition of thinking in terms of internal and external imbalance formed the background to Keynes’s thinking about global imbalances – and, this book argues, is an essential prism on today’s global economy. This short book (and I like a short book) aims to re-introduce the Keynes who thought with such clarity about international links to a modern audience. It includes the historical context, including Keynes’s membership of the Macmillan Committee in 1930-31 and his early thinking about the gold standard, as well as (relatively brief) mention of Bretton Woods. It goes on to walk through the basics of Keynesian international macroeconomics – the IS-LM framework, the Swan diagram showing schedules of internal and external balance, and aggregate demand and supply. There is a

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final chapter on ‘An International Paradox of Thrift’ which argues there is a parallel between 2014 and the fag end of the gold standard in the 1920s-30s, with too many countries trying to increase savings. What would Keynes recommend now, they ask, answering that all of Germany, China, the US and UK should expand their domestic economies. Of course, there’s nothing novel about suggesting that Germany and China need to acknowledge the harm their ever-increasing export surpluses have been causing – I’m more surprised by the advice to the US and UK to expand their external deficits further. The book justifies this on the basis that both countries have significant stocks of overseas assets and low interest rates. This would be a useful book for students starting out on their international macro – it’s a very clear exposition of the basic models. I’m sceptical that one can find all of the wisdom needed to solve today’s problems in re-readings of Keynes, not least because of his trite remark that “in the long run we are all dead.” We’re in Keynes’s long run now, and the flaws with a framework that has looked only at flows (GDP) and not assets (natural, physical capital) are all too plain. Still, the international Keynes is more relevant to today than the domestic Keynes, and the pre-2008 global imbalances problem is still a problem today.

Update: I’ve been reprimanded on Twitter for misrepresenting Keynes. It’s true that his “long run” comment was a reference to how useless it is to think about equilibrium outcomes when the world never gets to equilibrium. However, whenever I’ve seen it quoted, it has been in the sense of there being no need to worry about long-run consequences of a favoured action. Still, to be accurate, I should indeed have attributed the triteness not to Keynes but to subsequent uses of the remark. http://www.enlightenmenteconomics.com/blog/index.php/2014/10/hume-keynes-and- wisdom/

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mainly macro

Comment on macroeconomic issues

Friday, 24 October 2014 Redistribution between generations I ought to start a series on common macroeconomic misunderstandings. (I do not watch zombie films.) One would be that the central bank’s balance sheet normally matters, although this nice comment on my last post does the job pretty well. Here is one that crops up fairly regularly - that government debt does not involve redistribution between generations. The misunderstanding here is obvious once you see that generations overlap. Take a really simple example. Suppose the amount of goods produced each period in the economy is always 100. Now if each period was the life of a generation, and generations did not overlap, then obviously each generation gets 100, and there can be no redistribution between them. But in real life generations do overlap. So instead let each period involve two generations: the old and young. Suppose each produced 50 goods. But in one period, call it period T, the government decides that the young should pay 10 goods into a pension scheme, and the old should get that pension at T, even though they contributed nothing when young. In other words, the young pay the old. A fanciful idea? No, it is called an unfunded pension scheme, and it is how the state pension works in the UK. As a result of the scheme, the old at T get 60 goods, and the young only 40, of the 100 produced in period T. The old at T are clear winners. Who loses? Not the young at T if the scheme continues, because they get 60 when old (and assume for simplicity that people do not care when they get goods). The losers are the generation who are old in the period the scheme stops. Say that is period T+10, when the young get to keep their 50, but the old who only got 40 when young only get 50 when old. So we have a clear redistribution from the old in period T+10 to the old in period T. Yet output in period T and T+10 is unchanged at 100. That example did not involve any debt, but I started with it because it shows so clearly how you can have redistribution between generations even if output is unchanged. To bring in debt, suppose government taxes both the old and young by 10 each period, and transforms this 20 into public goods. So each generation has a lifetime consumption of 80 of private goods. Now in period T the government says that the young need pay no taxes, but will instead give 10 goods in exchange for a paper asset - government debt - that can be redeemed next period for 10 goods. In period T nothing changes, except that the young now have this asset. In period T+1 this allows them (the now old) to consume 50 private goods rather than 40: the 40 it produces less tax and the 10 it now gets from the government by selling the debt. Their total consumption of private goods has increased from 80 to 90. How does the government obtain these 10 to give the now old? It says to the young: either you pay 20 rather than 10 in taxes, or you can buy this government debt for 10. As people only care about their total consumption, the young obviously buy the debt. 266

They now consume 30 in private goods in T+1, but 50 in T+2 when they sell their debt, which gets us back to the original 80 in total lifetime consumption. This process continues until period T+10, say, when the government refuses to give the young the choice of buying debt, and just raises an extra 10 in taxes on the young. So the debt disappears, but the young are worse off, as they only have 30 of private goods to consume this period. Their total lifetime consumption of private goods is 70. We have a clear redistribution of 10 from the young in period T+10 to the young in period T enacted by the government issuing debt in period T. If you are thinking that these redistributions need not occur if the debt is never repaid or the pension scheme never wound up, then we need to get a bit more realistic and bring in interest rates and growth (and the famous r<>g relationship), which these posts of mine (and these at least as good posts from Nick Rowe) discuss. But the idea with this post is to get across in a very simple way how redistribution between generations can work because generations overlap. Unfunded pension schemes and intergenerational equity Government debt and the burden on future generations The Burden of Government Debt Nick Rowe How time travel is possible, The burden of the (bad monetary policy) on future generations http://mainlymacro.blogspot.com.es/2014/10/redistribution-between-generations.html

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Europe's fiscal wormhole - with all of the rules pointing toward recession, how can Europe boost recovery? by Guntram B. Wolff on 24th October 2014 The International Monetary Fund now estimates a 30% risk of deflation in the eurozone, and growth figures within the monetary union continue to disappoint. But policymakers seem trapped in a cat’s cradle of economic, political, and legal constraints that is preventing effective action. The fulfillment of policy rules appears to be impossible without growth, but growth appears to be impossible without breaking the rules. Tweet This The fulfillment of policy rules appears to be impossible without growth, but growth appears to be impossible without breaking the rules. German Finance Minister Wolfgang Schäuble is politically committed to outdoing his country’s tough domestic fiscal framework to secure what he calls a “black zero” budget. The French government is working to regain credibility on reform promises made in exchange for delays on fiscal adjustment, and Italy, with one of the highest debt burdens in the eurozone, has little room to use fiscal policy. Meanwhile, the European Central Bank is constrained by doubts about the legality of its “outright monetary transactions” (OMT) scheme – sovereign-bond purchases that could result in a redistributive fiscal policy. With all of the rules pointing toward recession, how can Europe boost recovery? A two-year €400 billion ($510 billion) public-investment program, financed with European Investment Bank bonds, would be the best way to overcome Europe’s current impasse. Borrowing by the EIB has no implications in terms of European fiscal rules. It is recorded neither as new debt nor as a deficit for any of the member states, which means that new government spending could be funded without affecting national fiscal performance. Thus, some of the investment spending currently planned at the national level could be financed via European borrowing to relieve national budgets. Such an indirect way of dealing with strict rules would also be easier than starting long and wearying negotiations on changes to the fiscal framework. The EIB is worried that such a scheme could come at the cost of its triple-A rating. Indeed, though it can currently borrow at 1.6% on a long maturity, it has used its recent capital-raising exercise to reduce leverage rather than substantially increase its loan portfolio, as would be warranted at a time of retrenchment in private lending. In any case, a rating change would hardly affect funding costs in the current low-yield environment, as lower-rated sovereigns have demonstrated. In addition, the ECB could purchase EIB bonds on secondary markets, which would help to keep funding costs low – or even reduce them. More important, purchases of 268

EIB bonds would enable the ECB to undertake quantitative easing without triggering the degree of controversy implied by intervening in 18 separate sovereign-bond markets, where concerns that ECB purchases would affect the relative pricing of sovereigns are very real. Already, €200 billion of EIB bonds are available. Adding €400 billion would increase the pool substantially. Together with asset-backed securities, covered bonds, and corporate bonds, €1 trillion of assets – the threshold widely thought to make quantitative easing by the ECB credible – would be available for purchase. Tweet This A two-year €400 billion ($510 billion) public-investment program, financed with European Investment Bank bonds, would be the best way to overcome Europe’s current impasse A central question, of course, concerns the type of government spending that should qualify as investment spending, and which European investment projects should be supported. It will be impossible to define new and sensible European projects worth €200 billion per year. Common projects such as the European energy union will need more time to be precisely defined. As a result, the bulk of investment now will have to come from national policymakers. In part, this means that existing infrastructure projects that are supposed to be financed from national budgets could be funded by the EIB. By removing some of the burden from national budgets, the current decline in public investment could be reversed. Some of the new resources could also be used to allow for budget consolidation in France without pro-cyclical cuts. France could get this helping hand in complying with the fiscal rules in exchange for serious and necessary structural reforms, as could Italy, where EIB-funded bonds would provide a much-needed growth stimulus without new government commitments. In Germany, the freed-up resources could be used to accelerate existing investment projects while still meeting its black-zero pledge. Similar arrangements could be found for the other eurozone countries. To prevent the misuse of money, the European Commission should vet all national investment projects. More broadly, the program would be an important step toward establishing the eurozone’s missing fiscal union. That goal will be reached more quickly once the benefits of achieving it are apparent to all. http://www.bruegel.org/nc/blog/detail/article/1465-europes-fiscal-wormhole/

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Three major nations absent as China launches World Bank rival in Asia SHANGHAI Fri Oct 24, 2014 8:02am BST

1 OF 5. A general view of the signing ceremony of the Asian Infrastructure Investment Bank at the Great Hall of the People in Beijing October 24, 2014. CREDIT: REUTERS/TAKAKI YAJIMA/POOL RELATED NEWS//ADB chief doesn't welcome Chinese-backed Chinese rival

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(Reuters) - Australia, Indonesia and South Korea skipped the launch of a China-backed Asian infrastructure bank on Friday as the United States said it had concerns about the new rival to Western-dominated multilateral lenders. China's $50 billion (31.18 billion pounds) Asian Infrastructure Investment Bank (AIIB) is seen as a challenge to the World Bank and Asian Development Bank, both multilateral lenders that count Washington and its allies as their biggest financial backers. China, which is keen to extend its influence in the region, has limited voting power over these existing banks despite being the world's second-largest economy.

The AIIB, launched in Beijing at a ceremony attended by Chinese finance minister Lou Jiwei and delegates from 21 countries including India, Thailand and Malaysia, aims to give project loans to developing nations. China is set to be its largest shareholder with a stake of up to 50 percent. Indonesia was not present and neither were South Korea and Australia, according to a pool report. Japan, China's main rival in Asia and which dominates the $164 billion Asian Development Bank along with the United States, was also not present, but it was not expected to be. Media reports said U.S. Secretary of State John Kerry put pressure on Australia to stay out of the AIIB. However, State Department spokeswoman Jen Psaki said: "Secretary Kerry has made clear directly to the Chinese as well as to other partners that we welcome the idea of an infrastructure bank for Asia but we strongly urge that it meet international standards of governance and transparency. "We have concerns about the ambiguous nature of the AIIB proposal as it currently stands, that we have also expressed publicly."

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In a speech to delegates after the inauguration, Chinese President Xi Jinping said the new bank would use the best practices of the World Bank and the Asian Development Bank. "For the AIIB, its operation needs to follow multilateral rules and procedures," Xi said. "We have also to learn from the World Bank and the Asian Development Bank and other existing multilateral development institutions in their good practices and useful experiences." PERSONAL LOBBYING The Australian Financial Review said on Friday that Kerry had personally asked Australian Prime Minister Tony Abbott to keep Australia out of the AIIB. "Australia has been under pressure from the U.S. for some time to not become a founding member of the bank and it is understood Mr Kerry put the case directly to the prime minister when the pair met in Jakarta on Monday following the inauguration of Indonesian President Joko Widodo," the paper said. South Korea, one of Washington's strongest diplomatic allies in Asia, has yet to say it will formally participate in the bank. Its finance ministry said last week it has been speaking with China to request more consideration over details such as the AIIB's governance and operational principles. "We have continued to demand rationality in areas such as governance and safeguard issues, and there's no reason (for Korea) not to join it," South Korean Finance Minister Choi Kyung-hwan said in Beijing on Thursday. The Seoul-based JoongAng Daily quoted a South Korean diplomatic source as saying: "While Korea has been dropped from the list of founding members of the AIIB this time around, it is still in a deep dilemma on what sort of strategic choices it has to make as China challenges the U.S.-led international order." The AIIB is expected to begin operations in 2015 with senior Chinese banker Jin Liqun, ex-chairman of investment bank China International Capital Corp, expected to take a leading role. Last month, China's finance ministry said Australia and South Korea had expressed interest in the AIIB. On Thursday, the Asian Development Bank (ADB) chief said he did not welcome a China-backed rival bank that will have a virtually identical aim. "I understand it, but I don't welcome it," said bank president Takehiko Nakao. "I'm not so concerned." The ADB, created in 1966, offers grants and below-market interest rates on loans to lower to middle-income countries. At the end of 2013, its lending amounted to $21.02 billion. China has a 6.5 percent stake in the ADB, while the United States and Japan have about 15.6 percent each. (Reporting by Brenda Goh; Additional reporting by Arshad Mohammed, Sonali Paul, Jake Spring, Choonsik Yoo and Rosemarie Francisco; Editing by Raju Gopalakrishnan)

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http://uk.reuters.com/article/2014/10/24/uk-china-aiib-idUKKCN0ID08O20141024

Special Report - Why Madrid's poor fear Goldman Sachs and Blackstone

Madrid Fri Oct 24, 2014 8:42am BST 8:42am BST By Sonya Dowsett Madrid (Reuters) - Last year Madrid’s city and regional governments sold almost 5,000 rent-controlled flats to private equity investors including Goldman Sachs and Blackstone. At the time, the tenants were told their rental conditions would remain the same. But as old contracts expire, dozens of people have received demands for higher rent, been told their rents will increase dramatically, been threatened with eviction or moved out to escape the insecurity. Thousands of Spain’s poor now depend for their homes on the generosity of private equity. Jamila Bouzelmat is one of them. The mother of six lives in a four-bedroom flat on the outskirts of the Spanish capital that was bought jointly by Goldman and a Spanish firm. The 44-year-old said that until March her family paid 58 euros (45.54 pounds) a month in rent out of her husband’s 500-euro unemployment benefit. In April, her bank statement shows, her new landlords suddenly took 436 euros from her bank account. She discovered the payment when she tried to pay an electricity bill. “We went to take money out and there wasn’t a cent left in the bank,” she said, her 18- month-old daughter playing at her feet. She got charity hand-outs to feed her children, aged between 18 months and 19 years, and now lives in fear of the rent bill. Goldman declined to comment. In the buildings sold to the funds, Reuters has spoken to more than 40 households who face similar difficulties. They include some of Madrid’s most vulnerable people: an 273

unemployed single mother of five with a severely disabled daughter, for example, and an HIV patient with one lung. Both faced evictions that were temporarily halted at the last minute. There is no suggestion the buyers have acted illegally. Having bought around 15 percent of Madrid’s publicly held social housing, the new owners are simply exercising their right to charge commercial rents once reduced rents that tenants have paid expire. However, Socialist councillors in Madrid have launched lawsuits directed at the state bodies that sold the rent-controlled homes, and tenants meet weekly to organise street protests. Evictions ordered and postponed by the new owners are an increasingly common sight in Spain’s media. The ructions in Madrid come as Spain tries to recover from its historic property-market collapse and deep economic crisis. Between 2007 and 2013, Spanish property prices fell by nearly 40 percent. More than 3 million houses and apartments sit empty, according to official figures. Spain has one of the smallest stocks of social housing in Europe, but as Madrid’s authorities cut their budgets, they have sold what they can at fire-sale prices. For the private equity firms that bought the flats, the deal was good business. For tenants, less so. The poorest had long benefited from rent reductions - some of them officially documented contracts, others informal arrangements with well-meaning public officials. Of the homes Goldman bought, around 400 benefited from official rent reductions, according to one government source. Such cuts were agreed individually for up to two years, and some tenants used to pay less than 20 percent of the going rate. The informal deals are hard to count. The apartments were sold by two government agencies. One of them, the Madrid city housing body, told Reuters the sales were crucial to paying its debt, but did not answer questions on the number of tenants affected or their situation. The other, the regional housing body known as IVIMA, sold its flats to Goldman Sachs International and Azora, a Spanish private equity firm which invests in rental accommodation. Azora set up a management firm, Encasa Cibeles, to manage the flats, and both Goldman and Azora referred inquiries to Encasa Cibeles. In the case of Bouzelmat, whose rental agreement ended in March, an Encasa Cibeles spokesman declined to comment on “processes and methods of payment.” But he said Bouzelmat had been paying by direct debit. The company said it respects all ongoing contracts, including rent reductions, and once these expire, reviews each tenant case-by- case. “Evictions occur in an extremely small number of cases,” the spokesman said: “Our priority is to help those in need and we are doing this with a team of social workers looking to help the most vulnerable.” Pablo Sola, a spokesman for IVIMA, said the deal had been exemplary and IVIMA meets Encasa Cibeles every week to ensure “no family that wants to pay” is evicted. “The Madrid government has not washed its hands of the management of these flats. We are following up the process to avoid the eviction of any family in financial difficulty.”

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The public-sector real estate workout is creating winners and losers. Spain needs new investment to put a floor under its property market - a necessary condition for a broader recovery - and at the same time its social safety net needs funds. Economist Miguel Hernandez said foreign investors play an important role by providing cash to public institutions. “These funds may appear to be acting like vultures, but they are also helping the system, because the administrations had very few options to get the cash they needed,” said Hernandez, professor at IE Business School. “A GOOD PRICE” The red-brick development where Bouzelmat lives is in Vallecas, a working-class area in the south of Madrid. Thousands of new flats – many of them state-owned social housing – were built there during Spain’s property boom in the early 2000s. When boom turned to bust in 2008, Spain’s budget for housing collapsed. It was 1.4 billion euros in 2008 and is now 800 million. That left local governments scrambling to cut costs, and eyeing privatisations. To lure foreign investors, Madrid overhauled rental laws, making it easier for landlords to evict non-paying tenants. It worked: Investment in Spanish real estate increased 12-fold last year to 5.2 billion euros. A confidential May 2013 report – commissioned by Madrid city council and prepared by PriceWaterhouseCoopers – found that the city’s housing unit, known as EMVS, was unsustainable. EMVS, set up over 30 years ago to house the poor and disadvantaged, had higher debt repayments than its cash income. PWC’s report advised Madrid to sell some flats immediately. In July 2013, the city sold 1,860 properties to a fund jointly owned by Blackstone and Spanish fund Magic Real Estate. The average price per apartment was around 67,200 euros. EMVS said the sales were crucial to paying down its debt. Opposition United Left councillor Angel Perez said it was an outrage. “You are playing with people’s lives,” he told an angry town hall session at the time. Blackstone declined to comment. Magic Real Estate did not respond. Within weeks of the Madrid City Council’s sale, IVIMA, the regional housing body, sold another 2,935 apartments - including Bouzelmat’s - to Goldman Sachs and Azora for roughly 68,500 euros per unit. Taking an average size of around 70 square metres for the flats sold, Goldman and Blackstone and their Spanish partners paid around 970 euros per sq m for the properties. Flats in Vallecas sell for around 2,000 euros per sq m, real estate agent websites show – about 200,000 euros for a 100-sq-km home. "The price per unit was very cheap," said Fernando Encinar of Madrid-based real estate agent Idealista. "In any market, if you buy in volume you get a good price." “TAKE NO ACTION” Last October, Pablo Cavero, Madrid councillor for transport, infrastructure and housing, told a council session that the only change for the IVIMA tenants would be “the name at the top of the rent bill," the minutes show. He declined to be interviewed.

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That month, tenants in Bouzelmat’s block, some of whom had official rent reductions, received a letter from Encasa Cibeles saying: “The rental contract will not suffer any change. You will maintain the same rental conditions that you have currently, including the monthly rent and the length of your contract.” The letter, seen by Reuters, said tenants needn’t do anything. It did not mention what would happen after the contracts ended, nor did it refer to reduced rents. These were separate arrangements that each tenant made with their state landlord. For instance, if a tenant lost their job, they would submit documentation and IVIMA would grant a discretionary reduction for a fixed period, documents seen by Reuters show. Of the 20,000 homes IVIMA now owns, around 27 percent have a formal rent reduction of between 5 percent and 95 percent, a source close to IVIMA said. Late last year, Encasa Cibeles invited four tenants’ representatives from Bouzelmat’s block to a meeting. The company told them rent reductions would not be renewed once contracts expired. “Encasa Cibeles told us they would respect reductions until the contract ended but then it would return to the base rate, because they were not a charity,” said Saida Juarez, the tenant representative from the block. "FULL PAYMENT" Unemployed hairdresser and mother-of-three Yasmin Rubiano lives in a flat now owned by Goldman and Azora. Rubiano said she stopped getting a printed rent bill once her reduced rent of 50 euros per month ended in December, but got no word from the new owners. In January she started to receive monthly text messages from her bank, which she showed a reporter, advising that it had received a demand for 498.18 euros. She has been paying 100 euros a month to show goodwill, but cannot pay more. In March, Rubiano said, she received a letter from Encasa Cibeles demanding full payment or threatening legal action. The Encasa Cibeles spokesman said it had nothing to do with the text messages. Social workers have been working for some time to find the best solution for the family, who still live in the flat, he added. “Encasa Cibeles has not started any legal action against them.” The situation with Blackstone and Magic Real Estate is slightly different. Their tenants generally have longer contracts and fewer formal deals for reduced rents, though most pay below market rates. As with the Goldman flats, tenants were told nothing would change: “The contracts ... are guaranteed,” seller EMVS said in a July news release. “The only thing that will change in the rent statement is the issuer.” As leases near expiry, at least 20 tenants in one block have signed new contracts for sharp rent rises, said a source with knowledge of the matter. When Blackstone and Magic Real Estate bought the flats, Jaime Gamarra, an unemployed 62-year-old receiving benefits of less than 400 euros a month, had not been paying full rent for around a year. After he lost both his jobs, a woman at the council had told him to pay what he could afford. On March 12, he got a letter from the new management company, Fidere, saying he owed them 5,133.54 euros in “inherent obligations” to be paid by March 5. 276

“I started to panic,” he said. He met Fidere and was told his arrangement with the council was not viable for the firm. On June 24 he got a letter of eviction. A judge overruled this in September, but Fidere can appeal. Gamarra fears he will be thrown out. “These flats were built with public money for people in difficulty,” Gamarra said. Jorge Arriba, a 37-year-old car mechanic, lives in a Blackstone flat; his 10-year contract ended in August. He used to pay 415 euros per month in rent, around a third of his salary. When he met Fidere in May, he said, they told him the rent would go up from September. On Aug. 6, the 20 tenants in Arriba’s block signed new contracts with Fidere, some of them seen by Reuters, which stipulate a rise of more than 40 percent in rent over three years. Blackstone referred inquiries to Fidere. “It is not true that it is our intention to increase rent once the contracts end,” Fidere spokesman Miguel Onate said in an email. Later, he said “some people have lost the public subsidy they received from the council.” Of the flats under Fidere’s management, he said, fewer than 2 percent have recurring problems with payments. Six sources involved in the bidding process told Reuters that bidders knew the straitened circumstances of the tenants. The funds that entered final bidding – nine in all – were given detailed information. The sale terms, seen by Reuters, show the regional government stressed that the new owners must honour all the tenants’ rights and obligations. Goldman went for the Madrid homes after a successful pair of similar deals in Germany, a person familiar with the matter said. Goldman looked at the profiles of the tenants and considered whether the properties were “under-managed from a yield perspective” and whether new ownership could “improve rents.” The deal was particularly appealing because 85 percent of the flats were occupied and most tenants were paying rent, in contrast to other properties with high percentages of defaulted mortgages or laws that made it hard to raise rents. Some local politicians say IVIMA acted illegally by selling the flats cheap. IVIMA Director Ana Gomendio declined to comment. Now a judge will decide who, if anyone, to blame. Any tenants evicted can reapply for social housing. Around 13,000 households are already on the waiting list for flats owned by Madrid city council, a source close to the council said. (Edited by Sara Ledwith) http://uk.reuters.com/article/2014/10/24/uk-spain-housing-specialreport- idUKKCN0ID0HQ20141024

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Calculated risk Fri Oct 24, 2014 8:27am BST (Reuters) - In August 2013, Goldman Sachs and Azora bought 2,935 apartments in Vallecas, Madrid, for an average 980 euros ($1,240) per square metre – roughly a 50 percent discount to the market rate. About 2,500 of the flats were occupied, including around 400 with tenants on reduced rents. If the funds collected zero rent from the empty flats and from those on reduced rents, this would give a delinquency rate of up to 28 percent. That compares with a rate of about 6.4 percent on mortgage loans in Spain. “It’s a high default rate,” said IE Business School professor Miguel Hernandez. The lower the price, the higher the default rate an investor can risk. Sources: IVIMA, Madrid real estate agents, sources close to the funds. Calculations are approximations. Average price based on flat size of 70 sq m, excludes garage space etc. (Reporting by Sonya Dowsett; Edited by Sara Ledwith) http://uk.reuters.com/article/2014/10/24/uk-spain-housing-maths- idUKKCN0ID0J920141024 How Spain’s social housing imploded Fri Oct 24, 2014 8:27am BST (Reuters) - Social housing in Spain is not generous. Rented social housing makes up just 2 percent of all residential property compared with 18 percent in Britain and 17 percent in France, according to the European Federation of Public, Cooperative and Social Housing. The country’s investment in social housing is just 0.79 percent of Gross Domestic Product, about half the European average, according to Human Rights Watch. Rather than offer subsidies to help people rent cheaply, Spain’s government has focussed on helping people to buy. Social housing tenants have typically rented for around 10 years and then been given the option to buy. The property crash has torpedoed that policy. Rent-to-buy agreements set the purchase price at the start of the rental lease. When prices rise, that works. But any flats coming up for sale now were priced at the height of the boom. Today's buyers would likely pay above a property’s current market value. (Reporting by Sonya Dowsett; Edited by Sara Ledwith) http://uk.reuters.com/article/2014/10/24/uk-spain-housing-socialhousing- idUKKCN0ID0JG20141024

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Internacional La UE aprueba medidas para aliviar el aislamiento energético de España Madrid anuncia un acuerdo que mejora las interconexiones con el resto de Europa CLAUDI PÉREZ / LUCÍA ABELLÁN BRUSELAS 23 OCT 2014 - 23:11 CEST53

Los nietos de Van Rompuy acompañaron al presidente del Consejo en la foto de familia de su última cumbre. / Atlas / AFP España cantó este jueves victoria en una de sus reivindicaciones europeas históricas: aliviar su situación de isla energética, sin apenas conexión con otros países para abastecerse. La UE aceptó anoche incluir medidas para mejorar la interconexión de la península Ibérica, que ahora no llega al 3% de su capacidad de producción eléctrica, entre los compromisos de la cumbre europea que arrancó en Bruselas. Así figura en el documento de conclusiones cerrado anoche, aunque distintas fuentes diplomáticas advertían de que la redacción final es lo suficientemente ambigua como para que todo el mundo pueda darse por satisfecho. El Gobierno español anunció un acuerdo político: Francia da por primera vez su visto bueno a la puesta en marcha de varios proyectos de interconexión, y la Comisión Europea examinará todo el proceso. Está por ver cómo, cuándo y quién financiará esos planes, con el objetivo de alcanzar un 10% de interconexión en 2020 y un 15% en 2030, explicaron fuentes francesas. Pero Francia ha quedado muy señalada en esta cumbre, según el Ejecutivo español. La falta de conexiones a través de los Pirineos ha alimentado durante años una batalla política con París, que finalmente acepta que esa frontera vaya siendo más permeable. El aislamiento geográfico de España obliga a tener en marcha un dispositivo permanente muy costoso para evitar los apagones: “Ese sistema encarece un 5% la producción de energía”, según fuentes españolas.

MÁS INFORMACIÓN/ Juncker adelanta el plan de inversión por miedo a la recesión/ Hollande alerta del riesgo de un “estancamiento duradero”/ Merkel se enroca pese al riesgo de recesión de la Unión Europea

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Para aliviar el problema, las conclusiones del Consejo Europeo reconocen por primera vez que se trata de un problema europeo, no solo intergubernamental, y recogen la necesidad de dar prioridad a esos proyectos de interconexiones en la planificación comunitaria. España apunta que París ya no podrá oponerse a los cinco proyectos de interconexión con Francia —cuatro por los Pirineos y uno por mar—, aunque está por ver cómo se sustancia ese acuerdo. “Vamos a acordar los proyectos que hagan que la interconexión energética sea posible”, señaló el presidente del Consejo Europeo, Herman Van Rompuy, a primera hora de la madrugada de este jueves en una comparecencia en la que detalló lo tratado. “La Comisión Europea garantizará que el acuerdo se cumple”, añadió. “La Comisión examinará los progresos y reportará regularmente al Consejo con el objetivo de llegar a la meta del 15% de interconexión en 2030, en particular para los países que todavía no han alcanzado un grado mínimo de integración en el mercado energético, como Portugal, España y los bálticos”, apunta el texto. El proyecto permitirá a España recurrir más rápidamente a otras fuentes de energía cuando detecte un pico de consumo y también vender al exterior la sobreproducción que ahora tiene —por las renovables— y que no puede almacenar. Los líderes acudieron a Bruselas a hablar principalmente de clima y energía, la doble cartera que asumirá en unos días el español Miguel Arias Cañete. La pérdida de confianza en Rusia a raíz de la crisis ucrania ha alertado a los países miembros de que deben mejorar su eficiencia energética, reducir las emisiones contaminantes y, sobre todo, depender menos de Moscú para calentarse. Los líderes comunitarios pactaron tres objetivos: recortar un 40% las emisiones hasta 2030, en comparación con el nivel de 1990; fijar un volumen de renovables equivalente al 27% de la energía consumida y un porcentaje idéntico en eficiencia energética. Ese no fue el único pulso de la cumbre. El primer ministro italiano, Matteo Renzi, hizo público por la mañana un documento confidencial en el que Bruselas presiona a su país para que apruebe un presupuesto más austero. Cartas secretas, golpes bajos y malas artes en el debate fundamental de la política europea: Renzi criticó abiertamente las maneras de la Comisión y advirtió que “el tiempo de las cartas secretas acabó”. No se quedó ahí: ninguneó las diferencias entre Roma y Bruselas, que limitó a “1.000 o 2.000 millones” que Italia “puede poner mañana” sin problemas. Y defendió, junto a la Francia de François Hollande, que recortes adicionales pueden ser contraproducentes por la frágil recuperación. Italia y Francia abogan por incumplir sus compromisos con el déficit. Ambos Gobiernos están dispuestos a hacer alguna concesión para evitar un choque, pero no van a meter la tijera con la intensidad que reclama Bruselas. Pese a que es poco probable que la sangre llegue al río, esa bronca sobrevuela todas las reuniones de líderes europeos: la canciller Angela Merkel anunció a su llegada que el crecimiento debe ser la prioridad, pero advirtió de que a la vez “hay que respetar las reglas fiscales si queremos tener credibilidad”. Hollande y Renzi usaron casi las mismas palabras, pero con un matiz bien distinto: “Respetaremos las normas, pero con el máximo de flexibilidad”. http://internacional.elpais.com/internacional/2014/10/23/actualidad/1414092666_94 1116.html

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ft. com World Europe Brussels October 23, 2014 5:13 pm Row between Rome and Brussels heats up James Politi in Rome

©Bloomberg The European Commission has asked Italy to detail by Friday how it will avoid violating EU budget rules, according to a confidential letter published by the Italian finance ministry that stoked tensions between Rome and Brussels. In a letter to Pier Carlo Padoan, Italy’s finance minister, Jyrki Katainen, the commission’s vice-president, said Rome’s 2015 budget, presented last week, would “breach” EU rules under the stability and growth pact because it did not reduce the country’s structural deficit quickly enough. More ON THIS TOPIC// Brussels Blog It’s Renzi vs Barroso over EU’s budget letter/ Italian budget close to defying EU rules/ Italy poised for property renaissance/ Italy targets legal profession for reform IN BRUSSELS// EU agrees target to cut gas emissions/ Q&A EU’s challenging energy targets/ EU states warn Juncker over trade deal/ EU takes step toward rejecting budgets Mr Katainen then asked Mr Padoan for explanations with regard to how “Italy could ensure full compliance with its budgetary policy obligations” and urged the government to offer an answer at “your earliest convenience and, if possible, by October 24”. Although Italy’s deficit – unlike that of France– is projected to be below the 3 per cent of gross domestic product limit set by the EU, the reduction in the country’s structural deficit – which takes account of economic cycles – is expected to be meagre. Italy is one of five countries – with France, Austria, Slovenia and Malta – to have received notifications this week from Brussels that they could be deemed in violation of EU budget rules set at the height of the eurozone sovereign debt crisis. Italy’s decision to publish the letter from Mr Katainen – which was described as “strictly confidential” – upset the EU and increased friction ahead of an October 29 deadline for Brussels to accept the Italian budget or send it back for revisions. “The commission was not in favour of making that letter public. We are in favour of consultations . . . we want to conduct these talks in an atmosphere of mutual trust, “ José Manuel Barroso, the departing president of the European Commission, said on Thursday. 281

Brussels blog Renzi vs Barroso over EU budget letter

On day one of the EU summit in Brussels, a letter warning over Rome’s new Budget – and Italy’s decision to post it – suddenly became the subject of a very public tit-for-tat between José Manuel Barroso, the outgoing Commission president, and Matteo Renzi, the Italian prime minster Under Matteo Renzi, its 39-year-old reformist prime minister, Italy has been allied with France in arguing for greater flexibility on EU budget rules, amid fears that excessive austerity could further depress its economy, which is already suffering from a triple-dip recession. At a meeting with reporters in Brussels, Mr Renzi said the disagreement was only a matter of €1bn or €2bn, suggesting it could easily be sorted . But Mr Renzi took on Mr Barroso for being surprised at the publication of the commission’s letter to Italy. In a punchy tone, Mr Renzi said there should be no more “secret letters” coming from Brussels in a new age of transparency. On Thursday the country’s budget received the backing of the Bank of Italy, which is independent. “Given the exceptional duration and depth of the recession, the government’s choices appear justified,” it said in its October economic bulletin. If Brussels were to reject Mr Renzi’s budget, Italy may well have to approve additional spending cuts beyond the €15bn already agreed, or reduce some of the €18bn in tax cuts for companies and individuals it had planned. The Italian finance ministry has already said it would provide clarifications to the EU by Friday as requested in the letter, and said its staff was in contact with EU officials. Additional reporting by Duncan Robinson in Brussels http://www.ft.com/intl/cms/s/0/d498e0fc-5ac4-11e4-b449- 00144feab7de.html#axzz3GhDhDPeH

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Insight - Mario Draghi's German problem BY NOAH BARKIN , EVA TAYLOR AND PAUL TAYLOR BERLIN/FRANKFURT/PARIS Thu Oct 23, 2014 5:12pm BST

1 OF 2. Mario Draghi, president of the European Central Bank (ECB), addresses the media during the ECB's monthly news conference in Frankfurt in this September 4, 2014 file photo. CREDIT: REUTERS/KAI PFAFFENBACH/FILES (Reuters) - In early October, European Central Bank board member Benoit Coeure paid a discreet visit to the Chancellery in Berlin to express concerns about rising criticism of the bank from German politicians. The Frenchman, one of ECB President Mario Draghi's closest allies in Frankfurt, hoped for reassurances that the bank bashing, led by Finance minister Wolfgang Schaeuble, would stop. But the message from Chancellor Angela Merkel's advisers was not entirely comforting, according to one official familiar with the discussion. Merkel would continue to refrain from questioning the ECB's policies in public. But the broader backlash would be difficult to contain, especially if Draghi pressed ahead with unconventional measures to bolster the European economy, for example buying mass quantities of government bonds. "Then you would see a real debate," a top German official told Reuters on condition of anonymity. "Public criticism in Germany would take off."

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Back in 2012, Draghi appeared to save the euro zone from breaking up with his promise to do "whatever it takes" to defend the single currency, a stance that won swift backing from Merkel, who said the ECB was acting within its mandate. But two years on, the Italian's relationship with his most important stakeholder - the Germans - is fraying, with worrying implications for Europe and its faltering economy.

This tension is most obvious in the relationship between Draghi and Bundesbank President Jens Weidmann, which according to numerous officials who spoke to Reuters on the understanding they would not be identified, has almost broken down. But it goes further than that. According to German officials, Merkel felt betrayed by Draghi's speech at a central banking conference in Jackson Hole, Wyoming in August in which he pressed Berlin for looser fiscal policy to stimulate the economy. Her entourage is also deeply sceptical about Draghi's plan to buy up asset-backed securities (ABS) and covered bonds in the hope of encouraging commercial banks to lend. Most of all, politicians in Berlin worry that if this scheme doesn't work, the ECB president will be tempted to launch full-blown government bond buying, or quantitative easing. This is a taboo in Germany and a step Merkel's allies fear would play into the hands of the country's new anti-euro party, the Alternative for Germany (AfD). Losing the support of the euro zone's biggest and most influential member state would be fatal for the ECB's credibility, eroding confidence in its ability to work with governments to get the euro zone economy growing again. "Until now the ECB was confident, despite all the criticism in the German media, that it could count on Schaeuble and Merkel," said Marcel Fratzscher, the former head of

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international policy analysis at the ECB and now president of the DIW economic institute in Berlin. "But the recent criticism has been a real wake up call. There are questions about whether they have the full support of Berlin. The German criticism is a big concern for the ECB." The ECB, citing its independence, declined specific comment on the state of relations with Berlin. A German government spokesman said Berlin trusted that the ECB was acting within its mandate to ensure price stability, and would therefore not comment further on its policy decisions. "TOTALLY ROTTEN" Ties between Draghi and Weidmann, a former Merkel adviser who became head of the conservative German central bank three years ago, are now severely strained, according to half a dozen central bankers and government officials who spoke to Reuters. The relationship has never been easy; Weidmann publicly opposed the OMT bond- buying programme that Draghi unveiled months after making his landmark promise. Weidmann has also not shied away from criticising the ECB chief's decisions since then. But in the past months, mutual suspicions have grown, according to officials who know both men. A week after Coeure's visit to Berlin, Draghi and Weidmann's communications chief gave separate briefings on the same day to small groups of German reporters at an International Monetary Fund (IMF) meeting in Washington. Draghi listed all the ECB measures Weidmann had opposed since taking the helm of the Bundesbank. The Weidmann aide complained that the ECB president was keeping national central banks in the dark and not taking time to build consensus in the 24- member Governing Council, according to people who attended the briefings. Days later, at a Governing Council meeting in Frankfurt, the long-simmering row boiled over, with the two central bankers accusing each other of active sabotage through the media, according to one official familiar with the exchange. That evening, at the ECB's annual cultural evening, held at the grand Alte Oper concert house in Frankfurt, the tension around them was palpable. "The relationship is totally rotten, it's beyond repair," said a second official who knows them both. "It has become personal," a third official from the ECB said. "Whenever Draghi and Weidmann are somewhere at the same event, there are bets about whether their paths are going to cross. Weidmann avoids Draghi like the plague." An ECB spokesman played down the conflict, saying it was "healthy" for Governing Council members to hold different views "which are then exchanged in a frank yet collegiate manner". "The decisions taken in the last three years have been backed either unanimously or by the overwhelming majority of Governing Council members," the spokesman added. 285

The Bundesbank declined comment. Tensions between the ECB president and German members of the council are not entirely new. Weidmann's predecessor at the Bundesbank, Axel Weber, and ECB board member Juergen Stark both resigned in 2011 in protest at the bond-buying policies of Jean-Claude Trichet, the Frenchman who led the bank before Draghi. There are no signs that Weidmann might be considering a similar step. "WE WILL HAVE TO FIGHT" But even senior Bundesbank officials have begun to express concerns about the deteriorating relations between the two institutions. ECB Council members admit to being worried about hardening attitudes towards the bank in Germany, where supportive voices like Fratzscher have been drowned out by sceptics such as influential economist Hans-Werner Sinn and Holger Steltzner, the hard- line commentator for the Frankfurter Allgemeine newspaper, who dismiss the ECB as a "bad bank". "We will have to fight" to keep the Germans on board, said one member of the council. Merkel's government stood by the ECB when Weber and Stark bolted three years ago, helping Trichet to ride out the defections. But it seems more unsettled by Draghi's course, partly because of the threat posed by the AfD, a party created last year which made big gains in recent regional elections, stealing votes from the chancellor's Christian Democrats (CDU). One problem, officials says, is that since the departures of board member Joerg Asmussen and Draghi's top adviser Christian Thimann last year, the ECB president has not had a German ally in Frankfurt who can spread his message in Berlin. Asmussen was replaced by Sabine Lautenschlaeger, an expert in financial regulation with no political experience, and Thimann's post was taken by Frank Smets, a Belgian. This is why it fell to Coeure, who took over responsibility for government relations when Asmussen left, to make the trip to the Chancellery earlier this month. Frustrations have been exacerbated by Draghi's leadership style, officials say. The Italian prefers to operate with a small group of confidants, led by Coeure and Peter Praet, the bank's Belgian chief economist, rather than sounding out a broad range of views on the ECB Council, as Trichet often did. "There is a lack of team playing going on in the Governing Council," Juergen Stark, the former ECB board member, told Reuters. "The governance is changing." Before his speech in Jackson Hole, Draghi sought advice from U.S. Federal Reserve Vice Chairman Stanley Fischer, his professor at the Massachusetts Institute of Technology in the 1970s, while leaving some ECB Council members out of the loop. According to one ECB source, Draghi has also clamped down on circulating policy papers to national central banks because they were often leaked. This close-to-the-chest approach has irritated others besides the Germans.

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But the ECB source played down the idea that there were big tensions between the bank and Berlin, noting that Draghi and Schaeuble had talked on the sidelines of the recent IMF meeting and that Merkel had steered clear of criticising the ECB. Still, Schaeuble has grown increasingly outspoken on the direction of policy, saying last month that he was "not particularly happy" with the idea of the ECB buying securitised products like ABS, and telling parliament the ECB had "exhausted" all its tools for reviving the European economy. One official in Berlin who is critical of Schaeuble's recent rhetoric pointed to the AfD as an important new factor that was encouraging Merkel's party to take a tougher line with the ECB. Regardless of the reasons, a growing list of conservative German lawmakers are joining the bandwagon. Earlier this month, Hans Michelbach of the Bavarian Christian Social Union (CSU), the top conservative in the Bundestag's finance committee, went so far as to label Draghi's appointment to the top ECB post a "mistake". (Reporting by Paul Carrel, Andreas Framke and Eva Taylor in Frankfurt, Noah Barkin, Andreas Rinke and Gernot Heller in Berlin, Paul Taylor in Paris, Jan Strupczewski in Brussels; Editing by Mike Peacock and David Stamp) http://uk.reuters.com/article/2014/10/23/uk-ecb-germany-insight- idUKKCN0IC1U720141023

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Last updated:October 23, 2014 5:55 pm Europe gas demand to stay weak until mid-2030, says IEA economist Anjli Raval and Ed Crooks in London

©AFP Natural gas demand in Europe is likely to remain weak for almost two decades, according to the chief economist at the International Energy Agency, casting doubt on the continent’s ability to diversify its energy supplies and achieve climate change goals at an affordable cost.

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“Current European gas consumption is back at where we were 15 years ago,” said Fatih Birolfrom the wealthy nations’ energy watchdog, adding that EU gas consumption would not regain its 2010 level until mid-2030. “I don’t see a bright picture for Europe’s natural gas sector.” More ON THIS TOPIC// Oil Search buoyed by PNG gas project/ Morgan Stanley mulls sale of gas business/ Japan to fire up first LNG trading hub/ US gas prices slip on EIA report IN COMMODITIES// Figure from LME Sumitomo scandal returns/ Oil rises on claims of Saudi supply cut/ Miners face juggling act on dividends/ Goldcorp says Asia buying supports gold Europe, which consumed more than 500bn cubic metres of natural gas at its peak at the height of the boom, saw demand fall to 448 bcm in 2013. Analysts at Energy Aspects, a London-based consultancy, expect the level to fall to 420 bcm this year. A weaker economy since the financial crisis, a push towards renewable energies and low coal prices compared with those for gas, Mr Birol said, were among factors to blame for the weakness of gas demand. Lower carbon taxes that favoured the use of dirtier fuels and the shutdown of gas-fired power stations even as more coal-fuelled ones emerged had not helped either. The IEA will give its detailed assessment on the European gas situation in its annual World Energy Outlook next month. But speaking at a Financial Times conference, Mr Birol said tough policy reforms would have to be enacted for any improvement to be seen. Europe had already fallen behind in pushing gas as part of its energy mix, he said. It is necessary for the continent, like the US, to secure cheaper supplies by pushing shale gas exploration. But the sector has come under fire in Europe for its perceived environmental risks. Instead Europe has spent vast sums to subsidise renewable energy sources, such as wind and solar, as it seeks to reduce carbon emissions. But this has led to high energy prices for businesses and households. Despite sluggish economic growth for the foreseeable future, and poor demand for energy-intensive goods, Mr Birol said gas could fill the vacuum left by a shift away from nuclear power by countries such as France and Germany, if political will allowed. “Today nuclear energy is facing serious problems in Europe. A big chunk of existing nuclear plants are going to be retired in the next 20 years. There may be room for natural gas to fill [the gap] if price is competitive,” said Mr Birol. Francis Egan, chief executive of energy company Cuadrilla Resources, who also attended the conference, said a reconciliation between the gas and renewables sector was necessary. The EU needed to work out where its energy would come from, he said. “If we don’t, the US and China are going to eat our lunch.” http://www.ft.com/intl/cms/s/0/deadcc58-5ac7-11e4-b449- 00144feab7de.html#axzz3GhDhDPeH 288

ft.com comment Columnists October 23, 2014 4:44 pm The jingle that sounds the road to economic recovery

Gillian Tett It sometimes pays to wipe the debt slate clean rather than sweep problems under the carpet

©Getty This winter Patrick Honohan, the governor of Ireland’s central bank, will be listening out for “jingle mail”. It is something of a novel sound for Europe. During America’s subprime crisis of the past decade, thousands of households escaped from hefty mortgages they could not repay by abandoning their homes – and loans – after posting the keys to the lender (with a jingle). Until recently that idea was almost entirely unknown on the other side of the Atlantic. In countries such as Ireland, it has always been difficult for individuals to abandon a debt completely, even after default. But this month Mr Honohan revealed during a debate at the International Monetary Fund that some Irish mortgage providers were now offering “non-recourse” loans, which give them the right to repossess property in the event of default but not to pursue borrowers personally. If these experiments spread, it could change the pattern of mortgages: in future some borrowers could walk away. Jingle mail would have an Irish tone. More ON THIS STORY// Markets Insight Stakes high for Europe bank stress tests/ Banks shun packaged UK mortgage deals/ US risk-retention rule given US approval/ Annuity reforms will ‘restrict mortgages’ ON THIS TOPIC// Record outflows from Europe-focused ETFs/ Martin Wolf Eurozone needs more than reform/ Market turmoil tests investors’ nerves/ Reza Moghadam Break Europe’s taboos GILLIAN TETT// The quiet heroes of wartime Italy/ Markets parched for liquidity/ Philanthropy for dinner/ Cooking on shale

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Is this a good idea? Some say No. Letting the irresponsible escape looks distasteful to responsible borrowers. And when Mr Honohan raised the issue at the IMF meeting, the European bankers in the room were unimpressed. Such revulsion is natural, but it misses the point. Default is never pleasant. In the case of mortgages, it is usually more sensible for banks to restructure delinquent debt (or to avoid making unwise loans in the first place) than to create a system where borrowers can run away from bad loans. But there is one benefit to jingle mail: it draws a line in the sand. And that is something that the eurozone badly needs – in relation to debt of all kinds. To understand why, take a look at the numbers. During the credit bubble household debt as a proportion of disposable income jumped sharply in the US. But since then the ratio has tumbled more than 20 percentage points. About two-thirds of that decline reflects default, as banks foreclosed on delinquent debtors or borrowers ran away. However, the ratio of household debt to gross domestic product in the eurozone has risen, not fallen, since 2008. Corporate debt has also grown. To a degree that reflects Europe’s lack of growth. But lenders have also been painfully slow to resolve bad debts. That is partly because of unrealistic optimism about the future and a shortage of bank capital to absorb write-offs. But another issue is the legal framework: many parts of Europe simply do not have the mechanisms needed to resolve bad loans quickly, be that a system akin to America’s Chapter 11 code for company reorganisation – or jingle mail. Thus in Ireland (to name but one example), one-in-six mortgage borrowers are in default on their loans. However, two-thirds of those loans have never been restructured. Furthermore, while household debt has recently declined a little, a central bank study shows that this decline reflects the efforts of the rich to repair their balance sheets; not any real deleveraging among the poor. The latter remain in limbo. What is still missing, in many quarters, is a recognition by bureaucrats and bankers that failure is an inevitable part of the market system Perhaps that will eventually change. The new, looming, round of bank stress tests from the European Central Bank could prompt lenders to get tougher. And on the ground, there are some hints of practical reform. Sean Hagan, legal counsellor of the IMF, says that in Portugal there is now a big increase in out-of-court restructurings of corporate debt (to circumvent the woefully slow court system). In Spain, corporate debt has recently declined because banks have been more aggressive in forcing through consolidation. Banks are also selling more non-performing loans in places such as Spain, Germany and France to private equity firms, which are aggressively seeking resolution. But what is still missing, in many quarters, is a mindset – most notably a recognition by bureaucrats and bankers that failure is an inevitable part of the market system, and that it sometimes pays to wipe the slate clean rather than endlessly sweep problems under the carpet.

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Letting borrowers run away from bad loans may not be healthy; but it is even less healthy to leave a chunk of the population trapped in the virtual prison of debt that can never be repaid. For evidence of that, just look at Japan. Or to put it another way, if attitudes towards default are now changing in Ireland – a touch – that can only be a good thing, particularly if these ideas spread in the eurozone. The tragedy is that it has taken so long. http://www.ft.com/intl/cms/s/0/cfd24804-5936-11e4-a33c- 00144feab7de.html?siteedition=intl#axzz3GhDhDPeH ft. com World Europe Brussels October 23, 2014 5:13 pm Row between Rome and Brussels heats up James Politi in RomeAuthor alerts

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Although Italy’s deficit – unlike that of France– is projected to be below the 3 per cent of gross domestic product limit set by the EU, the reduction in the country’s structural deficit – which takes account of economic cycles – is expected to be meagre. Italy is one of five countries – with France, Austria, Slovenia and Malta – to have received notifications this week from Brussels that they could be deemed in violation of EU budget rules set at the height of the eurozone sovereign debt crisis. Italy’s decision to publish the letter from Mr Katainen – which was described as “strictly confidential” – upset the EU and increased friction ahead of an October 29 deadline for Brussels to accept the Italian budget or send it back for revisions. “The commission was not in favour of making that letter public. We are in favour of consultations . . . we want to conduct these talks in an atmosphere of mutual trust, “ José Manuel Barroso, the departing president of the European Commission, said on Thursday. Podcast Europe’s budget wrangles

Gideon Rachman is joined by Peter Spiegel, Brussels bureau chief, and Tony Barber, Europe editor, to discuss the threat that the European Commission will reject the budgets of some of Europe’s biggest nations, in particular France and Italy. Is such a move really possible and what would be the political and economic consequences? Under Matteo Renzi, its 39-year-old reformist prime minister, Italy has been allied with France in arguing for greater flexibility on EU budget rules, amid fears that excessive austerity could further depress its economy, which is already suffering from a triple-dip recession. On Thursday the country’s budget received the backing of the Bank of Italy, which is independent. “Given the exceptional duration and depth of the recession, the government’s choices appear justified,” it said in its October economic bulletin. If Brussels were to reject Mr Renzi’s budget, Italy may well have to approve additional spending cuts beyond the €15bn already agreed, or reduce some of the €18bn in tax cuts for companies and individuals it had planned. The Italian finance ministry has already said it would provide clarifications to the EU by Friday as requested in the letter, and said its staff was in contact with EU officials. Additional reporting by Duncan Robinson in Brussels http://www.ft.com/intl/cms/s/0/d498e0fc-5ac4-11e4-b449- 00144feab7de.html#axzz3GhDhDPeH

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Commissioners tasked ‘with putting Europe back on its feet” Juncker sets out his plan By Andy Carling 22.10.2014 - 11:20 There was real excitement in the European Parliament as Jean-Claude Juncker presented his programme for the next five years. The challenges are obvious; growth jobs and reform. Underneath, it is the need to connect an increasingly disillusioned society to the European Project. The new Commission president – there is no danger of parliament not approving – showed he fully understood, “My conviction is this is a last chance saloon commission, either we succeed in bringing people closer to Europe or fail.” Success he said was not just economic, “I would like the EU to find its way back and to have a triple A rating socially, it’s just as important as the financial triple A.” He also promised that Europe’s unemployed would find something under the Christmas tree, “an ambitious €300 billion Investment package for Jobs, Growth and Competitiveness.” Juncker began by saying he wasn’t “going to start a new career as a dictator,” and his political commissioners would have views and he expected “lively debate” in the college. Juncker paid tribute to his predecessor, saying Barroso was “President during a difficult period” and “did a good job” and was “criticised in a way that was embarrassing to me”. Of course, if Barroso was that good, then one can only wonder at what mess would be left behind by a less able commission chief. Much of Juncker’s address concerned how to recover from the previous five years. The new commission “We’re not just a bunch of anonymous technocrats,” he said, insisting “I did all I could to, how do I put it, get some heavyweights from governments” but he lauded their experience, in the EU and in member states. His biggest struggle was in attracting women to the top posts. “Nine out of twenty-eight is pathetic,” he said, and he made perhaps the most extraordinary offer ever heard in the European Parliament, “In the short run, I can’t change my sex, in the longer term, maybe.” More seriously, Juncker blamed the member states, saying “I had to fight national governments to put forward nine women,” and said he turned down some male nominations for commissioner.” He defended his decision to reorganise the commission, “I had the idea of asking the former Prime ministers to balance and co-ordinate the work of others.”

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He added, “My Commission will not only look different but will also work differently. Not as the sum of its parts, but as a team. Not through silo mentalities, clusters and portfolio frontiers, but as a collegiate, political body.” He stressed, “All commissioners must be involved in the task of putting Europe back on its feet.” Changes to portfolios "I have followed - with varying degrees of interest I admit - the EP hearings with the Commissioners-designate," he confessed, and set out the changes he had made as a result of the MEPs interrogations. Violeta Bulc, from Slovenia will get Transport, “while Maroš Šefčovič, an experienced member of the outgoing Commission, will be Vice-President in charge of Energy Union.” “I have decided to enlarge Frans Timmermans' remit to include the horizontal responsibility for sustainable development,” he announced, adding, “Sustainability and environmental concerns are important to our citizens. We have the tools to address them in the new Commission: with powerful green portfolios that have big budgets and regulatory teeth.” One large controversy was dealt with. “Responsibility for medicines and pharmaceutical products will stay with the Directorate-General for Health because I agree with you that medicines are not goods like any other.” Space policy “can make an important contribution to the further development of a strong industrial basis in Europe – one of the priorities of my Commission,” goes to Internal Market. With the parliament unhappy with Hungarian Tibor Navracsics, “I have decided to place Citizenship under the responsibility of Dimitris Avramopoulos Commissioner in charge of Migration and Home Affairs.” In return, the controversial Hungarian gets Sport. There was one more major change, “I have asked Frans Timmermans, in his role as First Vice-President in charge of the Rule of Law and the Charter of Fundamental Rights, to advise me on the matter. There will be no investor-to-state dispute clause in TTIP if Frans does not agree with it too.” In the corridors, the talk is always of winners and losers from any deal, but when it came to the reorganised commission, Juncker had his own view, “The big loser is me!” He explained that he had delegated a lot of his powers to the Vice-presidents, “If I want to see an item on the agenda, I need the agreement of the VP.” The investment package “It is time we had a real 'grand bargain', a broad coalition of countries and the main political parties who will work together on a three pillar structure: structural reforms, fiscal credibility and investment,” he said. “The response to the current economic challenges cannot be top-down. I do not believe in miracles - there is no magic bullet or growth button to push in Brussels. Structural

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reforms, fiscal credibility and investment at national and EU level have to go hand in hand,” he continued. Noting that investment had dropped by €500 billion since 2007, Juncker said, “We are facing an investment gap. We have to work to bridge that gap.” This would be done with his promised €300 billion Investment package for Jobs, Growth and Competitiveness. The commission had not yet met to discuss this, or anything else, but “You have my word that my College will start working on this day and night from the moment we take office.” He added, “We will present the Package before Christmas. This is not a promise, it is an affirmation." He concluded, “This investment programme is very close to my heart. Trying to distract me won’t work.” Digital futures "Every day, Europe is losing out by not unlocking the great potential of our huge digital single market. Jobs that should be there are not being created. Ideas – the DNA of Europe's economy! – do not materialise to the extent they should. Let us change this for the better," he said. Stability pact He tacked the argument between austerity and growth, no mean feat, “To those who think excessive austerity will revive growth, drop those ideas. Dealing with deficit and debt does not automatically lead to growth.” The stability pact was the cause of much disagreement during and after the May European elections, but Juncker thinks he has a suitable compromise – using a degree of flexibility. “Main task ahead of us is combating unemployment, not just the scandalously high youth unemployment, but the whole issue,” he said. “I will abide by what the European Council decide on the stability pact,” he pledged. “The rules will not be changed. We will not touch the rules but the rules will be implemented with a degree of flexibility.” He added, “We will have budgetary discipline, flexibility and reforms.” In conclusion, Juncker reminded MEPs of the outside world, “Citizens are losing faith, extremists on the left and right are nipping at our heels, our competitors are taking liberties. It is time we breathed a new lease of life into the European project.” He added, “It is up to us to ensure that the handwriting of the European Social Model is clearly visible in everything we do.” Yes, ‘Social Europe’ is back on the agenda. http://www.neurope.eu/article/juncker-sets-out-his-plan

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Spain's credit card scandal sparks corruption backlash BY SARAH WHITE AND JESÚS AGUADO MADRID Tue Oct 21, 2014 1:11pm BST QUOTES Bankia SA BKIA.MC €1.33 -0.00-0.38%/ 10/17/2014 (Reuters) - Two days before he quit in May 2012 as chairman of Bankia (BKIA.MC) -- the lender then on the verge of Spain's costliest ever bailout -- Rodrigo Rato took out 1,000 euros (804.49 pounds) in cash on a company credit card. It was his sixteenth withdrawal for that amount in three months, in addition to around 1,500 euros spent on the card in garden centres, restaurants and a tailor, according to documents filed with the Spanish High Court as part of an investigation into whether cards held by Rato and dozens of other former board members and executives were misused for personal expenses. The splurges have sparked fury among Spaniards, who suffered a deep recession after the country's weakest banks were bailed out by European partners to the tune of more than 40 billion euros, and many of whom lost money in the collapse of Bankia. But the case has also raised hopes the financial crisis is finally catching up with bankers and that, with support for anti-establishment parties on the rise, the authorities will at last take a tougher line on corruption. Judges have ordered Rato, a former International Monetary Fund chief, and Miguel Blesa -- who chaired savings bank Caja Madrid before it was merged with others to form Bankia in 2010 -- to deposit millions of euros with the High Court by Wednesday to cover possible civil penalties, or face having assets seized. "There is a greater sensitivity now among judges, even among politicians," said Fernando Jimenez, a political scientist and corruption expert at the

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University of Murcia, highlighting that Spain's opposition Socialist party had kicked out some members caught up in the credit cards probe. "That kind of thing would have been unthinkable even five years ago," he added. Rato, a stalwart of the ruling centre-right People's Party (PP) and a former finance minister, late on Monday asked for a temporary suspension of his PP membership while the case rumbles on, as pressure grew for him to be expelled. Both he and Blesa deny any wrongdoing. Politicians and even royals in Spain have been engulfed in graft scandals in recent years. Public perception of fraud is among the highest in Europe, and after the country's sky-high unemployment rate, corruption has been Spaniards' second-biggest concern since early 2013, official polls show. Yet few people have so far been held to account by long-winded court processes. Most probes into failed savings banks including Bankia are dragging on with no trial in sight. Only at small Caixa Penedes were four ex-managers convicted this year in relation to pension payouts -- though in other countries devastated by banking crises, such as Ireland, convictions have been equally scarce as courts struggle to pin down responsibility for bad management. But the credit card splurges at Caja Madrid and Bankia, on allegedly undeclared tabs unearthed by current managers, have already forced union leaders, business representatives and King Felipe VI's private adviser Rafael Spottorno to step down, as well as tarnishing parties of all leanings. THE LAST STRAW "This marks a beginning and an after in political life (in Spain)," said Joaquin Yvancos, a lawyer representing almost 300 small investors who lost money in Bankia's 22.5 billion euro bailout, and are interested parties in the court probe. "In reality it's not even the worst that has happened at Caja Madrid and Bankia ... but as far as public opinion was concerned, it was the last straw." Other probes are now underway, with Spain's tax office investigating the country's large companies over possible misuse of credit cards too, though few expect a quick resolution of any ongoing investigations.

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The FROB, which handles government stakes in banks, last week sent prosecutors details of irregular real estate and debt operations at Catalunya Banc and NCG Banco, two rescued lenders it has already sold off at a loss for taxpayers. The deals, from several years ago, could have caused combined losses of about 1.5 billion euros, the FROB said. Rato has to deposit 3 million euros with the court on Wednesday and Blesa, a friend of former PP Prime Minister Jose Maria Aznar, has to pay 16 million euros. Their lawyers did not return requests for comment. Rato and Blesa were among those who this week testified in Spain's High Court they thought the credit cards were part of their salaries, said a source present at the hearings, which were closed to the public. Rato, who spent around 99,000 euros on his -- less than some colleagues -- said he had thought the cards were authorized and subject to tax, according to the source. About 15.5 million euros was racked up on the Bankia and Caja Madrid credit cards by 86 former staff between 2003 and 2012, the court documents seen by Reuters show. The purchases, a mix of the mundane and the extravagant -- from cinema tickets, groceries and flowers to jewels, holidays and clothes -- have fuelled public demands for reform. "They're always charging us commissions ... and at their end, it's just take, take, take," said Gregoria Alonso, a fruit stall manager in Madrid and a Bankia customers. (Additional reporting by Carlos Ruano; Editing by Julien Toyer and Mark Potter) http://uk.reuters.com/article/2014/10/21/uk-spain-banks-scandal- idUKKCN0IA1B920141021

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The world's richest economies China no more Oct 16th 2014, 8:13BY C.W. | IN THIS week’s print edition we published a chart that looks at the world’s biggest economies over time. We timed it to coincide with the news that China, at least in purchasing-power parity terms, is now the world's biggest economy. People tend to find this historical stuff rather interesting, so below we have produced a similar chart that shows GDP per capita over the same time frame. The results are quite different. Europe is much more dominant than it was in the original chart. The Netherlands, which does not feature at all in the original graph, does particularly well. Britain, which during the 1700s and 1800s developed a capital-intensive, trade-boosting navy, was a leader during these two centuries. By the 1950s, tiny but oil-rich states did nicely.

For analysis of Europe's ascendancy, see our discussion of the "Great Divergence". http://www.economist.com/blogs/freeexchange/2014/10/worlds-richest-economies 299

Five Reasons Not to Fear Deflation: Which Ones Make Sense? Author: Ed Dolan · October 23rd, 2014 · Comments (1) In a post earlier this week, I explained why a majority of economists fear deflation. They argue that deflation disrupts the operation of financial markets and labor markets in a way that risks touching off a downward spiral. At the same time, they say, deflation weakens the power of monetary policy to reverse the downward slide. Even radical measures like quantitative easing have limited power. For that reason, the standard advice is to prevent deflation before it gets started. In the conventional view, that can best be done by maintaining a moderate but positive rate of inflation of 2 percent or so—enough to provide a cushion against unexpected economic shocks. Not all economists are aboard the anti-deflation bandwagon, however. Some argue that deflation is actually a good thing, while others make the more nuanced argument that deflation can be either benign or malign according to circumstances. Let’s take a look at some of their arguments to see which make sense and which do not. Three weak arguments in support of deflation Before turning to the serious reasons why deflation might not always bad, let’s begin with three pro-deflation arguments that seem to me to be weak. The benefits of low interest rates. Writing in Forbes, John Matonis tells us, “Contrary to the central banking and political class’s insistence that deflation must be prevented at all costs, an economy with a monetary unit that increases in value over time provides significant economic benefits such as near zero interest rates.” To understand what is wrong with this argument, we need to distinguish between nominal and real interest rates. As we saw in the preceding post, nominal interest rates are those stated in terms of dollars of interest per year per dollar of the amount borrowed—the way interest rates are expressed on loan contracts and ads in the window of your local bank. The real interest rate, on the other hand, is the nominal interest rate minus the rate of inflation. The real interest rate represents the true burden on the borrower and the true return to the lender. If there is no inflation, a nominal interest rate of 5 percent means that a person who borrows $100 for a year at 5 percent will have to put up $105 at the end of the year to repay the loan, a sum that has a purchasing power 5 percent greater than that of the original $100 borrowed at the beginning of the year. On the other hand, if the loan terms are the same but there is 4 percent inflation over the course of the year, the $105 surrendered by the borrower has a purchasing power equivalent only about 1 percent higher than the $100 borrowed had at the beginning of the year. The real interest rate is just 1 percent. The problem with Matonis’ contention that deflation brings low interest rates is that it applies only to nominal rates. In times of deflation, nominal interest rates go down, but

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when they get to zero, they hit their lower bound. We cannot have negative nominal interest rates—at least not for ordinary borrowing and lending between private parties. Once nominal interest rates hit the zero bound, then, any increase in the rate of deflation causes the real interest rate to increase. If the nominal rate is zero and we subtract a rate of inflation of -2 percent (that is, if prices are falling at 2 percent per year), then we get 0 – (-2) = +2 percent for the real rate. If the rate of deflation accelerates to 5 percent, then we get 0 – (-5) = +5 percent for the real rate, and so on. In short, the faster the rate of deflation, the higher the real interest rate. If you want to ease the burden of borrowing in order to encourage people to buy cars and build houses, you need low real interest rates, so should strongly oppose any but the mildest forms of deflation. Lower prices increase demand. On the web site of the Ludwig von Mises Institute, Doug French writes, “Lower prices increase demand; they do not reduce or delay it. That’s why more and more people own flat-screen TVs, cellular telephones, and laptop computers: the prices of these goods have fallen, and people with lower incomes can afford them.” The problem here is that the examples of flat-screen TVs and similar items pertain to decreases in relative prices. No one disputes that when the price of one good falls relative to others, demand for that good tends to increase. However, a decrease in relative prices is not deflation. Deflation means a decrease in the average price level of all goods and services. When the average price level falls, the sales revenues of producers also fall, which in turn, squeezes their profits and puts downward pressure on nominal wages. In short, because general deflation tends to cut both the average level of prices and average incomes, it does nothing to increase anyone’s purchasing power, whether they be rich or poor. Deflation encourages saving. In an interview with Louis James, editor of the International Speculator, Doug Casey says, “Deflation can be a very good thing, because when dollars are worth more over time, it encourages people to save—and one of our big problems is that nobody’s saving.” This is the exact opposite of French’s argument that deflation makes people spend more and save less. Both arguments can’t be true, and if French is wrong, then Casey could be right. In fact, he is right, at least in part. Rapid deflation does tend to push up real interest rates, and by itself, that does give people an incentive to save more. He is also right that in the long run, economies where people save and invest more will tend to grow more rapidly than ones where saving and investment are low. The problem here is one of timing. An economic slump that is deep enough to produce rapid deflation is exactly the wrong time for added saving. As we saw in the preceding post, during a deflationary slump, borrowers are struggling to pay off expensive loans that they took out earlier when nominal interest rates were high. Banks are reluctant to make loans because they fear defaults and falling values of collateral. To get out of a severe recession like that, the economy needs more spending, not more saving. Bad deflation and good deflation Not all pro-deflation arguments rest on such weak foundations. A more credible argument holds that deflation may be bad, but it is not always bad. 301

Chris Farrell, a contributing editor at BloombergBusinessweek, puts it this way: How fearful should we be of deflation? It depends on why prices are falling. Bad deflation stems from a “demand shock” in a highly indebted economy, say, a housing market implosion or collapsed banking system (the story of the Great Depression and Great Recession). . . Deflation isn’t always bad, however. Sometimes, mild deflation can signal a vigorous, creative, healthy economy. Good deflation stems from a positive supply shock, e.g., a string of major innovations that combine to push down costs and prices while opening up new markets and opportunities. In a more analytical paper, economist George Selgin says much the same thing: The truth, however, is that deflation need not be a recipe for depression. On the contrary, a little deflation can be a good thing, provided that it is the right kind of deflation. Since the disastrous 1930s, economists and central bankers seem to have lost sight of the fact that there are two kinds of deflation—one malign, the other benign. Malign deflation, the kind that accompanied the Great Depression, is a consequence of shrunken spending, corporate earnings, and payrolls. . . Strictly speaking, even in this case, it is not so much deflation itself that is harmful as its underlying cause, an inadequate money stock. In response, firms are forced to curtail production and to lay off workers. Prices fall, not because goods and services are plentiful, but because money is scarce. Benign deflation is something else altogether. It is a result of improvements in productivity, that is, occasions when changes in technology or in management techniques allow greater real quantities of finished goods and services to be produced from a given quantity of land, labor, and capital. A simple equation will help to understand the difference between good and bad deflation. Let P stand for the price level, Y stand for real GDP, and Q stand for nominal GDP. By definition, Q = P X Y. Malign deflation is driven by a collapse in nominal GDP, whether attributable to a decrease in the money stock (as Selgin suggests) or some other cause. As Q falls, both P and Y fall along with it. In contrast, benign deflation occurs when rising productivity causes Y to grow strongly, while monetary and fiscal policy hold Q unchanged, or allow it to grow a little, but not as fast as Y. By simple arithmetic, P must then fall, producing moderate deflation. For three reasons, the benign, supply-side variant of deflation does not produce the downward spiral described in the first part of this series: 1. Strong investment demand keeps real interest rates high enough to prevent nominal rates from hitting the zero bound despite a moderately negative rate of inflation. For example, we might have a 3 percent real interest rate and a -1 percent annual change in the price level, allowing a nominal interest rate of +2 percent. 2. Strong demand for housing, factories, industrial equipment and other real assets supports the value of the collateral that backs bank loans. Even when occasional

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defaults occur, lenders are able to sell their collateral for enough to cover the outstanding balance of the loan. 3. Rising productivity and full employment ensure that real wages are rising. Even if deflation holds the growth of nominal wages below that of real wages, it can still be positive. For example, real wages might grow by 4 percent per year while nominal wages grow by 3 percent. With paychecks growing and workers’ standard of living growing even faster, there is little cause for widespread labor unrest. Can benign deflation happen in the real world? Yes. As the following chart from a 2003 IMF paper shows, the average trend of prices was downward in both the US and the UK throughout most of the nineteenth century, and more briefly, in the 1920s. These were, on the whole, periods of healthy economic growth, despite interruptions by periodic recessions in the nineteenth century.

Unfortunately, it has been almost 100 years now since any major economy has experienced a lengthy episode of benign, productivity-driven deflation. The best known deflation of recent years is that which has afflicted Japan on and off since the 1990s. It has been of the malign variety, accompanied by stagnation of real output and rising unemployment. The deflation now threatening the eurozone is clearly more like Japan’s than like the benign inflation of the 1920s. Is it really all that hard to reverse deflation? Finally, some economists argue that we need to have no fear of deflation, not because it is good, but because it should be easy to reverse and even easier to avoid. The trick, they say, is to provide monetary and fiscal stimulus in a sufficiently vigorous and coordinated way. This argument has been made by modern monetary theorists like

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William K. Black and also by more orthodox economists like Willem H. Buiter, chief economist at Citigroup. According to this view, monetary policy alone, even in the form of quantitative easing (QE), cannot cure severe deflation. Although QE floods the banking system with new reserves, growth of reserves does not by itself guarantee more lending and spending. That is especially true in a slump, when potential borrowers are already struggling to work off excessive debt and lenders are afraid of defaults and falling prices for collateral. Fiscal stimulus, whether in the form of additional government purchases, tax cuts, or transfer payments, cannot do the job alone either. According to the conventional view, without support from monetary stimulus, fiscal stimulus would drive up interest rates, which in turn would crowd out private spending and make the stimulus less effective. The right course, then, would be to apply expansionary fiscal and monetary policy together, in massive doses if necessary. Buiter calls large-scale tax cuts or transfer payments financed by the monetary expansion “the combination that always succeeds.” How exactly could we implement such a policy? Milton Friedman famously proposed that the Fed could print tons of fresh $100 bills and drop them over city streets and shopping malls from a helicopter. People would treat the $100 bills as newfound wealth and would spend at least a substantial part of the windfall. Paper currency, although technically a liability of the federal government, bears no interest, so it would not push up interest rates and crowd out private borrowing. Because paper currency has no expiration date, it does not require tax increases or cuts in other spending to service the debt. A helicopter drop would be a foolproof way to stimulate aggregate demand. In practice, there would be no need for actual helicopters. The Treasury could accomplish exactly the same thing by mailing tax rebate checks to every household. For internal bookkeeping purposes, it would cover the checks by selling an equivalent quantity of newly issued Treasury bonds to the Fed, which, in turn, would credit that amount to the account it keeps open for use by the Treasury. Just like a literal helicopter drop, this operation would give consumers a windfall increase in wealth without increasing the net amount of redeemable, interest-bearing government debt in the hands of the public. Instead of transfer payments, an increase in government purchases of goods and services, financed in the same way, would have much the same effect. However, although the economic logic of a helicopter drop is strong, political constraints make such a policy hard to implement. One such constraint is the belief that a prudent government should confront hard times in the same way that a household does, by cutting expenditures and paying off debt. This view, often derisively called “austerianism,” is particularly strong among politicians and the general public in Germany and the United States. Japan is the country that has done the most to use coordinated fiscal and monetary expansion to break out of deflation. Shinzo Abe, prime minister since December 2012, has backed an expansionary program, popularly known as “Abenomics,” that consists of three components (three “arrows”, he calls them). The first is monetary policy that targets a 2 percent minimum rate of inflation (rather than treating 2 percent inflation as

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an upper limit, as in the EU). The second arrow is expansionary fiscal policy and the third is a package of pro-growth structural reforms. To date, however, only the monetary component has come fully into force. An increase in consumption taxes earlier this year seriously undercut the fiscal component while structural reforms have been slow to get off the ground. Although inflation has been above the 2 percent mark since April, growth of real GDP fell below zero in the second quarter, breaking a run of three quarters of strong growth. The ultimate success of Abenomics remains uncertain. The bottom line We have now reviewed five reasons not to fear deflation. None of their supporting arguments can be accepted without reservation and some not at all. The first three reasons are the claims that deflation benefits the economy through low interest rates, increased spending, and increased saving. Each of these arguments appears to rest on faulty economic reasoning. The fourth reason is that deflation can take both good and bad forms. This proposition appears to be conceptually sound. It is further supported by historical episodes in the US and UK when economies experienced sustained economic growth combined with a falling price level. The only problem is that the deflation that Japan has experienced on and off since the 1990s and that which faces the eurozone today are clearly of the malign variety, driven by a collapse of demand rather than a productivity boom. At least in the short run, the benign deflation scenario looks more like a theoretical and historical curiosity than a serious pathway to prosperity for Europe. The final reason not to fear deflation is that even if it is harmful, it can easily be reversed through a sufficiently strong and properly coordinated program of fiscal and monetary stimulus. The necessary stimulus could come in the form of a hypothetical “helicopter drop,” or more concretely in the form of something like Abenomics. The reservation here is that although the economic reasoning is sound, there is strong political resistance in many countries to implementing any such policy. The bottom line, then, is that Europeans are right to fear deflation. Countries such as Greece, Spain, and Italy where prices have been falling are experiencing high unemployment, declining living standards, and social unrest. Others that are slipping toward deflation, like France and Belgium, fear the same outcome. France and Italy are currently making a last-ditch effort to form an anti-austerity coalition within the eurozone. They appear to have the support of Mario Draghi at the European Central Bank. However, they are meeting stubborn opposition from German politicians who remain determined to balance their own budget despite a slowing economy and to enforce strict budget rules for the rest of the currency area. The eurozone economy, then, appears poised between outright deflation and mere stagnation, with an early return to prosperity no more than a slim hope. - See more at: http://www.economonitor.com/dolanecon/2014/10/23/five-reasons-not- to-fear-deflation-which-ones-make- sense/?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+econ omonitor%2FOUen+%28EconoMonitor%29#sthash.VKyUhj0V.dpuf

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Juncker tells Cameron: you can’t destroy EU migration rules Commission president warns PM over ‘irresponsibility’ as new poll reveals 56% support in Britain for remaining in union Nicholas Watt, chief political correspondent The Guardian, Thursday 23 October 2014

Jean-Claude Juncker: 'This is a basic principle of the EU since the very beginning and I am not prepared to change this.' Photograph: Patrick Seeger/EPA Jean-Claude Juncker, the incoming president of the European commission, has rejected out of hand any attempt by David Cameron to “destroy” the fundamental rules of the EU on free movement of people. In an echo of the remarks by the outgoing president José Manuel Barroso, who warned that the prime minister is making a “historic mistake” on the EU, Juncker said on Wednesday that he would not compromise in an “irresponsible way” on rights that date back to foundation of the EEC. The intervention by Juncker, at the European parliament in Strasbourg, as MEPs approved the appointment of his new commission team, came as a new poll showed growing support among UK voters for continuing membership of the EU. The Ipsos Mori poll, commissioned by the pro-EU Business for New Europe group, found that 56% of voters would support UK membership while 36% would vote to leave if a referendum were held now. The poll shows support for the EU has risen since the issue returned to centre stage with the rise of Ukip after the PM suggested in the summer of 2012 that he would support a referendum on EU membership. In November 2012, five months after Cameron floated the idea of a referendum and two months before he formally committed himself to one, Ipsos Mori found 48% of voters would like to leave the EU while 44% would support membership. The latest poll is a mixed blessing for pro-Europeans. It shows that 43% of voters either broadly support Britain’s EU membership terms (29%) or support the idea of the UK joining with other member states for closer integration (14%). But the poll also found that 51% of voters want Britain to be a member of an economic community with no political links (34%) or would like to leave the EU altogether (17%).

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Juncker said he would like to help secure a “fair deal” with Cameron if he were to put a package of reforms to EU leaders after a general election win. But the incoming commission president brushed aside recent suggestions from government sources that restrictions should be imposed on migrants from current EU states. Speaking at a press conference at the European parliament, Juncker said: “As far as the freedom of movement is concerned ... I do think this is a basic principle of the EU since the very beginning and I am not prepared to change this because if we are destroying the freedom of movement other freedoms will fall in a later cause. So I am not ready to compromise in an irresponsible way.” But Juncker said that any EU leader was free to table proposals to the European Council – the body that comprises the leaders of the 28 EU member states. He added: “We want a fair deal with Britain and it has to be seen how far reaching the compromises can be. “I am not in a situation to tell you exactly what the British government will propose and so I am not in a position to tell you what the European commission will deliver as an answer to a British request. But this is not as dramatic a question as it seems. Believe me, it is not as dramatic as it seems.” Cameron is expecting to face questions about his reform plans on the margins on an EU summit in Brussels today and on Friday which will formally discuss climate change, economic growth, the Ebola crisis and Ukraine. Herman Van Rompuy, the outgoing European Council president, has said that he would like EU leaders to agree to cut the EU’s carbon emissions by 40% below 1990 levels by 2030. Cameron is planning to shame fellow EU leaders over their dinner on Thursday night into stepping up their response to the Ebola crisis by ensuring that the combined contribution of all 28 EU member states amounts to €1bn and that 2,000 workers are sent to west Africa. Britain has contributed £125m (€156m) to its former colony Sierra Leone. The prime minister will say that Britain is contributing €40m ahead of the EU’s largest economy, Germany, four times more than France and 50 times more than Spain, which “with the cases they have had in Madrid have got a real experience of the challenges presented by Ebola”. The total amount pledged by EU states so far amounts to €750m. Alisdair McIntosh, director of Business for New Europe, said of the new poll: “Many of the public recognise the important economic benefits of staying within the EU. Politicians are mistaken if they think people just want to hear ever-louder Eurosceptic rhetoric, especially at a time of economic and political uncertainty. This only increases cynicism about the major political parties. “Politicians need to lead from the front, not shout from the back. They need to set the agenda, and reflect the importance of EU membership to business and the economy. The way to promote prosperity in Britain is to secure realistic reforms of the EU. The government should fight for the reforms that matter most – those that will create growth and jobs.” http://www.theguardian.com/world/2014/oct/23/juncker-tells-cameron-cant-destroy-eu- migration-rules?CMP=EMCNEWEML6619I2

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ft.com Comment Blogs Gavyn Davies

It is very striking that western commentators and investors have become extremely sceptical about any good news emanating from the Chinese economy. This week, for example, official economic data showed growth in gross domestic product at a quarterly annualised rate of about 8 per cent, with industrial production bouncing back in September from a weak reading in August. Yet markets were unimpressed. Although this latest news clearly reduced the danger that China is entering a hard landing as the property sector adjusts sharply, many headlines proclaimed, correctly, that the economy is now growing at the slowest pace since the last recession. So is China bouncing back from a weak patch of growth, or is it headed for a prolonged slowdown lasting many years?Actually, both are probably true. Cyclical fluctuations are occurring around a clearly slowing long-term trend for growth, and this can defy simple good news/bad news interpretations. At present, it seems that the latest cyclical slowdown is being controlled, despite the property crash. First, let us examine the latest fluctuations in the short-term cycle. According to the official data, real GDP growth has bounced back from its weakness at the start of the year, with two successive quarterly annualised growth rates at just above 8 per cent. Because the first-quarter of 2014 was extremely weak, however, the 12-month growth rate has slowed to about 7.3 per cent, which is fractionally lower than in the past couple of years. 308

The pessimists have focused on this, and on the fact that industrial production has slowed down more than real GDP. As usual, there is also widespread scepticism about the accuracy of official Chinese data, given that some series such as cement, steel and electricity production have plummeted. The benign explanation for all this is that the industrial sectors closest to the property market are indeed suffering a hard landing, but this is being offset by firm growth in real retail sales, especially in the internet retail sector, which is up 50 per cent on last year. Growth in “new China” is offsetting the slowdown in “old China” in this interpretation. Another supportive factor has been firmness in exports, which is encouraging and somewhat surprising in view of growing pessimism about global economic activity. The next few months will be crucial. The shake-out in the property sector will continue and, according to Goldman Sachs, this might reduce the contribution of housing investment to GDP growth from 1.8 per cent in 2013 to about 0.3 per cent by next year. This hit to growth has been met by a major easing in monetary conditions, which started in February and is still under way. Fiscal policy is also being fine tuned to ensure that the imploding housing sector does not cause a hard landing for the economy as a whole.

So far, so good, then on the latest cycle. But what about the longer term? Until 2011, mainstream economic forecasters (such as the International Monetary Fund, for example) believed that the trend growth rate in China would remain in the 9-10 per cent region for as far ahead as the eye could see. Now almost no one thinks that. The IMF now seems to think that the trend growth rate is declining gradually to only about 6.3 per cent by about 2019. Others are more pessimistic. The Conference Board forecast this week that trend growth after 2020 would be only 4 per cent a year, and warned that this “long, soft fall” in growth would inevitably have painful patches. The reasons given by forecasters for these large markdowns in China’s medium-term growth projections are familiar:

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• the need to reduce the rate of growth in credit/GDP ratio will slow the growth in investment; • as investment slows, the growth in industrial capacity, which has been the main source of expansion from the supply side, will drop; • the process of urbanisation will slow or even stop altogether, and the transport and housing infrastructure that is needed is already in place; • the reform of the financial sector will lead to higher interest rates and to much slower lending from shadow banks to the local government and other state- owned entities that have until recently been a prime source of growth. This powerful set of factors underpins the much more cautious projections that have now become the norm for China’s medium-term growth rate. History has plenty of earlier examples of countries that have failed to live up to excessively optimistic extrapolations of spurts in GDP growth, including the Soviet Union in the 1980s, Japan in the 1990s and even Argentina a century ago. Lawrence Summers and Lant Pritchett have just released an updated version of their fascinating study on the powerful nature of mean reversions in medium-term growth rates. These are replete in the historical database of economic growth rates. (See this excellent summary by David Keohane at FT Alphaville.) Their key point is that high growth rates in the recent past do not offer much reason to believe that growth will be higher than the world average in the medium-term future. What goes up must come down, is the gist of the message. This applies in particular to growth spurts in emerging markets, and to situations in which there is a shift away from authoritarianism. For China, they argue that “par” for the statistical course would involve a decline in the trend growth rate to only 5 per cent over the next 10 years, and to 3.9 per cent on average over the next two decades. The latest IMF and consensus forecasts for China’s medium-term growth rate have started to come more into line with the Summers/Pritchett norms, but they are not there yet. In assessing Chinese growth data, investors therefore need to juggle with two different forces. First, the long-term trend growth rate is probably slowing from about 7.5 per cent now to, at best, 6 per cent by 2020 (with a lot of uncertainty around that). Second, there will be cyclical fluctuations around that trend, which the authorities will seek to smooth through policy changes. Financial markets are likely to be sensitive not to the decline in the long-term trend, but to significant cyclical fluctuations below that trend (“hard landings”). The latest data are not indicative of a hard landing at present. http://blogs.ft.com/gavyndavies/2014/10/23/chinas-slowdown-is-secular-not-cyclical/

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Environment & Sustainability

Jeffrey D. Sachs Jeffrey D. Sachs, Professor of Sustainable Development, Professor of Health Policy and Management, and Director of the Earth Institute at Columbia University, is also Special Adviser to the United Nations Secretary-General on the Millennium Development Goals. His books include The End of Poverty and Common Wealth. OCT 23, 2014 A New Macroeconomic Strategy NEW YORK – I am a macroeconomist, but I dissent from the profession’s two leading camps in the United States: the neo-Keynesians, who focus on boosting aggregate demand, and the supply-siders, who focus on cutting taxes. Both schools have tried and failed to overcome the high-income economies’ persistently weak performance in recent years. It is time for a new strategy, one based on sustainable, investment-led growth. The core challenge of macroeconomics is to allocate society’s resources to their best use. Workers who choose to work should find jobs; factories should deploy their capital efficiently; and the part of income that is saved rather than consumed should be invested to improve future wellbeing. It is on this third challenge that both neo-Keynesians and supply-siders have dropped the ball. Most high-income countries – the US, most of Europe, and Japan – are failing to invest adequately or wisely toward future best uses. There are two ways to invest – domestically or internationally – and the world is falling short on both. Domestic investment comes in various forms, including business investment in machinery and buildings; household investment in homes; and government investment in people (education, skills), knowledge (research and development), and infrastructure (transport, power, water, and climate resilience). The neo-Keynesian approach is to try to boost domestic investment of any sort. Indeed, according to this view, spending is spending. Thus, neo-Keynesians have tried to spur more housing investment through rock-bottom interest rates, more auto purchases through securitized consumer loans, and more “shovel-ready” infrastructure projects through short-term stimulus programs. When investment spending does not budge, they recommend that we turn “excess” saving into another consumption binge.

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Supply-siders, by contrast, want to promote private (certainly not public!) investment through more tax cuts and further deregulation. They have tried that on several occasions in the US, most recently during the George W. Bush administration. Unfortunately, the result of this deregulation was a short-lived housing bubble, not a sustained boom in productive private investment. Though policy alternates between supply-side and neo-Keynesian enthusiasm, the one persistent reality is a significant decline of investment as a share of national income in most high-income countries in recent years. According to IMF data, gross investment spending in these countries has declined from 24.9% of GDP in 1990 to just 20% in 2013. In the US, investment spending declined from 23.6% of GDP in 1990 to 19.3% in 2013, and fell even more markedly in net terms (gross investment excluding capital depreciation). In the European Union, the decline was from 24% of GDP in 1990 to 18.1% in 2013. Neither neo-Keynesians nor supply-siders focus on the true remedies for this persistent drop in investment spending. Our societies urgently need more investment, particularly to convert heavily polluting, energy-intensive, and high-carbon production into sustainable economies based on the efficient use of natural resources and a shift to low-carbon energy sources. Such investments require complementary steps by the public and private sectors. The necessary investments include large-scale deployment of solar and wind power; broader adoption of electric transport, both public (buses and trains) and private (cars); energy-efficient buildings; and power grids to carry renewable energy across large distances (say, from the North Sea and North Africa to continental Europe, and from California’s Mojave Desert to US population centers). But just when our societies should be making such investments, the public sectors in the US and Europe are on a veritable “investment strike.” Governments are cutting back public investment in the name of budget balance, and private investors cannot invest robustly and securely in alternative energy when publicly regulated power grids, liability rules, pricing formulas, and national energy policies are uncertain and heavily disputed. In the US, public investment spending has been slashed. Neither the federal government nor the states have political mandates, funding strategies, or long-term plans to catalyze investment in the next generation of smart, clean technologies. Both neo-Keynesians and supply-siders have misunderstood the investment paralysis. Neo-Keynesians see investments, public and private, as merely another kind of aggregate demand. They neglect the public-policy decisions regarding energy systems and infrastructure (as well as the targeted R&D to promote new technologies) that are needed to unleash smart, environmentally sustainable public and private investment spending. Thus, they promote gimmicks (zero interest rates and stimulus packages), rather than pressing for the detailed national policies that a robust investment recovery will require. The supply-siders, for their part, seem utterly oblivious to the dependence of private investment on complementary public investment and a clear policy and regulatory 312

framework. They advocate slashing government spending, naively believing that the private sector will somehow magically fill the void. But, by cutting public investment, they are hindering private investment. Private electricity producers, for example, will not invest in large-scale renewable energy generation if the government does not have long-term climate and energy policies or plans for spurring construction of long-distance transmission lines to carry new low-carbon energy sources to population centers. Such messy policy details have never much bothered free-market economists. There is also the option of using domestic saving to boost foreign investments. The US could, for example, lend money to low-income African economies to buy new power plants from US companies. Such a policy would put US private saving to important use in fighting global poverty, while strengthening the US industrial base. Yet here, too, neither the neo-Keynesians nor the supply-siders have exerted much effort to improve the institutions of development finance. Instead of advising Japan and China to raise their consumption rates, macroeconomists would be wiser to encourage these economies to use their high savings to fund not only domestic but also overseas investments. These considerations are reasonably clear to anyone concerned with the urgent need to harmonize economic growth and environmental sustainability. Our generation’s most pressing challenge is to convert the world’s dirty and carbon-based energy systems and infrastructure into clean, smart, and efficient systems for the twenty-first century. Investing in a sustainable economy would dramatically boost our wellbeing and use our “excess” savings for just the right purposes. Yet this will not happen automatically. We need long-term public-investment strategies, environmental planning, technology roadmaps, public-private partnerships for new, sustainable technologies, and greater global cooperation. These tools will create the new macroeconomics on which our health and prosperity now depend. https://www.project-syndicate.org/commentary/declining-investment-in-rich-countries- by-jeffrey-d-sachs-2014-10

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ft.com Comment Blogs FT Alphaville Welcome [email protected] Regressing to the mean in China or why if something cannot go on forever, it will stop David Keohane Author alerts | Oct 20 09:39 | 12 comments | Share GET ALERTS With a h/t to Marginal Revolution, here’s Larry Summers and Lant Pritchett on why — for the same reason the USSR didn’t overtake the US, and Shinzo Abe has a tough job on his hands — “excessive extrapolation of performance in the recent past and treating a country’s growth rate as a permanent characteristic rather than a transient condition” is a bad idea. Most particularly where China is concerned. From the paper (our emphasis): We are trying to reverse the default assumptions often made in forecasting GDP, which is that, in the absence of any reason to think otherwise, the current growth rate persists. In this view what has to be justified with argumentation is why the growth rate would decelerate. However, this mode of forecasting or projection or even formulation of scenarios is counterfactual to the single most robust fact about growth rates, which is strong reversion to the mean. Our argument is that the default prediction/projection/forecast should be that a country’s growth rate will be subject to regression to the mean. What has to be justified with argumentation is why the growth rate would persist at rates higher (or lower) than the world mean growth rate. So when looking at China, the default position has to be that growth will slow… because, even aside from the related Pettis led rebalancing arguments, that’s what rapid growth does. Of course, those same Pettis led arguments and the nature of its authoritarian system mean China is perhaps even more vulnerable to such regression. Hello Fourth Plenum based on a Chinese conception of the rule of law, do please meet the need to rebalance an economy stuffed with elite beneficiaries of the rent-seeking status quo. As Summers and Pritchett somewhat understate, “it is difficult for corruption to remain organized during a transition in political power.” Or, to put it another way, if China is moving to build more social capital and robust institutions in order to transition to another stage of (most probably lower growth) it will not be a painless process. Anyway, the real point from Summers and Pritchett is that we should pay less attention to the middle income trap as simple regression to the mean is more relevant and is “perhaps the single most robust and empirical relevant fact about cross-national growth rates”. 314

Which makes continued high Chinese growth rather unlikely and a fall to 3.9 per cent rather more likely: …knowing the current growth rate only modestly improves the prediction of future growth rates over just guessing it will be the (future realized) world average. The R- squared of decade-ahead predictions of decade growth varies from 0.056 (for the most recent decade) to 0.13. Past growth is just not that informative about future growth and its predictive ability is generally even lower over longer horizons… There is some consensus that China will not maintain 9 to 10 percent growth rates, but even the view that China’s growth will slow to something like 7 percent assumes substantial persistence. The predicted growth over the next two decades using regressions is 3.9 percent (with a coefficient on past growth of 0.24), and the regression standard error of estimation is 1.6 percent, so a continuation of even 7 percent is two standard deviations in the tail, and a continuation of a growth rate of 9 percent is three standard deviations. So yeah, it’s possible that China will keep going at elevated growth rates above 7 per cent but it would be a real tail event. The fact is that “China’s experience from 1977 to 2010 already holds the distinction of being the only instance, quite possibly in the history of mankind, but certainly in the data, with a sustained episode of super-rapid (> 6 ppa) growth for more than 32 years”. Hell, the risk of a sudden stop is arguably more likely than that continuing into the future. Speaking of extremely unlikely scenario’s, here’s as aside on what Summers and Pritchett have to say on China transitioning to democracy: Among 22 countries in which episodes of large democratic transition coincided with above-average growth, all but one (Korea in 1987 with an acceleration of only 0.22 percent) experienced a growth deceleration. The combination of high initial growth and democratic transition seems to make some deceleration all but inevitable. The magnitude of the decelerations was very large: The median deceleration across the 22 countries was 2.99 percent and the average deceleration was 3.53 percent. And, perhaps more relevant, here’s what the broader risk of a slowdown means for the rest of us: If China and India continued at their current rate, they would reach over $66 trillion and hence just mechanically the annual growth rate of world GDP is 3.5 percent and then 4.45 percent in the next two decades (accelerating just because India and China mechanically have a larger share of the total). Conversely, with regression to the mean scenarios for China and India, the global growth rate is 2.48 percent and 2.27 percent. Of course this mechanical calculation underestimates the role of China and India as growth engines by assuming that other country growth rates are not raised by faster growth in the giants. To the extent there are positive linkages, then this mechanical calculation underestimates (perhaps substantially) the impact on global growth of regression to the mean. Do read the full paper but here’s a final chunk from the conclusion:

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We suggest several implications of these conclusions. First, there will be a strong tendency to assume that, if growth slows substantially in China or India, it will represent an important policy failure. This is not right. Regression to the mean in a decade or so is the rule, not the exception. What would require much more explanation would be continued rapid growth, which would be very much outside the general run of experience. Second, those making global projections should allow a very wide confidence interval with respect to growth for countries whose current growth rates are far from the mean. Given the sensitivity of commodity demands in particular to growth rates in Asia, this suggests substantial uncertainty about the medium-term path of commodity prices. In the same way, forecasts of global energy use and climate change impacts should also recognize the possibility of discontinuities in Asia. Third, much geopolitical analysis has focused on the implications of a rising China, and certainly Chinese international relations theorists have extensively studied past rising powers. Contingency planning should also embrace scenarios in which Chinese growth slows dramatically, presumably bringing with it a range of domestic and international political implications. (Partial header credit to Herbert Stein and Marg Rev commenter prior_approval. Ta) http://ftalphaville.ft.com/2014/10/20/2013232/regressing-to-the-mean-in-china-or- why-if-something-cannot-go-on-forever-it-will-stop/?

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ft. com World Europe Brussels October 22, 2014 3:48 pm EU states tell Juncker not to water down trade deal By Christian Oliver and Peter Spiegel in Brussels Fourteen EU countries have fired a warning shot at Jean-Claude Juncker, incoming president of the European Commission, insisting that his administration should not strip contentious clauses on investor protection out of a landmark trade deal with the US. Even before the new commission takes office at the beginning of next month, Brussels has shown that it is divided about how to handle the Transatlantic Trade and Investment Partnership, potentially the world’s biggest trade deal. More ON THIS TOPIC// Earnings positive note amid eurozone gloom/ European groups expect weak euro boost/ Business groups boost EU-US trade deal/ UK hits at transatlantic trade critics IN BRUSSELS// EU takes step toward rejecting budgets/ EU leans on big banks for bailout fund/ EU and China agree truce on trade spats/ Poland leads opposition to EU energy deal The most sensitive part of the accord concerns rules that will allow foreign investors to sidestep national courts and sue governments via international arbitration, a measure known as investor-state dispute settlement. The measure has become especially contentious in Germany and Mr Juncker, assisted by his German chief of staff, has signalled his opposition. On Tuesday, 14 EU ministers sent a letter to the commission insisting that the inclusion of ISDS was part of a mandate issued by national capitals and should not be overruled by Mr Juncker and his staff, who have expressed reservations about its inclusion. “There is a unanimous mandate from the council,” Bruno Maçães, Portugal’s Europe minister and a signatory of the letter told the Financial Times. “It cannot be changed because of political considerations in one member state, especially when that member state already has several ISDS agreements in place,” he added, in a clear reference to Germany. Other nations to sign included Britain, Spain, Denmark, Finland, Ireland and the Czech Republic. ISDS is fast becoming one of Europe’s thorniest political issues, uniting the French far-right and German centre-left in their opposition. European campaign groups argue that ISDS will allow big US corporations to undermine EU courts and lower European standards in key areas such as food, health and the environment. Despite the warning from the 14 countries, Mr Juncker on Wednesday took the unusual step of curbing the autonomy of his trade commissioner. Sweden’s Cecilia Malmström, a Liberal, would no longer have exclusive control over the ISDS question, he said.

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Instead, the arbitration measure would also have to be approved by Frans Timmermans, a Dutch Labour party stalwart who will be the commission’s first vice-president. “There will be no investor-to-state dispute clause in TTIP if Frans does not agree with it too,” Mr Juncker said. ISDS’s defenders say that such arbitration is a standard feature of all trade pacts and protects investors. They argue that dropping it from the US deal would make it harder to keep such a legal safeguard in an accord with China or other major emerging nations. According to officials in Brussels, Mr Timmermans’ supervisory role over ISDS is seen as a compromise to cool tensions between Ms Malmström and Mr Juncker’s influential chief of staff, Martin Selmayr, who opposes ISDS. Trade officials say their antagonism boiled over before the commissioner’s confirmation hearing earlier this month at which Mr Juncker’s staff had wanted Ms Malmström to pledge to exclude ISDS from the US trade deal. Ms Malmström resisted. While she admitted that ISDS was potentially “toxic”, she argued that it was too early to exclude it. Marietje Schaake, a Dutch liberal who sits on the European Parliament’s trade committee, said Mr Timmermans’ appointment should not be seen as an attempt to exert a veto over Ms Malmström. Instead, it was an attempt to ensure broader political support for a final deal. “The Dutch Labour party . . . is not against ISDS in TTIP, but would like to see improvements,” she said. “To involve Timmermans in the thinking about ISDS brings in a social democrat to the process. Given much of the protests coming from that direction, involving someone with that political hat can be helpful.” http://www.ft.com/intl/cms/s/0/e1dac340-59e1-11e4-9787- 00144feab7de.html#axzz3GhDhDPeH

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EU's Juncker Pledges Investment Plan for Jobs

By Reuters Filed: 10/22/14 at 12:50 PM The incoming head of the EU executive, Jean-Claude Juncker, told the European Parliament on Wednesday that he would present his 300-billion-euro plan for investment to bolster growth and jobs by the end of this year, before a vote saw his new-look European Commission approved by the assembly. Switching significantly to German during a keynote address ahead of a parliamentary vote to endorse his new European Commission, Juncker said investment was vital to restoring growth and creating jobs. Germany, Europe's dominant economy, is resisting calls for it to spend more to kick-start growth. Juncker, a conservative former prime minister of Luxembourg, stressed, however, that, as German Chancellor Angela Merkel has said, that much of the 300 billion euros should come from private investors and that governments should continue to contain their budget deficits. "If you give us your support today, we will present the jobs, growth and investment package before Christmas," Juncker told parliament in Strasbourg, adding that investment should focus on improving economic efficiency, not short-term spending. Berlin has been resisting calls from other euro zone states and beyond for it to increase public investment spending to rekindle economic growth on the continent. Juncker also said that the European Union's budget rules that limit the size of government deficits and public debt will not be weakened. The Commission is preparing a review of the rules and their effectiveness with a report due by the middle of December, while France and Italy are pushing for more leniency in required budget consolidation efforts. "The rules will not be changed," Juncker said. "But they can be implemented with a degree flexibility." Investment, he said, was only one part of a three-pillar strategy, along with structural reforms of national economics and renewed fiscal credibility for governments. VOTE The major parties in parliament endorsed the Juncker's 28-strong new Commission and the new executive will take office on Nov. 1, replacing that led by outgoing President Jose Manuel Barroso.

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Juncker pledged a "very political" team that would focus during its five-year mandate on carrying out major programs while leaving lesser matters to national governments - a key demand from Britain, where there are strong demands for the country to quit the EU. He said a new, two-tier hierarchy Commission whose number has soared with the expansion of the EU to 28 member states, was designed to make it more efficient and to break down "parochial attitudes" in which commissioners pursued individual projects. A new layer of vice-presidents would coordinate them. Acknowledging the surge in anti-EU sentiment during elections to the parliament in May, Juncker said the Union had to show Europeans it was working in their interests. "Citizens are losing faith," he said. "Extremists on the left and right are nipping at our heels. Our competitors are taking liberties. It is time we breathed a new lease of life into the European project." He stressed that economic improvement was vital: "Either we succeed in reducing unemployment. Or we will have failed.” http://www.newsweek.com/eus-juncker-pledges-investment-plan-jobs-279022

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VOX, CEPR’s Policy Portal Research-based policy analysis and commentary from leading economists “Mensch tracht, und Gott lacht” – what’s the best guidance on monetary policy? David Miles22 October 2014 Many central banks embrace forward guidance by announcing expected interest rate paths. But how likely it is that actual rates will be close to expected ones? This column argues that quantifying such uncertainty poses great difficulties. Precise probability statements in a world of uncertainty (not just risk) can be misleading. It might be better to rely on qualitative guidance such as: “Interest rate rises will probably be gradual and likely to be to a level below the old normal”. Related/ Forward policy guidance at the Federal Reserve John C. Williams/Forward guidance in the UK Spencer Dale, James Talbot/ Forward guidance and the ECB Peter Praet/ Forward guidance for monetary policy: Is it still possible? Michael Woodford “Mensch tracht, und Gott lacht” is a Yiddish proverb – men plan and God laughs. Woody Allen puts the same thought this way: “If you want to make God laugh tell him about your plans”. Some people might see these words as a fitting epitaph for forward guidance on monetary policy. The Bank of England has certainly faced a good deal of criticism for the guidance that it has recently been giving, as has the Federal Reserve in the US. In both cases the nature of the guidance has evolved, though I think it is rather harsh to assume that God has been laughing at how things have gone; anyway it is hard to know. Yet there is a real question here that is worth thinking about: What is the most useful way for a central bank to provide information about the way in which it will set monetary policy? Consider a spectrum of choices a central bank might face about what it says about its future policies. At the minimalist end of the spectrum (which we might associate with Montagu Norman)1 is just a statement that the central bank will continue to do what it sees as most appropriate over time. At the other end of the spectrum is an explicit commitment that policy will be set in a specific way at each point in the future – not just a rule that might be followed but a commitment to a particular policy setting. Between these two are a great many intermediate points. Nearer the vague end is a statement of the goal of policy (e.g. an inflation target) but little beyond that. Further along again might be an assessment of how the policy set by the central bank might evolve for different outcomes of some of the main forces driving the economy. That would tell you something about the central bank’s reaction function. Or the central bank could give an explicit forecast of what it thinks its most likely future policy will be. I think it is helpful to think about forward guidance as being a choice about which point to settle on along the spectrum I have described.

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There is not a lot of generally agreed-upon and directly applicable economic theory to help with this. To a large extent this is because in many standard economic models this is a bit of a non-question. If everyone in an economy is completely rational, has unlimited computational powers, has the same information, and understands the processes driving the economic outcomes, then so long as the central bank tells people what its goals are then there is not much more to be said. People outside the central bank will work out what the optimal policy will be for the central bank to follow given how the economy seems to be evolving. Everyone will form the same expectations about the course of future policy. There are a few wrinkles to this. Under some circumstances optimal policy might be time inconsistent – that is a situation when the central bank plan which is optimal today is no longer optimal at some point in the future simply because of the (entirely predictable) passage of time and not because of some news. But time inconsistency is a slightly tangential issue.2 The main point is that when everyone shares common information and understanding (and that is the default assumption in many economic models) the central bank just needs to say what its aims are. Of course this is very unrealistic. So it is not a very good guide to the practical policy issue about what guidance the central bank should give. Give us more certainty Much of the most vocal recent criticism of guidance given by central banks really reflects a seeming preference to take one of the extreme ends of my spectrum. The Bank of England is very often criticised for ‘flip-flopping’ – for giving different signals about policy at different times, for seeming to change its mind on the right path for policy – in short, for not providing certainty about policy. I think in many cases this boils down to the criticism that while the Bank of England now claims to be giving guidance on policy, it is not saying what policy will be – it is not giving a specific path for interest rates, and not even saying when it is going to start raising rates. And it is true that the Monetary Policy Committee (MPC) could commit to a certain path for future interest rates, and stick to it whatever economic circumstances materialise. Indeed the more uncertain the economic environment, the more valuable might people find it to have certainty about where interest rates are heading. Yet the greater the uncertainty, the greater are the chances that the economic environment will turn out to be very different from what the MPC expected at the time they committed to an interest rate path. And this means that sticking to that path can be very costly. To explore this issue of the effects of committing to a specific path for interest rates, I have used a simple model of the economy which accounts for several types of uncertainty and their effects on monetary policy. (For details see Miles 2014.) My aim is to assess how much of a difference it would make if the central bank fixed the path for policy over the next few years rather than making it conditional upon the way the economy actually pans out. I calibrate the uncertainty about the size of the output gap, the impact of monetary policy, the growth momentum in the economy, and the path of productivity. I also specify the aim of the central bank as being to try to keep inflation close to a target and output close to its estimate of the supply capacity of the economy. I then compute an optimal policy rule showing how the interest rate should

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respond to the (uncertain) evolution of actual inflation and output so as to best achieve the aims of policy. Figure 1 shows the resulting probability distributions for the path of Bank Rate. Along the central path (that is the median where 50% of the outcomes are with lower interest rates and 50% have higher rates) the level of Bank Rate rises gradually. But it remains materially below its pre-Crisis average of around 5% even after four years. Figure 1 also shows that things may turn out quite differently from the central path. This simple model suggests that there is a 10% chance that the appropriate level of Bank Rate increases to above 5% within 18 months (the line labelled ‘90th percentile’). It also shows that there is a 10% chance that the appropriate level of Bank Rate is around zero for two years to come and is only just over 1% even four years ahead (the line labelled ‘10th percentile’). Figure 1. Optimal Bank Rate, simulation

How does a policy of fixing the interest rate for a three- or four-year horizon look in the light of this model? Not very attractive I should say. Suppose that interest rates are set at the outset so that they follow the central (median) path. On average this is an appropriate policy – but in the light of how things actually evolve it could be very different from the interest rate that would be appropriate based on what actually happens to inflation and output. How wrong could it be? Well, four years ahead the interest rate to which the central bank commits at the outset if it fixes policy at what is (ex ante) the average outcome could, with about 10% probability, be at least 2.5 percentage points too low, and with 10% probability it could be at least 2 percentage points too high. Having interest rates that far from the right level, and for an extended

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period, seems to me a very high price to pay for the certainty of following a given path for interest rates. It would probably generate outcomes that were wildly unstable. Suppose instead that the central bank accepts that it must respond to events as they unfold. Suppose in fact that the central bank calculates what the appropriate response is given the uncertainties and sees that the fan chart for interest rates is as in Figure 1. How might it then give guidance on policy? A natural response might be to say it should just publish Figure 1. I want to consider some practical issues with that in a moment. But setting those to one side for now, how might you describe in everyday language the message that Figure 1 conveys? (And using everyday language is absolutely central to effective communication. The amount of training and time needed to really understand what Figure 1 means is surprisingly large). One might try the following as guidance: “Interest rates are likely to rise gradually from their current exceptionally low point, but probably to a level that is meaningfully short of the level of around 5% that used to be thought normal. But the exact path that interest rates should follow cannot be known for certain since how the economy will evolve is not known in advance.” I don’t think that is a bad summary – in everyday language – of what Figure 1 shows. It is also pretty much the message on policy that the MPC at the Bank of England have been giving for some months. Whether or not something more precise and quantified than this broad description is useful is the issue I want to turn to next. Are precise probability statements good guidance? One type of guidance is for the central bank to provide an expected path for the policy rate (for example the median path shown in Figure 1 above). But without giving some idea about how likely it is that policy will be close to this path, this may not be particularly useful – and it could be seen as more of a commitment than an expectation. Quantifying that uncertainty is tricky. One might just draw on the volatility of past interest rates (around some previously expected path) as a guide to uncertainty in the future. Or a stochastic simulation using a monetary policy rule could be used to derive fan charts for the policy rate. The policy rule could be (an approximation) to an optimal rule – which is one way to interpret Figure 1 above. So the MPC could use a mechanical procedure that is some sort of very rough approximation to its decision-making so as to produce a fan chart for interest rates. But there is no getting around the fact that constructing fan charts of interest rates that represent the MPC’s view of the probability of different paths presents many problems. It involves, for example, the quantification of the chances of various events happening which may go beyond what can meaningfully be done. The apparent precision of probability statements in a world of uncertainty (not just risk) can be misleading. Currently, it might be just as useful – and probably less misleading and possibly even more accurate – to give forms of guidance which are more qualitative, such as: “Interest rate rises will probably be gradual and likely to be to a level below the old normal”. That says something substantive; and most people can understand it.

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Disclaimer: This is the view of David Miles and not that of the Monetary Policy Committee at the Bank of England of which he is a member. Footnotes 1 In recognition of his reputed dictum “never apologise, never explain”. 2 Woodford (2013) has an extensive discussion of the conditions under which the optimal monetary policy of a central bank might be time inconsistent. This depends upon the nature of the goals of the central bank, which need to be precise enough to determine a policy path. The key condition is that “…the sequence of target criteria for different horizons are of the same form (i.e., if the target criterion is independent of the horizon)… then the forecast-targeting procedure will be inter-temporally consistent.” I believe that the way the MPC at the Bank of England interprets its goals satisfies this condition. References Miles, D (2014), “Mensch tracht, und Gott lacht: Giving guidance on future monetary policy” Speech at the London School of Economics, 30 September. Woodford, M (2013), “Forward Guidance by Inflation-Targeting Central Banks”, CEPR Discussion Paper 9722, November. http://www.voxeu.org/article/forward-guidance-human-plans-and-divine-laughter

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ft.com Markets MARKETS INSIGHT October 22, 2014 5:41 am Stakes high for Europe’s bank stress tests Huw van Steenis Good news on key issue of assisting capital-raising

©EPA As Europe is spooked by the spectre of deflation, never has it been more important to unclog Europe’s lending channels. Eurozone bank lending to companies remains weak and fragmented. So the stakes are high for the European Central Bank’s comprehensive assessment and related stress tests. They have the potential to accelerate the process of cleansing banks’ balance sheets to support economic recovery. But to achieve the catharsis the eurozone needs, the stress tests need to be a catalyst for a shift in the broader policy debate. Investors naturally come with a degree of scepticism given the ill-fated prior stress tests. So how should we judge the current tests’ success? More ON THIS TOPIC/ Lex European banks – light Sunday reading/ Editorial A dose of deregulation for EU capital markets/ Inside Business Checks put focus on Italy bank mergers/ Brussels bid to unblock credit MARKETS INSIGHT// Emerging markets foster gloom/ Market nerves do not portend global slump/ Deflation threat to Draghi’s credibility/ Winners and losers from oil price plunge First, are they rigorous enough to give confidence and help lower the banks’ cost of funding? For instance, Italian banks pay on average 1.1 per cent more for deposits than German banks, which inevitably gets passed on through higher costs to companies and consumers. The tests ideally should help give assurance so that funding costs for Italian banks can fall in much the same way they did for Spanish banks post their stress tests. While most of the inputs do look tough, it is a shame deflationary scenarios are not in this year’s exercise. Banks appear to have been treated as consistently as possible, even if local rules mean there are a large number of inconsistencies. Second, will there be transparency in the results? The odds look reasonable as we will get over 10,000 data points on the scenarios. But the market will also want to know what the implications for capital plans and dividends will be for banks with only marginal passes, and the ECB and European Banking Authority are likely to be silent on this. 326

Third, do they facilitate capital-raising and restructuring? This is the acid test, as this is what will form the basis for future lending. The good news is the larger banks have used their time well. Some €48bn equity has been raised into the stress tests while banks have also sold many underperforming assets that were weighing on their balance sheets. While some will want to see a few large institutions fail the tests to show their toughness, we wonder if the true signal of success will be how big a clean-up is driven both through the aggregate size of writedowns on the day and assets sold over the following year, than simply how many banks fail the tests. But, to get the full benefit, it is critical the test results shift the policy debate. This exercise underscores that Europe sorely needs a more competitive and diverse funding market for companies. The crisis has shown the drawbacks of over-reliance on a bank- centred lending model. We need to find new ways to channel non-bank finance to businesses and infrastructure projects, which will require major changes to Europe’s market plumbing as well as the approach of policy makers to markets. That is why urgent action needs to be taken to turn the slogan of Capital Markets Union into a workable programme of initiatives. We also need to address blockages to the flow of funding to companies – whether accelerating managing non-performing loans or modestly recalibrating overlapping rules if they are holding back good lending. As the blockages are cleared, it will become even clearer that stronger measures to support aggregate demand are needed – and it is not just the banks to blame. Our rule of thumb has been the weakness of eurozone bank lending has been two-thirds weak demand and one-third supply side issues. Take, for example, the weak take-up of the first Targeted Longer-Term Refinancing Operation. We estimate northern European banks took just 5 per cent of their eligible funds, underscoring their lack of confidence in their lending prospects. As Mario Draghi, ECB president, powerfully put it at Jackson Hole this year, action on “aggregate demand has to be accompanied by national structural policies.” Last, dare I say it, there could be advantages if the ECB were to make the stress tests an annual process, akin to the US Federal Reserve’s. Rome was not built in a day, and nor will be the Banking Union. But the benefits would not just be at the macro level – where policy makers can see the system in the round – but also change the incentives for bank executives. Moreover, as no test can encompass all emerging risks, an ongoing process can incorporate them next time – heading off inevitable criticism. Huw van Steenis is a Managing Director at Morgan Stanley and a member of World Economic Forum’s Global Agenda Council for Banking http://www.ft.com/intl/cms/s/0/ee3d694e-591e-11e4-9546- 00144feab7de.html#axzz3GhDhDPeH

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ft. com World Europe October 21, 2014 8:41 am Franco-Spanish energy spat tests EU Christian Oliver in Brussels and Tobias Buck in Madrid

©AFP When it comes to Europe’s energy networks, Spain is an island – and it blames France for its isolation. After decades of frustration, Madrid’s anger is now boiling over ahead of an EU summit this week, where diplomats expect a showdown between Prime Minister Mariano Rajoy and French President François Hollande. More ON THIS TOPIC// Editorial Europe needs will to build energy union/ Ukraine fears winter energy crisis/ Energy Can Europe wean itself off Russian gas?/ Hungary halts flow of gas to Ukraine IN EUROPE// Russia slaps conditions on Ukraine gas deal/ Sweden vows to increase defence spending/ Turkey struggles with Isis reverberations/ Sweden shuts airspace as sub hunt intensifies Renewable energy lies at the heart of their dispute: Spanish wind turbines easily produce more power than is needed in the domestic market but that energy is wasted because there are few transmission lines to carry it across the border to France. Viewed from Madrid, the Pyrenees are a protectionist barrier behind which France has been shielding its nuclear industry from the competition posed by Spain’s abundant renewables. At a summit in Brussels on Thursday, Spain and Portugal will demand changes to force the 28 member states to connect their power grids to neighbours in an attempt to resolve their frustration. They are even threatening to block the EU’s climate package for 2030 – the centrepiece of its effort to fight global warming – unless they get their way. The Franco-Spanish dispute has become the most notorious test-case for whether Europe has the political will to build a long-promised “energy union”, a priority for Donald Tusk, incoming president of the European Council that has been given fresh urgency by the west’s strained relations with Russia. In theory, a single EU market for gas and electricity – as opposed to a patchwork of national ones – would reduce wastage and harmonise prices. It would also help lessen 328

dependence on outside suppliers such as Russia, with whom relations have become strained over its involvement in Ukraine. The consultancy Strategy& estimates Europe could save €40bn a year by 2030 if it integrated its energy grids. I don’t see Spain getting a binding deal on 15%. France is dead against . . . but Spain will not agree to any 2030 deal without very strong commitments on interconnectors But Madrid’s experience in the Pyrenees – where its attempts to run pylons into France have been thwarted for decades – illustrates why it is so hard to connect neighbouring countries despite the apparent benefits and encouragement from Brussels. Governments have tended to resist integration because they do not want to expose their energy incumbents to outside competition or cannot generate commercial enthusiasm to fund and build the necessary infrastructure. In the case of France, the culprit appears to be the state-backed nuclear industry, which produces three-quarters of the country’s electricity. Spain accuses Paris of being reluctant to open its border to intermittent flows of renewable energy that pose technical challenges for the atomic power stations that dominate its grid. The Spanish government said that interconnectors were “not a bilateral issue but one that affects all of Europe . . . Spain supports the creation of a single European market for energy, but to reach this objective there has to be interconnection.” In Paris, a senior French official said the big increase in Spanish renewable generating capacity over the past 10 years was to blame for the difficulties in expanding links between the two countries. Constructing overhead power lines over the Pyrenees was “not so simple”, he said, and underground connections were “never cheap”.

The two sides needed to work in a “dispassionate way” to agree a strategy on the issue, including gaining access to the “maximum” European-level funding, he said. “We believe we can find a solution that responds in a concrete way” to Spanish demands, he said. But in recent years, Spain has also been thwarted by French protesters arguing that cross-border pylons would be an eyesore and damage tourism. Despite such opposition, 329

a modest Pyrenean interconnector will open next year. But in a €700m compromise to the protesters, two 780-tonne drilling machines had to bore a tunnel through the mountains to hide the cables.

Spain has been so discouraged by its attempts to connect to France that it is considering an 895km link under the Bay of Biscay to sell its surplus power to Britain in a project that could cost as much as €2.5bn. At this week’s EU summit it is demanding compulsory legislation on cross-border electricity interconnectors. Spain wants a target obliging countries to be able to exchange 15 per cent of their national generating capacity over their borders, arguing that previous voluntary targets have not worked.

“Ultimately, I don’t see Spain getting a binding deal on 15 per cent. France is dead against,” said one official close to the talks. “But Spain will not agree to any 2030 deal without very strong commitments on interconnectors.” If adopted, Spain’s binding 15 per cent interconnectivity target would require building interconnectors across Europe. Spain’s interconnectivity with France is a meagre 3 per cent – and the interconnector opening next year will only lift that to 6 per cent. Currently, the EU only has a non-binding target for interconnectivity of 10 per cent by 2020. Across the continent, the average is 8 per cent, achieved mainly by Germany and central European nations. The countries that would be challenged by a high target include Britain and Italy. Britain should be helped by a €2bn interconnector with Norway – the world’s longest to run underwater – which should become operational in 2020. This cable is intended to use Norwegian renewables, such as wind and hydropower. Italy’s problems are caused by poor connectivity from the south – where wind and solar farms are unable to transmit their power northwards, even within Italy itself. //Additional reporting by Hugh Carnegy in Paris/ http://www.ft.com/intl/cms/s/0/8e94079c-585f-11e4-b331- 00144feab7de.html#axzz3GhDhDPeH

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ft. com World Europe Brussels October 21, 2014 2:12 pm EU leans on big banks to finance bailout fund Peter Spiegel and Alex Barker in Brussels and Alice Ross in New York

©AFP Michel Barnier France’s banks will foot the biggest bill for Europe’s banking union, paying up to €2bn more than Germany’s lenders towards a new €55bn bank rescue fund, according to a Brussels proposal. The European Commission on Tuesday unveiled its plans to set contributions to the fund handling bank failures, which leaned heavily on France’s big banks and favoured the hundreds of small and medium sized lenders in Germany and Spain. More ON THIS STORY// Marathon talks seal EU banking union/Wolfgang Münchau A flawed banking union/In depth European banking union/Paris and Berlin in bank rescue fund row ON THIS TOPIC//Wolfgang Münchau Italian debt/Europe’s lenders urged to raise capital now/Foundations for banking union laid but bricks still to fall in place/The Short View Bank tests prove relatively stress-free IN BRUSSELS//EU takes step toward rejecting budgets/EU and China agree truce on trade spats/Poland leads opposition to EU energy deal/EU agrees laws to end banking secrecy

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While the complex calculations are provisional and still subject to agreement, commission estimates seen by the Financial Times suggest France’s highly concentrated sector will contribute around €17bn over eight years, representing almost 30 per cent of the fund. Germany pays in around €15bn, or 27 per cent. Diplomats have already spent months squabbling over whose banks should bear the cost of the eurozone’s march to banking union. The subject has proved particularly fraught because Berlin put up stiff resistance last year to increasing the heft of the fund or accelerating its mutualisation. Under the commission plans 90 per cent of the €55bn would come from the eurozone’s large banks, which EU officials said accounted for 85 per cent of all banking assets. Planned adjustments mean the French sector, including the likes of BNP Paribas and Société Générale, will pay 70 per cent more than required under the EU regime for national bank resolution funds. German banks pay in 9 per cent less and Spanish banks almost half. Small banks – defined as those with less than €1bn in assets and deposits of less than €300m – would only pay 0.3 per cent of the total rescue funds even though they account for 1 per cent of eurozone banking assets. Medium-sized banks, which account for 14 per cent of assets, would pay in just 9.7 per cent. The rules could mean that more than a quarter of Germany’s army of politically- connected Sparkassen – small, regional savings banks – would be classified as “small”, paying as little as €1,000 a year towards the fund. A total of 116 Sparkassen have less than €1bn in assets, meaning that if their liabilities are also less than €300m, they will pay a flat rate of between €1,000 and €50,000 a year. Germany’s savings bank group – which includes 417 Sparkassen and seven larger Landesbanken – have a combined balance sheet of nearly €2.3tn, which is larger than Deutsche Bank, the country’s biggest single lender by assets. European Commission officials justified making the eurozone’s largest banks pay more by arguing they were the most likely to need rescue cash from the bailout fund in a crisis. When the fund is complete in 2024, IT will amount to 1 per cent of deposits in countries participating in the EU banking union. “The approach chosen is fair as each bank will contribute in proportion to its size and risk profile,” said Michel Barnier, the EU’s outgoing chief financial regulator. “It is also proportionate as the smallest banks have their own adjusted regime of contributions.” Still, some of the most spectacular bank failures of the eurozone crisis – such as Ireland’s Anglo-Irish, Spain’s Bankia and Cyprus’s Laiki – were small or midsized banks. EU officials insisted many similar banks would still end up paying more since the contributions would be based on not only their size but also how risky their balance sheet was. The riskiest banks could end up paying nearly twice what banks with large deposit bases will. EU officials declined to make public how much each country would contribute to the €55bn fund. They acknowledged that, under the system, some countries with highly- concentrated banking systems would end up paying as much as 4.5 times as they would under existing EU rules for national schemes. 332

In some countries, the banks are going to pay much more than they had to pay previously - EU official Tweet this quote Officials insisted Germany would not be the country most advantaged, however. “There are also a couple of very big banks,” one official said in an apparent reference to Deutsche Bank and Commerzbank. Similarly, the official said France was not the country that would have to ratchet up its payments the most. Commission estimates, which have not been published, suggest Luxembourg banks will pay 350 per cent more in the transition from a national to a single rescue fund. Both the German regional banks and their Spanish equivalents, known as cajas, were among the financial institutions needing the biggest rescues during the eurozone crisis. German savings banks have lobbied aggressively to be exempt from certain key parts of the new rules. Just one Sparkasse is included in the European Central Bank’s stress tests of the eurozone’s largest lenders, which will be unveiled on Sunday. Katharina Barten, a banking analyst at Moody’s, pointed out that German savings banks had benefited from bailouts of banks in other countries during the financial crisis. “When the market benefits, the savings banks benefit as well. Whenever market participants are truly scared, they park their excess cash in that sector,” Ms Barten noted. In order to help countries that will suddenly have to ask much more from their banks, those disadvantaged in the new system will be allowed to offer promises of funds rather than cash immediately. But officials said those promises must be backed by collateral and highly liquid in case the cash is needed in a crisis. “In some countries, the banks are going to pay much more than they had to pay previously,” said the official. http://www.ft.com/intl/cms/s/0/abc93c04-591f-11e4-a722- 00144feab7de.html#axzz3GhDhDPeH

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Rolling the dice, again October 21, 2014 The headline on Reuters at Mon Oct 20, 2014 6:05pm EDT read “U.S. regulator targeting lower down payments on mortgages.” At first, we thought perhaps the headline was from 2004, not 2014. After the financial crisis of 2007-2009, it seemed inconceivable that U.S. authorities would again put some of the largest U.S. intermediaries – or the taxpayers who provide for them – at risk of failure. Sadly, we were wrong. In a speech to the Mortgage Bankers Association, Melvin L. Watt, the Director of the agency that regulates Fannie Mae and Freddie Mac, made the following statement: “To increase access for creditworthy but lower-wealth borrowers, FHFA [Federal Housing Finance Agency] is also working with the [Government-Sponsored] Enterprises to develop sensible and responsible guidelines for mortgages with loan- to-value ratios between 95 and 97 percent.” What Reuters dutifully reported is that the FHFA is developing rules to allow government guarantees on mortgages where borrowers put down as little as 3 percent of the purchase price. Ironically, Mr Watt delivered this astounding news in Las Vegas, where today, house prices are still more than 40% below their pre-crisis peak (see chart). S&P/Case-Shiller Index of Housing Prices: Las Vegas and 20-city Average

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Sources: S&P Dow Jones Indices LLC and FRED. We can only hope that the U.S. government will quickly abandon this plan. The global cost of the financial crisis has been measured in the tens of trillions of dollars. While the crisis had many causes, it was initially known as the U.S. subprime crisis for a reason. Highly-leveraged lenders took on enormous risks and encouraged U.S. households to do the same. As a result, many people who could not afford to make mortgage payments became homeowners with little or no equity. In effect, they were renters who owned an option on the upside of the house price. We know how that turned out: the House of Debt came tumbling down with the price of houses. Today, most jurisdictions are trying to figure out ways to ensure that borrowers can afford their mortgages. This generally means raising the minimum down payment (or lowering the maximum loan-to-value ratio) to lower leverage and reduce the probability of default. We know of no other regulator who proposes to return to the good old days of a decade ago. Put simply, it is difficult to overstate how bad this idea is. Let's be clear: we are not against homeownership. And we are not against subsidizing homeownership for young families or first-time homeowners. But there are good ways and bad ways to provide that subsidy. As we explained in an earlier post, if the government wishes to promote homeownership, it should provide people with home equity, not more “cheap” debt. We hope that the proponents of this plan, who supervise Fannie and Freddie, will read it. http://www.moneyandbanking.com/commentary/2014/10/21/rolling-the-dice-again

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Hollande takes on '50th worker' reform October 21 2014 at 01:13pm Reuters

Dominique Goubault, chief executive of Goubault Imprimeur, poses inside his factory in La Chapelle-Sur-Erdre near Nantes, October 20, 2014. Paris - Of all the decisions that Dominique Goubault says have helped to keep his 117- year-old family business alive, one in particular raises eyebrows: limiting his staff numbers to 49 or fewer. The chief executive is among many bosses in France who won't hire a 50th worker, in order to avoid the subsequent obligation to run and pay for an in-house works council - something Goubault says is costly, time-consuming, and “entirely useless”. Goubault's frustration is shared by bosses of small and mid-sized businesses right across France, who say their growth is stifled by endless bureaucratic demands regulating everything from worker representatives to office space to healthcare. It's a cry that President Francois Hollande - watching the country's economy stagnate and its unemployment levels stick above 10 percent - is finally heeding.

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While all of Europe is grappling with poor growth and the threat of deflation, France is one of its weakest members - and under pressure from its euro zone partners to take action to halt the drag. Though Hollande is now pushing through market reforms such as limited deregulation of protected jobs and more Sunday opening times in order to get more people into work and jumpstart the economy, Goubault says it may be too late. Bosses have been for so long cowed by high taxes, punitive workforce rules and worries about the wider European economy that, even unshackled, they may still balk at hiring. “It's great that they are finally doing something about these idiotic rules,” said Goubault, 49, the fourth generation of printers to run Goubault Imprimeur in western France. “But in the current context, with all the other issues we have, I don't think we should expect companies to start recruiting aggressively overnight.” DEAL BY YEAR-END Hollande has asked managers and unions to strike a deal by year-end to work around rules mandating escalating bureaucratic obligations that kick in at 10, 50 and 300 employees. France's Ifrap think tank wrote in a recent study that removing threshold effects could create 140,000 jobs, with more than 22,500 firms likely to grow if thresholds were removed. In 2012, France counted 1,600 companies with 49 employees, which fell abruptly to 600 firms with 50 employees, according to CGPME, the main lobby for small- and medium-sized businesses. “Companies just don't try to expand, which means they don't have enough critical mass to export their products,” said Genevieve Roy, vice president of social affairs at the CGPME. It's this lack of export capacity that has hurt the French economy and set its firms at a disadvantage to competitors in Germany - a raft of mid-sized, export-oriented firms that have steadily gained market share from France in the past few years and helped keep Germany's economy afloat. Germany's firms are helped by more flexible worker representation thresholds. A works council can be elected in any unit with staff of five or more, but is not obligatory, while firms with more than 20 employees need only choose one 'safety advisor' - rather than the committee of several that is required in French firms with 50 workers or more. In 2013, Germany had 55,510 medium-sized firms with more than 250 workers versus 21,418 in France, according to European Commission data. Medium-sized firms accounted for 2.6 percent of all firms in Germany versus 0.9 percent in France. Among French law's most irksome features for managers - aside from electing worker representatives at set levels - are rules requiring them to set aside designated office space, create permanent health and wellness committees, set up profit-sharing schemes

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and, in the case of downsizing, strike collective severance deals - all of which drains resources. Hiring a 50th staffer also increases the amount of paperwork the companies must file to the state. That extra head means companies then have to apply a further 30 legal norms, including obligations to maintain detailed records of their hiring activity to ensure gender equality. SATELLITES The rules are so off-putting that many small business-owners simply prefer to start new, satellite firms rather than hire a 50th worker - creating yet more tiny corporate structures. “I've been tempted at various points to hire a 50th worker,” said Goubault, 49. “But when you look at the costs - 3.5 percent of my total salary costs - and all the obligations, you think, what's the point? It bothers me and doesn't help my workers.” “I also explored putting workers into a holding company and all sorts of acrobatics to get around the rules. But at the end of the day all of it was more complicated than just keeping our current, close-knit structure,” he added. The Organisation for Economic Co-operation and Development said on Friday that if France implements the reforms it has flagged, growth could improve by 0.3 percentage points annually. Labour market moves alone would account for a total 0.4 percentage points over five years. But implementing those reforms may prove tricky. Relations between employer and union groups are at a low ebb - tested by years of low growth and cost-cutting - and neither side is in the mood to make concessions. If they have not reached a deal on circumventing the most onerous demands of workforce number thresholds by year-end, Hollande has said he will implement the reform by decree. That's a risky move for a government whose unpopularity is already at record levels and has many of its Socialist Party members arguing that worker representation is a core right. One manager participating in talks on thresholds was sceptical about the chances of a negotiated deal and said both sides were barely on speaking terms. “Things are very, very complicated,” said the manager, who declined to give his name because of the sensitivity of the discussions. “In France, when you have given something, unions consider it given for life. You can't go back on it, or with enormous difficulty.” - Reuters http://oecd.einnews.com/article/230278989/Erv8suLk4BtJwKA9?n=2&code=YE4u1DI RGs-Vsvg5

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ft.com Comment FT View October 21, 2014 6:42 pm Europe needs the will to build an energy union A bitter row between France and Spain exposes the bloc’s inefficiency

©EPA The EU’s 28 member states face many challenges if they are to revive Europe’s sluggish economy. One of the most important – and one receiving too little attention – is the need to co-ordinate energy policy. The fragmentation of the European energy market is a glaring strategic weakness, highlighted by the fact that the club, as a whole, imports more than half its gas and electricity. EU heads of government will discuss the matter at a Brussels summit on Thursday but progress remains grindingly slow. The EU is under pressure to develop a more coherent and efficient energy policy for two reasons. The Ukraine crisis means member states need to reduce their dependence on Russia for power supplies, especially gas. Some 30 per cent of EU gas comes from this source, meaning the bloc is nowhere near enjoying energy security vis-à-vis Moscow. The US shale gas revolution should also be concentrating minds in Europe. Shale is giving American companies a big competitive advantage over European rivals which are paying a far higher price for electricity. More ON THIS STORY// Energy spat tests EU resolve/ Eastern Europe attacks planned EU emissions curbs/ Energy Can Europe wean itself off Russian gas?/ Hungary halts flow of gas to Ukraine ON THIS TOPIC// Ukraine fears winter energy crisis/ Spain’s EC nominee sells oil holdings/ Ukraine gas deadlock poses threat to EU/ EU energy plan targets Russian gas links EDITORIAL// Mexico is struggling over rule of law/ Abe has no easy fix for Japan’s economic woes/ Good news from the lower price at the pump/ Controlling the past and future in Russia Donald Tusk, the incoming EU Council president, has rightly made the task of building an EU energy union one of his main missions. In his view, EU nations comprise a patchwork of inefficient “energy islands” while a properly functioning EU market for gas and electricity would reduce wastage and bring down prices. The consultancy firm

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Strategy& (formerly Booz & Co) believes the EU could save €40bn a year by 2030 if it were to integrate its energy grids. However, harmonisation has proved hard to deliver. Some member states such as Hungary and Bulgaria have been hard to wean off their reliance on relatively cheap Russian gas supplies. Others worry a more unified system would expose national energy champions to external competition. Connecting member states has moved at a glacial pace. The EU’s investment in transmission lines and interconnectors will be a paltry €6bn over the next six years compared to the €200bn demanded by the EU Commission. A row between Spain and France over renewable energy demonstrates how protectionist EU member states have become. Spanish wind turbines produce far more power than is needed in the domestic market but the energy cannot be exported to Spain’s biggest neighbour because there are few transmission lines to carry it across the Pyrenees. Mariano Rajoy’s government says France is reluctant to open its border to flows of cheap renewable energy, accusing the French state-backed nuclear industry of blocking the move. France argues that intermittent flows of renewable Spanish electricity pose a technical challenge to their nuclear power stations, whose output cannot easily be adjusted. But Spain’s argument about the need for Europe to boost interconnectedness is sound. At Thursday’s summit Madrid will demand that all member states sign up to a binding target obliging them to be capable of transferring 15 per cent of national generating capacity over borders. Its partners should give the Spanish proposal a fair hearing. Since 2008 Europe’s agenda has been dominated by the eurozone crisis and the need for national leaders to respond urgently to potential financial meltdown and extinguish the blaze. Despite the conflict in Ukraine, the challenge of forging an energy union has not generated the same sense of urgency. Success in this matter is critical to Europe’s economic future. European leaders should start to focus on this project with far more resolution and dynamism than they are currently demonstrating. http://www.ft.com/intl/cms/s/0/b8727392-592b-11e4-a722- 00144feab7de.html#axzz3GhDhDPeH

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ft.com comment Columnists October 21, 2014 6:59 pm Reform alone is no solution for the eurozone

Martin Wolf A policy that may work for Germany alone cannot work for an economy more than three times as big

Might the policies of the eurozone result in a robust recovery? My answer is: no. Since the eurozone generated 17 per cent of world output in 2013 (at market prices), that answer has global significance. It is Germany that set the economic strategy of the eurozone. It consists of three elements: structural reform; fiscal discipline; and monetary accommodation. So far, this set of policies has failed to generate adequate demand: in the second quarter of 2014, real demand in the eurozone was 5 per cent smaller than it was in the first quarter of 2008. More ON THIS STORY// Gideon Rachman Threats to EU/ Wolfgang Münchau Threat of Eurozone stagnation/ ECB starts buying covered bonds/ Tory plans risk EU exit, warns Clegg/ Editorial Good news from the lower price at the pump ON THIS TOPIC// Market turmoil tests investors’ nerves/ Reza Moghadam Break Europe’s taboos/ Markets Insight ‘Euroglut’ of gloom as Germany weakens/ France and Italy weigh on eurozone economy MARTIN WOLF// UK fiscal policy has no simple rules/ World can do better/ An extraordinary state of ‘managed depression’/ Caught in a credit boom trap

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Both France and Italy are being encouraged to accelerate “structural reforms” as a way to reignite growth in their own economies and so, given their importance, also in the eurozone. These two countries generate 38 per cent of eurozone gross domestic product, against 28 per cent for Germany alone. In both economies, the recommended programmes involve liberalising the labour market. They are both being encouraged to follow Germany’s “Hartz reforms”, introduced between 2003 and 2005, to which the country’s relatively good recent labour market performance is often attributed. Yet the one thing those reforms did not do is create dynamic aggregate demand. Between the second quarter of 2004 and the second quarter of 2014, Germany’s real domestic demand grew 11.2 per cent, a compound annual rate of 1 per cent. It could have been worse. But this is hardly the performance of a “locomotive” (see chart below). Examination of Germany’s sectoral financial balances – the differences between income and spending of the government, private sector and foreigners – strengthens this point. The response of the German private sector to the reforms of the early 2000s was to increase financial surpluses massively: that is, to spend far less than their incomes. Since the fiscal deficit also shrank, the capital outflow soared. This is striking and significant. In brief, the response of the private sector to the labour market reforms and fiscal tightening was to become increasingly frugal and so accumulate large quantities of (often poor-quality) foreign assets. In terms of raising private domestic demand, reforms achieved little. On the contrary, Germany became heavily dependent on foreign demand. Similarly, fiscal tightening did not unleash stronger private spending. Expecting similar labour-market reforms to promote demand in France and Italy is likely to prove highly over-optimistic. This does not mean reforms achieved nothing. Germany has low unemployment despite quite weak growth. The UK also has relatively low unemployment despite still weaker post-crisis economic growth. In both cases, the labour reforms encouraged the sharing of a large negative shock across the population via stagnant or even falling real earnings. A symptom of this form of an adjustment is weak productivity. In German industry, productivity has not risen since 2007. Productivity performance has also been poor in the UK. But German unemployment was 4.9 per cent in July and the UK’s only 6 per cent against 10.4 per cent in France. The upshot is that labour market reforms do little if anything to promote demand; in Germany’s case, much of the demand has come from abroad. What might this mean for the eurozone as a whole? A theoretical possibility is that the eurozone would seek to generate a current account surplus that is as big relative to GDP as Germany’s. This would mean a surplus not of $300bn, as in 2013, but of $900bn. This could never be sustained: the rest of the world would not absorb it and an appreciation of the euro is likely to defeat it. The proper complement to structural reform is additional demand inside the eurozone. That is needed, in any case, to eliminate the difficulties being created by ultra-low inflation and the possibility of deflation. German core inflation of only 1.2 per cent is too low to let adjustment work satisfactorily.

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With conventional monetary policy at its limits, the choices are between unconventional monetary policy or expansionary fiscal policy. Germany is extremely uncomfortable with both.

Yet, partly because of its haven status, Germany is also able to borrow at extraordinarily favourable interest rates. The 30-year Bund is now yielding 1.8 per cent. If one assumes the European Central Bank will meet its inflation target, this means a long-term real interest rate of zero. Such negligible costs of borrowing must transform views of the costs of fiscal deficits. Germany should both refinance its debt at such rates and borrow to finance additional public investment. Focusing on deficits and debts, without noticing the interest rate, makes no sense. In the same way, the focus on whether the French deficit breaks the rules is absurd. Even French 10-year bonds are yielding 1.1 per cent. The markets are screaming: borrow. The big challenge for the eurozone is not to create institutions, but to promote adjustment and restore growth. The people of the eurozone cannot be expected to remain patient forever. Indeed, the dangers of continuing economic stagnation are obvious. Germany is right that euro states need much long-term reform. But Germany is wrong to believe that this might, on its own, generate strong growth. The evidence from its experience with reforms is decisive on this point: it will not do so. Nor does it make sense to rely on ever-greater external surpluses, instead. A policy that may work for Germany alone (a debatable proposition) cannot work for an economy more than three times as big as Germany’s. The eurozone needs to reach a bargain between more reform and extra demand. In doing so, it must recognise that persistent stagnation is a big threat to stability. The eurozone should risk expansion. That is now the safer course. http://www.ft.com/intl/cms/s/0/43276fc4-5841-11e4-a31b- 00144feab7de.html#axzz3GhDhDPeH

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ft.com comment Columnists October 21, 2014 1:14 pm Epitaph for France does a lively trade By Hugh Carnegy in Paris

Writing the country off has become a popular national pursuit, says Hugh Carnegy

©Dreamstime I f you want an indication of the collective mood in France at the moment, try this for a best-selling book title: Le Suicide français. In the past few weeks this cheerless tome by Éric Zemmour, a journalist, has been flying off the shelves. Its 530 pages are a relentless polemic against what Zemmour calls the destruction of the nation by a “vast subversive project” imposed via feminism, globalisation, immigration and the “monstrous Brussels bureaucracy”. More ON THIS STORY// Berlin and Paris paper over budget cracks/ Global Insight Hollande’s reform road is long and tortuous/ John Lewis apologises for France comments/ Business Blog Street right to rue tirade/ Simon Kuper France – the way the French see it ON THIS TOPIC// Comment Sarko’s ‘nuclear’ delight/ Centre-right to control French Senate/ Crowds rejoice at Sarkozy’s return/ Comment President Bling-Bling IN COLUMNISTS// Mob justice is a dangerous trend/ Jeremy Banx/ James Crabtree Bittersweetness for India’s Jews/ Miserable Britons Andy Street, chief executive of John Lewis, the British retail chain, came under fire for “French bashing” when he declared recently that France was “finished”. Zemmour has found ready customers for his conclusion: “France is dying, France is dead.” His book has been outselling the latest work by Patrick Modiano, proud French winner of this year’s Nobel literature prize. There are estimates that Le Suicide français will sell north of 300,000 copies, more than three times the pre-prize average sales of Modiano’s books. It still falls short of this year’s true French publishing phenomenon – the devastating takedown of François Hollande by his sometime partner Valérie Trierweiler, a journalist with the magazine Paris Match. Trierweiler’s book, Merci pour ce moment (Thanks for the moment) has already sold more than half a million copies and is set to be translated for several foreign markets, including the US and UK. Its pitiless portrayal of the

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erstwhile first lady’s betrayal by the president – a French wag called it the ultimate example of embedded journalism – has cemented his lowly standing among the French public. That is troubling enough for Mr Hollande, whose prospect of re-election in 2017 looks distant, to say the least. But the popularity of the Zemmour book has sent a deeper shudder through a French establishment long used to decliniste books bemoaning the state of the nation and surveys showing the French are less optimistic about their future than Iraqis. The disturbing issue for all mainstream French politicians is the parallel between the public reaction to the Zemmour book and the recent rise in popularity of the far-right National Front, led by Marine Le Pen. The author is not a direct part of the FN bandwagon, but Le Suicide français echoes much of the Le Pen discourse. The chronological account begins with the symbolically rainswept funeral of Charles de Gaulle in November 1970 – the end of more than 150 years of “glorious” leaders, starting with Napoleon Bonaparte, writes Zemmour. Rooting France’s decline in the “revolution” of May 1968, when students rose up in Paris, he works his way through a litany of events in which France is portrayed as having successively given up its sovereignty and cultural identity to Europe and the forces of global economic and social liberalism, including mass immigration. He also indulges in a bizarre apologia for the wartime Vichy regime’s expulsion of Jews to Nazi concentration camps, saying it sacrificed foreign Jews to save French Jews. This proposition has been angrily rebutted by several historians – but it prompted the explicit approval of Jean-Marie Le Pen, the FN founder and Marine Le Pen’s father. Taken together with the FN’s recent electoral gains and Ms Le Pen’s rising poll ratings, the popularity of Zemmour’s book underscores the deep political tremors the past few years of economic crisis have caused in France. Nicolas Sarkozy, the former president now launched on his political comeback, and his rivals for supremacy in the centre-right UMP party, are relishing the current miserable plight of Mr Hollande and his Socialist government. But they need to be careful what they wish for: without a turnround in the economy Mr Hollande is desperately struggling to engineer, both mainstream parties will face a bruising challenge from Ms Le Pen, who scents blood and is deadly serious about her tilt for power. ● There may yet be hope for the president. As I wind up three years in Paris this week, I recall that after leaving previous postings in Ireland in the mid-1980s and Israel and then Sweden in the 1990s, their economies swung from bust to boom. My return to London may just be a buy signal for France. You read it here first. http://www.ft.com/intl/cms/s/0/ed7c7356-5851-11e4-a31b- 00144feab7de.html#axzz3GhDhDPeH

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vox

Research-based policy analysis and commentary from leading economists Sovereign-debt relief and its aftermath: The 1930s, the 1990s, the future?

Carmen M Reinhart, Christoph Trebesch 21 October 2014 To work towards resolving Europe’s ongoing debt crisis this column looks to the past. From the recent emerging market debt crisis (1980s-2000s) and the interwar episode of the 1920s-1930s we learn that debt write-downs and defaults are able to be postponed but not prevented. Punishment for default is temporary, sometimes followed by a renewed surge in borrowing that leads to another crisis. Related// Revisiting sovereign bankruptcy Lee C. Buchheit , Beatrice Weder di Mauro, Anna Gelpern, Mitu Gulati, Ugo Panizza, Jeromin Zettelmeyer/ Restructuring sovereign debt, 1950–2010: From process to outcomes Udaibir S Das, Michael G. Papaioannou, Christoph Trebesch/ Shifting motives: Explaining the build-up in official reserves in emerging markets since the 1980s Atish R Ghosh, Jonathan D Ostry, Charalambos Tsangarides Since 2008 Europe has been mired in a combination of economic depression, financial crisis, and public and private debt overhangs. Greece was the first advanced economy to restructure its debt in more than a generation, and the ongoing depression in Europe’s periphery has already surpassed the economic collapse of the 1930s by some markers. In most advanced economies record private debt overhangs are unwinding only slowly, while the steady upward march in public debts continues largely unabated. As a result, the broad subject of sovereign debt crises and the role of debt write-offs in their resolution is no longer a matter of solely academic interest. This column adds a historical perspective to the small body of work on sovereign debt relief episodes of recent decades (see, in particular, Arslanalp and Henry 2005, Chauvin and Kraay 2005, Dias et al. 2013, Sturzenegger and Zettelmeyer 2007). In Reinhart and Trebesch (2014) we draw lessons from two main historical episodes of sovereign default and debt relief: • the well-known emerging market debt crises of recent decades (1980s-2000s), and • the lesser-known debt crisis and overhang episode of war-related debt in advanced economies of the 1920s and 1930s, which emerged as a result of WWI and its aftermath. We collect a new dataset on indebtedness, default and relief for both episodes and then study the economic landscape before and after the resolution of the crises.

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The magnitudes of debt relief The findings for the 1930s are particularly revealing: many of today’s advanced economies benefited from large-scale debt relief thanks to their 1934 default on war-related debt owed to the US and UK, the two main creditor governments of the time. The amounts were substantial: in France, Greece, and Italy, the war debt relief accounted for 36%, 43%, and 52% of 1934 GDP respectively. These debts were fully written off and the debt largely forgotten. Table 1 provides an overview on the amounts involved. Table 1. Unpaid allied wartime and postwar debt owed to the US and the UK: The 1934 summer defaults

Sources: Debt amounts owed to the US are from the Annual Report of the Secretary of the Treasury on the State of the Finances – For Fiscal Year Ended June 30, 1934, pp. 391. Debt figures are given for Nov 15, 1934. We add to this the amount of arrears, i.e. overdue payments under the debt restructuring agreements of the 1920s. Debt amounts owed to the UK are from the Moody's Manual of Investments and Securities Rating Service: Foreign and American Government Securities, 1935, p.1927. Debt figures are given for March 31, 1934, plus arrears. To compute present values (last column) we use the terms shown in the original loan documents, as shown in Moulton and Pasvolsky (1932). We follow their approach and use a 5% annual rate to discount future war debt payments. The amounts of debt outstanding under the broad category of WWI debt includes, especially for Eastern Europe, debts taken on after the war in connection with reconstruction. The breakdown is given for each debtor country in Reinhart and Rogoff 347

(2014). Exchange rates are from Historical Statistics of the United States and United Nation (1948). The sources for nominal GDP for 1934 are as follows: US and UK from Measuring Worth; France, Historical National Accounts Database (HNAD), 1815-1938 ; Italy, Francese and Pace (2008) 1861-2006; Belgium, 1835-2005, BNB, Center d'études économiques de la KUL; Greece, Kostelenos (2003), 1830-1939; Austria, 1924-1937. Global Financial Data; Finland GDP, Historical National Accounts Database (HNAD), 1860-2001; Portugal: Estadisticas Historicas Do Portugal, 1851- 1952; New Zealand: Statistics New Zealand, 1900-1947; Australia: GFD, Haig (2001) 1852-1948; Note: For a full set of references see Reinhart and Trebesch (2014). Figure 1a shows that the average magnitudes of debt relief in the 1930s are similar to those in emerging market debt crisis events of recent decades, while Figure 1b provides greater detail on the advanced economy episode of the 1920s-1930s. More specifically, we find that, across 45 debt crisis episodes for which we have sufficient data, debt relief averaged 19% of GDP for advanced economies (1932-1939) and 16% of GDP for emerging markets (1979-2010). The figure includes one domestic debt event in the 1930s: the abrogation of the Gold Clause in the US in 1934. Figure 1a. Default, restructuring, and debt relief: World War I debt to the US and the UK, 1934, emerging markets, 1978-2010 (debt relief as a percent of GDP)

Sources: Cruces and Trebesch (2013), Reinhart and Rogoff (2009), Reinhart and Trebesch (2014) 348

Figure 1b. War debt relief of major European countries as a share of GDP in 1934

Notes: Estimates of war debt relief in % of creditor country GDP. Figures are shown for debt owed to the US and to the UK separately. The sources are the same as in Table 1a. The present value estimates use an annual discount rate of 5% and the contractual debt service streams of the original agreements as in Moulton and Pasvolsky (1932). Parallels in crisis resolution We also find parallels in the progression and outcomes of the two debt crisis eras. Box 1 provides a thumbnail comparison of three international episodes: the 1920s/1930s, the 1980s/1990s, and post-2007. War debts were the dominant type of indebtedness for

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many advanced countries in the 1920s, just as were bank loans to developing countries in the 1970s and 1980s.1 Box 1. Selected features of international debt overhang episodes

In the 1920s, much of the international policy discourse focused on the need for debt relief. There were preliminary rescheduling agreements in the early 1920s which postponed war debt repayments to the US and the UK by more than 20 years, but without a reduction in the nominal debt burden. This is very similar to the 1980s, where short-term debt reschedulings (1982-1985) were followed by multi-year rescheduling agreements within the Baker plan (1987-1989), again without nominal write-offs. Ultimately the war debt overhang was resolved via large-scale debt reduction and the default of 1934, in which 15 European countries as well as Australia and New Zealand suspended their payments to the UK and the US. This explicit debt reduction was a central way to cope with Fisher’s (1933) debt-deflation spiral, thus crucially complementing the devaluation and inflation events. This resembles the 1990s, when the Brady agreements resulted in substantial debt write-offs in 17 developing countries. The aftermath of debt relief Figure 2 plots average real per capita GDP (normalised to equal one at time T) around final restructurings (exit from default).2 The average covers 33 of the 35 middle-high income emerging markets (Table 3) for which we have real per capita GDP data.3 The red line shows the comparable average for 12 of the 16 defaulters the 1930s shown in Table 1a plus the US and Germany. While the lines show the level of per capita GDP from both the normalisation to T=1 and the inset box, Figure 2 also summarises the growth performance.

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For the 1930s average, 1932 marks the trough in per capita GDP with barely any change through 1934. After 1934 there is a sharp rebound (cumulative growth is 16% from T to T+4) following a prolonged collapse of 7%. Rebound notwithstanding, it takes six years to recoup the income level recorded in T-4 (as we will show, it takes even longer to surpass the prior economic peak in per capita GDP, which usually predated T-4 and corresponds to 1930). The emerging market countries show a flat per capita GDP path while in the default spell (through T) but a substantial pick up thereafter. Figure 2. Real per capita GDP around final restructurings (exit from default) in middle- high income emerging markets, 1978-2010 and selected 1934 sovereign default episodes (mostly on World War I debt to US) 8-year window around credit event, level of real per capita GDP at T=1

Sources: IMF World Economic Outlook, Maddison Database, Reinhart and Rogoff, (2009 and 2013) Total Economy Database and authors’ calculations. War debt defaults on debts to the US. The general picture that emerges is that, once the restructuring is completed decisively, economic conditions improve in terms of growth, debt servicing burdens, debt sustainability and international capital market access. Both the advanced economy and emerging market samples provide evidence in this regard. The critical modifier is ‘completed decisively’. Ex post it is straightforward to date the deal that ends the debt crisis spell. Ex-ante it is difficult to ascertain whether a restructuring proposal will deliver that decisive outcome (given that the debt sustainability calculus is crucially driven by assumptions of future growth and how quickly risk premia decline). These observations are not meant to imply that the restructuring or default process is not fraught with a variety of risks including reputational issues; it is meant to suggest that the ‘punishment’ is neither permanent nor even persistent. In effect, exit from default

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has in a few cases been followed by a renewed surge in borrowing culminating in a new debt crisis within a decade of the exit of the previous crisis. The 2010s: Another lost decade? Much of the 1920s and 1930s were ‘lost decades’ for European countries – similar to the 1980s in Latin America and Africa. In both eras there were countless conferences and international summits on how to solve the debt problem of the time. In the end, debt write downs and defaults were delayed but not prevented. It has already been seven years since the onset of the subprime crisis in the summer of 2007. Perhaps past episodes can offer insights into the current predicament, as the debt overhang of the 2010s still awaits resolution. References Arslanalp, S and P Henry (2005) "Is Debt Relief Efficient?" Journal of Finance, Vol. 60 No. 2, 1017-1051. Chauvin, N D and A Kraay (2005) “What Has 100 Billion Dollars Worth of Debt Relief Done for Low-Income Countries?” Washington, DC, World Bank, September. Dias, D A, C Richmond and M L J Wright (2013) “In for a Penny, In for a 100 Billion Pounds: Quantifying the Welfare Benefits from Debt Forgiveness”, mimeo. Reinhart, C M and C Trebesch (2014) “A Distant Mirror of Debt, Default, and Relief”, CEPR Discussion Paper 10195, October. Sturzenegger, F and J Zettelmeyer (2007) “Creditors Losses versus Debt Relief: Results from a Decade of Sovereign Debt Crises.” Journal of the European Economic Association, Vol. 5 No. 2-3, 343–351. Footnotes 1 Ahamed (2010) often harks back to the war debt overhang theme. 2 See Tomz and Wright (2007) for a long-run study on the link between sovereign default and output. 3 The data comes from Maddison http://www.ggdc.net/maddison/ for pre-1950 and the Total Economy Database (TED) subsequently. http://www.voxeu.org/article/sovereign-debt-relief-and-its-aftermath-1930s-1990s- future

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lanacion.com | Lunes 20 de octubre de 2014 | Publicado en edición impresa Economía Inflación, estancamiento y crisis cambiaria, la síntesis del diagnóstico privado Dos informes advierten que el Gobierno no asume las causas y, por lo tanto, equivoca la solución Inflación, estancamiento de la actividad y problemas cambiarios, generados, entre otros factores, por el default de la deuda pública. Es la síntesis del diagnóstico de la economía argentina actual y la de los próximos meses, según coinciden en señalar distintos analistas y consultores privados. "La estanflación [estancamiento económico más inflación] se profundiza trimestre tras trimestre", advirtió la consultora Economía y Regiones (E&R) en su último informe, y previno que "esta coyuntura se puede corregir o agravar en el futuro dependiendo de la claridad del Gobierno para diagnosticar las causas". El problema, a su juicio, es que "hasta ahora los diagnósticos fueron equivocados y, por ende, las políticas aplicadas agrandaron los problemas". "La macroeconomía argentina -resume el informe- se enfrenta principalmente a tres problemas: el cambiario, la caída del nivel de actividad (y del empleo) y el default de la deuda. Los problemas cambiarios generan caída de la actividad y aumento de la inflación, mientras que el default de la deuda agrava ambos." "El Gobierno no solucionó sino que agravó los problemas, no sólo porque puso el cepo que dio origen al dólar paralelo [y la brecha cambiaria], sino porque intensificó sus políticas fiscales y monetarias expansivas, que en realidad eran el origen del problema", cuestionó E&R. El informe señaló que "los problemas cambiarios se trasladaron a la producción, cuya tasa de crecimiento se desaceleró en un principio y se contrajo posteriormente". Según sus cálculos, el PBI arrancó el año con una baja de 1,2% en el primer trimestre y se profundizó la caída a 2,3% en el segundo. A este ritmo, el año terminará con una variación negativa en torno a 3%. "Si consideramos que la inflación (40,9% interanual en septiembre) publicada por el Congreso también se acelera, podemos decir sin titubear que la economía está actualmente inmersa en una fuerte, generalizada y creciente estanflación", analizó. Además, afirmó que "la actual estrategia del Gobierno para encarar el tema de los holdouts retroalimenta las expectativas negativas y la caída del nivel de actividad, potenciando el círculo vicioso".

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Otro efecto negativo, en la visión del equipo de investigación del Banco Ciudad, es que, al no corregirse la inflación, la fuerte devaluación del peso de principios de año agotó sus efectos, y plantear la misma estrategia impactaría sobre los precios. "P ese a su moderación en el margen, la inflación sigue alta y ya absorbió el grueso de la corrección cambiaria de inicios del año", señala un informe de la entidad. Y agrega: "En lo que va de 2014, la devaluación acumulada del peso (29%) ya fue neutralizada por la suba de los precios internos (31%), volviendo a enfrentarse un escenario de presión sobre el mercado de cambios similar al de diciembre 2013". En este escenario, el informe del Ciudad recuerda que en los primeros 11 días hábiles de octubre "la demanda de dólar ahorro se disparó casi un 40% respecto de igual período de septiembre". A este ritmo, la pérdida de reservas por este motivo podría llegar a US$ 500 millones mensuales (equivalente a 6000 millones anuales), "casi una cuarta parte de las reservas internacionales". "El problema es que en la medida en que se sigan atacando las consecuencias de la inflación vía regulaciones como el programa Precios Cuidados o la amenaza de aplicar la ley de abastecimiento, en lugar de avocarse a solucionar sus verdaderas causas (un déficit fiscal creciente, financiado vía emisión monetaria), las presiones sobre el nivel de precios seguirán vigentes, manteniéndose una inestable situación macroeconómica y cambiaria".. http://www.lanacion.com.ar/1736988-inflacion-estancamiento-y-crisis-cambiaria- la-sintesis-del-diagnostico-privado

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How big should central bank balance sheets be? October 20, 2014 In 2007, the Fed’s balance sheet was less than $1 trillion. Today, it is nearly $4.5 trillion. The U.S. experience is far from unique. Since 2007, global central bank balance sheets have nearly tripled to more than $22 trillion as of mid-2014. And, the increase is split evenly between advanced and emerging market economies (EMEs) (see chart). Central Bank Assets (Trillions of U.S. Dollars)

Source: National central banks. So what’s the right size? The answer depends on the policy goals and the nature of the financial system. In the case of the Fed, we expect that it will be able to achieve its long-term objectives with fewer than half of its current assets. The size of central bank balance sheets varies dramatically from country to country (see the two charts below). In advanced economies, the range today is from less than 5% of GDP in Canada to more than 80% in Switzerland. Central banks in EMEs have balance

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sheets that are nearly twice the advanced-economy norm, ranging from 12% of GDP in Colombia to nearly 140% of GDP in Hong Kong. Advanced Economy Central Bank Assets (Trillions of U.S. Dollars)

/> Sources: National central banks and IMF.

/> Sources: National central banks and IMF. 356

We see five primary reasons for these differences: • Financial system structure • Regulation • Payments technology • Policy objectives • Degree of central bank independence In financial systems where banks dominate, central bank balance sheets will be larger. Where reserve requirements are high, central banks need bigger balance sheets to satisfy commercial bank reserve needs. Where payments technology relies heavily on currency (rather than electronic transfers), the public holds more cash and commercial banks also seek larger reserve buffers to meet payments obligations. Policymakers focused on exchange rate stability typically need big foreign currency reserves. Finally, central banks that are not politically independent may hold a large volume of assets in their role as the government’s bank, allowing them to target favored assets. In contrast, independent central banks tend to hold small portfolios of relatively short-term government securities. Such “asset neutrality” establishes a bulwark against influence over the central bank by the fiscal authority. These five factors go a long way toward explaining why emerging market central bank balance sheets tend to be larger than those in advanced economies. Emerging market financial systems are more likely to be bank-based, have high reserve requirements, and rely on currency as the premier means of payment. Their central banks also are more prone to target exchange rate stability and to act as the government’s agent in allocating credit to targeted assets. The same factors also explain some of the within-category differences. Among advanced economies, for example, Canada has a zero reserve requirement while the Eurosystem is relatively bank-centric, helping to account for the latter’s bigger balance sheet. Among EMEs, China, Hong Kong, Saudi Arabia, and Singapore need a large stock of foreign currency to manage their exchange rates, while Colombia, the Czech Republic, and Poland let their currencies float. So what factors drove the enormous and widespread balance sheet changes since 2007? Broadly speaking, there are four classes of motives associated with specific policy goals (see this recent paper): • Foreign exchange operations • Lender of last resort or market function operations • Stabilization of aggregate demand at the zero bound • Forced government financing (aka fiscal dominance) Most of the crisis-driven balance sheet growth since 2007 was in the first and second categories, with some in the third. For example, the expanded balance sheets in China, Hong Kong and Switzerland reflect operations to steady exchange rates. Interventions in dysfunctional markets played a significant role in the United States and the United Kingdom. In many countries, including Japan, the United States, and the United

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Kingdom, demand stabilization at the zero bound eventually became the leading driver. [So far, no leading central bank has been compelled to finance its government.] The vast balance sheet changes in recent years have been aimed at influencing far more than just the overnight interbank lending rate. U.S. monetary policy makers altered both the size and composition of their balance sheet, initially to counter dysfunctional markets, but eventually to influence both the term structure and credit risk structure of interest rates. By increasing their portfolio size and duration, the Fed compressed the term premium on U.S. government debt. And by purchasing government-insured mortgage-backed securities, the U.S. authorities were able to narrow the yield spread on mortgage loans. (You can find a discussion of various unconventional monetary policies, including balance sheet policies, here.) But U.S. financial markets are now functioning well, and the aggregate demand rationale for altering the term and risk structure of interest rates is waning. So, what should the Federal Reserve aim to do about the extraordinary size of its balance sheet? The answer requires weighing the benefits and costs of maintaining a large balance sheet in normal times when monetary policy is set by altering the policy interest rate (see table). Maintaining a Large Central Bank Balance Sheet in Normal Times

Benefits Costs

Ability to influence a range of securities prices Portfolio risk

Provision of high-quality liquid assets to economy Substitute for private intermediaries

Limit excessive liquidity/maturity transformation Risk to central bank independence

We see three main benefits. A central bank that holds a large, diverse portfolio of assets has the ability to influence a variety of securities prices and can provide a large volume of high-quality liquid assets to firms and households. In addition, by offering banks a large level of reserves at low cost (the leading central banks now all pay interest on reserves), central banks discourage bank risk-taking in the form of liquidity and maturity transformation. Put differently, paying interest on reserves can be viewed as a price-based version of a liquidity requirement (something we wrote about in a recent post). We also see three main costs. First, a large balance sheet will mean portfolio risk, partly in the form of high leverage. For example, the Federal Reserve System currently has total assets of more than 150 times its capital. And, its holdings of long-term bonds expose it to substantial risk of loss if interest rates rise. Yet, quite a few central banks probably operate today without positive net worth – a state of affairs that poses risks only if their capital shortfall subjects the central bankers to political pressures. (You can find a general discussion of central bank finances here.) Second, if central banks remain big players in a broad array of financial markets, they substitute their own balance sheet for that of private intermediaries. When markets were dysfunctional – as in the heat of the financial crisis – this was desirable. In normal 358

times, private intermediaries have strong incentives to allocate savings to their most efficient uses, and are less prone than a central bank to political influence. Finally, and most importantly, a government that comes to rely on a central bank to hold a large quantity of its debt poses a threat to central bank independence. History teaches us that when the central bank loses control of its balance sheet to the fiscal authority, the results can be catastrophic. So, where does all of this leave us? In a recent statement of principle, the FOMC expressed the intention over the long run to “hold no more securities than necessary to implement monetary policy efficiently and effectively.” In addition, it will “hold primarily Treasury securities” to limit the balance sheet’s effect “on the allocation of credit across sectors of the economy.” The stated goal of a minimal, asset-neutral balance sheet is well suited to a highly independent central bank in normal times. The Fed still retains the authority, in some future crisis, to intervene in dysfunctional markets. Its willingness to intervene provides the financial system valuable insurance against tail risk, but has negligible balance sheet impact in normal times. So how much is the Fed’s balance sheet eventually likely to shrink? Plenty. There seems little desire to replace its $1.7 trillion of mortgage-backed securities as they mature. The remaining assets would be sufficient to support more than $1 trillion of bank reserves. But monetary policy can be implemented efficiently with few (or even no) reserves. Our view is that the most likely result is a long-run Fed portfolio at most half its current size, even if policymakers decide they wish to provide significant high- quality liquid assets, and substantially less if they do not. It will take many years to get to this lower long-run level of assets, but making that transition ought not be a problem for setting monetary policy. With the ability to pay interest on reserves, combined with other new instruments like reverse repo, the Fed should be able to adjust its policy interest rate regardless of the size of its balance sheet. http://www.moneyandbanking.com/commentary/2014/10/20/how-big-should- central-bank-balance-sheets-be

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Does The Secular Stagnation Theory Have Any Sort of Validity?

Author: Edward Hugh · October 20th, 2014 · In a number of blog-posts (Paul Krugman’s Bicycling Problem, On Bubble Business Bound, The Expectations Fairy) I have examined some of the implications of the theory of secular stagnation. But I haven’t up to now argued why I think the hypothesis that Japan and some parts of Europe are suffering from some kind of secular stagnation could well be a valid one. Strangely, while I would suggest the most obviously affected countries are those mentioned above, most of the debate has centered around the US economy. Since it is not at all clear that the US economy is actually suffering from either a liquidity trap or secular stagnation at this point, this has lead many to question whether the idea might not be ill-founded. The Economist, for example, in a revue article (Fad or Fact) of Teulings and Baldwin’s Vox e-book on the topic conclude the concept “remains a baggy one”, one which is “arguably too capacious for its own good”. Viewed in this light the concept does at times appear vague, and lacking in clear definition. In part this is because Alvin Hansen’s original idea was made up of two components, a technological and a demographic one. Naturally if there is a slowdown in the rate of impact of technological innovation then this would be felt equally across those economies which are operating near the technological frontier. But the phenomenon which is being described today as secular stagnation isn’t being witnessed equally across all those countries. Economies in both the UK and the US appear to have responded differently to those in Sweden, the Euro Area and Japan, a phenomenon which is obvious to the theory’s critics. Thus the Economist author goes on to argue, “it is hard to avoid the conclusion that many of the euro area’s difficulties result from a dysfunctional monetary union rather than a susceptibility to secular stagnation.” And it would be hard to disagree with the writer, except… except ….except that there is the awkward little case of Japan, which doesn’t actually use the Euro, as there are possible cases like the Czech Republic, Sweden or Hungary that don’t either.

Which brings us nearer to the demographic part of the argument. Is there any pattern emerging in the way symptoms which look like those which would be presented in 360

cases suffering from secular stagnation are showing up? Well, I would argue there is. I think it is generally accepted that the first affected country was Japan. It was in Japan that a slowdown in GDP growth (not GDP per capita growth) was first noted. Japan was also the first country were working age population started to turn negative (in 1997) and where the correlation between declining growth momentum in this group and creeping deflation first started to be noticed.

Here’s what movements in EU working age population look like.

And here’s why I don’t think considerations of demography can really justify the secular stagnation thesis in the United States context at the present time. EU working age populations started to decline in the years between 2009 and 2012. They will now continue to decline for many years to come. In the United States however, while the rate of growth in this population segment has slowed in recent years, it is about to start accelerating again. As Calculated Risk’s Bill McBride pointed out, the US Census Bureau now reports that Baby Boomers aren’t the largest US cohort anymore, and that the prime working-age force is expected to start growing again in a few years. In other words, in terms of the demographic outlook, the dynamic points to stronger, rather than weaker, economic growth. By 2020, eight of the top ten largest

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cohorts (five year age groups) will be under 40, and by 2030 the top 11 cohorts will be the youngest 11 cohorts. (see the marvelous animation Bill has at the end of his post).

Not All Europe Is The Same Naturally, demographic dynamics are not the same in every country across Europe. The two oldest countries on the planet are Japan and Germany with median population ages of around 46. Then comes Italy with with one of 45. I have recently written about the possibility Germany is bogged down in some kind of secular stagnation process. The Economist writer argues that what Europe’s economies need are structural reforms, but it isn’t clear if he also thinks Germany needs another swathe of these. Long term growth is low in Germany, and inflation pressures are weak. It is not clear, however, that Germany is stuck in any kind of any kind of balance-sheet-recession-type liquidity trap. Loan growth is low, but this may well be a function of the age structure of the population. It’s no big secret really that Italy is suffering long term growth stagnation (which many, like the Economist and Beppe Grillo simply attribute to Euro membership).

And Italy has recently begun to have negative inflation levels.

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Next on the list come countries like Austria (median age, 44), Finland (43,2), The Netherlands (42.1), Switzerland (42) and Sweden (41.2). It is striking that both Finland and The Netherlands have recently been suffering from very weak growth and almost constant recessions, while Sweden and Switzerland have an ongoing problem with a deflation threat. If we fan out a bit, and move over to Eastern Europe, where working age populations are almost universally falling, the sharp fall in growth rates between the years before and the years after the crisis is also pretty noteworthy.

Before the crisis annual growth rates were in the 4% to 6% range, now they are in the 1% to 2% range, and these are all emerging economies with levels of GDP per capital well below the EU average, countries who should in theory be experiencing strong “catch up” growth.

At the same time inflation, which was previously a significant problem, has all but disappeared and in fact deflation risk is pretty general across the region. Normally CEE countries have median ages of around 41, much older than say Ireland with a median age of 35.7, or the United States with one of 37.6.

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So we seem to be observing the following pattern: working age population growth approaches zero and starts to turn negative, growth slumps to about 1% a year and falling, and inflation weakens to the point of becoming deflation. If this rough correlation is reasonably valid the next countries where we see secular stagnation setting in are South Korea and China, since working age populations are now in the process of turning there too. A Simple Mechanism So how do secular stagnation work? What’s the mechanism? Well so far we have been offered two, one from Paul Krugman. “To have more or less full employment, we need sufficient spending to make use of the economy’s potential. But one important component of spending, investment, is subject to the accelerator effect: the demand for new capital depends on the economy’s rate of growth, rather than the current level of output. So if growth slows due to a falloff in population growth, investment demand falls — potentially pushing the economy into a semi-permanent slump.” A slowdown in the rate of increase in domestic demand leads to a slowdown in investment, and this double slowdown pushes the economy into a dependence on exports and very weak GDP growth. The first place this “underinvestment” phenomenon showed up was in Japan.

Then we have seen it in Germany.

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And now the “German” phenomenon has spread to the rest of Europe.

The second pathway through which demographically driven secular stagnation operates was described by a group of IMF economists in a recent research paper: “Is Japan’s Population Aging Deflationary?” Lower demand from older populations (less credit growth) leads to oversupply and deflationary pressure. The first part of the paper abstract runs as follows: “Japan has the most rapidly aging population in the world. This affects growth and fiscal sustainability, but the potential impact on inflation has been studied less. We use the IMF’s Global Integrated Fiscal and Monetary Model (GIMF) and find substantial deflationary pressures from aging, mainly from declining growth and falling land prices. Dissaving by the elderly makes matters worse as it leads to real exchange rate appreciation from the repatriation of foreign assets. The deflationary effects from aging are magnified by the large fiscal consolidation need.” So while there is no definitive answer at this point to the question whether or not what we are seeing is a creeping process of secular stagnation which will gradually spread from one economy to another as the respective working age populations start to contract, there is strong prima facie evidence that there may be, that the theory is worth examining and that the hypothesis should continue to be tested. Postscript http://www.economonitor.com/edwardhugh/2014/10/20/does-the-secular-stagnation- theory-have-any-sort-of- validity/?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+ec onomonitor%2FOUen+%28EconoMonitor%29

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business/ Guardian business live

Graeme Wearden//Tuesday 21 October 2014 19:56 BST

Weak wage growth is hitting tax receipts Duncan Weldon, 21-Oct-2014, 9: 56

Why is Britain borrowing more than a year ago, even though the economy has been growing pretty strongly over the last year? The answer is weak wage growth, which means that income tac receipts are barely higher in April-September 2014 compared with 2013. The ONS reports, that in the first half of this financial year: VAT receipts increased by £2.3 billion, or 3.9%, to £61.5 billion; income tax-related payments increased by £0.1 billion, or 0.1%, to £71.5 billion; stamp duties (on shares, land & property) increased by £1.5 billion, or 25.2%, to £7.3 billion; corporation tax increased by £0.9 billion, or 5.4%, to £18.4 billion; Duncan Weldon@DuncanWeldon Follow Growth better than OBR expected, hours worked higher & unemployment lower but borrowing overshooting. One big reason: weak wage growth. 10:38 AM - 21 Oct 2014 Duncan Weldon@DuncanWeldon Follow The UK is learning the same lesson as much of the Eurozone - when inflation & wage growth are v low, it's hard to bring a govt deficit down. 10:45 AM - 21 Oct 2014 http://www.theguardian.com/business/live/2014/oct/21/china-growth-slows-uk-public- finances-business-live

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Economist's View

« 'The Problem of Riches' | Main | What Makes Cities Successful? » 'Why our Happiness and Satisfaction Should Replace GDP in Policy Making' Richard Easterlin: Why our happiness and satisfaction should replace GDP in policy making, The Conversation: Since 1990, GDP per person in China has doubled and then redoubled. With average incomes multiplying fourfold in little more than two decades, one might expect many of the Chinese people to be dancing in the streets. Yet, when asked about their satisfaction with life, they are, if anything, less satisfied than in 1990. The disparity indicated by these two measures of human progress, Gross Domestic Product and Subjective Well Being (SWB), makes pretty plain the issue at hand. GDP, the well-being indicator commonly used in policy circles, signals an outstanding advance in China. SWB, as indicated by self-reports of overall satisfaction with life, suggests, if anything, a worsening of people’s lives. Which measure is a more meaningful index of well-being? Which is a better guide for public policy? A few decades ago, economists – the most influential social scientists shaping public policy – would have said that the SWB result for China demonstrates the meaninglessness of self-reports of well-being. Economic historian Deirdre McCloskey, writing in 1983, aptly put the typical attitude of economists this way: Unlike other social scientists, economists are extremely hostile towards questionnaires and other self-descriptions… One can literally get an audience of economists to laugh out loud by proposing ironically to send out a questionnaire on some disputed economic point. Economists… are unthinkingly committed to the notion that only the externally observable behaviour of actors is admissible evidence in arguments concerning economics. Culture clash But times have changed. A commission established by the then French president, Nicolas Sarkozy in 2008 and charged with recommending alternatives to GDP as a measure of progress, stated bluntly (my emphasis): Research has shown that it is possible to collect meaningful and reliable data on subjective as well as objective well-being … The types of questions that have proved their value within small-scale and unofficial surveys should be included in larger-scale surveys undertaken by official statistical offices.

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This 25-member commission was comprised almost entirely of economists, five of whom had won the Nobel Prize in economics. Two of the five co-chaired the commission. These days the tendency with new measures of our well-being – such as life satisfaction and happiness – is to propose that they be used as a complement to GDP. But what is one to do when confronted with such a stark difference between SWB and GDP, as in China? What should one say? People in China are better off than ever before, people are no better off than before, or “it depends”? Commonalities To decide this issue, we need to delve deeper into what has happened in China. When we do that, the superiority of SWB becomes apparent: it can capture the multiple dimensions of people’s lives. GDP, in contrast, focuses exclusively on the output of material goods. People everywhere in the world spend most of their time trying to earn a living and raise a healthy family. The easier it is for them to do this, the happier they are. This is the lesson of a 1965 classic, The Pattern of Human Concerns, by public opinion survey specialist Hadley Cantril. In the 12 countries – rich and poor, communist and non- communist – that Cantril surveyed, the same highly personal concerns dominated determinants of happiness: standard of living, family, health and work. Broad social issues such as inequality, discrimination and international relations, were rarely mentioned. Urban China in 1990 was essentially a mini-welfare state. Workers had what has been called an “iron rice bowl” – they were assured of jobs, housing, medical services, pensions, childcare and jobs for their grown children. With the coming of capitalism, and “restructuring” of state enterprises, the iron rice bowl was smashed and these assurances went out the window. Unemployment soared and the social safety net disappeared. The security that workers had enjoyed was gone and the result was that life satisfaction plummeted, especially among the less- educated, lower-income segments of the population. Although working conditions have improved somewhat in the past decade, the shortfall from the security enjoyed in 1990 remains substantial. The positive effect on wellbeing of rising incomes has been negated by rapidly rising material aspirations and the emergence of urgent concerns about income and job security, family, and health. The case to replace Examples of the disparity between SWB and GDP as measures of well-being could easily be multiplied. Since the early 1970s real GDP per capita in the US has doubled, but SWB has, if anything, declined. In international comparisons, Costa Rica’s per capita GDP is a quarter of that in the US, but Costa Ricans are as happy or happier than Americans when we look at SWB data. Clearly there is more to people’s well-being that the output of goods. There are some simple, yet powerful arguments to say that we should use SWB in preference to GDP, not just as a complement. For a start, those SWB measures like 368

happiness or life satisfaction are more comprehensive than GDP. They take into account the effect on well-being not just of material living conditions, but of the wide range of concerns in our lives. It is also key that with SWB, the judgement of well-being is made by the individuals affected. GDP’s reliance on outside statistical “experts” to make inferences based on a measure they themselves construct looks deeply flawed when viewed in comparison. These judgements by outsiders also lie behind the growing number of multiple-item measures being put forth these days. An example is the United Nations’ Human Development Index (HDI) which attempts to combine data on GDP with indexes of education and life expectancy. But people do not identify with measures like HDI (or GDP, of course) to anywhere near the extent that they do with straightforward questions of happiness and satisfaction with life. And crucially, these SWB measures offer each adult a vote and only one vote, whether they are rich or poor, sick or well, native or foreign-born. This is not to say that, as measures of well-being go, SWB is the last word, but clearly it comes closer to capturing what is actually happening to people’s lives than GDP ever will. The question is whether policy makers actually want to know. Posted by Mark Thoma on Tuesday, October 21, 2014 at 09:24 AM in Economics, Methodology | Permalink Comments (58) http://economistsview.typepad.com/economistsview/2014/10/why-our-happiness-and- satisfaction-should-replace-gdp-in-policymaking.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A +EconomistsView+%28Economist%27s+View%29 Original:

http://theconversation.com/why-our-happiness-and-satisfaction-should-replace-gdp-in- policy-making-30934

Pero véase también: Maximising happiness does not maximise welfare

Edward Glaeser, Joshua Gottlieb, Oren Ziv15 October 2014

Governments are now measuring happiness, or subjective wellbeing, and some have begun trying to maximise it. This column discusses recent research showing that happiness is not the same thing as utility. The choices people make suggest that they have desires and objectives other than happiness. It is therefore possible to make people worse off while increasing their reported subjective wellbeing. http://www.voxeu.org/article/maximising-happiness-does-not-maximise-welfare

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21 October 2014, 4.46am BST Look to China’s productivity gains, not headline growth figures James Laurenceson, Deputy Director and Professor, Australia-China Relations Institute (ACRI) at University of Technology, Sydney

China needs to adopt a productivity reform agenda to avoid falling living standards. AAP China’s economy grew by 7.3% during the third quarter of 2014, meeting market expectations. Polling by Reuters and the Wall Street Journal put the consensus forecast at 7.2-7.3%, the slowest pace in more than five years. But to see where China is really headed, a closer look needs to be taken at its productivity. With iron ore prices already sitting at five year lows, a further slowdown in Chinese growth is not the sort of news that Australian policy-makers need. What is of greater concern is whether we are seeing the beginning of something more permanent. Will China have a similar trajectory to Japan since the early 1990s? This would impact the rise of China’s middle class – conceivably growing by another 850 million by 2030. It is this middle class that is set to underpin demand for Australia’s exports for decades to come. In the long run economic growth is delivered when productivity climbs. That means finding better ways of doing things. The only other way to produce more output is to use more inputs. However, the problem is diminishing returns. Building a rail link that connects an inland city with a port brings enormous benefits but once built, there is little need for another. This is precisely the problem that Nobel Prize winning economist Paul Krugman found confronted the Soviet Union in the 1950s and Asian countries such as Singapore more

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recently. It is also the big worry associated with China’s current growth model which saw investment hit 47.8% of GDP last year, an extraordinarily high level. Can China’s productivity improve? Productivity struggles to attract the attention of commentators because it is hard to calculate. Professor Chris O’Donnell and I recently published some new estimates for China. Over the period 1978-2010 we found evidence of rapid productivity growth across most provinces. This is good news but also no surprise - China had access to easy sources of productivity gains such as borrowing technology from overseas. The key question is whether productivity can continue to improve as the economy matures? China has many of the basic policy settings right. The government has spent much on human capital and the results are significant. In 2004, China had eight universities in the world’s top 500 and none in the top 200. Just a decade on and the respective figures are 32 and six. China’s universities are now second only to those in the United States in terms of their total research output. But for truly rich productivity gains to be unlocked, reforms are needed that shift the economy away from its dependence upon investment. For consumers to take the lead they need more income. Getting state-owned banks to pay the household sector market rates of return on their savings deposits is one example of the type of policy that is sorely needed. Why China needs to adopt new reforms now Delays to reform will be costly. In their latest country report released in July, the International Monetary Fund forecast that if needed reforms were swiftly implemented, China would grow at around 6.5% in 2020 and 5.5% in 2025. Without them, growth could fall to as low as 4% and 3%, respectively. Facing a downturn in economic activity, the first instinct of China’s leaders is to pull policy levers that pump up aggregate demand. But temporary measures to boost growth such as expanding the supply of credit have largely run their course and are no longer sustainable. Comments made by Premier Li Keqiang to the World Economic Forum in Tianjin last month suggest that China’s leaders now understand this. When pushed they have also shown themselves to be nothing if not pragmatic. President Xi Jinping’s aggressive tackling of official corruption in response to public anger is a case in point. If stalled living standards are to be avoided, committing to a productivity- enhancing reform agenda is really the only option that China has left. So don’t get lost in the headline growth number. Focus instead on what the data says about the trajectory of productivity. Through the first half of 2014 consumption contributed 54% of GDP growth, while investment chimed in with 49% (net exports were responsible for -3%). The overall growth rate may be disappointing but if there is a widening of the gap in favour of consumption then this is exactly the sort of news that China and Australia needs. http://theconversation.com/look-to-chinas-productivity-gains-not-headline-growth-figures-32940 371

20 October 2014, 1.02am BST Who calls the tune? Asia has to dance to duelling trade agendas Michael Wesley, Professor and Director of School of International Political and Strategic Studies at Australian National University

Diplomatic smiles and handshakes are in order when Chinese and US representatives meet, but separate trade talks driven by Beijing and Washington represent a high-stakes contest for influence. EPA/Michael Reynolds Ten years on from the Australia-US Free Trade Agreement, Australia is entering another round of negotiations towards the new and controversial Trans-Pacific Partnership. In this Free Trade Scorecard series, we review Australian trade policy over the years and where we stand today on the brink of a number of significant new trade deals.

Amid the Abbott government’s push to conclude bilateral trade agreements with Japan, South Korea and China, you’d be forgiven for having missed the larger trade negotiations Australia is party to. The Trans-Pacific Partnership (TPP) is being negotiated by 12 countries: Chile, New Zealand, Singapore, Brunei, the United States, Malaysia, Peru, Vietnam, Canada, Mexico, Japan – and Australia. Simultaneously, Australia is in talks on a Regional Comprehensive Economic Partnership (RCEP) along with the 10 members of ASEAN, Japan, China, South Korea, India and New Zealand. For many, this is all to the good. More than two-thirds of Australia’s trade is with the Asia Pacific and, with all of these forums and suitors, the fears of being shut out of Asian markets seem so early ‘90s. But Australia would be naïve to ignore the more serious edge to what it is involved in here. The key fact about TPP and RCEP is that each excludes one of the world’s two largest economies. China is not party to the TPP talks. The US isn’t part of RCEP negotiations. This is a pretty clear sign that it’s all not just about free trade and 372

goodwill. It’s about TPP versus RCEP, as trade agendas become a major vehicle in the growing strategic competition between Washington and Beijing. For flint-eyed trade economists, the non-trade aspects of TPP versus RCEP are obvious. Apart from Japan, none of the parties to the TPP negotiations are significant trading partners of the US; and six of its 12 parties already have trade agreements with the US. On the RCEP side, trade economists point to the remarkably low utilisation rate of existing trade agreements among Asia Pacific countries – meaning that very few companies actually make use of the profusion of preferential trade agreements that span the region. Why are nations pursuing both agreements? If the economic advantages are unlikely to be significant, why are countries spending so much diplomatic coin in pursuing TPP and RCEP? A closer look at the negotiating strategies of the main parties – the US and China – and the broader geopolitical dynamics in the region suggests that TPP and RCEP are part of a high-stakes contest between Washington and Beijing over the regional rules of the road. The main dilemma of America’s Asia policy for the past 15 years has been how to integrate the rapidly rising powers in the region – and China in particular – into the established rules for how the Asia Pacific works. Washington was not alone in this. A host of countries in the western Pacific, including Australia, wanted to be able to benefit from the dynamism of the Chinese economy, but worried that China’s rise would disrupt a stable and prosperous regional order. The answer was a strategy that can be called co-optive socialisation. This was the belief that by welcoming rising powers into regional institutions and being willing to shift representational and decision-making structures to accommodate their interests, while demonstrating the material benefits they received from existing arrangements, this would convert outsiders into supporters of the prevailing order. Or as former US deputy secretary of state Robert Zoellick put it, “responsible stakeholders”.

A Chinese vessel turns water cannons on a Vietnamese boat near an oil rig China has set up in a disputed part of the South China Sea.EPA/Vietnam Coast Guard By about 2010, there was a growing realisation in Washington, Canberra and other capitals that this strategy hadn’t really worked. As China threw its weight around in the 373

South and East China Seas, policymakers began to realise that perhaps socialisation was working in reverse: having joined all the region’s organisations, Beijing was using them to deflect pressure from its more assertive policy. Over the same 15 years, China’s main dilemma has been how to preserve those elements of the existing rules that are to its ongoing benefit, while changing those it believes are a risk to its stability and prosperity, or are an affront to its sense of its rightful status in the world. Its initial answer was reverse socialisation – joining institutions, accepting a greater say and using its weight to block or undermine those aspects it disagrees with. But China too realised the limits of this strategy in around 2010. Reverse socialisation just wasn’t delivering the changes Beijing wants at a rate commensurate with the growth of its economic stature and sense of status. TPP vs RCEP: a regional test of strength Enter TPP versus RCEP – each representing the new phase in Sino-American order rivalry in Asia. Washington’s strategy behind TPP might be called coercive socialisation: a belief that non-compliance should be met with a re-investment in the original rules, along with imposing clear costs on those that don’t comply with them.

Barack Obama’s ‘rebalancing’ strategy in Asia depends heavily on the fate of the TPP.EPA/SIPA USA-KT Everyone from US president Barack Obama down champions the TPP as a “high quality” trade agreement, because it includes measures targeting “behind the border” trade protection. These include highly politically contentious issues such as intellectual property rights, government procurement, investor-state dispute resolution, and labour and environmental standards. TPP advocates argue that the winners in the new global economy, in which manufacturing and services are widely distributed and must flow seamlessly to capture economic gains, will be countries that are first to conclude “gold standard” trade agreements like the TPP. Through the TPP, the US is stating clearly its insistence on what it believes to be the foundation rules and values of Asia Pacific prosperity. But it’s tying these to clear 374

benefits: balanced and steady economic growth, a dynamic and integrated trade and investment system, and a stable and secure region underpinned by an American security guarantee. It is a tough-love message: getting into the TPP will be a hard grind, but staying out of it will bring real costs. And by offering accession to all regional comers, including China, the US is making entry conditional on socialisation, rather than vice versa. China’s response has been to back RCEP as part of its new strategy of gravitational re- engineering: relying on the size, dynamism and momentum of one’s own economy or example to attract swing players to one’s own alternative institutions or side in an existing institution or negotiation. For Beijing, RCEP is a defensive measure against the TPP. It is calculating that the lure of the size and dynamism of the Chinese economy will convince the region to opt for a more “Asianist” grouping, rather than the TPP’s Pacific model, which threatens to divide Asia’s economic regionalism. The ambitions of RCEP are much lower: while covering trade, services and intellectual property, the terms are much less politically demanding of the negotiating parties. The stakes are high for both the US and China. If Washington has set TPP’s ambitions so high that it is unable to close the deal, it will represent a major setback to Obama’s “rebalancing” strategy in Asia. The key country is Japan. Without Tokyo, TPP becomes much less convincing and the costs of staying outside much less worrisome for Beijing. But if the US lowers the bar for Japan, it loses a major chance to advance its coercive socialisation agenda. If Beijing pushes too hard for a compromise deal on RCEP, the lure of TPP will remain for other Asian economies. The nightmare for China would be to be the last major economy to join TPP – and therefore subject to all the tender mercies of US trade negotiators.

This article draws on research prepared for the 2014 Workshop “Ten Years since the Australia-US Free Trade Agreement: Where to for Australia’s Trade Policy?” Sponsored by the Academy of the Social Sciences in Australia and Faculty of Arts and Social Sciences, UNSW Australia. http://theconversation.com/who-calls-the-tune-asia-has-to-dance-to-duelling-trade- agendas-32813

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ft.com/ companies Financials Banks THE SHORT VIEW October 20, 2014 10:34 pm ECB’s bond move whets appetite for QE Christopher Thompson

©EPA News that the European Central Bank has begun its programme of buying covered bonds from banks in Spain, France and Germany will only whet the market’s appetite for full-blown quantitative easing. Covered bonds – considered palatable assets because they give the buyer dual recourse, to both underlying collateral and the issuing bank – are part of Mario Draghi’s recipe for lowering banks’ borrowing costs, boosting their lending, and strengthening the ECB’s own balance sheet. But, like the best amuse-bouches, Mr Draghi’s plan is being derided by some as wafer thin – in volume and substance. More ON THIS TOPIC// Equity markets rally on low rate hints/ Gillian Tett Markets parched for liquidity/ Markets Insight Deflation threat to Draghi’s credibility/ Bank of Canada in forward guidance retreat THE SHORT VIEW// Greek woes no sequel to eurozone crisis// Rocking the markets/ Worse ahead, but do cyclicals beckon?/ US bull market takes a breather On paper, at least, the opposite seems true. The ECB president has implied that the bank intends to buy a meaty €1tn of covered bonds and other asset-backed securities. One ECB official has estimated that the value of outstanding eligible covered bonds was €600bn. However, because banks benefit from covered bonds’ low risk weights under the Basel III rules, they are unlikely to want to sell. According to some estimates, the ECB could potentially target about one-third of the eligible market – but it would be competing with existing investors, much to the latter’s chagrin. New issuance is shrinking fast: only €91.7bn-worth have been issued in the year to date – the lowest total for nearly two decades, according to Dealogic. Meanwhile, yields, which help to determine borrowing costs, are already on the floor. Average covered bond yields dropped below 1 per cent for the first time in June, according to Bank of America Merrill Lynch’s euro covered bond index. They currently

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stand at about 0.55 per cent after a record low of 0.48 per cent last week as investors made a dash for haven assets amid market turmoil.

Then there is the biggest obstacle: European banks do not need the ECB’s cheap financing help. If the ECB wants to have an appreciable effect on boosting lending, critics say it needs a plan to deal with the riskier assets on banks’ balance sheets that consume capital and hinder new loans. It should also target those bonds it can buy in super-large quantities, say analysts, such as sovereign debt. A simple hors d’oeuvre of covered bonds will not do. The market wants a 12-course meal. [email protected] http://www.ft.com/intl/cms/s/0/d412dcdc-586c-11e4-942f- 00144feab7de.html#axzz3GhDhDPeH

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As cracks in its economy widen, is Germany’s miracle about to fade? As the markets tumbled last week, Germany, hailed only months ago for its resilience in the European crisis, came under fresh scrutiny. What lies ahead for the European powerhouse? Philip Oltermann The Observer, Sunday 19 October 2014

Chancellor Angela Merkel and her allies are increasingly struggling to dismiss warnings over a declining economy. Photograph: Markus Schreiber/AP Locals call the cantilever truss bridge that connects the Dresden suburbs of Blasewitz and Loschwitz the “blue miracle”. Built in 1893 without the support of river piers, it is the kind of German engineering tour de force that could rightly claim a place in the British Museum’s current Memories of a Nation exhibition, were it not impossible to transport. However, in recent years the blue miracle has lost some its sheen. The blue paint has faded to a dull turquoise (“the grey misery” is a common jibe), and a 2013 inspection revealed a persistent problem with rust and erosion due to the 25,000 cars that pass over the bridge every day. Local author Uwe Tellkamp, a winner of the German Book Prize, has even called for cars to be banished altogether, as on Venice’s Rialto bridge. Dresden city council is aware of the problem, but it is under financial pressure. Twenty- one million euros are being spent on overhauling the Albert bridge in the city centre, which was crumbling away so badly that bits of concrete were falling on the heads of cyclists passing underneath. The Augustus bridge, the jewel in Dresden’s eight-bridge crown, will have to come next after it was damaged by floods last year. “Busy roads and bridges have a 70-year cycle. Sometimes they all come up for renovation at the same time,” says Jörn Marx, Dresden’s mayor for development, walking through the building site on the Albert bridge. “I know politicians across the country who are really struggling to find the money at the moment.” Crumbling bridges and potholed roads are a politically sensitive issue in Germany these days. Forty per cent of all bridges and a fifth of the motorway network are said to be in a “critical state”, causing traffic jams and delays up and down the country. Worse still, a growing choir of economists and politicians warn that such cracks in the country’s 378

infrastructure are only the beginning of a much bigger problem. Germany, Europe’s model austerian, they say, is saving itself to death.

GDP.Photograph: Guim Mercedes cars sell all over the world because of their engineering, but the company is falling behind on superior software.Photograph: Yuri Kochetkov/EPA Only months ago, the German economy was widely championed for its dynamism and resilience; its industry had weathered the eurozone crisis surprisingly well and looked like the only engine capable of pulling the rest of the continent out of the mire. Newspapers announced a repeat of the “economic miracle” of the postwar period; books predicted that the country was in for a “bright future”. But in October 2014 it is the pessimists who are setting the tone: the German economy is looking about as rusty as the blue miracle in Dresden. In his book, The Germany Bubble, Olaf Gersemann describes the current boom as the “last hurrah” of a nation that faces almost certain decline after six successive generations of rising living standards, while economist Marcel Fratzscher’s The Germany Illusion argues that the country needs to shed itself of the fantasy that it can thrive while the rest of the continent continues to struggle. Both identify a lack of investment in infrastructure as symptomatic of a wider malaise. Cliche may forever have Germany as the country of efficient autobahns and trains that run on time, but in reality it has invested less in maintaining its roads and bridges than other European state. Its investment rate in 2013 was the fourth lowest in the EU; only Austria, Spain and Portugal spent less. Fratzscher, who is head of the German Institute for Economic Research, calculates there is an “investment gap” of €80bn (£63bn).

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The export market.Photograph: Guim Basic computer skills.Illustration: Guim But at least potholes can be spotted and filled. Missed investment in education, research and industry, on the other hand, might only be felt once it is too late. Gersemann, a journalist for the centre-right daily Die Welt, points out that official statistics show negative net investment in seven of the eight largest manufacturing industries since 2000, with the car industry the only exception. “The government needs to think urgently about how it can convince businesses to stay in Germany,” he said. Fratzscher points out that Germany only invests 5.3% of its overall economic performance back into education, 0.9% less than the average Organisation for Economic Co-operation and Development country, the equivalent of €25bn. “Among western European countries, only Italy spends less money on its education sector than Germany,” he said. Chancellor Angela Merkel and her allies are increasingly struggling to dismiss such warnings, with her finance minister, Wolfgang Schäuble, coming under attack from Merkel’s coalition partners, the Social Democrats. Schäuble’s plans for the next budget see Germany taking on no new sovereign debt for the first time since 1969, a historic achievement in the eyes of many German conservatives and an important demonstration of fiscal discipline to the rest of the eurozone. However, many on the left say the obsession with a balanced budget – colloquially known as the “black zero” – is starving Germany and the rest of Europe of much- 380

needed investment. “The black zero is a fatal signal,” said Fratzscher. Balancing the budget has become a “holy grail” for a succession of German finance ministers, wrote Jakob Augstein in Der Spiegel, the stuff of mystery and folklore, not genuine economic policy. Die Zeit likened Schäuble’s team to mountaineers who were so focused on reaching the summit that they had become blind to the storm gathering around them. When Social Democrat deputy chairman Ralf Stegner pointed out that “the black zero is not a Social Democratic zero”, the Christian Democrats’ Peter Tauber retorted tetchily by calling Stegner a “red zero”. To add to Merkel’s woes, she is facing dissent from her own ranks within the CDU for the first time in years. Last week 50 young Christian Democrats signed a manifesto urging their party leader to push for an “Agenda 2020”. While Germany had been urging other states in Europe to reform their labour markets, they said, it had been slow to implement reforms in its own backyard. “While we have been enjoying our success, we’ve been falling behind in key areas such as the digital economy,” said Jens Spahn, one of the initiators. “Today people across the world may be buying BMWs and Mercedes cars because of their quality engineering, but tomorrow we may be choosing one car over the next because it has superior software.” The government, he said, needed to do far more to support startup companies, teach IT skills at schools and actively attract qualified immigrants: “Do we really need to wait until we are the ‘sick man of Europe’ again until we have the strength to change?” Assessments of the gravity and inevitability of Germany’s downturn differ. The government may have been forced to downgrade its growth forecast for 2015 from 2% to 1.2%, yet the economy minister and vice-chancellor, Sigmar Gabriel, refused to sound too pessimistic. Compared with 0.7% growth in 2012, Germany was still on a path to prosperity, he said last Tuesday: “Employment is still rising; unemployment is still decreasing.” China’s slowdown and the impact of Russian sanctions were always bound to have a knock-on effect on the German economy, say others. Some, such as Kiel university’s Rolf Langhammer, go as far as arguing that the latest growth figures aren’t bad news at all, but encouraging signs that Europe may be rebalancing. By keeping down workers’ wages, Langhammer said, Germany had for years profited from rising labour costs in southern Europe. Now there were signs that the trend had been bucked: German workers were not only spending more thanks to low interest rates, but the introduction of a minimum wage in 2015 was also set to make German unit labour costs more expensive. “What we’re seeing is precisely what we’ve been asking for from economies in southern Europe: they are exporting more, starting to kill their deficits and becoming more competitive,” he said. “Yet somehow some German politicians didn’t realise that this would also have an impact on our own economy.” Germany, he maintained, wasn’t doing as well as people said during the boom years – but it wasn’t headed for quite the disaster some were making out now either.

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Economist Fratzscher remains positive that strategic investments and sufficient “political will” would allow Germany to avert the looming crisis – which is hardly surprising given that he is currently advising the government on its investment plans.

Ageing population.Photograph: Guim UN population prospects.Photograph: Guim Gersemann is much more pessimistic: “The current success of the German economy is built on a much less stable foundation than the government pretends. Consumers have been stabilising the economy, but that’s partly because the central bank’s base rate is being kept artificially low – people are effectively forced to spend rather than save. That’s hardly a stable footing.” Current demographic trends, he said, painted a bleak picture for the German economy in the long run. UN forecasts see ageing Germany losing its status as Europe’s most populous nation to both Britain and France some time after 2040. “We’ve been talking about the pending demographic crisis for years, but we’ll only start to feel its impact in the next few years,” said Gersemann. “The baby boomer generation of the 50s and 60s will slowly start to disappear from the labour market. Total hours’ work will start to fall within a couple of years, depressing Germany’s growth potential. “Germany in 10 years’ time will feel so different that we will look back on today as the good old days.” http://www.theguardian.com/world/2014/oct/19/german-economy-miracle-about- to-fade

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Mardi 21 Octobre 2014

Paris et Berlin sont d’accord pour relancer les investissements CATHERINE CHATIGNOUX / CHEF DE SERVICE ADJOINTE |LE 20/10 A 19:53, MIS A JOUR A 20:04

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« Nous allons élaborer un document commun avec des propositions extrêmement concrètes et opérationnelles », a promis Michel Sapin. - TOBIAS SCHWARZ /AFP La conjoncture qui s’assombrit pousse à agir.L’Allemagne privilégie les investissements privés. Emmanuel Macron, le ministre français de l’Economie, a-t-il demandé à ses homologues allemands d’injecter 50 milliards d’investissements publics dans leur économie ? « Non », bien sûr, le ministre français de l’Economie n’a « rien demandé » à ses homologues allemands. De même, le ministre allemand des Finances, Wolfgang Schäuble, n’a en aucun cas réclamé à Paris des réformes structurelles en échange d’un soutien au budget 2015 de la France, comme le suggérait, dimanche, le « Spiegel ». Lundi, après leur réunion à quatre, à Berlin, les ministres allemands et français de l’Economie et des Finances ont tenté de tordre le cou aux caricatures ou aux non-dits, qui émaillent les relations franco-allemandes. Accueil plutôt positif « En Europe, nous n’avons pas besoin de maîtres d’école qui donnent des leçons ou font du “bashing”, chacun doit agir pour relever ses propres défis »,a commenté le ministre social-démocrate de l’Economie, Sigmar Gabriel. Dont acte. La réunion de lundi, la deuxième du genre dans ce format « à quatre » a démontré une fois de plus que, face à l’adversité, aujourd’hui une croissance anémiée et un risque de rechute économique, le couple franco-allemand se serre les coudes, au moins en apparence. Les deux ministres français étaient venus vendre un plan d’investissement massif en Europe, et si possible en Allemagne. L’accueil a été plutôt positif à Berlin, même si beaucoup reste à faire. « Nous devons accroître les investissements publics qui, dans notre pays, sont insuffisants », a reconnu Sigmar Gabriel, qui cite les chiffres de l’OCDE : « Nous devrions être à 20 % de notre PIB, nous ne sommes qu’à 17 %. Nous voulons redresser ce ratio au cours des prochaines années ». Un écart qui correspondrait, à peu près, aux 50 milliards évoqués par Emmanuel Macron, a-t-il laissé entendre. Plus prudent, Wolfgang Schäuble a refusé de donner des chiffres, même s’il a confirmé que les deux pays s’étaient engagés à « augmenter les investissements dans [leurs] pays respectifs ». Mais cette politique doit s’inscrire « dans le cadre de nos politiques financières ». On sait que le ministre des Finances, qui est sur le point de décrocher, en 2015, un strict équilibre budgétaire du budget fédéral – pour la première fois depuis 1969 –, ne veut pas risquer de compromettre cet objectif. Et alors qu’Emmanuel Macron refuse l’approche manichéenne entre investissements publics et privés, les premiers étant nécessaires, selon lui, pour déclencher les seconds, les deux ministres allemands soulignent, chacun à sa manière, que l’essentiel est de faire redémarrer les investissements privés, sans lesquels les entreprises n’auront pas d’avenir sur le marché mondial. Il faudra attendre le prochain Conseil économique et financier franco-allemand – le CEFFA– le 1er décembre pour connaître les projets d’investissements qui seront retenus. « Nous allons élaborer un document commun avec des propositions extrêmement concrètes et opérationnelles », a promis Michel Sapin, tandis que son collègue, Sigmar Gabriel, ajoutait qu’il pourrait s’agir « de 10 ou 12 projets », certains pouvant même être « franco-allemands, ainsi que des idées pour des projets européens. »

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En savoir plus sur http://www.lesechos.fr/monde/europe/0203875051348-paris-et- berlin-sont-daccord-pour-relancer-les-investissements- 1055680.php?6fp3JfeMIXDw3Bcq.99 http://www.lesechos.fr/monde/europe/0203875051348-paris-et-berlin-sont-daccord- pour-relancer-les-investissements-1055680.php Paris et Berlin négocient un accord global CATHERINE CHATIGNOUX / CHEF DE SERVICE ADJOINTE |LE 20/10 A 06:00, MIS A JOUR A 12:05

Les deux pays tentent de sceller un pacte sur les réformes et le budget. Paris réclame 50 milliards d’euros d’investissements à Berlin. C’est un rendez-vous prévu de longue date, mais il intervient dans un contexte délicat. Les ministres des Finances et de l’Economie, Michel Sapin et Emmanuel Macron, se rendent à Berlin aujourd’hui pour défendre auprès de leur duo d’homologues, Wolfgang Schäuble et Sigmar Gabriel, un budget français qui est dans le collimateur de Bruxelles et plaider pour une relance des investissements dans une Europe à nouveau menacée de récession. La récente détérioration de la conjoncture (y compris allemande) ainsi que l’imminence du verdict budgétaire bruxellois donnent une certaine urgence à ce rendez-vous. Car il s’agit de savoir si les deux pays partagent la même analyse des difficultés et s’accordent sur la manière d’y remédier. Les deux gouvernements sont d’accord, désormais, sur le constat d’un manque d’investissements dans la zone euro, qui étaient, fin 2013, de 15 % inférieurs à leur niveau d’avant-crise. Sur le calibrage, les ministres de Bercy demandent à l’Allemagne, dans un entretien au « Frankfurter Allgemeine Zeitung », un plan 385

d’investissements de 50 milliards d’euros sur trois ans, qui serait le pendant du plan d’économies français (50 milliards). Paris veut aussi le feu vert de Berlin au plan européen de Jean-Claude Juncker (300 milliards). Mais il y a encore des réticences à surmonter outre-Rhin. « Nous souhaitons qu’il s’agisse de ressources véritablement nouvelles et non pas d’un recyclage de fonds européens et de la BEI », indique-t-on à Paris. Et Berlin tient à ce que les projets soient précisément définis avant de « signer des chèques ». Paris cherche à vendre ce plan comme un moyen d’accompagner ses réformes structurelles . Si la France mène des réformes sans coup de pouce, ces dernières risquent d’avoir un effet récessif, souligne-t-on à Bercy : « L’enjeu, ici, est de mener des réformes structurelles et, côté allemand, c’est d’accepter d’investir davantage. » Tel est le « bon deal » développé hier par Emmanuel Macron sur RTL. Encore faut-il que l’Allemagne cautionne les réformes françaises. Le troisième volet de la stratégie française sera l’obtention du feu vert de l’Allemagne au budget 2015 de la France et son accord au délai supplémentaire de deux ans nécessaire pour revenir à 3 %. Emmanuel Macron a assuré hier être « totalement sûr à ce stade » que l’avis de la Commission ne sera pas négatif, « parce que nous ne mettons pas dans cette situation. C’est la Commission qui va décider, mais la France est un grand pays qui a à mener ce débat ». Ainsi, vue de Paris, l’imbrication des politiques budgétaires, des réformes et de l’investissement peut trouver une cohérence. La semaine dernière, Laurence Boone, conseillère économique du président, s’est rendue à Berlin pour tenir ce discours. L’ancienne chef économiste de Bank of America Merrill Lynch a dîné avec des économistes et rencontré, jeudi, des responsables de la chancellerie. Parer à une crise politique Les décideurs allemands sont dans un mode de « préoccupation bienveillante », cherchant des solutions à ce qui est devenu le problème français. « Der Spiegel » affirme que Berlin entend à tout prix éviter un rejet du budget français par la Commission. Mais les responsables allemands restent prudents. Alors qu’ils attendent une grande réforme symbolique, certains perçoivent les mesures annoncées comme un « catalogue à la Prévert ». Au-delà du décrochage économique, Berlin redoute cependant de plus en plus une crise politique en France. « Face à la menace du FN, le pays a besoin d’une unité nationale, juge une députée conservatrice outre-Rhin. Je ne comprends pas ce que font les syndicats et l’UMP. Lorsque Gerhard Schröder a fait ses réformes, la CDU l’a soutenu. » Catherine Chatignoux et Thibaut Madelin, Les Echos En savoir plus sur http://www.lesechos.fr/journal20141020/lec1_monde/0203871767167-paris-et-berlin- negocient-un-accord-global-1055370.php?SYdCy0segTv0YEjA.99 http://www.lesechos.fr/journal20141020/lec1_monde/0203871767167-paris-et-berlin- negocient-un-accord-global-1055370.php

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La loi Macron, un symbole fort, mais à la portée limitée GUILLAUME DE CALIGNON / JOURNALISTE |LE 20/10 A 06:00 La loi pour l'égalité des chances économiques n'aura pas un impact important sur la croissance, estiment les économistes. Que pensent les économistes du projet de loi pour l'égalité des chances économiques présenté la semaine dernière par le ministre de l'Economie, Emmanuel Macron, et fer de lance des réformes structurelles lancées par le gouvernement Valls ? La réponse est importante car, même si son promoteur s'en défend, il semble bien qu'un des objectifs de ce texte soit d'amadouer Bruxelles sur la question des dérapages récurrents du déficit public français. Ce projet de loi, qui concerne des domaines différents, des professions réglementées au droit du travail en passant par le transport par autocar, n'a pas encore fait l'objet d'un chiffrage précis. « Il permet de faire la pédagogie de la concurrence auprès des Français »,réagit David Thesmar, professeur à l'Ecole d'économie de Toulouse. « Mais c'est plus un symbole qu'autre chose car les mesures envisagées ne réforment pas les secteurs qui ont un vrai poids macroéconomique, comme la santé, l'éducation et les métiers de réseau comme l'énergie. Or, il s'agit de réservoirs d'emplois si on les libéralise dans une certaine mesure »,avance-t-il. « Timides avancées » Pour Elie Cohen, professeur d'économie, « Emmanuel Macron fait ce qu'il peut. Il a élaboré un canevas de mesures prudentes, un peu sur le marché du travail, sur celui des biens et des professions réglementées. Mais il s'agit de timides avancées par rapport à ce que l'état économique du pays exigerait que l'on fasse, en raison des contraintes qui pèsent sur le gouvernement. Sa majorité n'est pas solide, l'opinion a du mal à accepter les réformes et les nouvelles sont mauvaises sur le front économique ». Conséquence, selon lui, « les effets positifs éventuels de ces réformes seront faibles. »« Ca va quand même dans le bon sens », rétorque Ludovic Subran, chef économiste d'Euler Hermes. « Mais le surcroît de croissance, même s'il est bon à prendre, se chiffre en dixièmes de point de PIB. Et le risque existe que la loi se transforme en coquille vide », ajoute-t-il. D'autres, tel Eric Heyer, économiste à l'OFCE, ne sont absolument pas convaincus : « Sur le travail le dimanche, par exemple, les économistes ont maintenant suffisamment de recul pour avoir la preuve que cela ne crée pas plus d'activité, sauf dans les zones touristiques, car la contrainte principale, ce n'est pas le temps mais le porte-monnaie. » Au-delà, « certaines réformes, pesant sur la demande, ont des effets récessifs à court terme. Il faut donc éviter de les faire en période de bas de cycle, comme c'est le cas actuellement »,rappelle-t-il. Guillaume de Calignon, Les Echos

En savoir plus sur http://www.lesechos.fr/journal20141020/lec1_monde/0203863849134-la-loi-macron-un-symbole-fort- mais-a-la-portee-limitee-1055403.php?uW9mpDlhzIPCA3GK.99 http://www.lesechos.fr/journal20141020/lec1_monde/0203863849134-la-loi-macron- un-symbole-fort-mais-a-la-portee-limitee-1055403.php 387

VOX, CEPR’s Policy Portal Research-based policy analysis and commentary from leading economists Why China can afford (and benefit from) a generous unfunded pension system Zheng Song, Kjetil Storesletten, Fabrizio Zilibotti, Yikai Wang19 October 2014 The design of the pension system is a hot policy issue in China, given its fast-ageing population. This column discusses how different pension systems could allow different generations to share the benefits of high growth. The authors argue that a reform of the current system is necessary to achieve financial sustainability. However, delaying its implementation is advisable on the grounds of its effect on income inequality. Related// The cleansing effect of the minimum wage in China Florian Mayneris, Sandra Poncet/ Pension reform and equity Benedict Clements, Csaba Feher, Sanjeev Gupta/ Minimum wages in China Yi Huang, Prakash Loungani, Gewei Wang Sharing high growth between generations China faces a sharp demographic transition. The total dependency ratio has fallen from 75% in 1975 to 37% in 2010. This change is due to the combination of high fertility in the 1960s and the family planning policies introduced in the 1970s. The expansion of the labour force implied by this transition has contributed to economic growth. However, China is now at a turning point – by 2040 the old-age dependency ratio will have increased from the current 13% to 39%. The ageing population threatens, on the one hand, the viability of the traditional system of old-age insurance – the share of elderly without children who can actively support and care for the parents is growing, due to shrinking average family size. On the other hand, it undermines the fiscal viability of redistributive pension system. The common wisdom is that the best response to such adverse demographic dynamics is to switch to a pre-funded pension system (see, for instance, Feldstein 1999, Feldstein and Liebman 2006 and Dunaway and Arora 2007). However, there is no consensus. Barr and Diamond (2008) argue that China should not reform the pension system in a pre-funded direction. In Song et al. (2014), we study the extent to which alternative pension systems can allow different generations to share the benefits of high growth in China. The current Chinese pension system has two tiers. The first pillar is a standard transfer-based basic pension system with resource pooling at the provincial level. The second pillar is based on individual accounts. In spite of this notional distinction, the system has a low capitalisation, and hinges de facto on the contributions of workers although it permits, as does the US Social Security system, the accumulation of a trust fund to smooth the ageing of the population. The current replacement ratio is relatively generous (ca. 60% on average), although it has a limited coverage. Only a fraction of the urban workers, estimated to be about 60% of the workforce, is currently enrolled in the system. Rural workers earn no pension, although a new limited rural pension programme was launched in 2013. 388

Social bail-out of unlucky generations In many respects, China today is reminiscent of Western nations when these first introduced their modern pension systems. For instance, the US introduced Social Security in 1935 to curtail poverty among the generation of elderly whose wealth had been wiped out by the great depression. The pension systems in the West expanded significantly after WWII, at a time when growth rates of output (and population) were large. In these countries, the relatively poor initial old generations were largely ‘bailed out’ by the old-age programmes – they received pension benefits without having paid pension contributions during their working life. The initial systems had a large pay-as- you-go component, implying that workers' contributions were used to finance current pension benefits, instead of being saved to finance the future the pension benefits of those who paid the contributions. Similarly, a booming China faces the challenge of bailing out the unlucky generation that entered the labour force at the time of the ‘cultural revolution’, and that contemplates retirement having contributed little-to- nothing to the pension system. Intergenerational inequality is indeed important in today’s China. The present value of earnings for a worker entering the labour force in 2000 is six times as large as that of a worker entering in 1970, before the start of economic reforms. While young Chinese workers earn much higher wages than did their parents, poverty among the elderly is pervasive, aggravated by the gradual demise of traditional family insurance.1 We calibrate a multi-period overlapping generation model to the Chinese economy prior to 2013 (based on Song et al. 2011) and use it to generate future wage and interest rate sequence. Our main quantitative findings are that: The current is not financially viable; given its current statutory rules and the demographic outlook, the present value of the promised benefits exceeds the present value of the contributions. This means that sooner or later a reform that either increases contributions or reduces benefits is necessary. Despite such imbalance (that in turn is due to the demographic transition), China can afford to design its reform so as to keep intergenerational redistribution high during the next 40 years and to bail out the current generation without imposing a major burden on its future generations. China is ‘quasi dynamically inefficient’ The intuition for our result is rooted in a classical argument in economics. It says that if the interest rate on savings were lower than the growth rate of aggregate wages (and, hence, of the tax base), then a pay-as-you-go system would be self-financing. Diamond (1965) labels such a scenario (when it persists in the long-run) as a ‘dynamically inefficient’ economy. In dynamically inefficient economies, the introduction of a pay- as-you-go is a win-win situation where all generations – including the future ones – are net benefactors of the system. However, if the economy is dynamically efficient, there is no free lunch, and some generations must pay a price. Whether or not China is dynamically efficient, it faces a long transition during which paying generous transfer to low-income retirees is cheap. The bill that will be presented to future generations entering the labour force after 2050 will be surprisingly low, given the much higher wages that these will earn.

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Welfare criterion: A highly forward-looking social planner We use a calibrated model to assess quantitatively the financial sustainability and welfare properties of alternative reforms. In line with previous studies (e.g., Sin 2005), we find that the current pension system is not financially sustainable, due to the unfavourable demographic transition that will increase the old age dependency ratio in coming years. The welfare effects of alternative sustainable reforms are evaluated from the perspective of a benevolent planner who weighs the utility of different generations with a geometrically declining weight. We take as a conservative benchmark a highly patient (i.e., forward-looking) planner who has no desire to redistribute resources across generations in mature economies (or, equivalently, in the steady state of the Chinese economy). This planner has an annual discount rate of 0.5%, being closer to the low social discount rate advocated by Stern (2007) than to that advocated by Nordhaus (2007) in the debate on environmental policies. Such a low discount rate (i.e., a high weight on future generations) translates in our context into a high concern for the cost imposed on future generations to bail out the poor initial generations. The low-discount planner is a conservative benchmark; the optimal pension system would be even more redistributive if the choice were entrusted to a more impatient planner endowed, as in Nordhaus (2007), with a social discount rate equal to the market interest rate. Alternative pension reforms As a benchmark, we consider an immediate reform adjusting benefits so as to make the system long-run sustainable (in the sense that the benefits and taxes would not need any future adjustment). This policy, which we label as the benchmark reform, involves a draconian permanent reduction in the replacement rate, from 60% to 39%, for all workers retiring after 2012 without reneging on the outstanding obligations to current retirees. This implies the accumulation of a large pension fund until 2052 to pay for the pensions of future generations retiring in times when the dependency ratio will be very high. We consider, then, three alternative reforms. • The first reform is a delayed reform, by which the current rules of the Chinese system remain in place until 2050 (which we show to be the optimal delay). Thereafter, benefits are permanently reduced so as to balance the pension system in the long run. This reform is equivalent to letting all current workers stay in the existing system and letting all workers entering in the future be in a new and less generous pension system. This policy yields large welfare gains for the transition generations relative to the benchmark reform in 2013. The cohorts retiring between 2013 and 2050 would enjoy welfare gains equivalent, on average, to a 16% increase in their lifetime consumption. Later cohorts would only suffer negligible welfare losses in the form of a three percentage point reduction in the future replacement ratio. Figure 1 shows the evolution of the replacement rate in the benchmark reform (panel a, dashed line) compared with the case in which the reform is delayed until 2050. Panel b shows tax revenue and expenditures, expressed as a share of aggregate urban labour income, for the benchmark reform (dashed curve) and the delayed reform (solid curve). Finally, panel c shows the evolution of government debt, expressed as a share of aggregate urban labour income (the benchmark reform is dashed and the delayed reform

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is solid). Negative values indicate a surplus. Note that, as anticipated above, the immediate reform implies the build-up of a large government surplus to finance the future pension system when the dependency ratio will be higher. Figure 1. Comparisons between an immediate (‘benchmark’) draconian reform and a delayed reform, implemented in 2050

• The second reform is a fully funded reform that replaces the defined benefit transfer-based pension with a fully funded individual account system. To honour existing obligations, the government issues bonds to compensate current workers and retirees for their past contributions. A standard trade-off emerges – all generations retiring after 2059 benefit from the fully funded reform, whereas earlier generations lose. On the one hand, such a reform reduces tax distortions on labour supply. On the other hand, it eliminates a redistributive policy that the planner values. We find that both the low-discount planner and, a fortiori, the Nordhaus planner prefer the delayed reform to the fully-funded reform. • The third reform is switching to an unfunded pay-as-you-go system where the replacement rate is endogenously determined by the dependency ratio, subject to a sequence of balanced budget conditions for the pension system. Given the demographic transition of China, the pay-as-you-go system delivers very generous pension benefits to early cohorts at the expense of the generations retiring after 2045. This reform yields substantial welfare gains by allowing the poorer current generations to share the benefits of high wage growth with the richer generations entering the labour market when China is a mature economy. The gains outweigh the

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losses originating from the larger labour supply distortion relative to the fully funded reform. Figure 2 displays welfare gains for each cohort of the alternative reforms described above relative to the benchmark reform. The gains are expressed as percentage increases in consumption equivalent relative to the benchmark reform. As discussed above, the pay-as-you-go and the delayed reform yield large welfare gains to the earlier generations, and small losses for the generations entering the labour market after 2045 and 2050, respectively. In contrast, the fully funded reform imposes sizeable losses on the earlier generation, and delivers small gains for the future generations. Figure 2. Welfare effects of alternative reforms (expressed in terms of percentage consumption equivalent changes)

The results above accrue in a standard neoclassical model which takes into account the distortions to savings and labour supply that a more generous pension system would entail. The key for the results are a high wage growth and a low rate of return on savings. The same model yields in fact mainstream normative predictions for mature economies. For instance, in an economy where wages grow at a constant 2% per year, the planner would prefer a fully funded reform (or, alternatively, the immediate draconian reform) to a delayed reform or to a pure pay-as-you-go system. Appropriate policies and institutions Our analysis illustrates a general point that applies to fast-growing emerging economies. Even for economies that are dynamically efficient, the combination of a prolonged period of high wage growth and a low return on financial savings makes it possible to run a relatively generous pension system over the transition without imposing a large burden on future generations. The sharp contrast of the normative prediction of our theory across developed and emerging economies illustrates the general principle that

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mechanically transposing policy advice from mature to developing or emerging economies may be misleading, as argued by Acemoglu et al. (2006). References Acemoglu, D, P Aghion, and F Zilibotti (2006), “Distance to Frontier, Selection, and Economic Growth”, Journal of the European Economic Association, 4 (1), 37-74. Cai, F, J Giles, and X Meng (2006), “How well do children insure parents against low retirement income? An analysis using survey data from urban China”, Journal of Public Economics, 90(12), 2229--2255 Diamond, P(1965), “National debt in a neoclassical growth model”, American Economic Review 55 (5): 1126–1150. Dunaway, S V, and V B Arora (2007), “Pension Reform in China: The Need for a New Approach”, IMF Working Paper WP/07/109. Feldstein, M, (1999), “Social Security Pension Reform in China”, China Economic Review, 10(2), 99-107. Feldstein, M, and J Liebman (2006), “Realizing the Potential of China's Social Security Pension System”, China Economic Times, February 24. Huang, Y, P Loungani and G Wang (2014), “Minimum wages and firm employment: Evidence from China”, VoxEU.org, 16 May Mayneris, F and S Poncet (2014), “The cleansing effect of the minimum wage in China”, VoxEU.org, 13 October Park, A, Y Shen, J Strauss, and Y Zhao (2012), “Relying on Whom? Poverty and Consumption Financing of China's Elderly”, chapter 7 in Smith James and Maly Majmundar (eds.): Aging in Asia Findings From New and Emerging Data Initiatives. National Academies Press; Washington (DC) Sin, Y (2005), “China: Pension Liabilities and Reform Options for Old Age Insurance”, World Bank Working Paper No. 2005--1. Song, Z, K Storesletten, and F Zilibotti (2011), “Growing Like China”, American Economic Review, 101(1), 196--233. Song, Z, K Storesletten, Y Wang, and F Zilibotti (2014), “Sharing High Growth Across Generations: Pensions and Demographic Transition in China”, Forthcoming in the American Economic Journals: Macroeconomics. Stern, N (2007), The Economics of Climate Change: The Stern Review, Cambridge University Press. Footnote 1 Cai et al. (2006) document that, although retirees in urban China receive transfers from their children in response to negative income shocks (e.g., pension arrears), such transfers provide only very limited insurance. Their study concludes that improving the public pension system is unlikely to lead to any significant crowding out of private transfers. This conclusion is shared by Park et al. (2012) who document that, irrespective of the public pension system, the effectiveness of the informal private insurance system declines over time as economies develop (an example being the recent history of Latin America), since the elderly will have fewer children and more of them will live separately from their children. http://www.voxeu.org/article/china-can-benefit-generous-unfunded-pension-system 393

Austerity Tales: the Netherlands and Italy

- the analysis in this article warns that the deflation is likely to be a country-specific phenomenon, requiring counter measures at the country level by Giulio Mazzolini and Ashoka Mody on 3rd October 2014 515324559

Lightspring In 2008 and early-2009, most euro area countries joined in an internationally- coordinated stimulus of the global economy to ward off the menacing crisis. But by late-2009, especially after the Greek fiscal hole was revealed in October, the focus shifted to reducing public debt. This shift was encouraged by the global economy’s brief display of economic strength in 2010, which lulled policymakers everywhere into believing that the crisis was largely over. Since then, the euro area countries have single-mindedly pursued the objective of debt reduction. There was reason to be concerned about the rapid increase in euro area public debt. But the policy pursued had serious unforeseen consequences. This article documents the unusually severe and persistent austerity, which has yet to make a dent in the debt burdens but has slowed growth and created deflationary tendencies. The emerging link between frustrated debt reduction efforts and deflation in the most stressed economies is particularly worrisome. Specifically, we find: Tweet This Because austerity caused growth rates to fall, public debt ratios today are much higher than in 2010 and private debt ratios are no lower • Even making allowance for their high public debt-to-GDP ratios, euro area countries adopted significantly greater austerity than on average in other advanced economies. 394

• The austerity response within the euro area was remarkably similar across countries: Netherlands (with a relatively low public debt ratio) and Italy (with a high ratio) responded with equal aggressiveness. • Because austerity caused growth rates to fall, public debt ratios today are much higher than in 2010 and private debt ratios are no lower. • Public debt ratios have not only increased but they have exceeded forecasts. The higher-than-projected debt ratios have gone hand-in-hand with lower-than- projected inflation, highlighting the operation of a country-specific debt-deflation cycle. As an incomplete monetary union, the eurozone has no tools to deal with such country-specific pathologies.

IMF WEO 2014 (http://www.imf.org/external/ns/cs.aspx?id=28). Even within the eurozone’s operational constraints, the outcomes could have been better. Our findings reflect the balance in the deployment of macroeconomic management tools. In the euro area, the most proactive tool for addressing the crisis was fiscal policy pursued under the framework of the Stability and Growth Pact (the SGP). The unwavering commitment to fiscal austerity—despite its adverse growth consequences—arose from a “wait-and-watch” approach in the use of other macroeconomic policy instruments. Unlike their counterparts in the United States and the United Kingdom, the euro area authorities have remained unwilling to use monetary policy aggressively to provide economic stimulus—indeed, interest rates were raised at moments of critical weakness. And there has been only token effort—restricted to the most egregious cases—in dealing with unviable banks. Moreover, the euro area does not have well-developed systems to address household and personal financial distress (Claeys, Darvas and Wolff, 2014). Thus, despite occasional calls to make it more “flexible,” the traditional SGP emphasis on the perceived vulnerability arising from high public debt and the emphasis on deficit reduction have had long-lasting, possibly irreversible, effects.

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Measuring Austerity The crisis caused public debt ratios to rise sharply in much of the advanced world, and especially in the euro area (Figure 1). Hence, fiscal austerity to lower these ratios seemed prudent. Because tax receipts fall and government expenditures for social safety nets rise, the fiscal balance decreases (equivalently, the fiscal deficit increases) when output falls below the economy’s potential. For this reason, the traditional measure of austerity is the increase in the structural fiscal balance, which is the improvement in the balance after making allowance for the shortfall due to the recessionary conditions. Tweet This The degree to which the primary budget surplus is increased (equivalently, the primary deficit is decreased) relative to the public debt ratio is a measure of the fiscal austerity that allows for the objective of lowering the debt-to-GDP ratio But the change in the structural balance may also inappropriate when comparing two countries with very different debt ratios. A country with a higher debt ratio may be more concerned with the risk that the debt ratio may become unsustainable (spiral out of control). Debt sustainability requires that a rise in the public debt-to-GDP ratio be countered by an improvement in the primary budget balance (the balance that does not include interest expenses). The degree to which the primary budget surplus is increased (equivalently, the primary deficit is decreased) relative to the public debt ratio is a measure of the fiscal austerity that allows for the objective of lowering the debt-to-GDP ratio (Bohn, 1998). In determining the relationship between the primary balance and the public debt-to- GDP ratio, it is necessary to control for the economy’s position relative to its potential. For, as noted above, if output is below potential, revenues will be depressed and income transfer and unemployment support payments will be elevated, depressing the primary balance. This procedure leads to the following equation, so-called “solvency equation:"

PBi,t = β0 + β1Di,t-1 + β2Ÿi,t + ci + εi,t

Where PBi,t is the primary balance, Di,i-1 is the (lagged) gross debt over GDP, Ÿi,t is the output gap. A higher β1—the metric of austerity—implies a stronger response to the debt ratio. The term c1 controls for country characteristics that do not change over time and εi,t is error term representing unmeasured variables. Austerity in and outside the Euro Area

Regression results are reported in Table 1. A positive β1, the coefficient on the debt-to- GDP ratio, indicates that the rise in primary surplus in response to public debt will eventually achieve debt sustainability. A larger coefficient implies greater deference to the debt reduction objective. Notes: The dependent variable is primary fiscal balance/GDP; t-statistics in brackets; *** p<0.01, ** p<0.05, * p<0.1. The data point for primary balance in 2010 in Ireland is dropped from regression (2) (2008-13), as that country had to deal with an extraordinarily high deficit (-27.2) due to banks bailouts.

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A finer view of the time variation in the responsiveness to debt, β1, is reported in Figure 2, which reports the coefficient on debt for each five-year period ending in that year. Note: The rolling regressions are estimated as in Table 1, and the coefficient on debt- to-GDP ratio is for the year in which the five-year sample ends.

IMF WEO 2014 (http://www.imf.org/external/ns/cs.aspx?id=28) Before the crisis (2003-2007), the countries in the euro area increased their primary balance by about 0.06 percent of GDP for a 1 percent increase in their public debt ratios. There was no notable difference between the euro and non-euro countries during this period. During the years 2009 and 2010, the world was preoccupied a coordinated fiscal stimulus to stave off another Great Depression (Eichengreen and O’Rourke, 2012), and (quite rightly) the concern with public debt diminished. However, that concern reemerged soon thereafter and vigorously so in the euro area.

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For the five-year period ending in 2013 (which includes the stimulus years), the rise in euro area primary balance was about 0.15 percent of GDP for a one-percent increase in the public debt-to-GDP ratio For the five-year period ending in 2013 (which includes the stimulus years), Table 1 and Figure 2 show that the rise in euro area primary balance was about 0.15 percent of GDP for a one-percent increase in the public debt-to-GDP ratio. As the stimulus years are left behind, the preoccupation with debt is more starkly evident, and the coefficient on debt reached 0.20 in the five-year period ending in 2014. The concern with rising debt ratios also increased in other advanced economies, but to a much lower degree and with less persistence. The Netherlands and Italy In Figure 3, we ask if the responsiveness of the primary balance to public debt was similar across the euro area countries. The finding is represented in a so-called “partial plot,” the relationship between the primary balance and public debt, controlling for the output gap, for the period 2008-2013, as in Table 1. The figure is normalized so that the mean debt-to-GDP ratio for each country is zero. The dots mark the different member states in the different years, and show that the countries behaved more-or-less similarly around their mean debt ratios. Note: Based on Table 1, column 2. The axes values are deviations from the country mean and are expressed as percentage of GDP.

IMF WEO 2014 (http://www.imf.org/external/ns/cs.aspx?id=28) We focus on the Netherlands, where the public debt-to-GDP ratio in 2009 was 61 percent of GDP and Italy, where it was 116 percent of GDP. The lines connecting the dots for Italy (blue) and the Netherlands (red) tell us that, around their respective mean 398

debt ratios, both countries displayed the same tendency to increase their primary balances in response to their rising debt ratios. This is also true if the same picture is examined for later years. Tweet This While fiscal austerity does reduce debt over a period of time, it has an almost immediate impact on reducing growth

IMF WEO 2011 and 2014 (http://www.imf.org/external/ns/cs.aspx?id=28) But while fiscal austerity does reduce debt over a period of time, it has an almost immediate impact on reducing growth. Blanchard and Leigh (2013) have proposed a method to assess the growth impact of austerity. If a country’s GDP fell “unexpectedly” below its forecast, they suggest that a likely cause was an underestimation of the “fiscal multiplier”—the extent to which austerity hurts growth. Their paper reports extensive robustness tests to test for biases due to omitted variables and influential observations (and the spirit of their findings has been confirmed by several scholarly studies). They find that in the period 2010-2012, an extra 1 percent of GDP fiscal consolidation was correlated with between a 0.6 and 1.0 percentage shortfall in growth relative to the forecast. We do not undertake new analysis in this regard, but present a graphical version of the Blanchard-Leigh relationship in Figure 4. Over the years 2011 to 2013, the unexpected growth of a country is the actual growth minus the growth that was projected in the IMF’s April 2011 World Economic Outlook. The unexpected growth of several advanced economies is plotted against the fiscal consolidation over the same period.

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The negative relationship shows that greater consolidation (austerity) was associated with actual growth that was lower than projected. Note: The average annual unexpected growth is calculated as the difference between the average annual realized growth between 2011 and 2013, as reported in the 2014 WEO data release, and the average annual expected growth projected for the same period in the April 2011 WEO data release. Tweet This The growth shortfall in Italy and the Netherlands bore about the same proportion to austerity as in Greece Notice that in Figure 4 the Netherlands and Italy fall on the regression line, which extends to Greece. Italy and (more so) the Netherlands had lower debt-to-GDP ratios than did Greece, so they undertook less austerity. However, the growth shortfall in Italy and the Netherlands bore about the same proportion to austerity as in Greece. Notice also that the United States and, to a lesser extent, the United Kingdom, are above the regression line, implying that austerity was less costly in terms of foregone output growth. It is likely that the more aggressive monetary policy in these two countries and the early efforts to restore banks to health created alternative avenues of growth. In the euro area, monetary policy remained stodgy (Mody, 2014) and bank restructuring and recapitalization was delayed (Reichlin, 2014). 1 Recent revisions of the Italian data have lowered the entire trajectory of the Italian debt ratio by about 5 percentage points. Note: Dashed lines refer to projections at the time.

IMF WEO 2011 and 2014 (http://www.imf.org/external/ns/cs.aspx?id=28) Because austerity in the euro area caused growth to slow, the debt ratios continued to rise—and faster than the projected. Figure 5 reports the time paths of debt ratios for the Netherlands and Italy, as seen in April 2011 (blue line) and April 2014 (red line). As austerity was stepped up in 2011, the projection was for debt ratios to stabilize. However, the ratios continued to rise. The debt ratio for the Netherlands now appears to be stabilizing, but that for Italy is unlikely to start falling as projected.1 400

In sum, we see a consistent pattern of fiscal austerity, slower than expected growth, and higher than expected debt ratios. Where do we stand? Tweet This Today, the Netherlands has to deal with a more serious public debt problem than in 2011 and with an undiminished private debt burden

Eurostat (http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database), Bureau of Economic Analysis (http://www.bea.gov/regional/index.htm) and Federal Reserve Bank of New York (http://newyorkfed.org/microeconomics/data.html). For the Netherlands, the austerity was gratuitous. At its relatively low level of public debt ratio, the Netherlands could have afforded fiscal stimulus. GDP growth would have been higher and, it is possible, that the public debt ratio may have been lower. In the Netherlands, the costs of austerity were especially high because the private debt burden was substantial (since households had borrowed extensively to buy homes). In such a circumstance, a more stimulative fiscal policy is particularly desirable since the increased incomes help to pay down debt, which in turn opens the space for further spending and economic growth. Today, the Netherlands has to deal with a more serious public debt problem than in 2011 and with an undiminished private debt burden. Together, these will continue to dampen growth as the necessary deleveraging occurs over time. 401

The Netherlands example has a more general echo through the euro area: even as the public debt ratios rose while fiscal austerity was pursued, the private debt burdens did not fall (Figure 6a). In contrast, household debt ratios fell across virtually every state in the United States (Figure 6b) While U.S. commentators have been critical of the insufficient policy effort to alleviate mortgage-related distress (see Mian and Sufi, 2014), the extent of such efforts was substantially greater than in the euro area.

Eurostat (http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database), Bureau of Economic Analysis (http://www.bea.gov/regional/index.htm) and Federal Reserve Bank of New York (http://newyorkfed.org/microeconomics/data.html). Tweet This Today, the Italian debt ratio has just crossed 135 percent of GDP, and the warning applies with greater force In Italy, with its high debt ratio, the options were more limited and more painful. In 2010, an IMF paper argued that the Italian debt ratio of over 120 percent of GDP had become unsustainable for practical purposes (Ostry et al, 2010). While the debt could, in principle, be reduced through fiscal consolidation, the authors warned that the austerity needed was so large even by Italian historical norms that it would be

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politically unacceptable. Today, the Italian debt ratio has just crossed 135 percent of GDP, and the warning applies with greater force. The euro area authorities have ruled out the restructuring of public debt, except if a Greek-like situation repeats itself. Their concern is that restructuring would cause widespread contagion and damage to the European (and global) economies and financial systems. Thus, the strategy is to persevere with austerity. The projections of reduced debt ratios starting in 2015 rely overwhelmingly on the continuation of historically severe levels of austerity. The risk is that the primary surpluses will not materialize, growth will be compromised, and the debt ratios will continue to rise (see Darvas, 2013). Debt and Deflation

IMF WEO 2011 and 2014 (http://www.imf.org/external/ns/cs.aspx?id=28) Finally, we examine the relationship between debt and deflation. Figure 7 is a plot of the unexpected rise in debt-to-GDP ratio in the latest 2014 estimates versus those projected in 2011 against the unexpected fall in inflation over the same period. Notice that in virtually every country the debt ratio was higher than projected and inflation was lower. Moreover, these two errors are strongly correlated. A clear negative correlation emerges: higher levels of unexpected debt correspond to higher deflation. Once again, both Italy and The Netherlands fall along the regression line. The implication is that fiscal austerity had had far reaching unforeseen consequences: not only was growth lower (as described in Figure 4 above), but debt was higher, and the prospect of deflation was not even considered.

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Note: The unexpected inflation is calculated as the difference between the realized inflation in 2014, as reported in the 2014 WEO data release, and the projected inflation for 2014, as reported in the 2011 WEO data release. The unexpected debt-to-GDP ratio is computed similarly. If Cyprus is included, the relationship is even stronger. The importance of this finding is that the deflationary tendencies in the euro area are neither uniform nor randomly distributed. Rather, they are associated with the rise in debt: as debt has risen, the policy of austerity has thus far failed to rein in the desired increase, but it has weakened demand and, hence, reduced inflation rates. The latest data suggest that prices are actually falling in some of the high debt countries. And, since the cycle of higher debt and lower prices will not correct itself, a strong stimulatory policy with a country-specific focus will be needed. Conclusions Tweet This A policy of more modest austerity everywhere in the eurozone, with active stimulus in a few countries, would have paid dividends A policy of more modest austerity everywhere in the eurozone, with active stimulus in a few countries, would have paid dividends. Such an approach would have created a more stimulative overall fiscal policy stance throughout the euro and would have been particularly beneficial since European economies trade so much with each other (Figure 8): the boost to domestic demand would have been amplified through trade. The growth performance throughout the euro area would have been superior, which would have helped debt reduction with less austerity.

Eurostat (http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database) Instead, simultaneous austerity caused a drag on all countries. For the Netherlands, there was no trade-off: less austerity would have been unambiguously better. For Italy, an early effort to engineer a restructuring of public debt, while a controversial decision, would have allowed more space to lower the burden of austerity and create the

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conditions for stronger growth. Foregoing this choice would be particularly unfortunate if debt restructuring is eventually rendered inevitable. Tweet This Austerity might be driving the eurozone into a debt-deflation cycle, as higher debt and deflation feed off each other The damage may not be over. Austerity might be driving the eurozone into a debt- deflation cycle, as higher debt and deflation feed off each other. Earlier this year, the ECB viewed the dip in inflation as temporary (Mody, 2014). Even now, ECB officials regard deflation to be unlikely. And the safeguards that they are glacially moving towards take a eurozone-wide view rather than differentiating across countries. Yet, the analysis in this article warns that the deflation is likely to be a country-specific phenomenon, requiring counter measures at the country level. The eurozone, by its construction, has no instruments to deal with a country debt-deflation threat. We are very grateful to Ajai Chopra, Zsolt Darvas and Guntram Wolff for their helpful comments. *** References Blanchard, O.J., 2013, “Growth forecast errors and fiscal multipliers,” National Bureau of Economic Research Working Paper 18779. Bohn, H., 1998, “The behavior of US public debt and deficits,” Quarterly journal of economics, 949-963. Claeys, G., Darvas, Z., & Wolff, G. B., 2014, “Benefits and drawbacks of European unemployment insurance,” Bruegel Policy Brief, Bruegel. Darvas, Z., 2013, “The Euro Area’s tightrope walk – debt and competitiveness in Italy and Spain,” Policy Contribution, Bruegel. Eichengreen, B. and O’Rourke, K. H. (2009). A tale of two depressions. VoxEu Mian, A., & Sufi, A., 2014, “House of Debt,” Chicago: The University of Chicago Press. Mody, A., 2014, “The ECB is much too stodgy.” Ostry, J. D., et al., 2010, “Fiscal space,” International Monetary Fund, Research Department. Reichlin, L., 2014, “Monetary policy and banks in the Euro Area: the tale of two crises,” Journal of Macroeconomics, 39, 387-400. http://www.bruegel.org/nc/blog/detail/article/1449-austerity-tales-the-netherlands-and- italy/

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