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Número 102.3 ANEXO X

Alvaro Espina 24 Noviembre de 2014 Entre 8 y el 20 de octubre de 2014 10/20/2014 12:10 PM 'Poets and Alchemists' Berlin and Paris Undermine Euro Stability By SPIEGEL Staff Market uncertainty over the future of the euro has returned, but that hasn't stopped France from flouting European Union deficit rules. Berlin is already busy hashing out a dubious compromise. Following three hours of questioning at European Parliament, a visibly exhausted Pierre Moscovici switched to German in a final effort to assuage skepticism from certain members of European Parliament. "As commisioner, I will fully respect the pact," he said. Moscovici was French finance minister from 2012 until this April and will become European commissioner for economic and financial affairs when the new Commission takes office next month. But can he be taken at his word? There is room for doubt. In response to the unprecedented euro-zone debt crisis, the European Union agreed to strengthen its Stability and Growth Pact in recent years. Member states gave the European Commission in Brussels greater leeway to monitor national budgets and also bestowed it with rights to levy stiffer fines for countries that violate those rules. Smaller member states have already been forced to comply. Still, as German Chancellor Angela Merkel herself has told confidants, the real test will come when a major member state is forced to submit to the EU corset. That time is now. And the big EU member state in question is France. The development is creating a dilemma for Merkel. Market Jitters The issue is far greater than a few tenths of a percentage point in the French budget deficit. At stake are France's national pride and sovereignty -- and the question as to whether the lessons of the crisis can actually be applied in practice. Also at stake is the euro-zone's trustworthiness, and whether member states will once again fritter away global faith in the common currency by not abiding by their own internal rules. "The markets are watching us," says one member of the German government -- and he doesn't sound particularly confident that the world will be impressed. The markets are indeed jittery. The German economy is growing more sluggishly than expected and is no longer strong enough to buoy the rest of the euro zone. Interest rates for Greek government bonds have suddenly surged, likely because of domestic political instability, rising close to the levels that threatened to push the country into bankruptcy in early 2010. Meanwhile, the European Central Bank has already used up a good deal of the instruments it might have used to combat a new crisis. Euro fears are returning, certainly not a good time to sow additional seeds of doubt. But if experts in Brussels are right, France is doing exactly that with its 2015 draft budget, submitted last week. It suggests that the French government is on the verge of delivering even less than the already low expectations of the European Commission. One high-ranking EU diplomat scoffed at the 60-page draft budget, saying it gave the impression that it had been written mostly by "poets and alchemists." The document itself speaks of "substantial efforts since 2012" and "unprecedented fiscal consolidation measures." Paris Wants to Increase Debt The tone doesn't become more subdued until near the end. Instead of reducing borrowing in 2015 to the 3 percent of gross domestic product (GDP) permitted under the pact, Paris is now planning deficit spending of 4.3 percent. The country doesn't plan to bring itself back in line with Stability Pact rules until 2017. In addition, the sovereign debt ratio is to rise from 92.2 percent of GDP in 2013 to 97.2 percent next year. The numbers look markedly better in many other euro-zone countries, with deficits largely under control. That includes the majority of the crisis countries, which have subjected themselves to tight austerity and reform programs since 2010 in exchange for bailout loans. Against that background, the draft budget from Paris struck many officials at the Brussels headquarters of the Commission's Directorate General for Economic and Financial Affairs (ECFIN) as being particularly brazen. But what can they do? And how can they command respect? Under the provisions of the tightened rules, the European Commission has until Oct. 29 to either approve or reject the budget. Outgoing European Commissioner for Economic and Monetary Affairs Jyrki Katainen, a Finnish hardliner on budget policy, appears determined to enforce the Stability Pact rules. Although he is moving to a new post, he will still have similar responsibilities when he takes his position as vice president of the incoming European Commission. Some smaller euro-zone countries have already felt the brunt of the new pressure coming from Brussels, including Belgium. In December 2011, the European Commission threatened to levy fines against the country if it didn't present a 2012 budget conforming to the Growth and Stability Pact's rules. "They would have had to pay an €800 to €900 million fine," Olli Rehn, the currency commissioner at the time, told EU auditors last week. To avoid the penalty, the Belgian government made cuts to unemployment benefits and raised the age for early retirement. Are All EU Member States Equal? But does the euro stability pact truly apply equally to all member states, or are there countries that are more equal than others? That's the "€100,000 question," one German EU diplomat says. Smaller euro-zone nations indicated at the most recent meeting of EU finance ministers that they are unwilling to accept unequal treatment. "In Luxembourg, the principle of adhering to the applicable rules applies to both large and smaller countries. Rules create the stability and security that we need," says Luxembourg Prime Minister Xavier Bettel. However, he adds, the provisions of the stability pact also allow for some flexibility. During his visit to Berlin at the end of September, however, French Prime Minister Manuel Valls took the preventative measure of forbidding any comparisons with 2

smaller countries. "I will not permit people to discuss France in this context," he said tersely during a reception at the French Embassy. "France is a big country." Regardless whether the EU Commission demands more reforms and tougher savings, he said, "We won't do it." Michel Sapin, his current finance minister, upped the ante last week, saying, "we won't cut more anywhere and we also won't raise taxes." He added that the €21 billion in austerity measures already undertaken by France through the end of 2015 were sufficient. Still, even this pledge is on shaky ground. Observers at the High Council for Public Finances, a French public finance watchdog founded in 2012, are critical, arguing that some assumptions in the budget either haven't been proven or are "very unlikely." For example, in the midst of a crisis, there is nothing showing that consumption in private households will increase by 0.7 percent as the budget suggests. In addition, the High Council notes, some of the revenues calculated as part of the draft budget are likely to disappear -- such as the €0.5 billion that will go missing as a result of the French government's mid-October decision to drop plans for a levy on heavy trucks. The European Commission, which has given no indication yet that it has been intimidated by the harsh statements coming from French officials, is likely to have similar reservations. In the coming days, the Commission is expected to call on France to make improvements to the budget. Sources in Brussels say that if Paris doesn't comply, the Commission will reject the French budget on Oct. 29, one of the last days of its current term. "Europe is at a crossroads," says Manfred Weber, the chairman of the conservative European People's Party group in European Parliament, which represents Christian Democrats from across the Continent. "The European Commission's credibility is at stake with its review of the French and also the Italian budgets. France's budget has to be rejected. President Hollande needs to make improvements." Merkel Likely To Avoid Showdown Still, it's a showdown that Berlin would like to avoid, and Chancellor Angela Merkel is hoping for the support of incoming EU Commission President Jean-Claude Juncker. He will likely to want to sidestep a spat with France at the beginning of his five-year term. The conservative French daily Le Figaro recently wrote that an outright rejection of the budget would have the impact of an "atomic bomb". The signals coming out so far suggest there will ultimately be a compromise, and likely a dubious one at that. Speaking in German parliament on Thursday, Merkel played the part of the disciplinarian. "All, and at this point I will reiterate this again, all member states must fully respect the strengthened rules of the Stability and Growth Pact," she said. The chancellor's words reflected the sentiment of the members of parliament responsible for fiscal and EU policy. "If we make an exception for Paris here, then we are calling into question the entire stability pact," said Gunther Krichbaum, a member of Merkel's conservative Christian Democrats and head of the European Affairs Committee in the Bundestag. "France and Germany have done this before," he said, referring to past violations in 2003 and 2004. "We should not allow it to happen again."

Back then, Chancellor Gerhard Schröder and French President Jacques Chirac unceremoniously moved to soften the Stability Pact's criteria because they either could not or would not adhere to its rules. Even today, the move is considered to have been a serious blunder -- one that is often used against Merkel when she calls on other countries to strictly adhere to the rules. Firm Words, But Little Action German Finance Minister Wolfgang Schäuble has also had firm words for his French colleagues. "The request for an extension can't seriously mean that nothing gets done," he recently told French Finance Minister Sapin during a meeting. But behind the scenes in Berlin, a much softer tone can be heard. "You just can't do that with France, not with France," one German EU diplomat close to the foreign minister and chancellor said weeks ago. One high-ranking member of Merkel's government says that a formal rejection of France's budget would "massively burden German-French ties." He added: "It would be presented as if we were somehow responsible because of our obsession with austerity." In closed-door talks, Merkel's European policy advisor, Nikolaus Meyer-Landrut, has reportedly assured the French that Germany will oppose any efforts to impose a fine against France if the Commission decides to initiate debt proceedings against Paris. In return for its loyalty, Berlin wants Paris to stick to a detailed timetable for implementing reforms. Some officials in Brussels and Berlin are also pushing to unshelve one of Merkel's pet ideas, so-called "contractual agreements" -- written agreements between the European Commission and a euro-zone country that commit that member state to undertake specific savings measures or clearly delineated structural reforms. Under the original plan, the country could then obtain financial aid from a special fund in return. For France, the reward would be a further suspension of the deficit rules. "We need a calculable and perhaps even an actionable agreement between Brussels and Paris," German government sources say. Little Progress in Paris Sending any outward sign of trust to a country that has already been facing proceedings since 2009 for an "excessive deficit" is problematic. The European Commission has already given France two reprieves for getting its public finances in order, but Paris has shown little progress. Neither conservative French President Nicolas Sarkozy nor his Socialist successor François Hollande has managed to get the budget under control. Meanwhile, Prime Minister Valls is facing an open rebellion within the left wing of his party and has only a thin majority in parliament. Nor is it certain that French leaders would accept pressure from the German government to enter into a contract with bureaucrats in Brussels they often view disparagingly. Early this week, French and German economics and finance ministers plan to meet in Berlin. The end of the week will see an EU summit in Brussels. The talks are continuing, but deadline pressures and worries are growing. The issue, says European People's Party parliamentary group head Weber, is not about who is right. "The financial markets have already fired a warning shot at the euro-zone states.

A high level of credibility with debt rules is the prerequisite for preventing a new financial crisis." Rehn also has no illusions. "Let me be clear: Reforms in France were not enough to justify the extension," the politician, who is now a member of the European Parliament, said last week. He argues that the reverse should be true. "First, reforms need to be delivered. Then we can talk about an extension." He went on to say that he wishes France's Pierre Moscovici "better success than I had" as an EU commissioner. By Nikolaus Blome, Julia Amalia Heyer, Ralf Neukirch, Christoph Pauly, Gregor Peter Schmitz and Christoph Schult URL: • http://www.spiegel.de/international/europe/euro-stability-threatened-if-france- flouts-stability-rules-a-997995.html Related SPIEGEL ONLINE links: • 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 • France and Friends: Merkel Increasingly Isolated on Austerity (09/03/2014) http://www.spiegel.de/international/europe/the-anti-austerity-camp-is-growing-as- merkel-becomes-more-isolated-a-989357.html • A Tour of France: Examining the New Sick Man of Europe (07/23/2014) http://www.spiegel.de/international/europe/taking-stock-of-a-france-that-has-fallen- sick-a-982106.html • From the Archive: Germany's Leading Role in Weakening the Euro (07/16/2012) http://www.spiegel.de/international/germany/chancellor-gerhard-schroeder-key-in- weakening-the-euro-stability-pact-a-844458.html

OPINIÓN La reestructuración bancaria MIGUEL ÁNGEL FERNÁNDEZ ORDOÑEZ 20 OCT 2014 - 00:00 CEST Es lógico —y muy positivo para evitar que vuelva a suceder— que la opinión pública se haya centrado en el aprovechamiento personal de los gestores de algunas cajas de ahorro y en las conductas en contra de la ley que deben ser perseguidas y castigadas por la justicia. Pero la próxima publicación del ejercicio de revisión del Banco Central Europeo (BCE) podría aprovecharse para reflexionar también sobre el proceso de reestructuración bancaria española que se ha ido ejecutando a lo largo de los seis últimos años. La reestructuración financiera en España se inició nada más estallar la crisis de Lehman Brothers. Al mes siguiente del colapso de Lehman, hace ahora seis años, el Gobierno español aprobó un decreto creando el Fondo para la Adquisición de Activos Financieros y se empezó a buscar soluciones para la primera entidad que tenía problemas, la caja de Castilla-La Mancha. La intervención de esta entidad mostró que ni el Gobierno ni el Banco de España podían gestionar la crisis bancaria que se venía encima con los instrumentos tradicionales con que se habían gestionado las crisis anteriores. Y tanto el Gobierno como el principal partido de la oposición reaccionaron entonces rápida y positivamente a la petición del Banco de España de crear los instrumentos legales necesarios para gestionar una crisis más importante y, sobre todo, muy diferente de las que se habían vivido antes. Son varias las características de esta crisis bancaria que la hacen muy distinta de las sufridas por España anteriormente. En primer lugar, esta vez se produjo rodeada de una crisis mundial, por lo que los riesgos de desconfianza y contagio cobraban una importancia trascendental. Mantener la confianza en la parte buena del sistema bancario y evitar que la situación de las peores entidades se trasladara a las mejores debía ser la prioridad de cualquier declaración o actuación que se emprendiera. La segunda característica importante fue que, por primera vez en España, la crisis se planteó fundamentalmente en unas cajas de ahorros ocupadas por el poder político, frente a los episodios pasados en los que fueron los bancos los que tuvieron más problemas. La falta de profesionalidad de los gestores explica los problemas que había que resolver y las actuaciones de algunas comunidades autónomas explican la dificultad de resolverlos. La tercera característica importante era que esta vez España no contaba con un Banco de España que pudiera emitir dinero para ayudar a las entidades de crédito con rapidez y sin pasar por el presupuesto. A diferencia del pasado, las únicas ayudas posibles eran las presupuestarias y éstas tenían que someterse además a la aprobación de la Comisión Europea. Otra diferencia con las crisis anteriores era que el problema no era solamente el de aportar nuevos fondos, sino el de no perder súbitamente los que suministraban los acreedores extranjeros. La voluminosa dependencia de la financiación externa de nuestros bancos era algo nuevo. El FROB creado en 2009 ha sido y es el instrumento clave de la reestructuración 6

Han sido numerosos los cambios institucionales y legales que se han ido produciendo para poder gestionar adecuadamente esta especial crisis bancaria. Y es que la tarea no fue solo la de gestionar el salvamento de un buque que se hundía, sino que a la vez hubo que construir las barcas de salvamento. La creación del FROB el mismo año 2009 fue trascendental. Ha sido y es el instrumento clave para gestionar la reestructuración bancaria a lo largo de estos seis años porque el problema español no era un problema de activos de toxicidad inmediata que pudiera acometerse con una nacionalización rápida y generalizada del sistema. Su problema era el de un tumor —el inmobiliario— cuyo desarrollo dependería de cómo evolucionara la economía, que es la que determina el alcance del deterioro de activos y la rentabilidad del negocio. Por ello, a las entidades “buenas” bastaba con exigirles que provisionaran y se capitalizaran adecuadamente, pero sin necesidad de ninguna nacionalización ni de intervención del Estado. A las entidades “problemáticas” que no se habían integrado en las más sanas, se les ofrecieron dos posibilidades. Podían solicitar la inyección de recursos del FROB, pero éste solo les concedería ayudas públicas si aceptaban las exigencias de cambios de gestión y de planes de reestructuración concretos (reducción de oficinas, gastos de estructura, etcétera). Si no lo hacían, serían intervenidas en cuanto el Banco de España detectara su inviabilidad. Este esquema consiguió que, de las 45 cajas existentes en 2009, quedaran unas 15 a finales de 2011. Pero si el FROB fue el instrumento esencial de la reestructuración bancaria, hubo otros cambios institucionales que facilitaron el proceso y que, aunque ya no existan, cumplieron la función de esquivar la resistencia de algunos gestores y comunidades autónomas que querían seguir manteniendo el poder sobre esas entidades. El más importante fue el decreto que incentivó la conversión de cajas en bancos, que en un solo año consiguió que todas las cajas españolas convirtieran su actividad financiera en bancos. Esta actuación, que otros países todavía no se han atrevido a emprender, transformó completamente el sector de las cajas y homogeneizó el tratamiento de todas las entidades de crédito españolas por parte del Banco de España. Otro instrumento clave de la reestructuración acometida en estos seis años ha sido el de avanzar en la transparencia del sector. Ya en 2010, cuando el mercado empezó a desconfiar de la banca europea, el Banco de España exigió a las entidades que ofrecieran al mercado información adicional normalizada sobre su exposición al sector de promoción y construcción, desglosando los porcentajes de créditos de dudoso cobro, las garantías y las coberturas constituidas para afrontar su posible deterioro. También les exigió detallar la información sobre su cartera hipotecaria minorista, incluyendo los porcentajes de créditos dudosos. Además, deberían valorar sus necesidades de financiación en los mercados y las estrategias de corto, medio y largo plazo que habían puesto en marcha. Esta labor de transparencia ha sido una tarea continuada durante estos seis años. Además de las exigencias crecientes por parte del supervisor, España fue el primer país europeo que propuso hacer stress tests a sus bancos y acabó haciéndolo conjuntamente con los demás países bajo la dirección de la Agencia Europea en dos ocasiones, elaboró el informe FSAP con el FMI, y realizó los exigidos por el MOU del rescate o asistencia europea. Este mismo año está participando en el ejercicio del BCE cuyos resultados conoceremos en breve.

La desconfianza de 2012 tuvo un final feliz gracias a las autoridades europeas El mejor indicador del esfuerzo de reestructuración desarrollado durante estos seis años es el aumento extraordinario de los saneamientos de las entidades de crédito desde que se inició la crisis. Hasta finales de 2011, las provisiones y saneamientos efectuados fueron del orden de unos 115.000 millones de euros sin contar los más de 20.000 millones acumulados de provisiones genéricas. Desde entonces se ha saneado una cifra del mismo tenor, con lo que la suma total de saneamientos de las entidades a lo largo de estos seis años alcanza una cifra superior a los 240.000 millones. Otra medida de la importancia de la reestructuración española ha sido la de aumentar el capital de las entidades. La capitalización efectuada en 2012 es la que más ha llamado la atención, lo cual es explicable porque entonces hubo que pedir ayuda a Europa. Pero no se pueden olvidar, aunque fueran más discretas, las capitalizaciones que se han acometido desde el inicio de la crisis y que no requirieron grandes recursos del contribuyente ni pedir asistencia financiera europea. Me refiero a las que hicieron las propias entidades tanto a partir de sus resultados o acudiendo al mercado con emisiones, o aquellas que utilizaron fondos que no requirieron aportaciones del contribuyente como los recursos acumulados por los fondos de garantía de depósitos. Es la suma de todos los aumentos de capital efectuados desde que se inició la reestructuración la que ha permitido alcanzar unos ratios de capital que serán valorados en la revisión del BCE. ¿Qué juicio se puede hacer sobre la reestructuración financiera llevada a cabo durante estos seis años? Ciertamente, si se compara con países que no han tenido crisis bancaria porque no tuvieron previamente una burbuja de deuda, la foto de España no sale bien, porque ha tenido que aportar un volumen importante de recursos públicos. La crisis bancaria, como el desempleo, son en buena parte hijos de la burbuja de deuda y estos dos problemas no hubieran estado presentes durante las dos últimas legislaturas si durante las tres legislaturas precedentes no se hubiera acumulado un endeudamiento espectacular del sector privado, junto a una sistemática pérdida de competitividad. Por ello, si se compara con países que hayan acumulado una burbuja parecida, la foto de los avances conseguidos durante los dos últimos Gobiernos de España no sale tan mal. No sólo por la menor cantidad de recursos públicos aportados sino sobre todo por haber mantenido sin ayudas, sin intervención y sin nacionalización las tres entidades de crédito más importantes del país. Este es el acierto mayor de la reestructuración bancaria española: haber evitado que el tumor, que afectaba a un tercio del sistema y estaba enquistado en unas 30 entidades, se trasladase a las más grandes, pues en ese caso el panorama hubiera sido dramático. La reestructuración financiera en España se inició nada más estallar la crisis de Lehman Brothers Sólo hubo un momento, durante el primer semestre de 2012, en que la creciente desconfianza que se generó en ese periodo en el Reino de España y en el sistema bancario español contagió a las entidades españolas grandes, hundiendo su calificación por las agencias de rating y creándoles problemas graves de liquidez que no se habían visto nunca antes ni, afortunadamente, después. Fue un gran error no darse cuenta entonces de que la variable más importante a cuidar en una crisis bancaria es la confianza. Pero ese periodo de aumento espectacular de la desconfianza en España y en su sistema bancario, que podía haber acabado trágicamente con la salida del euro, tuvo un final 8

feliz gracias a la reacción de las autoridades europeas. Por una parte, las declaraciones de Draghi junto al respaldo de Merkel al euro consiguieron un descenso espectacular en los costes de financiación de los Tesoros y de los bancos de las economías periféricas, y ello ha ayudado a reducir el déficit público y a dar la vuelta a la sangría de resultados de la banca española. Por otra parte, aunque el ejercicio de transparencia que exigió la troika al Gobierno español a cambio de la asistencia financiera acabó proporcionando una cifra de necesidades de capital de nuestra banca —menos de 50.000 millones— similar a la estimada por las autoridades españolas, el hecho de haber sido programado y controlado por los componentes de la troika tuvo el efecto benéfico de que dejaran de pensar que las necesidades de capital estaban en la horquilla de entre 150.000 y 200.000 millones que manejaban algunos bancos de inversión. ¿El ejercicio de revisión del BCE que se publica este mes significará el final de la reestructuración bancaria de España? Esto sería lo más deseable y lo más probable a la vista de las previsiones económicas disponibles en este momento. Pero evidentemente todo depende de lo que suceda en el futuro y, desafortunadamente, éste no da la razón siempre a las previsiones. Desazona un poco observar que todos los organismos nacionales e internacionales previeron para 2012 unos crecimientos del PIB de España similares a los que ahora están previendo para 2015. Si esta vez se cumplieran los pronósticos y entráramos en una recuperación sostenida, incluso aunque fuera moderada, la reestructuración bancaria realizada a lo largo de los seis últimos años podría ser suficiente. Sin embargo, si ahora, como sucedió al final de 2011, la economía española entrase en recesión en contra de todas las previsiones, sería inevitable aplicar medidas adicionales de reestructuración y de apoyo público al sistema financiero. Pero esto no debería llevar a juzgar que lo hecho durante estos seis años no ha servido. No hay que descartar que los gobernantes salidos de las próximas elecciones, bajo el síndrome de Adán, presumieran de que no se ha hecho nada antes de que llegaran ellos. Pero esperemos que esta vez no suceda, bien porque la recuperación vaya hacia arriba, bien porque el adamismo vaya hacia abajo. http://economia.elpais.com/economia/2014/10/19/actualidad/1413743191_854712.ht ml

EDITORIAL Valor añadido industrial EL PAÍS 19 OCT 2014 - 00:00 CEST2 Archivado en: El crecimiento del peso específico de la industria en el valor añadido de las economías avanzadas se ha visto limitado desde hace años por la irrupción de algunas economías emergentes. Los países asiáticos fundamentalmente, pero no sólo ellos, llevan años asumiendo producción industrial que en el pasado llevaban a cabo las economías consideradas industrializadas. Los procesos de externalización y de deslocalización geográfica de fases de producción han provocado una integración de cadenas de valor en localizaciones nuevas, no sólo más competitivas en costes, sino con crecimientos de la demanda más intensos. Las ventajas competitivas originales han ido desplazándose a la periferia como consecuencia de la extensión de la dinámica de globalización. El resultado es la desindustrialización de algunas economías, y la intensificación de planes de reindustrialización de otras. Algunas economías emergentes hace tiempo que dejaron de ser las productoras de las fases de menor valor añadido. La intensificación de la inversión en capital tecnológico, en I+D+i, y en capital humano en algunas economías consideradas menos avanzadas crecen a mayor ritmo del que se realiza en algunas desarrolladas. Esa diferencia es muy explícita en relación con las economías de la eurozona, especialmente con las periféricas. Son éstas las que en mayor medida han visto sacrificados los recursos públicos a esas dotaciones de capital esenciales para desplazarse hacia actividades industriales menos susceptibles de ser eclipsadas por las ventajas en costes más reducidos que tienen las economías emergentes. El problema de Europa no es únicamente el sacrificio de la inversión en conocimiento que ha exigido la austeridad fiscal indiscriminada, sino también el agotamiento de la inversión privada, consecuencia del continuado estancamiento de las economías y de las dificultades financieras en la zona euro. Las empresas con capacidad han ampliado su internacionalización, han desplazado actividades básicas a otros países, con el consecuente impacto en el empleo y en otras sinergias generadas por esas actividades más intensivas en tecnologías avanzadas. El problema al que se enfrentan economías como la española no es únicamente la desindustrialización tradicional, sino la ausencia de iniciativas que sustituyan esa erosión de un sector esencial en cualquier economía. La dimensión media de las empresas españolas, insuficiente en muchos casos para llevar a cabo compromisos de inversión de cuantía suficiente para avanzar en esa inmersión tecnológica que la nueva competencia global exige, tampoco ayuda. Ni tampoco dispone de perfiles profesionales con la capacitación técnica requerida. Haría bien Europa en asumir que las amenazas de la desindustrialización son graves. Hay que decidirse por intensificar la inversión pública en investigación e innovación tecnológica, que es el factor que está alterando las ventajas competitivas tradicionales. Las tecnologías de la información y de la comunicación es el más evidente. En paralelo, 10

el fomento de la capacidad para emprender en sectores avanzados y la generación de incentivos a mayores dimensiones empresariales deberían formar parte de una necesaria política industrial moderna. Aceptar, en definitiva, como lo demuestran algunos países avanzados, que también hoy las políticas públicas en ámbitos como la necesaria reindustrialización, son necesarias. http://economia.elpais.com/economia/2014/10/17/actualidad/1413563451_848724.ht ml

NEGOCIOS Occidente busca revivir la industria La UE y EE UU impulsan el uso de las tecnologías más avanzadas para recuperar la riqueza y los empleos que generaban las manufacturas que se trasladaron a China GRÁFICO Las tres revoluciones industriales La reindustrialización, asignatura pendiente de España SUSANA BLÁZQUEZ 19 OCT 2014 - 01:21 CEST56

España tiene fábricas con impresoras que hacen piezas únicas en tres dimensiones (3D) sin soldaduras ni montajes, a base de sumar con un láser capas de polvo de metales, plásticos o materiales cerámicos. La asturiana Prodintec ha respondido a más de 3.000 pedidos industriales en 10 años, y el pasado junio abrió su tienda online para recibir diseños de todo el mundo que entrarán directamente en sus máquinas. La fábrica es una nave de 60 metros cuadrados con siete equipos de impresión y cinco ingenieros mecánicos que hacen desde piezas para el sector aeronáutico hasta prótesis de cadera. “La maquinaria 3D está presente, y cada vez más, tanto en las grandes fábricas como en pequeñas tiendas urbanas para servir al gran público”, asegura Íñigo Felgueroso, director gerente de Prodintec.// El mercado de fabricación 3D crece de forma exponencial. Empresas de todos los sectores la utilizan para abaratar y mejorar la producción. Ford ha conseguido rebajar el Robots trabajan en una planta de PSA coste de los prototipos de coches de 500.000 a Peugeot Citroën en la República 3.000 dólares. Boeing hace más de 20.000 Checa. / Vladimir Weiss (Bloomberg) piezas distintas para 10 modelos de aviones comerciales y militares en 3D.

El gigante General Electric tiene 300 máquinas para fabricar de esta forma, las utiliza en todas sus divisiones y prevé llegar a elaborar con ellas más de 100.000 piezas para los motores a reacción en 2020, entre otras cosas. Siemens ha desarrollado sistemas inteligentes para las máquinas de impresión con el objetivo de que puedan hacer hasta grandes turbinas en la décima parte del tiempo empleado hasta ahora. “Lo más importante es que con estos sistemas se pueden fabricar productos que antes nos estaban vetados. Forma parte de una revolución que eliminará y creará profesiones en los próximos 14 años”, añade Felgueroso.

La impresión 3D es una de las tecnologías clave de las fábricas inteligentes promovidas por las autoridades europeas y estadounidenses para recuperar el sector industrial que se trasladó a China en los noventa para fabricar con menores costes. Las potencias de Occidente llevan un par de años impulsando una nueva vuelta de tuerca a la tercera revolución industrial iniciada con la incorporación de las nuevas tecnologías a la automatización de la producción. El objetivo es tan claro como ambicioso: recuperar la gran industria, los millones de empleos y la riqueza que genera, y dar más protección a la propiedad intelectual. Es, en definitiva, la batalla contra el auge industrial de China con una nueva arma que algunas empresas han bautizado como las fábricas 4.0. La impresión 3D es una de las claves de las fábricas 4.0 que potencia Europa Plantas pioneras, como las de componentes médicos o las de bienes de equipo, empiezan a tomar forma en Europa tras la estela de Estados Unidos. “Si Europa no espabila, en dos o tres años tendremos los productos baratos y de bajo valor añadido hechos en China, y productos de muy alto valor añadido y personalizado procedentes de 12

Estados Unidos”, alerta Rosa García, consejera delegada de Siemens España, una de las empresas que impulsan la transformación europea. Europa no puede competir en el terreno chino y está obligada a sumarse a EE UU para conseguir esas factorías de alto valor añadido que darán pie a nuevos modelos de negocio y tipos de empleo. El presidente de EE UU, Barack Obama, fue el primero en respaldar oficialmente las fábricas 4.0. Lo hizo en 2011 con la puesta en marcha del programa Advanced Manufacturing Partnership (AMP) para recuperar para su país el desarrollo y la producción de industrias clave como defensa, agricultura, energía o tecnología. “Estados Unidos tiene industrias estratégicas que fabrican hasta la mitad de su cadena de valor fuera del país. El riesgo de esa externalización es alto, y un buen ejemplo de ello fue la huelga del fabricante asiático Foxconn, que produce los iPhone. Eso le costó a Apple una fuerte depreciación en Bolsa y demostró que sucesos similares pueden desestabilizar los mercados financieros”, cuenta Agustín Sáenz, director de industria de Tecnalia. La relocalización impulsada por Obama no supone el regreso a las fábricas del siglo pasado. “En Estados Unidos y Europa debemos impulsar una industria automatizada, muy productiva y competitiva en precios y productos. Volver a fabricar, y hacerlo de forma distinta para mantener una mano de obra muy cualificada que atraiga a los jóvenes universitarios. Eso solo se consigue con una tecnología y una estructura fabril diferentes de las que se usan ahora”, asegura Juan Mulet, director de la Fundación Cotec para la Innovación Tecnológica. Obama impulsó en 2011 el primer plan para relocalizar sectores estratégicos Aunque Occidente mantiene el liderazgo mundial en industrias como la de automoción o la farmacéutica y la química, reconquistar otros sectores ya muy establecidos en Asia requiere la capacidad de fabricar productos con mucho valor añadido y casi a medida. “Deberán tener una maquinaria muy flexible para adaptarse a la demanda. La fábrica interconectada 4.0 será capaz de producir para nichos grandes o muy pequeños, muy personalizados. Se podrá fabricar en masa, pero no habrá dos productos iguales. No habrá almacenamiento de productos ni gastos de transporte”, anticipa García. El Gobierno estadounidense ha programado una inversión inicial de casi 600 millones de dólares, luego aumentada, para desarrollar la tecnología de las nuevas fábricas. Con este dinero se puso en marcha la red National Manufacturing Innovation Network, uniendo 15 centros de investigación en tecnología industrial. Las universidades más punteras, famosos emprendedores y fabricantes como Dow Chemical, Ford, Intel, Corning o Johnson & Johnson trabajan en ella codo con codo. El informe The US manufacturing renaissance: which industries? (El renacimiento manufacturero de EE UU: ¿Qué industrias?) de Boston Consulting Group puso los números a la relocalización industrial de Obama. El trabajo indica que devolver siete sectores industriales al país aumentaría la producción anual de la economía en 100.000 millones de dólares, crearía de dos a tres millones de empleos y reduciría el déficit comercial de bienes no petrolíferos hasta en un 35% en cinco años. Califica de prioritarios a la industria de los bienes de transporte y de equipo, los ordenadores y la electrónica.

Europa sufre la misma pérdida industrial padecida por Estados Unidos, y países como Reino Unido y Alemania secundaron la iniciativa de Obama al más alto nivel. Sin embargo, a escala europea, el respaldo oficial a las fábricas 4.0 no se ha producido hasta este año. Fue el pasado marzo cuando la Comisión Europea instó a los jefes de Gobierno europeos a aprobar un plan para recuperar la industria. “La reindustrialización es un objetivo clave de la UE. La manufactura es esencial para la creación de empleo y el crecimiento económico del continente y para fomentar la competitividad. La Comisión Europea se propone aumentar la contribución de la industria al producto interior bruto (PIB) de la región hasta llegar al 20% en 2020, desde el actual 15,1%”, explica el comisario europeo de Industria, Ferdinando Nelli Feroci. El apoyo oficial obtenido por Bruselas fue la guinda de años de trabajo previos. “En 2008, la Comisión decidió que las medidas fiscales y los créditos eran insuficientes para la recuperación industrial, y que debíamos desarrollar un nuevo modelo industrial con tecnologías innovadoras”, cuenta Lorenzo Vallés, jefe de unidad para sistemas de fabricación avanzados en la Dirección General de Investigación e Innovación de la Comisión Europea. Desde 2009 se han impulsado casi 200 proyectos transnacionales de factorías del futuro, también con empresas e institutos de investigación españoles, con una dotación pública de más de 600 millones de euros en cuatro años. En diciembre pasado, el programa de investigación Horizonte 2020 ratificó los proyectos de fábrica del futuro con una partida de 2.000 millones de euros para su investigación. Un estudio realizado en todos los países determinará en breve el impacto laboral de las medidas. El 10,9% de la población activa de la UE (26,5 millones de personas) está sin trabajo. La tasa de paro sube al 12,1% en la zona euro (19,2 millones de personas), justo los países más ricos y donde más industrias se han deslocalizado. “Es urgente que Europa recupere el diseño de productos y el valor añadido industrial perdidos por la deslocalización hacia China. Ya no se limitan a hacer los diseños que les encargábamos, han empezado a investigar y a fabricar productos de valor añadido propios”, asegura Juan Mulet, director de la Fundación Cotec para la Innovación Tecnológica. El grupo de trabajo de la Comisión Europea para recuperar la capacidad que el continente ha perdido está enfocado desde principios de este año hacia el proyecto de elaborar una hoja de ruta que lleve las tecnologías más avanzadas a las factorías industriales. La parte formativa se pondrá en marcha en 2016 con el lanzamiento de la Comunidad de Conocimiento e Innovación en manufacturas de valor añadido para formar a los empleados en las nuevas herramientas. La Comisión Europea estima que la innovación y la modernización de la industria podrían generar más de 100.000 millones de euros hasta 2020. ¿Podrá lograrse este objetivo? Las inversiones en maquinaria y tecnologías de producción no se han recuperado desde el inicio de la crisis económica, y los activos productivos industriales se han devaluado en más de 75.000 millones de euros desde 2008. Además, la crisis ha mermado los recursos económicos de la región. La otra cara de la moneda es que Europa se mantiene como una potencia innovadora y aporta el 35% del mercado mundial de las soluciones automatizadas, un negocio de más de 54.000 millones de euros anuales. Alemania está a la cabeza de esta nueva etapa de la tercera revolución industrial. La canciller Angela Merkel apoya sin fisuras el plan germano, bautizado Manufactura 4.0, 14

y lo ha convertido en un desafío para el país. El programa arrancó en 2012 con una dotación de 500 millones de euros para proyectos concretos, y desde entonces ha ido en aumento. Alemania crea casi un tercio del valor añadido industrial en la UE. Le siguen Italia, con un 13%; Francia y Reino Unido, con un 10% cada uno, y España, con el 7%. Lo más notable es que Alemania ha mantenido el peso de la industria en su economía durante la crisis, mientras que la manufactura ha perdido posiciones en sus socios europeos. “Los países que han soportado mejor la crisis han sido los altamente industrializados, como Alemania, o los que invierten más del 3% de la riqueza nacional en innovación y desarrollo aplicado a la industria”, recuerda la jefa de Siemens España. La industria crea mano de obra muy especializada, estable y relativamente bien pagada. El 80% de sus puestos de trabajo son fijos. Sin embargo, “en España hemos vendido fábricas para hacer chalés de lujo que hoy están vacíos. Debemos volver a industrializarnos. Si la industria española se adaptara a las medias mundiales de los países que mejor fabrican, como Alemania o Japón, podríamos incrementar en dos puntos la riqueza nacional”, añade Rosa García. Eso supondría unos 20.000 millones de euros. http://economia.elpais.com/economia/2014/10/17/actualidad/1413538635_172748.ht ml?rel=rosEP

ECONOMÍA ANÁLISIS Atrapados en un círculo vicioso ÁNGEL LABORDA 19 OCT 2014 - 00:00 CEST1 De nuevo la espasmódica reacción de los mercados financieros esta semana nos ha venido a recordar que seguimos inmersos en la crisis, especialmente en Europa. Hay demasiada liquidez monetaria en el mundo que no absorbe la economía real en forma de crédito para consumir o invertir en capital productivo, al tiempo que los tipos de interés están en mínimos históricos, así que las inmensas disponibilidades de fondos se dirigen cual manadas de bisontes de un mercado financiero a otro en busca de ganancias, lo que provoca pequeñas —o a veces grandes— burbujas especulativas. Cuando el rebaño presiente algún riesgo para su negocio huye despavorido y se refugia en activos seguros (oro, deuda alemana o norteamericana), abandonando otros más arriesgados (Bolsa, deuda de los países periféricos de Europa o de los países emergentes). Son los efectos secundarios negativos de las políticas monetarias sumamente expansivas que desde hace años vienen realizando los bancos centrales de todo el mundo. Por eso la “normalización” de esas políticas se presenta problemática. En Europa urge poner en marcha de forma coordinada una estrategia de crecimiento a corto plazo Ahora bien, si a los bisontes les entra el pánico es porque hay motivos de fondo. El principal es que la economía mundial no crece al ritmo que ellos habían descontado, lo que significa que las empresas tendrán menos beneficios o que algún deudor pueda declararse insolvente. En Europa la economía está estancada y además surgen de nuevo

riesgos —si es que alguna vez habían desaparecido— de que Grecia deje de honrar su deuda, lo que contagia en seguida al resto de países periféricos. Lo que debe preocuparnos, pues, no es tanto el sube y baja de las Bolsas, sino el estancamiento de la economía, que se autoalimenta entrando en una especie de bucle, o círculo vicioso, del que es difícil salir: como la economía no crece, las empresas no invierten ni crean empleo, lo que mantiene el consumo estancado y las expectativas deterioradas. Por otra parte, esta coyuntura empeora la situación de los bancos, ya que las provisiones para insolvencias aumentan y sus beneficios descienden, lo que hace que se encoja la financiación a la economía. Todo ello conduce a lo que el FMI ha llamado estancamiento secular. Este bucle hay que romperlo cuanto antes, no podemos esperar a los efectos de las reformas estructurales o a la confianza que genera la consolidación de las cuentas públicas. Por eso, Europa necesita urgentemente que los Gobiernos y las instituciones comunitarias pongan en marcha de forma coordinada una estrategia clara de crecimiento a corto plazo, una especie de pacto con objetivos y medidas estructurales y coyunturales a los que se comprometan los Gobiernos bajo un liderazgo fuerte de las instituciones de gobierno comunes. Todo lo contrario del triste espectáculo que estamos viendo cada vez que se reúnen los ministros o jefes de Gobierno.

En España, la semana nos ha deparado numerosa e importante información económica. La inflación siguió en terreno negativo en septiembre (-0,2% interanual), aunque menos que en agosto (-0,5%). Las previsiones apuntan a que va a estar así (décima arriba o abajo) hasta, al menos, el final de este año, como consecuencia especialmente de la bajada que está registrando el precio del petróleo. Ello no sería malo, al contrario, ya que esta materia prima es un producto importado y su abaratamiento supone una ganancia de renta real para la economía española, que puede estimular el consumo. En el ámbito del sector exterior conocimos las cifras de comercio de Fuentes: Mº de Economía, INE, Banco de España y Funcas (previsiones IPC). Gráficos elaborados mercancías de agosto y la balanza de por A. Laborda / C. AYUSO pagos de julio.

Las exportaciones fueron un 5,1% en valor y un 1% en volumen inferiores a las del mismo mes de 2013, lo que apresuradamente se ha tomado como una muestra de que se están hundiendo. Pero ello no es así. Los datos mensuales son muy volátiles y casualmente los de julio fueron extraordinariamente elevados. Lo correcto es hacer la media de los dos meses, que da un crecimiento interanual del 2,3% en valor y del 5,3% en volumen. También obtenemos tasas positivas de crecimiento si comparamos la media de julio y agosto con la del trimestre anterior. El problema es que las importaciones, aunque se están desacelerando, crecen más: 7,2% en valor y 8,8% en 16

volumen en tasa interanual. Ello supone un freno para el crecimiento del PIB y acrecienta el déficit comercial, cuyas cifras acumuladas desde enero casi duplican las del mismo periodo del pasado año. La balanza de pagos por cuenta corriente continúa ofreciendo superávit, pero, como se ve en el gráfico inferior izquierdo, tiende a deteriorarse rápidamente. Ángel Laborda es director de coyuntura de la Fundación de las Cajas de Ahorros (Funcas). Cifra de negocios La cifra de negocios del sector servicios aumentó en agosto un 0,6% sobre el mes anterior. La media de julio y agosto da un crecimiento anualizado del 2,1% sobre la media del segundo trimestre, cifra inferior al 5,4% de ese periodo sobre el anterior. Continuaría, por tanto, según este indicador, la recuperación del mayor sector de la economía española en el tercer trimestre, aunque a un ritmo menor que en el segundo. Por su parte, la cifra de negocios del sector industrial, deflactada por el índice de precios industriales, aumentó un 1,1% sobre el mes anterior, compensando parcialmente las caídas de los tres meses anteriores. En este caso, la media de julio y agosto cae un 0,8% en tasa anualizada sobre el segundo trimestre, en el que la tasa trimestral fue del 5,4%. Es un perfil similar al del índice de producción industrial, que nos indica que este sector está registrando un enfriamiento en el tercer trimestre superior al de servicios. http://economia.elpais.com/economia/2014/10/17/actualidad/1413561182_609541.ht ml

ECONOMÍA “En España o Grecia se han hecho las reformas con el cuchillo en el cuello” CARLOS YÁRNOZ PARÍS19 OCT 2014 - 01:17 CEST66

Jean Tirole, Nobel de Economía y presidente de la Toulouse School of Economics. / EFE Jean Tirole (Troyes, Francia, 1953), acaba de ser galardonado con el Nobel de Economía. Presidente de la Toulouse School of Economics (TSE), compatibiliza sus clases en este centro con cursos en el MIT (Massachussetts Institute of Technology). En esta entrevista telefónica, afirma que los países que no hacen sus reformas a tiempo, se ven abocados a aplicar medidas de austeridad. Pregunta. Europa no encuentra la vía para superar la crisis. Respuesta. Algunos países, como los del sur, necesitan reformas que les den credibilidad. Del mercado de trabajo, de pensiones, de organización del Estado... Alemania las hizo, los escandinavos también. Como Canadá o Australia. En el sur de Europa hicieron poco. Se han hecho en Grecia o en España, pero ya con el cuchillo en el cuello. Y eso ha tenido costes. En Alemania no esperaron al último momento. Las hicieron en 2002 y 2003. “Si no se acometen los cambios, la única solución es la austeridad” P. No cita a Francia. ¿Qué reformas necesita Francia? R. Muchas. El mercado de trabajo, por ejemplo. No se puede sostener con estas tasas de paro. No se puede sacrificar así a los jóvenes. No se puede mantener un gasto público

tan elevado. Supone demasiadas cargas para el Estado, para los empresarios... Sale muy caro. Y resulta muy difícil ganar competitividad en estas circunstancias. P. ¿Es posible mantener el euro sin una unión política, sin una unión económica? “No es casual que en los países del sur haya más paro que en los del norte” R. Se necesita más Europa, sin duda, pero la Europa del norte es cada vez más reticente hacia la del sur. Es un tema para hablarlo durante horas. “No hay razón alguna para que Europa no tenga su Google” P. En Francia hay muchas resistencias a las reformas. R. Sí, en la opinión pública y entre los políticos. Pero la degradación económica es profunda y hay que actuar. Hay un ejemplo claro: la tasa sobre el carbono. La medida la tomó la derecha y todo el mundo estaba de acuerdo. Ahora, la mayoría de la clase política está en contra. Es un síntoma de que tenemos un Estado débil. Los lobbies tienen una gran influencia en Francia. P. En todo caso, usted mantiene que Francia no es un país en declive, en decadencia. R. No, porque tiene muchos valores. Eso sí, conviene no perderlos demasiado deprisa. P. ¿Cómo ve la batalla entre París y Bruselas por el elevado déficit francés? R. El déficit actual por encima del 4% no es una excepción. El problema de Francia es que desde hace cuatro décadas no tiene un presupuesto equilibrado. Incluso en periodos de bonanza aumenta el déficit y no hace reformas. La austeridad es complicada para la economía, pero si no se hacen reformas a tiempo, es la única solución P. ¿Ha analizado la política de austeridad en España? R. La cuestión es muy compleja. Está muy vivo el debate entre los economistas. Algunos piensan que es un error la fuerte disciplina presupuestaria, otros consideran lo contrario... Lo cierto es que los economistas no saben gran cosa. Lo que hay que hacer son las reformas. P. ¿Por qué defiende el contrato único? R. No es casual que los países del sur sufran más el paro. Tienen un doble sistema similar: el contrato indefinido, extremadamente protector, frente a otros que, como el temporal, están muy poco protegidos. O sea, hay un mercado dual. La mayor parte los contratos que se suscriben son temporales y estos trabajadores combinan contrato tras contrato con el paro. No tienen mucha formación porque sus empresas no invierten en ellos. No es buen sistema. Es necesario un contrato único. P. ¿Qué opina del sistema de los minijobs en Alemania? R. Los jóvenes alemanes tienen un problema específico de formación. Alemania hace mucho por la formación, pero hay un problema: las empresas son reticentes a contratar a alguien con baja formación y pagarles un salario mínimo porque pasan la mayor parte del tiempo formándose y luego el joven puede acabar encontrando un trabajo mejor o más estable en otra empresa. No se les puede exigir este esfuerzo a las empresas. 19

P. ¿Es partidario de un mercado europeo de la energía o de las telecomunicaciones con una autoridad única de regulación? R. Necesitamos a Europa. Veamos el mercado de la energía, el de la electricidad. Se decidió construir la Europa de la energía, pero se mantuvieron las reglas nacionales, las redes de transporte nacionales e incluso las autoridades nacionales de la competencia. Al mismo tiempo, y fue un paso positivo, se creó la autoridad europea de la competencia. Pero lo que hacen falta son más interconexiones. En la península ibérica hay un auténtico mercado ibérico, pero aislado del resto. El regulador europeo tendría que actuar. P. Usted defiende que los reguladores sean fuertes y que el Estado sea un árbitro. R. Los reguladores deben ser independientes para crear condiciones justas de competencia. No pueden desequilibrar la balanza a favor de unos u otros. El Estado puede jugar ese papel de árbitro, debe definir las reglas de juego, pero una economía de mercado también tiene que funcionar sobre un Estado fuerte. P. ¿Por qué Europa no tiene su Google? R. Hay un gran problema en las universidades europeas y sobre eso he trabajado mucho. Viene de la menor inversión en la economía del conocimiento. Ahora hay universidades de alto nivel que fomentan la creación de empresas y generan el ambiente necesario para que haya iniciativas innovadoras. Necesitan un sistema fiscal favorable, claro. No hay problema de capital humano. No hay razón alguna para que Europa no tenga su Google y empresas que generan la economía moderna. Ese ambiente de base que no existe es el problema y hemos perdido muchas oportunidades. P. ¿Se han convertido los mercados financieros en una amenaza para los Estados? R. No. Son importantes, pero no son una amenaza. Es cierto que, cuando se produce una quiebra pública, el problema debe ser soportado por el Estado. No es el poderío de los mercados los que deben dar miedo, sino esas situaciones en las que el Estado debe afrontar una quiebra y acaba trasladando el problema a los contribuyentes. Eso sí da miedo. http://economia.elpais.com/economia/2014/10/18/actualidad/1413659852_008887.html

ECONOMÍA La asignatura pendiente de España El Gobierno se limita a apoyar a los sectores ya consolidados de la economía GRÁFICO Las tres revoluciones industriales SUSANA BLÁZQUEZ 19 OCT 2014 - 01:59 CEST3

Un hombre muestra unos auriculares realizados por una impresora 3D. / Reuters United Photos La Administración española impulsa planes para potenciar lo que ya existe y está lejos de ofrecer un verdadero respaldo a las fábricas 4.0 en sectores perdidos durante la era de los traslados a China. El pasado junio, el presidente del Gobierno, Mariano Rajoy, presentó un plan de medidas para el crecimiento, la competitividad y la eficiencia, cuyo brazo industrial fue bautizado como Plan R. El objetivo es aumentar el peso de la industria en la creación de riqueza del país (PIB) del 15% al 17,4% y crear 370.000 empleos para 2017. El proyecto está dotado de 1.750 millones de euros a los sectores de bienes de equipo, químico-farmacéutico, agroalimentario y automoción (solo este 21

último se llevará 635 millones de euros), que son las fortalezas de la manufactura española. Sus plantas son innovadoras y realizan el 60% de las exportaciones industriales del país. No se contempla la relocalización de otros sectores industriales.

Otra iniciativa presentada en julio, la llamada agenda para el fortalecimiento del sector industrial en España, recoge medidas clásicas de apoyo al consumo, la educación, la legislación o la investigación y el desarrollo. Más de lo mismo, pero sin apoyos económicos. Menciona el documento aprobado por Rajoy en la Unión Europea, junto con el resto de jefes de Estado, “sobre un renacimiento industrial”, pero no recoge medidas relativas al mismo. “La principal herramienta del Gobierno para el desarrollo industrial es el CDTI, que sí trabaja a favor de la fábrica del futuro, pero su labor no se corresponde con las partidas presupuestarias para financiar su desarrollo. Es un esfuerzo insuficiente”, asegura Agustín Sáenz, director de la división industrial de Tecnalia. Institutos tecnológicos y empresas muy vanguardistas de toda España trabajan en las tecnologías de las futuras fábricas. “No podemos hacerlo solos, necesitamos una partida presupuestaria potente para hacer un cambio tan drástico. En Tecnalia trabajamos con talleres de toda Europa y vemos que los españoles no han invertido en 10 años, mientras sus similares de Finlandia o Alemania han gastado cuatro o cinco millones en tecnología gracias a las ayudas públicas. Estamos perdiendo competitividad”, subraya Sáenz. La asociación nacional de fabricantes de bienes de equipo (Sercobe) y la Corporación Mondragón han puesto en marcha la plataforma MANU-KET para trabajar en las cinco

tecnologías clave para las fábricas 4.0. Aunque agradecen al Ministerio de Economía mantener la plataforma informática que las une, señalan que la iniciativa carece de fondos públicos para impulsar los proyectos desarrollados por las casi 200 universidades, centros tecnológicos y empresas de la plataforma. “Las empresas damos dinero, pero no sabemos cuáles serán los fondos públicos necesarios para hacer una gran apuesta como país. El Gobierno nos dice que vayamos a Europa a buscarlos”, asegura un usuario de MANU-KET, que pide guardar el anonimato. En España, el sector privado va por delante del público en la transformación industrial. “Hay proyectos y realidades de fabricación avanzada en aeronáutica, automoción, tecnología sanitaria o textil, entre otros sectores”, asegura Daniel Carreño, presidente de General Electric España. Tecnalia, por ejemplo, ha programado a cuatro robots humanoides Hiro para trabajar en las nuevas fábricas y tres están en España. Son los robots colaborativos que detectan la presencia de un hombre que entre en su perímetro de trabajo, le pregunta lo que quiere y trabaja con él. Un Hiro trabaja en la planta de aviones de Puerto Real de Airbus, otro hace prototipos de automoción en las instalaciones de Tecnalia en San Sebastián. El tercero está en la planta de El Puerto de Santa María de Carbures. “Trabaja con un operario para hacer piezas de fibra de carbono para aviones y automóviles de más calidad y una cuarta parte más baratas que las convencionales. Costó 30.000 euros y lo amortizaremos en dos años y medio”, cuenta José María Tarragó, vicepresidente de operaciones de Carbures. Por su parte, la Corporación Mondragón fabrica robots avanzados que hacen medicamentos personalizados en los hospitales. También ha incorporado a muchos de sus productos sensores para vigilar su funcionamiento. Están en las piezas de aerogeneradores de energía eólica y en las máquinas de bienes de equipo que vende a la industria del transporte. Harán piezas para coches o trenes de más calidad y más baratas. “Investigamos para poner estos sensores inteligentes en todas las piezas de los automóviles y los trenes, nos dirán cuándo hay que repararlas y anticiparán situaciones críticas”, explica Eduardo Beltrán de Nanclares, director de innovación y tecnología de Corporación Mondragón. Ingenieros de CAF ya se han interesado en estos dispositivos para ponerlos en los trenes. http://economia.elpais.com/economia/2014/10/17/actualidad/1413539634_753298.html

ft.com Comment Blogs Gavyn Davies What is global market turbulence telling us? Gavyn Davies Oct 19 11:1172Share The extraordinary volatility in all financial asset classes in the past week can only be described as ominous. On Wednesday, the US ten year treasury, perhaps the most liquid financial instrument in the world, traded at yields of 2.21 per cent and 1.86 per cent within a matter of hours. This type of volatility in the ultimate “risk free” asset has previously been seen only in 2008 and other extreme meltdowns, so it clearly cannot be swept under the carpet. A few weeks ago, investors had widely expected a strengthening US economy to lead to a rising dollar and a tighter Federal Reserve, with an amazing 100 per cent of economists saying they were bearish about bonds in a Bloomberg survey in April. Instead the markets have started to act as if the world is about to topple into recession, and an abrupt reversal of speculative positions has probably led to exaggerated market moves, in both directions. Now that excessively large positions have been washed out, what is the underlying message from the past month of market action?

The first graph shows very clearly that the major asset classes have all moved in a classic “risk off” direction, consistent with a contractionary demand shock in the global economy – equities are down, especially outside the US, bonds are up, and commodities are down. Credit spreads have widened, including sovereign bond spreads in the euro area. Within the equity markets, cyclical stocks have under-performed, while defensives have done relatively well. So it all seems very straightforward. Surely there must have been a sudden deterioration in economic activity. After all, the German economy has slowed markedly, taking the euro area down with it. Recent data surprises must have been adverse.

Well, no, actually. There have been downward revisions to GDP forecasts in the euro area, but these have been offset by slight upward revisions in the US and recently even in China. The latest nowcasts for global activity have remained firm, and data surprises in the world as a whole have been close to flat for several months (see graph and more details here). Maybe the slowdown in the euro area has increased the perceived risk of recessions returning to other parts of the world, but there has been no general downward revision to central projections for global GDP. In fact, J.P. Morgan’s team of economists, which tracks global activity data extremely carefully, said on Friday that signs of above trend global GDP growth were beginning to emerge. Markets have clearly been out of synch with the flow of information in this regard. What there has been, however, is a marked drop in inflation expectations built into the bond market right across the world. This has also been led by the euro area, where 25

inflation expectations in the inflation swap market have started to challenge the ECB’s promise to keep inflation “below but close to 2 per cent”.

Mr Draghi has said on many occasions that he will adjust monetary policy as necessary to ensure that medium term inflation expectations are in line with the ECB’s target, but investors have become hugely sceptical about this. Unless the ECB is able to alter this perception drastically in the near future, the progressive “Japanification” of the euro area could become hard to reverse. So surely that must be it – declining inflation expectations, driven from events in the euro area, must have increased fears of debt deflation on a global basis. It is hard to deny that this factor has been important. But there is also a much more benign reason for the widespread drop in inflation expectations, and that is the 25 per cent decline in oil prices since last June. Since this has been triggered largely by an increase in oil supply, it will act like a positive supply shock to oil importing economies. In a low inflation environment, some economists may perceive even this as a bad development, since it could raise real interest rates, and may make it more difficult to service debt (see David Wessel) . But in any oil importing nation, the economy as a whole will be much better off as less resources are used to pay for oil imports, so the overall scope to service debt will improve. As long as inflation expectations remain fixed (which looks very doubtful in the euro area, but not elsewhere), the oil shock should be beneficial.

When oil prices fell sharply in 2009, global inflation went negative for a while, but inflation expectations remained stable at about 2 per cent, and no damage was done to the economic recovery. This time, real GDP is likely to benefit by about 0.5 to 1.0 per cent as a result of the oil supply shock. Overall, then, three separate factors have probably been at work: • a reversal of speculative positions, which has had temporary effects on asset prices; • a contractionary and deflationary demand shock in the euro area; • an oil shock that will also be deflationary, but will be expansionary for many economies. The combined effects of all this should be unequivocally supportive for bonds, but ambiguous or even supportive for some global equity markets. What am I missing? One concern is that the markets are beginning to recognise that secular stagnation may be gripping the world economy (see Robert Shiller). If so, the recent risk sell-off might have been reflecting a decline in medium term GDP growth expectations throughout the global economy. But once again this fails to show up in any recent change in consensus GDP forecasts. Another possibility is that the market shock will itself tighten monetary conditions sufficiently to cause a slowdown in global growth, as happened in previous euro crises. But the financial system seems more robust this time, and has not shown any sign yet of increased stress. Finally, the markets may be starting to doubt whether the central banks actually have the weapons needed to stop global deflationary forces in their tracks. Robin Harding reminds us that Ben Bernanke once said, wisely, that quantitative easing “works in practice but not in theory”. The implication is that it only works because it shifts inflation and other economic expectations in the desired direction. If markets start to doubt this, they have entered much more dangerous waters. But the relief rally on Friday, triggered by the merest hints that central banks may consider further asset purchases, suggests that we are not there yet. http://blogs.ft.com/gavyndavies/2014/10/19/what-is-global-market-turbulence- telling-us/

ft.com Comment Opinion October 19, 2014 2:57 pm Russia can withstand lower oil prices but not for very long Sergei Guriev The government will have either to cut spending or raise taxes, writes Sergei Guriev

©AFP R ussia does not face an immediate threat from the sharp fall in oil prices over recent months. While the economy is heavily dependent on oil, the country’s accumulated reserves and the floating rouble will mitigate the shock, and Russia should be able to withstand levels of $80 to $90 a barrel for about two years. But in the longer term, persistently low prices – reinforced by the pressure imposed by western sanctions – could pose an existential challenge to Vladimir Putin’s regime. The 25 per cent drop in the oil price over the past three months did come as a shock to the Russian government. The latest draft of the 2015-17 budget assumes a price of $100 a barrel (and average annual gross domestic product growth of 2.6 per cent). Even before the oil price shift, the government planned to deplete its Reserve Fund from 5 per cent of GDP to 3 per cent by the end of 2017, in order to pay for the deficit foreseen in each of the next three years. Much of Russia’s other sovereign fund, the National Welfare Fund, has already been committed to infrastructure and providing support to the banks and companies sanctioned by the west. More ON THIS STORY// Russia takes EU to court over sanctions/ Hungary questions EU sanctions on Russia/ beyondbrics Optimism over Russia crisis/ UK blocks €5bn Russian North Sea deal/ Inside Business Russia begins to feel sanctions impact ON THIS TOPIC// Saudi Arabia keeps the oil market guessing/ Editorial Good news from the lower price at the pump/ Oil rallies sharply after near 4-year low/ Comment Oil gush keeps prices low IN OPINION// Kurt Campbell Kim’s ‘discomfort’ is ours as well/ Philip Augar UK bank reform/ David Hockney Tobacco killjoys/ Ian Birrell A cosmopolitan party for UK Oil and gas account for about half of government revenues in Russia; a price drop from $100 to $80 a barrel would cause a shortfall of about 2 per cent of GDP. 28

Normally this would not be a great problem, as Russia would borrow in international markets, and Russian state-owned banks and companies would refinance their external debt. In the light of the west’s sanctions, the situation is a lot more uncomfortable. But this does not mean Russia will run out of cash before the end of 2017. The central bank has committed to the floating exchange rate, so the lower oil price will result in a weaker rouble, helping both the economy and the government’s own budget to weather the shock. Russian government spending is denominated in roubles; if depreciation is strong enough, the budget may be balanced even if the oil price is at $80. This will not solve Mr Putin’s real problem: stagnating, and most likely declining, real incomes. Capital outflows will continue to result in lower investment, and therefore lower growth, in coming years. The government’s 2 per cent growth forecast for 2015 already looks optimistic. Even before the oil price dropped, the consensus was for 1 per cent; the forecast by market analysts and international organisations is now about 0.5 per cent. And while the central bank will attempt to keep a lid on inflation, a weaker rouble will undermine the purchasing power of Russian consumers in real terms. Russia is a net importer of food and consumer goods; while there will be substantial import substitution, overall prices can be expected to increase. The central bank will try to keep a lid on inflation, but a weak rouble hurts consumers’ budgets Tweet this quote Mr Putin’s government has never faced budget constraints as tough. Even during the 2008-09 financial crisis, the challenge was more manageable. The budget then was based on an oil price of $40 to $50 a barrel, while Russia had much larger Reserve and National Welfare Funds, worth 20 per cent of GDP. Not surprisingly, the state spent its way out of the crisis. This time, the government will have to choose whether to cut spending, and thus publicly recognise its inability to deliver on Mr Putin’s 2012 electoral promises, or raise taxes – which would further hit investment and GDP growth. Either way, if oil prices remain in the $80 to $90 range, the government will have to placate an electorate suffering lower living standards. The experience of recent months gives us a good idea of how Mr Putin will respond: by convincing the public that they are in a besieged fortress and must rally around the flag whatever the cost. This will require raising propaganda and political repression to yet another level – and may involve even more unpredictable foreign policy choices. The writer, a former rector of the New Economic School in Moscow, is professor of economics at Sciences Po in Paris http://www.ft.com/intl/cms/s/0/988c386a-552a-11e4-89e8- 00144feab7de.html#axzz3GhDhDPeH

Franco-German mini-summit to tackle growth, budget 20 October 2014, 11:58 CET — filed under: diplomacy, budget, France, Germany, Headline3, economy (BERLIN) - French and German ministers are due to meet Monday to discuss ways of boosting growth in Europe's two biggest economies, as Paris called on Berlin to step up investment. After a massive sell-off on European stock markets last week triggered by a flurry of disappointing economic data, French Finance Minister Michel Sapin and Economy Minister Emmanuel Macron are to meet German counterparts Wolfgang Schaeuble and Sigmar Gabriel in Berlin. Boosting investment and growth are the official topics on the agenda but France's public finances as well as Germany's investment record will also likely be discussed. On the eve of the visit, Sapin and Macron called on Germany to increase investment by 50 billion euros ($64 billion) in the next three years to match the amount Paris is seeking to save from public spending. "Fifty billion euros savings for us and 50 billion of additional investment by you -- that would be a good balance," Macron was quoted as saying by the Frankfurter Allgemeine Zeitung in pre-released quotes in German for Monday's edition. "It's in our collective interest that Germany invests." Recent data has suggested that the German economy -- traditionally Europe's growth engine -- is stalling, threatening to pull the eurozone back into recession and put the brakes on the global recovery. France, grappling with sky-high unemployment and a ballooning budget deficit, has been spearheading a campaign for Germany to soften its stance on fiscal austerity and loosen its purse strings to provide much-needed stimulus. Both Italy and France have stepped up their calls for the European Union to switch course to focus on growth, not on balancing budgets. But these demands are being batted away by German Chancellor Angela Merkel, who insists the way out of the crisis is for all eurozone states to stick to agreed rules on the size of their deficits. It is a simmering row that could threaten to come to a head at an EU summit in Brussels at the end of the week. - Disagree on solution - 30

While Berlin and Paris agree that something urgent needs to be done, the two nations still appear to differ on what exactly the solution is. French President Francois Hollande's government has refused to approve further spending cuts needed to meet the EU's budget deficit target before 2017, arguing that more austerity would only further slow a stagnating economy. But Germany is adamant that all member states stick to the EU's budget rules and press ahead with much-needed structural reforms. Berlin is also concerned about the lack of progress in Paris in getting its finances in order and in reforming its economy. Nevertheless, it has refrained from making any public comment in recent weeks on the French budget so as not to antagonise its key ally and trading partner. A report by Spiegel news weekly said Germany was helping France to draw up a pact with the European Commission on deficit reduction and structural reforms to win Brussels' approval of its 2015 budget. On Sunday, Macron said he was "absolutely sure" that Brussels would not veto the French budget, which is expected to post a 4.3-percent deficit in 2015 -- overshooting the 3.0-percent ceiling set by the EU. The deficit -- the shortfall between revenue and spending -- is not expected to drop to that level until 2017. The EU's executive branch has around two weeks to decide whether countries' budget submissions break the rules. The Commission has new powers to enforce the deficit limit, and could for the first time send the budget back to Paris for changes. It will be Macron's second trip to Germany in a month following a visit at the end of September with Prime Minister Manuel Valls. Both capitals have tasked economists with drawing up a catalogue of measures which could revive growth and the measures will be aimed at both Germany and France. http://www.eubusiness.com/news-eu/germany-france.yb5

ft.com comment Columnists October 19, 2014 2:33 pm Eurozone stagnation is a greater threat than debt

Wolfgang Münchau Monetary policy can boost markets in the shortrun, but this cannot be sustained indefinitely

©AFP It would be wrong to think last week’s global market gyrations signal a return of the eurozone debt crisis. Sovereign bond spreads in the eurozone did not move by much, except in Greece. What happened last week is something rather different. Financial markets have woken up to the possibility of a eurozone-wide economic depression with very low inflation over the next 10 to 20 years. This is what the fall in various measures of inflation expectations tells us. Investors are not worried about the solvency of a member state. That was clearly different two years ago. More ON THIS STORY// Merkel and Renzi clash on growth/ Video Sell-off down to Eurozone crisis II/ Markets Insight Deflation threat to Draghi’s credibility/ Greek PM’s vow to exit bailout backfires/ Market turmoil fuels doubts over Europe WOLFGANG MÜNCHAU// Germany’s weak point/ Europe’s recovery dream/ Germany’s eurosceptics/ Italian debt But the present scenario is no less disturbing. The implications for those who live in such an economic snake pit are already visible: high unemployment; rising poverty; real and nominal wage stagnation; a debt burden that will not come down in real terms; a decline in public sector services, and in public investment. A shocking example is the decrepit state of German military hardware. Of the Luftwaffe’s 254 fighter planes, 150 cannot fly. The eurozone’s stagnation will affect the rest of the world to different degrees. The UK might manage to escape the same fate, but the eurozone economy is big enough to pull Britain down with it. Hardest hit will be the parts of central and eastern Europe that do not use the euro. They are caught between an imploding Russia and a stagnating Europe. It is hard to see how the oil price can recover in an environment of permanently low growth. And it is even harder to see how Russia can live with a permanently depressed oil price. Secular stagnation – the idea that a chronic shortfall of investment might produce a long period of weak demand – also has disturbing implications for financial investors. The 32

recent high levels of equity prices were premised on the best possible of all scenarios: that productivity growth rates would revert to historical averages, and that the level of gross domestic product would eventually catch up with the pre-crisis economic growth trajectory. Investors have now begun to realise that neither is going to happen. GDP is still only close to the levels of 2007; growth is slow. The share of GDP accounted for by profits cannot go much higher, either. So, if productivity growth remains low, it is hard to see how equity investments can yield large real returns. Monetary policy can boost markets in the short-run, but this cannot be sustained indefinitely. In such an environment, the yields on risk free securities will be low. With secular stagnation comes a permanent fall in inflation to levels below the 2 per cent target. The real value of public and private-sector debt will not therefore come down as fast as it should. This in turn will make it harder for governments, companies and individuals to reduce their debt. In such an environment, expect default rates to be high. German sovereign bonds become the only asset in the eurozone that investors regard as more or less risk-free. One would have thought that such a scenario would produce counteracting forces, for example a weaker exchange rate. Unfortunately, that is not necessarily true. The eurozone is running a current account surplus of close to 3 per cent of GDP this year. One would normally expect the currency of an economy with a persistent current account surplus to be strong. In any case, the exchange rate matters a lot more for smaller and medium-sized economies than for large ones such as the US and the eurozone because the share of trade in GDP tends to be smaller for large economies than for small ones. The eurozone is a large semi-closed economy, trading most of its goods and service internally, in euros. Whatever is going to save the eurozone, it cannot be the exchange rate, unless the euro depreciates to an extreme extent. Secular stagnation is thus a lot more dramatic than a debt crisis. With such a threat hanging over us, one would have thought every rational policy maker would want to avoid such a calamity. That would indeed be the case if the crisis occurred in a normal country. For a monetary union where policy is not co-ordinated and where policy makers take a national perspective, the risk of secular stagnation looms large. Even the European Central Bank, the only actor with a eurozone-wide remit, faces legal constraints. This may explain its reluctance to go for quantitative easing. Even as an advocate of QE, I cannot deny we are treading in a legally grey area. Eurozone policy makers face three choices. First, they can transform the eurozone into a political union, and do whatever it takes: a eurobond, a small fiscal union, transfer mechanisms and a banking union worthy of its name. Second, they can accept secular stagnation. The final choice is a break-up of the eurozone. The second and third choices are not mutually exclusive. As the political union is firmly off the table, this leaves us with a choice between depression and failure – or both in succession. http://www.ft.com/intl/cms/s/0/326b0cec-5560-11e4-89e8- 00144feab7de.html#axzz3GfoYXTba

ft.com Comment The Big Read October 19, 2014 7:16 pm The silver economy: Healthier and wealthier Norma Cohen By 2050 those aged over 65 will outnumber children under five. The first part of a series on ageing populations looks at how that demographic shift is creating a new and powerful consumer class

©Reuters W hen Del Webb built its first retirement community in Sun City, Arizona, in 1960, the typical occupants were a retired husband and his wife who had never worked outside the home. The development promised an “active new way of life”, with a golf course, a weekly “chow night” at the recreation centre and the occasional minstrel show put on by residents. “We would never build one like that now,” says Jacque Petroulakis of Del Webb. New developments hold fewer than 1,000 units and most have space for classrooms. Many have a motorbike clubhouse, and more than a quarter of buyers are single. “The whole idea of retirement is seen in a different light today,” says Ms Petroulakis. More ON THIS STORY//Companies target the $15tn silver economy/ Interactive The ageing consumer class/ John Kay Live longer – and thank economics/ Silver economy The changing face of growing old/ Western pharma giants’ expansion plans come up against local ambitions

ON THIS TOPIC// Japan aims to turn robotics into profit/ World’s 13 ‘super-aged’ nations by 2020/ John Authers Growing silver economy signals big winners/ US looks to mine Asia’s silver economy IN THE BIG READ// Markets Into uncharted waters/ Turkey In the line of ﬁre/ After QE Taking off the stabilisers/ Energy Can Europe wean itself off Russian gas?

The concept of retirement – and old age itself – is being reshaped by a record number of baby boomers who are, or are approaching, 65. The effects of this demographic shift are being felt well beyond Sun City. A recent Bank of America Merrill Lynch report cites UN estimates that the number of people worldwide aged 60 years and older will double to more than 2bn by mid-century. By 2050, the number of those aged over 65 will outnumber children aged five and under for the first time in human history. That scenario has huge implications for government, and business, not least where to find future generations of taxpaying workers. Sarah Harper, director of the Oxford Institute of Population Ageing, says “the vast majority of people in the world will make it to age 70”, once considered extraordinary old age. The shape of the classic “population pyramid” showing large numbers of young people at the bottom with a few elderly on top has changed. Fertility rates in developed countries, and in many emerging economies such as South Korea, have fallen so far that they face a shortage of younger workers and consumers. It means the number of those who once could be counted on to buy homes, cars, motorbikes, clothing and other consumer goods is also likely to shrink in the future. “We’ve gone from a pyramid to a skyscraper,” Professor Harper says. “It will change the 21st century in a way we never could have imagined.” The rise in longevity has upended policy on pensions and healthcare, with governments raising retirement ages and shifting responsibility for saving and investing on to individuals. 35

But there is another side of the coin to the ageing population: it offers many industries an opportunity to target a whole new market. Look at those middle-aged men in Lycra. They are riding bicycles that only a professional can afford. The way we think about ageing is changing - Sanjeev Sanyal, Deutsche Bank

These new consumers are members of the fast-growing older demographic who are healthier and wealthier not only when compared with earlier generations of the same age. Crucially their spending power will be greater than that of the more frequently targeted 18 to 39-year olds. BofAMerrill Lynch, which recently produced a report on what it calls The Silver Dollar, cites estimates that the over-50s account for almost 60 per cent of total US consumer spending and 50 per cent of that in the UK. Jody Holtzman, of the American Association of Retired Persons, whose members are aged 50 plus, says that for many people longer lives will mean an extended middle age rather than a descent into frailty. “It is only in Washington that addressing the needs of 100m people is called an unaffordable burden,” Mr Holtzman says. “In the private sector, it’s called ‘an opportunity’.” And industries are adapting. Sanjeev Sanyal, global strategist at Deutsche Bank, says the market for high-priced consumer goods – cars, watches, sports equipment – is dominated by older adults. “Look at those middle-aged men in Lycra,” says Mr Sanyal. “They are riding bicycles that only a professional can afford. The way we think about ageing is changing. “Within a generation we will have to get rid of this idea of retiring. A 70-year-old should be somebody who goes to the office every day.”

The way goods and services are marketed to older adults with deeper pockets is also changing. “Demographic drivers, including increasing life expectancy, raised retirement ages, longer working lives as well as inheritance, will further boost the incomes and spending power of older consumers,” according to the BofA report.

Companies are preparing for the new wave of older consumers. Property developers, carmakers, technology companies, financial services firms and the pharmaceutical industry are all tailoring their offerings accordingly. “We have a saying about things that were traditionally designed for older people,” says Stephen Johnston, co-founder of Ageing 2.0, a technology design network whose members develop niche products to improve quality of life for those with infirmities. “We call them Big, Beige and Boring.” Increasingly, he says, marketers are moving away from that format. “The biggest trend we see is a move towards ageless design.” 37

With good reason. Today, the wealthiest fifth of those aged 50 to 64 spend more each week on food and alcohol, recreation, restaurants, hotels and transport than those of the more-coveted 30 to 49-year-old age group. And Britain is no exception. Within a generation we will have to get rid of this idea of retiring. A 70-year-old should be somebody who goes to the office every day In wealthy countries, the effects of this spending power can already be seen. For example, the percentage of new cars bought by Americans aged over 65 is about a fifth of the total so far in 2014, up from 11 per cent in 2004, before the recession hit, according to IHS Automotive. The share bought by the core 18-to-34-year-old age group fell from 17 per cent to 11 per cent in the same period.

That is forcing manufacturers to design cars that are easier for older drivers to sit in and manoeuvre. Sven Hartelt, an IHS Automotive analyst, says manufacturers are adding features to help older drivers whose attention spans and reflexes are slowing. But because people are entering retirement in good health – and with far greater wealth than earlier generations – they are spending time and money in different ways to their parents. Stephen Bond, co-director of the Demographic Users’ Group of large UK retailers, is a former executive at Marks and Spencer. He says older adults are no longer willing to adopt traditional “old people’s” attire and are keen to dress fashionably.

He recalls a market research exercise with a panel of older, female shoppers, one of whom attended the first Glastonbury rock festival. “She was waxing eloquent about it,” Mr Bond says. “In her mind, she is still that same person. When you see yourself through your own eyes, you see the same person you always did.” http://www.ft.com/intl/cms/s/0/08bff556-52c7-11e4-a236-00144feab7de.html#slide0

Economía ECONOMÍA El BCE inicia su nuevo programa de compra de bonos garantizados El supervisor del euro adquiere títulos con una calificación mínima de BBB- EL PAÍS MADRID20 OCT 2014 - 13:39 CEST9

Mario Draghi, presidente del BCE, en Washington. / Andrew Harrer (Bloomberg) El Banco Central Europeo (BCE) ha puesto en marcha este lunes el tercer programa de adquisiciones de bonos garantizados, según confirmó a Bloomberg un portavoz del banco central. Este programa es una de las últimas medidas adoptadas por el supervisor del euro para mejorar la transmisión de la política monetaria e incrementar el flujo de crédito a la economía. La institución presidida por Mario Draghi ha reducido el tipo de interés al 0,05%, penaliza que la banca deje aparcados excesos de liquidez con una tasa negativa del - 0,2% y tiene pendiente otra inyección de liquidez, en diciembre, condicionada a que la banca preste a empresas y familias. Además del programa de bono garantizados estrenado esta semana, también tiene previsto comprar títulizaciones de activos (ABS) en el tramo final del año. Según Bloomberg, que cita dos fuentes conocedoras de la operación, el BCE habría comprado ya letras garantizadas emitidas por dos entidades francesas, BNP Paribas y Société Générale. El supervisor del euro solo negocia la adquisición de bonos y letras con una calificación mínima de BBB-, o equivalente. Un rating mínimo que el BCE ha decidido no aplica a los bonos garantizados de Grecia y Chipre, a los que se aplicará reglas específicas con medidas para mitigar los riesgos.

A diferencia de las titulaciones de activos, en los bonos garantizados, como las cédulas hipotecarias, el pago no solo esta garantizado por el valor del activo subyacente (hipotecas, préstamos estatales, créditos a particulares), sino también por todos los activos del emisor. "Desde hoy, comenzaremos a saber como de agresivo será el BCE en la apuesta por estos bonos", explicó Agustín Martín, analistas del BBVA en Londres. El Banco Central Europeo ya compró bonos garantizados en 2009, tras la quiebra de Lehman Brothers, y a finales de 2011, por la crisis de deuda europea. Los expertos creen que las compras del banco central se centrarán en el mercado existente, ya que por ahora no hay grandes emisiones previstas por entidades europeas. El presidente del BCE ha declinado ofrecer un cálculo aproximado sobre el volumen de las compras que llevará a cabo la institución, limitándose a señalar que el conjunto de medidas de la institución tendrá "un impacto significativo" en el balance del banco central y contribuirán al retorno de la inflación hasta niveles próximos al 2%. No obstante, Draghi apuntó que el "universo potencial de compras de titulizaciones y cédulas es de un billón de euros", pero recalcó que eso no significa que vaya a "comprarlas todas". http://economia.elpais.com/economia/2014/10/20/actualidad/1413805187_239734.ht ml

Internacional China aborda la reforma de la justicia para garantizar la paz social El Partido Comunista busca dar más poder a los jueces frente a los políticos MACARENA VIDAL LIY PEKÍN19 OCT 2014 - 22:42 CEST14

Policías chinos tapan con carteles el acceso al tribunal donde se juzga a un profesor en Urumqi (Xinjang) en septiembre. / goh chai hin (afp) Un discreto hotel del oeste de Pekín se convertirá esta semana en el corazón político de la segunda potencia mundial. La élite del Partido Comunista de China se reúne a puerta herméticamente cerrada en su plenario anual, que por primera vez dedicará a la reforma del poder judicial y al Estado de derecho. Es un proyecto que el presidente Xi Jinping considera imprescindible para consolidar la legitimidad del Partido al frente del país. Y urgente, a la luz del enorme desprestigio del sector en la sociedad y el desencanto de sus profesionales. La duda es si los cambios que se anuncien permitirán un sistema más justo e independiente o si —a la luz del endurecimiento de la campaña contra las voces disidentes— se quedarán en meras formalidades. “Veremos una abundancia de lenguaje positivo sobre reforma judicial, profesionalización judicial, opiniones positivas sobre el papel de los tribunales, la importancia del Estado de derecho y de un Gobierno sujeto a las leyes. Pero este tipo de lenguaje ya es bastante común y ya aparecía en el documento final del plenario anterior. La cuestión es a qué llevará en la práctica”, afirma Jacques de Lisle, catedrático de Derecho y director del Centro de Estudios de Asia Oriental de la Universidad de Pennsylvania (EE UU).

Para ello hay que tener en cuenta que en el lenguaje político chino, la expresión traducible como Estado de derecho (“yifazhiguo”) no significa lo mismo que en Occidente: tres poderes independientes donde en caso de conflicto es la ley quien tiene la última palabra. En China, la autoridad suprema es el Partido, que define y aplica la ley. No cabe, por tanto, conjeturar sobre una reforma que conduzca en el futuro a un sistema judicial similar al occidental o aborde cuestiones como los derechos humanos o los procesos extrajudiciales. Más bien, se anticipan una serie de cambios encaminados precisamente a reforzar el control del Gobierno central y su legitimidad, mediante nuevas medidas que luchen contra la corrupción, por ejemplo. La esperanza es que las innovaciones introduzcan también una mayor seguridad jurídica para los ciudadanos y una mayor transparencia de los tribunales.

MÁS INFORMACIÓN// Xi Jinping consolida el poder del Partido Comunista/ El exministro chino de Seguridad, investigado por corrupción/ La venganza brutal de Fuyou contra el desarrollismo chino “Aún no se cumplen los requisitos para una reforma cuyo objetivo sea la independencia judicial”, opina el catedrático de Derecho He Weifang, de la Universidad de Pekín, que ve las reformas como meros “arreglos técnicos” y se confiesa “pesimista”. “Se quedan sin abordar”, dice, “cuestiones importantes, como la relación entre el Partido y la administración de la justicia. No se ha reflexionado lo más mínimo sobre la enorme influencia negativa que ha tenido en el desarrollo del sistema legal la época de Zhou Yongkang [el antiguo jefe de los servicios de seguridad que dotó a estas fuerzas de un enorme poder, muy superior al de los tribunales]”. Zhou está siendo investigado por corrupción y precisamente durante el plenario se podría anunciar su expulsión del Partido. Este verano la Comisión de Reforma, que preside el propio Xi Jinping, ya adelantó una serie de líneas generales para los cambios. En julio, el Tribunal Supremo publicó un plan quinquenal de reforma de esta institución —y de los tribunales que depende de ella—, encaminado a aumentar las competencias de los jueces y a reducir el poder de las autoridades políticas locales sobre unas cortes judiciales que ven más de 11 millones de casos al año. Los afiliados al PCCh acusados de corrupción sufren detención extrajudicial M. vidal liy Un proceso que queda fuera del sistema judicial en China es el conocido como shuanggui, una forma de detención para miembros del Partido Comunista (PCCh) sospechosos de haber cometido “violaciones de la disciplina”, generalmente un eufemismo para casos de corrupción. Es el procedimiento al que se sometió durante más de un año a Bo Xilai, la antigua estrella del PCCh caído en desgracia en 2012 a raíz de que su mujer asesinara a un empresario británico. Actualmente está sometido a él, aparentemente desde agosto del año pasado, su antiguo protector, Zhou Yongkang, que llegó a ser uno de los nueve dirigentes más poderosos de China.

La campaña contra la corrupción que ha emprendido el presidente chino, Xi Jinping, desde su llegada al poder, garantiza que este sistema no vaya a quedar en desuso: solamente en Pekín, el número de casos de posible corrupción entre funcionarios alcanzaba los 772 en los primeros ocho meses de este año, según el diario Nuevo Pekín. El shuanggui , un proceso rodeado de secreto, se pone en práctica cuando la Comisión de Disciplina, el brazo de control interno del PCCh, detecta irregularidades en el comportamiento de alguno de los 85 millones de miembros del Partido. Detenido por los investigadores de la comisión, el sospechoso queda aislado en un lugar desconocido, sin contacto con abogados, amigos o familia. Durante su detención, que puede prolongarse meses hasta que es puesto en libertad o entregado a la justicia ordinaria para que se le juzgue, el afiliado es sometido a constantes interrogatorios para que confiese. El uso de tortura no es desconocido, según organizaciones pro derechos humanos. ONG como Dui Hua, con sede en San Francisco (California, EE UU), mencionan prácticas como “privación de sueño, simulación de ahogamiento, quemaduras en la piel con cigarrillos y palizas”. Un ingeniero sospechoso de corrupción, Yu Qiyi, murió ahogado en abril del año pasado mientras se le sometía a shuanggui. Su cuerpo mostraba lesiones externas e internas. Sus seis interrogadores fueron llevados a juicio y en septiembre de 2013 recibieron penas entre los cuatro y los 14 años de cárcel. El abogado de la familia de Yu, Pu Zhiqiang, tenía previsto lanzar una campaña contra el shuanggui. Pero Pu, uno de los letrados más célebres en China por su defensa de casos de derechos civiles —ha sido abogado también, entre otros, del artista y disidente Ai Weiwei—, se encuentra detenido desde mayo, acusado de “crear altercados y obtener información sobre personas por medios ilegales”. Hasta ahora, son las autoridades municipales las encargadas del nombramiento y promoción de los jueces, a los que pueden manipular así con facilidad. A menudo, el resultado de una causa ya se ha decidido en secreto antes de que comience la audiencia. Un juez tiene, en realidad, muy poco poder. La opinión del fiscal, o de la Policía, puede contar más que la suya. Ni siquiera tiene independencia para emitir la sentencia de un juicio en el que ha visto las pruebas y escuchado a los testigos: un consejo judicial tiene que dar su visto bueno al fallo. Como resultado, la actitud de los ciudadanos hacia los tribunales es, cuando menos, de suspicacia. Los miles de peticionarios que rondan las calles de Pekín venidos de toda China con la esperanza de contar su caso a algún dirigente y que éste intervenga por encima de los jueces dan buena fe de ello. Las reformas apuntadas por el Supremo ponen los nombramientos de los jueces en manos de las autoridades provinciales, lo que teóricamente evitaría las presiones a nivel local. También les permitirá emitir sentencias —aunque no en todos los casos; los políticamente delicados quedarán excluidos— sin contar con el consejo judicial. Se abre también la posibilidad de crear cortes especiales para disputas sobre medioambiente —uno de los asuntos que generan más movilizaciones de protestas, de las decenas de miles que se producen en China cada año— o sobre protección de la propiedad intelectual, uno de los temas que más preocupan a los inversores extranjeros.

El presidente del Tribunal Supremo, Zhou Qiang, ha apuntado también que aumentará la transparencia “para mejorar la credibilidad pública de los tribunales” y se permitirá que los extranjeros acudan con “regularidad” a juicios que afecten a empresas foráneas. Ahora no pueden asistir sin permiso del juez Son cambios que llegan demasiado tarde para el abogado Li, de 32 años y que sólo accede a ser identificado por el apellido. Fue juez durante dos años. Entonces apenas ingresaba 3.000 yuanes (unos 400 euros) mensuales y sufría “una sobrecarga de trabajo, un exceso de casos, mucha presión, poco reconocimiento y ningún sentido del honor”. Ahora se dedica a defender casos mercantiles y civiles en los tribunales pequineses. Aunque no quiere divulgar su salario actual, sí precisa con rotundidad que es “mucho mejor que el de los jueces”. Li no volvería a ser juez. Pero tiene claro qué recomendaría al plenario del Partido: “Un sistema judicial más completo, que conceda más derechos y competencias a los magistrados con el fin de promover la ecuanimidad y la transparencia de la justicia al servicio del pueblo”. http://internacional.elpais.com/internacional/2014/10/19/actualidad/1413749883_10 1178.html

Opinion The Opinion Pages| Op-Ed Columnist |NYT Now Amazon’s Monopsony Is Not O.K. OCT. 19, 2014

Paul Krugman Amazon.com, the giant online retailer, has too much power, and it uses that power in ways that hurt America. O.K., I know that was kind of abrupt. But I wanted to get the central point out there right away, because discussions of Amazon tend, all too often, to get lost in side issues. For example, critics of the company sometimes portray it as a monster about to take over the whole economy. Such claims are over the top — Amazon doesn’t dominate overall online sales, let alone retailing as a whole, and probably never will. But so what? Amazon is still playing a troubling role. Meanwhile, Amazon’s defenders often digress into paeans to online bookselling, which has indeed been a good thing for many Americans, or testimonials to Amazon customer service — and in case you’re wondering, yes, I have Amazon Prime and use it a lot. But again, so what? The desirability of new technology, or even Amazon’s effective use of that technology, is not the issue. After all, John D. Rockefeller and his associates were pretty good at the oil business, too — but Standard Oil nonetheless had too much power, and public action to curb that power was essential. And the same is true of Amazon today. If you haven’t been following the recent Amazon news: Back in May a dispute between Amazon and Hachette, a major publishing house, broke out into open commercial warfare. Amazon had been demanding a larger cut of the price of Hachette books it sells; when Hachette balked, Amazon began disrupting the publisher’s sales. Hachette books weren’t banned outright from Amazon’s site, but Amazon began delaying their delivery, raising their prices, and/or steering customers to other publishers. You might be tempted to say that this is just business — no different from Standard Oil, back in the days before it was broken up, refusing to ship oil via railroads that refused to grant it special discounts. But that is, of course, the point: The robber baron era ended when we as a nation decided that some business tactics were out of line. And the question is whether we want to go back on that decision.

Does Amazon really have robber-baron-type market power? When it comes to books, definitely. Amazon overwhelmingly dominates online book sales, with a market share comparable to Standard Oil’s share of the refined oil market when it was broken up in 1911. Even if you look at total book sales, Amazon is by far the largest player. So far Amazon has not tried to exploit consumers. In fact, it has systematically kept prices low, to reinforce its dominance. What it has done, instead, is use its market power to put a squeeze on publishers, in effect driving down the prices it pays for books — hence the fight with Hachette. In economics jargon, Amazon is not, at least so far, acting like a monopolist, a dominant seller with the power to raise prices. Instead, it is acting as a monopsonist, a dominant buyer with the power to push prices down. And on that front its power is really immense — in fact, even greater than the market share numbers indicate. Book sales depend crucially on buzz and word of mouth (which is why authors are often sent on grueling book tours); you buy a book because you’ve heard about it, because other people are reading it, because it’s a topic of conversation, because it’s made the best-seller list. And what Amazon possesses is the power to kill the buzz. It’s definitely possible, with some extra effort, to buy a book you’ve heard about even if Amazon doesn’t carry it — but if Amazon doesn’t carry that book, you’re much less likely to hear about it in the first place. So can we trust Amazon not to abuse that power? The Hachette dispute has settled that question: no, we can’t. It’s not just about the money, although that’s important: By putting the squeeze on publishers, Amazon is ultimately hurting authors and readers. But there’s also the question of undue influence. Specifically, the penalty Amazon is imposing on Hachette books is bad in itself, but there’s also a curious selectivity in the way that penalty has been applied. Last month the Times’s Bits blog documented the case of two Hachette books receiving very different treatment. One is Daniel Schulman’s “Sons of Wichita,” a profile of the Koch brothers; the other is “The Way Forward,” by Paul Ryan, who was Mitt Romney’s running mate and is chairman of the House Budget Committee. Both are listed as eligible for Amazon Prime, and for Mr. Ryan’s book Amazon offers the usual free two- day delivery. What about “Sons of Wichita”? As of Sunday, it “usually ships in 2 to 3 weeks.” Uh-huh. Which brings us back to the key question. Don’t tell me that Amazon is giving consumers what they want, or that it has earned its position. What matters is whether it has too much power, and is abusing that power. Well, it does, and it is. http://www.nytimes.com/2014/10/20/opinion/paul-krugman-amazons-monopsony-is- not-ok.html

This Age of Derp October 19, 2014 3:29 pmOctober 19, 2014 3:29 pm65Comments I gather that some readers were puzzled by my use of the term “derp” with regard to peddlers of inflation paranoia, even though I’ve used it quite a lot. So maybe it’s time to revisit the concept; among other things, once you understand the problem of derpitude, you understand why I write the way I do (and why the Asnesses of this world whine so much.) Josh Barro brought derp into economic discussion, and many of us immediately realized that this was a term we’d been needing all along. As Noah Smith explained, what it means — at least in this context — is a determined belief in some economic doctrine that is completely unmovable by evidence. And there’s a lot of that going around. The inflation controversy is a prime example. If you came into the global financial crisis believing that a large expansion of the Federal Reserve’s balance sheet must lead to terrible inflation, what you have in fact encountered is this: Photo

Credit I’ve indicated the date of the debasement letter for reference. So how do you respond? We all get things wrong, and if we’re not engaged in derp, we learn from the experience. But if you’re doing derp, you insist that you were right, and continue to fulminate against money-printing exactly as you did before.

The same thing happens when we try to discuss the effects of tax cuts — belief in their magical efficacy is utterly insensitive to evidence and experience. Now, not every wrong idea — or claim that I disagree with — is derp. I was pretty unhappy with the claim that doom looms whenever debt crosses 90 percent of GDP, and not too happy with the later claims that the relevant economists never said such a thing; that’s what everyone from Paul Ryan to Olli Rehn heard, and they were not warned off. But there has not, thankfully, been a movement insisting that growth does too fall off a cliff at 90 percent, so this is not a derp thing. But there is, as I said, a lot of derp out there. And what that means, in turn, is that you shouldn’t pretend that we’re having a real discussion when we aren’t. In fact, it’s intellectually dishonest and a public disservice to pretend that such a discussion is taking place. We can and indeed are having a serious discussion about the effects of quantitative easing, but people like Paul Ryan and Cliff Asness are not part of that discussion, because no evidence could ever change their view. It’s not economics, it’s just derp. Now, saying this brings howls of rage, accusations of rudeness and being nasty. But what else can one do? http://krugman.blogs.nytimes.com/2014/10/19/this-age-of-derp/

October 19, 2014 David Warsh, Proprietor Imperfect Competition, Legitimate at Last The Nobel award last week to Jean Tirole, of Toulouse School of Economics, capped a twentieth-century drama whose story has barely begun to be told. I can describe it here only in the broadest way; thanks to the Swedes, the details will now gradually emerge, as did those of similar developments in the past. But some idea about the episodes’ broader place in the scheme of things, as it pertains to you, can be had by viewing it in historical perspective. The story begins in the 1920s, in the years before John Maynard Keynes took center stage. Edward Chamberlin (1899-1967) was a bright young graduate student who had come east from Iowa City to Harvard University with a firm grasp of railroad economics. His 1927 thesis developed what he called a theory of monopolistic competition: a more realistic account, he said, of the behavior of companies in markets where sellers are few, industries he called oligopolies, and the prospect of more intelligent regulation. In fact, Chamberlin was rediscovering ideas published by Augustin Cournot, in 1838, so the story of strategic economic behavior really begins then. If you have a taste for historical detective work, read Secret Origins of Moderrn Microeconomics: Dupuit and the Engineers , by Robert B. Ekelund Jr. and Robert F Hébert (University of Chicago, 1999). In terms of the memories of the living, the story starts in the ’20s). It took Chamberlin six years to get The Theory of Monopolistic Competition ready for the university press. By then he was a Harvard professor. By then, too, a young mother married to British economist Austin Robinson had developed a similar way of amending the prevailing dogma. Joan Robinson (1903-83) obtained a job as an assistant lecturer at Cambridge University, from whose Girton College she had graduated a few years before. Her book, The Economics of Imperfect Competition, appeared in Britain just weeks apart from Chamberlin’s in the US. Chamberlin and Robinson began a battle over whose critique of standard theory would prevail. (Harold Hotelling, of Columbia University, had joined the fray as well.) The excitement was enough to bring young Paul Samuelson to Harvard as a graduate student the autumn of 1935, but it didn’t last long. Keynes’ General Theory of Employment, Interest and Money appeared the next year, and by 1938 monopolistic competition had been shouldered aside by the new “macroeconomics,” of which Samuelson became the avatar. After the war, the literature that Chamberlin (but not Robinson) had spawned mostly retreated into business schools, disguised as corporate strategy. Harvard 51

economist Joseph Schumpeter joined a center for entrepreneurial studies just before he died. Harvard professor Edward Mason soldiered on, training a new generation of specialists (including Carl Kaysen) in industrial organization and development economics. Chamberlin and Robinson continued to bicker. Chamberlin never developed a second act; Robinson in the early ’50s began a bold but ultimately unsuccessful attempt to improve on Ricardo and Marx. (Samuelson later wrote that the Swedes had missed a chance when they failed to add Robinson’s name to the 1974 award to Gunnar Myrdal and Friedrich von Hayek, two other influential theorists of the ’30s.) Meanwhile, leadership in industrial organization swung from Harvard to the University of Chicago, where George Stigler had nothing but contempt for Chamberlin. The three central tenets of Chicago price theory, as Stigler described them: that markets were more efficient than was commonly supposed (advertising, for example, was signaling, a source of information); that competition was far harder to eliminate; and that regulators were easily influenced by those whom they regulated. Twenty-five years of studies in these veins by Stigler, his colleagues and their students culminated in a Nobel Prize for Stigler in 1982. In his 1988 autobiography, Memoirs of an Unregulated Economist, he wrote that Chicago economics had conquered the field: “By 1980 there remained scarcely a trace of the two Harvard traditions of Chamberlin and Mason in the work of current economists.” The joke was on him. Monopolistic competition was about to come roaring back, in the form of The Theory of Industrial Organization, published that same year by a young MIT PhD, Jean Tirole. He had written most of it as a researcher at the Ecole Nationale des Ponts et Chaussées, the very school of bridges and highways at which Jules Dupuit had pioneered price theory a hundred and fifty years earlier. Tirole returned to MIT as an assistant professor in 1984. Interest in monopolistic competition had been building in Cambridge throughout the ’70s, owing to the possibility of coming to grips with strategic interaction afforded by game theory. Now a new microeconomics hit Chicago price theory head on, couched in the formal style of expression developed at MIT. Stigler knew the blow was coming, from “the major eastern schools and Stanford University”; it was “closely related in spirit to Chamberlinian economics,” he wrote, “much more rigorous (as well it should be fifty years later) but has not shown equal gains in empirical motivation or empirical applicability.” Last week the Royal Swedish Academy of Sciences disagreed, awarding its prize in economics to Tirole, thirty-two years after the recognition of Stigler. More drama unfolded in 1982, the year that four Stanford economists colloquially (and jokingly) known as “the Gang of Four” published a series of articles showing how incomplete information could be incorporated into all manner of problems in industrial organization, starting with what had become known as “the chain store problem” (clobber or accommodate the new entrant who tries to enter your market?). The most important of these, “Reputation and Imperfect Information,” by David Kreps and Robert Wilson, and “Predation, Reputation and Entry Deterrence,” by Paul Milgrom and John Roberts, published simultaneously in the Journal of Economic Theory, showed how cooperative behavior could emerge and evanesce in everyday competitive settings. The new models were tools that rendered Tirole’s subject dynamic, open to experiment and investigation. Powerful and inexpensive computers suddenly yielded a means. A green

flag dropped on a decade of breakneck work on a “new empirical industrial organization.” Not everyone welcomed the new style. A new Handbook of Industrial Organization was dominated by Tirole’s work. Sam Peltzman, of the University of Chicago, reviewed it this way in 1991. Here the reader is ushered into the City of Theory. This is an ethereal sort of place. Policy makers and policy issue are very much in the background. The businesspeople who dwell here are not the type who are troubled by details such as the best way to get something produced and delivered to customers. Rather they resemble chess players whose consuming passion is to divide their opponents’ grand strategy. When they do worry about dealings with subordinates or customers, strategic considerations are never far from their minds In part the reason in that there is not much of a legal system in the City of Theory, and in part that the subordinates and customers are fairly good chess players themselves. So many contracts are implicit and their provisions must be… compatible. Over the course of the ’90s, policy makers and policy issues, corporations and their customers, came to be seen more and more as resembling the chess players that had been described by Tirole. Deregulation opened a torrent of possibilities, from corporate restructurings to auctions to outsourcing and new compensation arrangements. Practice was informed by theory; the strategic perspective carried the day. By the end of the decade, the University of Chicago surrendered; it hired Roger Myerson away from Northwestern to teach game theory to the next generation of students; in 2007 Myerson shared a Nobel Prize himself with Eric Maskin and Leonid Hurwicz for the work that had put Tirole in business. In 1994 Tirole moved back to France. Today he is chairman of the Toulouse School of Economics, where he consults widely on issues of regulation, especially in Europe. He has become an expert on banking. Joshua Gans, of the University of Toronto, compares Tirole’s impact on regulatory economics to that of Pasteur on public health; Peter Klein, of the University of Missouri, finds his Ecole Polytechnique/MIT style irritatingly abstract; Tyler Cowen lauds Tirole’s essays in behavior economics. The worst thing that can be said of the Nobel is that, by freezing discussion until the returns are in and a decision has been made, it forces us to view current events in a rearview mirror. Perhaps that is just as well; sometimes the excitement isn’t sustained. But by providing a series of focal points, the Nobel Prize in economic sciences renders unmistakably visible events that otherwise would be easy to miss. If Chamberlin and Robinson were around, they might stop arguing long enough to grump “We told you so” – perhaps even marvel at the verisimilitude that eighty years of ingenuity had wrought. http://www.economicprincipals.com/issues/2014.10.19/1658.html

The return of market volatility - the size of the market gyrations this week took everybody by surprise by Jérémie Cohen-Setton on 20th October 2014

What’s at stake: The size of the market gyrations this week took everybody by surprise. Several stories have been put forward to rationalize these movements, but the abruptness of the adjustment is puzzling and underlines that the degree of liquidity in these markets may have been overestimated. Last week wrap-up Tweet This We are definitely back in the “risk-on-risk-off” regime again Sober Look writes that we are definitely back in the “risk-on-risk-off” regime again. In its Global Market overview, the FT notes this morning that high volatility will likely remain the story for now especially as expectation on monetary policies shift back and forth. Luigi Speranza write that market fluctuations have reached fever pitch over the past few days, with the continued decline in equity markets accompanied by new cyclical lows in bond yields and, more recently, a sharp widening of eurozone bond spreads. Gavyn Davies writes that on Wednesday, the US ten year treasury, perhaps the most liquid financial instrument in the world, traded at yields of 2.21 per cent and 1.86 per cent within a matter of hours. This type of volatility in the ultimate “risk free” asset has previously been seen only in 2008 and other extreme meltdowns, so it clearly cannot be swept under the carpet. What is the market telling? Tweet This The most prominent story since the September peak seems to be a “global slowdown” with associated “deflation Gavyn Davies writes that overall three separate factors have probably been at work: 54

• a reversal of speculative positions, which has had temporary effects on asset prices; • a contractionary and deflationary demand shock in the euro area; • an oil shock that will also be deflationary, but will be expansionary for many economies.

Economist.com/graphicdetail Robert Shiller writes that the most prominent story since the September peak seems to be one of a “global slowdown” with associated “deflation.” Underlying this tale are deeper, longer-term fears. There is a name for these concerns too. It is “secular stagnation” — the idea that there is disturbing evidence that the world economy may languish for a very long time, even for generations, as the word “secular” suggests. Gavyn Davies expresses doubts about this story since this fails to show up in any recent change in consensus GDP forecasts. Paul Krugman writes that the financial turmoil of the past few days has widened the gap between what we’re told must be done to appease the market and what markets actually seem to be asking for. We have been told repeatedly that governments must cease and desist from their efforts to mitigate economic pain, lest their excessive compassion be punished by the financial gods, but the markets themselves have never seemed to agree that these human sacrifices are actually necessary. The real message from the market seems to be that we should be running bigger deficits and printing more money. And that message has gotten a lot stronger in the past few days. Market volatility and growth 55

Roger Farmer writes that that a persistent 10% drop in the real value of the stock market is followed by a persistent 3% increase in the unemployment rate. The important word here is persistent. If the market drops 10% on Tuesday and recovers again a week later, (not an unusual movement in a volatile market), there will be no impact on the real economy. For a market panic to have real effects on Main Street it must be sustained for at least three months. And there is no sign that that is happening: Yet. Tweet This A persistent 10% drop in the real value of the stock market is followed by a persistent 3% increase in the unemployment rate Mohamed El-Erian writes that after a period of excessive risk taking and prolonged complacency, it will probably take some time for markets to fully recalibrate – a choppy process that will be driven both by fundamentals and by technically-oriented repositionings of crowded trades. Liquidity, regulation and price swings Philip Gisdakis writes in Unicredit Sunday Wrap that with some clouds on the horizon, it took only a tiny trigger to send everyone bolting for the exit. With tightened market regulation also affecting banks’ trading books, market liquidity was gone within seconds, which resulted in huge price jumps. Mohamed El-Erian writes that traders are discovering – yet again – that market liquidity is not as deep as they had hoped for, causing wild price gyrations even in the most traditional of all asset classes (for eg, witness the speed and size of Wednesday’s price movements in US equities and Treasuries). Gillian Tett writes that the question of “liquidity” – the degree to which assets can be traded – matters hugely. What is worrying is that liquidity appears to have decreased because unorthodox monetary policy experiments have collided with financial reforms and technological upheaval in an unexpectedly pernicious way. Having lots of money in the system does not guarantee that funding will flow freely, or that traders can cut deals. Systems flooded with cash can sometimes freeze. Sometimes this occurs because investors lose faith in each other and stop doing trades, as they did in 2008. But markets can also become illiquid because it is difficult to match buyers and sellers. In the past big investment banks often matched buyers and sellers by holding large inventories of securities. But since 2008 banks have slashed their inventories by between 30 and 80 per cent (depending on the asset class) to meet tighter rules. This reduced their ability to act as market makers, and removed shock absorbers from the system. http://www.bruegel.org/nc/blog/detail/article/1463-the-return-of- market-volatility/

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October 19, 2014 11:56 pm Barroso warns Britain it would be irrelevant outside EU Jim Pickard, Chief Political Correspondent

©Getty The outgoing president of the European Commission will on Monday fire a parting shot at David Cameron, warning Britain will lose almost all relevance in the world if it leaves the EU. The provocative remarks from José Manuel Barroso come as the political debate in Britain takes an increasingly eurosceptic tone. The UK Independence party, which wants to pull out of the bloc, came first in May’s European elections. More ON THIS TOPIC/ Cameron warned of Tory EU ‘opt in’ revolt/ EU too busy for reform, France tells UK/ Lib Dems ready to shift ground on EU vote/Chris Grayling Europe’s damaging distortion on rights/ IN UK POLITICS & POLICY// UK backs unlicensed medicines bill/ Miliband’s minimum wage plan under fire/ Treasury rules out big election giveaways/ MoD to sell equipment repair unit And the Conservative party has promised a referendum on EU membership in 2017 if it wins next year’s general election.

“Even the largest, proudest European nation cannot hope to shape globalisation – or even retain marginal relevance – by itself,” Mr Barroso will say in a speech at Chatham House. He will argue that Britain has pursued various goals, whether on climate change, Ukraine or Isis, by working within the EU. “Could the UK get by without a little help from your friends? My answer is probably not,” he will say. On Sunday, Mr Barroso told the BBC’s The Andrew Marr Show that the influence of the British prime minister would be “zero” if Britain left the bloc. On Monday, Mr Barroso will claim that British politicians are failing to make the “positive case” for the EU, drawing comparisons with the “Better Together” pro-union campaign in last month’s Scottish referendum. “It worries me that so few politicians on this side of the Channel are ready to tell the facts as they are,” he will say. “My experience is that you can never win a debate from the defensive. We saw in Scotland that you actually need to go out and make the positive case.” The leaders of all three main political parties in Westminster are expected to argue for Britain to remain in the EU in the event of a referendum. Yet Mr Cameron’s stance will depend on whether he can first achieve a successful renegotiation of Britain’s relationship with Europe. Some senior Tory politicians, including London mayor Boris Johnson, claim that Britain could thrive outside the EU. Philip Hammond, foreign secretary, said on Friday that his party’s referendum pledge was “lighting a fire” under the bloc. Mr Barroso was dismissed on Sunday by Grant Shapps, chairman of the Conservative party, as an “unelected bureaucrat”.

In depth Britain in Europe David Cameron is under pressure from all sides and faces a delicate balancing act in attempting to renegotiate an acceptable UK membership settlement with the EU// Further reading Mr Cameron is seeking ways to tackle the rise of Ukip, which has struck a chord with voters with its hostile stance against Brussels and immigration. He failed by a wide margin to fulfil his 2010 election promise to bring annual immigration below 100,000. Net migration was 243,000 in the year to March. It was reported on Sunday that the prime minister is considering a plan to cap the number of low-skilled incomers from Europe by limiting the number of national insurance numbers allocated to migrants. A coalition aide said the plan was “one option” among several ahead of a key speech by the prime minister on immigration later in the year. Mr Barroso told the BBC on Sunday that “any kind of arbitrary [migration] cap seems to me to be not in conformity with European laws”.

He also pointed out that Mr Cameron had invoked EU free movement rules when he complained about Spanish restrictions on Gibraltar. Even if the restrictions could be introduced, critics argue that they would simply steer immigrants towards the black market. In his speech, Mr Barroso will say he understands Britain’s concerns about immigration. But he will warn that the “tone and substance” of politicians’ rhetoric is alienating Britain’s natural allies in central and eastern Europe. The prime minister has already been warned by EU officials that meaningful curbs on the right of free movement within the bloc would require a change to treaties that would be impossible to deliver. http://www.ft.com/intl/cms/s/0/22d48cfc-57a1-11e4-8493- 00144feab7de.html#axzz3GfoYXTba

Barroso warns Cameron that arbitrary migration cap would breach EU law European commission chief tells PM his tougher stance on EU migration could have knock-on effect for Britons living abroad Nicholas Watt, chief political correspondent The Guardian, Sunday 19 October 2014 11.26 BST

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José Manuel Barroso said Britain would have 'zero' geopolitical influence if it left the EU. Photograph: Jeff Overs/BBC/PA David Cameron has suffered a blow to his EU reform plans after the outgoing president of the European commission, José Manuel Barroso, said an arbitrary cap on free movement within the EU would be incompatible with European law. In a sign of the deep frustration with the Tories in Brussels, Barroso also dismissed the claim by the UK’s foreign secretary, Philip Hammond, that the party was “lighting a fire” under the EU by pledging to hold an in/out referendum by 2017. “I think this reference to fires and weapons is more appropriate for defence than foreign secretary,” Barroso told the BBC’s Andrew Marr Show, in a reference to Hammond’s previous job as defence secretary. “I think it is very important to have a positive tone between Britain and the EU.” Barroso was speaking after the Sunday Times reported that Cameron was planning to cut EU migration by imposing a cap on the number of national insurance numbers issued to EU immigrants with low skills. National insurance numbers could be issued for a limited period to ensure the prime minister delivers on his pledge to reduce net migration to the tens of thousands. Barroso, who pointed out that Cameron had invoked EU free movement rules when he complained about Spanish restrictions on Gibraltar, said his plan would be incompatible with EU law. The European commission president said: “In principle arbitrary caps seem to me in contradiction with EU laws. That is quite clear from my point of view.” 60

He added: “I cannot comment on specific suggestions that have not yet been presented. What I can tell you is that any kind of arbitrary cap seems to be not in conformity with Europeans laws. For us it is very important – the principle of non-discrimination. “The freedom of movement is a very important principle in the internal market: movement of goods, of capital, of services and of people. By the way, I remember when prime minister Cameron called me to ask the commission to be tough ensuring the freedom of movement between Gibraltar and Spain. The British citizens have freedom of movement all over Europe. There are 700,000 living in Spain. So the principle of the freedom of movement is essential, we have to keep it.” Barroso, who will stand down as commission president next month after 10 years, said he expected EU leaders to be open to some of the reforms proposed by Cameron, including addressing the abuse of benefits systems. He expressed “full support to all ways of suppressing abuse of benefits because they are against the spirit of our legislation”. The prime minister plans to outline a hardening of his EU renegotiations plans in the next month. Cameron, who has already revealed plans to crack down on EU benefit tourism, wants to go further, imposing restrictions on the movement of people from current EU member states. This would require a revision of the treaty of Rome, the founding document of the EEC, which guarantees free movement of people. Downing Street is seeking to respond to the threat from the right from Ukip. But Cameron also wants to show Tory Eurosceptics he is serious about reform. They have said in recent weeks that the plan to crack down on benefit tourism showed No 10 was not serious about introducing major reforms because there is relatively little evidence of benefit abuse by EU citizens. Barroso questioned whether British citizens who lived in other EU countries – believed to be between 1.4 and 2 million people – would be able to continue to do so if Britain imposed restrictions on free movement. “Britain has to offer to other European citizens [what] the EU offers to British citizens,” he said. “It is a matter of fairness.” The European commission president warned that Britain would have “zero” influence if it left the EU, pointing out that Cameron was currently seeking to persuade fellow EU leaders to contribute an extra €1bn (£792m) to fight the Ebola virus. “What would be the influence of the prime minister of Britain if he was not part of the EU? It would be zero. Inside the EU you can get much more than outside the EU.” Britain would have less influence on the world stage outside the EU. “It would be negative for the EU and for Britain,” he said of a UK withdrawal. “Britain is a great country with a great history. But it is 60 million people. Do we believe that Britain alone can discuss on an equal footing with the US or with a giant like China? If it does it in the EU – yes we have much more influence.” http://www.theguardian.com/uk-news/2014/oct/19/jose-manuel-barroso- david-cameron-eu-migration

OECD: Reforms could add 3.7pc to French growth over 10 years Saturday 18th, October 2014 / 19:28 Written by Oman Observer in Business PARIS — The moribund French economy could get a sharp boost each year over a decade if highly controversial reforms to help businesses are enacted, predictions from the OECD showed. Such changes could add 0.4 per cent to economic output every year over the next 10 years, it said, with the total benefit amounting to 3.7 per cent of gross domestic product (GDP). In the next five years, as the measures take effect, the benefit could equate to 0.3 per cent of output each year, the Organisation for Economic Cooperation and Development said. The calculations by the Paris-based body, a policy forum for 34 advanced democracies including France, point to a significant extra benefit since France’s economy is set to grow by only 0.4 per cent this year. “To put the French on the path to stronger growth, but also more inclusive, requires the reinforcement of structural reforms started in 2012,” OECD Secretary General Angel Gurria said in a statement with the report, which was to be given to President Francois Hollande later on Friday. France’s economic growth has sunk into the doldrums this year, held back by near record unemployment and the government’s huge pile of debt, which has put it on a collision course with the European Union. The reforms are strongly opposed on the left of the governing Socialist party. Hollande is counting on the measures to turn the economy around. Finance Minister Michel Sapin forecast at the beginning of the month that France’s output would grow by only 0.4 per cent this year, recovering to 1.0 per cent in 2015, 1.7 per cent in 2016 and 1.9 per cent in 2017. Paris also predicts its budget deficit — the shortfall between revenue and spending — will hit 4.3 per cent of GDP next year and only fall to the EU’s debt ceiling of 3.0 per cent in 2017, instead of next year as previously promised. That has put it at loggerheads with the European Commission, the EU’s executive arm, which many expect could demand that Paris modify its 2015 budget to bring it in line with rules governing the 18-country euro zone. To turn around its economic fortunes, France must swiftly implement Hollande’s “Responsibility Pact”, the OECD said. — AFP http://www.oecd.org/newsroom/FRANCE_ReformesStructurelles.pdf http://oecd.einnews.com/article/229874388/yGu8NFacbmsk6IG9?n=2&code=YE4u1DI RGs-Vsvg5

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Mohamed El-Erian October 17, 2014 Beware of calls for QE4 It is so predictable yet also so unfortunate. The financial market volatility of recent days is enticing a growing number of market participants to urge and expect the US Federal Reserve to implement “QE4” – that is a new programme of securities purchases (quantitative easing) to calm markets and bolster sagging stock, corporate bond and commodity prices. Yet the hurdle for such a policy step is high; and it should be if it is not accompanied by a more comprehensive policy response out of Washington. This month’s financial market turmoil has been driven by a perfect storm consisting of: first, downward revisions to growth projections on account of both economic and noneconomic factors; second, signs of internal and external divisions when it comes to the European Central Bank implementing more aggressive monetary stimulus; and third, disruptive technical spillover effects from heightened volatility in the currency markets caused by greater dispersion in the policy stance of the world’s major central banks. Together, these factors have disrupted the markets’ love affair with two enticing notions that have led to excessive risk taking and general complacency: a low-level growth equilibrium that minimises the probability of both recession and, on the other side, an inflationary boom; and central banks that are both able and willing not to repress market volatility, thus bolstering asset prices. As a result, traders are now scrambling to reposition themselves. In the process, they are discovering – yet again – that market liquidity is not as deep as they had hoped for, causing wild price gyrations even in the most traditional of all asset classes (for eg, witness the speed and size of Wednesday’s price movements in US equities and Treasuries). Based on the past reactions of the Fed to financial market disruptions, including last year’s response to the markets’ “taper tantrum”, an increasing number of participants are now calling and expecting the US central bank to intervene; and, notably, to do so by introducing a new asset purchase programme (“QE4”) to replace the one set to expire this month (“QE3”). The argument for QE4 runs along the following lines. While the US economy has been steadily recovering, and doing so at a much faster rate than most of the other advanced economies, it is yet to attain escape velocity. As such, it remains vulnerable to headwinds that undermine actual and potential growth rates while also maintaining some risk of damaging deflation. The resulting challenges would be significantly compounded if, now, financial market instability were to undermine corporate and consumer confidence, thus adding to the headwinds coming from a weakening global economy, the Ebola scare and unsettled geopolitical conditions in the Middle East and Ukraine.

As appealing as this may sound, it is also incomplete. The most direct target of QE4 – interest rates on government bonds, new mortgages and home refinancings – are already at a very low level (and especially so after the recent flight to quality in financial markets). Banks still hold large excess reserves with the Fed. There are few, if any signs, of a less polarised US Congress for the Fed to bridge to to the holistic policy response that is urgently needed to put the US economy on a stronger growth and employment footing while countering excessive inequality. And, on the more positive side, most companies and households will benefit from the recent sharp sell-off in energy prices. All this is to say that the QE delicate policy balance – which in August 2010 Ben Bernanke, then chair of the Fed, posed as one of “benefits, costs and risks” – is far from compelling. The expected benefits would be small in terms of generating incremental growth that is both sufficiently durable and inclusive; and, if more robust growth remains elusive, the US economy could suffer down the road from another round of artificially boosted asset prices, and the excessive risk-taking that comes with that. For all these reasons, QE4 is likely to face a very high implementation hurdle. But this does not mean that Fed officials will stay on the sidelines. Look for them to make calming remarks that seek to reassure markets that interest rates will remain low for long. They may even hint at the possibility of some delay in this month’s expected elimination of QE3 (though now that the programme is down to just $15bn of monthly purchases, this would be symbolic rather than deterministic). After a period of excessive risk taking and prolonged complacency, it will probably take some time for markets to fully recalibrate – a choppy process that will be driven both by fundamentals and by technically-oriented repositionings of crowded trades. Market participants’ calls for QE4 to short circuit all this are understandable but misguided. Acting alone, renewed Fed intervention of that type would deliver insufficient growth while making the subsequent market correction more dangerous for main street. The writer is chief economic adviser to Allianz, chairman of President Barack Obama’s Global Development Council, and author of ‘When Markets Collide’ http://blogs.ft.com/the-a-list/2014/10/17/beware-of-calls-for-qe4/

ft. com World Europe Last updated:October 16, 2014 4:43 pm Merkel defends fiscal rules as Paris and Rome put growth first Stefan Wagstyl in Berlin and James Politi in Rome

©EPA German chancellor Angela Merkel on Thursday delivered a tough defence of the eurozone’s fiscal rules, raising tensions with France and Italy just a day after they submitted budgets to Brussels that challenge those limits. “All member states must accept in full the strengthened rules,” she told the German parliament. As well as rebuffing French president François Hollande and Italian premier Matteo Renzi, who are demanding that Brussels allow them more budget flexibility, Ms Merkel seemed intent on calming the world’s financial markets, which saw some of their sharpest sell-offs of the week on Thursday, including a steep drop in Greek bonds. More ON THIS TOPIC// Timmermans promises to slash EU red tape/ Brussels clears telecoms groups/ Hill prepares for Brussels’ baiting/ Lombard Lord Hill / Kingfisher / Tartan IPOs IN EUROPE// Moscow battles to ease dollar shortage/ France unveils deregulation proposals/ Russia’s defence budget hit by slowdown/ Wall St calm at axing of Double Irish tax The chancellor said that only when the eurozone’s rules were seen as trustworthy could they fulfil their role as “the central anchor for stability and, above all, for trust in the eurozone”. But her comments brought a swift retort from the Italian and French leaders. “Europe needs to reflect a bit more: the crisis is not resolved, it’s international, it’s a matter of confidence,” Mr Renzi said as he hosted European and Asian leaders at a summit in Milan. “Europe needs to be capable of an economic response that invests in growth and not just rigour and austerity,” he said. Mr Hollande said “relaunching growth is the best way of stabilising the markets.”

Ms Merkel was speaking hours after Mr Renzi proposed a 2015 budget heavy on stimulus measures, from tax cuts to investments, that sees the planned deficit rise from 2.2 per cent of gross domestic product to 2.9 per cent, a fraction short of the EU’s 3 per cent ceiling. Far from apologising for sailing so close to the wind, a defiant Mr Renzi said after presenting the budget: “It’s the biggest tax cut ever done by a government in a year. It’s a sign of Italy’s great strength, solidity, and determination.” France has already published a budget with a planned 4.3 per cent deficit, which would break the 3 per cent limit for the third year in succession. Paris, which just last year had promised to get its deficit under the ceiling by 2015, has also promised to stick to its guns, rejecting demands from Brussels for a rethink. The review of the budgets, an exercise that emerged as part of the EU’s response to its crippling debt crisis, will pose an immediate test to a new European Commission that must balance the need to enforce the rules with greater demands for stimulus measures in a eurozone desperate for growth. Paris and Rome have argued that their embrace of structural reforms, such as a recent Italian move to overhaul a sclerotic labour market, should afford them some relief from the fiscal rules. As the EU’s biggest economy, Berlin has always had the key say in that debate and has privately been urging the European Commission to take a tough line. Ms Merkel said the financial crisis in Europe was “not permanent” but neither had it been “sustainably overcome”. 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 In Italy, the centrepiece of Mr Renzi’s budget is an €18bn mix of tax cuts for businesses and lower-income individuals. The prime minister, in his first budget since gaining power in February with a mission of dramatic economic reform, hopes it will help jolt the eurozone’s third-largest economy back to life, amid projections that it will contract 0.3 per cent this year. Mr Renzi is also proposing more spending in a number of areas, including a boost to unemployment insurance in connection with his sweeping overhaul of Italian labour laws and more money for education, bringing the total cost of the stimulus package to €36bn. But the expenses for the debt-laden Italian government will only be partly covered by spending reductions in other areas, which will amount to about €15bn. That figure is

significantly smaller than the budgetary trimming of up to €20bn Mr Renzi had set as a goal last month. The shortfall means most of the remaining gap will be plugged by an increase in Italy’s budget deficit from 2.2 per cent of GDP to 2.9 per cent of economic output, leading it to the very edge of the 3 per cent limit set by EU budget rules. Perhaps more problematically, Rome, which is required by Brussels to gradually cut its national debt to 60 per cent of GDP – next year it is projected to hit 134 per cent – unilaterally slowed its efforts to get there. Under a debt-reduction path agreed with the European Commission, Italy was supposed to reduce its structural deficit – its excessive spending when one-off and cyclical factors are stripped out – by 0.7 per cent; instead, it will be cut by just 0.1 per cent. This could set up a possible clash with Brussels, against the backdrop of an even bigger fight brewing between France and the EU over a move by Paris to exceed its deficit target. “I believe Brussels will not like this [Italian budget]. At the same time, I believe that Renzi will try to ‘use’ a potential warning by the commission as a political propaganda tool to show Italians that he has no fear to contradict Brussels,” said Francesco Galietti, an analyst at Policy Sonar consultancy in Rome. http://www.ft.com/intl/cms/s/0/fedbfcfc-5518-11e4-b616- 00144feab7de.html#axzz3G1L0w6ka

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October 16, 2014 9:47 pm BoE lashes out at EU bonus cap rules Sam Fleming and Martin Arnold in London and Alex Barker in Brussels

©Bloomberg The Bank of England has launched a full-blooded counter-attack on the EU cap on banker bonuses, calling it the “wrong policy” just one day after European regulators tried to stop banks from dodging the rule. In a sign of mounting tension between EU countries over pay, Andrew Bailey, the chief of the BoE’s Prudential Regulation Authority, said the debate over bonuses was “misguided” and that variable pay should play a significant role in banker remuneration. More ON THIS STORY// Watchdog calls for clampdown on bank pay/ Top pay up to 120 times that of workers/ In depth Bank bonuses/ Bankers fear rules will scare off talent/ IMF urges shake-up of top bankers’ pay ON THIS TOPIC// EU to rate banks in push for unity/ Favourable treatment of covered bonds backed/ EU regulators give stress test details/ EU watchdog aims to cool Bitcoin fever IN BANKS// Credit Suisse in investment bank reshuffle/ Saudi bank to float despite turmoil/ UBS in US talks over forex probe deal/ Bank investors fear new outlook for rates His criticism comes after the European Banking Authority on Wednesday set a December 31 deadline for EU watchdogs to crack down on the use of role-based “allowances”, which are being used by investment banks to circumvent the bonus cap. The UK is expected to ignore the year-end deadline set in the EBA opinion, which does not carry legal force, instead waiting for more detailed guidelines on pay from the EBA in 2015. Mr Bailey said: “Let me be blunt, the bonus cap is the wrong policy, the debate around it is misguided, and the best thing I can say about allowances is that they are a response to a bad policy. They are not a good solution.

“I will not win friends in some places for saying this, but it dismays me to see a debate which is at times so divorced from the heart of the matter, which is setting appropriate incentives by putting a meaningful amount of pay at risk.” The EU capital requirements directive mandates that bonuses should be no more than 100 per cent of salary – or 200 per cent with shareholder approval. British chancellor George Osborne has launched a legal challenge to the cap in the European court. The BoE has previously said it opposes the bonus cap, fearing that it will make it harder to align pay with performance. Mr Bailey told a City of London dinner on Thursday night that he was not “pro bonuses” per se, but he cited the UK’s Parliamentary Commission on Banking Standards, which said there were advantages to a “significant” proportion of banking remuneration being in variable rather than fixed form. The BoE is bringing into force its own regime requiring bonuses to be deferred for years and allowing them to be clawed back in the case of wrongdoing – even if the employee has already spent the money. The EBA said on Wednesday that a review of 39 banks had suggested that allowances were being widely used to circumvent the bonus cap. It called on EU national regulators to take “all necessary measures” to ensure allowances were adjusted to comply with the law. The PRA was outvoted by other regulators when it opposed the EBA opinion setting a year-end deadline for action on allowances, although the EBA’s report investigating allowances won unanimous consent. Bankers are now awaiting further guidance on allowances. One banking executive said that given the PRA had not blocked allowances to date, banks believed it was unlikely the regulator would “turn round and tell us they are no longer acceptable”. However, as a last resort the European Commission can take legal action against the UK for a failure to comply with EU rules, or the EBA could order banks directly to cease the practices. In his speech, Mr Bailey also defended UK regulations that will pile greater burdens on banks’ top management, including rules that will impose a presumption of responsibility where there is wrongdoing. The Senior Managers Regime has attracted criticism from the industry amid concerns about the burdens it will pile on non-executives, in particular. “Is it really unreasonable to expect the most senior figures to assume responsibility? Not in my view, and in my experience not in the view of those who take on these roles,” Mr Bailey said. http://www.ft.com/intl/cms/s/0/28d35148-554d-11e4-b750- 00144feab7de.html#axzz3G1L0w6ka

ft.com/markets MARKETS INSIGHT October 16, 2014 8:09 am Deflation threat to Draghi’s credibility Ralph Atkins in London Markets expect inflation to undershoot central bank targets Precipitous, unexpected decreases. A market mood that has changed worryingly. It is not just global share and oil prices, or bond yields, that have swung wildly this week. At least as dramatic have been sharp falls in “inflation expectations” – assumptions about future inflation rates priced into bond and swaps markets. As energy costs slid and global growth stuttered, markets appeared to believe long-run inflation would seriously undershoot policy targets on both sides of the Atlantic. The implications are potentially large: plunging inflation expectations will make it harder to increase US or UK interest rates any time soon. By threatening their credibility as guardians of price stability, they make central bankers’ lives even more difficult. For Mario Draghi, European Central Bank president, they are a market vote of no- confidence in his ability to avert deflation. More ON THIS TOPIC// Bank of Canada in forward guidance retreat/ ‘Fear gauge’ at highest since eurozone crisis/ Global Insight Sensible for Fed to speak out on dollar/ Forex trading bounces back strongly MARKETS INSIGHT// Winners and losers from oil price plunge/ Big bond fund outflows are risk for banks/ ‘Normal’ interest rates are distant dream/ ‘Euroglut’ of gloom as Germany weakens Or are they? Inflation expectations are watched by central banks because they affect price-setting in the real economy. What markets price in should tell them if they are doing their job properly. But that assumes the gauges do not send false signals. A well established phenomenon in economics – known as “Goodhart’s law” after Charles Goodhart, the UK banking professor – is that once a measure is targeted, it ceases to be a good measure. Could that have happened in the eurozone? In August in Jackson Hole, Wyoming, Mr Draghi cited specifically a sudden fall in the “five-year, five year” inflation rate – the average rate over five years starting in five years priced into swaps markets. It sounded technical, but essentially Mr Draghi was admitting that the ECB was losing its control over inflation expectations. His comments emboldened ECB colleagues – and within weeks, the Frankfurt-based institution had cut interest rates further and launched a private sector asset purchase programme. But to Mr Draghi’s embarrassment, the 5y5y “break even” inflation rate has since fallen even further – this week it dropped to just 1.71 per cent, the lowest since records started a decade ago. Given the gauge usually trades comfortably above the ECB’s target of an annual inflation rate “below but close” to 2 per cent, the drop is alarming. Some in the ECB

wonder if the measure is being distorted, perhaps deliberately, by investors trying to bounce it into further, more aggressive policy action. That seems unlikely. Inflation swaps, used by investors to hedge against price risks, would be a strange place to take big positions. “I wouldn’t say it was the investors testing central banks directly – it is not a particularly liquid market to trade,” says Francis Diamond, inflation strategist at JPMorgan. Moreover, market assumptions about future inflation rates have also fallen steeply in the US – which suggests the ECB is simply faring worst amid a global shift in expectations. US policy makers focus, not on inflation swaps, but signals from US Treasury inflation-protected securities – for which there is a deeper market than for European inflation-linked bonds. At play are factors such as tumbling oil prices, and weaker than expected inflation data released this week in the UK or China. Nevertheless, inflation expectation measures could still be exaggerating the falls expected by markets. “Break-even” inflation rates are implied by the difference between nominal (before adjusting for inflation) and real interest rates. As well as expressing expectations about future inflation, however, investors demand a “risk premium” for buying inflation-linked bonds. If a bigger “risk premium” pushed up real yields, break-even inflation rates would fall – even if investors’ views on likely inflation rates had not changed. “My inclination would be that a lot of the recent change in market measures of inflation expectations, at least in the US, has been driven by the time-varying risk premium,” says Benjamin Mandel, economist at Citigroup in New York. Market expectations measures have misled badly in the recent past. After Lehman Brothers investment bank collapsed in late 2008, markets priced in US deflation for 2013. That never happened. That is either reassuring – or worrying. It is reassuring if fears about low inflation are overdone, but worrying if higher “risk premiums” reflect broader concerns about the stability of economies – and the waning effectiveness of central banks. http://www.ft.com/intl/cms/s/0/39d49fc2-5478-11e4-b2ea- 00144feab7de.html#axzz3G1L0w6ka

ft.com Comment Blogs Andrew McAfee We’re living through a new industrial revolution Andrew McAfee Oct 16 05:00

© Oli Scarff/Getty Images History teaches us that nothing changes the world like technology. For thousands of years, until the middle of the 18th century, there were only glacial rates of population growth, economic expansion, and social development. Then an industrial revolution happened, centered around James Watt’s improved steam engine, and humanity’s trajectory bent sharply and permanently upward. Great wars and empires, despots and democrats, the insights of science and the revelations of religion – none of them transformed lives and civilizations as much as a few practical inventions. Technological progress never occurs in a vacuum, of course, and the industrial revolution was greatly helped along by innovations and institutions such as banks, universities, joint stock companies, and patents. But we shouldn’t let this fact obscure the larger truth, which is that, as the physicist Freeman Dyson put it: “Technology is a gift of God. After the gift of life it is perhaps the greatest of God’s gifts. It is the mother of civilizations, of arts and of sciences”. A second industrial revolution grounded in electricity and the internal combustion engine (and, in some accounts, indoor plumbing) greatly boosted industrial productivity and economic growth starting in the late 19th century. Many innovations — such as Thomas Edison’s work on the electric light, and Henry Ford’s mass automobile production — would have a striking impact on economic development; in the case of the US, helping it become the world’s leading economy. Harold Evans’ designation of the 20th as the ‘American Century’ underscores how important it is for a country to be at the technological frontier. More than 200 years of experience have given us some ability to recognise industrial revolutions as they’re unfolding. And many of us, myself included, are convinced that we’re living through another one right now. This one is brought on by progress in all things digital – computers, networks, sensors, data, robots, and so on. And while the

older two revolutions helped us overcome the physical limitations to getting more work done, this one is allowing us to overcome the limits of our minds and senses. The first industrial revolution ushered in humanity’s original machine age, and the second one continued it. Now comes the second machine age (as Erik Brynjolfsson and I labelled it in our book of the same name), which will be the subject of this blog. I’ll work here to describe and analyse an economic and societal transformation as it’s happening. I’ll discuss the technological marvels that are at the heart of the changes taking place – things like driverless cars, artificial intelligence applications, 3D printers, robots and drones, and computing devices that are ever-more powerful, cheaper, and varied. I’ll also talk about how these innovations are changing how companies do business, how industries are structured, and how we live our lives. I find the second machine age fascinating because all around the world it’s affecting innovation, competition, profits, jobs and wages, affluence and equality, policy, privacy and security, and many other things that readers of the Financial Times care about very much. My viewpoint, which I’ll use this blog to elaborate, is one of mindful optimism. Optimism because I agree with Dyson: technological progress is the best economic news on the planet. Mindfulness because as digital tools are racing ahead they’re leaving lots of people behind in their capacity as workers who want to offer their skills to an employer. As technology can do more and more, in other words, we will need some kinds of human labour less and less. Dealing with this situation will, I believe, be the central policy challenge of the next generation. I’d like to make this a conversation instead of a broadcast so please do comment, question, and join in here. I look forward to hearing from you. http://blogs.ft.com/andrew-mcafee/2014/10/16/were-living-through-a-new- industrial-revolution/

ft.com/global economy EU Economy Last updated: October 15, 2014 10:05 pm Budget pushes Italy to the edge of EU deficit rules James Politi in Rome

©Anna Gordon Matteo Renzi, Italy’s prime minister, has proposed a budget heavy on stimulus measures – from tax cuts to investments – and lighter than expected on spending cuts, which will bring the country within a whisker of breaching EU deficit rules. The centrepiece of Mr Renzi’s first budget since gaining power in February with a mission of dramatic economic reform is an €18bn mix of tax cuts for businesses and lower-income individuals he hopes will help jolt the eurozone’s third-largest economy back to life, amid projections that it will contract 0.3 per cent this year. More ON THIS TOPIC// Italy poised for property renaissance/ Italy targets legal profession for reform/ Alarm at plan to end Italy’s Mare Nostrum/ Analysis China swoops in on Italian assets IN EU ECONOMY//Germany slashes its economic forecasts/Sweden slides further into deflation/Timeline – Events leading to ECB case/IMF meetings focus on Germany’s woes “It’s the biggest tax cut ever done by a government in a year,” Mr Renzi said after gaining the approval of the council of ministers on Wednesday evening. “It’s a sign of Italy’s great strength, solidity, and determination,” the 39-year-old former mayor of Florence added. Mr Renzi is also proposing more spending in a number of areas, including a boost to unemployment insurance in connection with his sweeping overhaul of Italian labour laws, and more money for education, bringing the total cost of the stimulus package to €36bn. But the expenses for the debt-laden Italian government will only be partly covered by spending reductions in other areas, which will amount to about €15bn. That figure is significantly smaller than the budgetary trimming of up to €20bn Mr Renzi had set as a goal last month.

The shortfall means most of the remaining gap will be plugged by an increase in Italy’s budget deficit from 2.2 per cent of gross domestic product to 2.9 per cent of economic output, leading it to the very edge of the 3 per cent limit set by EU budget rules. This could set up a possible clash with Brussels, against the backdrop of an even bigger fight brewing between France and the EU over a move by Paris to exceed the deficit target. “I believe Brussels will not like this [Italian budget]. At the same time, I believe that Renzi will try to ‘use’ a potential warning by the commission as a political propaganda tool to show Italians that he has no fear to contradict Brussels,” said Francesco Galietti, an analyst at Policy Sonar in Rome. Although Italy would not technically be in breach of EU deficit rules, it has already delayed its target for reaching a structurally adjusted budget balance – taking into account the economic cycle – from 2015 to 2017, which has already raised eyebrows at the EU. And the fewer than expected spending cuts in this year’s budget may stoke further concern in Brussels – as well as Berlin – that Italy is not being as aggressive as it could be in terms of budgetary restraint. Italy’s so-called “spending review” has been led by Carlo Cottarelli, a former International Monetary Fund executive who has at times clashed with Mr Renzi and is set to leave the government following the rollout of the budget. Nonetheless, Italian officials insist Brussels should have no reason to complain and the country’s “exceptional circumstances” – from the government’s push for structural reform, to the dire economic outlook – should warrant some flexibility. “We are willing to have a dialogue with the commission today and tomorrow,” Mr Renzi said. Italy may also have bought some good will among other EU countries in recent weeks by moving more speedily to approve a contentious labour market reform plan that is seen as a key test of the country’s commitment to resolving its structural economic problems. Though the political battle over the labour reform is far from over, and many of the details of the legislation still need to be written, Mr Renzi this month overcame opposition from within his own party to secure the approval of the measure in the Italian Senate. http://www.ft.com/intl/cms/s/0/f79cf99a-5460-11e4-b2ea- 00144feab7de.html#axzz3G1L0w6ka

ft. com World Europe October 15, 2014 5:03 pm France touts deregulation as budget scrutiny intensifies Hugh Carnegy in Paris

©APFrance's economy minister, Emmanuel Macron From opening intercity bus routes to extending Sunday shop opening, France has unveiled deregulation plans in an attempt to persuade sceptical European partners that it is serious about economic reform. The announcement of the measures coincided with the formal delivery on Wednesday of France’s much criticised 2015 budget to the European Commission in Brussels, which is expected to take a dim view of a further two-year delay requested by Paris to meet its EU-designated deficit targets. President François Hollande hopes to avoid potential pushback on the budget by increasing his commitment to structural reforms long demanded by Brussels to overcome stagnation in the eurozone’s second-biggest economy. More ON THIS STORY// French government ousts Proglio at EDF/ Paris stands firm against fiscal enforcers/ French economy news ON THIS TOPIC// France tackles rules crimping company growth// France tells Europe to focus on growth// France defiant on missed deficit target// Hollande warns France of spending cuts IN EUROPE// Moscow battles to ease dollar shortage// Russia’s defence budget hit by slowdown// Wall St calm at axing of Double Irish tax/ Ukraine fears winter energy crisis The new measures were laid out by economy minister Emmanuel Macron, a former Rothschild banker, who, with prime minister Manuel Valls, has become the government’s standard-bearer for reform. “Europe is in difficulty but France is in even more difficulty,” Mr Macron said. “We must increase our growth potential. France needs renovation and to open itself up.” Measures he announced covered a loosening of regulation in the transport sector, retail, the legal profession, the pharmacy trade, dentistry and steps to ease curbs on employee share ownership. “Complexity is a French illness – we love laws, decrees and texts,” Mr Macron said.

He reiterated the government’s willingness to sell off part of the state’s €100bn company shareholdings. Mr Macron said this could yield up to €10bn in the next 18 months to pay down debt and fund new investment – although the government intends to retain its influence, or control, over key sectors such as energy. The economy minister said more proposals would be announced next month. The measures come on top of €40bn in business tax cuts due over the next three years and other reforms in areas such as the labour market. But legislation to enact the new measures is not due until early next year, risking criticism that the government, elected in 2012, is taking too long to implement reforms.

Some of the measures also fell short of expectations. Monopolies in the pharmacy and legal professions, which have both mounted strong protests against reform, will apparently not be broken up, although steps will be taken to ease restrictions on starting businesses and consolidation of businesses and activities in these areas. Most non- prescription medications such as paracetamol will remain available only in pharmacies. Nevertheless, some significant changes were promised, including removing a virtual prohibition on running domestic intercity coach services, put in place over years to protect the railway industry. The number of Sundays in a year that local authorities can authorise general shop opening will be increased from five to 12. Big cities, such as Paris, will benefit from the extension of designated tourist zones where rules against Sunday and evening trading do not apply: railway stations will also be exempt. Trade unions have furiously defended Sunday and evening trading restrictions and are likely to fight the new rules. But Mr Macron said: “Many French people shop on Amazon on Sundays. We cannot leave Sunday trading to big groups like Amazon that pay little tax in France.” He warned, however, that such reforms would take years to have their full effect on growth and employment. “The truth is it will take time,” he said. “That is why a big investment plan in Europe is needed in the short term.” http://www.ft.com/intl/cms/s/0/0f3b8128-546d-11e4-b2ea- 00144feab7de.html#axzz3G1L0w6ka 77

China seeking to cash in on Europe’s crises - since 2010, Chinese investment has been increasing in European European countries that needed to privatize quickly and at cheap price by Silvia Merler on 16th October 2014

Last Tuesday, I posted about the increasing investment of China in Russia, wondering whether and to what extent it could help Russia smooth the economic impact of European sanctions. But as shown by a recent analysis of the Financial Times, China has been increasingly investing in Europe as well, focusing recently on crisis-hit countries. Tweet This Chinese FDI to Europe has been very small until 2010. But since then it has been significantly increasing, reaching 27bn euro in 2012 China has traditionally been a receiver of European FDI, which according to Deutsche Bank, accounted for 18% of total China’s FDI stock. On the contrary, Chinese FDI to Europe has been very small until 2010. But since then it has been significantly increasing, reaching 27bn euro in 2012. Even so, Chinese FDI still represents a minimal share (0.7%) of total FDI stocks that EU countries receive from non-EU countries. Tweet This Between 2008 and mid-2014, China sealed more than 200 cross-border M&A or joint venture deals in the EU

According to Deutsche Bank, between 2008 and mid-2014, China sealed more than 200 cross-border M&A or joint venture deals in the EU. Most M&A projects were undertaken in the industrial sector, consumer products, energy and basic materials (figure 2, right). Deutsche Bank also highlights the existence of different strategies across destination countries: in Germany, deals appear to have been focused mostly on machinery, alternative energy, automotive parts and equipment; in France, the target was mostly consumer industries; while in the UK target industries reflect a broad-based mix.

EUROSTAT

Deutsche Bank Germany attracted the largest number of deals (figure 2, left) - most notably Greenfield investments - followed by the UK and the Netherlands. Italy, Greece, Portugal and 79

Spain, seem to have become more interesting to Chinese investors only from 2012 onwards. Tweet This Italy, Greece, Portugal and Spain seem to have become more interesting to Chinese investors only from 2012 onwards The Financial Times published this week an analytical series (“Silk Road redux”) that looks more into this new wave of Chinese FDI in crisis-hit European countries. Sources quoted in the articles suggest that with the 2010 European crisis, China has indeed started to shift its foreign investment focus from mostly natural resources-related investments in Africa, Asia and Latin America, towards assets in European countries that, at the height of the crisis, were often faced with the need to privatize quickly and at relatively cheap price (figure 3). In Italy, the FT reports that at the end of 2012, an estimated 195 SMEs (with combined total revenues of €6bn and 10,000 employees) had been wholly or partly taken over by Chinese or Hong Kong investors. China managed to secure stakes in big companies as well. In July this year, Chinese State Grid invested heavily in the Italian power grid, buying 35% in CDP Reti. Safe in turn invested estimated 2 billions in ENI and ENEL, two state-controlled energy groups, while the state Administration of Foreign Exchange bought 2% stakes in FIAT Chrysler Automobiles, Telecom Italia and Prysmian, for a total of 670 million. In Greece, Chinese investors are focusing on shipping and tourism. In June, Greece and China signed shipbuilding deals worth $3.2bn that will be financed by the state-owned China Development Bank. The Chinese state shipping group Cosco Pacific had already acquired a concession to operate in the Piraeus port back in 2009, and is competing to buy the 67% stake currently held by the Greek State. Greece’s Transport ministry is also reportedly expecting China’s State Construction Engineering Corporation to participate in a tender to build and operate a new 800 million euro airport in Crete, which could offer the first direct connection between China and Greece. Chinese tourists are increasing in Greece, and (in 20 years time) they could possibly enjoy the huge luxury commercial centre that will be built on the coastal site of the former Athens airport. A long-term project worth 5 billion in which Chinese Fosun is participating together with Greece and Gulf state partners. Tweet This In Portugal, Chinese investment is reported to account for 45% of the total privatization conducted in the context of the EU/IMF programme In Portugal, Chinese investment is reported to account for 45% of the total privatization conducted in the context of the EU/IMF programme. Chinese early investments were in power utility and infrastructure, with Three Gorges Corporation acquiring in 2011 a stake of 21% in Energias de Portugal and China State Grid acquiring 25% of REN, the national grid operator. In 2014, instead, investment was concentrated in financial services, with Fosun buying 80% of the Portuguese Caixa Seguros, the largest insurance company, and now bidding for BES assets.

On top of these investments, Chinese buyers are potentially revitalising the otherwise paralysed real estate market in crisis-hit countries. The FT reports that government of Portugal, Cyprus, Greece, Hungary, Latvia and Spain are managing to attract Chinese real estate buyers by offering residency permits to non-Europeans who buy local property of a certain amount. The practice is known under the name of “golden visas”.

Financial Times In Portugal, the golden visa requires buying a property for at least 500,000 euros, the same in Spain (which is at present reported to have 500 application pending) whereas in Greece and Hungary it takes a 250,000 sale. Portugal is reportedly the country where the scheme has been more successful, with 1360 visa issued (81% of which to Chinese nationals) and an associated 900 million real estate investments (forecasted to reach 2 billion by end-2015). Despite the recent increase, Chines FDI to Europe are still in an infancy state and more data will be needed before drawing conclusion on whether this can qualify as a meaningful trend. But it looks like the euro crisis might have opened to China the doors of otherwise locked European investments http://www.bruegel.org/nc/blog/detail/article/1461-china-seeking-to-cash-in-on-europes- crises/?utm_source=Bruegel+Fact+of+the+Week&utm_campaign=42e8046fa1- Bruegel+Fact&utm_medium=email&utm_term=0_397314f092-42e8046fa1-277671613

ft.com Comment The Big Read October 15, 2014 7:34 pm After QE: Taking off the stabilisers Ralph Atkins Markets are braced for increased volatility as central banks signal an end to unlimited liquidity

In the six years since Lehman Brothers collapsed, global financial markets have held to one certainty: central banks were their friends, willing to support asset prices and deploy the unlimited firepower of a monopoly printer of money. The force of central bank actions – or often, just the hint that they might act – drove impressive rallies across markets. After reaching a post-crisis bottom in March, 2009, US share prices have surged above previous peaks, with the S&P500 rising 170 per cent. The FTSE All-World Share Index is up 130 per cent over the same period. Bond yields, which move inversely with prices, tumbled to historic lows; across much of continental Europe investors in effect pay to lend short-term to governments. Even amid the turmoil of the eurozone crisis and periods of global political instability, investors saw the central banks as an anchor of stability. But the expected end of the US Federal Reserve’s quantitative easing programme this month – which expanded the central bank’s balance sheet to $4.45tn – will mark the moment when that anchor is lifted. More ON THIS STORY// US quantitative easing defying theory/Monetary policy An unconventional tool/US inflation measure is headache for Fed/BoJ downgrades outlook for economy/James Grant Low rates jam vital signals ON THIS TOPIC//Markets Insight Deflation threat to Draghi’s credibility/Bank of Canada in forward guidance retreat/‘Fear gauge’ at highest since eurozone crisis/Global Insight Sensible for Fed to speak out on dollar IN THE BIG READ//Energy Can Europe wean itself off Russian gas?/Indonesia Now for the hard part/Buybacks Money well spent?/Ebola virus ‘Our people are dying’ While deterioration in the US economy could yet force the Fed to turn QE back on again, its next step is more likely to be a rise in its interest rate target, which has sat near zero for almost six years. The last time the Fed raised rates was in 2006. The end of QE is already upsetting markets. With the global economic outlook turning distinctly gloomier – the International Monetary Fund last week warned of a new era or mediocre growth – investors are bracing for rougher times. The All-World Share Index has tumbled 9 per cent since early September. Yields on 10-year US Treasuries, which move inversely with prices, yesterday saw a sudden lurch below 2 per cent – the lowest for more than a year. Given the uncertainty about what happens next to global economies and financial systems – the unknown unknowns as well as the known unknowns – further disruption is inevitable. “The current monetary regime is so second nature to all of us that if you change that regime you should not be surprised if the initial reaction is rather extreme,” warns George Magnus, former chief economist at UBS. “The questions now are what are the unintended consequences and how do we deal with the unwinding of QE,” says Keith Skeoch, chief executive of Standard Life Investments, the asset manager. “This part of the experiment neither we, nor the economists, really understand.” How financial markets react will help determine the success or otherwise of an unprecedented policy offensive by central banks . Along with the Fed’s programme, the

European Central Bank flooded the eurozone financial system with liquidity and theirUK and Japanese counterparts launched aggressive QE policies . The objective was to avert economic catastrophe and ensure the proper functioning of markets. A relatively smooth transition to a more normal policy framework could help global economic growth by boosting investor confidence and allowing markets to channel finance to the real economy. A bumpy ride, however, could unwind the shaky progress made so far – as well as fuel fears that QE has masked serious weaknesses in the financial system, left markets overdependent on central bank support and simply created the conditions for the next crisis. Turning points in the interest rate cycle are rarely easy to manage. “Historically, US monetary policy tightening has always caused some fallout for the global economy – regularly and consistently,” Axel Weber, UBS chairman and former Bundesbank president, warned in Washington last week. “My advice to investors is: fasten seat belts.” In 1994, an unexpectedly sharp tightening of US monetary policy caused havoc in bond markets. The Fed has since honed its ways of communicating with markets – and is proceeding with extreme caution this time, clearly telegraphing that the first rise in US rates is probably at least six months away. But the Fed’s challenge in navigating the world into a post-QE era is particularly complicated. For a start, the global economy is at an awkward juncture. While the US economy is recovering, Europe may be falling back into recession, and fragilities are apparent in emerging markets. To some extent, looser monetary policies in Japan and the eurozone could act as a counterbalance to the Fed’s shift towards an eventual rate rise. However, there could still be abrupt moves in currency markets. “There is certainly a risk of serious complications in this multi-track world of central banking,” warns Mohamed El-Erian, chief economic adviser to Allianz, the German insurer. “Judging from history, sharp and rapid currency adjustments often end up breaking something.”

Because interest rates have been so low for so long, even a small absolute increase could have a much greater impact than in the past. QE also may have changed the way

markets function. The sheer size of central bank operations means they often are the market, acting as the most important lenders, or buyers of assets. By deliberately flooding the financial system, they have also disrupted the traditional way of controlling interest rates – by rationing access to liquidity. As it moves toward lifting rates, the Fed will have to reassert control over market borrowing costs. “Central banks have interfered with the basic plumbing,” says Manmohan Singh, market infrastructure expert at the IMF. The Fed’s usual target – the “Fed funds rate,” or the market cost of borrowing reserves – is no longer a good indicator of financial conditions, Mr Singh says. “It sounds technical but it matters – the effects will reverberate around global markets,” he says. The Fed has had plenty of time to prepare and it is testing new ways of controlling borrowing costs. But communicating with markets will become more fraught as the first rate rises approach. Both the Fed and Bank of England have made tighter monetary policies conditional on improving economic data, which is another way of admitting many unknowns. “It will take a lot of skill on the part of the Fed and presumably also the Bank of England to communicate to markets what is on their minds – if indeed they know what is on their minds,” says Mr Magnus. Even a relatively small inflection can cause trouble. A comment in 2013 by Ben Bernanke, then Fed chairman, hinting at plans to “taper” QE purchases led to a sudden reversal of capital inflows into emerging markets. After years of low bond yields because of QE, investors had poured into riskier economies seeking higher returns, but Mr Bernanke’s remarks changed their minds. The disruption highlighted how interconnected capital markets had become, with retail – or non professional – investors quickly switching portfolios at the first scent of trouble.

The so-called “taper tantrum” proved relatively shortlived, and the Fed’s QE programme has been phased out with few real upsets. Many analysts argue that the footloose capital has fled, investors have learned from the experience and that emerging

market equity and bond prices should better reflect the “fundamentals” of local economies. “It is growth differentials that ultimately drive capital from one place to another,” says Gerardo Rodriguez, portfolio manager at BlackRock and a former Mexican finance official. A deliberate objective of QE was to encourage risk taking as a way of boosting economic growth. “Quantitative easing has driven up strikingly the price of risk assets, but the Fed would not see that as a distortion, it is exactly what it wanted,” says Harm Bandholz, chief US economist at UniCredit. In June, however, the Bank for International Settlements in Basel – which acts as a bank for central banks – warned that “euphoric” markets had become detached from economic reality. “The issue is less QE per se and more the extent to which central banks, acting without the support of other policy makers, have opted for liquidity- induced growth at the risk of future financial instability,” adds Mr El-Erian. Less clear is the extent to which QE has changed investors’ behaviour. A striking feature this year, until recent weeks, has been the lack of financial market volatility at times of heightened geopolitical tensions – whether over Russia’s incursions into Ukraine, chaos in Iraq or pro-democracy demonstrations in Hong Kong. One explanation is that markets had been mesmerised into believing central banks will always ride to their rescue. Investors have become used to a world of unlimited liquidity, warns Mr Magnus. “Change that and you change the whole psychology of investing.” Adds Mr Skeoch: “The structural impact [of QE] on economies and markets is not understood well at all. The band of uncertainty is wide.” Still, there is widespread agreement that market volatility is likely to rise as higher US interest rates edge closer. In the past, crises often followed periods in which interest rates were low relative to economic growth rates – in the US just before the dotcom crash at the turn of the century, for instance, or in Germany in the early 1990s before the continent’s exchange rate crisis. “It is natural to feel worried given that history shows that when interest rates go ‘too low’ bad things happen,” says Benjamin Mandel, US economist at Citigroup in New York. The uncertainty over how markets will cope with the unwinding of crisis-fighting monetary policies is all the greater because they coincide with upheaval in regulations affecting the global financial system. The aim was to strengthen the system’s resilience – but rule changes may have unintended consequences. To make banks safer, for instance, bond dealers now hold relatively little “inventory” – stockpiles of bonds held to meet orders quickly, especially corporate bonds. As a result, markets “now have the same problem as Lehman”, argues Alberto Gallo, strategist at RBS. If confidence in the market disappears, a “liquidity crunch” could hit. “Bond dealers cannot offer liquidity and they are carrying less risk,” says Mr Gallo. When tensions increase, desperate sellers may be able to do so only by slashing prices – turning a small event into something much bigger. “Low interest rates have fuelled 86

issuance [of bonds], which is hiding all sorts of stuff in markets and this is what we are worried about,” says Richard Prager, head of trading and liquidity strategies at BlackRock, the asset manager. “What happens when rates rise and investors need to sell bonds? Without the shock absorbers you have the potential for a disorderly repricing.” That sense of nervousness has been apparent in the markets. The Vix index of US stock market volatility – known as the Wall Street “fear gauge” – has hit levels not seen since the eurozone crisis. Markets now listen more warily to comments from Fed and other central bank officials, hoping that there will be delays in tightening monetary policy. Any hints at further loosening elsewhere are seen as positive by at least some investors – even if they follow poor economic news. A suggestion by a Fed official this week that another round of QE was still possible in the US stabilised stock markets briefly. A new certainty may be dawning on markets: volatility is back and their relationship with central banks is changing, with unpredictable consequences. http://www.ft.com/intl/cms/s/0/cca0aaa2-4e02-11e4-adfe- 00144feab7de.html#axzz3G1L0w6ka

ft.com comment Columnists October 14, 2014 6:57 pm How to do better than the ‘new mediocre’

By Martin Wolf We must launch well-crafted reforms in both emerging and high-income economies

©James Ferguson A re we to believe that slower growth in the world economy is here to stay? Christine Lagarde of the International Monetary Fund thinks so; “the new mediocre” is the managing director’s disheartening term for what she sees as the new normal. The worsening forecasts published in successive issues of the World Economic Outlook support her view (see charts). Significantly, while the performance of high-income economies has been poor, especially in the eurozone, in the medium-term it is the emerging economies whose prospects appear bleakest. Yet disappointments need to be kept in proportion. If average annual growth of emerging economies were to remain over 5 per cent, their output would double every 14 years. This would mean rapid increases in the standards of living of a huge proportion of humanity. An additional source of good cheer is that the economies of emerging Asia are expected to achieve growth of 6.5 per cent this year and 6.6 per cent in 2015. This is no small matter, since emerging Asia contains half of humanity. The IMF has made no downgrade of its forecasts for emerging Asia since last April. In addition, the second-fastest growing region is sub-Saharan Africa. Its growth is forecast to be 5.1 per cent this year and 5.8 per cent in 2015. Since these two regions contain nearly all of the world’s poorest people, this performance is of far wider human significance than are the disappointments elsewhere.

More ON THIS STORY// Gavyn Davies It’s the ‘new mediocre’/ IMF says countries must reform to succeed/ Comment Emerging markets enter slow growth era/ Greece coalition survives confidence vote MARTIN WOLF// An extraordinary state of ‘managed depression’/ Caught in a credit boom trap/ No equal union with the Scots/ Inequality is such a drag The worry, however, is that the downgrades might continue into the more distant future. One reason for believing this will not be the case is the scale of recent disappointments. The Russian economy, for example, is stagnant. Performance of the Latin America and Caribbean economies is little better, with growth forecast at 1.3 per cent this year and 2.2 per cent in 2015. It is always possible for these economies to do still worse: Vladimir Putin’s embrace of a hostile relationship with the west may make that quite likely for Russia. But substantial upside potential also exists. The trouble is that the IMF’s medium-term forecasts already assume such a rebound in emerging economies. It fears that this hoped-for rebound might not occur, because of a “lack of action on structural constraints . . . , a tightening of global financial conditions, a slow pace of recovery in advanced economies or any combination of these factors”.

The IMF adds that China’s economy might suffer a bigger slowdown than now assumed. This would probably be due not to a financial crisis (which should be avoided), but a failure to replace the demand lost when unsustainable credit booms subside. This, after all, is what happened to the high-income countries after their credit- driven growth came to a halt seven years or so ago. The WEO stresses the medium-term risk s of low potential growth and “secular stagnation” in high-income economies. The former means weak growth of supply. The latter means structural constraints on demand, including a rapid contraction of credit in vulnerable countries. (See chart.) A feedback relationship exists between the two: weak growth in demand saps confidence and damps innovation and investment. When growth is expected to be slow, private consumption and investment falter. Such a spiral is to be seen in the eurozone, where real demand is 5 per cent below its pre-crisis peak and deflationary risks are high. Ultra-low inflation, let alone deflation, exacerbates the burden of debt. 89

In the US, where balance sheets are no longer so constrained and there has been at least modest growth since 2009, the economy might now start to accelerate. Among the other drivers of such growth would be cheap energy, a pick-up in investment and a recovery in household formation, which has been running at about half its pre-crisis levels. This would be unlikely to produce the kind of untoward jump in inflation that would force the Fed to apply the brakes. With the world economy weakening and oil prices falling, inflation should not be a real danger. The Fed should tighten slowly — and this is unlikely to create problems for economies outside the US.

The position of the eurozone is, alas, different. Germany, its most creditworthy country, remains dependent on external demand. It is also largely opposed to the unconventional monetary policies that might stimulate that demand. It is even more opposed to potent fiscal policies, either at home or across the eurozone. It hopes that the magic of “structural reform” will awaken the animal spirits – although its own structural reforms in the past decade awakened no such spirits at home. At Berlin’s insistence, the eurozone has turned into a battleground for meagre scraps of demand, under the rubric of “competitiveness”. This inability to move beyond the intellectual framework of a small open economy to a continental one is a tragedy. A renewal of the crisis is possible, given the risk that bond yields – now subdued – will again begin to climb. It is important not to exaggerate the story of slowdown in the world economy. Yet it is also vital to avoid a progressive downward slide in growth. To address this risk, it is necessary to launch well-crafted reforms in both emerging and high-income economies. In the latter, the biggest challenges are inside the eurozone, where the failures to craft a balanced economic strategy remain both egregious and very dangerous. As the IMF argues, there is also a powerful argument for more public investment in infrastructure. This could pay for itself and so lower rather than raise public debt, in today’s circumstances of weak growth and ultra-low real interest rates. It is vital to craft strategies for growth that neither ignore demand constraints nor rely on credit booms. Can that be done? Yes. Will it be done? I doubt it. http://www.ft.com/intl/cms/s/0/65486afc-52e4-11e4-a236-00144feab7de.html#axzz3G1L0w6ka

ft.com Comment The Big Read October 14, 2014 6:28 pm Can Europe wean itself off Russian gas? By Christian Oliver and Henry Foy Political tensions and high prices from Gazprom are driving shifts that suggest Moscow does not hold all the cards

©AFP Pressure points: a worker checks pipelines on the Nord Stream project supplying Russian gas to Germany. EU countries are trying to cut back on volumes from their eastern neighbour T he night shift at Agropolychim, Bulgaria’s biggest fertiliser plant, received a fax at 4.30am on January 6 2009 warning that their gas supply was going to be cut off immediately. The engineers demanded four more hours: an instant shutdown would leave a cocktail of explosive chemicals to congeal in the plant’s pipes, destroying vital equipment. “It was all hands on deck,” recalls Philippe Rombaut, Agropolychim’s chief executive. Bulgaria was one of the countries hardest hit when Russia cut the gas supply to Europe during that biting winter. Electric heaters sold out within hours. People in many parts of the Balkans had to go back to burning wood. In Sofia, the zoo’s shivering African monkeys were kept alive with buckets of herbal tea mixed with lemon and honey. More ON THIS STORY// Mestrallet confident of Russian gas flow/ Russia cuts off gas supplies to Ukraine/ Ukraine gas price dispute hits Gazprom/ Q&A the Gazprom dispute/ Gazprom heat is off IN THE BIG READ// Indonesia Now for the hard part/ Buybacks Money well spent?/ Ebola virus ‘Our people are dying’/ China’s migrants thrive in Spain’s crisis Today, Bulgaria is once again seen as extremely vulnerable if political tensions over Ukraine trigger an energy crunch this winter. Scars from Russia’s gas cuts in 2006 and 2009 run deep across eastern Europe and, at first glance, the continent appears to be in danger again this year thanks to a seemingly unshakeable dependence on Gazprom, Moscow’s gas export monopoly. Europe’s imports from Russia rose 16 per cent last year to hit a record high. Overall, Gazprom supplies 30 per cent of Europe’s gas but, in many eastern states, the reliance is closer to 100 per cent.

Half of Europe’s imports from Russia flow through Ukraine and that supply is always a potential hostage to politics. In June, Gazprom stopped gas sales to Kiev in a pricing dispute, raising fears that Ukraine will be forced to siphon off the EU’s transit gas if supplies are not resumed by winter. Moscow is also tightening the noose around Kiev by preventing EU countries from re-exporting Russian gas as a lifeline to Ukraine in so- called “reverse flows”. Hopes are rising among diplomats that the EU, Russia and Ukraine will strike an agreement on resuming gas supplies to Kiev in negotiations in Berlin next week. But even if there is a deal, most eastern European governments can hardly relax. “Our baseline scenario is no transit gas through Ukraine,” says Vaclav Bartuska, the Czech government’s energy ambassador. The EU’s first line of defence lies in far higher gas reserves than those in 2009 and countries have been stockpiling heavily since spring. The stocks are now 93 per cent full, giving most states a cushion of several weeks, or more, if Russia were to cut supplies. Since the previous crisis, Hungary has expanded underground storage facilities to 6.2bn cubic metres to meet annual consumption of 10.2 bcm. They currently hold 4.2 bcm. The Czech Republic has filled its stores with 3.3 bcm, a comfortable margin for a country with annual consumption of 7.5 bcm.

With oil prices sinking beneath $90 a barrel, the EU is increasingly confident that Moscow’s treasury does not want any cut in gas sales nor risk more European customers making a generational shift away from gas to other fuels. “They realise that they would also get into trouble,” says Karel De Gucht, the outgoing EU trade commissioner. “Russia also has an interest that they are seen as a reliable supplier”.

But it may be too late for the Russians to stop the gradual but profound shift away from Gazprom that is under way. Mr Rombaut’s plans at Agropolychim show that Moscow does not hold all the cards. Next year, he will switch from gas to biomass, running on straw and woodchips. That is highly significant for Gazprom because Agropolychim and Neochim, Bulgaria’s leading fertiliser plants, jointly consume about 25 per cent of the country’s gas. The story is similar in Poland, where Grupa Azoty, the country’s biggest gas consumer, is seeking to break its dependence on Russia. Grupa Azoty, also a fertiliser group, consumes 15 per cent of Poland’s annual gas imports but has vowed that half the 2.3 bcm will come from non-Russian sources by 2016. “I strongly believe that we will be able to get there,” says Pawel Jarczewski, chief executive officer.

Mr Jarczewski’s confidence is partly based on deep structural changes in the EU, loosely referred to as the “energy union”. EU countries are building core infrastructure – such as import terminals for liquefied natural gas and cross-border pipelines – to break the stranglehold of Russian supply routes. However, progress has been agonisingly slow. Fitch, a rating agency, does not expect Europe to lessen its reliance on Russia “for at least the next decade and potentially much longer”. Major western EU nations are at less risk because they already have greater diversity of supply and big LNG ports, procuring gas from Norway, Algeria and further afield. Germany has the direct Nord Stream pipeline from Russia that is considered unlikely to be caught up in a spat because it does not pass through Ukraine. The western nation viewed as most vulnerable is Italy, which would be in trouble if it suffered simultaneous disruptions from Russia and Libya. Grupa Azoty is likely to benefit from an LNG terminal at Swinoujscie on Poland’s Baltic coast, due to open next year. The Baltic will also be served by a terminal at Klaipeda in Lithuania, also beginning operations in 2015. “A pipeline connecting the terminal and [Azoty subsidiary] Zaklady Chemiczne Police will allow us to benefit from additional flows of non-Russian gas from the Gulf or US

shale gas,” says Mr Jarczewski. The US is debating whether it will send supplies to Poland, which will not happen unless Washington lifts restrictions on gas exports. Agropolychim and Grupa Azoty say they are diversifying away from Russia as much because of Gazprom’s high prices as security of supply. Gazprom could not be reached for comment.

Mr Rombaut says he is shifting for financial reasons, with Russian prices far higher than those at European hubs such as Zeebrugge, where gas is traded on an open market. “I am a businessman . . . this is economics. If I had the same price [for gas] as biomass, I would not go over to biomass,” he says. Ilian Vassilev, an energy analyst and Bulgaria’s former ambassador to Moscow, says Russia’s high prices are crippling the competitiveness of central European industries such as chemicals, metallurgy and central heating. “Few if any remain afloat,” he says. In effect, says Mr Vassilev, Gazprom is helping to kill off its own customers, with high prices accelerating deindustrialisation. Bulgaria’s gas imports fell to 2.7 bcm last year from 6.7 bcm in 1989, the last year of communist rule. He argues that any decision by Russia to cut gas this winter would depend on political factors in Moscow. “President Vladimir Putin’s irrationality has limits and these limits are set by his sense of what is needed to survive and his grip on the oligarchs,” he says. Russia would be eager to avoid any shock that would push the EU to adopt other fuels, he adds.

“I do not expect that even if gas supplies are interrupted that this will last long – as Moscow is aware that such a move will trigger radical diversification trends in the EU that it will not be able to control,” says Mr Vassilev. In Prague, Mr Bartuska also warns that Mr Putin could find that there would be no way back: “Fuel switching is not easy, would be costly and would take some time – but once done, many customers would not come back to gas, even if the whole industry begged them on their knees.”

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To G-20 Leaders: Urgent Need to Boost Demand in the Eurozone Authors: Biagio Bossone & Richard Wood · October 14th, 2014 · The economies in the Eurozone are continuing to slide into recession and depression. Senior officials of G-20 countries (including those in Australia, the host government) have not understood, or anticipated, that the Eurozone crisis is a major threat to global recovery. The officials have provided sub-standard advice to their leaders. The deepening crisis must be addressed. This article identifies a strong monetary/fiscal policy combination that could boost consumer and aggregate demand, and simultaneously address high public debt burdens and deflation. The G-20 Conundrum: How to Ensure Economic Recovery The G-20 Leaders may well endorse a higher global ‘growth target’ at the forthcoming meeting in Australia, but they will only pay lip service to this objective if they fail to outline the monetary/fiscal policy combination that is required to substantially lift aggregate consumer demand and economic growth. G-20 Leaders will go to their meeting believing monetary and fiscal policies have reached their limits (as interest rates are at zero bound and public debt is excessive in afflicted countries). As a consequence, they will focus not on the large-scale demand stimulus policies needed to pull the afflicted countries away from dangerous reefs, but on an elaborate check-list of supply-side structural and infrastructure policies. The G-20 leaders will not be focussed on the major issue. The IMF is reportedly examining 900 of these small-tug-boat-type policies. And these 900 will, in future weeks, probably need to be joined by hundreds more to reach growth targets. The G-20 hope is that they will be able to organise a sufficiently large and impressive armada of tiny tugboats to push and pull at small crippled or malfunctioning parts of major economic blocks. However, while structural reforms and infrastructure investment may always be desirable, the required locomotive power to substantially lift consumer demand and economic growth is far and away beyond that which can be harnessed from small tugboats. The Failure of Current Policies Throughout history, economic stimulus via monetary policy has been effected through two broad channels. First, new money has been injected through the bank and financial market intermediation channel, which stimulates lending and spending by making additional purchasing power available to the private sector at lower cost conditions. Lately, as a response to the global crisis and in a situation where policy rates had approached the zero bound level and financial intermediaries faced weak incentives to lend, new money has been injected through central bank purchases of longer-term and 96

riskier assets directly from holders, with a view to affecting spending decisions through price and portfolio effects. This has been the aim of quantitative easing (QE). QE programs have also been adopted as refinancing tools to help financial intermediaries to repair their strained balance sheets. Second, new money has been injected in the economy through the public sector channel. Money has been issued to finance budget deficits, with the twofold objective of a) holding interest rates at low levels by limiting government recourse to the financial market to funds new debt issuances and b) supporting aggregate demand by making larger public spending or tax cut programs possible. Currently, with fiscal policy restrained in most countries due to public debt sustainability concerns, and a widespread attitude from policymakers against monetary financing of public deficits, attempts to fuel the recovery in crisis-hit economies has mainly relied on QE interventions and other kinds of unconventional monetary policy. However, worries have been growing in many quarters lately ─ including at the Bank of International Settlements and the Financial Stability Board ─ that the ultra-low interest rate QE policies adopted by Japan and the United States are creating large risks in the form of risk mispricing, asset price overvaluation, and an inability to affect inflation expectations and real-sector spending to the extent required. Also, where QE has been attempted, the lack of coordination – if not outright inconsistency – between monetary and fiscal policies has created uncertainty and contributed toward overall policy ineffectiveness. In the Eurozone, the countries running external surpluses and enjoying relatively safe and sound fiscal conditions have deliberately decided against boosting internal demand, thereby withdrawing potential stimulus from the global economy and providing none of the powerful locomotive potential they could provide to revive the Eurozone block. The recessionary and deflationary tendencies among Eurozone countries are intensifying and spreading due to falling incomes and declining aggregate demand, aided by continued austerity policies. What else should be done? Overt Money Financing The most effective solution for economies still mired in deep economic recession and distressed by large public debts would be to undertake ‘overt money financing’ (OMF) of budget deficits, that is, finance tax cuts or new public spending programmes with newly created money. Defended in the past by such eminent and diverse economists as Henry Simon, Irving Fisher, John Maynard Keynes, Abba Lerner, and Milton Friedman as the most effective macroeconomic policy lever when it comes to stimulating a stagnating economy, the idea of OMF was resurrected by Bernanke (2002) when he indicated that the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. Specifically – Bernanke argued – the government could adopt a broad-based tax cut, increase transfers or spending on current goods and services, or even acquire existing real or financial assets, and accommodate it with a program of open-market purchases to alleviate any tendency for interest rates to increase. This would stimulate consumption and hence

prices and, even if households decided not to increase consumption but instead re- balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values – Bernanke added – would lower the cost of capital and improve the balance sheet positions of potential borrowers. The idea of OMF has been further considered in greater depth. McCullay and Pozsar (2013) and Turner (2013) have compared it to existing policy alternatives concluding it to be superior, and Buiter (2014) has identified the conditions under which OMF increases aggregate demand. One of these conditions is the irreversibility of the new money base stock creation, which – by being irredeemable – constitutes a permanent addition to the total net wealth of the economy. Such irreversibility can be attained if overt monetary financing operations are executed by one of two routes. The first would be by having the government issue interest bearing debt, which the central bank would buy and hold in perpetuity, rolling over into new government debt when the existing debt on its balance sheet reaches maturity. In this case, the government would face a debt interest servicing cost, but the central bank would make an exactly matching profit from the difference between the interest rate it receives on its debt and the zero cost of its money liabilities, and would return this profit to the government. A second route would have the central bank buy special government securities that are explicitly non-interest bearing and never redeemable. In terms of the fundamentals of money creation and government finance, the choice between these two routes would make no difference (Turner 2013). Both would differ from conventional bond financing of budget deficits, in that the government would be under no obligations to repay the debt purchased by the central bank under OMF. The irreversibility condition would be required for if the policy was reversed, and the central bank sold the bonds to the private sector, public debt would instantly increase and the government would be under an obligation to repay it. Other authors have submitted that a more effective form of OMF, as a demand management crisis tool, would be to allow the Treasury/Ministry of Finance to finance new budget deficits by issuing its own money, or a pseudo-money, since this would not require explicit irreversibility condition (see Wood (2012), Cattaneo and Ziboldi (2014), Bossone et al (2014)). These authors propose that in highly leveraged and depressed economies the Ministry of Finance be granted the power to issue a form of complementary money to finance fiscal deficits large enough to stimulate demand. The government would have full sovereignty on the issuance of the complementary money. Interestingly, these proposals have an historical antecedent in the special government bonds that Germany issued in the 1930s, under central banker and minister of economics Hjalmar Schacht, to survive the Great Depression. The operation succeeded in pushing the German economy through a speedy recovery, reaching full employment without inflation. In relation to OMF, the following propositions can be claimed.

First, OMF is the combination of monetary and fiscal policy that has the greatest impact in raising demand and output: • Unlike QE and other types of unconventional monetary policies designed to act on asset prices rather than consumer goods prices, OMF flows to households with a relatively high marginal propensity to consume ordinary goods and services. Under OMF, demand and consumer goods prices both rise relatively early. For countries experiencing deflation this is a critical feature. • Unlike conventional bond financing, OMF creates no rise in interest rates and hence there is no crowding-out. Second, OMF does not trigger Ricardian Equivalence effects (in contrast with conventional bond financing) since the intertemporal budget constraint of the state is permanently relaxed by the corresponding new money stock. Finally, OMF does not affect the health of public finances, since it does not require new debt issuance. In fact, by stimulating output and price growth, OMF even improves debt sustainability looking forward. Central Banks and Governments Under Different OMF Types Different forms of OMF bear different institutional implications, which need to be carefully considered. Monetizing fiscal deficits constitutes a joint monetary and fiscal policy decision. Where the central bank is an independent organ, as is today the case in many countries, cooperation between the government and the central bank is necessary to engineer OMF operations, and such policies require a specific framework for assigning duties and responsibilities to the two institutions (Bossone and Wood 2013). Obviously, this impairs or calls into question central-bank independence, but in times of crisis this kind of cooperation may be necessary for the collective good. Nothing makes the point more authoritatively than quoting the words spoken on this subject by former Governor Bernanke (2003): “[I]t is important to recognize that the role of an independent central bank is different in inflationary and deflationary environments. In the face of inflation, which is often associated with excessive monetization of government debt, the virtue of an independent central bank is its ability to say ‘no’ to the government. With protracted deflation, however, excessive money creation is unlikely to be the problem, and a more cooperative stance on the part of the central bank may be called for. Under [these] circumstances, greater cooperation for a time between [central banks] and fiscal authorities is in no way inconsistent with the independence of the central banks, any more than cooperation between two independent nations in pursuit of a common objective is inconsistent with the principle of national sovereignty.” It is critical in such times to have an appropriate framework in place for emergency policy actions. This framework should specify which institutions do what under which circumstances, and under which accountability rules. It should also be clear who is responsible for activating the emergency framework. In other words, just as in wars or national emergencies ordinary rules may be suspended and decisions delegated to a

chief commanding body, so might economic policy decisions be delegated during particularly severe systemic crises. This issue is automatically resolved in those cases where money is issued directly by the government, as in the alternative OMF proposals recalled above. Here the Ministry of Finance subsumes the money issuing function in relation to the OMF operations to be performed. OMF operations run directly by the government promise to be more effective since they only require a fiat decision by the government, and do not involve the central bank. For the very same reason, however, the consequences should be carefully considered of granting “monetary sovereignty” directly to the government. The independence gained over the years by central banks in many countries worldwide has removed from these countries the risk of possible monetary policy abuse at the hand of profligate governments. Based on such considerations, the provision of government-run OMF should be accompanied by stringent rules and control mechanisms precisely aimed to avert such risk. Why Is All This Important? The issues discussed in this note are critically relevant. First, if the arguments above are not clearly understood, then the policy of overt money financing could be misinterpreted, and its significance not appreciated, including by key policy makers who have, to date, seemingly turned a blind eye to it. Second, there can be no question that the policy mix so far adopted in crisis-hit countries has failed to deliver what was promised. Conventional and unconventional monetary policy tools have shown significant limitations, and the lack of consistency – not to mention coordination – between monetary and fiscal policies has been at the heart of the major failure of helping crisis-hit economies to exit from recession. A new approach to demand management policy needs to be developed to deal with economies, especially those constrained by limited fiscal space, which are trapped in deep recessions and are under threat of price deflation. Such economies are incapable of escaping the recession by resorting to large-scale bond financed deficit spending. Third, Eurozone countries are again sliding into depression and deflation. Current policies need to be radically altered to create the requirements for widespread and strong economic recovery. Fourth, Japan’s public debt levels are unsustainable, and the deflation tendency remains despite successive rounds of quantitative easing and bond financed budget deficits. Finally, there has been much conjecture about whether or not some advanced countries have entered an era of ‘secular stagnation’. Macroeconomists should treat secular stagnation as a ‘shock’ leading the economy to a persistent underemployment equilibrium, and should develop appropriate policies to counter it. Overt money financing offers the most effective monetary and fiscal policy response. Conclusion No doubt, under their powerful communication weapons, the G-20 Leaders will give the impression that a vast armada is being marshalled to attack the global growth problem. 100

It will look impressive. Some tug boats are already waiting at the docks, having been provisioned in earlier years but not yet ordered to sea. Others will remain mere plans on drawing boards. Some of the tugboats will have delayed launches (as with ‘the third arrow’ of Japan’s Prime Minister Shinzo Abe), and still some others may simply never complete their journeys, or, worse still, go belly-up on route. But besides the communication strategy success, the truth remains that, in the absence of a major reconsideration of macroeconomic policies, the G-20 meeting in Australia in November will be another non-event. References Bernanke B (2002) “Deflation: Making Sure ‘It’ Doesn’t Happen Here, Remarks by Governor Ben S. Bernanke before the National Economists Club, Washington, D.C., November 21. Bernanke B (2003) “Some thoughts on monetary policy in Japan”, Remarks by before the Japan Society of Monetary Economics, Tokyo, 31 May. Bossone B, M Cattaneo and G Zibordi (2014) ‘Which Options for Mr. Renzi to Revive Italy and Save the Euro?’, Economonitor, 3 July. Bossone B and R Wood (2013), “Overt Money Financing: Navigating Article 223 of the Lisbon Treaty”, EconoMonitor, 22 July. Buiter W (2014) ‘The Simple Analytics of Helicopter Money: Why it Works – Always’, Economics, Vol. 8, 2014-28. Cattaneo M and G Zibordi (2014) La Soluzione per l’Euro, Hoepli, Milano. (English version forthcoming) – See more at: McCulley P and Z Pozsar (2013) ‘Helicopter Money: Or How I Stopped Worrying and Love Fiscal-Monetary Cooperation’, Global Society of Fellows, 7 January. Turner A (2013) ‘Debt, Money and Mephistopheles: How Do We Get Out of This Mess’, Cass Business School Lecture, 6 February. Wood R (2012) ‘The Economic Crisis: How to Stimulate Economies Without Increasing Public Debt’, CEPR POLICY INSIGHT No.62, August. - See more at: http://www.economonitor.com/blog/2014/10/to-g-20-leaders-urgent- need-to-boost-demand-in-the-eurozone/#sthash.tOLrbKNS.YUmYBO7J.dpuf http://www.economonitor.com/blog/2014/10/to-g-20-leaders-urgent-need-to-boost- demand-in-the-eurozone/#

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ft. com World Europe Last updated:October 14, 2014 12:23 pm ECB defends bond-buying plan at top EU court By Peter Spiegel in Luxembourg ECB president Mario Draghi walking ahead of the ECB governing council before their meeting in Naples on October 2 The European Central Bank on Tuesday delivered a vigorous defence of its signature bond-buying programme credited with ending the eurozone crisis, telling the EU’s highest court that it was essential in preventing the break up of the common currency and therefore within its legal mandate. Hans-Georg Kamman, the ECB’s lead lawyer, told the 15-judge European Court of Justice panel that the programme, known as Outright Monetary Transactions, was central to returning price stability to the eurozone – the primary policy goal of the ECB as defined in the EU’s treaties. More ON THIS STORY// Timeline – Events leading to ECB case/ Greek bonds rally on ECB buying moves/ ECB to press ahead with ABS-buying plan/ Economists point to emerging ‘Draghinomics’ ON THIS TOPIC// Draghi vows to fight eurozone deflation/ Eurozone inflation gauge hits record low/ The Short View Inflation outlook brings ECB QE into view/ Editorial Criticism of Draghi’s actions is misguided IN EUROPE// Stoiber plan raises hopes on EU reforms/ Dublin ends Double Irish loophole/ Double Irish faces its demise/ Catalan leader calls off referendum He reminded the judges of the atmosphere in mid-2012, when Greece was at risk of leaving the eurozone and Italian borrowing costs rose to near record levels, arguing that OMT was intended to lower “interest rate peaks” that were unjustified by economic fundamentals and instead tied to market panic that the euro was breaking apart. “Numerous banks and companies started to prepare more or less openly for an end of the euro,” Mr Kamman told the court. “The situation was moving ever closer to crisis. The feared collapse risked becoming an uncontrollable self-fulfilling prophesy.” Mr Kamman said the panic meant that the normal ECB policy measures – cutting interest rates – were not having any effect on borrowing costs in the most troubled eurozone countries, justifying a bond-buying programme as a monetary tool. “The capital market was fragmented, cross-border interbank lending had virtually dried up,” Mr Kamman said. “Price stability in the euro area was seriously at risk.” The events leading to case Deliberations have begun on the legality of the bond-buying programme. Find out the key dates that got us to this point Read more

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The legal fight over OMT, brought by a group of German politicians and activists, has become one of the most closely watched legal cases in the EU’s history. It not only threatens the programme that in effect ended the eurozone crisis but calls into question the ECB’s ability to purchase government bonds as one of its policy tools – something it is considering to fight the ongoing risk of deflation that is gripping the common currency. The programme, which was unveiled after ECB chief Mario Draghi declared he would do “whatever it takes” to save the euro, stopped the sell-off of Italian and Spanish bonds – which had risen to levels where other eurozone countries had required bailouts – by signalling to the bond market that the ECB would use its printing press to stop panicked sell-offs of eurozone debt. 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 The case centres on whether it was violating the EU treaties ban on “monetary financing” – loaning ECB funds to eurozone governments – by authorising the purchase of bonds of struggling countries. The German constitutional court in February largely sided with the plaintiffs in the case, but referred the case to the ECJ as the authority over EU law – an unprecedented ceding of legal authority by the highly-influential court. Lawyers for the lead plaintiff in the case, German lawmaker Peter Gauweiler, a member of the centre-right Christian Social Union party in the Bundestag, argued that the OMT programme was an “egregious extension of [ECB] powers”, allowing it to pursue an economic policy that went well beyond its monetary mandate. “OMT-based purchases serve directly to lower the bond yields of certain states in difficulty . . . and avert the insolvency of member states,” said Mr Gauweiler’s lawyer, Dietrich Murswiek, arguing such a policy goal was “quite openly an economic objective.” Mr Murswiek likened the ECB’s defence to a bank robber justifying his actions as charity because he intended to donate his proceeds to the needy. Just because the ECB claimed OMT had monetary goals did not mean it was really monetary policy, he argued. Instead, Mr Murswiek said OMT would allow the ECB to shift debt owed to bondholders on to the shoulders of eurozone taxpayers. “With OMT, the ECB will turn the monetary union into a debt union without consulting the member states,” he said. Mr Kamman, the ECB lawyer, argued that just because monetary policy had a direct effect on government borrowing costs did not make it improper ECB intrusion into economic policy. He noted that at the outset of the eurozone crisis, steep cuts in key ECB interest rates led to concomitant drops in yields in sovereign bonds. “Were these cuts in key interest rates economic policy measures or even unlawful financing of state budgets? Clearly not,” Mr Kamman argued.

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The judges offered no hint of where they were leaning, listening stoically through both the ECB arguments and the presentations by five different groups of complainants, each of whom had a slightly different reason they felt OMT was illegal. The German government lawyer remained largely neutral, arguing that while Berlin believed firmly in the ban on monetary financing, it believed the ECB had wide discretion to determine on its own what constituted monetary policy. He also argued that just because monetary policy occasionally bled into economic policy it was not necessarily illegal – as long as it was mostly focused on monetary matters. “The ECB has a good deal of discretion in adopting monetary policy,” said the German government’s lawyer, Ulrich Häde. “It is part of the ECB’s intended role to decide on its own.” Still, Mr Häde urged the ECJ to better define what kind of bond purchases were legal under EU treaties, something that could have a direct impact on future ECB quantitative easing policies. Timeline – Events leading to ECB case As the European Court of Justice begins deliberations on the legality of the European Central Bank’s bond-buying programme, here are the key dates that got us to this point: July 26 2012 – Mario Draghi, ECB president, makes his pronouncement to do “whatever it takes” to preserve the euro. His remarks have an instant, calming effect on debt-laden eurozone periphery countries, with Spanish and Italian government bond yields falling after his speech. It is not clear exactly what the pledge will involve. September 6 – The ECB reveals its backstop plan for saving the euro: outright monetary transactions, or OMTs. If a eurozone government asks for help, the ECB will buy that government’s bonds in the market. “Whatever it takes” now has form and substance, but the German central bank is opposed to the measures. September 12 – Germany’s constitutional court says it will review OMT as part of its investigation into the European Stability Mechanism. April 25 2013 – “It is not the duty of the ECB to rescue states in crisis,” says the German central bank in a leaked submission to the German constitutional court. The document, submitted to the court in December, sets out the detail of the Bundesbank’s opposition to the OMT. June 11 and 12 – The German constitutional court holds hearings on OMT, days after Mr Draghi confidently declared in a speech that “OMT has been probably the most successful monetary policy measure undertaken in recent times”. November 21 – Still no decision from Germany’s highest court, which announces that no ruling will be made in 2013. At the time, Germany was without a government as parties were embroiled in coalition negotiations after general elections in September. February 7 2014 – Finally, a decision. Of sorts. OMT is illegal, says the German constitutional court, but refers it up to the European Court of Justice. By passing the case up to the ECJ, the German court acknowledged the ECJ’s supremacy over EU institutions. After the ECJ rules, the matter is due to return to the German court, which could block Germany’s participation in OMT. October 14 – The question of whether the ECB is allowed to do “whatever it takes” to save the euro finally reaches the ECJ. Cases referred by governments take, on average, 16 months before a preliminary ruling, so forget about a ruling this year.// Timeline compiled by Kadhim Schubber http://www.ft.com/intl/cms/s/0/389d1502-5325-11e4-b917- 00144feab7de.html#axzz3G1L0w6ka

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ft. com World Europe Brussels October 14, 2014 4:51 pm EU agrees laws to end banking secrecy Peter Spiegel in Luxembourg EU finance ministers took an important step towards ending banking secrecy in Europe by agreeing legislation that would require all 28 countries to disclose assets held by foreign EU nationals in their financial institutions. The legislation, which had been blocked for more than six years by EU countries with reputations as tax havens, was finalised after Luxembourg and Austria agreed to lift their vetoes. Both countries have seen changes in government in the past year. More ON THIS TOPIC// UK tax evasion prosecutions up by a third/ Cash-strapped countries eye trillions held offshore/ Comment Tech company tax deal/ New antitrust head promises action on tax IN BRUSSELS// Poland leads opposition to EU energy deal/ Q&A What is the double Irish?/ EU raids ethanol groups in 2 countries/ Bratusek withdrawal frees up commission Under the law, all EU countries would be required to automatically send data back to tax authorities in a European depositor’s home country, a requirement regarded as one of the most powerful ways to prevent tax evasion. “This [measure] promises full and lasting tax transparency in Europe,” said Algirdas Semeta, the outgoing EU tax commissioner who has been working for an agreement on the legislation since taking office five years ago. “Bank secrecy is dead.” The deal would cover dividends, capital gains and all other forms of financial income as well as account balances, opening up a wide array of previously opaque assets and income sources to tax authorities in national governments. Luxembourg surprised other EU members by agreeing to implement the data exchange along with most other countries in 2017. That left Austria alone to request an extension to 2018. Austrian finance minister Hans Jörg Schelling said he needed the extra time to create a new reporting system so the country can comply with the law. “My problem in this respect is technical,” Mr Schelling told his fellow ministers. “In Austria, there is no data connection between the banking sector and the administration. We have to build a new system from scratch, and that takes time.” Mr Schelling’s predecessor, Maria Fekter, had vehemently resisted the legislation, and officials said it has put Austria behind in preparations for sharing information, leading ministers to accept the one-year extension. “Luxembourg and 26 other governments in the EU have agreed to implement these new rules by 2017 and I hope that Austria can join us as soon as possible,” said David Gauke, the UK’s Treasury financial secretary.

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Mr Semeta said he believed the EU could sign bilateral deals with other European jurisdictions outside the EU with reputations as tax havens – including Monaco, Switzerland and Lichtenstein – by the end of the year. The agreement comes amid a worldwide effort to fight tax evasion that was spurred by the global financial crisis. Voters in several developed countries have railed against taxpayer-financed bank bailouts while some of the rich shield their income from government authorities. The EU legislation was given new impetus by similar laws adopted in the US in 2010. After Washington aggressively pushed several European countries with reputations as tax havens – including non-EU member Switzerland – to sign bilateral treaties disclosing such information on Americans with bank accounts in Europe, some of the largest EU member states agreed to voluntarily share similar data among each other. It was not until Tuesday’s agreement, however, that all 28 EU members will be compelled to comply. “We should treat each other as well as we treat non-EU states,” said Mr Semeta. Peter Spiegel in Luxembourg http://www.ft.com/intl/cms/s/0/0ca39924-53b3-11e4-929b- 00144feab7de.html#axzz3G1L0w6ka

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Opinión LA CUARTA PÁGINA La hora de la inversión pública en Europa No debe darse por supuesto que las extraordinarias condiciones de financiación actuales van a durar toda la vida. Hay que saber aprovecharlas para no caer en un estancamiento que puede durar años EMILIO ONTIVEROS14 OCT 2014 - 00:00 CEST La eurozona está cerca de la recesión. El diagnóstico difundido por el Fondo Monetario Internacional (FMI) la pasada semana eleva las probabilidades de que el valor de la producción de bienes y servicios del área monetaria aborde una nueva fase con tasas negativas de crecimiento, la tercera desde 2008. Los indicadores posteriores al cierre de ese informe confirman la virtualidad de ese horizonte, cuyos rasgos son cada día más próximos al que Japón sufrió durante más de una década. Con la significativa diferencia de tasas de desempleo muy superiores en la eurozona. Para el alejamiento de ese escenario de estancamiento secularya no serán suficientes las decisiones excepcionales preparadas por el Banco Central Europeo (BCE). Es necesario que las políticas fiscales adopten una orientación más expansiva de la demanda, preferiblemente mediante la intensificación de la inversión pública. 1. El diagnóstico. Las advertencias del FMI no son nuevas ni exclusivas. En informes anteriores de esa institución y en los análisis de otras, el BCE entre ellas, se ha venido advirtiendo de los frágiles fundamentos en los que descansaba la tibia recuperación económica de la eurozona. De la erosión en el crecimiento potencial consecuente con la severidad de la crisis y la aplicación de políticas económicas inadecuadas dan cuenta las dificultades para reducir de forma significativa el desempleo y la deuda de las familias y empresas. Y la priorización por estas de la reducción de sus deudas seguirá limitando la necesaria expansión de la demanda, revelando una amplia capacidad productiva sin utilizar. Las expectativas de ascenso en la inflación, hacia esa referencia en el entorno del 2% definida por el BCE, apenas han mejorado por una depreciación del euro limitada. La deflación acentúa las dificultades de familias y empresas para asimilar esas deudas, para que su peso sobre la renta descienda. Ya no son solo las economías periféricas las afectadas. A la revisión a la baja de las previsiones de crecimiento del FMI para la eurozona le han seguido indicadores más recientes que han pronunciado la debilidad en las principales economías de la eurozona. En el segundo trimestre de este año las tres mayores —Alemania, Francia e Italia— quedaron estancadas o directamente en recesión. La locomotora germana contrajo su crecimiento trimestral antes de que otros indicadores confirmaran la persistencia de la debilidad. Es el caso de la caída en la actividad industrial o el descenso de las exportaciones en agosto, el mayor desde 2009. Las decisiones de gasto e inversión de familias y empresas, así como las de inversión crediticia de los bancos, siguen inhibidas por un manifiesto debilitamiento de la confianza, al tiempo que la mayoría de las Administraciones Públicas contienen las

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suyas. La severidad diferencial con que en la mayoría de las economías de la eurozona se ha llevado a cabo el ajuste fiscal no ha conseguido precisamente reducir la deuda pública. Pero sí ha contribuido a pronunciar la caída de la demanda agregada, el reducido crecimiento y la inquietante baja inflación. Esa austeridad fiscal indiscriminada es la responsable de la descapitalización de no pocas economías, reduciendo la inversión pública en la totalidad de las dotaciones de capital, físico, humano y tecnológico, sin las que no es posible volver a crecer de forma sostenida. 2. Las terapias. El retorno a una senda que recupere en un plazo razonable los ritmos de crecimiento previos a la crisis, suficientes para reducir el endeudamiento y el desempleo, requiere decisiones que estimulen de forma significativa la demanda agregada.

Los Gobiernos de la eurozona tienen que cambiar sus orientaciones en política fiscal

Las adoptadas hasta ahora no han sido consecuentes con el diagnóstico comentado. Por eso, el propio presidente del BCE, al tiempo de prometer que seguirá siendo activo con sus políticas monetarias excepcionales, ha sugerido hace semanas que los Gobiernos deberían flexibilizar sus políticas fiscales. El BCE debe mantener el empeño en cumplir con sus principales obligaciones, alejar el riesgo de deflación, conseguir que el crédito fluya con normalidad en todas las economías del área y que desaparezca la fragmentación financiera que sigue penalizando a las empresas de menor dimensión de la periferia europea. Pero esa institución es consciente de que incluso la aplicación de las decisiones más agresivas, como la compra de deuda pública en el mercado secundario, no serán suficientes. Por eso es necesario que, sin menoscabo de las reformas que hagan falta en la oferta, todos los Gobiernos de la eurozona asuman la necesidad de cambiar sus orientaciones en política fiscal con el fin de estimular la demanda. Pueden hacerlo en las siguientes direcciones (y preferiblemente en las tres, simultáneamente): a) La primera decisión necesaria para esa mayor acomodación a un entorno recesivo es flexibilizar las exigencias del Pacto de Estabilidad para aquellos países que incumplen el objetivo de déficit público, inicialmente concebido para condiciones normales, y que mantienen su producción muy por debajo de la potencial. Han de distribuirse en el tiempo de forma más racional los necesarios objetivos de saneamiento de las finanzas públicas. Pero también hay que dejar fuera del cómputo del déficit presupuestario la inversión pública: recuperando esa regla de oro, en otro tiempo asumida como racional, y hoy más necesaria que nunca. b) Se deben adoptar estímulos fiscales en aquellas economías que disponen de margen de maniobra para hacerlo. Alemania es el caso más claro. Podrían hacerlo mediante reducción de impuestos o aumentando la inversión pública. La evidencia señala que el impacto más inmediato e importante sobre la demanda agregada es el aumento de la inversión pública. La conveniencia es mayor si tenemos en cuenta las necesidades específicas de fortalecimiento de las infraestructuras en economías como la propia alemana.

Mejorar las circunstancias de vida futuras es clave para garantizar la unión monetaria

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c) Adopción de programas de inversión por las instituciones europeas, el Banco Europeo de Inversiones de forma destacada. Esta institución, lejos de intensificar sus inversiones las redujo entre 2010 y 2012, cuando más necesario era compensar la desaceleración de la mayoría de las economías europeas, generada por las políticas de austeridad fiscal. En lugar de reducir su inversión como parece planear en este año y el próximo, debería intensificarla de forma significativa. Ello requiere, efectivamente, aumentar las aportaciones a su capital por los países miembros por encima de los 10.000 millones de euros acordados en 2012. Tengamos en cuenta que la capacidad inversora de que dispone esta institución es de varias veces su capital, en la medida en que puede acceder al endeudamiento en los mercados de capitales. Las razones que amparan el aumento de la inversión pública en proyectos bien seleccionados atendiendo a su influencia sobre la productividad de la economía han sido suficientemente ilustradas en análisis empíricos con rigor suficiente. El del propio FMI, al que ha dedicado un capítulo de su último informe, es el más reciente, pero numerosos académicos, desde Larry Summers a Jordi Galí, han reforzado esas conclusiones. Como lo han hecho los ortodoxos institutos económicos alemanes la semana pasada, al tiempo que reducían las previsiones de crecimiento en este y el próximo año para su economía. La expansión de la demanda a corto plazo y el aumento del crecimiento potencial a medio plazo, asociados a ese aumento de la deuda pública, contribuirían a generar ingresos suficientes con los que pagar el aumento de la deuda pública, e incluso reducirla. Recordemos que la deuda pública agregada de la eurozona, en términos de su PIB, sigue siendo hoy inferior a la de EE UU o Reino Unido. La viabilidad de esas decisiones de inversión pública cuenta con la excepcional complicidad de unas condiciones de financiación históricamente favorables, que hay que aprovechar. No puede darse por descontado que la abundancia de liquidez, la excepcional disposición del BCE y los históricamente bajos tipos de interés de la deuda pública a largo plazo vayan a durar toda la vida. Aprovecharlas ahora de forma eficiente contribuiría a que el estancamiento no fuera el escenario dominante durante años. No solo frenaría el deterioro de las condiciones de vida actuales, sino que mejoraría las futuras. Y esta es hoy la condición más importante para que la propia existencia de la unión monetaria quede garantizada. http://elpais.com/elpais/2014/10/13/opinion/1413213275_094828.html

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Economía Alemania confirma la desaceleración de su economía El Gobierno atribuye las menores expectativas de crecimiento a factores externos y asegura que no ve ningún motivo para modificar su política El temor a la recesión aumenta en Alemania tras el bajón exportador LUIS DONCEL / CLAUDI PÉREZ BERLÍN / BRUSELAS14 OCT 2014 - 14:14 CEST61

La canciller alemana, Angela Merkel. / Krisztian Bocsi (Bloomberg) Hace ya tiempo que los expertos y organismos como el Fondo Monetario Internacional avisan de lo que ayer confirmó el Gobierno alemán: la primera economía del euro está peor de lo esperado. El ministro de Economía, el socialdemócrata Sigmar Gabriel, anunció que este año el PIB crecerá un 1,2% (en lugar del 1,8% pronosticado hasta ahora); la previsión para 2015 asciende al 1,3% (frente al 2% anterior). Esos recortes en los pronósticos provocaron el castigo en los mercados a la deuda española, italiana o griega, ante la constatación de que Europa está ante un largo estancamiento; ya ni siquiera es descartable una tercera recesión. Los datos, tozudos, van de mal en peor. Pero la UE sigue sin cambiar el paso de su política económica, enzarzada en luchas intestinas sobre si es más urgente reformar, estimular o dar margen fiscal a los países con problemas.

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Alemania quiere reformas antes de abrir la mano a todo lo demás. Y sigue en sus trece, poco amiga de dar volantazos en la gestión de la eurozona. Gabriel no se limitó a ofrecer un discurso técnico plagado de cifras: aprovechó la presentación del nuevo panorama económico en Berlín para lanzar un mensaje político de primera magnitud. “No hay ningún motivo para cambiar nuestra política económica y fiscal”, subrayó. Horas más tarde, su jefa en el Gobierno de gran coalición, la canciller Angela Merkel, insistió en ese discurso de ahorro y de rechazo de nuevas deudas. También el ministro Wolfgang Schäuble marcó esa línea roja ante sus colegas europeos en el Ecofin. La presión internacional —FMI, G-20, OCDE y BCE— no hace mella en Alemania: el mundo entero le pide que invierta, pero Schäuble se agarra al guion de la ortodoxia: “Vamos a invertir, pero sin histerias, sin volver a caer en el déficit público”.

MÁS INFORMACIÓN// El temor a la recesión aumenta en Alemania tras el bajón exportador/ El Eurogrupo pone a Francia en su punto de mira/ Los expertos rebajan drásticamente las previsiones de Alemania La inversión es la variable macroeconómica que más ha caído en el conjunto de Europa en lo que va de crisis, casi un 20%. Pero los datos de Alemania son especialmente sonrojantes, con cifras inferiores a las de España y solo ligeramente superiores a las de Portugal, dos países sumergidos en una crisis oceánica. “Que nadie espere grandes planes inversores en Alemania”, decía ayer una alta fuente europea. Ante ese panorama en Berlín, los ministros de Economía de la UE reclamaron a la nueva Comisión que acelere sus planes de inversión, un paquete de 300.000 millones de euros para los tres próximos años del que se sabe poco y del que nadie termina de fiarse. “El riesgo es que ese plan no sea efectivo hasta 2017, y necesitamos un impacto significativo en 2015 y 2016 ante los nuevos riesgos que se ciernen sobre la recuperación”, resumió el francés Michel Sapin. Francia, que pide flexibilidad fiscal y a quien todo el mundo señala por su incapacidad para aprobar reformas, chocó abiertamente con Alemania en las reuniones de Luxemburgo. Y ese conflicto amenaza con llegar hasta Bruselas, que presiona para que París recorte algo más su presupuesto. A pesar del riesgo de que la crisis económica se transforme en una crisis política de incierto final, está claro que Berlín se resiste a los virajes: ni siquiera el ala izquierda de la coalición que dirige Merkel está por la labor. El número dos del Gobierno y líder de los socialdemócratas echó un jarro de agua fría sobre aquellos que le reclaman desde su propio partido un giro en la política de austeridad. “Endeudar más a Alemania no va a generar más crecimiento en Italia, Francia, España o Grecia”, respondió Gabriel a los que recomiendan que el Gobierno reaccione al empeoramiento de la coyuntura. Berlín considera que los problemas no son suyos. “Sobre todo Europa”, fue la respuesta de Gabriel a la pregunta sobre los factores que explican la desaceleración de la economía alemana. “La crisis geopolítica, fundamentalmente Ucrania, ha aumentado la incertidumbre y el lento crecimiento mundial está pesando sobre la economía”, añadió. Frente a los desafíos externos, el Gobierno ve en casa factores para la esperanza. La demanda interna y el mercado laboral dan señales de fortaleza. Y decisiones adoptadas por la gran coalición, como la instauración de un salario mínimo, contribuirán a aumentar la renta disponible. “Los ciudadanos tendrán más dinero en su bolsillo”, se enorgulleció. 111

El ministro se vio obligado a hacer encaje de bolillos al ofrecer un mensaje positivo cuando las malas noticias se acumulan. El mismo día en que anunciaba una drástica revisión de sus previsiones, otros indicadores como la producción industrial o los índices de confianza mostraban signos de flaqueza. Después de que el PIB retrocediera en el segundo trimestre del año, aumentan los temores de que el país vuelva a entrar en recesión. “No vemos cercana la recesión, pero la economía alemana depende del exterior. Y ahí es donde están los riesgos”, explica Jens Ulbrich, el economista jefe del Bundesbank. El PIB del euro se estancó en el segundo trimestre; tras el revés alemán, no hay un solo dato que haga pensar que el tercero va a ser mucho mejor. El riesgo es ya una tercera recesión: tres socavones en el PIB que en realidad son tres muescas de la misma crisis. “La recesión más grave de la posguerra requiere un amplio acuerdo político”, apuntó el ministro italiano Pier Carlo Padoan al cierre del Ecofin. Ese acuerdo, a día de hoy, brilla por su ausencia. De Guindos se desmarca CLAUDI PÉREZ Alemania no cambia el paso a pesar de que los datos económicos son cada vez peores; la eurozona sigue sin encontrar la política económica adecuada en el octavo año de la crisis. Nadie dijo eso tan claro en Luxemburgo como el ministro francés Michel Sapin. Por necesidad: Francia está en la diana, entre la espada de Bruselas y Berlín y la pared de la presión en casa si se pasa de rosca con los recortes. Sapin encontró una feroz resistencia en Alemania, que le cantó las cuarenta en el Eurogrupo, y en un bloque cada vez más amplio que le reprocha su inveterada inacción: Holanda, Austria, Finlandia, Luxemburgo y hasta Portugal quieren algo más que un toque de atención para París. España, en cambio, se desmarcó de ese grupo. “La eurozona necesita un plan creíble, coherente, un discurso claro en política económica”, dijo ante la prensa Luis de Guindos. Traducción bastarda: la política económica del euro no funciona. Guindos hizo ayer una especie de enmienda a la totalidad del liderazgo del presidente del Eurogrupo, Jeroen Dijsselbloem, en esta fase de la crisis. Donde Dijsselbloem pone el acento en la preocupación por la ausencia de reformas y la dosis insuficiente de recortes que presenta Francia a sus socios, Guindos recuerda que España “hizo reformas, pero también recibió flexibilidad en el cumplimiento de los objetivos, y esa receta funcionó”. “Hay que avanzar en las reformas, y a la vez dejar claro que las reglas permiten flexibilidad”, enfatizó. España reaparece así como un aliado de Francia e Italia: sus intereses y su situación le acercan a esos dos países, pese a que la retórica del Ejecutivo esté a menudo cerca del discurso alemán. Al cabo, la desaceleración europea está castigando el amago de recuperación de España, y es posible que también Madrid necesite una nueva ronda de flexibilidad. De momento, Guindos predica y da trigo: presume de reformas, “que empiezan a dar sus frutos”, pero a la vez apunta a la necesidad de activar el plan de inversión y de usar la flexibilidad. “No hay lugar para la confrontación”, reitera el ministro. Pero el pulso está ahí. En Francia. http://economia.elpais.com/economia/2014/10/14/actualidad/1413288842_917988.html

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ft. com World Europe October 14, 2014 7:39 am EU’s top court begins legality test of ECB bond-buying plan By Peter Spiegel in Luxembourg

©AP ECB president Mario Draghi walks in front of the ECB governing council prior to their meeting in Naples on October 2 The EU’s top court will begin a potentially explosive legal review on Tuesday of the European Central Bank’s bond-buying plan that may ultimately determine whether the scheme credited with ending the eurozone’s sovereign debt crisis could ever be used. The European Court of Justice is not expected to give a final ruling on the legality of the bond-buying programme – known as Outright Monetary Transactions – until summer 2015. But today’s hearing could give an early sense of how the judges will handle the arguments in the case. It is also a reminder of the increasingly hostile sentiment in Germany towards the ECB’s exceptional measures for tackling the eurozone crisis. More ON THIS STORY// Timeline – Events leading to ECB case/ Greek bonds rally on ECB buying moves/ ECB to press ahead with ABS-buying plan/ Economists point to emerging ‘Draghinomics’ ON THIS TOPIC// Draghi vows to fight eurozone deflation/ Eurozone inflation gauge hits record low/ The Short View Inflation outlook brings ECB QE into view/ Editorial Criticism of Draghi’s actions is misguided IN EUROPE// Catalan leader calls off referendum/ Orbán vows to squeeze Hungary’s banks/ Doubts over Catalan independence vote/ Paris stands firm against fiscal enforcers Ultimately the ruling could impinge on future asset purchases by the ECB under a wider quantitative easing programme designed to save the eurozone from the threat of deflation. At a time the eurozone crisis threatened to spin out of control in mid-2012 amid fears of Greece being ejected from the euro, instability in Spanish banks, and rising Italian borrowing costs, the announcement by ECB chief Mario Draghi that he would do

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“whatever it takes” – followed by the unveiling of the OMT programme – helped bring relative stability to the common currency that has held ever since. The case has been closely watched because any court ruling that the ECB cannot use its printing presses to churn out cash to be used to buy sovereign bonds of struggling countries, could raise questions about the bank’s ability to be a lender of last resort – potentially calling the currency’s survivability into question again. According to court files, the ECJ will examine whether Mr Draghi’s programme violates EU treaties’ “prohibition on monetary financing” – using central bank money to lend to governments – a policy that is not only illegal, but anathema in German economic circles. 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 The case has already made history. It follows the first referral to the Luxembourg court by Germany’s constitutional court earlier this year. The German case was originally brought by 37,000 people protesting against the legality of ECB bond-buying, announced in 2012 to calm markets but never used, and of the eurozone’s bailout fund. When referring the case, Germany’s constitutional court in Karlsruhe took the unusual step of outlining the ways in which it thought the OMT scheme would be illegal and breach the ECB’s mandate unless certain restrictions were imposed. The fear is that any caveats imposed by the ECJ could make the OMT, and future asset-purchases, less effective. The German court also reserved the right to review the ECJ’s decision although most experts think such a constitutional clash – which would have grave consequences for the EU’s legal system – is unlikely. The Karlsruhe judges asked the Strasbourg court to rule whether the bond-buying scheme exceeded the ECB’s mandate because it was tied to a programme of reforms and budgets cuts and targeted at selected eurozone members. It also asked for a ruling on whether it breached EU law because bond purchases could be unlimited, take no account of default risk and treat private creditors in the same was as public ones. Even if the generally pro-integration European Court rejects the Karlsruhe objections and these are respected by the German court, it could rebound politically in Germany. “The risk is that with Karlsruhe potentially caving in, two of Germany’s most-trusted non-political institutions – the court and the Bundesbank – would subordinate themselves further to European law,” said Carsten Nickel of Teneo Intelligence, in a note. “In turn, this might increase pressures on the political system to better represent concerns regarding Europe.

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Timeline – Events leading to ECB case As the European Court of Justice begins deliberations on the legality of the European Central Bank’s bond-buying programme, here are the key dates that got us to this point: July 26 2012 – Mario Draghi, ECB president, makes his famous pronouncement to do “whatever it takes” to preserve the euro. His remarks have an instant, calming effect on debt-laden eurozone periphery countries, with Spanish and Italian government bond yields falling after his speech. What this promise actually looks like is as yet unknown. September 6 – The ECB reveals its backstop plan for saving the euro: outright monetary transactions, or OMTs. If a eurozone government asks for help, the ECB will buy that government’s bonds in the market. “Whatever it takes” now has form and substance, but the German central bank is opposed to the measures. September 12 – Germany’s constitutional court says it will review OMT as part of its investigation into the European Stability Mechanism. April 25 2013 – “It is not the duty of the ECB to rescue states in crisis,” says the German central bank in a leaked submission to the German constitutional court. The document, submitted to the court in December, sets out the detail of the Bundesbank’s opposition to the OMT. June 11 and 12 – The German constitutional court holds hearings on OMT, days after Mr Draghi confidently declares in a speech that “OMT has been probably the most successful monetary policy measure undertaken in recent times”. November 21 – Still no decision from Germany’s highest court, which announces that no ruling will be made in 2013. At the time, Germany was without a government as parties were embroiled in coalition negotiations after general elections in September. February 7 2014 – Finally, a decision. Of sorts. OMT is illegal, says the German constitutional court, but refers it up to the European Court of Justice. By passing the case up to the ECJ, the German court acknowledged the ECJ’s supremacy over EU institutions. After the ECJ rules, the matter is due to return to the German court, which could block Germany’s participation in OMT. October 14 – The question of whether the ECB is allowed to do “whatever it takes” to save the euro finally reaches the ECJ. Cases referred by governments take, on average, 16 months before a preliminary ruling, so forget about a ruling this year. Timeline compiled by Kadhim Schubber http://www.ft.com/intl/cms/s/0/389d1502-5325-11e4-b917- 00144feab7de.html#axzz3G1L0w6ka

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ft. com World Europe October 13, 2014 4:10 pm Jean Tirole: 5 things to know about the Nobel Prize winner’s work By Lindsay Whipp and Robin Harding

©AP Jean Tirole became the second Frenchman to receive a Nobel Prize this year, winning the Economic Sciences award for his research into curtailing the power of oligopolies. Below are five aspects of his work that the Sveriges Riksbank in Memory of Alfred Nobel honoured on Monday. More ON THIS STORY// Jean Tirole wins Nobel Economics Prize/ FT Alphaville If you’re not paying for it, you are the market, Nobel edition/ Malala and Satyarthi win Nobel Prize/ LED invention wins Nobel Prize for physics/ Anti-slavery fighter saves 80,000 children IN EUROPE// Catalan leader calls off referendum/ EU court reviews ECB bond-buying plan/ Orbán vows to squeeze Hungary’s banks/ Doubts over Catalan independence vote What were Mr Tirole’s most important contributions? The committee praised Mr Tirole for developing the first “encompassing and coherent theory” of industrial organisation – the field of economics that deals with industry structure and competition between companies – and lauded his contribution to the regulation of oligopolies. It noted the breadth of his contributions and his rethinking of industrial organisation. The committee noted his research on “strategic investments and R&D races”, “dynamic oligopoly” and on “co-marketing”, all of which he worked on with several research partners. What were his crucial findings on regulating oligopolies? Before Mr Tirole, economics was good at perfect competition – commodity markets, for example – and good at situations of monopoly. There was also a general understanding of how companies behave in oligopoly. Mr Tirole’s achievement was to make this understanding far more detailed and specific to particular industries. He argued there is no blanket way to regulate an oligopoly. He built a framework using new tools such as game theory (the mathematic study of conflict and co-operation) and contract theory (the study of how contracts can be agreed in the face of asymmetric access to information).

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One of the big problems with regulating oligopolies was the lack of full information on issues such as costs and pricing at the companies. Along with his research partner, the late Jean-Jacques Laffont, in the 1980s, he developed the idea of using complex industry-specific incentive contracts to regulate oligopolies. These reduced the need for the regulator to have full knowledge of individual company’s economic conditions, but would ensure that consumers and society at large did not lose out through excessive profit generation within the industry. He focused particularly on telecommunications and banking regulation. 3. What about competition policy? Mr Tirole’s subtle, industry-specific analysis of competition led to a similarly subtle rethink of regulation. For example, regulators often restrict so-called “predatory pricing”, where companies slash prices temporarily to drive rivals out of business. But Mr Tirole studied industries such as newspapers where free circulation can attract a critical mass of readers and as a result encourage advertising. He worked with Jean- Charles Rochet on such “platform markets” where there is a “strong link between players on different sides of a technical platform”. That meant readers and advertisers in the case of newspapers, but software and internet competition works in much the same way. 4. What else? There are plenty more findings in Mr Tirole’s long list of publications. The committee draws on the problems surrounding monopolies in a specific area of the production chain. Along with Patrick Rey and Oliver Hart, he concluded that a monopoly in one part of the production chain can have a knock-on effect on other parts as well. This is because the monopoly can dictate how available it wants to make its product or service and to which companies. 5. Within what context has Mr Tirole won the prize? Mr Tirole’s work is becoming more and more important. New corporate giants such as Apple and Google compete, but in a way that has little to do with the classic economic model of many producers and many customers trading an identical product. Instead, their prices may be free to the consumer, while their competition on new technology often leads to at least temporary dominance of a market. How to regulate such companies is a pressing policy question. Google is being probed by EU regulators over its dominance and practices in web search. The French competition authority is also continuing its probe into alleged widespread breaches of antitrust laws by several delivery companies, including Royal Mail and TNT, both of which announced settlements recently. And Mr Tirole has not been soft on the role of government and regulators in the global financial and the euro crisis. In an interview with French newspaper Les Echo in 2012, Mr Tirole said that both crises “originated” in lax prudential supervision in the case of the global financial crisis, and lax government supervision in the run-up to the euro crisis. http://www.ft.com/intl/cms/s/0/01bc3910-52ca-11e4-a236- 00144feab7de.html#axzz3G1L0w6ka 117

Joseph E. Stiglitz// a Nobel laureate in economics and University Professor at Columbia University, was Chairman of President Bill Clinton’s Council of Economic Advisers and served as Senior Vice President and Chief Economist of the World Bank. His most recent book, co-authored with Bruce Greenwald, is Creating a Learning Society: A New Approach to Growth, Development, and Social Progress. OCT 13, 2014 26 The Age of Vulnerability NEW YORK – Two new studies show, once again, the magnitude of the inequality problem plaguing the United States. The first, the US Census Bureau’s annual income and poverty report, shows that, despite the economy’s supposed recovery from the Great Recession, ordinary Americans’ incomes continue to stagnate. Median household income, adjusted for inflation, remains below its level a quarter-century ago. It used to be thought that America’s greatest strength was not its military power, but an economic system that was the envy of the world. But why would others seek to emulate an economic model by which a large proportion – even a majority – of the population has seen their income stagnate while incomes at the top have soared? A second study, the United Nations Development Program’s Human Development Report 2014, corroborates these findings. Every year, the UNDP publishes a ranking of countries by their Human Development Index (HDI), which incorporates other dimensions of wellbeing besides income, including health and education. America ranks fifth according to HDI, below Norway, Australia, Switzerland, and the Netherlands. But when its score is adjusted for inequality, it drops 23 spots – among the largest such declines for any highly developed country. Indeed, the US falls below Greece and Slovakia, countries that people do not typically regard as role models or as competitors with the US at the top of the league tables. The UNDP report emphasizes another aspect of societal performance: vulnerability. It points out that while many countries succeeded in moving people out of poverty, the lives of many are still precarious. A small event – say, an illness in the family – can push them back into destitution. Downward mobility is a real threat, while upward mobility is limited. In the US, upward mobility is more myth than reality, whereas downward mobility and vulnerability is a widely shared experience. This is partly because of America’s health-care system, which still leaves poor Americans in a precarious position, despite President Barack Obama’s reforms. Those at the bottom are only a short step away from bankruptcy with all that that entails. Illness, divorce, or the loss of a job often is enough to push them over the brink. The 2010 Patient Protection and Affordable Care Act (or “Obamacare”) was intended to ameliorate these threats – and there are strong indications that it is on its way to 118

significantly reducing the number of uninsured Americans. But, partly owing to a Supreme Court decision and the obduracy of Republican governors and legislators, who in two dozen US states have refused to expand Medicaid (insurance for the poor) – even though the federal government pays almost the entire tab – 41 million Americans remain uninsured. When economic inequality translates into political inequality – as it has in large parts of the US – governments pay little attention to the needs of those at the bottom. Neither GDP nor HDI reflects changes over time or differences across countries in vulnerability. But in America and elsewhere, there has been a marked decrease in security. Those with jobs worry whether they will be able to keep them; those without jobs worry whether they will get one. The recent economic downturn eviscerated the wealth of many. In the US, even after the stock-market recovery, median wealth fell more than 40% from 2007 to 2013. That means that many of the elderly and those approaching retirement worry about their standards of living. Millions of Americans have lost their homes; millions more face the insecurity of knowing that they may lose theirs in the future. These insecurities are in addition to those that have long confronted Americans. In the country’s inner cities, millions of young Hispanics and African-Americans face the insecurity of a dysfunctional and unfair police and judicial system; crossing the path of a policeman who has had a bad night may lead to an unwarranted prison sentence – or worse. Europe has traditionally understood the importance of addressing vulnerability by providing a system of social protection. Europeans have recognized that good systems of social protection can even lead to improved overall economic performance, as individuals are more willing to take the risks that lead to higher economic growth. But in many parts of Europe today, high unemployment (12% on average, 25% in the worst-affected countries), combined with austerity-induced cutbacks in social protection, has resulted in unprecedented increases in vulnerability. The implication is that the decrease in societal wellbeing may be far larger than that indicated by conventional GDP measures – numbers that already are bleak enough, with most countries showing that real (inflation- adjusted) per capita income is lower today than before the crisis – a lost half-decade. The report by the International Commission on the Measurement of Economic Performance and Social Progress (which I chaired) emphasized that GDP is not a good measure of how well an economy is performing. The US Census and UNDP reports remind us of the importance of this insight. Too much has already been sacrificed on the altar of GDP fetishism. Regardless of how fast GDP grows, an economic system that fails to deliver gains for most of its citizens, and in which a rising share of the population faces increasing insecurity, is, in a fundamental sense, a failed economic system. And policies, like austerity, that increase insecurity and lead to lower incomes and standards of living for large proportions of the population are, in a fundamental sense, flawed policies. Read more at http://www.project-syndicate.org/commentary/economic-failure- individual-insecurity-by-joseph-e--stiglitz-2014-10#KE5BmsbPHz8Dxr5b.99

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Jean Tirole Wins Nobel Prize in Economic Sciences Posted: 13 Oct 2014 08:52 AM PDT This is not my area, so I'll turn the discussion over to others: . Nobel Prize 2014: Jean Tirole - A Fine Theorem . Tirole and Pasteur - Digitopoly . Jean Tirole, Nobel Prize Economics 2014 - Cheap Talk . Tirole’s Nobel Prize Is a Win for Microeconomic Theory - Justin Wolfers . Nobel Prize 2014: The Regulator - Lindau Economics . The 2014 Nobel Laureate in economics is Jean Tirole - Marginal Revolution . Jean Tirole and Industrial Organization - Marginal Revolution . Jean Tirole and Platform Markets - Marginal Revolution . Jean Tirole and Intrinsic and Extrinsic Motivation - Marginal Revolution . A Nobel Prize for real world economics - The Enlightened Economist . Economics: The Nobel prize goes to Jean Tirole - The Economist . Why Jean Tirole’s work matters in the Age of Google - The Guardian . Jean Tirole Wins Nobel for Work on Regulation - NYTimes.com . Nobel Prize in Economics Q&A: Why Jean Tirole? - WSJ . Nobel Prize in Economics: Who Is Jean Tirole? - WSJ . If you’re not paying for it, you are the market, Nobel edition - FT Alphaville . Jean Tirole wins Nobel Prize for Economics - FT.com . Why Jean Tirole the economics Nobel Prize - Vox . One paper by Jean Tirole that every internet user should know - Vox . Nobel for Charles Barkley of Economics - Bloomberg View . Tirole on why societies resist policy recommendations - Washington Post . Tirole Helps Explain Huge CEO Bonuses - Business Insider . Jean Tirole on Energy, Climate, and Environment - CFR

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http://marginalrevolution.com/ The 2014 Nobel Laureate in economics is Jean Tirole by Tyler Cowen on October 13, 2014 at 7:04 am in Current Affairs, Economics | Permalink A theory prize! A rigor prize! I would say it is about principal-agent theory and the increasing mathematization of formal propositions as a way of understanding economics. He has been a leading figure in formalizing propositions in many distinct areas of microeconomics, most of all industrial organization but also finance and financial regulation and behavioral economics and even some public choice too. He is a broader economist than many of his fans realize. Tirole is a Frenchman, he teaches at Toulouse, and his key papers start in the 1980s. In industrial organization, you can think of him as extending the earlier work of Ronald Coase and Oliver Williamson with regard to opportunism and recontracting, but applying more sophisticated and more mathematical forms of game theory. Tirole also has been a central figure in procurement theory and optimal contracts when there is asymmetric information about costs. The idea of mechanism design runs throughout his papers in many different guises. Many of his papers show “it’s complicated,” rather than presenting easily summarizable, intuitive solutions which make for good blog posts. That is one reason why his ideas do not show up so often in blogs and the popular press, but they nonetheless have been extremely influential in the economics profession. He has shown a remarkable breadth and depth over the course of the last thirty or so years. His possible pick had been heralded for some numbers of years now, this award should not be considered a surprise at all. You will note that the Swedes mention Jean-Jacques Laffont, who died a decade ago, and who co-authored many of the key papers in this area with Tirole. Such a mention is considered a nod in the direction of implying that Laffont, had he lived, would have shared in the prize. Here is Tirole’s home page. Here is Tirole on Wikipedia. Here is a short biography. Here is Tirole on scholar.google.com. Here is the press release. Here is background from the Swedes. Here is the 54-page document on why he won, one of the best places to start. Here is the Twitter commentary. One idea of Tirole’s I use frequently has to do with renegotiability. Let’s say a regulator and a monopolist agree to a scheme of regulation and provision, creating some surplus for both parties. As time passes, will each side of that bargain stick with the original agreement? A simple example here is the defense contractor. After a procurement contract is written, sometimes the supplier has the incentive to conduct a hold-up, to report that costs are higher than expected, and to ask for more money in return for timely fulfillment of the contract. Of course this is a contract breach, but if no 121

other supplier can step in and do the job, it may be optimal for the government to give in to these demands to some degree. The question then is: how should the contract best be designed in advance, so as to prevent this problem from popping up later on? Or should the renegotiation simply be allowed? Anyone wishing to tackle these questions likely would start with the papers of Tirole on this topic. For one thing, these papers help explain why a second-best optimal contract may offer some rents to agents and appear to give the agent “too good a deal.” Some of his key papers focus on asymmetric information about costs. Say a firm knows its costs and the regulator can only guess. Ideally the regulator would likely to make the firm price at marginal cost, but the firm will pretend marginal cost is higher than it really is. The regulator and the firm thus play a game. Tirole figured out with rigor which principles govern how this game works and what a second-best regulatory solution might look like. With Laffont, here is his key paper in that area. David Baron made contributions to this area as well. Again, there is a potential argument for an “agent rent,” to limit the incentive of the agent to lie too much about costs, for fear of losing that rent if the cooperative relationship breaks down. Tirole, writing sometimes with Rey, wrote some important papers on vertical agreements and how they can be used to extend market power, for instance when can buying up parts of a supply chain help extend monopoly power? His paper with Oliver Hart figures out some of the conditions under which vertical acquisitions can help foreclose a market. With Rey, Tirole surveys the literature on vertical relations and foreclosure. This early 1984 paper, with Drew Fudenberg, laid out the conditions when firms should overinvest in capacity to deter competitive entry, or when firms should instead look “lean and mean” for entry deterrence. The underlying analysis has shaped many a business school discussion. I am a fan of this 1996 paper on how we can think of firms as credible ways of carrying reputations in a collective sense. For instance the existence of a firm called “Google” transmits real information about the qualities of the people you deal with when you are transacting with members of the Google firm. This was an important addition to the usual Coasean vision of thinking of a firm in terms of economizing transaction costs. He has written some key papers on financial intermediation, collateral, and the agency problems associated with lending, here is one well-cited paper by him and Holmstrom. Here is a non-gated version (pdf). A key argument is that a decline in the value of the collateral in a lending relationship can lower efficiency and also output, and this can help explain some features of business cycles. This 1997 paper was well ahead of its time and it remains one of Tirole’s most widely cited works. Arguably it is relevant for recent financial crises. He has a 1994 book with Mathias Dewatripont on the prudential regulation of banks and how to apply the proper incentives to make sure banks do not take too much risk at public expense. Obviously this also has since become a much more important topic. How many of you know his 1996 paper with Rochet on “Interbank Lending and Systemic Risk“? They show the contradictions which can plague a “too big to fail” policy and the attempts of central banks to maintain a “creative ambiguity” about what kinds of bailouts will occur, using rigorous game theory of course. 122

With Rochet, he has a well-known paper on platform competition, laying out the basics of how these “two-sided” markets work. Think of internet or payment portals which must get both sides of the market on board. What are the efficiency properties of such markets and what are the game-theoretic issues? In this setting, how do for-profits compare to non-profits? Competition to monopoly? Rochet and Tirole laid out some of the basics here, here is their survey piece on the field as a whole. Alex’s post above has much more on these points, and Joshua Gans covers this area too, here is Vox. In public choice economics, he and Laffont have an important paper on when regulatory capture is actually likely to occur. I have yet to see the insights of this paper incorporated into the rest of the literature adequately. His paper on the internal organization of government considers the relative appropriateness of high- vs. low- powered incentives as applied to government employees, among other matters. His 1999 paper with Mathias Dewatripont, “Advocates,” shows in game-theoretic terms why something like the Anglo-American system of competing lawyers might make sense as the best way of discovering information and adjudicating the truth. This paper shows how career concerns affect bureaucratic incentives and what is the optimal degree of specialization within a government bureaucracy. He has thought very deeply about the nature of liquidity and what is the optimal degree of liquidity in a securities market. There can be some side benefits to illiquidity, namely that it forces parties to stay committed to an economic relationship. This must be weighed against the more obvious benefits of liquidity, which include having better benchmarks for measuring managerial performance, namely stock price (see this paper with Holmstrom). This kind of analysis can be applied to the question of whether the shares of a firm should stay privately traded or be put on a public exchange. This 1998 paper, with Holmstrom, is a key forerunner of the current view that the global economy does not have enough in the way of safe assets. Here is his paper on vertical structure and collusion in bureaucracies (pdf). Here is his very useful survey article, with Holmstrom, on the theory of the firm. His textbook on Industrial Organization is a model of clarity and remains a landmark in the field, even though it came out almost thirty years ago. He has written a book on telecommunications regulation (with Laffont) although I have never read that material. In finance he wrote this key 1985 paper, deriving the conditions under which you can have an asset bubble in a market with rational expectations. The problem of course is that the price of the asset tends to keep rising, relative to the size of the economy as a whole, and eventually it becomes impossible to keep on buying the asset. This has to mean an eventual crash, unless the growth rate of the economy exceeds the general rate of return on assets. This paper helped us think through some issues which recently have resurfaced with the work of Thomas Piketty. His earlier 1982 paper on speculation is also relevant to this topic. Most economists think of Tirole as game theory, finance, and industrial organization, but his contributions to finance are significant as well. Just to show his breadth, here is his paper with Roland Benabou on incentives and when they undermine the intrinsic desire to do a good job. For instance if you pay kids to get good grades, will that backfire and kill off their own reasons for wanting to do well?

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Alex covers that paper in more detail. This other paper with Benabou, “Self-Confidence and Personal Motivation,” is a great deal of fun. It analyzes the benefits of overconfidence, namely greater motivation, and shows how to weigh those benefits against the possible costs, namely making more mistakes. It shows Tirole dipping a foot into the waters of behavioral economics and again reflects his versatility in terms of fields. I like this sentence from the abstract: “On the supply side, we develop a model of self-deception through endogenous memory that reconciles the motivated and rational features of human cognition.” Again with Benabou, here is his paper on willpower and personal rules, very much in the vein of Thomas Schelling. Here is Tirole on intellectual property and health in developing countries, with plenty on policy. It’s an excellent and well-deserved pick. One point is that some other economists, such as Oliver Hart and Bengt Holmstrom, may be disappointed they were not joint picks, this would have been the time to give them the prize too, so it seems their chances have gone down. Overall I think of Tirole as in the tradition of French theorists starting with Cournot in 1838 (!) and Jules Dupuit in the 1840s, economics coming from a perspective with lots of math and maybe even some engineering. I don’t know anything specific about his politics, but to my eye he reads very much like a French technocrat in terms of approach and orientation. Jean Tirole is renowned as an excellent teacher and a very nice person. - See more at: http://marginalrevolution.com/marginalrevolution/2014/10/2014-nobel- laureates-in-economics-are-jean-tirole.html#sthash.TjitoXNX.dpuf http://marginalrevolution.com/marginalrevolution/2014/10/2014-nobel-laureates-in- economics-are-jean-tirole.html

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ECONOMICS Nobel for Charles Barkley of Economics

7Oct 13, 2014 11:55 AM EDT// By Noah Smith I managed to call this year’s Economics Nobel correctly. Actually, it wasn’t difficult. Jean Tirole is a name uttered so frequently in the field that the most surprising thing about his Nobel win today was that he hadn’t won the prize already. That’s how the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel works -- it’s usually a lifetime achievement award rather than an award for a specific innovation or discovery. That fact made the committee’s decision particularly hard this year, because Tirole is an economics polymath. Bill Walton once said of Charles Barkley: “[He doesn’t] really play a position. He plays everything. He plays basketball.” Tirole is kind of like the Charles Barkley of economics, only without the politically incorrect commentary. If you could summarize Tirole’s area of research in a single sentence, it would be about corporations. One might think that corporations are one of the easiest, most natural things for economists to study, but one would be wrong -- in fact, many economists wonder why corporations even exist. A lot of macroeconomic models, for instance, assume that companies work like Chinese peasants in the Great Leap Forward -- a million identical little producers, all making steel in their backyards. Only a few economists have both the mathematical chops and the sheer mental doggedness to try to slice through the jungle that is the modern U.S. corporation, but Tirole has both of these. The machete he wields is game theory. Game theory is very different from the typical econ theory you hear about -- Adam Smith’s “invisible hand” is nowhere to be found. Instead, game theory deals with strategic interactions, with smart people trying to bluster, wheedle, threaten and team up with each other. That sounds a lot like working in a corporation. And it also sounds a lot like the way corporations interact with each other, and with the government. The work the Nobel committee finally decided to cite in Tirole’s award was about the way that government should regulate firms in different kinds of competitive environments. If you have a monopoly, that requires different regulation from an oligopoly, which in turn is different from a perfectly competitive situation. Things such as mergers and acquisitions require their own sort of regulation, as do cartels. Adam Smith warned darkly about cartels but it wasn’t until the advent of game theory that we understood something about how to deal with them.

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Notice that Tirole’s work on regulation defies the typical stereotype of what economists do. Many people think that economics is all about providing justifications for free markets, or assuming that businesses always do what’s best for their shareholders. Tirole, instead, takes a more practical approach, dealing with businesses as they are, not as they should be, and recommending government intervention when such intervention could improve the situation. Personally, I’m familiar with a different side of Tirole’s oeuvre -- his work on finance. Tirole has written a book on the theory of corporate finance (called, not surprisingly, “The Theory of Corporate Finance”). It deals with all the aspects of finance theory that don’t get a lot of attention in the press -- hostile takeovers, for example, or corporations’ bias toward financing themselves with debt. The basic idea is that to understand how corporations finance themselves, you have to understand the strategic interactions among managers, shareholders, bondholders, customers, suppliers, employees, the government and others. If the Efficient Market Hypothesis -- the idea that markets rapidly assimilate all information, making it hard for investors to profit -- makes an appearance in Tirole’s theory, it is only as a very bit player. But rest assured, Tirole has also taken on the topic of asset markets and efficiency. In fact, Tirole has shown not one, but at least two ways that efficiency could fail and bubbles could take over. The first way is if traders think only in the short term and ignore the long term -- not an unrealistic idea, for those of us who have met some real- world traders. The second way results from trading between older and younger generations. Tirole has also done a lot of theory about financial crises and liquidity, the things that demonstrated their importance in 2008. One point to note about Tirole’s work is that it’s mostly theoretical -- and by “mostly,” I mean everything I’ve ever read or seen. Another common knock against economists is that they focus too much on deduction and theory, imagining how people should interact without going out and seeing how they do interact. But that criticism doesn’t always hit the mark -- it’s perfectly natural to have a division of labor where some people make the theories and others test them. And many of Tirole’s theories are perfectly testable. There is a lot more to Tirole’s work than what I’ve managed to describe here, but that would be true even if I wrote three times as much as I have. When you’re dealing with the Charles Barkley of economics, sometimes all you can do is sit back and admire the whole body of work. To contact the author of this article: Noah Smith at [email protected]. To contact the editor responsible for this article: James Greiff at [email protected]. http://www.bloombergview.com/articles/2014-10-13/nobel-for-charles-barkley-of- economics

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http://www.businessinsider.com/ The Economist Who Won The Nobel Prize Figured Out Why CEOs Get Such Gigantic Bonuses

Shane Ferro

Read more: http://www.businessinsider.com/the-economics-nobel-prize-winner-helps- explain-huge-ceo-bonuses-2014-10#ixzz3G7b5ObsjWhy are CEOs paid so well? In part, because they constantly have the opportunity to renegotiate their contracts, which are often heavy on the stock-based bonuses. The work of Jean Tirole, the newest Nobel Prize winner in economics, helps explain why this is the case. Contracts Are Not Immutable A lot of theories of negotiation before Tirole assumed that a contract was immutable once it was signed. But in reality, a contract often can be renegotiated. When both parties know that, it changes the way they approach the original contract. Take, for example, an executive compensation agreement. Tirole’s research with Drew Fudenberg explains that moral hazard is affected in a long-term contractual agreement when there’s an option for renegotiation. Specifically, it helps explain why so much of what a CEO gets paid is tied to performance and tied up in things like stock options. The CEO gets what seems like a lot, but knowing that he can ask for more next year makes it important that that compensation is tied to how well the company is doing. The paper notes that the Tirole-Fundenberg model has two implications for executive compensation. First, "an executive who has made important long-run decisions (project or product choices, investments), will be offered the discretion to choose from a menu of compensation schemes, some offering a fairly certain payment and some offering riskier, performance-related payment." In reality, there's a broad range in what and how executives get paid, but a lot of them choose the high risk, high reward plan. The second implication is that executive compensation usually doesn't have a lot to do with how the company does when she's gone from the company, although some CEOs do continue to get bonuses after they retire. For example, giving an executive $10 million per year in stock options that don’t vest until next year may seem ludicrous on its face, but it’s better than promising him $5 million in cash and watching him walk away after the company crumbles six months in.

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Government Defense Contracts Tyler Cowen writes about the implications Tirole's work has for government deals with monopolistic industries (like defense contractors). Say the government signs a five year contract with a defense contractor. Previous research focused on how the two parties should negotiate the contract assuming that what they agreed to would never been renegotiated. In reality, three years into the project, the company can (and probably would) come back to the government and say, “The project is harder than expected. We won’t be able to finish unless you give us X more money.” Given the costs of losing the contract, it might actually be better for the government to just give in to these demands. Tirole’s paper finds that when you factor in this potential issue, it might be better for the government to give in to certain demands in the original contract that it otherwise wouldn’t if the contract could never been renegotiated — which helps explain why a lot of government contractors seem to get really sweet deals. Tirole is an economist at the Toulouse School of Economics. He won the prize, according to the Nobel committee’s reasoning, for his work on the overall theory of industrial organization (IO) and regulation. For a more comprehensive overview of Tirole’s work, see Tyler Cowen’s excellent roundup and the Nobel committee's summary.

Read more: http://www.businessinsider.com/the-economics-nobel-prize-winner-helps- explain-huge-ceo-bonuses-2014-10#ixzz3G7azwo9w

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ft.com Comment Opinion October 13, 2014 5:32 pm If you believe the bond markets, we are all Japanese now By Peter Tasker Low yields have an easy explanation: declining growth and low inflation, writes Peter Tasker

©Bloomberg When William Gibson, the cyberpunk novelist, declared at the turn of the century that “Japan is still the future”, he was probably not thinking of bond yields. Yet recent action in bond markets is a sign that the global economy risks following Japan’s unhappy path. Back then, Japan’s super-low interest rates were a unique phenomenon that observers struggled to rationalise. Was it patriotism that led Japanese investors to plough money into government bonds that paid a pittance, even as public debt grew? Surely it was only a matter of time before yields would soar. This belief was common not just among hedge funds and rating agencies but in Japan itself, where Japanese Bonds, Main Kouda’s novel of financial apocalypse, became a bestseller in 2001. More ON THIS STORY// An extraordinary state of ‘managed depression’/ Purists retreat in global debate on fiscal policy/ Europe’s low bond yields hit pensions/ German exports fall stokes recession fear ON THIS TOPIC// Foreign buyers hold key to debt prices/ Markets Insight Stick with consensus and sell Treasuries/Spain sells second inflation-linked bond/ Fast FT Spain set to sell its second ever linker IN OPINION// Defend the ‘double Irish’ tax loophole/ Amir Sufi Flaws in bank thinking/ Joe Zhang China’s policy ramble/ James Grant Low rates jam vital signals What has happened since the financial crisis of 2008 is the exact reverse. The rest of the world has converged with Japan. Today 10-year bond yields are 0.4 per cent in Switzerland, 0.9 per cent in Germany and 1.2 per cent in France. Outside the troubled eurozone, the picture is not much different. The UK and the US are currently the best performing developed economies, but bond yields remain close to multi-century lows at about 2 per cent. What was once an anomaly has become standard.

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It once seemed that Asia’s growth momentum might steer it clear of the deflationary sludge in which the developed world was mired. If bond markets are any guide, such optimism is no longer warranted. Local currency bonds issued by Thailand, the focal point of the 1997-8 Asian crisis, yield just 3.3 per cent. Bonds in Singapore, South Korea, Hong Kong and Taiwan pay even less. Bond prices, which move inversely to yields, are high, but not without reason. If there is a bubble, it is not in government debt but internet stocks, prime property and contemporary art. As in Japan since the mid-1990s, low bond yields have a fundamental explanation: the prospect of declining growth and low inflation almost everywhere. Consumer prices are already falling not just in eurozone countries such as Belgium, Spain and Italy, but in Sweden and Poland too. This year the UK is expected to grow at 3.5 per cent, the fastest among the developed countries, yet the Bank of England recently halved its forecast of wage growth to 1.25 per cent. As Albert Edwards, a Société Générale strategist, points out, US inflation expectations have declined precipitously since the summer even as the Federal Reserve plots its exit from quantitative easing. Meanwhile the Chinese economy appears to be slowing. What has brought us to this unhappy juncture? Factors often cited include globalisation and increasing inequality. The new economy itself appears to have a deflationary influence as it destroys intermediaries such as bookshops and concentrates wealth in a few hands. Even so it is worth recalling that the Japan that slid into deflation in the 1990s was not particularly globalised, had a fairly egalitarian distribution of wealth and negligible exposure to internet commerce. The paramount factor was the knock-on effect of an unprecedented asset market collapse. Bad policy compounded the damage and spawned a feedback loop between the asset markets and the real economy that continued for the best part of 20 years. Japanese authorities were too slow to clean up the banking system, too cautious in using monetary policy and too scared of Ms Kouda’s bond blow-up to use fiscal policy creatively. Sadly, this last tendency remains; the administration of Shinzo Abe increased the consumption tax by 3 per cent this spring. The message of the bond markets is clear. There is not a whiff of inflationary risk and governments have the most favourable borrowing terms imaginable for funding targeted tax cuts, infrastructure projects – whatever is needed to prove Mr Gibson wrong. The writer is a Tokyo-based analyst at Arcus Research http://www.ft.com/intl/cms/s/0/6dc2c674-52ca-11e4-9221- 00144feab7de.html#axzz3G1L0w6ka

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Partie de poker menteur entre Paris et Bruxelles sur les réformes

Le Monde.fr | 14.10.2014 à 08h00• Mis à jour le14.10.2014 à 09h55 |Par Cécile Ducourtieux (Bruxelles, bureau européen) Abonnez-vous à partir de 1 € Réagir Classer Partagerfacebooktwittergoogle +linkedinpinterest L’ambiance était tendue à l’Eurogroupe de Luxembourg, lundi 13 octobre, le dernier avant la remise à la commission européenne par les dix-huit pays de la zone euro de leurs projets de budget pour 2015. Même si les contacts sont constants depuis plusieurs semaines entre Paris et Bruxelles sur le sujet, c’est une des dernières occasions officielles, pour les partenaires européens de la France, de lui demander de modifier son texte. Une situation inédite pour un grand pays. Car en l’état, le projet de loi de finances (PLF) que la France a rendu public, le 1er octobre, est très largement en dehors des clous de Bruxelles. Non seulement le déficit public ne redescendra pas, l’année prochaine, en dessous des 3 %, l’objectif du pacte de stabilité et de croissance, contrairement à l’engagement pris par la France en 2013. Mais, pire pour la commission : l’effort de réduction du déficit structurel (hors effet de la conjoncture) consenti par la France serait limité à 0,2%, contre un effort attendu de 0,8 %. Lire aussi : Le budget de la France à l’épreuve du Parlement et de Bruxelles « IL N’Y A PAS DE RÈGLES POUR LES UNS ET DE RÈGLES POUR LES AUTRES » Depuis quelques jours, les sources européennes se multiplient qui affirment que le budget français, en l’état, sera « retoqué » par Bruxelles. Et que la commission européenne, qui en a la possibilité, pourra demander à la France, dans les 15 jours qui suivent la réception de ce document, s’il est le même que celui qui a été présenté le 1er octobre en conseil des ministres. Pour l’instant, officiellement, chacun campe sur ses positions. Côté français, Michel Sapin, le ministre des finances, a réaffirmé, comme la France le fait depuis des semaines, que le pays respectera les règles, « Il n’y a pas de règles pour les uns et de règles pour les autres » a t-il rappelé. Mais il a aussi réitéré le point de vue de Paris, à savoir que le pacte devrait être appliqué en tenant compte de la conjoncture économique qui s’est détériorée dans la zone euro cet été, de l’inflation très basse, et du « risque de scénario à la japonaise ».

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Néanmoins, personne n’ayant intérêt à une crise ouverte avec Paris, des pistes d’ouverture sont apparues, lundi. M. Sapin a précisé de son côté que le projet de budget pour 2015, qui allait commencé d’être discuté au parlement mardi 14 octobre, pourrait être modifié à tous moments par amendements, « y compris gouvernementaux », jusqu’au mois de décembre. Lundi soir, Jyrki Katainen, le commissaire européen à l’économie (en charge de l’examen des budgets), a, sans citer explicitement la France, joué lui aussi l’apaisement : « il y a eu beaucoup de spéculations concernant certains pays, elles sont prématurées ». Mais il est resté ferme : « la Commission européenne traitera tous les pays de la même façon, c’est une question de justice et de crédibilité ». Avant que la situation ne se dénoue véritablement, la « France doit bouger, même si sa majorité politique est fragile. On veut voir une réforme. Après, on pourra discuter » assure une source allemande. Lundi, Bercy a confirmé une information du Spiegel selon laquelle Emmanuel Macron, ministre de l’économie et son homologue à Berlin Sigmar Gabriel, avaient décidé d’élaborer des propositions communes d’investissement mais aussi de réformes dans les deux pays. De là à voir le soutien tant attendu de Berlin à Paris, il n’y a qu’un pas, qu’on ne franchit pas encore à l’Elysée : « c’est bien trop prématuré ». Lire aussi : Jeroen Dijsselbloem distribue ses coups de griffe à Paris et Berlin Cécile Ducourtieux (Bruxelles, bureau européen) Journaliste au Monde http://www.lemonde.fr/economie/article/2014/10/14/partie-de-poker-menteur- entre-paris-et-bruxelles-sur-les-reformes_4505581_3234.html Budget de l'Etat

• Le budget de la France à l’épreuve du Parlement et de Bruxelles • Budget : que se passe-t-il si la France ne respecte pas les obligations de l'UE ? • Déficit : l'Europe va-t-elle sanctionner la France ?Vidéo

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• Budget : l’exécutif louvoie sous l’œil de Bruxelles • Premiers remous sur le projet de budget 2015 du gouvernement • Les prévisions de l'Insee jettent le doute sur la crédibilité du projet de budget 2015

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Les trois scénarios de la bataille budgétaire entre la France et l’Europe LE MONDE | 07.10.2014 à 17h47• Mis à jour le 08.10.2014 à 06h59 | Par Cécile Ducourtieux (Bruxelles, bureau européen) L’épreuve de force ne fait que commencer, mais elle est à haut risque pour François Hollande, son gouvernement, et leurs partenaires européens. Comme jamais depuis la création de l’Union monétaire, la France et la Commission européenne divergent sur la meilleure façon de respecter le Pacte de stabilité et de croissance. En cause : la persistance d’un déficit français supérieur au fameux seuil de 3 % du produit intérieur brut (PIB), en dépit des deux ans de délai accordé en 2013 à Paris pour rentrer dans les clous d’ici à 2015. Désormais, la France n’entend pas respecter cet objectif avant 2017, contre l’avis de la Commission européenne, qui veut obliger Paris à couper plus vite et plus fort dans les dépenses publiques, tout en opérant les réformes strusturelles qui permettraient de restaurer la compétitivité de la deuxième économie de la zone euro. La tension est montée de plusieurs crans ces dernières semaines, à mesure que le gouvernement français dévoilait son projet de loi de finance pour 2015. Le document doit être transmis à Bruxelles d’ici au 15 octobre. La Commission aura en principe jusqu'à fin novembre pour évaluer s’il est conforme au Pacte de stabilité et de croissance. Les équipes de la commission – la DG Ecfin, qui examine les budgets nationaux, celles de Jean-Claude Juncker, le futur président de la Commission (théoriquement à partir du lundi 3 novembre)– sont déjà en contact étroit avec l'Elysée pour trouver une solution. « Clash » entre Paris et Bruxelles, concessions de Paris, ou sanctions de Bruxelles, quels sont les scénarios possibles pour les prochaines semaines ? • Le durcissement : Bruxelles demande à Paris de revoir sa copie La Commission européenne, gardienne du pacte de stabilité, envoie en ce moment des messages clairs à Paris : en l'état actuel, le projet de loi de finance « ne passe pas la barre », fait-on savoir à Bruxelles. En effet, le déficit public français devrait être de 4,4 % du PIB en 2014 et encore de 4,3 % en 2015. Pire, aux yeux de la Commission, le compte n'y est pas du tout sur le plan du déficit structurel (qui ne tient pas compte de l'impact de la conjoncture sur les comptes publics). Paris s'engage sur un ajustement structurel de seulement 0,1 % en 2014 et de 0,2 % du PIB en 2015, alors que les traités fixent un objectif de 0,5 % minimum. Il faudrait trouver quelque 8 milliards d'euros supplémentaires d'économies, soit en hausses d'impôts soit en réduction des dépenses – gel des retraites, des salaires des fonctionnaires, etc.–, pour être dans les clous de l'effort « structurel » demandé par les

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instances européennes. Des mesures à très haut risque politique pour le premier ministre Manuel Valls et le président François Hollande. Pour l'instant, les dirigeants français campent sur leurs positions : on ne change rien au projet de loi de finance (PLF). le ministre des finances, Michel Sapin, l'a encore répété mardi 7 octobre au matin sur RTL : « La France ne fera pas en 2015 d'économies en plus des 21 milliards d'euros déjà prévus par le projet de budget et n'entend pas non plus augmenter les impôts. » Le premier ministre Manuel Valls s'est dit « optimiste » sur la capacité de la France à convaincre Bruxelles qu'elle ne peut « aller plus loin » dans la réduction des dépenses publiques. Si les Français n'infléchissent par leur discours et leur copie, dans les dix jours – d'ici en gros, l'envoi du PLF à Bruxelles, le 15 octobre, et si la Commission campe sur ses positions, elle devrait alors enjoindre Paris de revoir sa copie avant même que le projet de loi de finance ne soit voté par les parlementaires français. Et ce, en vertu de pouvoirs jamais utilisés à ce stade, mais actés par le gouvernement de Nicolas Sarkozy, au plus fort de la crise de la zone euro. • Le clash : Paris mis à l’amende Si Paris ne cède pas, refusant de modifier son projet de loi de finance, et si la Commission reste ferme, cette dernière peut même envoyer à la France une mise en demeure, voire lui imposer une amende de 0,2 % du PIB français (plus de 4 milliards d’euros). Jamais encore ce type de sanctions n'a été actionné par la Commission contre un pays de la zone euro. Mais l'exaspération contre la France a atteint des sommets à Bruxelles. Cela fait dix ans maintenant que le pays n'a pas respecté l'objectif des 3 %. Aujourd'hui, Paris passe vraiment pour le mauvais élève de l'Europe. Lire notre décryptage : Dette, déficit : la France est-elle parmi les mauvais élèves de la zone euro ? Par ailleurs, des pays du nord et de l'est de l'Union, la Finlande, la Lettonie, qui se sont imposés des régimes de réduction des dépenses publiques pour surmonter la crise ces dernières années, ne supporteraient pas que la France passe outre le pacte, censé s'imposer à tous, petits comme grands pays. Beaucoup redoutent la répétition du scénario de 2003, quand la France et l’Allemagne, les deux poids lourds de l’Union, avaient été les premiers à se soustraire aux règles de Maastricht, à l’époque. Et les avaient vidées de leur sens. A ce stade, ce scénario du pire est cependant peu probable. « Personne n’a envie de sanctionner Paris, ce serait un échec pour tout le monde », glissait déjà une source européenne, au dernier Eurogroup, à Milan, mi-septembre. • La transaction : un nouveau délai contre des réformes C'est le plus probable à ce stade, même s’il ne devrait pas aller sans des négociations très tendues. Jean-Claude Juncker, futur président de la Commission – à partir de début novembre – « ne voudrait pas commencer son mandat avec une crise ouverte avec une grande capitale », assurait une source européenne, lundi 6 octobre. Dans cette hypothèse, les deux parties auraient quelques semaines pour trouver un terrain d’entente. 134

Lire aussi : Entrée en matière tendue pour la commission Juncker face aux eurodéputés Avec un objectif : accorder un nouveau délai à la France, en contrepartie d’un plan détaillé de réformes structurelles susceptibles de régler, de manière durable ses problèmes budgétaires. Paris devra alors avancer un plan de réformes plus précis, plus argumenté, et mieux chiffré. Donner un « timing », par exemple, de la réforme des professions réglementées. Les négociations vont durer des semaines, jusqu'à la publication de « l'avis de la commission sur le PLF français », d’ici à la fin novembre. Le document, soumis ensuite aux ministres des finances de la zone euro, devrait alors inclure les engagements détaillés de Paris en matière de réformes. Cet avis, qui s'impose au pays membre, sera très probablement rendu conjointement par l’ancien ministre français des finances Pierre Moscovici, futur commissaire à l'économie, et par le Letton Valdis Dombrovskis, futur vice-président chargé de l'euro. Les deux hommes ont promis de respecter les règles du pacte de stabilité, tout en appliquant les « flexibilités » qu’il prévoit. Ils ont encore trois semaines, avec Jean- Claude Juncker, pour préciser leur intentions, en fonction des gages donnés par le gouvernement de François Hollande. Cécile Ducourtieux (Bruxelles, bureau européen) Journaliste au Monde http://www.lemonde.fr/politique/article/2014/10/07/les-trois-scenarios-de-la-bataille- budgetaire-entre-la-france-et-l-europe_4502099_823448.html

Jean Tirole, Prix Nobel d'économie, appelle à réformer un marché de l'emploi « assez catastrophique »

Le Monde.fr | 13.10.2014 à 13h10• Mis à jour le13.10.2014 à 18h57 Le prix Nobel d'économie a été décerné au Français Jean Tirole, président de la Toulouse School of Economics (TSE). L'Académie royale des sciences de Suède distingue les travaux de l'économiste sur la régulation des marchés. « C'est une grosse surprise, ça fait plaisir », a réagi l'intéressé, qui a profité d'une conférence de presse à l'Ecole d'économie de Toulouse pour appeler à une réforme rapide du marché de l'emploi, « assez catastrophique », en France. Présenté comme « l'un des économistes les plus influents de notre époque » par le comité Nobel, Jean Tirole « ne pense pas que l'économie française est un cas désespéré », car « on a quand même beaucoup d'atouts. On a des grandes entreprises qui

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marchent bien, un tissu de PME qui est encore trop faible et beaucoup de capital humain ». Mais il pense qu'il va falloir très vite « changer les choses » pour « donner un avenir à nos enfants ». « Depuis trente ans, quarante ans, il y a du chômage, et les jeunes, on leur propose des CDD dans leur très grande majorité parce que les entreprises ont trop peur de donner des CDI. On se retrouve donc avec une situation complètement absurde qui est qu'à force de trop protéger les salariés, on ne les protège plus du tout. Ce n'est pas un hasard que toute l'Europe du Sud, qui a exactement les mêmes institutions du marché du travail, se retrouve avec beaucoup de chômage alors que l'Europe du Nord, la Scandinavie par exemple, qui a un système différent, se retrouve avec assez peu de chômage. » En 2003, Jean Tirole avait proposé avec Olivier Blanchard, aujourd'hui chef économiste du Fonds monétaire international, l'instauration d'un contrat de travail unique qui se substituerait aux contrats à durées déterminée et indéterminée (CDD, CDI), assorti d'une augmentation progressive des droits des salariés en fonction de l'ancienneté >> Lire ses portraits : Jean Tirole : le quotidien en équations et Jean Tirole, un « entrepreneur en recherche » IL « FAÇONNE LA MANIÈRE DONT NOUS PENSONS L'ÉCONOMIE MONDIALE » Professeur à Polytechnique, Jean Tirole a poursuivi ses études au Massachusetts Institute of Technology (MIT) de Boston et fut Médaille d'or du Centre national de la recherche scientifique (CNRS) en 2007, après avoir reçu avec Jean-Jacques Laffont en 1993 le prix Yjrö Jahnsson, de l'Association européenne d'économie. L'un de ses livres les plus célèbres est The Theory of Industrial Organization, une analyse des comportements stratégiques des acteurs économiques en fonction des structures de marché, publié en anglais et traduit en six langues. L'attribution du Nobel à Jean Tirole illustre le succès rencontré actuellement par les économistes français. Cet été, le FMI dressait la liste des vingt-cinq chercheurs qui, selon lui, « façonnent la manière dont nous pensons l'économie mondiale ». Parmi ces économistes figuraient sept Français, dont Thomas Piketty. Le premier ministre, Manuel Valls, a salué cette récompense et ce « pied de nez au french bashing ». http://in.reuters.com/article/2014/10/13/germany-france-reforms- idINL6N0S84AF20141013

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ft.com/ companies Financials Banks October 14, 2014 12:00 am Terms laid down for taming shadow bank risk Sam Fleming and Tracy Alloway

©Reuters Global regulators have taken a landmark step towards taming risk in a key segment of the shadow banking system, outlining tougher rules on collateral for short-term lending which will affect both banks and non-bank players. Shadow banks have emerged as a key regulatory concern as risk migrates out of the traditional banking sector into more thinly policed reaches of the financial markets. More ON THIS STORY// Lombard Shadow banking / Jimmy Choo / Quindell/ IMF questions fitness of eurozone banks/ Fink blames regulators for heated markets/ China’s bad bank clean-up crew ON THIS TOPIC// Inside Business Insurers examine home truths/ Growth fears weigh on Chinese trusts/ Yukon Huang China’s banking threat overstated/ Citic sues Qingdao Port Group IN BANKS// JPMorgan net income rebounds to $5.57bn/ Levin Zhu quits as CICC chief executive/ UKAR secures £2.7bn deal for mortgage portfolio/ IPO banks seek measure of success Shadow banks can include a broad array of institutions engaged in bank-like activities, among them hedge funds, private equity groups and money market funds. The Financial Stability Board, an umbrella group of regulators, on Monday night published a framework imposing minimum requirements on the collateral needed when such firms borrow money from banks through short-term loans secured by stocks or bonds. The global standards are intended to stop excessive lending, and so avoid a repeat of the reckless behaviour that helped precipitate the financial crisis of 2008. They also take aim at a key segment of the shadow banking world, known as the repurchase, or “repo,” market.

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This emerged as a prime area of weakness during the crisis and regulators are said to be concerned about the potential impact that a “fire sale” of assets used as collateral for loans could have on the wider financial system. Crucially, the FSB’s minimum floors for repo transactions are higher than initial proposals made in August last year, following calls for tough standards from US regulators. In a significant step, the FSB said it would also consult on applying the standards to deals struck between non-banks, rather than simply limiting them to repo transactions undertaken between banks and non-banks. However, the FSB rules would still fail to capture transactions that use government bonds as collateral, focusing instead on private debt and stocks, amid anxiety from some governments about the potential impact on sovereign debt markets. Lombard on shadow banking//FSB’s buzz cut for repo borrowers helps banks feel a little less bald, by Jonathan Guthrie. Continue reading http://www.financialstabilityboard.org/publications/r_141013a.pdf The FSB now wants a minimum 1.5 per cent “haircut” for corporate bonds with a maturity of between one and five years, up from 1 per cent before, and a 6 per cent haircut for equities, instead of 4 per cent previously. The latter would mean that a borrower would have to post $106 of equity collateral for a $100 loan. The FSB also set out non-numerical standards aimed at tackling the risk that haircuts get whittled away in benign market conditions. Mark Carney, chairman of the FSB and Bank of England governor, said the rules marked a “big step forward” in the global shadow banking agenda. Daniel Tarullo, chairman of the FSB Standing Committee on Supervisory and Regulatory Co-operation, added: “Securities financing transactions such as repos are important funding tools for a wide range of market participants, including non-bank financial firms. “The implementation of the numerical haircut floors on securities financing transactions will reduce the build-up of excessive leverage and liquidity risk by non-banks during peaks in the credit and economic cycle.” The FSB stressed that market participants should continue to set higher haircuts than the official requirements where prudent. The FSB said firms had expected only a “minimal” impact on market volume from its proposals. The FSB added that the haircut floors could in future be raised and lowered as part of efforts to lean against fluctuations in the financial cycle, but that this would require further work. The repo market has already been under pressure from new rules that make it more expensive for banks to broker the transactions or undertake their own repo borrowing. While many in the market concede that runs in the repo market were a prime cause of Lehman Brothers’ collapse in 2008, they also warn that limiting the repo market could affect liquidity in a long list of financial assets. http://www.ft.com/intl/cms/s/0/897bf21a-52dd-11e4-9221-00144feab7de.html#axzz3G1L0w6ka 138

Regulatory framework for haircuts on non-centrally cleared securities financing transactions 14-Oct-2014 Based on the initial recommendations to strengthen oversight and regulation of the shadow banking system as set out in its report submitted to the G20 in October 2011, the Financial Stability Board (FSB) set up the Workstream on Securities Lending and Repos (WS5) to assess financial stability risks and develop policy recommendations, where necessary, to strengthen regulation of securities lending and repos. On 29 August 2013, the FSB published the report Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos (hereafter August 2013 Report) that set out policy recommendations for addressing financial stability risks in relation to securities lending and repos (hereafter securities financing transactions). These included: standards and processes for data collection and aggregation at the global level to enhance transparency of securities financing markets, which is currently being taken forward by an FSB data expert group that will propose standards and processes by November 2014; minimum standards on cash collateral reinvestment; requirements on re-hypothecation; minimum regulatory standards for collateral valuation and management; and policy recommendations related to structural aspects of the securities financing markets (central clearing and possible changes in the bankruptcy law treatment of securities financing transactions). The FSB also agreed in March 2014 implementation dates for these recommendations as set out in Recommendations 1 to 11 in Annex 1 of this document. Although most of the policy recommendations had been finalised, the August 2013 Report included consultative proposals on a regulatory framework for haircuts on certain non-centrally cleared securities financing transactions. The FSB invited comments from the public on these proposals by 28 November 2013 and consultation responses were received from more than 20 respondents including trade associations representing securities borrowers and lenders, intermediaries in the securities lending and repo markets, asset managers, market infrastructure providers, public authorities and individuals. In finalising its regulatory framework for haircuts, the FSB focused on addressing the financial stability issues as described in Section 1 of the August 2013 Report and in the interim report Securities Lending and Repos: Market Overview and Financial Stability Issues published in April 2012. In addition, the FSB has endeavoured to ensure that its recommendations minimise the risk of regulatory arbitrage as well as undue distortion of markets, and are consistent with other international regulatory initiatives. In particular, the FSB launched in April 2013 a two-stage quantitative impact study (QIS)

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to assess the potential impact and unintended consequences associated with its recommendations on minimum haircut methodology standards and numerical haircut floors. The first stage of this QIS (QIS1) took place in April-June 2013 and consisted of collecting detailed historical haircut data from a small pool of large financial intermediaries globally so as to calibrate the proposed minimum haircut recommendations. The FSB subsequently conducted the second stage of the QIS (QIS2) in November 2013 - January 2014 to assess the scope and quantitative impact of the consultative proposals on a wider set of market participants including banks and broker- dealers, agent-lenders, and non-bank entities. Annex 2 summarises the results of the QIS2. The finalised regulatory framework for haircuts on non-centrally cleared securities financing transactions consists of: (i) qualitative standards for methodologies used by market participants that provide securities financing to calculate haircuts on the collateral received (Sections 2); and (ii) a framework of numerical haircut floors that will apply to non-centrally cleared securities financing transactions in which financing against collateral other than government securities is provided to entities other than banks and broker-dealers (hereafter "non-banks") (Section 3). After consideration of the consultation findings and QIS results, the levels of numerical haircut floors have been raised as shown in Table 1 in Section 3.2. The revised levels have been calibrated based on (i) the QIS1 and QIS2 results, (ii) existing market and central bank haircuts, and (iii) data on historical price volatility of different asset classes (which is summarised in Annex 3). Additionally, another maturity bucket has been introduced for debt securities with a residual maturity of more than ten years. To ensure shadow banking activities are fully covered, to reduce the risk of regulatory arbitrage, and to maintain a level-playing field, the FSB believes it is essential to expand the scope of its numerical haircut floors to cover securities financing transactions between non-banks or "non-bank-to-non-bank transactions". In this regard, the FSB is now issuing a consultative proposal on the application of numerical haircut floors to cover non-bank-to-non-bank transactions backed by collateral other than government securities (Annex 4). Application of the regulatory framework for haircuts may vary in details across jurisdictions, depending on existing regulatory frameworks and approaches adopted by national/regional authorities for implementing the numerical haircut floors. The FSB members are committed to timely implementation of the framework and consistency of outcomes across jurisdictions. Such implementation at the national and regional level will be monitored through the FSB process as set out in Section 3.6. The FSB welcomes comments on these proposals set out in Annex 4. Comments and responses to questions should be submitted by 15 December 2014 by email to [email protected] or by post (Secretariat of the Financial Stability Board, c/o Bank for International Settlements, CH-4002, Basel, Switzerland). All comments will be published on the FSB website unless a commenter specifically requests confidential treatment. http://www.financialstabilityboard.org/publications/r_141013a.htm

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UPDATE 1-Berlin and Paris seek reform proposals to avert policy clash Mon, Oct 13 2014 * Gabriel and Macron seek reform study by mid-November * Aim is to defuse Berlin-Paris clash on economic policy * France under fire for deficit, Germany for budget rigour (Adds French statement, quotes) By Noah Barkin and Rene Wagner BERLIN, Oct 13 (Reuters) - The German and French economy ministers have asked experts in Berlin and Paris to come up with reform recommendations for both countries in an apparent attempt to avert a full-blown clash between the euro zone heavyweights over economic policy. In letters signed by Sigmar Gabriel and Emmanuel Macron and seen by Reuters, the two ministers note that the European recovery is lagging that of other advanced economies, raising the risk of a "lost decade" of weak growth, excessively low inflation, high debt and high unemployment. The letters ask Henrik Enderlein, head of the Jacques Delors Institut in Berlin and a professor at the Hertie School of Governance, and Jean Pisani-Ferry, a French government adviser and former head of the Brussels-based Bruegel think tank, to compile a report by mid-November with concrete reform proposals. "As the two largest economies in Europe, France and Germany have a particular responsibility and a critical role to play to ensure both a rapid recovery and a strong and sustainable growth going forward," Gabriel and Macron write. By asking the two experts to make reform recommendations for both countries, the ministers seem intent on defusing an escalating war of words between Berlin and Paris, in which German officials have repeatedly lectured France on the need for more hard- hitting economic reforms. France announced earlier this month that it would not bring its deficit down within European Union limits until 2017, four years later than originally pledged, setting up a confrontation with the European Commission. Germany is also under fire for sticking with its ambitious goal for balanced budget next year despite a weakening German and European economy.

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Finance Minister Wolfgang Schaeuble came under fierce criticism at a meeting of the International Monetary Fund (IMF) in Washington last week for refusing to consider more public investments to stimulate growth. France, Italy and some other euro nations have been pressing Germany to agree to a Europe-wide initiative to boost investment. TITANIC One senior official in Berlin suggested that by proposing the joint reform study Gabriel, a Social Democrat (SPD), was seeking to avert a damaging confrontation between hard- liners in Berlin and the Socialist French government. "We want a solution that prevents the Titanic from hitting the iceberg," the official told Reuters. Another person familiar with the plan said: "We really need to end the France bashing in Germany and the Germany bashing in France by putting forward very specific proposals on what the countries should do." Sources said the Chancellery had been briefed on the plan beforehand. Angela Merkel's spokesman Steffen Seibert told a government news conference that the chancellor welcomed any initiative which might help France in its reform efforts. But a statement from the French economy ministry showed that Paris expects movement from Berlin as well. Macron's ministry said the request for reform recommendations reflected a desire for a "New Deal" in Europe that included a Europe- wide investment plan to be carried out "in the coming months". In their letters to Enderlein and Pisani-Ferry, the ministers ask them to focus on key structural reform needs that could be addressed by 2017, with a focus on investment and modernisation. They are also asked to outline possible joint Franco-German initiatives that could enhance competitiveness, structural convergence, integration and growth in Europe. (Reporting by Rene Wagner, Michael Nienaber in Berlin and Natalie Huet in Paris; Writing/Editing by Noah Barkin) http://in.reuters.com/article/2014/10/13/germany-france-reforms- idINL6N0S84AF20141013

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Infrastructure Investment Truly a No-Brainer : Tuesday Focus for October 14, 2014 by Brad DeLong Posted on October 13, 2014 at 6:17 pm Share I note the publication of the IMF World Economic Outlook and its chapter 3 calling for North Atlantic economies to borrow more and spend it on infrastructure because, right, now in today’s exceptional circumstances, it is–as Larry Summers and I pointed out in 2012–a policy that is self-financing does not increase but rather reduces the relative burden of the national debt. It is thus time for Larry and me–and everyone else who has been doing the arithmetic– to take a big victory lap. We have had no effect on policy in the North Atlantic in the past 2 1/2 years. But we were (and are) right. And it is important to register that–both so that our intellectual adversaries rethink their models and thus their positions, and so that the North Atlantic economic policymakers can do better next time. And next time is, come to think of it, right now: interest rates on the debts of reserve currency-issuing sovereigns are no higher, infrastructure gaps are larger, and output gaps are at least as large as they were 2 1/2 years ago. It’s not too late to do the right thing, people! Jérémie Cohen-Setton: Infrastructure Investment Is a No-Brainer: “Infrastructure investment is a no-brainer… …for countries with infrastructure needs, the combination of low interest rates and mediocre growth mean that it’s time for an investment push. What’s at stake: For countries with infrastructure needs, the combination of low interest rates and mediocre growth mean that it’s time for an investment push. While Brad DeLong and Lawrence Summers already laid out the theoretical case in a 2012 Brookings paper, the empirical case was laid out this week in Chapter 3 of the latest IMF World Economic Outlook. Lawrence Summers writes that in a time of economic shortfall and inadequate public investment, there is for once a free lunch – a way for governments to strengthen both the economy and their own financial positions. Greg Mankiw writes that the free-lunch view is certainly theoretically possible (just like self-financing tax cuts), but we should be skeptical about whether it can occur in practice (just like self-financing tax cuts). 143

Abiad and al. write on the IMF blog that the evolution of the stock of public capital suggests rising inadequacies in infrastructure provision. Public capital has declined significantly as a share of output over the past three decades in both advanced and developing countries. In advanced economies, public investment was scaled back from about 4 percent of GDP in the 1980s to 3 percent of GDP at present (maintenance spending has also fallen, especially since the financial crisis). This makes a very strong case for sharply increasing public investment in a depressed economy Paul Krugman writes that this is disinvestment madness. Real interest rates are extremely low, indicating that the private sector sees very little opportunity cost in using funds for public investment. There has been a lot of slack in the labor market, so that many of the workers one would employ in public investment would otherwise have been idle–so very little opportunity cost there either. This makes a very strong case for sharply increasing public investment in a depressed economy; a case that doesn’t rely on claims that there is a large multiplier, although there’s every reason to believe that this is also true. The authors of the WEO’s chapter 3 write that in contrast to the large body of literature that has focused on estimating the long term elasticity of output to public and infrastructure capital using a production function approach, the IMF analysis adopts a novel empirical strategy that allows estimation of both the short- and medium-term effects of public investment on a range of macroeconomic variables. Specifically, it isolates shocks to public investment that can plausibly be deemed exogenous by following the approach of smooth transition VARs of Auerbach and Gorodnichenko (2012, 2013), where the shocks are identified as the difference between forecast and actual investment. In the WEO chapter, the forecasts of investment spending are those reported in the fall issue of the OECD’s Economic Outlook for the same year. The positive effects of increased public infrastructure investment are particularly strong when public investment is undertaken during periods of economic slack and monetary policy accommodation The authors of the WEO’s chapter 3 write that a problem in the identification of public investment shocks is that they may be endogenous to output growth surprises. But the public investment innovations identified are only weakly correlated (about –0.11) with output growth surprises. Another possible problem in identifying public investment shocks is a potential systematic bias in the forecasts concerning economic variables other than public investment, with the result that the forecast errors for public investment are correlated with those for other macroeconomic variables. To address this concern, the measure of public investment shocks has been regressed on the forecast errors of other components of government spending, private investment, and private consumption. Abiad and al. write on the IMF blog that the benefits depend on a number of factors. The authors find that the positive effects of increased public infrastructure investment are particularly strong when public investment is undertaken during periods of economic slack and monetary policy accommodation, where additional public investment spending is not wasted and is allocated to projects with high rates of return

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and when it is financed by issuing debt has larger output effects than when it is financed by raising taxes or cutting other spending. Mario Monti writes that while a simplistic stability pact may have been the right choice when the euro was in its infancy, Europe can no longer afford to stick with such a rudimentary instrument. By failing to recognize the proper role of public investment, it has pushed governments to stop building infrastructure just when they should have built more. What is needed is not the flexibility to deviate from the rules, but rules that are economically and morally rigorous. The new Commission should announce a proposal for updating the rules on fiscal discipline, to reflect the role of productive public investment. The commission would then enforce the existing stability pact while allowing for the favorable treatment of public investment within the limits set out in 2013. Europe needs mechanisms for carrying out self-financing infrastructure projects outside existing budget caps Lawrence Summers writes that Europe needs mechanisms for carrying out self- financing infrastructure projects outside existing budget caps. This may be possible through the expansion of the European Investment Bank or more use of capital budget concepts in implementing fiscal reviews. And: Greg Mankiw: Greg Mankiw’s Blog: The IMF on Infrastructure: “The IMF endorses the free-lunch view of infrastructure spending… …That is, an IMF study suggests that the expansionary effects are sufficiently large that debt-financed infrastructure spending could reduce the debt-GDP ratio over time. Certainly this outcome is theoretically possible (just like self-financing tax cuts), but you can count me as skeptical about how often it will occur in practice (just like self- financing tax cuts). The human tendency for wishful thinking and the desire to avoid hard tradeoffs are so common that it is dangerous for a prominent institution like the IMF to encourage free-lunch thinking.” I think that it is time to crank my ire level up to 11. The Laffer Curve proposition holds true–tax-rate cuts are self-financing–if, defining α to be the elasticity of production with respect to the net-of-tax rate: τ > 1/(1+α) If: τ = 1/(1+α) then tax revenue is at its maximum. If: τ < 1/(1+α) then the Laffer Curve proposition fails, and tax-rate cuts are not self-financing. Arguments that the Laffer Curve proposition fails–that tax-rate cuts reduce revenue–are invariably arguments, with various bells and whistles added on, that the economy’s parameter α is in the range from 0.25 to 1, depending, and thus that the critical tax rate τ

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at which the Laffer Curve proposition becomes true is between 50% and 80%, and thus above the current tax rate t. Arguments that infrastructure investment is not self-financing should, similarly, invariably be arguments, with bells and whistles, that the net revenue raised ρt–the product of ρ, the comprehensive net rate of return on and thus the income produced by a dollar of infrastructure investment, multiplied by the current tax rate t–is less than the real rate of interest r at which the government must borrow to finance its infrastructure investment: In a world where the real rate at which the U.S. Treasury can borrow for ten years is 0.3%/year and in which the tax rate t is about 30%, infrastructure investment fails to be self-financing only when the comprehensive rate of return is less than 1%/year. Now you can make that argument that properly-understood the comprehensive rate of return is less than 1%/year. Indeed, Ludger Schuknecht made such arguments last Saturday. He did so eloquently and thoughtfully in the deep windowless basements of the Marriott Marquis Hotel in Washington DC at a panel I was on. But Mankiw doesn’t make that argument. And because he doesn’t, he doesn’t let his readers see that there is a huge and asymmetric difference between: • my argument that tax-rate cuts are not (usually) self financing, which at a tax rate t=30% requires only that α < 2.33; and: • his argument that infrastructure investment is not self-financing, which at a tax rate t=30% requires that ρ < 1%/year. To argue that α < 2.33 is very easy. To argue that ρ < 1%/year is very hard. So how does Mankiw pretend to his readers that the two arguments are equivalent? By offering his readers no numbers at all. The data of economics comes in quantities. We can count things. We should count things. Please step up the level at which you play this game, guys… http://equitablegrowth.org/2014/10/13/infrastructure-investment-truly-brainer-tuesday- focus-october-14-2014/

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Infrastructure investment is a no- brainer

- for countries with infrastructure needs, the combination of low interest rates and mediocre growth mean that it’s time for an investment push by Jérémie Cohen-Setton on 13th October 2014

What’s at stake: For countries with infrastructure needs, the combination of low interest rates and mediocre growth mean that it’s time for an investment push. While Brad DeLong and Lawrence Summers already laid out the theoretical case in a 2012 Brookings paper, the empirical case was laid out this week in Chapter 3 of the latest IMF World Economic Outlook. Lawrence Summers writes that in a time of economic shortfall and inadequate public investment, there is for once a free lunch – a way for governments to strengthen both the economy and their own financial positions. Greg Mankiw writes that the free-lunch view is certainly theoretically possible (just like self-financing tax cuts), but we should be skeptical about whether it can occur in practice (just like self-financing tax cuts). Disinvestment madness Tweet This In advanced economies, public investment was scaled back from about 4% of GDP in the 1980s to 3% of GDP at present Abiad and al. write on the IMF blog that the evolution of the stock of public capital suggests rising inadequacies in infrastructure provision. Public capital has declined 147

significantly as a share of output over the past three decades in both advanced and developing countries. In advanced economies, public investment was scaled back from about 4 percent of GDP in the 1980s to 3 percent of GDP at present (maintenance spending has also fallen, especially since the financial crisis).

IMF Tweet This This makes a very strong case for sharply increasing public investment in a depressed economy Paul Krugman writes that this is disinvestment madness. Real interest rates are extremely low, indicating that the private sector sees very little opportunity cost in using funds for public investment. There has been a lot of slack in the labor market, so that many of the workers one would employ in public investment would otherwise have been idle — so very little opportunity cost there either. This makes a very strong case for sharply increasing public investment in a depressed economy; a case that doesn’t rely on claims that there is a large multiplier, although there’s every reason to believe that this is also true. Methodology for identifying investment shocks The authors of the WEO’s chapter 3 write that in contrast to the large body of literature that has focused on estimating the long term elasticity of output to public and infrastructure capital using a production function approach, the IMF analysis adopts a novel empirical strategy that allows estimation of both the short- and medium-term effects of public investment on a range of macroeconomic variables. Specifically, it isolates shocks to public investment that can plausibly be deemed exogenous by following the approach of smooth transition VARs of Auerbach and Gorodnichenko (2012, 2013), where the shocks are identified as the difference between forecast and actual investment. In the WEO chapter, the forecasts of investment spending are those reported in the fall issue of the OECD’s Economic Outlook for the same year.

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Tweet This The positive effects of increased public infrastructure investment are particularly strong when public investment is undertaken during periods of economic slack and monetary policy accommodation The authors of the WEO’s chapter 3 write that a problem in the identification of public investment shocks is that they may be endogenous to output growth surprises. But the public investment innovations identified are only weakly correlated (about –0.11) with output growth surprises. Another possible problem in identifying public investment shocks is a potential systematic bias in the forecasts concerning economic variables other than public investment, with the result that the forecast errors for public investment are correlated with those for other macroeconomic variables. To address this concern, the measure of public investment shocks has been regressed on the forecast errors of other components of government spending, private investment, and private consumption. Main results Abiad and al. write on the IMF blog that the benefits depend on a number of factors. The authors find that the positive effects of increased public infrastructure investment are particularly strong when public investment is undertaken during periods of economic slack and monetary policy accommodation, where additional public investment spending is not wasted and is allocated to projects with high rates of return and when it is financed by issuing debt has larger output effects than when it is financed by raising taxes or cutting other spending. Infrastructure investment in Europe Mario Monti writes that while a simplistic stability pact may have been the right choice when the euro was in its infancy, Europe can no longer afford to stick with such a rudimentary instrument. By failing to recognize the proper role of public investment, it has pushed governments to stop building infrastructure just when they should have built more. What is needed is not the flexibility to deviate from the rules, but rules that are economically and morally rigorous. The new Commission should announce a proposal for updating the rules on fiscal discipline, to reflect the role of productive public investment. The commission would then enforce the existing stability pact while allowing for the favorable treatment of public investment within the limits set out in 2013. Tweet This Europe needs mechanisms for carrying out self-financing infrastructure projects outside existing budget caps Lawrence Summers writes that Europe needs mechanisms for carrying out self- financing infrastructure projects outside existing budget caps. This may be possible through the expansion of the European Investment Bank or more use of capital budget concepts in implementing fiscal reviews. http://www.bruegel.org/nc/blog/detail/article/1457-infrastructure-investment-is-a-no- brainer/

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vox Research-based policy analysis and commentary from leading economists The cleansing effect of the minimum wage in China Florian Mayneris, Sandra Poncet13 October 2014 Minimum wage laws are often shown to have little impact on employment as the labour price rise can be offset by lower turnover, lower markups, and heightened efficiency, or ‘cleansing’ effects. This column shows that in a fast-growing economy like China, there is a ‘cleansing’ effect of labour market standards. Minimum wage growth allows more productive firms to replace the least productive ones and forces incumbent firms to become more competitive. Both mechanisms boost the aggregate efficiency of the economy. Can higher minimum wages ensure that economic development benefits the poorest without hindering growth? The question is controversial in both academic and policy circles. The recent riots in Bangladesh and Cambodia show that the social demand for a more equal distribution of the benefits of growth is high in developing countries. In China, polls reveal that concerns about inequality have grown as "roughly eight-in-ten have the view that the rich just get richer while the poor get poorer'' (Pewresearch Center 2012). The debate is also heated in developed economies. Renowned politicians and economists have called for a significant rise in minimum wages in the US (Woellert 2014), as has Barack Obama in his 2014 State of the Union address. On the other hand, any attempt by authorities to increase minimum wages is opposed by employer federations, who argue that higher wages will erode their margins, forcing them to fire workers or entirely relocate their activities to countries with lower wages. Some economists also argue that a minimum wage has detrimental effects on employment, especially for low-skilled workers (Neumark et al. 2013) In a recent article (Mayneris et al. 2014), we investigate these issues in the case of China, the fastest growing economy of the past 15 years, both at the firm level and at the aggregate level How are minimum wages set in China? Minimum wages were first introduced in China in 1993. As different Chinese regions have very different living standards, China does not have one national minimum wage; minimum wages are rather established following a decision process involving both national and local authorities. Each province, municipality, autonomous region, and even district sets its own minimum wage according to both local conditions and national guidelines. However, the 1993 rules did not really cover migrants, and the penalties in the case of non-enforcement were only low. As such, minimum wages in the 1990s did not really bind in China. In March 2004, the Rules for Minimum Wages (2004 Rules) took effect.

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These extended minimum-wage coverage to migrant workers, and penalties in the case of non-enforcement were dramatically increased. Why is China an interesting case? China is a relevant case to analyse for a number of reasons. First, China is a showcase in terms of low wages. In 2004, average monthly wages in manufacturing were $141 in China, versus $342 in Mexico and over $2,500 in the US. Moreover, China is characterised by great variations in both the level and the growth-rate of minimum wage across cities. This decentralised fixation of minimum wages ensures spatial variations in the level of minimum wages but gives rise to an endogeneity problem. Local authorities may fix the level of minimum wage depending on local economic conditions, which makes it difficult to disentangle the effect of minimum wage from other local factors. The reform passed in 2004 is interesting in this respect, since it follows a top-down logic. The aim of this reform was to increase workers' wages and bring about convergence between localities in terms of the minimum wage. After 2004, city-level minimum wages had to fall within a range of 40-60% of the local average wage. This rule imposed unprecedented rises in the minimum wage, in particular in localities where they were initially the lowest. We exploit this quasi-natural experiment feature of the reform for the estimation of firm-level and aggregate effects of minimum wage growth. How binding is the 2004 reform of minimum wages in China? The reform imposes a massive rise in city-level minimum wages. As shown in Figure 1, city-level minimum wages increase all over the 2000-07 period, with a clear acceleration from 2004 onwards. While the average annual growth rate in city-level minimum wages was 6.9% between 2000 and 2003, it was 15.5% between 2003 and 2007. Moreover, as targeted by national authorities, the dispersion of minimum wages across localities narrowed significantly (the coefficient of variation of city-level minimum wages decreasing by 25% between 2003 and 2007, (Figure 2)). City-level minimum wages may have only little effect for two reasons: a lack of enforcement, or the minimum wage not really binding (if firm-level wages are rising faster than the minimum wage, for example). This does not seem to be the case. First, the 2004 reform aimed to increase firm-level compliance by strengthening controls and reinforcing non-compliance penalties. Prior to 2004, average wages were at least equal to the local city-level minimum wage in roughly 88.5% of active firms. This figure rose to 93.2% after 2004, suggesting that the Chinese minimum-wage reform was accompanied at the local level by greater enforcement. Moreover, Figure 3 shows that firm-level wages increase markedly between 2003 and 2005, the distribution of individual wages in 2005 being right-shifted as compared to the one observed before the 2004 reform. However, these changes do not occur uniformly along the distribution. In 2005, fewer firms declare an average wage lower than the local minimum wage as compared to 2003. In contrast, more firms now declare an average wage that is equal or slightly higher than the local minimum wage. This concentration of the distribution of firm-level average wages around the level of the city-level minimum wage cannot be attributed to a specific trend, since no such pattern is observed when comparing 2001 and 2003.

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Figure 1.

Figure 2.

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Figure 3.

The 2004 reform thus produced unprecedented changes in the minimum wage, both in nominal and real terms. Moreover, these changes seem to be binding. The share of complying firms rose sharply, as did the share of firms with average wages that are equal to or only slightly higher than the minimum wage. Minimum wages as a way to foster productivity Regarding the micro effects of this reform, we find that higher minimum wages reduced the survival probability of local firms between 2003 and 2005. However, in the surviving firms wages rose without any effect on employment. The main explanation for this finding is that productivity rose significantly, allowing firms to absorb the cost shock without affecting employment or profitability. At the city level, our results suggest that the overall effect of firm-level adjustments in city-level industrial employment is zero, with entries cancelling out exits. Moreover, higher minimum wages increase aggregate productivity growth thanks to productivity improvements among incumbent firms and the net entry of more productive firms. The effects we measure are economically large. Minimum wage growth between 2003 and 2005 explains on average 20% of firm-level and city-level productivity gains in China over the period under consideration. Conclusion Other studies on developed countries such as the US or the UK find little or null effects of minimum wage on employment (Schmitt 2013). There might be good reasons for this. From a theoretical viewpoint, the cost shock brought about by a minimum wage

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increase can be compensated by reduced turnover of employees, lower markups for firms (as shown by Draca et al. 2011 in the UK) or better efficiency. Both firm-level inefficiency and the misallocation of resources across firms have been proposed as explanations of the lower aggregate productivity in developing countries (Hsieh and Klenow 2009). Regarding the first channel, a number of recent papers have shown that there is a fixed cost of adopting better practices/technologies, due to specific investments, cognitive bias or a fixed utility cost for entrepreneurs associated with a change in the way they usually do (Bloom et al. 2013; Duflo et al. 2011). Low wages reduce the cost of not adopting the best production processes. In some developing countries, the absence of minimum wage might thus give incumbent firms little incentive to adopt more efficient but also more costly technologies or management practices; they might also allow some inefficient firms to survive. In line with this intuition, our results show that in a fast-growing economy like China, there is a cleansing effect of labour market standards. Minimum wage growth allows more productive firms to replace the least productive ones and forces incumbent firms to become more competitive, these two mechanisms boosting the aggregate efficiency of the economy. References Bloom N, J Liang, J Roberts and Z J Ying (2013), "Does working from home work? Evidence from a Chinese experiment", NBER WP No. 18871. Draca M, S Machin and J Van Reenen (2011), "Minimum Wages and Firm Profitability", American Economic Journal: Applied Economics 3(1): 129-51. Duflo E, M Kremer and J Robinson (2011), "Nudging farmers to use fertilizer: Theory and experimental evidence from Kenya", American Economic Review 101(6), 2350- 2390. Hsieh, C T and P Klenow (2009), "Misallocation and Manufacturing TFP in China and India", Quarterly Journal of Economics 124 (4): 1403-48. Mayneris F, S Poncet and T Zhang (2014), "The cleansing effect of minimum wage : Minimum wage rules, firm dynamics and aggregate productivity in China", CEPII Working Paper, N°2014-16, September. Neumark D, J M I Salas and W Wascher (2013), "Revisiting the Minimum Wage- Employment Debate: Throwing Out the Baby with the Bathwater?", NBER Working Paper No. 18681. Pewresearch Center (2012), Growing Concerns in China about Inequality, Corruption. Schmitt, J (2013), "Why Does the Minimum Wage Have No Discernible Effect on Employment?", CEPR working paper. February. Woellert, L (2014), "Seven Nobel laureates endorse higher US minimum wage," The StarPhoenix, Bloomberg Wire Service, January 15. http://www.voxeu.org/article/cleansing-effect-minimum-wage-china

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ft. com World Europe October 13, 2014 7:06 pm Paris stands firm against fiscal enforcers By Peter Spiegel in Luxembourg and Hugh Carnegy in Paris

©Bloomberg Michel Sapin, France's finance minister Ever since the French government unveiled its 2015 budget two weeks ago, fiscal enforcers in Brussels have attempted to convince Paris it must do more – making additional spending cuts and implementing more reforms – for them to accept the plan. In recent days, as the prospect of an EU rejection became imminent, the discussions moved beyond the normal economic channels, pulling in members of the still-to-be- approved European Commission, including Jean-Claude Juncker, its incoming president, and Frenchman Pierre Moscovici, his economic nominee. More ON THIS TOPIC// Nick Butler Is privatisation the answer for France?/ Sigfox eyes ‘internet of things’ network/ Sylvie Goulard France’s magical thinking/ France to adopt plain cigarette packaging IN EUROPE// Moscow battles to ease dollar shortage/ France unveils deregulation proposals/ Russia’s defence budget hit by slowdown/ Wall St calm at axing of Double Irish tax “Juncker’s line is: help me to help you,” said one EU official involved in the talks. But with Paris due to submit its plan on Wednesday, hopes of an eleventh-hour deal have faded. The chances of the French government making any changes before the outgoing Commission rules on the budget at the end of the month are also waning. “The figures we are hearing from Paris are not very hopeful,” Jeroen Dijsselbloem, the Dutch finance minister who heads the eurogroup committee of his eurozone counterparts, said on Monday at the group’s meeting in Luxembourg. Instead, Paris has adopted a defiant stance. Manuel Valls, the prime minister who is a strong advocate of reforms, has responded angrily to Mr Dijsselbloem’s increasingly vocal charges that France has not done enough. “The president of the eurogroup should not make remarks like these. It is we who decide our budget,” he said. “I will not accept lessons on good government.”

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The intransigence has left the European Commission little choice but to use the last meeting of its mandate to reject the budget, sending it back to Paris for more work. In an effort to soften the blow, officials are considering adding three other countries to the reject list – most controversially Italy, but also Malta and Slovenia – in an effort to show it is not singling out Paris. Italy has also been defiant, insisting it will not breach EU rules when it submits its spending plan despite warnings it is not reducing its debt fast enough. “There is no negotiation with Brussels,” insisted Pier Carlo Padoan, the Italian finance minister, in Luxembourg. The last time France sought lenience from Brussels was just last year. On the sidelines of a February G20 meeting in Moscow, Mr Moscovici, then the French finance minister, agreed with Olli Rehn, the then EU economic chief, on a set of reforms his government would make. Mr Rehn took the government at its word and granted it a two-year extension of its deadline – originally 2013 – for bringing the deficit within the EU limit of 3 per cent of national output. “In a way, I always considered it as a test case,” Mr Rehn said in an interview. “It’s not fair to say they didn’t do anything, but they didn’t do enough . . . The Commission is bound to take a critical decision.” Michel Sapin, the finance minister, said in an interview earlier this month that going beyond the €50bn in spending cuts promised over the next three years would pose too great a recessionary risk. For domestic political reasons, the government also cannot be seen to be caving in to Brussels before it has even deposited its budget proposal. Mr Valls needs to keep onside a ruling Socialist party already restive over policies widely seen as being imposed by Brussels. But the government is acutely aware it needs to show its European partners it is willing to do more if it wants to win approval for further delay in reaching the deficit target. Instead, it will actually rise this year to 4.4 per cent before falling slightly to 4.3 per cent by next year’s deadline. Mr Moscovici, who will inherit the unenviable task of ruling on his former boss’s work when he takes office on November 1, has been urging President François Hollande to be more forthcoming, particularly on the deficit. Officials said that in private conversations Mr Hollande is more open to at least showing his government is on the right track and has urged measures that would see the deficit continue to drop. But the government is putting the emphasis on its willingness to push on with economic reforms rather than budget cutting. There was uproar in Socialist ranks at the weekend over successive suggestions by Mr Valls and Emmanuel Macron, the liberal-minded new economy minister, that they favoured an overhaul of France’s generous unemployment benefits regime. More immediately, Mr Macron is preparing a new package of reforms to be unveiled in the coming weeks. He says these will tackle a range of rigidities in the economy long criticised by the EU, including deregulation of the labour market, breaking down service

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sector monopolies, extending Sunday and evening opening in the retail trade and simplification of rules governing the housing sector. “It is time for France to go back on the offensive. France has to do its job,” he said in an interview with a Sunday newspaper. “We have six months to create a new deal in France and Europe.” http://www.ft.com/intl/cms/s/0/87e14888-52f1-11e4-b917- 00144feab7de.html#axzz3G1g7NOhM

ft.com Comment Blogs Gavyn Davies It’s the “new mediocre”, not a global recession Gavyn Davies Oct 12 14:4922Share Financial markets caught a nasty chill last week, when extremely weak activity data from Germany coincided with fears that the ECB could not overcome Bundesbank opposition to more aggressive quantitative easing. Then the IMF reported that there is a 40 per cent probability of a recession in the euro area within 12 months, along with a 30 per cent chance of outright deflation. Markets fear that policy makers in the euro area are once again losing control over their weakening economy. Since markets often sniff out impending trouble before economists do, there is, as Martin Wolf warns, no room whatever for complacency. But, so far, the blip in global risk assets hardly registers on the Richter scale. Nor is there much evidence from published data of a major slowdown in global GDP growth up to now.

US domestic demand is strengthening, and the 20 per cent fall in oil prices since June will boost the oil importing economies markedly in coming months. Unless euro area

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policy is spectacularly dysfunctional, which I do not expect, the slide in the euro area should not be powerful enough to offset these expansionary forces. The latest activity data for the global economy are shown in this chart pack. Here are some of the main points. First, recent downgrades to global GDP forecasts, which admittedly have been fairly large, are replicating a pattern seen in successive years since the financial crash. Repeatedly, economists have been optimistic that a strong global recovery is just around the corner, only to be disappointed in the course of the following year. There are plenty of reasons to be worried about this “secular stagnation”, but it has not yet resulted in a renewed global recession. Mini cyclical slowdowns in the context of moderate expansion have been the pattern. Revisions to growth projections in 2014 look rather similar: Second, the latest bout of weakness is concentrated mainly in the euro area, with forecasts for the US actually being revised upwards since the summer. One of these two trends is likely to overpower the other; currently, there still seems to be a good chance that the US strength will win out:

Third, nowcast models, which probably offer the best snapshots of recent economic data, have not picked up any slowdown yet in overall global activity. (Nor, incidentally, have PMI business surveys – see chart pack page 11.) Surprisingly, in view of recent pessimism about China, the nowcast for that economy remains firm, as it has since the policy easing in February. Overall, the global growth rate is shown to be stable at around 3.7 per cent, despite clear weakness in the euro area: Fourth, the drop in oil prices from $115/barrel for Brent in June to about $90 now should start to boost domestic demand in oil importing counties fairly soon. This oil price decline seems to have been triggered partly by the sluggish growth in global manufacturing output, and partly by supply side forces, including increased oil output in Iraq and Libya. Supply driven oil shocks tend to have the bigger impact on global 158

activity.

The IMF last week published a simulation of the downside impact on global growth that would follow an adverse supply shock in the oil market, causing an upward spike in oil prices.Reversing the signs of these simulations, we find that a persistent drop of $25/barrel in oil prices would boost the level of global GDP by about 0.5-1.5 per cent in the second year (depending on financial market and other confidence effects). It is surprising that such a large positive force is being largely ignored in financial markets. Fifth, what if there is a euro area recession? How much damage would it do to the global economy? If it causes major shock waves in financial markets, it could certainly have very damaging effects on confidence elsewhere. But even in the extreme euro crisis of 2012, it was not enough to send the world economy as a whole into recession, although it certainly damaged global equities for a while, and required dramatic ECB action to solve it.

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The simulation below (estimated by my Fulcrum colleague Juan Antolin Diaz, using factor models and VAR models of the world economy) shows what might happen to the global economy if the euro area falls into the kind of mild recession envisaged by the IMF. It would reduce global GDP growth by about 1 per cent at the worst point next year, and this would dent (but not eliminate) growth prospects in the US and China, both of which would continue to grow at close to trend:

Maybe this assessment will prove far too optimistic. Perhaps the combination of high global debt levels, declining growth in nominal GDP, and excessive increases in leverage in the emerging world, will prove fatal for the global recovery. But these depressing forces have been around for several years, and until now they have suppressed the strength of the global recovery, rather than ending it altogether. Last week, IMF Managing Director Christine Lagarde warned about the “new mediocre”. Mediocre it certainly is, but that is better than recession. http://blogs.ft.com/gavyndavies/2014/10/12/its-the-new-mediocre-not-a-global- recession/

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vox Research-based policy analysis and commentary from leading economists The great mortgaging Òscar Jordà, Alan Taylor, Moritz Schularick12 October 2014 The Global Crisis prompted Lord Adair Turner to ask if the growth of the financial sector has been socially useful, catalysing an ongoing debate. This column turns to economic history to investigate whether the financial sector is too big. New long-run, disaggregated data on banks’ balance sheets show that mortgage lending by banks has been the driving force behind the financialisation of advanced economies. Real estate lending booms are chiefly responsible for financial crises and weak recoveries. Related// Private and public debt in crises: 1870 to now/ Òscar Jordà, Moritz Schularick, Alan Taylor/ Fact-checking financial recessions: US-UK update Moritz Schularick, Alan Taylor/ Credit booms go wrong Alan Taylor, Moritz Schularick Understanding the causes and consequences of the rise of finance is a first order concern for macroeconomists and policymakers. The increasing size and leverage of the financial sector has been interpreted as an indicator of excessive risk taking1 and has been linked to the increase in income inequality in advanced economies,2 as well as to the growing political influence of the financial industry (Johnson and Kwak 2010). Yet surprisingly little is known about the driving forces behind these trends. Figure 1. Average ratio of two types of bank lending to GDP in 17 advanced economies

Notes: Mortgage (residential and commercial) and non-mortgage lending to the business and household sectors. Average across 17 countries.

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Figure 2. Shares of bank lending by type in 17 advanced economies at key dates

Notes: Share of mortgage lending to total lending in 1928, 1970, and 2007 for each of the countries in the sample. 162

In our recent research we turn to economic history. We build on our earlier work that first demonstrated the dramatic growth of the balance sheets of financial intermediaries in the second half of the 20th century and how periods of rapid credit growth were often followed by systemic financial crises and severe recessions (Schularick and Taylor 2012, Jordà et al. 2013). We unveil a new long-run dataset covering disaggregated bank credit for 17 advanced economies from 1870 to today (Jordà et al. 2014). The new data allow us to delve much deeper than has been previously possible into the forces driving the growth of finance. For the first time we can construct the share of mortgage loans in total bank lending for most countries back to the 19th century. In addition, we can calculate the share of bank credit to business and households for most countries for the decades after WW2, and back to the 19th century for a handful of countries. The global mortgage boom The first important insight from our data collection effort is that the sharp increase of credit-to-GDP ratios in advanced economies in the 20th century has been first and foremost a result of the rapid growth of loans secured against real estate – i.e. mortgage and hypothecary lending. The share of mortgage loans in banks’ total lending portfolios has roughly doubled over the course of the past century –from about 30% in 1900 to about 60% today, as Figure 1 demonstrates. In other words, banking today consists primarily of the intermediation of savings to the household sector for the purchase of real estate. The core business model of banks in advanced economies today resembles that of real estate funds: banks are borrowing (short) from the public and capital markets to invest (long) in assets linked to real estate. By contrast, non-mortgage bank lending to companies for investment purposes and nonsecured lending to households have remained stable over the 20th century in relation to GDP. Nearly all of the increase in the size of the financial sectors in Western economies since 1913 stems from a boom in mortgage lending to households and has little to do with the financing of the business sector. These findings have important implications for the debate about the role of finance. The intermediation of household savings for productive investment in the business sector – the textbook description of the financial sector – constitutes only a minor share of the business of banking today, even though it was a central part of that business in the 19th and early 20th centuries. Figure 2 well illustrates this structural shift in financial intermediation for all the countries in our sample at three benchmark years: 1928, 1970, and 2007. Record leverage A natural follow-up question is whether the surge in household borrowing reflects rising asset values without substantial shifts in household leverage ratios (the ratio of household mortgage debt to the value of residential real estate); or whether households increased debt levels relative to asset values. The latter would raise greater concerns about the macroeconomic stability risks stemming from more highly leveraged household portfolios.

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We also gathered historical data for the total value of the residential housing stock (structures and land) for a number of benchmark years in order to relate household mortgage debt to asset values. We combine information from Goldsmith’s (1985) seminal study of national balance sheets with the more recent and more precise estimates of historical wealth to income ratios by Piketty and Zucman (2014). We find that, as a byproduct of the boom in mortgage lending, household leverage ratios (mortgage debt divided by the value of the housing stock) have increased substantially in many economies over the 20th century, as seen in Figure 3. Put differently, household mortgage debt has typically risen faster than asset values, resulting in record-high leverage ratios that potentially increase the fragility of household balance sheets and the financial system itself. Real estate credit and macro-prudence Another important finding of our study is that mortgage credit has played an increasingly important role in the generation of financial fragility in advanced economies. We present evidence that the changing nature of financial intermediation has shifted the locus of crisis risk towards mortgage activity. Mortgage lending booms were only loosely associated with financial crisis risks before WW2, but since then real estate credit has become a significant predictor of impeding financial fragility in the postwar era. Figure 3. Trends in aggregate loan-to-value ratios

Sources: Piketty and Zucman (2014), Goldsmith (1985) and our data. Individual data points are rough approximations relying on reconstructed historical balance sheet data for benchmark years. Complementing the influential recent work of Mian and Sufi (2014) for the US, our work takes a longer and wider view to show that the blowing up and bursting of private

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credit booms – centered on aggressive mortgage expansion – reflects deep processes at work across all of the advanced countries. This is a phenomenon that has built up persistently across the mid to late 20th century. The crucial role of mortgage credit in financial fragility is significant for the design of new macro-prudential policies today. The results underline the need for better, more nuanced monitoring of the buildup of financial instability: it is not just a matter of how loose credit is in the aggregate, but also how it is being used. Housing finance and the business cycle In the last part of the paper, we turn to the aftermath of lending booms and study their consequences for the real economy. The objective is to see if the important shifts in the structure of financial intermediation have had implications for the role of credit over the business cycle: is there historical evidence that recessions are more severe if they are preceded by real estate lending booms? Our analysis is based on the near-universe of business cycles in advanced economies since 1870, and we use local projections with a broad set of macroeconomic controls. We employ inverse probability weighting to re-randomise the allocation of observations into normal business cycles and those associated with a financial crisis so as to address endogeneity concerns. Figure 4. Conditional cumulated deviations (in %) for real GDP per capita from the start of the recession by type of recession and mortgage/non-mortgage credit perturbations

Notes: Samples are 1870-1939 (excluding WWI), and 1948-2010. Each path shows IPWRA estimates of the cumulative change relative to peak for years 1-5 of the recession/recovery period under different experiments. The blue solid line with the shaded region refers to the average path in normal recessions. The shaded region is a 95% confidence interval. The red solid line without a shaded region refers to financial crisis recessions. The dotted lines refer to the path in a normal/financial crisis recession when nonmortgage credit during the expansion 165

grew at the mean plus one standard deviation. The dashed lines refer to the path in a normal/financial crisis recession when mortgage credit during the expansion grew at the mean plus one standard deviation. The IPWRA estimates are conditional on the full set of macroeconomic aggregates and their lags, with paths evaluated at the means. By using our new disaggregated credit data we can demonstrate that contemporary business cycles seem to be increasingly shaped by the dynamics of mortgage credit, with nonmortgage lending playing only a minor role. Since WW2, it is only the aftermaths of mortgage booms that are marked by deeper recessions and slower recoveries. Both in normal recessions and in financial crisis recessions, the slump is deeper and the recovery slower if mortgage growth was rapid in the preceding boom, as Figure 4 shows. Conclusions Our new research combines modern methods of statistical analysis with the painstaking construction of a new large-scale historical dataset. We expect that the value of this dataset will transcend the present paper and that it will become an important resource for macroeconomic research going forward. Our findings call for a more differentiated view on credit growth and on the implications that this differentiation has for financial stability, macroeconomic policies, and financial regulation. Important insights into the sources of financial fragility and the role of credit in the business cycle would be overlooked without a disaggregated perspective on the various types of credit and their development over the course of modern macroeconomic history. In the second half of the 20th century, banks and households have been heavily leveraging up through mortgages. Mortgage credit on the balance sheets of banks has been the driving force behind the increasing financialisation of advanced economies. Our research shows that this great mortgaging has been a major influence on financial fragility in advanced economies, and has also increasingly left its mark on business cycle dynamics. References Admati, A, and M Hellwig (2013) The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about It, Princeton, N.J.: Princeton University Press. Aikman, D, A G Haldane, and B D Nelson (2014) "Curbing the Credit Cycle“, Economic Journal, forthcoming. Godechot, O (2012) "Is Finance Responsible for the Rise in Wage Inequality in France?“ Socio-Economic Review 10(3): 447–70. Goldsmith, R W (1985) Comparative National Balance Sheets: A Study of Twenty Countries, 1688–1979, Chicago: University of Chicago Press. Johnson, S, and J Kwak (2010) 13 Bankers: The Wall Street Take Over and the Next Financial Meltdown, New York: Vintage Books. Jordà, Ò, M Schularick, and A M Taylor (2013) "When Credit Bites Back“, Journal of Money, Credit and Banking 45(s2): 3–28.

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Jordà, Ò, M Schularick, and A M Taylor (2014) "The Great Mortgaging: Housing Finance, Crises, and Business Cycles“, NBER Working Papers 20501. Mian, A, and A Sufi (2014) House of Debt: How They (and You) Caused the Great Recession, and How We Can Prevent It from Happening Again, Chicago: University of Chicago Press. Phillipon, T, and A Reshef (2013) "An International Look at the Growth of Modern Finance“, Journal of Economic Perspectives, 27(2): 73–96. Piketty, T, and G Zucman (2014) "Capital is Back: Wealth-Income Ratios in Rich Countries, 1700–2010", Quarterly Journal of Economics, Forthcoming. Piketty, T (2013) "On the Long-Run Evolution of Inheritance: France, 1820–2050“, Quarterly Journal of Economics 126(3): 1071–1131. Schularick, M, and A M Taylor (2012) "Credit Booms Gone Bust: Monetary Policy, Leverage Cycles, and Financial Crises, 1870–2008“, American Economic Review 102(2): 1029–61. http://www.voxeu.org/article/great-mortgaging

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ft.com comment Columnists October 12, 2014 5:14 pm Germany’s weak point is its reliance on exports

By Wolfgang Münchau Wherever stimulus comes from, it will not be from Europe’s powerhouse

©Bloomberg One of the biggest misconceptions about the eurozone has been a belief in the innate strength of Germany – the idea that competitiveness reforms have transformed a laggard into a leader. This is nonsense. The German model relies on the presence of an unsustainable investment boom in other parts of the world. That boom is now over in China, in most of the emerging markets, in Russia certainly. What we saw last week is what happens once the world returns to economic balance: Germany reverts to lower economic growth. I have heard the suggestion that this is actually good news. If Germany is weak, it is more aligned with the other eurozone countries, and hence more likely to accept the need for policy action, such as asset purchases by the European Central Bank or even a fiscal stimulus. More ON THIS STORY// Markets Insight ‘Euroglut’ of gloom as Germany weakens/ Gavyn Davies Germany is stalling/ Berlin holds firm on fiscal rigour/ IMF sees risk of new eurozone recession ON THIS TOPIC// Editorial Germany needs to fix its economic model/ German exports fall stokes recession fear/ Creaking transport threatens German growth/ Working pensioners offer Germany a boost WOLFGANG MÜNCHAU// Europe’s recovery dream/ Germany’s eurosceptics/ Italian debt/ Wolfgang Münchau Declining influence Be careful what you wish for. On the evidence so far, the opposite is the case. The political opposition to the ECB’s asset purchase policies has been hardening. With interest rates at close to zero, conventional monetary policy tools have been exhausted. German commentators have expressed outrage at the proposed fiscal relaxation in France and Italy. Last week’s debate in Germany was not about fiscal stimulus, but about measures to further improve the country’s competitiveness.

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Fiscal consolidation is politically popular. The government’s main policy goal for 2015 is fiscal balance. Even Germany’s hawkish economic institutes derided this as a “prestige project”, and concluded that the government has room to increase spending on early childhood education and the country’s ageing roads and railways. Instead, MPs are discussing further expenditure cuts to ensure that projections of a fiscal balance hold under the assumption of weaker economic growth. What would it take to shift their intransigence? Again, you do not wish for that situation to arise. It would take far more than a few quarters of weak economic growth. The main number to watch is the unemployment rate. At 4.9 per cent, Germany has one of the lowest in the EU. Unless that number goes up, Berlin is not going to change its position. When that number goes up, I would expect even less willingness to accept fiscal transfers to the eurozone periphery. So wherever stimulus comes from, it will not be from Germany – and this will make it rather toxic. What is the reason for Germany’s weakness? We understand the causes of weakness of the eurozone as a whole – a financial crisis followed by austerity policies. But that did not happen in Germany. There was no financial instability in the domestic economy; no credit booms, no subsequent credit crunches. Fiscal policy was fairly tight, but there was no outright austerity. Unemployment is lower now than it was in 2007. Germany had a pretty good crisis. First of all, we should put last week’s numbers into perspective. They were bad, but not quite as bad as they appeared. Industrial production fell by a shocking monthly rate of 4 per cent during August. But it was up by 1.6 per cent in July. Statisticians never manage to account fully for the fact that German states take their annual summer holidays in different overlapping periods. Add July and August together, and you get a clearer picture: industrial production fell 2 per cent in two months. But even this is not good. The root cause of the problem is the age-old overreliance on exports – and on plant and machinery exports in particular. The various global shocks – the wars in the Middle East and Russia’s aggression in Ukraine – had an additional impact. As an exporting powerhouse, Germany is highly sensitive to small changes in foreign demand. There are no signs of a strong global recovery, let alone of a global investment boom. It is thus reasonable to expect a mediocre performance by the German economy for a while. The German economics institutes, in their joint forecast, foresee growth of 1.3 per cent this year, falling to 1.2 per cent next year. That seems about right. On top of that comes a demographic shock which is gathering force. The number of people in retirement will shoot up as the baby boomers retire, further weighing on the growth rate. I have heard warnings from German economists that the potential growth rate may fall to below 1 per cent over the next decade. Previously, the main characteristic of the eurozone had been strong growth in the core that partially offset contraction in the periphery. Now both the core and the periphery are weak. And policy is not responding sufficiently. Add the two together and it is not hard to conclude that secular stagnation is not so much a danger as the most probable scenario. http://www.ft.com/intl/cms/s/0/46452fe8-4fa4-11e4-a0a4-00144feab7de.html#axzz3G1L0w6ka

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Trade engine shifts down just as global growth needs a boost

Sun, Oct 12 2014 By Krista Hughes WASHINGTON (Reuters) - Policymakers scrambling to keep the world economy from settling into the "new mediocre" of sluggish growth can no longer rely on global trade to do the heavy lifting. International trade helped the global economy tide over rough spots over two decades before the financial crisis, when it grew nearly twice as fast as economic output, but this engine is running out of fuel. That is bad news for officials taking part in discussions at the International Monetary Fund and World Bank meetings this week, focused on preventing what International Monetary Fund chief Christine Lagarde warns could be a long spell of sub-par performance for the global economy. The impetus from China and Russia opening their doors and the emergence of global supply chains, linking factories in emerging markets with rich consumers in the developed world, has largely run its course, economists say. "It's that particular engine which seems to have exhausted its propulsive energy for now," said World Bank trade specialist Aaditya Mattoo. The McKinsey Global Institute calculates trade and cross-border financial flows contribute up to a quarter of global growth, leaving policymakers with a gaping hole to fill if trade shifts into a lower gear. As the IMF cut its global growth outlook, it also forecast annual trade growth to average just 4.2 percent in the 10 years starting in 2016, compared to 6.7 percent in the decade leading up to the 2008-2009 financial crisis. One reason for that downgrade is obvious enough: it is hard to replicate the effect of an economy of China's size tearing down trade barriers.

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Add to that slower growth in other emerging markets as they become richer and have less catching up to do, a smaller wage gap between developed and developing nations and a renewed leaning to make inputs for final products close to home. NEW SPARK NEEDED RBC Global Asset Management chief economist Eric Lascelles predicts trade's contribution to growth will be half a percentage point lower than in the previous two decades - half of that because of weak global demand, trade barriers and geopolitical tensions and half reflecting permanent changes in trade dynamics. "We could expect some of the lost trade to come back but realistically a lot of it is probably gone forever and we may actually be in an area of diminished globalization, primarily via lower trade flows but perhaps also via less on the migration front and less on the financial flows front," he said. The pressure is on policymakers to regain as much momentum as possible through far- reaching regional and global pacts and standards under the aegis of the World Trade Organization. "We have been living too much off past trade liberalization," WTO Director-General Roberto Azevedo told the IMF's steering committee, urging policymakers to support a global pact to cut customs red tape, now stalled by opposition from India. Economists estimate that those changes, when fully implemented, could boost global output by $1 trillion per year, equivalent to a 1.3 percent boost to the world economy. That's roughly twice as much as the combined impact of major trade deals being negotiated between the United States and Europe and another between 12 Pacific Rim countries, including the United States, Japan, Canada and Australia. Economist Ed Gresser, from Washington-based think tank Progressive Economy, said services trade could expand as technological innovations made it easier to provide services like education and healthcare across borders. In the United States alone, internet-friendly services such as communications and financial services had grown to make up 11.7 percent of exports by 2012, from 7.6 percent in 2000. "The natural path of that should be to bring services up, in the same way that manufacturing trade grew relative to resources and agriculture in the second half of the 20th century," he said. HSBC global chief economist Stephen King said there was also potential to increase trade among countries in Latin America, Asia, the Middle East and Africa, which had not been fully captured by recent waves of trade growth. But he said an increase in so-called south-to-south trade and increased demand for services in developing countries would fall short of the 0.5 to 1.0 percentage point boost trade had given to global growth, on average, since the 1950s. "Once you have opened up all those opportunities, you can't keep opening them up because there are no more opportunities to open," he said. //(Editing by Tomasz Janowski)// http://www.reuters.com/article/2014/10/12/us-imf-trade- idUSKCN0I10YO20141012 171

Euro zone seeks to soften German opposition to stimulus spending

By Robin Emmott Sun, Oct 12 2014 LUXEMBOURG (Reuters) - France and Italy will keep pressure on Germany this week to use government money to revive the euro zone's stagnating economy but in a sign of inertia, a promised list of projects to create growth will not be ready until December. European finance ministers take the argument to Luxembourg on Monday for two days of talks following last week's International Monetary Fund meetings in Washington. There, German Finance Minister Wolfgang Schaeuble ruled out "writing checks" for the euro zone. One compromise is an infrastructure investment fund of public and private money, although even the first draft of a list of potential projects will not be ready until December, according to a document prepared for the Luxembourg meeting. The euro zone's sinking fortunes are raising alarm among global policymakers who fear the bloc is again dragging on the world economy just two years after its last crisis and say the continued strict focus on budget rigor is misplaced. EU officials are nevertheless seeking last-minute changes to the French and Italian budgets for 2015 to reduce their fiscal deficits, sources have told Reuters -- a sign of the difficult balancing act underway in the euro zone. Ministers will also hear from European Union and IMF inspectors on Greece's plans to exit its financial rescue program in 2015, a year ahead of schedule. There are signs that a poor run of German data may be softening Chancellor Angela Merkel's opposition to public spending. Merkel says her government is exploring ways to encourage more investment in the German economy, which contracted by 0.2 percent in the second quarter and could weaken further going into 2015. The German government will cut its economic growth forecasts for 2014 and 2015 next week, sources have told Reuters, while Britain is also concerned about the impact euro zone stagnation is having on its recovery. 172

EU finance ministers are pinning their immediate hopes on a plan by the European Commission and the European Investment Bank to create a pipeline of projects to boost business dynamism and growth potential, according to the EU document seen by Reuters. The European Union hopes that small amounts of money from the EIB and the EU's budget could be seed financing. Investment in the 28-country bloc has fallen by about 20 percent since 2008, according to the European Central Bank. But there are few details other than that ministers are eager to bring in as much private investment as possible and compliment a 300 billion euro investment program proposed by the incoming Commission president, Jean-Claude Juncker. "FISCAL SPACE" Jyrki Katainen, who is set to take over as the European Commission's official responsible for jobs and growth next month, told Reuters that energy, transport and broadband Internet were priorities. [ID:nL6N0S43WC] Despite an urgent need to tackle near record unemployment, concerns about rushing into projects that will not have a clear economic pay-off mean efforts are proceeding cautiously. A list of projects and ways to finance them will be presented in December, delaying a pledge made in Milan last month to have something ready for this week's meeting. France and Italy, the euro zone's second and third largest economies respectively, are relying on Germany to increase public spending because they are unable to as the European Commission deems their debt and deficits to be too high. Following a crisis that nearly broke it apart, the euro zone now has strict rules that seek to force countries to live within their means and the executive Commission can reject budgets. But Rome and Paris have been encouraged by calls from the European Central Bank and the IMF, who want to see countries using government money prudently to avoid the euro zone slipping into its third recession since 2008. That means Germany, Europe's biggest economy, which is deemed to have room to spend after posting its biggest budget surplus since reunification in the first half of 2014. "For governments that have fiscal space it makes sense to use it. You decide to which countries this sentence applies," ECB President Mario Draghi said in Washington. Following the Luxembourg meeting, euro zone leaders will hold a summit on Oct. 24 in Brussels to discuss the economy and which will see more sparring over the spending issue. (Editing by Catherine Evans) http://www.reuters.com/article/2014/10/12/us-eurozone- economy-idUSKCN0I10XN20141012

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October 13, 2014 The World vs Germany The current mood in policy circles is as panicked as we have ever seen it. They fear a secular stagnation in the eurozone and a prolonged downturn in emerging markets. Germany once again came under pressure to accept a stimulus – domestically and/or at EU level – but Wolfgang Schauble resisted with the usually steeliness. At one of the meetings one of us witnessed, an audience of senior bankers were asked to cast a vote on what constitute the biggest threat to the global recovery. 50% were most worried by the eurozone, 20% by Putin, and another 20% by China

wsj Global Slowdown Threatens Recovery Gathering signs of a slowdown across many parts of the world are roiling markets and confounding policy makers, who after years of battling anemic growth have limited tools left to jump-start a recovery Europe File French Bravado Being Put to the Test in Eurozone Europe File: France’s defiance can have long-term consequences for Europe. By Simon Nixon// Oct. 12, 2014 9:22 p.m. ET Behind the scenes at the International Monetary Fund’s annual meetings in Washington, D.C., over the weekend, the fiercest arguments concerned France’s refusal to respect the eurozone fiscal rules set less than three years ago. This is shaping up to be a defining ideological confrontation with profound long-term consequences for the whole of Europe.// Meanwhile in Washington, Germany was once again cast as the villain, urged by a... 174

Draghi-Weidmann Fight Intensifies as ECB Debates Action By Stefan Riecher and Simon Kennedy - Oct 13, 2014 Mario Draghi and Jens Weidmann are clashing anew over how much more stimulus the ailing euro-area economy needs from the European Central Bank. As Europe’s woes again proved the chief concern at weekend meetings of the International Monetary Fund in Washington, President Draghi repeated he’s ready to expand the ECB’s balance sheet by as much as 1 trillion euros ($1.3 trillion) to beat back the threat of deflation. Bundesbank head Weidmann responded by saying that a target value isn’t set in stone. The differences at the heart of policy making risk leaving the ECB hamstrung as the region’s economy stalls and inflation fades further from the central bank’s target of just below 2 percent. History suggests Draghi will ultimately prevail over his German colleague. “There’s an enormous conflict within the Governing Council on what the ECB should do,” said Joerg Kraemer, chief economist at Commerzbank AG in Frankfurt. “Clearly, it’s Draghi against Weidmann once again. In the end, Draghi will get his way and we will see quantitative easing next year.” The ECB is swelling its balance sheet as it seeks to revive inflation of 0.3 percent, the lowest in almost five years. By buying private-sector assets, as it plans to do from this month, or continuing to accept collateral from banks in return for cheap loans, it is pushing liquidity into the economy. Still unresolved is if it will ultimately buy sovereign debt, a taboo subject in Germany where politicians worry it amounts to financing governments and removing pressure on them to act. Last Tool Building up assets is the last monetary tool the ECB has left after it cut interest rates to a record low, Draghi said on Oct. 11 in Washington. Action taken so far pushed the euro as low as $1.2501 this month, the least since 2012. The ECB’s balance sheet now stands at 2.05 trillion euros, below the 2012 peak of 3.1 trillion euros and 2.7 trillion euros at the start of that year. “I gave you a kind of ballpark figure, say about the size the balance sheet had at the start of 2012,” Draghi told reporters. Weidmann responded within minutes. “I don’t need to explain to you that there has been communicated a certain target value for the balance sheet,” he said. “How formal this target value is, that’s a different question.”

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The Bundesbank head is concerned that a balance-sheet target may lead to the ECB paying too much for assets under its programs to purchase asset-backed securities and covered bonds, he said on Oct. 9. Differing Opinions Asked about differing opinions between Draghi and Weidmann and within the Governing Council, an ECB spokesman said it is natural that policy makers hold a range of views which they discuss together at regular meetings in a collegiate environment. A Bundesbank spokesman said that while Weidmann opposed the decisions on ABS purchases in September and October, he agreed to far-reaching measures in June. Instead of debating personal relationships, Weidmann prefers to argue about substance, he said. In more heated language, Germany’s Focus magazine reported, without citing anyone, that Draghi finds cooperating with Weidmann has become “almost impossible” and that he no longer divulges his plans to him beforehand. The euro-area re-emerged as the main worry of officials at the IMF’s annual meeting as they fret about the outlook for global growth. The IMF last week cut its euro-area growth forecast to 0.8 percent for 2014. Another Downturn “There was too much complacency about the euro zone getting out of its crisis,” said Nouriel Roubini, chairman of Roubini Global Economics LLC in New York. “The center of tension is another downturn in the euro zone.” The clash between the 67-year-old Italian ECB president and the 46-year-old German is only the latest in a series dating back to Europe’s sovereign debt turmoil. Weidmann was one of the officials to oppose a plan to buy asset-backed securities before the end of this year. He also objected to an interest rate cut last November and an unlimited bond- buying program in 2012. The fight’s climax may be nearing as the ECB comes closer to having to decide whether to purchase government bonds. Draghi emphasized this month that a decision may come “in the coming months, not coming years” and repeated in Washington that the bank is open to more unconventional measures if needed. Weidmann says the time for this option hasn’t yet arrived. Agreement Areas There are some areas of agreement between Draghi and Weidmann, the representative of Europe’s most powerful economy. Both want countries such as Italy or France to increase labor-market flexibility and reduce the level of government debt and each say that monetary policy can’t be a panacea for the region’s pain. “Where there is unanimity is on what monetary policy alone can achieve,” said Michala Marcussen, global head of economics at Societe Generale SA in London. “What they all keep saying is there needs to be a concerted effort on structural reform and a more coordinated fiscal response.”

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Draghi told governments he is “uncertain that there will be very good times ahead if we do not reform now” and warned politicians that failure to act would cost them the support of voters. While the ECB president can count on German support on his call for economic overhauls, Wolfgang Schaeuble, the country’s finance minister warned against easing fiscal discipline and spoke out against more central-bank stimulus, adding that there’s no threat of deflation in the region. He did say a “clear weakening” of the German economy will prompt more government investment. “With monetary policy you can’t solve the problems, you have to solve it with the decisions by national governments because we have no fiscal and economic union,” Schaeuble said. “Monetary policy can only accommodate, it can buy time.” http://www.bloomberg.com/news/2014-10-12/draghi-weidmann-fight-intensifies-as- ecb-debates-action.html

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The Opinion Pages| Op-Ed Columnist |NYT Now Revenge of the Unforgiven How Righteousness Killed the World Economy

Paul Krugman 13/10/2014 Stop me if you’ve heard this before: The world economy appears to be stumbling. For a while, things seemed to be looking up, and there was talk about green shoots of recovery. But now growth is stalling, and the specter of deflation looms. If this story sounds familiar, it should; it has played out repeatedly since 2008. As in previous episodes, the worst news is coming from Europe, but this time there is also a clear slowdown in emerging markets — and there are even warning signs in the United States, despite pretty good job growth at the moment. Why does this keep happening? After all, the events that brought on the Great Recession — the housing bust, the banking crisis — took place a long time ago. Why can’t we escape their legacy? The proximate answer lies in a series of policy mistakes: Austerity when economies needed stimulus, paranoia about inflation when the real risk is deflation, and so on. But why do governments keep making these mistakes? In particular, why do they keep making the same mistakes, year after year? The answer, I’d suggest, is an excess of virtue. Righteousness is killing the world economy. What, after all, is our fundamental economic problem? A simplified but broadly correct account of what went wrong goes like this: In the years leading up to the Great Recession, we had an explosion of credit (mainly to the private sector). Old notions of prudence, for both lenders and borrowers, were cast aside; debt levels that would once have been considered deeply unsound became the norm. Then the music stopped, the money stopped flowing, and everyone began trying to “deleverage,” to reduce the level of debt. For each individual, this was prudent. But my spending is your income and your spending is my income, so when everyone tries to pay down debt at the same time, you get a depressed economy. So what can be done? Historically, the solution to high levels of debt has often involved writing off and forgiving much of that debt. Sometimes this happens explicitly: In the 178

1930s F.D.R. helped borrowers refinance with much cheaper mortgages, while in this crisis Iceland is outright canceling a significant part of the debt households ran up during the bubble years. More often, debt relief takes place implicitly, through “financial repression”: government policies hold interest rates down, while inflation erodes the real value of debt. What’s striking about the past few years, however, is how little debt relief has actually taken place. Yes, there’s Iceland — but it’s tiny. Yes, Greek creditors took a significant “haircut” — but Greece is still a small player (and still hopelessly in debt). In major economies, very few debtors have received a break. And far from being inflated away, the burden of debt has been aggravated by falling inflation, which is running well below target in America and near zero in Europe. Why are debtors receiving so little relief? As I said, it’s about righteousness — the sense that any kind of debt forgiveness would involve rewarding bad behavior. In America, the famous Rick Santelli rant that gave birth to the Tea Party wasn’t about taxes or spending — it was a furious denunciation of proposals to help troubled homeowners. In Europe, austerity policies have been driven less by economic analysis than by Germany’s moral indignation over the notion that irresponsible borrowers might not face the full consequences of their actions. So the policy response to a crisis of excessive debt has, in effect, been a demand that debtors pay off their debts in full. What does history say about that strategy? That’s easy: It doesn’t work. Whatever progress debtors make through suffering and saving is more than offset through depression and deflation. That is, for example, what happened to Britain after World War I, when it tried to pay off its debt with huge budget surpluses while returning to the gold standard: Despite years of sacrifice, it made almost no progress in bringing down the ratio of debt to G.D.P. And that’s what is happening now. A recent comprehensive report on debt is titled “Deleveraging, what deleveraging?”; despite private cutbacks and public austerity, debt levels are rising thanks to poor economic performance. And we are arguably no closer to escaping our debt trap than we were five years ago. But it has been very hard to get either the policy elite or the public to understand that sometimes debt relief is in everyone’s interest. Instead, the response to poor economic performance has essentially been that the beatings will continue until morale improves. Maybe, just maybe, bad news — say, a recession in Germany — will finally bring an end to this destructive reign of virtue. But don’t count on it. http://www.nytimes.com/2014/10/13/opinion/paul-krugman-how-righteousness-killed-the- world-economy.html?_r=0

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ft.com Comment The Big Read October 12, 2014 4:21 pm Buybacks: Money well spent? By Michael Mackenzie, Tom Braithwaite and Nicole Bullock Critics say that the boom has diverted corporate cash from creating jobs and investment

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There was no sign of Carl Icahn’s trademark aggression in the letter he sent last week to Tim Cook, Apple’s chief executive. The one-time corporate raider began by applauding Apple’s recent product launches and calling Mr Cook the “ideal” CEO for the world’s most valuable company.

He then politely requested that Mr Cook ask Apple’s board to use more of its $133bn cash pile – together with money raised in the debt market – to buy back more of its shares. “We thank you for being receptive to us the last time we requested an increase in share repurchases, and we thank you in advance now” for pushing the idea again to the Apple board, he wrote. More ON THIS STORY// Person in the news Carl Icahn/ Tech blog Apple expected to unveil latest iPad range/ Edward Luce Short-sighted US buyback boom/ S&P 500 companies reduce buybacks/ Capital Group raps activist investors 181

IN THE BIG READ// Ebola virus ‘Our people are dying’/ China’s migrants thrive in Spain’s crisis/ US elections Tailored message/ China swoops in on Italian assets

While the 14-page letter lacked the antagonism he is known for, the billionaire investor was nonetheless placing himself at the centre of a fight: share buybacks have become one of the most contentious issues in corporate America. Mr Icahn and other “activist” investors argue that buybacks help successful companies such as Apple reach their true value. But to others, including Larry Fink, chief executive of BlackRock, they sap investment that could pay for jobs or research on new products in favour of short-term gain – ultimately hurting the economic recovery.

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“Too many companies have cut capital expenditure and even increased debt to boost dividends and increase share buybacks,” Mr Fink wrote in an open letter to chief executives this year. “We certainly believe that returning cash to shareholders should be part of a balanced capital strategy; however, when done for the wrong reasons . . . it can jeopardise a company’s ability to generate sustainable long-term returns.” Share buybacks are not new, but US companies have been gorging themselves on their own stocks in recent years – in part spurred on by activists such as Mr Icahn. But they are also a broader reflection of how the Federal Reserve’s aggressive policy of lowering interest rates has benefited financial assets – notably stocks, bonds and house prices – even as the recovery in the broader US economy has been halting. The contrast between record share prices – the S&P 500 has nearly tripled since its March 2009 nadir – and the sluggish rebound remains a striking aspect of the central bank’s quantitative easing era, which draws to a close this month. The longevity of QE and suppression of interest rates has created fertile conditions for the buyback boom. In the 12-month period to the end of June, S&P 500 companies have returned a record amount of cash to shareholders, consisting of $533bn in buybacks and paying out $332.9bn in dividends, according to S&P Dow Jones Indices. Since the start of 2011, buybacks have exceeded $1.6tn. “When QE was launched, it was not envisaged lasting for five years,” says Edward Marrinan, head of credit strategy at RBS Securities. “It was seen as providing a short kick-start for the economy and not becoming a protracted policy that has changed the incentives for markets and companies.”

Larry Fink fears for the effects of short-term gain on the economy The post-financial crisis performance of the economy, dubbed by some as a “secular stagnation” during the QE era, has animated critics of buybacks. Rather than returning excess cash to shareholders, they say companies should invest in their businesses and recruit more workers at higher wages to sow the seeds for sustained long-term growth of the economy. William Lazonick, professor of economics at University of Massachusetts Lowell, says buybacks manipulate share prices. While that can boost prices in the short term, their long-term consequences include undermining income equality, job stability and overall economic growth. “When you have an economy dominated by large-scale corporations, their decisions about the allocation of capital drives the economy,” he says. “Executives are judged on the performance of the company’s stock price and that is something they can control and manipulate.” Apple epitomises the US companies selling cheap debt and then ploughing the proceeds back into enormous purchases of their own stock to pay chunky dividends to shareholders. Over the past 18 months, Apple has sold two blockbuster offerings of

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bonds to the tune of $29bn, which has helped fund $50bn of buybacks. It lags behind only ExxonMobil and IBM in terms of such largesse since the start of 2009. Mr Fink says he feels strongly that activism such as Mr Icahn’s is “creating a chilling response” among chief executives, spurring them to eschew spending on capital expenditures in favour of share buybacks. “I am not here to suggest that there are not examples where the activists were entirely right but when you have one activist tell Tim Cook to raise $150bn in bonds to buy back shares – I don’t agree with that type of behaviour,” he said in an interview. . . . Companies reducing their amount of outstanding shares and boosting earnings have provided a tail wind for the S&P 500’s bull run during the QE era. Barclays estimates that buybacks are adding more than $2 a share to S&P 500 earnings at the index level. Buybacks are executed secretly since market knowledge of their size and actual timing would push prices higher and cost the company more. But the constant source of demand for shares via buybacks has certainly been rewarding for company insiders and equity investors. Vadim Zlotnikov, chief market strategist at AllianceBernstein, estimates the top 100 S&P companies undertaking buybacks and issuing dividends – with share repurchases going beyond just settling expiring options – have outperformed the rest of the S&P by 4 per cent this year, and 8 per cent for all of 2013. “These are huge numbers,” he says. Digging deeper into the numbers reveals a gulf between buybacks and cash spent on capital projects. Barclays estimates that the portion of cash flow allocated to repurchases for S&P 500 companies has increased to more than 30 per cent, nearly twice what it was in 2002, while the portion allocated to capital expenditures is down to 40 per cent from more than 50 per cent in the early 2000s Critics say devoting large amounts of cash to buybacks can also signal that a management team has run out of ideas for sources of long-term growth. A common example is how RIM splurged on buybacks when the BlackBerry dominated the mobile handset market, while underestimating the challenge being mounted by Apple and Samsung. Thanks to cost-cutting and low interest rates, companies have generated record profits in recent years. But the missing component has been solid revenue growth because of a sluggish economy. As a result many companies have decided that the best option for deploying their cash flow is in acquisitions and buybacks. Mr Zlotnikov says buybacks will continue until companies regain pricing power – a sign of a robust economy. “There are a lot of projects and investments that look less attractive when pricing power is under pressure.” . . . The most pressing question is whether US equities can continue rising as the Fed ends QE. Companies will face a higher cost of buying back their stock while having not yet really committed capital for long-term expansion. 184

Jonathan Glionna, head of US equity strategy research at Barclays, says the market has entered a period of lower returns as “share repurchases prove to be already priced in and a return of faster revenue growth becomes a prerequisite for another re-rating higher”.

©Reuters Carl Icahn argues that buybacks help successful companies reach their true value With the central bank ending QE and poised to start normalising interest rate policy in 2015, the buyback boom has shown signs of easing, potentially removing a vital pillar of support for the equity bull run. In the three months ending in June, the pace of buybacks dipped to $116.17bn, the lowest quarterly figure since early 2013, though there are signs they picked up in the third quarter. “Companies issuing at low yields into this buying frenzy are doing what they always like doing with debt in the final throes of an economic cycle: they issue cheap debt to buy expensive equity,” says Albert Edwards, strategist at Société Générale. “This pro-cyclical process always ends in tears and is regarded in retrospect as typical end-of-cycle madness.” Share buybacks peaked during the third quarter of 2007, just before the financial crisis began. Companies that had splurged on share buybacks found themselves scrambling to save cash. The rise in US share prices – thanks in part to QE – requires vindication in the form of a stronger economy, marked by rising wages that can propel consumer spending and company revenues. However, that requires a change in the mindset of companies whose managers have focused on their stock price rather than long-term growth, many argue. “Wall Street loves buybacks as there is a large buyer supporting the market,” says Prof Lazonick, who believes the focus on cost cutting and buybacks has hurt average workers and exacerbated income equality. “A prosperous economy comes when people have stability in terms of being employed.” Additional reporting by Tom Braithwaite http://www.ft.com/intl/cms/s/0/16e71bdc-4f16-11e4-9c88-00144feab7de.html#slide0

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Speech

Vice Chairman Stanley Fischer At the Per Jacobsson Foundation Lecture, 2014 Annual Meetings of the International Monetary Fund and the World Bank Group, Washington, D.C. October 11, 2014 The Federal Reserve and the Global Economy It is a great honor to deliver the Per Jacobsson Foundation Lecture, and I thank the organizers for inviting me.1 Per Jacobsson, a Swede, was the third Managing Director of the International Monetary Fund (IMF), serving from 1956 to 1963. During his tenure, the fund supported the return to convertibility of the major European currencies, increased its resources by securing the General Arrangements to Borrow, and established the Compensatory Financing Facility to help member countries cope with temporary fluctuations in international payments. It is a particular pleasure to be delivering this lecture at the IMF. My service in the IMF was a highlight of my professional career. But I speak now as a central banker, one who faces a new set of responsibilities. My lecture today is on the special challenges that face the Federal Reserve and the global economy in an increasingly interconnected world. Over the past 50 years, global trade has more than tripled relative to world gross domestic product (GDP), and the ratio of total exports to global GDP now stands at about 30 percent. International trade has not loomed as large in the U.S. national accounts as it has for many other countries, but it is an increasingly important driver of the U.S. economy, with the share of trade in U.S. GDP currently at about 15 percent. Although the U.S. share of world GDP has gradually declined since the mid-20th century, the broader importance of the United States to the global economy has diminished less, or possibly not at all, as a result of increasing financial linkages over the same period. In particular, U.S. residents' ownership of foreign assets has risen to nearly $25 trillion (more than 140 percent of annual U.S. GDP), reflecting the leading role of U.S. capital markets in cross-border finance. Total foreign investment in the United States is even larger, at more than $30 trillion. U.S. Treasury securities are a key component of these external liabilities: As the world's favorite safe asset, they are the preferred form of collateral for a range of financial contracts, and they also account for more than half of other countries' foreign reserves. In a progressively integrating world economy and financial system, a central bank cannot ignore developments beyond its country's borders, and the Fed is no exception. This is true even though the Fed's statutory objectives are defined as specific goals for

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the U.S. economy. In particular, the Federal Reserve's objectives are given by its dual mandate to pursue maximum sustainable employment and price stability, and our policy decisions are targeted to achieve these dual objectives.2 Hence, at first blush, it may seem that there is little need for Fed policymakers to pay attention to developments outside the United States. But such an inference would be incorrect. The state of the U.S. economy is significantly affected by the state of the world economy. A wide range of foreign shocks affect U.S. domestic spending, production, prices, and financial conditions. To anticipate how these shocks affect the U.S. economy, the Federal Reserve devotes significant resources to monitoring developments in foreign economies, including emerging market economies (EMEs), which account for an increasingly important share of global growth. The most recent available data show 47 percent of total U.S. exports going to EME destinations. And of course, actions taken by the Federal Reserve influence economic conditions abroad. Because these international effects in turn spill back on the evolution of the U.S. economy, we cannot make sensible monetary policy choices without taking them into account. In this lecture, I would like to emphasize both aspects of our global connectedness-- spillovers from the United States to foreign economies and the effect of foreign economies on the United States. I will first review the effect of the Fed's monetary policies on the rest of the global economy, particularly the EMEs, which has received considerable attention in recent years. Prior to the spring of 2013, this attention was focused on the international spillover of the Fed's accommodative policies, especially our asset purchases. But beginning last year, the focus has shifted to the normalization of our policies, as exemplified by last summer's "taper tantrum."3 Although the effect of the U.S. economy on other countries is of vital importance to this audience, I will briefly digress to remind you that developments in other economies also can have significant spillovers to the United States, which in turn prompt reactions from U.S. policymakers. For example, in the past few years, the deflationary environment in Japan, together with the fallout from the euro-area fiscal crisis, has entailed persistent weakness in those economies, which historically have been among our most important trading partners, are major recipients of our foreign investments, and loom large in the international credit exposures of U.S. banks. These effects have weighed on global growth, which needs to be taken into account in the setting of U.S. monetary policy. Returning to spillovers from the United States, in the second part of the lecture, I will address prospective outcomes and possible risks associated with the normalization of our policies. In determining the pace at which our monetary accommodation is removed, we will, as always, be paying close attention to the path of the rest of the global economy and its significant consequences for U.S. economic prospects. In the third part, toward the end of the lecture, I will discuss the responsibilities of the Fed in the world economy. Like other national central banks, we must answer first to our own citizens and taxpayers. But, because of our size, developments in the U.S. economy will always affect foreign economies. And, since the U.S. dollar is the most widely used currency in the world, our interests in ensuring a well-functioning financial system inevitably have an international dimension. I. International Transmission of Monetary Policies 187

The recognition that a change in interest rates in one nation can spill over to other countries dates back at least to the 18th-century writings of David Hume on the international effect of changes in the money supply.4 The standard models incorporating the international transmission of monetary policy were developed in Per Jacobsson's tenure at the IMF--the pioneering research in the early 1960s by IMF staffer Marcus Fleming and Robert Mundell, which extended standard macroeconomic models to the analysis of an open international economy--work that we know now as the Mundell- Fleming model. In the Mundell-Fleming framework, as well as in modern developments of the same theme, a shift toward a more accommodative monetary policy in the United States spills over to foreign economies by causing their interest rates to fall--though typically by less than in the United States--and their currencies to appreciate against the dollar. At the same time, international capital flows tend to shift toward foreign economies in response to their relatively more attractive interest rates. The pass-through of changes in U.S. policy rates abroad depends importantly on how foreign monetary authorities respond. A decline in U.S. policy rates has a relatively large effect on foreign policy rates in economies that opt to limit exchange rate fluctuations, at least for economies with reasonably open capital accounts. Thus, for example, a fall in U.S. policy rates has a commensurate effect on interest rates in Hong Kong. By contrast, the central bank in an economy with a freely floating exchange rate might choose to lower its interest rate by a much smaller amount than in the United States if it believes that domestic conditions so warrant. In this case, the country's exchange rate would appreciate as investors rebalance their portfolios in favor of assets denominated in its currency in response to the higher interest rate differential.5 Moving beyond the Mundell-Fleming framework, there is also evidence that monetary policy actions can influence investors' willingness to hold risky assets, the so-called risk-taking channel.6 Such effects seem to be most potent when financial conditions are stressed. And countries that offer high prospective returns but have weak policy frameworks or other structural vulnerabilities may be particularly sensitive to fluctuations in international investment associated with global risk factors.7 International spillovers from monetary policy have been a contentious issue going back at least to the 1920s. To facilitate the United Kingdom's return to the gold standard at its pre-war parity in 1925, which valued the pound above purchasing power parity, the Fed cut interest rates substantially. Britain's subsequent departure from gold created further challenges for the Federal Reserve; tight U.S. money policy in the wake of the exit of the sterling bloc from gold in the fall of 1931 helped keep the United States on gold until 1933 but exacted high economic costs on the United States and other countries remaining on gold.8 During the Bretton Woods period, overly expansionary U.S. monetary policy starting in the second half of the 1960s was exported to trading partners through the system of fixed exchange rates. More than a decade later, the Fed's aggressive tightening under newly appointed Chairman Paul Volcker had unwelcome contractionary effects on other economies. However, the Fed's success in achieving a permanent reduction in inflation through tight monetary policy bolstered the credibility of policies focused on achieving low and stable inflation, and many other countries followed.

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Turning to more recent events, I'll next assess the effects of the Fed's quantitative easing and other unconventional monetary policies pursued by central banks in advanced economies since 2008. Effects of Monetary Accommodation since the Global Financial Crisis During the period of extensive monetary accommodation after the 2007-08 global financial crisis, there has been heightened concern about the international spillovers of monetary policies--and of ours, in particular. Some EME critics argued that U.S. policy accommodation contributed to a surge of capital inflows and excessive credit growth in their economies, creating risks of financial instability. But, as time wore on, most EMEs seemed glad to receive those flows. There is little doubt that the aggressive actions the Federal Reserve took to mitigate the effects of the global financial crisis significantly affected asset prices at home and abroad as well as international capital flows. While the Fed's asset purchases were composed wholly of Treasury, agency, and agency-backed securities (for legal and practical reasons), the program also aimed to boost the prices of riskier assets and ease financial conditions for the private sector.9 (And this is what the textbooks say the program should have done.) The preponderance of evidence suggests that the Fed's asset purchases raised the prices of the assets purchased and close substitutes as well as those of riskier assets.10 Importantly, evidence--including the evidence of our eyes--shows that foreign asset markets have been significantly affected by the Fed's purchase programs.11 For example, event studies of announcements associated with the Fed's purchase programs have found that they prompted inflows into investment funds holding both foreign debt and foreign equity securities. For asset prices, the strongest evidence came in the form of reduced foreign bond yields, but valuations of foreign currencies and stock prices also increased appreciably in some cases. The largest market reactions occurred after announcements in late 2008 and early 2009 associated with the initial program of quantitative easing, commonly referred to as QE1, likely at least in part because global financial conditions were extremely stressed at that time, but also perhaps because QE1 demonstrated that it was still possible to ease policy, even when the federal funds rate was constrained by its effective lower bound.12 Although much of the recent commentary on spillovers has focused on the United States, it bears mentioning that other countries' monetary policy announcements can leave an imprint on international asset prices, with market reactions to new initiatives announced by the European Central Bank (ECB) in the past few weeks the most recent example.13 However, event studies tend to find larger international interest rate spillovers for U.S. policy announcements than for those of other central banks.14 It is also worth emphasizing that asset purchases are merely one form of monetary accommodation, made necessary when policy interest rates hit their zero lower bound. Earlier studies of the international effects of conventional U.S. monetary policy-- namely, changes in the policy rate--have also found significant spillovers to asset prices in other countries.15 Studies that have compared the spillovers of monetary policy across conventional and unconventional measures generally conclude that the effects on global financial markets are roughly similar.16

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Given the relatively fast recovery of many EMEs from the crisis, post-crisis monetary accommodation in the United States and other advanced economies created policy challenges for many EMEs.17 If they resisted currency appreciation pressures by lowering their policy rates, they risked over stimulating domestic demand, exacerbating financial excesses, and overheating their economies. If, instead, they reduced their policy rates less than the US had done while intervening to resist currency appreciation, capital inflows could have increased further, thus partially offsetting their attempts to stabilize their economies. And, if they allowed currency appreciation pressures to pass through to their full extent, this could threaten their recoveries by hurting exports. In the event, EMEs tried to make the best of a difficult set of tradeoffs by allowing some exchange rate appreciation, partially reducing their interest rates, and in some countries also using capital controls. Along with the boost from U.S. monetary policy during this period, many other factors contributed to the easing of global financial conditions between 2009 and 2012, including macroeconomic policy in a number of other countries and other measures that supported stabilization of the global financial system. EME sovereign yields declined by more during that period than can be explained by movements in U.S. Treasury yields alone, and there was a worldwide recovery in markets for riskier assets.18 I would also argue strongly that U.S. monetary policies were not beggar thy neighbor policies in that, on balance, they generally did not drain demand from other economies. Federal Reserve staff analysis finds that an easing of monetary policy in the United States benefits foreign economies from both stronger U.S. activity and improved global financial conditions. It also has an offsetting contractionary effect on foreign economies because their currencies appreciate against the dollar. But, on average, model-based estimates imply that the net effect on foreign economies appears to be both modest in magnitude and most likely positive, on net, for most countries.19 Moreover, because these models do not fully capture benefits from the role of Federal Reserve policies in alleviating the financial market stress and boosting confidence, positive spillovers abroad are likely to be somewhat larger than implied by the models, especially under conditions of extreme financial market stress. The taper tantrum of 2013 We should also expect spillovers when monetary policy is tightened. Central bank communications can be a tricky business, but it has long been understood that shifting perceptions of policy can have an immediate effect on market prices and investors' portfolio decisions. Indeed, financial markets reacted strongly to the first statements by Chairman Bernanke in the spring of 2013 that the Fed's asset purchases were likely to decelerate in the near future and come to an end not long after that. Some market participants clearly understood these statements to be broadly in line with previous guidance about the eventual normalization of policy as recovery of the U.S. economy took hold. But others may have grown accustomed to continuing asset purchases; the most recent purchase program, QE3, had been first announced less than a year before and was proceeding at a steady pace of $85 billion per month. The onset of the taper tantrum went well beyond a roiling of U.S. financial markets. Spillovers to other advanced-economy financial markets included stock price declines, significant increases in sovereign yields, higher overnight interest swap rates in the 190

United Kingdom and euro area, and rising credit spreads in some countries. The ECB and Bank of England responded by using so-called forward guidance to push short-term yields back down in an effort to foster recovery.20 Spillovers to EME asset markets were significantly stronger. Inflows to EME investment funds reversed sharply, EME currencies depreciated, and other asset prices declined.21 II. Normalization of Monetary Policies The cumulative effects over half of a decade of the extraordinary actions by the Federal Reserve and other central banks will need to be unwound in the coming years, as progress toward economic recovery makes it necessary to withdraw our substantial monetary accommodation. In the normalizing of its policy, just as when loosening policy, the Federal Reserve will take account of how its actions affect the global economy. The taper tantrum episode notwithstanding, most EMEs have generally weathered the wind-down of our asset purchases reasonably well so far. The actual raising of policy rates could trigger further bouts of volatility, but my best estimate is that the normalization of our policy should prove manageable for the EMEs. We have done everything we can, within the limits of forecast uncertainty, to prepare market participants for what lies ahead. Some critics of our policies have argued that, by continuing for so long with quantitative easing, the United States fueled a global boom in asset prices and credit growth that could provide the seeds of the next financial crisis, with the removal of monetary accommodation serving as an eventual trigger. But I am much more hopeful. First, the Federal Reserve and other central banks are going to great lengths to communicate policy intentions and strategies clearly. Given this, markets should not be greatly surprised by either the timing or the pace of normalization. In fact, it bears mentioning that, following the taper tantrum, when the Fed started to taper its purchases, there was little reaction from markets. Second, the tightening of U.S. policy will begin only when the U.S. expansion has advanced far enough, in terms both of reducing the output gap and of moving the inflation rate closer to our 2percent goal. Thus, tightening should occur only against the backdrop of a strengthening U.S. economy and in an environment of improved household and business confidence. The stronger U.S. economy should directly benefit our foreign trading partners by raising the demand for their exports, and perhaps also indirectly, by boosting confidence globally. And if foreign growth is weaker than anticipated, the consequences for the U.S. economy could lead the Fed to remove accommodation more slowly than otherwise. Third, the EMEs themselves have generally done a good job of reducing their financial and economic vulnerabilities over the past couple of decades, which should bolster their resilience should normalization lead to financial market stresses. Since the 1990s, many EMEs have made remarkable progress on reducing inflation, improving government debt ratios, building foreign reserves, and better regulating and capitalizing their banking systems. In addition, the development of local-currency debt markets has made EMEs less vulnerable to exchange rate fluctuations. To be sure, some EMEs continue to face a wide array of structural and policy challenges, including, prominently, rapid

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credit growth. But it does not seem that the overall risks to global financial stability are unusually elevated at this time, and they are very likely substantially less than they were going into the financial crisis. Nevertheless, it could be that some more vulnerable economies, including those that pursue overly rigid exchange rate policies, may find the road to normalization somewhat bumpier. This gives all the more reason for the Fed and other major central banks to communicate policy intentions clearly and for EMEs to continue to strengthen their policy frameworks and to consider their own policy responses to the forthcoming normalization in the United States and some other advanced economies. III. The Fed's Responsibility to the Global Economy So far, I have focused on the immediate spillovers of U.S. monetary policy abroad and the feedback of those effects to the U.S. economy. More tacitly than explicitly stated has been my view that the United States is not just any economy and, thus, the Federal Reserve not just any central bank. The U.S. economy represents nearly one-fourth of the global economy measured at market rates and a similar share of gross capital flows. The significant size and international linkages of the U.S. economy mean that economic and financial developments in the United States have global spillovers--something that the IMF is well aware of and has reflected in its increased focus on multilateral surveillance. In this context and in this venue, it is, therefore, important to ask, what is the Federal Reserve's responsibility to the global economy? First and foremost, it is to keep our own house in order. Economic and financial volatility in any country can have negative consequences for the world--no audience knows that more than this one--but sizable and significant spillovers are almost assured from an economy that is large. There is no question that sharp declines in U.S. output or large deviations of U.S. inflation from its target level would have adverse effects on the global economy. Conversely, strong and stable U.S. growth in the context of inflation close to our policy objective has substantial benefits for the world. Thus, as part of our efforts to achieve our congressionally mandated objective of maximum sustainable employment and price stability, the Federal Reserve will also seek to minimize adverse spillovers and maximize the beneficial effect of the U.S. economy on the global economy. As the recent financial crisis showed all too clearly, to achieve this objective, we must take financial stability into account. For half a decade, we have been working to understand and better guard against the financial disruptions that were the genesis of the Great Recession. These efforts have spawned many speeches, including some of my own, which testify to our efforts.22 In these speeches, we often emphasize that, given the integration of global capital markets, what happens in one market affects others. Thus, our efforts to stabilize the U.S. financial system also have positive spillovers abroad. These financial stability responsibilities do not stop at our borders, given the size and openness of our capital markets and the unique position of the U.S. dollar as the world's leading currency for financial transactions. For example, the global financial crisis highlighted the extent of borrowing and lending in U.S. dollars by foreign financial institutions. When these institutions came under pressure, their actions contributed to the strains in both foreign and domestic dollar funding markets. To achieve financial stability domestically and maintain the flow of credit to American households and 192

businesses, we took action. Importantly, we developed swap facilities with central banks in countries that represented major financial markets or trading centers in order to facilitate the provision of dollar liquidity to these markets. We did so in recognition of the scope of dollar markets and dollar-denominated transactions outside of our country, the benefits they provide to U.S. households and firms, and the adverse consequences to our financial markets if these centers lose access to dollar liquidity. We have continued to maintain swap facilities with a number of central banks. Although usage is currently very low, these facilities represent an important backstop in the event of a resurgence in global financial tensions. But I should caution that the responsibility of the Fed is not unbounded. My teacher Charles Kindleberger argued that stability of the international financial system could best be supported by the leadership of a financial hegemon or a global central bank.23 But I should be clear that the U.S. Federal Reserve System is not that bank. Our mandate, like that of virtually all central banks, focuses on domestic objectives. As I have described, to meet those domestic objectives, we must recognize the effect of our actions abroad, and, by meeting those domestic objectives, we best minimize the negative spillovers we have to the global economy. And because the dollar features so prominently in international transactions, we must be mindful that our markets extend beyond our borders and take precautions, as we have done before, to provide liquidity when necessary. That said, as will be discussed in many venues this weekend and beyond, the world is not without resources to guard against adverse economic and financial spillovers. Most obviously, the IMF has played and will continue to play a critical role in providing liquidity and financial support to member countries. To that end, I hope that the 2010 agreement to increase IMF quotas will be fulfilled. In this regard, we also should be realistic about what a backstop is. Any global backstop or liquidity facility should have certain features--accountability and monitoring, some degree of stigma in good times, and a high hurdle for usage. In other words, backstops are not built to be liked. In the United States, we are working to ensure that our financial institutions and other market participants are prepared for the normalization of monetary policy and the return to a world of higher interest rates. It is equally important that individuals, businesses, and institutions around the world do the same. For our part, the Federal Reserve will promote a smooth transition by communicating our assessment of the economy and our policy intentions as clearly as possible. IV. Concluding Remarks To summarize and conclude, the Fed's statutory objectives are defined by its dual mandate to pursue maximum sustainable employment and price stability in the U.S. economy. But the U.S. economy and the economies of the rest of the world have important feedback effects on each other. To make coherent policy choices, we have to take these feedback effects into account. The most important contribution that U.S. policymakers can make to the health of the world economy is to keep our own house in order--and the same goes for all countries. Because the dollar is the primary international currency, we have, in the past, had to take action--particularly in times of global economic crisis--to maintain order in international capital markets, such as the central bank liquidity swap lines extended during the global financial crisis. In that case, 193

we were acting in accordance with our dual mandate, in the interest of the U.S. economy, by taking actions that also benefit the world economy. Going forward, we will continue to be guided by those same principles.

References Ahmed, Shaghil, and Andrei Zlate (forthcoming). "Capital Flows to Emerging Market Economies: A Brave New World?" Journal of International Money and Finance. Avdjiev, Stefan, and Elod Takáts (2014). "Cross-Border Bank Lending during the Taper Tantrum: The Role of Emerging Market Fundamentals (PDF)," BIS Quarterly Review, September, pp. 49-60. Bank of England (2013). Inflation Report (PDF). London: BOE, August. Bernanke, Ben S. (2010a). "The Economic Outlook and Monetary Policy," speech delivered at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, August 27. ——— (2010b). "Semiannual Monetary Policy Report to the Congress," statement before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, Washington, July 21. ——— (2012). "U.S. Monetary Policy and International Implications," speech delivered at "Challenges of the Global Financial System: Risks and Governance under Evolving Globalization," a seminar sponsored by the Bank of Japan and the International Monetary Fund, Tokyo, Japan, October 14. ——— (2014). "The Federal Reserve: Looking Back, Looking Forward," speech delivered at the Annual Meeting of the American Economic Association, Philadelphia, January 3. Borio, Claudio, and Haibin Zhu (2012). "Capital Regulation, Risk-Taking and Monetary Policy: A Missing Link in the Transmission Mechanism?" Journal of Financial Stability, vol. 8 (December), pp. 236-51. Bowman, David, Juan M. Londono, and Horacio Sapriza (2014). "U.S. Unconventional Monetary Policy and Transmission to Emerging Market Economies (PDF)," International Finance Discussion Papers 1109. Washington: Board of Governors of the Federal Reserve System, June. Bruno, Valentina, and Hyun Song Shin (forthcoming). "Cross-Border Banking and Global Liquidity," Review of Economic Studies. Chen, Qianying, Andrew Filardo, Dong He, and Feng Zhu (2012). "International Spillovers of Central Bank Balance Sheet Policies (PDF)," BIS Papers Series 66p. Basel, Switzerland: Bank for International Settlements, October. D'Amico, Stefania, and Thomas B. King (2013). "Flow and Stock Effects of Large- Scale Treasury Purchases: Evidence on the Importance of Local Supply," Journal of Financial Economics, vol. 108 (May), pp. 425-48. Draghi, Mario, and Vitor Constâncio (2013). "Introductory Statement to the Press Conference (with Q&A)," speech delivered at the European Central Bank, Frankfurt, July 4. 194

Ehrmann, Michael, and Marcel Fratzscher (2005). "Equal Size, Equal Role? Interest Rate Interdependence between the Euro Area and the United States," Economic Journal, vol. 115 (October), pp. 930-50. ——— (2009). "Global Financial Transmission of Monetary Policy Shocks," Oxford Bulletin of Economics and Statistics, vol. 71 (December), pp. 739-59. Eichengreen, Barry (2013). "Does the Federal Reserve Care about the Rest of the World?" Journal of Economic Perspectives, vol. 27 (Fall), pp. 87-104. Federal Open Market Committee (2014). Statement on Longer-Run Goals and Monetary Policy Strategy (PDF). Washington: Board of Governors of the Federal Reserve System, January 28. Fischer, Stanley (2014). "Financial Sector Reform: How Far Are We?" speech delivered at the Martin Feldstein Lecture at the National Bureau of Economic Research, Cambridge, Mass., July 10. Fleming, J. Marcus (1962). "Domestic Financial Policies under Fixed and under Floating Exchange Rates," International Monetary Fund Staff Papers, vol. 9 (November), pp. 369-80. Fratzscher, Marcel (2012). "Capital Flows, Push versus Pull Factors and the Global Financial Crisis," Journal of International Economics, vol. 88 (November), pp. 341- 56. Fratzscher, Marcel, Marco Lo Duca, and Roland Straub (2013). "On the International Spillovers of U.S. Quantitative Easing (PDF)," Working Paper Series 1557. Frankfurt: European Central Bank, June. Furceri, Davide, Stephanie Guichard, and Elena Rusticelli (2011). "Medium-Term Determinants of International Investment Positions: The Role of Structural Policies," OECD Economics Department Working Paper Series 863. Paris: Organization for Economic Co-operation and Development, May. Gagnon, Joseph, Matthew Raskin, Julie Remache, and Brian Sack (2011). "Large-Scale Asset Purchases by the Federal Reserve: Did They Work? (PDF)" Federal Reserve Bank of New York, Economic Policy Review, vol. 17 (May), pp. 41-59. Glick, Reuven, and Sylvain Leduc (2013). "The Effects of Unconventional and Conventional U.S. Monetary Policy on the Dollar (PDF)," Working Paper Series 2013-11. San Francisco: Federal Reserve Bank of San Francisco, May. Hamilton, James D., and Jing Cynthia Wu (2012). "The Effectiveness of Alternative Monetary Policy Tools in a Zero Lower Bound Environment," Journal of Money, Credit and Banking, vol. 44 (February), pp. 3-46. Hanson, Samuel, and Jeremy Stein (forthcoming). "Monetary Policy and Long-Term Real Rates," Journal of Financial Economics. Hausman, Joshua, and Jon Wongswan (2011). "Global Asset Prices and FOMC Announcements," Journal of International Money and Finance, vol. 30 (April), pp. 547-71.

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Hume, David (1742). "Of Interest," Political Discourses, essay IV, in Eugene F. Miller, ed., Essays, Moral, Political, and Literary. Indianapolis: Liberty Fund, Inc. (1987). International Monetary Fund (2013). IMF Multilateral Policy Issues Report: 2013 Spillover Report (PDF). Washington: IMF, August. Joyce, Michael A.S., Ana Lasaosa, Ibrahim Stevens, and Matthew Tong (2011). "The Financial Market Impact of Quantitative Easing in the United Kingdom," International Journal of Central Banking, vol. 7 (September), pp. 113-61. Kindleberger, Charles P. (1986). The World in Depression, 1929-1939. Berkeley, Calif.: University of California Press. Luca, Oana, and Nikola Spatafora (2012). "Capital Inflows, Financial Development, and Domestic Investment: Determinants and Inter-Relationships (PDF)," IMF Working Paper Series WP/12/120. Washington: International Monetary Fund, May. Morris, Stephen, and Hyun Song Shin (2014). "Risk-Taking Channel of Monetary Policy: A Global Game Approach (PDF)," working paper, Princeton University, January. Mundell, Robert A. (1963). "Capital Mobility and Stabilization Policy under Fixed and Flexible Exchange Rates," Canadian Journal of Economic and Political Science, vol. 29 (November), pp. 475-85. Neely, Christopher J. (2011). "The Large-Scale Asset Purchases Had Large International Effects (PDF)," Working Paper Series 2010-018C. St. Louis: Federal Reserve Bank of St. Louis, January. Powell, Jerome H. (2013). "Advanced Economy Monetary Policy and Emerging Market Economies," speech delivered at the Federal Reserve Bank of San Francisco 2013 Asia Economic Policy Conference, San Francisco, November 4. Rey, Hélène (2013). "Dilemma Not Trilemma: The Global Financial Cycle and Monetary Policy Independence (PDF)," paper presented at "Global Dimensions of Unconventional Monetary Policy," a symposium sponsored by the Federal Reserve Bank of Kansas City, held in Jackson Hole, Wyo., August 22-24. Rogers, John H., Chiara Scotti, and Jonathan H. Wright (2014). "Evaluating Asset- Market Effects of Unconventional Monetary Policy: A Cross-Country Comparison (PDF)," International Finance Discussion Papers 1101. Washington: Board of Governors of the Federal Reserve System, March. Sahay, Ratna, Vivek Arora, Thanos Arvanitis, Hamid Faruqee, Papa N'Diaye, Tommaso Mancini-Griffoli, and an IMF Team. (2014). "Emerging Market Volatility: Lessons from the Taper Tantrum (PDF)," IMF Staff Discussion Note SDN/14/09. Washington: International Monetary Fund, September. Takáts, Elod, and Abraham Vela (2014). "International Monetary Policy Transmission (PDF)," BIS Papers Series 78. Basel, Switzerland: Bank for International Settlements, August. Tarullo, Daniel K. (2014). "Stress Testing after Five Years," speech delivered at the Third Annual Stress Test Modeling Symposium, sponsored by the Board of Governors 196

of the Federal Reserve System and the Federal Reserve Bank of Boston, Boston, June 25. Yellen, Janet L. (2014). "Monetary Policy and Financial Stability," speech delivered at the 2014 Michel Camdessus Central Banking Lecture, sponsored by the International Monetary Fund, Washington, July 2.

1. I am grateful to John Ammer, Christopher Erceg, Joseph Gruber, and Beth Anne Wilson of the Federal Reserve Board's staff for their assistance in preparing this lecture. Return to text 2. The Federal Open Market Committee (FOMC) has judged that 2 percent inflation in the price of personal consumption expenditures is most consistent over the longer run with the Federal Reserve's statutory mandate. For more information, see Federal Open Market Committee (2014). The Fed also has separate responsibilities for promoting financial stability (some of which are spelled out in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010) that are, in many respects, complementary to the dual mandate. See Yellen (2014) for further discussion. Return to text 3. See Powell (2013) for an earlier discussion of many of these topics. Return to text 4. See Hume (1742). Return to text 5. See Mundell (1963) and Fleming (1962). One key implication of the Mundell- Fleming framework is that a central bank can exercise full control over both the exchange rate and the domestic interest rate only when there are significant barriers to the international capital mobility. Accordingly, policymakers face the constraint of the "impossible trinity," which states that a country cannot simultaneously have an independent monetary policy, free capital movement, and a fixed exchange. Return to text 6. Several recent papers discuss risk-taking channels through which monetary policy influences financial conditions more broadly than the level of safe interest rates. See Borio and Zhu (2012), Rey (2013), Morris and Shin (2014), Bruno and Shin (forthcoming), and the Hanson and Stein (forthcoming) "reaching for yield" concept. Return to text 7. Studies using panel data typically have found that country-specific factors help explain cross-sectional differences in international investment and capital flows. See, for example, Furceri, Guichard, and Rusticelli (2011); Fratzscher (2012); and Luca and Spatafora (2012). Avdjiev and Takáts's (2014) study of cross-border bank lending during the taper tantrum shows a larger pullback for countries with weaker current account balances, and Sahay and others (2014) find that country-specific market reactions during this period also were affected by high inflation, weak growth prospects, and relatively low reserves. Return to text 8. See Eichengreen (2013). Return to text 9. See, for example, Bernanke (2010a, 2010b). Return to text 10. See, for example, D'Amico and King (2013); Gagnon, Raskin, Remache, and Sack (2011); Hamilton and Wu (2012); and Rogers, Scotti, and Wright (2014). Return to text 197

11. See Neely (2011); Fratscher, Lo Duca, and Straub (2013); Rogers, Scotti, and Wright (2014); and Bowman, Londono, and Sapriza (2014). Also, Ahmed and Zlate (forthcoming) show that both conventional and nonconventional U.S. monetary expansion have driven capital flows into EMEs. Return to text 12. See Neely (2011); Fratscher, Lo Duca, and Straub (2013); Rogers, Scotti, and Wright (2014); and Bowman, Londono, and Sapriza (2014). Return to text 13. See Rogers, Scotti, and Wright (2014) and Chen, Filardo, He, and Zhu (2012) for more systematic evidence. Return to text 14. See, for example, Rogers, Scotti, and Wright's (2014) recent event study of central bank announcement effects on sovereign yields in different countries. Similarly, earlier work by Ehrmann and Fratzscher (2005) finds larger reactions in euro-area interest rates to U.S. rate changes than vice versa. Return to text 15. See, for example, Ehrmann and Fratzscher (2009) and Hausman and Wongswan (2011). Return to text 16. Among studies of spillovers from conventional versus unconventional U.S. monetary policy, Rogers, Scotti, and Wright (2014) report no significant differences in relative announcement effects on advanced foreign economy asset prices and Treasury yields; Bowman, Londono, and Sapriza (2014) find similar EME asset price responses; Takáts and Vela (2014) report mixed results for EMEs, with a weaker post-2007 relationship in levels of EME policy rates with U.S. rates but a stronger post-2008 relationship in levels of five-year yields; and Glick and Leduc (2013) also report similar spillovers to exchange rates. The effects of the Bank of England's quantitative easing program on corporate bond yields and sterling exchange rates are similar to predictions from a model estimated over an earlier period by Joyce, Lasaosa, Stevens, and Tong (2011). Return to text 17. See the discussion in Bernanke (2012). Return to text 18. See Bowman, Londono, and Sapriza (2014). And, over a longer sample, Ahmed and Zlate (forthcoming) show that capital flows to EMEs are affected by factors other than relative interest rates, including relative growth prospects and global risk sentiment. Return to text 19. Simulations of the Federal Reserve Board's econometric models of the global economy suggest that the effects are roughly offsetting, so that accommodative monetary policies in the advanced economies do not appear, on net, to have adverse consequences for output and exports in the emerging market economies. Similar results are obtained model analysis presented in International Monetary Fund (2013). Return to text 20. See Draghi and Constâncio (2013) and Bank of England (2013). The success of forward guidance, of course, depends crucially on the ability of policymakers to make informative statements about their intentions without a formal commitment device. Return to text 21. Powell (2013) notes that EMEs with larger current account deficits experienced both greater depreciations of their currencies and larger increases in their bond yields in mid- 2013, suggesting that, while a reassessment of U.S. monetary policy may have triggered 198

the retrenchment from EME assets, investor concerns about underlying vulnerabilities appear to have amplified the reactions. Return to text 22. Bernanke (2014), Fischer (2014), and Tarullo (2014) also discuss concrete steps that U.S. authorities have taken in the past five years to implement financial reform of large financial institutions (including introducing a systematic framework for stress-testing, stronger capital and liquidity requirements, and progress on resolution mechanisms for failed institutions), of financial market infrastructures, and in short-term funding markets. Return to text 23. See Kindleberger (1986). Return to text http://www.federalreserve.gov/newsevents/speech/fischer20141011a.htm

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Mainly macro Comment on macroeconomic issues

Thursday, 9 October 2014 Do we need a crisis to reduce the deficit? The macroeconomic case for not cutting the deficit straight after a major recession is as watertight as these things get, at least outside of the Eurozone. (It is also true for the Eurozone, but just a bit more complicated, so its easier to just focus on the US and UK in this post.) If you want to bring the government deficit and debt down, you do so when interest rates are free to counter the impact on aggregate demand. As the problems of high government debt are long term there is no urgency for debt reduction, so the problem can wait. The costs of fiscal consolidation in a liquidity trap are large and immediate, as we have experienced to our cost. Sometimes austerity proponents will admit this basic macroeconomic truth, but say that it ignores the politics. Politics means that it is very difficult for governments to reduce debt during booms, they say. Although it would be nice to wait for interest rates to rise before cutting the deficit, it will not happen if we do, so we have to cut now. Like all good myths, this is based on a half truth: in the 30 years before the recession, debt tended to rise as a share of GDP in most OECD countries. And it always sounds wise to say you cannot trust politicians. However both the UK and US show that this is not some kind of iron law of politics. In the UK debt came down from over 100% of GDP between the wars to less than 50% of GDP by the mid-1970s, and was lower still before the recession. (Debt was lower before the recession than when Labour came to power in 1997.) US debt also fell sharply after WWII, but rose again under Reagan and Bush, fell under Clinton and then rose again under the other Bush. So the empirical evidence on US and UK debt is not that it is inherently difficult to reduce in booms; it is do not elect Republican presidents. My reason for returning to this issue was thinking about the post 2015 UK election plans of all three main political parties. As I have outlined before, all involve tight fiscal control - in my opinion tighter than would be prudent from a macroeconomic point of view. This is fully six years after the recession. So it looks like politics is capable of promising fiscal consolidation well after a crisis. Are we meant to believe that if instead of austerity we had had additional fiscal stimulus after the recession, within the framework that Jonathan Portes and I suggest, things would have been quite different by 2015? [1] It is true that no party is - as yet - telling us exactly how these numbers would be achieved, but this does not mean it will not happen: the Conservatives delivered in 2010, and Labour broadly stuck to its fiscal rules until the recession. The only party to go back on their election promises were the LibDems, who campaigned for less austerity than they ended up delivering. http://mainlymacro.blogspot.com.es/2014/10/do-we-need-crisis-to-reduce-deficit.html

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Wage-Price Inflation and the Way Things Work In Economics

Thursday, 09 October 2014 07:00

There's an old saying in economics that it doesn't matter if what you say is right, what matters is if the right person says it. I was reminded of this line when I read Matt O'Brien's wonkblog post on the success of the Fed in allowing the unemployment rate to fall below the nearly universally accepted measure of the NAIRU, without having any notable acceleration of inflation. This is a great history that should be tattooed on the forehead of everyone involved in the current debate on how low the unemployment rate can go without kicking off a wage price spiral. Back in the mid-1990s all right thinking economists thought that the NAIRU was in the neighborhood of 6.0 percent. This meant that if the unemployment rate was below 6.0 percent the inflation rate would begin to increase. And, it would keep increasing as long as the unemployment rate stayed below 6.0 percent. While there was some difference on the precise number (the usual range went from 5.6 percent to 6.4 percent), there was almost no dispute on the basic point. As O'Brien notes, even Janet Yellen adhered to this view, expressing concerns in 1996 that if the Fed didn't raise interest rates inflation would be a big problem. (Paul Krugman also expressed a similar view at the time.) Thanks to the eccentricities of Alan Greenspan, the Fed did not raise interest rates. Instead it allowed the unemployment to continue to fall. It fell below 5.0 percent in 1997, it crossed 4.5 in 1998, and reached 4.0 percent as a year-round average. And inflation remained tame. The result was that millions of people had jobs who would not have otherwise. Tens of millions of workers at the middle and bottom of the wage distribution saw substantial real wage gains for the first time in a quarter century. And, for the folks fixated on budget deficits, we saw a large surplus for the first time in decades. As much as the Clintonites like to boast of their great surpluses, the reality is that the budget would have remained in deficit if Clinton's Fed appointees (Janet Yellen and Lawrence Meyer) had gotten their way. It is only because the Fed allowed the unemployment rate to fall far lower than these folks thought wise that the budget shifted from deficit to surplus. (In 1996 the Congressional Budget Office projected a deficit of $240 billion [2.5 percent of GDP] for 2000. In fact, we ran a surplus of roughly the same amount. According to CBO, the legislative changes over this four year period went a small amount in the wrong direction.) Anyhow, all of this should be a good reminder that the whole of the economics 201

profession can be completely wrong on the most important issues affecting the economy. But that isn't why I brought you here today. My main reason for doing this post is that O'Brien reminded me of one of my pet peeves about the NAIRU history. When we didn't see the predicted acceleration of inflation, the surprised economists went running around looking for explanations for why their theory had failed. This issue is discussed at some length in a book by Janet Yellen and Alan Blinder, The Fabulous Decade. One of the explanations they give for inflation not rising is that there were changes in the measured rate of inflation that lowered the CPI relative to the actual rate of inflation. In other words, because changes in the methodology used to construct the CPI, if the true rate of inflation was 2.5 percent throughout the decade the CPI might show a 3.0 percent rate of inflation in 1994, but a 2.5 percent rate of inflation in 2000. If workers don't recognize that the way to measure the CPI has changed, then they may not adjust their wage expectations accordingly. This means that if they were expecting wage increases that were 1.0 percentage point above the CPI measure of inflation in 1994, then they were expecting wage increases that were 1.5 percentage points above the true rate of inflation. However if they expected wage increases that were 1.0 percentage point above the measured rate of inflation in 2000, then they were expecting wage increases that were just 1.0 percentage points above the true rate of inflation. Yellen and Blinder argue that this could be a reason that inflation did not take off as they had predicted. (Their measure of inflation uses the same methodology over the whole period.) I think there can be some plausibility to the Blinder-Yellen story, albeit not very much. The reality is that the measured rate of inflation did not change all that much during this period. The gap between the inflation rate shown by the CPI and the currently used measure peaked at around 0.5 percentage points for six years, from 1988 to 1993. It had previously been less than 0.3 percentage points. The Bureau of Labor Statistics then introduced a series of changes that lowered the gap to less than 0.2 percentage points by 1997 and to 0.0 by 2000. Insofar as the CPI provides a reference point for wage increases, these changes could have some moderating effect, but the impact would be very limited compared to the predicted inflation. But this gets me back to the my original comment. Yellen and Blinder felt it was important to note the impact of changes in the measurement of inflation on the course of actual inflation in the late 1990s. But this is not the first time we had measurement issues with inflation. We all know about how we had a wage-price spiral back in the bad old days of the late 1960s and 1970s. That was when our links between the unemployment rate and inflation were supposed to be really tight. Well, it turns out that this was also a period in which we had large gaps between the inflation rate as shown by the CPI and what we would now view as the actual rate of inflation using current methods. The gaps in those years were several times larger than the gaps that concerned Yellen and Blinder. In 1969 and 1970 the gap between the inflation rates shown by the official CPI and the CPI-UX1 that we now view as more accurate were 1.0 percentage point and 0.9 percentage points, respectively. The gap reached 1.1 percentage in 1974 and 202

averaged almost 2.0 percentage points in 1979 and 1980, as double digit inflation was ravaging the land. Not only were the measurement issues far larger in the late 1960s and 1970s, but the official CPI was almost certainly more important for wage setting. The unionization rate was well over 20 percent through this period. Unions would naturally look to the CPI in making their wage demands. And many wage contracts, both union and non-union, were directly linked to the CPI, meaning that any error in the measured rate of inflation would be passed on directly in wages. In other words, if Yellen and Blinder are at all right in their view of the lower than expected inflation in the late 1990s, then the measurement error in the CPI must explain a substantial portion of the inflation in the late 1960s and 1970s. However as far as I know, no one has looked into this. (I have an old working paper with EPI that did find a strong link.) Anyhow, one day someone important will look at the impact of measurement error on inflation in the 1960s and 1970s. I suspect that we will then find a less direct link between unemployment and inflation than is currently believed. http://www.cepr.net/index.php/blogs/beat-the-press/wage-price-inflation-and-the- way-things-work-in-economics

About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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Bernanke defends AIG bailout in court Mary Thompson | @MThompsonCNBC 13 Hours AgoCNBC.com

Getty Images Former Chairman of the Federal Reserve Ben Bernanke arrives at U.S. Court of Federal Claims to testify at the AIG trial October 9, 2014 in Washington. Former Federal Reserve Chairman Ben Bernanke took the stand in the American International Group bailout trial Thursday afternoon appearing slightly combative and vaguely annoyed at having to testify. Wearing a grey suit, white shirt and dark tie, Bernanke provided mostly curt answers to questions from the lead plaintiff's attorney, David Boies. Bernanke defended the government's bailout package for AIG, including an equity stake taken by the government. Watch: Hank Greenberg challenges AIG bailout "I knew that the equity component was additional compensation to the taxpayer for the risk being taken" he said, when asked if he knew the basis for the government taking what became a 92 percent stake in the insurance giant. Boies spent a good part of the more than two hours Bernanke was on the stand, asking about that equity stake. He asked Bernanke if he had sought other opinions, or asked on what basis an equity stake needed to be taken in AIG. He also asked Bernanke if he had asked for any additional analysis on why the rates on the loans to AIG were so high.

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Bernanke said he had not. Boies asked Bernanke if he had asked about the basis of various fees that were part of the bailout package. Bernanke said he had not. Read MoreAIG bailout trial may be good therapy! What Bernanke did say was that in approving the deal along with the rest of the Fed's Board of Governors he relied on the judgment of the New York Federal Reserve Bank, which was providing the initial commitments to AIG. "All I recall is that the package needed to minimize the windfall to shareholders and protect the taxpayers," Bernanke said. The lawsuit, which is being heard in a six-week bench trial, was brought by Starr International, once AIG's biggest shareholder and the investment firm of AIG's former CEO Hank Greenberg. Greenberg ran AIG for 40 years before stepping down in 2005 amid an accounting investigation. Read MoreHank Greenberg sues Eliot Spitzer for defamation The lawsuit alleges the government violated AIG and its shareholders Fifth Amendment rights by treating the firm unfairly, and improperly compensating shareholders for the equity stake the government took. With his questioning, Boies is trying to paint a picture of government exceeding its scope of emergency powers to force a slap dash rescue package on AIG that failed to properly value the company, a rescue package down without the appropriate due diligence to justify the terms of the agreement. The government has maintained as the lender of last resort to a failing AIG, the terms were appropriate given the risk it was taking, and that the terms were needed to discourage other firms from seeking similar bailouts. Bernanke was called to the stand following the conclusion of more than two days of testimony from former Treasury Secretary Tim Geithner, who ran the New York Federal Reserve at the time of the financial crisis. The last of the "big three" witnesses to take the stand this week, Bernanke appeared to be the most put out at being in court. Monday's testimony from former Treasury Secretary Hank Paulson was short, only two hours long, and marked by the easiness of the exchanges between Paulson and the plaintiff's attorney David Boies. Even Geithner, who faced far more extensive questioning from Boies, punctuated his answers with some lighter replies and was affable during most his time on the stand. Bernanke, Paulson and Geithner were the architects of the government's response to the financial crisis, including the AIG bailout in 2008. Bernanke will take the stand again on Friday.

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The Opinion Pages| Op-Ed Contributor Don’t Soak the Rich By EDWARD D. KLEINBARDOCT. 9, 2014 LOS ANGELES — IN response to the growing income disparity between the wealthy and the merely well off — not to mention the middle class and working class — an increasing number of economists and politicians have called for higher tax rates on top incomes. That would collect more revenues, and make our tax system more progressive, by collecting a disproportionate share of those new revenues from the highest income taxpayers, a fact that appeals to many people’s sense of fairness. But even taking into account regressive state and local taxes, the American tax system already is the most progressive in the developed world. And the scars left by the 2013 fight over the “fiscal cliff” tax deal imply that trying to raise top marginal income tax rates to the levels suggested by some academics would be, well, a wholly academic exercise. That does not mean, however, that we are bereft of instruments to tackle income inequality. In fact, achieving equality through the tax structure is the wrong way to think about the issue. Reformers have blundered by confusing what seems fair — more progressive taxation — with what is actually important, and lacking: a progressive fiscal system. As other developed countries have figured out, reducing inequality is not about where the money comes from, but where the money goes, and how much of it is spent. A fiscal system encompasses both the tax and the spending sides of government. What we should care about is whether those two functions, taken as a whole, enhance the lives of average citizens. To that end, the right focus is not how progressively we finance government spending (i.e., tax ourselves), but rather the net effect of both sides of the equation — government taxing and government spending. Does the combination of the two advance or retard Americans’ prospects for a decent standard of living and equality of opportunity? It turns out that progressive fiscal outcomes do not require particularly progressive tax systems — just big ones, to support substantial government investment and insurance programs. That’s because government spending invariably is very progressive: Lower- income Americans get disproportionately more value from government spending, relative to their incomes, than do the affluent, because they rely much more on public schools, social services and health care. It is easy to see that government spending on programs like food stamps, which go almost exclusively to the poor, is highly progressive. But the point applies to almost all government programs that have individual beneficiaries — every working American might receive Social Security, for example, but by design it has a progressive payout structure, because lower-income beneficiaries get more benefits relative to their contributions than do higher-income ones. Likewise, Medicare is highly subsidized out of general tax revenues, so that the value of Medicare insurance is also progressively distributed.

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And while it is true that about 40 percent of government spending — on highways or other infrastructure, or our defense budget — does not flow to specific beneficiaries, this spending also is progressive in its effect. In 2013, the nonpartisan Congressional Budget Office offered its first tentative analysis of who benefits from this general spending; it found, unsurprisingly, that the benefits from unallocated spending are broadly shared. A chief executive who earns 200 times as much as her typical employee does not get 200 times the benefit from our investments in highways. The better response to income disparity, then, is not to tax the rich more, but to boost revenue over all so that government can invest more, and offer higher quality social insurance programs. We have our work cut out for us: Our net investment in public infrastructure is only around 0.5 percent of our gross domestic product, and our social insurance programs are much smaller than those of most other developed economies. Our peer countries typically rely on large, regressive tax systems to mitigate income inequality far more than we do. For example, I compared Germany and the United States, using 2007 data (the last year unaffected by the Great Recession) collected by the Organization for Economic Cooperation and Development. The two countries had virtually equivalent levels of income inequality. Moreover, the American tax system as a whole was quite progressive, while Germany’s actually was regressive. Nonetheless, the American fiscal system as whole (including state and local government spending) reduced inequality in market income — that is, income before subtracting taxes and adding back government benefits — by only 22 percent, while Germany’s reduced it by 41 percent. The reason is that the German fiscal system was significantly larger in overall terms: Taxes accounted for about 36 percent of German gross domestic product, against 28 percent for the United States. It’s the spending side, not the taxes, that makes the difference. In short, both conservatives and progressives get things wrong. To address troubling trends in income inequality, we need more government, not less. But we do not need steeply higher marginal income tax rates to yield a richer, more equal and happier society. Edward D. Kleinbard is a professor of law and business at the University of Southern California and the author of “We Are Better Than This: How Government Should Spend Our Money.” http://www.nytimes.com/2014/10/10/opinion/dont-soak-the- rich.html?partner=rss&emc=rss

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Categorized | Economy An extraordinary state of ‘managed depression’ Martin Wolf, 9-10-2014 Suppose we had been told two decades ago that a time would come when the highest short-term intervention rate implemented by the four most important central banks of the high-income countries was just half a per cent. Suppose, too, we were told that the European Central Bank was down to 0.05 per cent, after a brief and unsuccessful effort to raise the rate from 1 per cent to 1.5 per cent in 2011. Suppose, not least, we had been told that by late 2014, rates almost as low as this, or even lower, had been in effect for more than five years, and in Japan for two decades. What would we have expected as the result of such policies? High inflation, if not hyperinflation, would have been our answer. Indeed, we would have wondered why policy makers had gone mad. Risky business

Suppose we then learned that the yield on 10-year government bonds was just 2.6 per cent in the US, 2.4 per cent in the UK, 1 per cent in Germany and 0.6 per cent in Japan. One would have to forget the notion of high inflation; we would suggest instead that these economies had been allowed to fall into a deep, prolonged depression. If we were told that central banks had also implemented huge expansions of their balance sheets, confidence in this hypothesis would strengthen. Why else would policy makers have been so unorthodox? Up to a point, we would also have been right. In the US, UK and the eurozone, output has fallen far below what virtually everybody expected eight years ago. The same is true of Japan, though the trend in question ended two and a half decades ago. Yet, contrary to what we might also have expected, we do not observe accelerating deflation: the latest data on annual consumer price inflation are 1.7 per cent in the US, 208

1.5 per cent in the UK and 0.3 per cent in the eurozone. None of these figures, even the last, are all that distant from announced targets. When we look at the high-income economies in this way, we must recognise that they are in a truly extraordinary state. The best way to describe it is as a managed depression: aggressive monetary policies have been sufficient to halt accelerating deflation, but they have been insufficient to produce a strong expansion. This is particularly true of the eurozone, where real domestic demand in the second quarter of this year was 5 per cent lower than in the first quarter of 2008. In the US, by contrast, real demand was 6 per cent higher. The latter is an extraordinarily feeble recovery, but the eurozone’s performance is little short of appalling. Recent suggestions by the ECB’s president, Mario Draghi, that the eurozone needs a radical shift in policy regime, is the self-evident truth. Yet the powers that be in the eurozone – notably, the German government – plan to do nothing about it. How are we to make sense of this predicament? The answer is that it reflects a prolonged slump in aggregate demand to which policy makers have failed to craft an adequate response. Lawrence Summers, former US Treasury secretary, has even recalled the phrase “secular stagnation”, first used in the 1930s. In my book The Shifts and the Shocks, I argue that pre-crisis trends – huge global current account imbalances, rising inequality and weak propensity to invest – had already created weak underlying demand in high-income countries. The de facto response of policy makers was toleration, if not promotion, of credit booms. When these collapsed, extraordinary policy easing was needed both to replace the lost demand impetus from the credit bubbles and to offset the drag on demand from debt overhangs, predominantly in private sectors: too many people had borrowed too much. We can, at last, see some reasons for optimism about the US and UK. We can envisage the beginnings of a return to more normal policy, though confidence in the ability of these economies to weather normalisation cannot be strong. More radical alternatives, such as higher inflation targets and debt restructuring, may yet be needed. In the eurozone and Japan, however, the picture looks more uncertain. In the eurozone, more action is needed if a successful and widely shared recovery is to be achieved. In Japan, achievement of the inflation target of 2 per cent is not yet assured. Adding to the challenges for a world in which high-income economies are not yet restored to anything close to health is the gathering slowdown of the emerging economies. These provided most of the economic dynamism both before and after the financial crises in high-income economies. In a noteworthy blog, Sweta Saxena of the IMF notes that growth of emerging economies has slowed from 7 per cent a year before the crisis to a forecast of 5 per cent between 2014 and 2018. Moreover, this decline is not just due to the slowdown in China and India. Growth rates are now “lower than the pre-crisis average in . . . 70 per cent of emerging economies”. This slowdown in emerging economies is due to the prolonged weakness of high- income economies, failure to sustain economic reforms and the exhaustion of policy- 209

induced post-crisis boosts to domestic demand. The slowdown will mean weaker growth of world trade and lower commodity prices, and is likely to reveal unexpected losses in the financial sector. With growth in high-income economies constrained by inadequate domestic demand, a risk of feedback effects exists. The channels go from slowing emerging economies to high-income economies, especially the more export-dependent ones, and back again, as the IMF’s 2014 Spillover Report argues. Complacency would be foolish. The room for further disappointment is far too large for that. http://offshorecorporatesource.com/an-extraordinary-state-of-managed- depression/ Categorized | Capital Markets, Currencies, Economy New tools needed to tame capital flows

©AFP Paul Tucker, FT, 9-10-2014 While much has been done to reform the financial system, seven years after the crisis the faultlines in the international monetary system remain more or less as they were. We live with arrangements that lead to persistent international imbalances in the pattern of spending, saving and investment. When trouble hits one country, it quickly spreads abroad. How can we maintain the benefits of floating exchange rates and cross-border flows of capital without such serious costs? Realistically, there is little we can do about the imbalances. Throughout history there have been nations that saved less than they invested, which resulted in current account deficits. There have been nations that spent less, building up savings and current account surpluses. But the savers have never shown much interest in reducing their surpluses at a pace desired by other countries, seeing that as the duty and need of the debtors. What can be mitigated is the tendency for crises to spill across borders. The International Monetary Fund’s triennial review of how it monitors economic and financial risks and policies – to which I have contributed, along with my colleague David Li of Tsinghua University – provides an opportunity to do just that. There was a time when most international capital flows were associated with financing a country’s net trade in goods and services. This meant the size of current account positions was more or less all that mattered; countries that were in balance, exporting about as much as they imported, did not fear turbulence in international markets. But

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that has not been true for decades, as a string of crises attests. A country can be vulnerable if its borrowers – whether in business, government or the financial sector – have taken too many short-term loans in foreign currencies or from abroad. Countries have different vulnerabilities. In the Asian crisis of the 1990s, South Korea’s was concentrated in its banking sector; for Indonesia the problem was the overreliance of its non-financial businesses on dollar financing on international markets. In the recent crisis, even though the eurozone was running a broadly balanced external (current account) position, far too many of its banks relied on flighty dollar funding from US money market funds. What matters is not just the net total of capital inflows and outflows but the composition of a country’s national balance sheet, which takes account of the external claims and obligations of all sectors. With too much short-term debt, a country can be as vulnerable to runs as a bank that has funded itself from fickle sources. The run might be triggered by problems in the borrowing country or by spillovers from abroad. Lenders might withdraw funds to plug balance sheet holes that are opening up at home. Or they might see better opportunities for short-term returns elsewhere, as when funds fled emerging market economies during the summer of 2013 on perceptions the US Federal Reserve would tighten monetary policy sooner than previously thought. It is not good enough just to monitor those vulnerabilities. Something needs to be done about them The problem of spillovers is not confined to emerging markets. For even the largest economies, there is a boomerang problem. As long ago as the early 1980s, the US faced the prospect of its big banks going bust when Latin American sovereigns could not service their dollar obligations at the high rates of interest entailed by the Fed’s fight against inflation under Paul Volcker, then chairman. It is not good enough just to monitor those vulnerabilities. Something needs to be done about them. In recent years some countries in Asia and Latin America have been turning to new tools. Faced with capital inflows that pushed up asset prices and fuelled local credit booms, they have required financial institutions to hold more resources to cover the credit risk, or more liquid assets to protect against a bout of capital flight. This is similar to the macroprudential approach developed to sustain credit supply within countries, but applied to an economy’s external vulnerabilities – its national balance sheet. This is a sensible approach. But the objective should be limited: guarding against threats to stability. It should not become an attempt to tax all short-term capital flows. And it is very different from deploying capital controls to protect local companies from foreign competition, which would merely delay needed macroeconomic adjustment. The IMF needs to make those distinctions clear. For all its members, it should review national balance sheet vulnerabilities and macroprudential policies, just as it offers advice on monetary and fiscal policy. The global financial system can be made safer and more robust. The writer, a former deputy governor of the Bank of England, is a senior fellow at Harvard university http://offshorecorporatesource.com/new-tools-needed-to-tame-capital-flows/

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ft.com Comment Blogs Gavyn Davies It’s Draghi versus Weidmann on ECB QE Gavyn Davies Oct 10 10:28

© CARLO HERMANN/AFP/Getty Images Last week’s press conference by ECB President Mario Draghi left the markets disappointed and somewhat perplexed about the shift towards quantitative easing that had just been sanctioned by the governing council (GC). Because this was focused on private sector assets, in the form of asset backed securities and covered bonds, there were doubts about whether the new policy could be implemented in sufficient size to deal with the deflationary threat in the euro area. Mr Draghi was noticeably hesitant about giving any firm indication about the likely scale of the programme. Although private sector quantitative easing (QE) is likely to suit the needs of the euro area rather well, as I argued here, the absence of any firm guidance on scale certainly undermined the beneficial announcement effects of the policy change. The ECB president addressed this issue on Thursday in an appearance at Brookings in Washington. This time, freed from the need to speak for the entire GC, he clearly changed his tune on the scale of the programme. But this highlighted the extent of the gap between his view and that of Bundesbank President Jens Weidmann, who presented his position in a revealing interview with the Wall Street Journal on Monday. It is far from obvious how this disagreement will be bridged. At Brookings, Mr Draghi spoke mainly about structural reform, but the key passage in his speech was the following: With our asset purchase programme – this is a pretty important point – we are transitioning from a monetary policy framework predominantly founded on passive provision of central bank credit to a more active and controlled management of our balance sheet. We expect our measures to have a sizeable impact on our balance sheet… The Governing Council has repeated many times: it is unanimous in its commitment to

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take additional unconventional measures to address the risks of a too prolonged period of low inflation. This means that we are ready to alter the size and/or the composition of our unconventional interventions, and therefore of our balance sheet, as required. This promise of a proactive approach to increasing the balance sheet appeared very different from his tone last week. In the Q&A, he hinted that the ECB had estimated how large the balance sheet would need to be to return inflation to target (see video). When pressed on why the GC had not set a specific target for this, he said that this could not be done because they did not know how much net take-up there would be in the TLTRO offerings by the banking sector, so the growth in the balance sheet was not entirely in the GC’s hands. This is hard to understand. Even if the banking sector pays back liquidity to the ECB, the central bank could, if it chose to do so, simply increase its asset purchases to compensate. Provided that it is willing to reduce interest rates across the yield curve (thereby raising bond prices) as far as is necessary to make the required bond purchases from private investors, the overall size of the balance sheet would remain under the control of the central bank. This is what happened, after all, in the US, the UK and Japan. Why, then, has the ECB not announced a target for its overall asset purchases? Presumably because it would imply a willingness to purchase enough government bonds to fill any gap left by a shortage of private assets available for purchase.

© ERIC PIERMONT/AFP/Getty This is where Jens Weidmann’s interview becomes highly relevant. He described government bond purchases as “a dangerous path”, and he stopped well short of endorsing Mr Draghi’s view that purchases of secondary market bonds would be clearly within the ECB’s mandate. When asked directly about this, he said: Purchases of government bonds on the secondary market are not forbidden as such. However, the ECB’s mandate is more narrowly limited than that of central banks in other currency areas. Monetary financing is prohibited for good reason, and this prohibition should not be allowed to be circumvented through secondary market purchases. He added that his views on this would be different if the euro area constituted a genuine political union, and said that the GC discussions about private sector asset purchases

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had been “contentious”, which may explain Mr Draghi’s subdued demeanour at last week’s press conference. It is not completely clear whether Mr Weidmann opposes private sector QE because he thinks it is premature, or because of more fundamental objections. What does seem apparent from his remarks is that any shift to sovereign bond purchases would run into fundamental objections from the Bundesbank, requiring (at the very least) safeguards to ensure that there is no monetary financing of budget deficits, especially in countries with unsustainable public debt positions. That would certainly complicate any programme of sovereign bond purchases very considerably. It is probable that Mr Draghi could, in extremis, get a GC majority for sovereign bond purchases, even if the Bundesbank maintained its strong opposition. But that could cause a major rift on the GC, and public dissent from the Bundesbank, affecting public opinion within Germany. In the absence of some form of compromise here, it is difficult for the ECB to give a clear target for the scale of its asset purchase programme. Mr Draghi, and other leading members of the GC, have now come very close to saying that they want to have a specific objective for the balance sheet. It will be interesting to watch how they get there. http://blogs.ft.com/gavyndavies/2014/10/10/its-draghi-versus-weidmann-on-ecb-qe/

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ft.com/global economy EU Economy October 9, 2014 5:20 pm Draghi vows to fight eurozone deflation By Robin Harding and Claire Jones in Washington

©AP President of European Central Bank Mario Draghi walks in front of the ECB governing council prior to their meeting in Naples on October 2 Mario Draghi has vowed the European Central Bank is determined to prevent the eurozone falling into deflation, but warned that monetary policy will not be sufficient for the single currency bloc to resume sustained growth. The governing council is “unanimous in its commitment to take additional unconventional measures to address the risks of a too prolonged period of low inflation”, said the ECB president at the Brookings Institution in Washington on Thursday. More ON THIS TOPIC// Eurozone inflation gauge hits record low/ The Short View Inflation outlook brings ECB QE into view/ Editorial Criticism of Draghi’s actions is misguided/ ECB to start asset purchases this month IN EU ECONOMY// German exports fall stokes recession fear/ Poland cuts interest rate to record low/ IMF questions fitness of eurozone banks/ Irish central bank to impose mortgage cap “This means that we are ready to alter the size and/or the composition of our unconventional interventions, and therefore of our balance sheet, as required,” he added.

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Mr Draghi’s words send a strong signal that the ECB is willing to embark on large-scale government bond buying – also known as quantitative easing – despite the apparent opposition of some ECB officials. At 0.3 per cent, eurozone inflation is now at a five-year low, and far from the central bank’s target of below but close to 2 per cent. Inflation expectations, which central bankers regard as crucial to keeping inflation on track, have also been falling. The International Monetary Fund warned earlier this week that the eurozone’s economy, which stagnated between the first and second quarters, faced a four in 10 chance of re- entering recession. But while Mr Draghi’s speech reinforced the ECB’s willingness to act, much of it was aimed at other eurozone policy makers, with demands for action on fiscal policy and structural reform. “I am uncertain there will be very good times ahead if we do not reform now,” said Mr Draghi. “Potential growth is too low to lift our economies out of high unemployment.” “Thus, while stabilisation policies that raise output towards potential are necessary, they are not enough. We need to urgently raise that potential.” Mr Draghi said the eurozone had made plenty of progress on cleaning up its banking system and claimed that, as a result, monetary policy will now gain more traction. “Now, as the banking sector is progressively cleaned up and the deleveraging process reaches its conclusion, banks will have new balance sheet capacity to lend, and our monetary policy will become even more effective,” he said. In a bold and optimistic declaration, he said: “I expect credit to pick up soon next year.” Mr Draghi also called for countries with a solid budgetary situation to use fiscal policy to support growth. “If confidence in public finances is assured, the next stage – and this is where we are now – is to exploit the available fiscal space, so that fiscal policy can work with rather than against monetary policy in supporting aggregate demand,” he said. The ECB president said the necessary combination of monetary, fiscal and structural reforms was clear and it was time for the eurozone to deliver. “This combination of policies is complex, but it is not complicated. Each of the steps involved is well understood. The issue now is not diagnosis, it is delivery. It is commitment. And it is timing,” he said. “I recently said of monetary policy that, at the current juncture, the risks of doing too little exceed the risks of doing too much. If we want a stronger and more inclusive recovery, the same applies to doing too little reform.” http://www.ft.com/intl/cms/s/0/6b8dfada-4fbf-11e4-908e- 00144feab7de.html#axzz3FjBZQbRC

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ft. com World Europe October 9, 2014 8:45 pm

©AFPMichael Noonan, Irish finance minister Brussels in crackdown on ‘double Irish’ tax loophole By Alex Barker in Brussels, Vincent Boland in Dublin and Vanessa Houlder in London Brussels is challenging the “double Irish” tax avoidance measure prized by big US tech and pharma groups, putting pressure on Dublin to close it down or face a full-blown investigation. As part of an ambitious and contentious tax clampdown, Europe’s top competition authority asked Dublin earlier this year to explain the controversial tax system used by the likes of Google, Microsoft, Facebook and Abbott Laboratories. More ON THIS STORY// Q&A What is the double Irish?/ Cork brushes off Apple tax claims/ New antitrust head promises action on tax/ Ireland under pressure over low tax rates/ Degrading of Number 10’s tech connection ON THIS TOPIC// Google UK pays £20.4m corporation tax/ Corporation tax cuts cost £5bn annually/ Juncker faces tax inquiry dilemma/ Fast FT Brussels opens tax probe into Apple, Starbucks, Fiat IN EUROPE// EU envoy seeks end to China trade dispute/ Merkel looks to China for Putin mediation/ US and Turkey in diplomatic stand-off/ Renzi victory as Senate backs reforms The initial enquiries have signalled that Brussels wants Dublin to call time on the tax gambit, which has helped Ireland become a hub for American tech and pharma giants operating in Europe. Several people familiar with the case say the threat of another full investigation is putting pressure on Michael Noonan, Ireland’s finance minister, as he considers closing the so-called “double Irish” in his 2015 budget on Tuesday. The loophole allows groups to reduce their effective tax bill well below Ireland’s already low 12.5 per cent corporation tax rate. It involves an Irish operating company paying fees for intellectual property to a second, related Irish company, which benefits from tax residence outside Ireland. This exploits different residence rules in US and Irish tax codes, allowing American companies to move profits into havens like Bermuda. Other tax reduction techniques rely on the differences in the way Ireland and the US view partnerships. Last year, Mr 217

Noonan phased out provisions allowing some Irish registered companies to be stateless for tax purposes, a regime used by Apple. One person who has seen the questions sent to Ireland said they reflect European Commission concerns the loophole offers “selective advantage” to certain eligible companies that may amount to illegal state aid. Such information requests do not mean the commission has concluded there is wrongdoing. Brussels’ offensive against state-supported tax avoidance has so far targeted alleged sweetheart deals between various countries and Apple, Fiat, Starbucks and Amazon. While it is also looking at tax schemes – including the “double Irish” and “patent boxes” used by up to 10 countries – the commission is still weighing whether to launch formal probes. The Irish finance ministry declined to comment on the questionnaire and said “the state aid investigation currently under way relates to one company only” -- a reference to the formal probe into Ireland’s Apple tax deal. While it was co-operating with that specific investigation, it added that “general discussions on taxation do not form part of these discussions”. Mr Noonan is considering closing the “double Irish” to new entrants from next year when he presents his budget on Tuesday. But ministers are said to be unwilling to act under so much pressure from Brussels, which wants to see the structure reformed with only a short transition period. Although the tax cases were launched by the outgoing competition commissioner Joaquín Almunia, his successor Margrethe Vestager is making the probes a “high priority”. At her confirmation hearing she described the “double Irish” as “a very unfortunate arrangement”. Lobby groups such as Ibec, the employers’ representative group, have said they are willing to see the loophole closed, arguing that it has become too controversial and that the vast majority of Irish companies gain no benefit from it. But they want the government to ensure that closing the “double Irish” does not immediately put the country at a disadvantage relative to competitors such as the UK and Netherlands. “Most people would accept that the days of the “double Irish” are numbered. It’s just a question of when and how,” said Pat Wall, international tax partner at PwC. The commission’s interest in the “double Irish” is prompted by the very low implicit tax rates – just 2.2 per cent in 2011 – reported by the Irish arms of US multinationals to the US Bureau of Economic Analysis. The Irish finance ministry rejects this number as flawed because it relates to profits that are not taxed in Ireland. Some politicians and companies operating in Ireland are deeply suspicious of the Commission motives and see the state aid investigations as means to attack Ireland’s low tax regime through the backdoor. All the companies ensnared in the Commission probes reject any wrongdoing, saying they paid the taxes due in full. The key question for any Commission state aid investigation would be whether the “double Irish” allows certain types of big multinational companies to benefit from a hidden state-subsidy unavailable to their smaller domestic rivals. 218

Irish pharmaceutical companies have also been able to make use of tax havens like Bermuda to achieve very low tax rates. But US businesses have a big advantage over those of most other countries, which cannot arbitrage residency rules and are normally blocked from using tax havens by anti-avoidance rules. http://www.ft.com/intl/cms/s/0/ba95cff0-4fcd-11e4-a0a4- 00144feab7de.html#axzz3FjBZQbRC

ft. com World Europe Brussels October 9, 2014 9:48 pm Q&A: What is the double Irish? By Vanessa Houlder The European Commission has threatened to launch a formal investigation into a vital aspect of Ireland’s tax system, known as the “double Irish”. This is a simple structure used by US technology and pharmaceutical companies to route profits to tax havens like Bermuda where they hold intellectual property. How does the double Irish work? The double Irish exploits the different definitions of corporate residency in Ireland and the US. Dublin taxes companies if they are controlled and managed in Ireland, while the US’ definition of tax residency is based on where a corporation is registered. Companies exploiting the double Irish put their intellectual property into an Irish- registered company that is controlled from a tax haven such as Bermuda. Ireland considers the company to be tax-resident in Bermuda, while the US considers it to be tax-resident in Ireland. The result is that when royalty payments are sent to the company, they go untaxed - unless or until the money is eventually sent home to the US parent company. More ON THIS TOPIC// Amazon probe steps up tax deals pressure/ Banks’ VAT bills set to soar after ruling/ G20 cracks down on corporate tax avoiders/ Global crackdown on tax secrecy nets €37bn IN BRUSSELS// EU raids ethanol groups in 2 countries/Bratusek withdrawal frees up commission/EU backs Hinkley Point C as costs soar/ Bratusek denied European Commission job Why is it so controversial? The double Irish and similar structures have allowed US multinationals to park about $1tn of cash in tax havens. That causes frustration for the US Treasury which cannot tax companies’ worldwide profits until they are repatriated to the US. It also annoys governments in the countries outside the US where these corporations do business. The ability to send profits to a tax haven has given companies an incentive to report as little profit as they can in the countries where they operate.

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What do the companies say? In their defence, US companies view it as a kind of self-help measure that allows them to compete internationally despite the US’s relatively high tax rate on worldwide profits. The companies also stress they are playing by the rules that are set by governments. When politicians attacked Google over its overseas tax rate of just 3.2 per cent in 2011, Eric Schmidt, executive chairman, said the tax structure was “based on the incentives that the governments offered us to operate”. Google employs thousands of people from dozens of countries in Dublin’s former docklands, although Ireland only taxes a sliver of profit from Google’s overseas sales which are booked in the country. The technology giant justifies shifting billions of dollars away from Ireland to Bermuda using a double Irish structure on the ground that its profits largely arise from the intellectual property generated in the US. Can Brussels attack the structure? To show the double Irish breached state aid rules, Brussels would need to show that it gave a selective advantage to certain types of companies, in this case US multinationals. It might be quite tricky to prove but the uncertainty would create a huge headache for business and tarnish Ireland’s low-tax brand. The structure’s days are generally thought to be numbered anyway, as a result of a planned overhaul of global tax rules initiated by G20 countries. What would it mean for business? A successful challenge under the State Aid rules could potentially force companies to pay billions of dollars of extra tax. Even if the double Irish was simply abolished, it would lead to a hike in tax rates and a dent in profits. Although US tax is only deferred – rather than avoided – on the money parked in tax havens, companies usually do not account for the US tax they may ultimately have to pay. Technology companies are often valued on their growth prospects rather than their earnings but even so, there will be a reluctance to abandon the very low foreign rates – in single digits – generated by the double Irish. So if Ireland closes the structure, the search will be on for other loopholes across the world that have escaped the crackdown. That is why Ireland is so queasy about the prospect of axing the double Irish before other countries have made changes, particularly if it cannot phase in the changes over several years. So Ireland will get rid of the double Irish in the end? There is a global consensus that routing profits to tax havens should be stopped. When that happens, many experts think that Ireland can block the use of the structure without too many ill effects. Both technology and pharmaceutical corporations have invested heavily in Ireland, so an exodus is unlikely. And low-tax Ireland is well-placed to compete under planned new global tax rules that will require companies to be taxed where they actually operate. http://www.ft.com/intl/cms/s/0/f7a2b958-4fc8-11e4-908e- 00144feab7de.html#axzz3FjBZQbRC

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ft. com World Europe October 9, 2014 7:55 pm EU trade envoy seeks to draw a line under China dispute By Christian Oliver in Brussels Karel De Gucht, EU trade commissioner, is seeking to lay to rest a festering trade dispute with Beijing before he steps down this month, freeing up his successor to focus on an important deal with the US. Mr De Gucht’s term as commissioner has been strongly coloured by tussles with China and last year he was scarred by a battle over the alleged dumping of Chinese solar panels in Europe. More ON THIS TOPIC// China reveals $10bn in fake trade/ Cotton hits snag as China cuts imports/Sri Lanka sees benefits of China’s ‘maritime silk road’ plan/ De facto head of Shanghai FTZ departs IN EUROPE// EU in crackdown on ‘double Irish’ loophole/ Merkel looks to China for Putin mediation/ US and Turkey in diplomatic stand-off/ Renzi victory as Senate backs reforms This year, the EU’s deepest source of concern has been telecommunications, with the EU threatening to launch an investigation into whether mobile equipment makers Huawei and ZTE should be penalised for receiving illegal state subsidies – a charge that Beijing denies. People close to EU-China talks say the two parties are now approaching a peace deal so that Mr De Gucht’s successor, Cecilia Malmstrom, will be able to dedicate more time to the Transatlantic Trade and Investment Partnership with the US, potentially the world’s biggest trade deal. “This was De Gucht’s thing and he wants to see it through,” said one person familiar with the China dispute. Chinese and EU officials will have an opportunity to discuss trade relations at a summit in Milan next week, attended by Li Keqiang, the Chinese premier. EU trade officials say that open disputes with China have proved counterproductive and the best way to resolve spats is through trade-offs within the context of a China-EU investment agreement. The EU announced in March that it would not proceed with a long-mooted anti- dumping investigation into Huawei and ZTE, but left open a threat of possible action on subsidies. The potential truce is intended to ensure that European companies should be fully consulted on the development of standards for next generation technologies in China. It will also seek to ensure there is no discrimination in public tenders and that European companies will not be cut out of funding for research in China. 221

Tenders have been a sore point among EU telecoms companies, particularly after Ericsson, NSN and Alcatel-Lucent were all awarded seemingly arbitrary 11 per cent stakes in China’s $3.25bn 4G tender. The parties are expected to discuss better ways to monitor their market shares in each other’s countries. Still, a deal is far from guaranteed and the issue of whether China’s export credits constitute an unfair competitive advantage has not been resolved, said one person close to the deal. Chinese and EU officials were not immediately available to comment. http://www.ft.com/intl/cms/s/0/3655f56e-4fda-11e4-a0a4- 00144feab7de.html#axzz3FjBZQbRC

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How are economic inequality and growth connected? by Carter C. Price , Heather Boushey Posted on October 8, 2014 at 9:42 am In the mid-20th century, economists began witnessing inequality’s decline in the developed world. Prior to the two World Wars and Great Depression, rising inequality was characteristic of most of the developed world, but in the aftermath of the upheavals, the trend reversed. At the time, many reasoned that declining inequality was a natural outgrowth of the development process: As countries become more economically mature, inequality would fall. This trend led Nobel Laureate economist Simon Kuznets to write: “One might thus assume a long swing in the inequality characterizing the secular income structure: widening in the early phases of economic growth when the transition from the pre-industrial to the industrial civilization was most rapid; becoming stabilized for a while; and then narrowing in the later phases.” Given the narrowing of inequality in the more economically developed nations, Kuznets’ analysis suggested that the inequality in poorer countries was a transitional phase that would reverse itself once these nations became more economically developed. Thus, similar to how the level of inequality was decreasing in wealthy nations, inequality would eventually decline in poorer countries as they became richer. In fact, some economists theorized that inequality in the less developed world was actually good for growth because it meant that the economy was generating select individuals wealthy enough to provide the savings necessary for investment-led growth. Download the full pdf report Today, the world looks very different than it did in 1955 when Kuznets made his famous assertion. In the past several decades, economic inequality in the United States and other wealthy nations has risen sharply, spurring renewed interest in the question of whether and how changes in income distributions affect economic wellbeing. Over the same time period, economic inequality has persisted and even grown in many poorer economies. These trends have sparked economists to conduct empirical studies, analyzing data across states and countries, to see if there is a direct relationship between economic inequality, and economic growth and stability. Early empirical work on this question generally found inequality is harmful for economic growth. Improved data and techniques added to this body of research, but the newer literature was generally

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inconclusive, with some finding a negative relationship between economic growth and inequality while others finding the opposite. The latest research, however, provides nuance that can explain many of the conflicting trends within the earlier body of research. There is growing evidence that inequality is bad for growth in the long run. Specifically, a number of studies show that higher inequality is associated with slower income gains among those not at the top of the income and wealth spectrum. Economists and policymakers today should not be surprised that empirical studies were inconclusive given the broad theoretical (and sometimes contradictory) reasons that hypothesized inequality would both promote growth and inhibit growth. On the one hand, hundreds of years of economic theory has been built on the hypothesis that inequality in outcomes creates incentives for individuals to work hard or be more productive than others in order to receive greater incomes—activity that spurs growth. In addition, many theorized that inequality would help individuals become rich enough to save some of their earnings and fund investments necessary to produce economic growth. On the other hand, economic theory also suggests the opposite—that inequality may inhibit the ability of some talented but less fortunate individuals to access opportunities or credit, dampen demand, create instabilities, and undermine incentives to work hard, all of which may reduce economic growth. Growing inequality could also generate a relatively larger group of low-income individuals who are less able to invest in their health, education, and training, thereby retarding economic growth. In this paper, we review the recent empirical economic literature that specifically examines the effect inequality has on economic growth, wellbeing, or stability. This newly available research looks across developing and advanced countries and within the United States. Most research shows that, in the long term, inequality is negatively related to economic growth and that countries with less disparity and a larger middle class boast stronger and more stable growth. Some studies do suggest that in the short run, inequality may spur growth before hindering it over the longer term, but overall there is growing evidence that, in the long run, more equitable societies are associated with higher rates of growth. In looking at studies that directly estimate the effect of inequality on growth, there are concerns about data quality and statistical methodology. The purpose of these studies is to establish whether economic inequality has some effect on economic growth or stability. For researchers, there are important two questions: is there a causal relationship between inequality and growth? If so, can researchers actually identify this factor, or are they actually measuring the effect of some other factor. Establishing causality is exceptionally difficult in the social sciences and the standard approach employed for studying relationships between inequality and growth has been to look at the level of inequality preceding the growth period being measured. This does not firmly establish causality but can be indicative of it. On the other hand, the approaches for detecting the relationship vary widely by the statistical design, the data, controls included. Given enough time and flexibility in their specifications, economists have demonstrated an ability to draw a variety of conclusions. The best practices in this area

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are evolving and so it is important to look at the breadth of the literature, rather than focus on a single paper or approach. Important as well for the purposes of this paper is this—the latest economic research we reviewed only examines the outcome of whether there are results for regressions that demonstrate positive or negative relationships between inequality and economic growth and stability. This means the paper cannot provide clear guidance for policymakers on exactly how to address inequality or mitigate its effects on growth. In other words, the research examined in this paper generally does not identify the channels or mechanisms by which inequality affects growth. An additional issue (above and beyond the challenges of how to specify a model) is the paucity of data to evaluate questions about inequality and growth. Ideally, economists would want a variety of measures for inequality, including earnings, income, and wealth, that can be compared across a large number of countries over a long period of time. Sadly, such a perfect data set does not exist. Therefore, economists are left to do the best estimates with the data at hand. Over time, though, the data sets that have been used to perform these analyses have been improving. Other scholars who have examined this literature have also come to the conclusion that to inform policymaking, we need to do more than search for a mechanis- tic relationship between inequality and growth. Dani Rodrik, the former Harvard University professor now at the Institute of Advanced Studies, underscores the limitations of this kind of research, arguing that methods for analyzing data that span across places and time are ill-suited to address the fundamental questions about the relationship of government policy and inequality with growth outcomes.2 This conclusion is echoed by University of Melbourne economist Sarah Voitchovsky in her recent review of the literature in the “Oxford Handbook on Economic Inequality,” where she says: “While data constraints continue to limit the type of empirical analyses that can be undertaken, investigations that focus on specific channels generally provide more robust conclusions than evidence from reduced form analyses.” This paper does not contain policy advice. Instead, it contains analysis that largely demonstrates there are direct, and possibly causal, relationships between economic inequality and growth—places that begin with a lower level of inequality subsequently tend to grow faster and have longer periods of growth than those with a higher level of inequality. In future research, we will focus on the channels through which inequality could or do http://equitablegrowth.org/research/economic-inequality-growth-connected/

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The Opinion Pages| Op-Ed Columnist |NYT Now Secret Deficit Lovers OCT. 9, 2014

Paul Krugman What if they balanced the budget and nobody knew or cared? O.K., the federal budget hasn’t actually been balanced. But the Congressional Budget Office has tallied up the totals for fiscal 2014, which ran through the end of September, and reports that the deficit plunge of the past several years continues. You still hear politicians ranting about “trillion dollar deficits,” but last year’s deficit was less than half-a-trillion dollars — or, a more meaningful number, just 2.8 percent of G.D.P. — and it’s still falling. So where are the ticker-tape parades? For that matter, where are the front-page news reports? After all, talk about the evils of deficits and the grave fiscal danger facing America dominated Washington for years. Shouldn’t we be making a big deal of the fact that the alleged crisis is over? Well, we aren’t, and once you understand why, you also understand what fiscal hysteria was really about. First, ordinary Americans aren’t celebrating the deficit’s decline because they don’t know about it. That’s not mere speculation on my part. Earlier this year, YouGov polled Americans on fiscal issues, asking among other things whether the deficit had increased or declined since President Obama took office. (In case you’re wondering, the pollsters carefully explained the difference between annual deficits and the level of accumulated debt.) More than half of those polled said it had gone up, while only 19 percent correctly said that it had gone down. Why doesn’t the public know better? Probably because of the way much of the news media report this and other issues, with bad news played up and good news downplayed if it’s reported at all. This has been glaringly obvious in the case of health reform, where every problem with the Affordable Care Act has been the subject of headlines, while in right-wing media — and to some extent in mainstream news sources — favorable developments go unremarked. As a result, many people — even, in my experience, liberals — have the impression that the rollout of Obamacare has been a disaster, and have no idea that enrollment is above expectations, costs are lower than expected, and the number of

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Americans without insurance has dropped sharply. Surely something similar has happened on the budget deficit. But what about people who pay a lot of attention to the budget, the self-proclaimed deficit hawks? (Some of us prefer to call them deficit scolds.) They’ve spent the past few years telling us that budget shortfalls are the most important issue facing the nation, that terrible things will happen unless we act to stem the flow of red ink. Are they expressing satisfaction over the fading of that threat? Not a chance. Far from celebrating the deficit’s decline, the usual suspects — fiscal- scold think tanks, inside-the-Beltway pundits — seem annoyed by the news. It’s a “false victory,” they declare. “Trillion dollar deficits are coming back,” they warn. And they’re furious with President Obama for saying that it’s time to get past “mindless austerity” and “manufactured crises.” He’s declaring mission accomplished, they say, when he should be making another push for entitlement reform. has been apparent for a while, if you have been paying close attention: Deficit scolds actually love big budget deficits, and hate it when those deficits get smaller. Why? Because fears of a fiscal crisis — fears that they feed assiduously — are their best hope of getting what they really want: big cuts in social programs. A few years ago they almost managed to bully the nation into cutting Social Security and/or raising the Medicare eligibility age; they even had hopes of turning Medicare into an underfinanced voucher program. Now that window of opportunity is closing fast. But isn’t the falling deficit just a short-term blip, with the long-run outlook as dire as ever? Actually, no. Falling deficits right now have a lot to do with a strengthening economy plus some of that “mindless austerity” the president condemned. But there has also been a dramatic slowdown in the growth of health spending — and if that continues, the long-run fiscal outlook is much better than anyone thought possible not long ago. Yes, current projections still show a rising ratio of debt to G.D.P. starting some years from now, and uncomfortable levels of debt a generation from now. But given all the clear and present dangers we face, it’s hard to see why dealing with that distant and uncertain prospect should be any kind of policy priority. So let’s say goodbye to fiscal hysteria. I know that the deficit scolds are having a hard time letting go; they’re still trying to bring back the days when Bowles and Simpson bestrode the Beltway like colossi. But those days aren’t coming back, and we should be glad. A version of this op-ed appears in print on October 10, 2014, on page A27 of the New York edition with the headline: Secret Deficit Lovers. http://www.nytimes.com/2014/10/10/opinion/paul-krugman-secret-deficit-lovers.html

Oct 8 4:00 pmOct 8 4:00 pm133 The Deficit Is Down, and Nobody Knows or Cares The CBO tells us that the federal deficit is way down — under 3 percent of GDP. And Jared Bernstein notes that Obama seems to get no credit.

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You may ask, what did you expect? But the truth is that a few years ago many pundits claimed that Obama would reap big political rewards by being the grownup, the responsible guy who Did What Had To Be Done. Worse, some reports said that the White House political staff believed this. It was, of course, nonsense on multiple levels. While pundits may like to script out elaborate psychodramas about voter perceptions, real perceptions bear no relationship to their scripts — in fact, a majority think the deficit has gone up on Obama’s watch, while only a small minority know that it’s down. And the deficit scolds themselves are unappeasable — nothing that doesn’t involve severely damage Social Security and/or Medicare will satisfy them. Why, it’s almost as if shredding the safety net, not reducing the deficit, was their real goal. Deficit obsession has been immensely destructive as an economic matter. But it has also involved major political malpractice. http://krugman.blogs.nytimes.com/2014/10/08/the-deficit-is-down-and-nobody-knows- or-cares/?_php=true&_type=blogs&module=BlogPost- Title&version=Blog%20Main&contentCollection=Opinion&action=Click&pgtype=Blo gs®ion=Body&_r=0 Oct 8 8:49 amOct 8 8:49 am105 Disinvestment Madness I’m at an IMF seminar today, discussing infrastructure investment — or actually lack thereof. And this is a good time to think about what we’ve actually done. Consider the situation: real interest rates are extremely low, indicating that the private sector sees very little opportunity cost in using funds for public investment. There has been a lot of slack in the labor market, so that many of the workers one would employ in public investment would otherwise have been idle — so very little opportunity cost there either. This makes a very strong case for sharply increasing public investment in a depressed economy; a case that doesn’t rely on claims that there is a large multiplier, although there’s every reason to believe that this is also true. So, what has actually happened? Public construction spending as a share of GDP, along with the 10-year real interest rate:

A brief uptick thanks to the ARRA, then a plunge. This is hugely dysfunctional policy.

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IMF warns period of ultra-low interest rates poses fresh financial crisis threat Almost zero borrowing costs has encouraged speculation rather than hoped-for pick up in investment, says Fund Larry Elliott in Washington The Guardian, Wednesday 8 October 2014 14.00 BST

One of the ways to safeguard financial stability is to curb lending to specific sectors such as housing.Photograph: David Levene for the Guardian A prolonged period of ultra-low interest rates poses the threat of a fresh financial crisis by encouraging excessive risk taking on global markets, the International Monetary Fund has said. The Washington-based IMF said that more than half a decade in which official borrowing costs have been close to zero had encouraged speculation rather than the hoped-for pick up in investment. In its half-yearly global financial stability report, it said the risks to stability no longer came from the traditional banks but from the so-called shadow banking system – institutions such as hedge funds, money market funds and investment banks that do not take deposits from the public. José Viñals, the IMF’s financial counsellor, said: “Policymakers are facing a new global imbalance: not enough economic risk-taking in support of growth, but increasing excesses in financial risk-taking posing stability challenges.” He added that traditional banks were safer after the injection of additional capital but not strong enough to support economic recovery.

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Viñals said the IMF had analysed 300 large banks in advanced economies, making up the bulk of their banking system. It found that institutions representing almost 40% of total assets lacked the financial muscle to supply adequate credit in support of the recovery. In the eurozone, this proportion rose to about 70%. “And risks are shifting to the shadow banking system in the form of rising market and liquidity risks,” Viñals said. “If left unaddressed, these risks could compromise global financial stability.” The stability report said low interest rates were “critical” in supporting the economy because they encouraged consumers to spend, and businesses to hire and invest. But it noted that loose monetary policies also prompted investment in high-yield but risky assets and for investors to take bigger bets. One concern is that much of the high-risk investment has taken place in emerging markets, leaving them vulnerable to rising US interest rates. “Accommodative policies aimed at supporting the recovery and promoting economic risk taking have facilitated greater financial risk taking,” the IMF said. As evidence it pointed to rising asset prices, smaller premiums on riskier investments and the lack of volatility in financial markets. In many cases, the IMF said the behaviour of investors was at odds with the state of the global economy. “What is unusual about these developments is their synchronicity: they have occurred simultaneously across broad asset classes and across countries in a way that is unprecedented.” The IMF said there was a trade-off between the upside economic benefits of low interest rates and the money creation process known as quantitative easing and the downside financial stability risks. While its report found that in some countries, including the UK and the US, economic benefits were becoming more evident, it warned that “market and liquidity risks have increased to levels that could compromise financial stability if left unaddressed”. It said developments in high-yielding corporate bonds were “worrisome”, that share prices in some western countries were high by historical norms, and that there were pockets of real estate over-valuation. “The best way to safeguard financial stability and improve the balance between economic and financial risk taking is to put in place policies that enhance the transmission of monetary policy to the real economy – thus promoting economic risk taking – and address financial excesses through well-designed macroprudential measures.” These include tougher supervision of banks, requirements on them to hold more capital, and curbs on lending to specific sectors such as housing. Viñals said it was time for traditional banks to overhaul their business models. This would involve not only changing the focus of their lending, but also consolidation and retrenchment. “In Europe, the comprehensive assessment of balance sheets by the European central bank provides a strong starting point for these much-needed changes in bank business models,” he said. http://www.theguardian.com/business/2014/oct/08/imf-low-interest-rates-financial- crisis-threat-speculation/print

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ft.com Comment The Big Read October 9, 2014 1:12 pm China’s migrants avoid Spain crises by keeping cash in the family By Tobias Buck in Madrid 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/f8d02554-3e93-11e4-a620- 00144feabdc0.html#ixzz3FfDKNreh From his first-floor office in an industrial estate south of Madrid, Chen Maodong can track the steady flow of bright orange delivery trucks passing through the gates of his sprawling warehouse complex. Laden with beer, liquor, soft drinks and snacks, the trucks are on their way to restock the thousands of Chinese-run corner shops and convenience stores that dot the Spanish capital. Business is good. It always has been, even in the worst moments of Spain’s economic crisis. Since 2008, the country has been through a housing bust, a banking crisis and a double-dip recession. But Don Pin, the wholesale company founded by Mr Chen, managed to triple its sales over the same time period. More ON THIS STORY// FT series Silk Road Redux/ Sea, sun and easy visas lure China buyers/ Analysis China swoops in on Italian assets/ Chinese translate the European work ethic/ China investors surged into EU in crisis With economic success has come a change in status for Mr Chen and for the Chinese community at large. “The Spaniards used to look at us like they looked at the other migrants, like people who do the dirty work. Now, when you go to a department store they have signs in Chinese, and staff who speak Chinese. They know: ‘Here are people who have money’.” The bonfire of bankruptcies that burnt its way through corporate Spain during the downturn left the Chinese largely untouched – a result of hard work, thriftiness, luck and a business culture that values long-term survival above quick profits. “In China, we believe that the key issue is not whether you lose money or not, but whether you manage to hold on. So the Chinese have developed a great ability to withstand a crisis. You have to endure,” says Marco Wang, a businessman in Madrid whose assets include Spain’s leading Chinese newspapers. The Financial Times this week is examining the modern trail of Chinese investment, migration and ambition in Europe. Still only 34 years old, Mr Chen has emerged as one of the most recognisable faces of the Chinese community in Spain – and as a symbol of its commercial clout and remarkable ability to withstand economic adversity.

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His story finds parallels across the crisis-scarred countries in southern Europe, which have seen a burst in Chinese migrant arrivals – and in Chinese economic activity – despite the brutal recession of recent years. Over the past decade, the number of Chinese arrivals in countries such as Spain, Italy and Portugal has soared. According to official data, there are now more than 180,000 Chinese nationals living in Spain, three times more than in 2003. Add in students and naturalised Chinese, and the figure leaps to more than 200,000, the fifth-largest minority in the country. Chinese migration to Spain continued to rise even after the start of the crisis, highlighting how well the community has been able to weather the economic storm. In a country where one-in-four workers is out of a job, unemployment is virtually unknown among the Chinese. Furthermore, they account for a vastly disproportionate share of business start-ups: there are now more than 40,000 self-employed Chinese on Spain’s commercial register, twice as many as before the crisis. At the same time, there are growing signs that the Chinese are starting to work their way up the economic value chain. Gone are the days when Chinese economic activity in Spain was confined to serving up rollitos de primavera (spring rolls) or selling trinkets in dusty 100-pesetas shops. Today there are Chinese-owned fashion chains, import- export businesses, media groups and law firms. According to one estimate, the annual turnover of Chinese-run convenience stores alone amounts to €785m in total. The community’s success has come, at least to European eyes, at a significant personal cost. Chinese shops stay open from morning until night, seven days a week, usually staffed by members of the same family.

Mr Chen says he has never taken a holiday. He returned to China for the first time 12 years after his arrival in Madrid, but is quick to stress that the trip was mainly for business. For most of his time in Spain, he spent money only on goods that he needed to make it through the day: “The moment you arrive in Spain as a migrant, you know that your mission is to earn money, not to enjoy life. You need a bed to sleep in and clothes to wear – nothing more. Later, when you have a business and things are going well you can allow yourself to buy something, but not before.”

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He knows that such single-minded dedication to work is viewed by Spaniards (and much of the rest of the world) as an incomprehensible sacrifice. But Mr Chen has no doubt that it lies at the heart of his nation’s extraordinary economic rise. “It is with this sacrifice that China is conquering the world,” he says. Dressed in a smartly cut black suit, white shirt and black tie, Mr Chen looks every inch the successful businessman. His replies are short and to the point, but he breaks into a wistful smile when he recalls how it all began. A native of Qingtian, an impoverished rural county in the coastal Chinese province of Zhejiang, he arrived in Madrid on November 10 1998. It is a date that is etched in his memory “like a second birthday”, he says. It was the first time he had left his home country. The decision to depart had been, above all else, a family decision: his high school grades were not good enough to go to university, and earning money without a higher education would be tougher in China than in Europe. Besides, his older brother was already living in Madrid, part of a fast-growing migrant community from Mr Chen’s home region. On the way from the airport, his first impression was that of a country not much richer than the one he was leaving behind: “The houses I saw along the way looked pretty bad. In China the houses are covered with tiles so they are pretty but here all you see are the bricks. I realised only later that Spaniards take greater care of the inside than the outside. Inside, their houses are always tidy, clean and pretty.” Like most Chinese migrants in those years, he came without money and spoke no Spanish. Just 18, he earned his first cash waiting tables in a Chinese restaurant and selling plastic toys and cheap clothes at funfairs in villages across Spain. The only Spanish words he knew at the time were numbers (to haggle over prices) along with hola, gracias and adiós. Determined to scrimp and save as much as possible, Mr Chen shared a single room with his brother, who had left the family home a few years earlier. “The only thing to do was to work, work, work. In the beginning, we didn’t even have a television. When we bought one, we bought a small one, so we could easily carry it with us when we had to move,” he recalls. Four years after he arrived, Mr Chen joined forces with his brother and uncle to set up their own business. His partners had savings but they had to ask for loans from two other family members to reach the €20,000 they needed to buy their delivery van. “We worked every day from 8am in the morning to midnight. Once, I made a whole round trip just to take a kilo of peanuts to one of our customers,” he says. The hard work paid off. As the number of Chinese-owned shops soared, so did the business of supplying them. Don Pin reported sales of €220,000 in its first year. Today it turns over more than €60m, boasts a fleet of 35 trucks and employs 110 workers. Many of the men and women who work in the offices and warehouses of Don Pin come from the same tiny corner of China as Mr Chen himself. Most speak to each other in Mandarin but many conversations take place in the regional dialect spoken in Qingtian. This concentration highlights a crucial feature of the Chinese migration pattern – the influence of family and regional networks. The vast majority of Chinese living in Spain arrived here because a brother, cousin, husband or uncle made the same journey before. 233

Estimates vary but some believe that as many as 70 or 80 per cent of Chinese migrants in Spain come not just from the same province (Zheijiang) but from the same small county, Qingtian. Their dominance is reflected not least on the walls of Chinese restaurants up and down the country, which often boast framed pictures of Qingtian city. “When you move abroad, you always ask yourself: ‘Do I have a friend or family member there or not?’ If you do, everything is easier. If not, it is so much more difficult,” says Mr Wang. But family networks are not just crucial in deciding what country the Chinese choose as their destination. They also play a critical role in helping the new arrivals get started in business – by providing all-important access to finance. “If you want to open a bar or start a corner shop, you don’t go to the bank to ask for €20,000. You just ask 10 friends and family members for €2,000 each. One month after opening, you pay back the first person. The second month you pay back the next. The system works very well,” explains Mr Wang. It works, above all else, on the basis of personal trust and mutual dependency. “You never sign a contract. And you never ask for interest,” says Mr Chen, adding: “This is not a system or an application. It is all about human trust.” It is possible to refuse requests. But by doing so a Chinese businessman shuts himself out of the intricate web of favours taken and favours owed that underpins his community. “Today I help you with a loan so you can open your shop. But tomorrow you help me to open my shop,” says Mr Chen. It is a system that was born, at least in part, out of necessity. Like most migrants, the Chinese arriving in Spain typically lacked the assets, credit history and financial guarantees sought by banks. But it also reflects a broader mistrust of the official banking sector. “The Chinese know that the bank always wins. So if we don’t have to ask for money from the bank, we don’t,” says Mao Feng, a Madrid-based businessman and the president of the Association of Chinese in Spain. Business leaders and analysts agree that the cheap, flexible system of financing is one of the crucial reasons why the Chinese were able to weather the recent crisis better than 234

most. Unlike their Spanish counterparts, the Chinese were largely insulated from the vagaries of the country’s tottering retail banking system. When lenders stopped the flow of credit to small and medium-sized companies, the Chinese were unaffected. And when a Chinese business had trouble repaying a loan, or paying staff salaries, it was usually easy to find a swift and flexible solution. Its main creditors, more likely than not, were not twitchy banks but family members and friends. Its workers, typically, were similarly close – and usually ready to accept a temporary wage cut.

“Who survives in a crisis? Those who have capital, or who have easy access to capital. And when the crisis came, the Chinese had their family network to fall back on to,” says Mario Esteban, of the Real Instituto Elcano in Madrid. Personal savings played another big part in seeing the Chinese business sector through the crisis. “When a Chinese earns €1,000 he will never spend it all. He will always set aside €500 or so to make provisions for the future or to invest,” Mr Mao says. Thriftiness and a capacity for hard work are at the heart of a business culture that has served the Chinese commercial class well – whether in Spain or elsewhere. Indeed, as much as they profess to admire Spain and the Spaniards, some Chinese find it hard to hide their disdain for some of the more carefree local habits. “When I tell a Chinese worker I need someone to work on a Saturday, he will do it and I’ll pay him,” Mr Chen says. “With a Spaniard, when I ask him to work on the weekend I have to negotiate. It is almost like I am asking him a favour!” The Chinese community in Spain kept growing long after the economic collapse – and even as other migrant groups began to return to their home countries. Newcomers say that the more recent wave of Chinese migrants is different from Mr Chen’s generation. Many arrive by choice, not out of economic necessity. They come to see something of the world, improve their skills, but they are also a little less driven than the early entrepreneurs Yun Ping Dong, 27, came to Spain five years ago to study but has no plans to return soon. “Life is freer here, and calmer,” she says. “We want to enjoy life a little bit more.” Work visas are harder to come by and – after decades of relentless economic growth in China – the economic gain of moving to Europe is not as clear-cut as previously. Some 235

data suggest that the number of new arrivals from China is finally dropping off: migrants are still coming, but there are fewer, they are better educated, and often come for a specific job or to study a particular course. “There is no reason to come to Spain any more. You live very well in China now,” remarks Mr Mao, the association president.

Yet just as the wave of migrants has crested, a new wave is building – this time bringing money and investment from China rather than workers and entrepreneurs. David Höhn, a partner at KPMG in Madrid, has watched it gather in strength since he began heading the accounting firm’s China desk in the Spanish capital. “The phone is hopping. It is as if someone lifted the barrier 18 months ago, and said: ‘Spain is OK now’,” he says. What the Chinese are looking for is, above all else, expertise. Mr Höhn points out that most transactions involve Chinese groups buying minority stakes in Spanish companies, with the aim of launching joint ventures either in third markets or back in China itself. “Group A buys group B – that is not the way forward for the Chinese. This is about setting up alliances.” Chinese companies have shown interest in sectors where Spain enjoys a strong record, such as tourism, food, infrastructure and construction. Over the past year, for example, Chinese investors have bought large stakes in NH, the Spanish hotel chain; in Campofrio, a maker of sausages, ham and other pork products; and in Osborne, the sherry group. It is an approach that mirrors the one taken by Chinese companies in Germany, where they have bought into the machinery and equipment sector, and in Italy, which has seen a string of deals in textiles and fashion. “What they want is access to specific expertise and to technology,” says Mr Höhn. In the case of Spain, he sees the tourism industry as a particularly enticing target for Chinese buyers. The NH deal aside, Chinese companies have also snapped up hotels across the country in an attempt to position themselves for the moment when Chinese tourists finally discover Spain.

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The most headline-grabbing transaction so far has been the deal to buy Madrid’s landmark Edificio España, a Franco-era skyscraper that towers over downtown Madrid. Wang Jianlin, the buyer, plans to convert the building into luxury apartments and a hotel. At a cost of €265m, the Edificio España deal is the most valuable so far. But there is also keen interest among Chinese buyers for apartments and houses worth just over €500,000. That is the threshold set by the Spanish government for awarding a so-called golden visa to property buyers from abroad. The trade-off is simple, and potentially attractive for both sides. Spain gets a new stream of buyers to turn around the country’s faltering housing market, while foreign investors receive residency visas that allows them to travel freely within much of the EU. Even as this outside investment helps the economy, it is prompting a broader sense of unease. Some view the Chinese and their fabled work ethic as a threat to the Spanish way of life. “The question people here ask is: ‘Do we have to work like the Chinese?’” says Mr Esteban. That, indeed, was the unwelcome message delivered by Juan Roig, a Spanish supermarket magnate, at the height of the crisis. It failed to endear him or the Chinese to the broader Spanish public, which was (and still is) wrestling with sky-high unemployment and a painful drop in living standards. As Mr Esteban points out, polls show that Spaniards typically have a lower opinion of China than their counterparts in other European countries. Chinese business leaders acknowledge that relations are far from perfect, but insist that the community is integrating well into Spanish society. “The first generation of Chinese migrants has a lot of difficulty with the language and with communication. They had no time to study. But their children study here in Spanish schools, they speak Spanish perfectly and they know Spanish culture very well. So I think things are getting better,” says Mr Mao. He echoes a common sentiment when he argues that most Chinese living in Spain are here to stay. “Many of us feel like the Spanish. The family is here, the kids are studying here. I think only few Chinese are thinking about returning. They like life in Spain.” Mr Chen, the founder of Don Pin, says there are countless things he likes about life in his adopted country. But he, for one, has no desire to grow old in Madrid. “When I die, I want to die in my village. I arrived here when I was 18 but I still feel my roots very strongly. But it is different for the children. My children will be Madrilians.” http://www.ft.com/intl/cms/s/0/f8d02554-3e93-11e4-a620-00144feabdc0.html#slide5

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ft.com Comment Blogs Andrew Smithers The eurozone and quantitative easing Andrew Smithers Oct 08 07:30 The eurozone’s economy appears to have stalled. It was widely expected that growth would pick up to 1 per cent this year, but these estimates are now being toned down as the first two quarters of 2014 have been below expectations. The pattern shown in chart one (below) is, at best, one of stagnation. It is therefore agreed with near unanimity that the eurozone’s economy needs a boost.

It is a common error to assume that economies are so alike that one medicine is always the answer for all those suffering from weakness or excessive strength. The difference between economists often consists of which nostrum they favour for all occasions, and they therefore give insufficient consideration to the particular and relevant circumstances of the individual economy being studied. Those who favour more fiscal stimulus have therefore been pushing this, not only for the eurozone, but for the UK and the US as well. Those who see money as the route of all growth want more quantitative easing everywhere and there are those for whom deflation or deleveraging is the bugbear. I hold that economics is much more complicated. Countries differ from one another and from their former selves as times change. I see the eurozone as being very different from Japan, where tax reform is the key and deflation presents no problem. It is different again from the UK, where a lower exchange rate is vital, and different again from the US, where the key lies in the reform of management incentives. Unlike Japan, the UK or the US, the eurozone is the economy where those who favour fiscal stimulus are correct. I am sorry that the message that they rightly preach for the eurozone should be weakened by their tendency to call for similar policies in Japan, the UK and the US, where they would be damaging rather than helpful.

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Two questions follow. The first is whether the eurozone can return to sustained growth without a fiscal stimulus, and the second is whether it will in time receive one. My objections to QE vary from country to country. My main concern is that in the US it has little impact on demand, but increases the risk of another financial crisis by driving up asset prices. I think it unlikely that QE by the European Central Bank will add much to the financial risks of excessive asset prices, but equally I doubt if it will do much for demand. It may serve to lower the euro, but this is a negative sum game in world terms and does nothing for demand worldwide. The main reason for the ECB to resort to QE, and for the support that this receives, is the feeling that something must be done to stop the rot. It is, however, unhelpful to do something silly because there seems to be nothing sensible that can be done. The view that the eurozone needs a fiscal stimulus seems to have near universal agreement outside Germany. Change will therefore require either a revision of German policy or a decision to take no notice of the fiscal rules that call for further cuts in government budget deficits. The latter seems to be happening slowly. Both France and Italy seem to be disinclined to cut their deficits. But the problem is that the one country with real scope for increasing its deficit is Germany. Mr Draghi has called for more fiscal stimulus but not for any weakening of the fiscal rules. This means that Berlin must act as it is only in Germany where such a combination is feasible. There are three possible ways forward. The first is that my prognosis is too pessimistic and domestic demand in the eurozone economy will pick up, either of its own accord or because QE is effective. The second is that Germany’s view changes under the pressure of reasoned argument and that its government introduces a sharp rise in its fiscal deficit. The third is that events, rather than reason, cause a policy change. This last is the usual pattern and therefore seems the most likely. The events that would precipitate the change are unlikely to be ones we welcome. I can readily envisage two. One is a deterioration in Ukraine to the point where Nato and the EU decide on massive financial aid to shore up a tottering government and economy. The other is a continued rise in voter support throughout the EU for populist and nasty political parties. It is hard to see the steady growth in their popularity that we have seen for them in recent years halting without an economic recovery. At some point, I hope, self-preservation will start to become the watchword of the established parties and be seen as more important than the preservation of the eurozone, at least under the current fiscal constraints. Ukraine’s economy is already in dire straits. It would be a statesmanlike move by David Cameron, or any other EU leader, to propose a new “Marshall Plan” funded by loans raised by the EU, jointly and severally guaranteed by its members, which would be lent to the Ukrainian government to support and develop its desperate economy. President Harry Truman is said to have persuaded the US Congress to approve his aid programme for Europe by the expedient of having it named after General Marshall, who was popular, rather than himself, who by then was not. Prime Minister Cameron should propose that the programme is called “The Merkel Plan”. Almost anything can be achieved by people, provided they do not want the credit for it. http://blogs.ft.com/andrew-smithers/2014/10/the-eurozone-and-quantitative-easing/

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Incomes and Outcomes |NYT Now The Great Wage Slowdown of the 21st Century OCT. 7, 2014

Credit Tomi Um David Leonhardt American workers have been receiving meager pay increases for so long now that it’s reasonable to talk in sweeping terms about the trend. It is the great wage slowdown of the 21st century. The typical American family makes less than the typical family did 15 years ago, a statement that hadn’t previously been true since the Great Depression. Even as the unemployment rate has fallen in the last few years, wage growth has remained mediocre. Last week’s jobs report offered the latest evidence: The jobless rate fell below 6 percent, yet hourly pay has risen just 2 percent over the last year, not much faster than inflation. The combination has puzzled economists and frustrated workers. Of course, there is a long history of pessimistic predictions about dark new economic eras, and those predictions are generally wrong. But things have been disappointing for long enough now that we should take the pessimistic case seriously. In some fundamental way, the economy seems broken.

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I probably don’t need to persuade most readers of this view, so the better way to think about the issue may be to consider the optimistic case. And last week, in his most substantive speech on domestic policy in months, President Obama laid out that case. The Great Wage Slowdown Since 2000, weekly earnings for low- and middle-income workers are nearly unchanged, after adjusting for inflation. Earnings for workers at the 90th percentile have risen. Cumulative percent change since 2000. Los tres escalones del eje vertical representan crecimientos del 10%, 5% y 0%, respectivamente. Las tres líneas, de abajo arriba, representan el percentil 90º, eel cuartil y la mediana, respectivamente,

2000 2002 2004 2006 2008 2010 2012 2014 Usual weekly earnings, full-time wage and salary workers // Source: Bureau of Labor Statistics It included the usual set of glass-half-full statistics and wishful-thinking proposals that officeholders talk about during political campaigns. More notable, though, was that Mr. Obama – speaking at Northwestern University – explained why he thought wage growth was likely to pick up. “If we take the necessary steps to build on the foundation,” he said, after a litany of the good news, “I promise you, over the next 10 years we’ll build an economy where wage growth is stronger than it was in the past three decades.” He may or may not be right about that. But the speech laid out the issues in unusually clear terms. And by any definition, the great wage slowdown – or its end – is one of the most important subjects in the country today. You can think of Mr. Obama’s argument as falling into two categories (even if he didn’t say so): the reasons that overall economic growth may accelerate, and the reasons that

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middle- and low-income workers may benefit more from that growth than they have lately. Both factors have contributed to the wage slowdown. The size of the pie hasn’t been growing very fast, and most of the increases have gone to a small share of already well-fed families. On the growth side of the ledger, both energy and education have been problems. The cost of energy, after temporarily falling in the 1990s, returned to its post-1970s norm in recent years and acted like a tax on the rest of the economy. Education, meanwhile, is the lifeblood of economic growth, allowing people to do entirely new tasks (cure a disease, invent the Internet) or to do old ones with less time and expense. Yet educational attainment has slowed so much that the United States has lost its once- enormous global lead. On both fronts, the country has been making progress, Mr. Obama rightly noted. The fracking boom and a more modest clean-energy boom have increased this country’s share of energy production and held down costs worldwide. The price of oil has been mostly flat for three years. And the number of high-school and college graduates is rising. The financial crisis deserves some perverse credit, because it sent people fleeing back to school, much as the Great Depression did. But some of the efforts to improve school performance – by raising standards and accountability – are also playing a role. Last year, 33.6 percent of 25- to 29-year-olds had a four-year college degree, up from 30.8 percent in 2008, according to the National Center for Education Statistics. That leaves a lot of room for further improvement, but it’s more progress than in prior years. In 2000, the share was 29.1 percent. Mr. Obama didn’t mention her in the speech, but another reason for optimism at the White House is Janet Yellen, who took over the Federal Reserve this year. Under Ben Bernanke, her predecessor, the Fed was heroically creative in fighting the financial crisis. After the crisis, though, Fed officials made the same mistake repeatedly: overestimating the health of the economy. Ms. Yellen has suggested that she’s learned that lesson and will be even more aggressive about trying to lift growth with low interest rates. As for the other entry in the ledger, the biggest reason to think economic growth may translate more directly into wage gains is the turnabout in health costs. After years of rapid increases, they have slowed sharply in the last three years. Mr. Obama likes to give more credit to the 2010 health care law than most observers do, but he’s not wrong about the trend’s significance. Health costs take a direct bite out of paychecks. Employers don’t have some secret stash of money to pay for health insurance; when it becomes more expensive, there is less money left for salaries. It’s no accident that the best period of wage growth in the last 40 years – the late 1990s – was also a period of quiescent health inflation. If you’re skeptical that these trends are actually encouraging, take a minute to play an alternate-history game. Imagine someone had come to you a few years ago and predicted that health inflation would slow sharply, that the cost of oil would be flat, that the United States would soon produce more oil than it imports and that both the high-

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school and college graduation rates would rise. Most of us would not have replied: Yeah, that all sounds right. But here’s where I become less optimistic than the president. Imagine that same prognosticator had added one more bit of clairvoyance: Despite all those positive trends, the real median weekly pay of full-time workers in mid-2014 would be slightly lower than it was in mid-2011. Or than it was in mid-2008, the year before Mr. Obama took office. Or in mid-2000. It’s certainly possible that we’re on the verge of a pay surge, much as we were in the mid-1990s, when the situation also seemed bleak. It’s also possible that the forces behind the great wage slowdown – from globalization to our often-sclerotic government to (at least for many workers) technological change – are still more powerful than the positive forces. In that case, the wage slowdown won’t end until the country makes much more progress in improving education, cutting medical waste and energy costs and creating a more responsive, nimble government. Either way, the great wage slowdown, or the end of it, will help set the tone for American life in the coming decade. It has already done so in the century’s first 15 years, causing widespread unhappiness with the country’s direction and leading voters to shift partisan directions multiple times. The political turmoil isn’t likely to end until the economic reality changes. The Upshot provides news, analysis and graphics about politics, policy and everyday life. Follow us on Facebook and Twitter. A version of this article appears in print on October 7, 2014, on page A3 of the New York edition with the headline: The Great Wage Slowdown of the 21st Century. http://www.nytimes.com/2014/10/07/upshot/the-great-wage-slowdown-of-the-21st- century.html?partner=rss&emc=rss&_r=1&abt=0002&abg=0

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ft.com Comment Blogs Gavyn Davies Germany is stalling Gavyn Davies Oct 07 16:46 Tuesday’s extremely weak German industrial production figures published for August have come an awkward time for the German government. An informal “employment conference” including some EU leaders has been called by Italian Prime Minister Renzi, and it is scheduled to take place, amid little advance publicity, in Milan on Wednesday. This will presumably set the stage for the next European Council meeting on October23. In between will be the International Monetary Fund/World Bank annual meetings in Washington, when the German approach to economic policy in the euro area will be heavily scrutinised. The official German line heading into these meetings is that the recovery is proceeding well, both in Germany and in the euro area as a whole, implying that the recent marked weakening in both gross domestic product and inflation data are just a temporary aberration. There is no sign that the Merkel administration is ready to change its longstanding formula for economic success in the eurozone: member states should stick to the fiscal targets in the Stability and Growth Pact, and should accelerate structural reforms, so that the expansionary monetary stance provided by the European Central Bank can bear fruit. Calls for fiscal easing, in the form of higher infrastructure spending, from the IMF, the ECB president and from other eurozone member states, have so far fallen on deaf ears in Berlin. This could change, however, if the German economy itself continues to weaken significantly. But how likely is this to happen? Although growth in the manufacturing sector has clearly fallen markedly since the start of the year, economic data from the services and employment sectors are not yet reporting the broad-based downward shift that is normally the hallmark of a recession. The weakness in the industrial sector is hard to assess, since much of it may have stemmed from a shift in the timing of holidays from July to August this year that was not picked up by the seasonal adjustment in the data. The drop of more than 25 per cent in auto production in August clearly points in this direction, and there will undoubtedly be a marked bounceback in September. But the July/August average for industrial output came in 0.7 per cent below the already-weak second quarter level, and both Ifo and purchasing managers’ index business surveys in the industrial sector have been falling continuously since January. The reasons for this decline are fairly obvious. The imposition of sanctions on the Russian economy have clearly impacted trade flows with Germany. More importantly, many of Germany’s major trading partners – including France, Italy, China and Brazil – have simultaneously experienced large drops in activity this year. Germany, as the world’s third-largest exporter, is bound to have suffered from this. The better news is that domestic demand in Germany seems to have held up fairly well as the industrial sector has weakened. There has been no sign yet of any weakening in 244

the labour market, and surveys of business activity in the services sector have remained stable at fairly buoyant levels. With different sectors of the economy giving very mixed signals about the business cycle, “nowcasting” methods can be very useful in determining the underlying state of economic activity. These methods use factor models to combine all of the published economic data into a single “activity” factor which provides a snapshot of the underlying growth rate at any given time. After Tuesday’s industrial production figures, the Fulcrum “nowcast” models, estimated by my colleagues Juan Antolin Diaz and Ivan Petrella, report the results shown in the graphs. Graph 1 shows that activity growth rate has slowed from about 2.6 per cent in late 2013 to 0.9 per cent now, indicating that the underlying economic growth rate has dropped as the industrial sector has lost momentum. It has not fallen yet into negative territory on an underlying basis, but it is certainly not acting as a powerful locomotive for the European economy. Far from it.

It is in fact possible that the official GDP data will show the two successive negative quarter-on-quarter growth rates that are commonly used to demarcate a “recession”. As Graph 2 shows, the Q2 official GDP growth rate of -0.6 per cent was already worse than had been expected by the “nowcast”. The central estimate of the latest “nowcast” for Q3 is that the GDP growth rate will rebound to 1.4 per cent annualised, but the timing effects of holidays might just produce another negative official GDP number. The Fulcrum model says that there is about a 28 per cent probability that this will happen. If so, I would describe this as a “technical recession” which might not mean very much for the employment sector or the financial markets. But we can also ask the model what is the probability that a genuine recession will develop in the next 12 months, with the activity growth rate on an underlying basis falling into negative territory for two

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successive quarters. The model reckons there is about a 17 per cent chance of this happening – a moderate, but clearly not a negligible, risk.

Summary This has all been a bit complicated, so what conclusion should we draw? The German economy is clearly in the midst of a serious slowdown, and there is little point in the government trying to paint a gloss over this. This has been mainly concentrated in the industrial sector, and has led to a drop in the underlying growth rate to 0.9 per cent on the latest “nowcast” data. The official GDP data have been even weaker than this, and it is conceivable that a “technical recession” will be called when the Q3 GDP data are published. However, the probability of a genuine, and therefore far more painful, recession developing in the next 12 months is only about one in six. Germany is therefore in a period of slow, and slowing, growth, but not yet in a full- blown recession. This is unlikely to be enough to change Berlin’s thinking on its preferred economic strategy for the eurozone, so once again the ECB may well have to go it alone.

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mainly macro Comment on macroeconomic issues Tuesday, 7 October 2014 The mythical debt crisis A constant refrain, from both the Conservative and LibDem party conferences, is how the current government saved the country from a crisis. Hereis Osborne: “Four years ago, our economy was in crisis, our country was on the floor.” Or LibDem Danny Alexander: “We’ve seen the economy through its darkest hour ..” Now someone from outside the UK would immediately think Osborne and Alexander had got their counting wrong: the Great Recession was in 2009, which was five not four years ago. But of course they do not mean that little old crisis - they are talking about the Great Government Debt crisis. The only problem is that this debt crisis is as mythical as the unicorn. The real crisis was the Great Recession. And if any politicians can claim to have saved the country from that crisis, it is Labour's Gordon Brown and Alistair Darling. They introduced stimulus measures (opposed by Conservatives) that helped arrest the decline in GDP. By 2010, which is when Osborne took over, the economy was growing by nearly 2%. But surely there was a debt crisis in 2010? Indeed there was, in other countries. Crucially, these were countries that could not print their own currencies. This became apparent when interest rates on Greek debt went through the roof. Interest rates on UK and US government debt after the recession stayed well below levels observed before the recession. UK and US governments never had any problems raising money, for the simple reason that there was never any chance they would default. So wrong time, wrong country, but also maybe wrong people. Consumers and firms in the US and UK did feel they had borrowed too much, or wanted to save more, as a result of the financial crisis. The personal savings ratio in both countries rose substantially, and stayed high for a number of years. But people need something to save, like government debt. Which is one reason why interest rates on UK and US government debt stayed low: although the supply of that debt increased, the demand for it was increasing even faster. So why do we not hear Labour claiming that they saved us from a crisis - at least their crisis was real! Why do claims that the current government saved us from an entirely mythical crisis generally go unchallenged? Such claims are the equivalent to the Republican Congress claiming they saved the US economy. Welcome to the strange world of mediamacro. What the media should be doing, the next time this government claims it saved us from the Great Government Debt crisis, is to borrow a phrase from Jim Royle: crisis my arse! http://mainlymacro.blogspot.com.es/2014/10/the-mythical-debt-crisis.html

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The Growth of Shadow Banking Posted on October 3, 2014 by iMFdirect By Gaston Gelos and Nico Valckx Shadow banking has grown by leaps and bounds around the world in the last decade. It is now worth over $70 trillion. We take a closer look at what has driven this growth to help countries figure out what policies to use to minimize the risks involved. In our analysis, we’ve found that shadow banks are both a boon and a bane for countries. Many people are worried about institutions that provide credit intermediation, borrow and lend money like banks, but are not regulated like them and lack a formal safety net. The largest shadow banking markets are in the United States and Europe, but in emerging markets, they have also expanded very rapidly, albeit from a low base. In our latest Global Financial Stability Report we discuss three ways of measuring the size of shadow banking: • The Financial Stability Board offers a broad definition of shadow banks as nonbank financial intermediaries engaged in credit intermediation (including investment funds), and a more narrow one which excludes entities which do not directly undertake credit intermediation or which are consolidated into banking groups. • We compute another measure, derived from flow of funds accounts, for a smaller set of countries. It focuses on “other financial intermediaries” and excludes non-money market investment funds, since the latter mainly manage assets on behalf of clients and thus do not engage directly in credit intermediation. • Lastly, we propose a new, alternative definition of shadow banking as financial activities using nontraditional funding, independently of the financial institution involved. The focus on activities is one advantage of this approach. For example, securitization is classified as shadow banking, whether it is conducted on-balance sheet by banks, or off-balance sheet through special purpose vehicles. These measures show some notable differences for the United States and the euro area. They all share a similar growth trend until 2007, after which their paths diverge markedly (Figure 1). After a mild drop around 2008, the Financial Stability Board’s measures now surpass their pre-crisis levels. Positive valuation effects are one of the reasons behind the pickup in the Financial Stability Board’s measures, given the growth in the investment fund industry. In contrast, our measures remain broadly constant or have fallen, which reflects two opposing forces: the decline in the role of certain activities after the crisis, such as securitization and securities and repo lending, and a concomitant rise in other activities, including those of country-specific entities, such as special financial institutions in the Netherlands and U.S. holding corporations.

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For broad monitoring purposes, it may be good to keep an eye on various measures, as they may capture different developments across the shadow banking spectrum.

The driver’s seat What drives shadow banking? Our analysis shows that shadow banking growth is associated with GDP growth, low interest rates and low term spreads (inducing search for yield), bank capital stringency (capturing regulatory circumvention), and with growth of institutional investors (Figure 2.A). Controlling for these factors, there also appears to be some complementarity with the size of the banking sector. Looking forward, the current financial environment remains conducive to further growth in shadow banking. Many indications point to the migration of some activities— such as lending to firms—from traditional banks to the nonbank sector. Especially in the euro area, the growth of lending by shadow banks seems to gather force, while its share of total lending remains high in the United States (Figure 2.B). The analysis in our report shows that in the euro area and the United States, investment funds, traditionally considered less risky (think PIMCO or Blackrock) have been growing the fastest since 2009—but taking on more risk. Some of these funds have been venturing into less liquid assets, including loans to companies. More data needed We recommend policymakers should keep an eye on how different shadow banking activities and entities grow and may contribute to systemic risk. We need more data on balance sheets of shadow banking entities to improve our understanding of the risks that shadow banks (and their growth) may pose—that is, whether they engage in excessive maturity or liquidity transformation, how much 249

leverage is involved, how risky their credit positions are, and how interconnected they are with the rest of the financial system. So far, such analysis can only be undertaken in very broad terms for some broad shadow banking sectors.

Hence, a definitive assessment of whether the growth of shadow banking is good or bad for financial stability cannot yet be given – but there are indications of risk build up, at least in some sectors. http://blog-imfdirect.imf.org/2014/10/03/the-growth-of-shadow-banking/

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Markets FT TradingRoom Markets Regulation October 7, 2014 11:50 pm Banks rewrite derivatives rules to cope with future crisis

By Tom Braithwaite and Tracy Alloway in New York

©Bloomberg The world’s biggest banks have agreed to tear up the rule book on derivatives to make it easier to resolve a future failing institution like Lehman Brothers. People familiar with the matter said 18 bank “dealers”, ranging from Credit Suisse to Goldman Sachs, have agreed to give up the right to pull the plug on derivatives contracts with a crisis-stricken institution. More ON THIS STORY// Financial crisis overhaul for credit swaps/ Centralised OTC plan ‘a dream’, says Isda/ FSB backs derivatives crisis-clause/ Swaps dealers warn on market transparency/ Europe reveals post-crisis swaps rules ON THIS TOPIC// John Kay Arbitrage wastes the finest minds// HFT ‘cheetahs’ get Chilton as an adviser// O’Malia to take helm at Isda Tougher capital rules boost traders’ feelings of security IN MARKETS REGULATION • Chicago prosecutor gets tough on spoofing • Trader faces criminal ‘spoofing’ charges • Forex industry creates its own lobby group • Wells Fargo brokerage arm fined $5m Several months of complex talks involved regulators and asset managers but were led by dealers under the umbrella of the International Swaps and Derivatives Association. US regulators, who have previously condemned the industry’s crisis planning as inadequate, had demanded banks come up with a plan to stop their counterparties terminating derivatives contracts in the event of a crisis. The banks portrayed the success of the talks as a rare positive example of industry collaboration.

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Isda is due to announce the agreement to change its “protocols”, which govern the $700tn market, in the next few days. They will take effect from January 1 2015. According to a report from the US Government Accountability Office, 80 per cent of Lehman’s derivatives counterparties closed out their deals with the bank within five weeks of its bankruptcy filing. That, in theory, helped the companies mitigate their counterparty risk with the failed bank but it also meant that Lehman’s estate had to spend years in court trying to claw back collateral from its partners. “One of the problems with Lehman was when there was a failure of one subsidiary clients of derivatives trades took funding away and took business away, adding to market instability,” said one bank negotiator. This also made it harder to find buyers for the rump of Lehman. The current thinking among regulators is that the core of a failing institution should be preserved. Although shareholders would be likely to be wiped out, the operating company would be recapitalised or sold to mitigate the shock to the broader financial system. “You have the financial sector absorb the losses but you have the company stay in business,” said another industry negotiator. “Assuming it gets signed up, it’s a very important step in ending ‘too big to fail’.” You have the financial sector absorb the losses but you have the company stay in business. Assuming it gets signed up, it’s a very important step in ending ‘too big to fail’ - Industry negotiator The concept of “too big to fail” has become hugely controversial since the financial crisis when AIG was bailed out by the US government because of fear of the consequences of its failure. Regulators have been struggling to come up with a viable system to avoid a repeat of the expensive bailout of AIG or the damaging failure of Lehman. The Dodd-Frank financial reforms in the US and parallel reforms in Europe instituted new procedures to “resolve” a failing institution but many believed these were unworkable without changes to derivatives contracts. The vast majority of derivatives contracts will be covered by the agreement to change the Isda protocols, according to banks, but there are several elements yet to settle. One of the most important is that large institutional investors such as BlackRock would not be covered by the changes, particularly if they are cross-border counterparties. Regulators are working to compel asset managers and hedge funds to accept the new protocols. Some of them argue they cannot voluntarily give up the right to cut off business with a failing bank because of a fiduciary duty to protect their investors’ interests. Another element that is not finalised is how the system would work in the event of a US company going through bankruptcy in the courts rather than the new resolution regime. Participants in the Isda talks said the industry had come to agreement and “prewired” the way this would work but it required regulation to make it effective. 252

The overhaul has drawn criticism from some who think that regulators may have made a mistake in asking the industry to update the derivatives documents voluntarily. Some market participants had suggested that regulators introduce incentives, such as preferential capital margin treatment, to speed negotiations. Additional reporting by Gina Chon in Washington http://www.ft.com/intl/cms/s/0/aeb57e26-4e6d-11e4-bfda- 00144feab7de.html#axzz3FXYKTmcL

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ft.com Comment Opinion October 8, 2014 9:33 am Europe’s leaders need to back shift on rules on public investment By Mario Monti More flexibility for countries is required to promote growth, writes Mario Monti

©AFP As European leaders meet in Milan today to discuss growth and employment, they should try to understand and address their divergences rather than burying them in joint declarations full of lip-service to their common determination. Three years ago, the euro risked exploding under pressure from the markets. After considerable initial tensions, national governments – in particular those of France, Germany and Italy – worked closely together and reached landmark decisions in the European Council of June 2012. More ON THIS TOPIC// Euro weakness strengthens policy makers/ Trading Post Euro’s ‘death cross’/ Trading Post Euro feeling the weight of investor gloom/ Euro hits nine-month low versus dollar IN OPINION// China should watch its periphery/ Ngozi Okonjo-Iweala Containing Ebola/ Hugh Willmott All at fault at Tesco/ Sarko’s ‘nuclear’ delight The European Central Bank found those decisions convincing enough to justify a more accommodating stance. By contrast today, amid quiet markets, it may be governments that are undermining the future of the euro – and the European economy as a whole. The French president, the German chancellor and the Italian prime minister arrive in Milan against a backdrop of escalating mutual recriminations. Even when couched in diplomatic terms, these reveal divergences of policy and, more deeply, of national cultures. Such divergences need to be handled in a responsible manner, not exploited between one summit and the next in ways that ultimately will only benefit the populists on the rise everywhere. 254

To stop this happening and for the EU, let alone the eurozone, to remain a ‘community’, there are two essential requirements: compliance with agreed rules and more growth. We will either achieve both or neither. France, Italy and more broadly the south must not accuse Germany and the north of being legalistic or technocratic simply because they expect rules to be observed, the basis of any community. Further, bending the rules tends to favour big member states at the expense of the small. That is why the violation of the stability pact by Germany and France in 2003 went down so badly among other Europeans. On the other hand, the insistence of France, Italy and the south on the need to create space for more growth must not be seen by Germany and the north as a sign of profligacy. More growth in the whole EU, and especially in the south, is imperative for each of the countries but also for the very survival of European integration. Reconciliation is possible. There should be two starting points. First, the stability pact, by and large, is not currently complied with. We cannot speak of compliance when many member states can easily secure extensions to deadlines for meeting the targets. Or even, as France has just done, simply announce that they will not comply and get the support of others, such as Italy, saying that the EU should not dare to consider this an infringement. Secondly, a simplistic stability pact may have been right for the infancy of the euro. But Europe can no longer afford to pay the price of such a rudimentary instrument. By not properly recognising the role of public investment, it has in fact pushed governments to cut it. We need to introduce more rigorous, not more flexible, rules. What is needed is not the flexibility to deviate from the rules, but rules that are economically and morally rigorous. At the time of its Wirtschaftswunder, or ‘economic miracle’, Germany’s constitution had a rule that public borrowing only be allowed for public investment. Germans called it the ‘golden rule’ and initially tried to have it enshrined in the Maastricht treaty: hardly the mark of an irresponsible principle. The idea of a more favourable treatment for public investment has been gaining ground. In 2013, the European Commission announced that it would apply it, within strict limits, in enforcing the stability pact. The International Monetary Fund and even the ECB are calling on governments to expand public investment. Jean-Claude Juncker, the new European Commission president, has announced a large EU investment plan. But the new Commission should go further. It should announce the promotion of a more investment-friendly implementation of fiscal discipline at the national level. This would see the full enforcement of the existing stability pact while allowing for the favourable treatment of public investment within the limits set out in 2013. It would also announce a proposal for updating the instruments of fiscal discipline, for example through a regulation, to reflect the role of productive public investment. And finally it would establish a group to provide agreed principles on which categories of public expenditure qualify as investments under these instruments, thus providing clarity and avoiding circumvention.

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Finally, a moral note. The virtue of fiscal discipline is that it protects future generations from the abuses of current politicians. Assume, however, that a country needs more and better infrastructure and its government can borrow at less than 1 per cent to fund infrastructure with a much higher rate of return in terms of growth. If that country decides to forgo such investment, is it not acting against the interest of future generations? Germany is such a country. It needs to be encouraged to act in line with its principles, and to propose, not oppose an alignment of the EU framework to those principles. The writer is president of Bocconi University and a former prime minister of Italy http://www.ft.com/intl/cms/s/0/ba9cd208-4d5e-11e4-bf60- 00144feab7de.html#axzz3FXYKTmcL National Post FULL COMMENT Joe Oliver: Avoiding the path to economic decline

Joe Oliver, National Post | October 7, 2014 6:51 AM ET

Despite Liberal MP Ralph Goodale’s assertion that “Conservative boasts about Canada’s relative economic performance are further and further out-of-date,” Canada has one of the best economic track records in the G7 (‘The myth of our roaring economy,’ Oct. 4). We created more than 1.1 million net new jobs since the depths of the great recession and we have a debt-to-GDP ratio that’s half of the G7 average. As a result, this country boasts a AAA credit rating with a stable outlook, which cannot be said by many other countries. Ralph Goodale: The myth of the roaring Canadian economy

Anyone who believes the Conservative government’s rosy rhetoric about the economy should be unsettled by a recent Ekos poll, which found that 64% of Canadians now believe hard work is no longer paying off, and that 57% think the next generation will have a worse quality of life than we do. These disturbing trends reflect Canada’s weak underlying economic performance. The International Monetary Fund forecasts that 129 other countries will grow faster than us this year, including the United States, Sweden and Australia. More still will do better than us next year. The meagre 15,000 new full-time jobs that were created in the past 12 months is simply not enough — 230,000 more Canadians are unemployed today, than before the recession. Fifteen of our peers in the Organisation for Economic Co-operation and Development will outperform our economy this year. Our federal tax burden is lower than it has been in over 50 years. Over a million low- income taxpayers are off the tax rolls and the average low-income family has benefited from a 95% reduction in their personal income taxes since our government took office.

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The average family has seen, on average, a $3,400 reduction in their personal taxes. Furthermore, the net worth of Canadians has increased by 46%. According to The New York Times, the Canadian middle class is one of the richest in the world, and is better off than its American counterpart. Corporate income taxes have also been lowered from 22% to 15%, to the point where KPMG estimates the total corporate tax burden is 46% lower than in the U.S. As a result, we are attracting and retaining capital for growth and employment. The 11% tax rate on small businesses, which are large generators of employment, is also very competitive by international standards. Our Small Business Job Credit will benefit 780,000 small companies — 90% of all businesses — create thousands of jobs, according to the Canadian Federation of Independent Business, and save employers $550-million. In contrast, the $1.5-billion Liberal plan would encourage companies to game the system by hiring and firing temporary workers. That is consistent with the party’s irresponsible approach to Employment Insurance (EI). While in office, the Liberals increased the EI surplus to almost $60-billion and used the money as a political slush fund, rather than protecting it for its intended purpose — supporting unemployed workers who contributed to it. Our plan will make sure it breaks even and is available for those who need it. When we entered office, Canada only had five free trade deals. The largest of which, NAFTA, was initiated by the Mulroney government and opposed by both the Liberals and the NDP. Our most recent trade deal is with the European Union, the largest economy in the world. We are now up to 43 trade deals, including the first with an Asian country, South Korea. That makes 51% of the world economy, not 2%, as Mr. Goodale pretends. Federal debt now represents one-third of our economy, which is lower than most developed countries, and will decline to one-quarter or less by 2021. Of course, that assumes we do not incur additional debt. However, if the Liberals are given an opportunity to create massive deficits, which would inevitably flow from their reckless spending plan, debt would increase as a percentage of GDP. Interest payments would also rise, cutting into our ability to fund social programs. Furthermore, our debt rating would be jeopardized and our attractiveness to job-creating investors would be undermined. We do not intend to go down that well-trod path to economic decline. Mr. Goodale can try to denigrate Canada’s economic success all he wants. Happily, he cannot succeed, because the facts do not support his hyper-partisan critique. He might do better spending a little time helping his leader develop a Liberal economic plan. So far, it is an empty vessel. Joe Oliver is the MP for Eglinton-Lawrence and the Minister of Finance. http://oecd.einnews.com/article_detail/227818934/HTyQ9TVVq2703sKq?n=2&code= YE4u1DIRGs-Vsvg5&continued=1

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ft.com comment Columnists October 7, 2014 6:41 pm

We are trapped in a cycle of credit booms

By Martin Wolf The eurozone seems to be waiting for the Godot of global demand to float it off into debt sustainability

H uge expansions in credit followed by crises and attempts to manage the aftermath have become a feature of the world economy. Today the US and UK may be escaping from the crises that hit seven years ago. But the eurozone is mired in post-crisis stagnation and China is struggling with the debt it built up in its attempt to offset the loss of export earnings after the crisis hit in 2008. Without an unsustainable credit boom somewhere, the world economy seems incapable of generating growth in demand sufficient to absorb potential supply. It looks like a law of the conservation of credit booms. Consider the past quarter century: a credit boom in Japan that collapsed after 1990; a credit boom in Asian emerging economies that collapsed in 1997; a credit boom in the north Atlantic economies that collapsed after 2007; and finally in China. Each is greeted as a new era of prosperity, to collapse into crisis and post-crisis malaise. More ON THIS STORY// British crisis consigned to past, says IMF/ Irish boost for hedge fund credit boom/ Availability of mortgages falls/ BoE seeks powers over buy-to-let loans/ Shadow banks step into the lending void

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MARTIN WOLF// No equal union with the Scots/ Inequality is such a drag/ Even Beijing balks at price to pay for a reserve currency/ Clean growth is a safe bet The authors of a fascinating new report, Deleveraging: What Deleveraging?, do not entertain my dystopian hypothesis. Rightly or wrongly, they consider these credit cycles to be essentially independent events. Yet the report is invaluable. It brings out clearly the limited nature of post-crisis deleveraging, the plight of the eurozone and the big challenges now facing China. If you look at the world as a whole, there has been no aggregate deleveraging since 2008. The same holds for the high-income economies, viewed as a single bloc. Financial sectors have deleveraged in the US and UK, however; so, too, have households in the US and, to a lesser degree, the UK. Liabilities of households have even converged between the US and the eurozone as a whole (see charts). Meanwhile, public debt has risen sharply. That financial crises lead to jumps in fiscal deficits was one of the most important findings of This Time is Different by Harvard’s Kenneth Rogoff and Carmen Reinhart. Since the crisis, the ratio of public debt to gross domestic product has jumped by 46 percentage points in the UK and 40 points in the US, against 26 points in the eurozone. Even in the US, where private deleveraging has been rapid, overall deleveraging has been small. This need be no disaster: if the government’s balance sheet is more robust than those of much of the private sector, it ought to take the strain. Since 2007 the ratio of total debt, excluding the financial sector, has jumped by 72 percentage points in China, to 220 per cent of GDP. One can debate whether this level is sustainable. One cannot debate whether such a rapid rate of rise is sustainable; it cannot possibly be so. The rise in debt has to halt with possibly significantly more adverse effects on China’s rate of growth than today’s consensus expects.

Credit cycles matter because they frequently prove so damaging. The report divides possible outcomes into three categories: in “type 1”, such as Sweden in the early 1990s, the level of output falls, never to regain its pre-crisis trend, but the growth rate recovers; in the more damaging “type 2”, as in Japan since the 1990s, there is no absolute fall in output, but potential growth falls far short of the pre-crisis rate; finally, in “type 3”, as in the eurozone now and probably the US and UK, there is both a fall in output and a permanent fall in potential growth.

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Several possible reasons exist for such permanent losses of output and growth. One is the pre-crisis trend was unsustainable. Another is the damage to confidence and so investment and innovation from a financial crisis. But among the most important is the debt overhang. As the report shows, deleveraging is hard. Mass bankruptcy, as in the 1930s, is devastating. But working out of debt is likely to generate a vicious circle from high debt to low growth and back to even higher debt.

Today long-term interest rates are low in high-income economies. In the eurozone this is largely due to the promise by Mario Draghi, the European Central Bank president, in July 2012 to do “whatever it takes”. Unfortunately, the growth of nominal GDP in the eurozone is also dismal: inflation is ultra-low and real GDP is growing weakly, under the blows of fiscal retrenchment and structurally inadequate private demand. Incredibly, the eurozone seems to be waiting for the Godot of global demand to float it off into growth and so debt sustainability. That might work for the small countries. It is not going to work for all of them. The report talks of a “poisonous combination . . . between high and higher debt and slow and slowing (both nominal and real) GDP growth”. The euro periphery, it adds, is where this perverse loop of debt and growth is severe. That is no surprise. Crisis-hit eurozone countries have been running to go backwards. The policies of the eurozone rule out needed growth.

Managing the post-crisis predicament requires a combination of prompt recognition of losses, recapitalisation of the banking sector and strongly supportive fiscal and monetary policies (where those are feasible) to sustain economic growth. The aim

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should be to use both blades of the scissors: direct debt reduction and recapitalisation on the one hand and strong economic growth on the other. The US has come closest to getting this combination right. Yet the biggest lesson of these crises is not to let debt run ahead of the long-term capacity of an economy to support it in the first place. The hope is that macroprudential policy will achieve this outcome. Well, one can always hope. These credit booms did not come out of nowhere. They are the outcome of the policies adopted to sustain demand as previous bubbles collapsed, usually elsewhere in the world economy. That is what has happened to China. We need to escape from this grim and apparently relentless cycle. But for now, we have made a Faustian bargain with private sector-driven credit booms. A great deal more trouble surely lies ahead. http://www.ft.com/intl/cms/s/0/1a9f058e-4d43-11e4-bf60- 00144feab7de.html#axzz3FXYKTmcL

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ft.com Comment The Big Read Last updated:October 7, 2014 8:10 pm China swoops in on Italy’s power grids and luxury brands By Rachel Sanderson in Milan EU debt crisis opened up periphery countries to Chinese investors

©Bloomberg

I taly’s business elite – senior executives from blue-chip companies such as Telecom Italia and Vodafone plus high-ranking government officials – filled a renaissance palazzo across from Milan’s gothic cathedral this summer to court one of the country’s biggest foreign investors.

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Huawei, the Chinese telecoms equipment maker, opened its only research and development centre outside China in Milan in 2008. The company, whose name means “splendid achievement” in Chinese, had brought people together to announce plans to double in size to 1,700 employees across Europe by 2017. More ON THIS STORY// China investors surged into EU in crisis/ China to put €2bn into Italian power grid/ Greece primps for big China state deals/ Wolfgang Münchau Italian debt The company, which is effectively excluded from doing business in many sectors in the US because of lawmakers’ concerns over its technology and potential national security implications, has invested €500m in Europe and there is a hunger for more, says William Xu, a Huawei board member in charge of marketing and strategy. Prime minister Matteo Renzi’s Italian government is particularly “open and collaborative”, he says. For China, the country offered an evocative base. “Six hundred years ago it was Marco Polo who built the bridge [between Europe and China],” Mr Xu says. “Two thousand years ago it was the Silk Road. Now the road is paved with telecoms. We are building the Silicon Road to bring the west and east closer together.” In recent months – to follow Mr Xu’s metaphor – the road from China to Europe has become swollen with cash. Chinese investors have snapped up assets across the continent, from a concession to build and operate container terminals at Greece’s port of Piraeus, to the Three Gorges Corporation’s acquisition of a fifth of Portugal’s national energy company Energias de Portugal and China Investment Corp, the country’s sovereign wealth fund, purchasing a 9 per cent stake in Thames Water.

For 15 years the Chinese state has sought to expand its markets and labour opportunities.

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But with the 2010 debt crisis, China adjusted its focus from mostly natural resource- related deals in Asia, Africa and Latin America. It trained its sights instead on struggling Europe to realise a once-in-a-century opportunity to buy world-class brands and shares in pivotal national infrastructure assets. This week, the Financial Times is exploring Chinese expansion and ambition in Europe and its interest in the most vulnerable economies. The eurozone’s periphery is benefiting from some deals, with Italy this year reaping the most in large-scale contracts: almost €3.5bn worth, according to the Heritage Foundation, a conservative think-tank. The phenomenon has been described as the dawn of a second Marshall Plan. Luigi de Vecchi, chairman of continental Europe for Citigroup, says the historic shift in investment is severing some relationships formed in postwar Europe. Government officials and diplomats explain the change in approach as partly driven by necessity but say it also reflects Europe’s response to changes in the balance of global economic power. The Marshall Plan supported investment in Europe – and especially Italy – after the second world war. That balance has changed with the eurozone crisis, says Mr de Vecchi, and the flight of US capital. “It destabilised the historic links of European governments, especially in Italy, with the US. So they looked east and have opened up to China as a way of diversifying their risk.” The buying spree has allowed the Chinese to adjust their horizons. “Chinese companies used to be only interested in buying European-listed resource companies with assets elsewhere like Latin America or Africa but now they are much more interested in buying things that are actually based in Europe,” says Derek Scissors, compiler of an independent database on Chinese outbound investment at the American Enterprise Institute, the think-tank. “An extended period of economic stress in Europe combined with the fact that Chinese companies have tons of money mean there are a lot more opportunities for Chinese purchases than before.” . . . But the attention of the Chinese investors is provoking some anxiety. “Is China nibbling at Europe’s soft underbelly?” asks Francesco Galietti, founder of the Rome-based think- tank Policy Sonar, hinting that some believe Europe is giving up too much. The answer is unclear. But investment in the country has spiralled over the past two years and appears to be part of a deliberate Chinese strategy, say bankers and government officials. Investors have swooped on symbols of Italian elegance – acquiring majority stakes in luxury yachtmaker Ferretti, a company that defaulted on its debt in 2009 – as well as buying into the country’s vast power grid. In July China’s State Grid, the world’s largest utility with 2m employees, bought a 35 per cent stake in CDP Reti, a subsidiary of Italy’s state financing agency that controls the country’s electricity grid operator and gas distribution. It also picked up a 25 per 264

cent stake in Portugal’s grid operator REN and is looking to buy into the Greek grid operator ADMIE, bankers familiar with the deal told the FT. European utilities offer Chinese state-owned investors safe, long-term investments that provide steady, predictable returns and strong legal protections. But the infrastructure deal with Italy is one that officials admit would have been unthinkable before the crisis since they would have balked at selling shares in a strategic asset to a foreign investor. “The CDP Reti deal is but the latest episode of China’s ‘charm offensive’ in the Italian energy sector,” wrote Policy Sonar in September, “and arguably gives State Grid unprecedented access to Italy’s energy technology and networks, as well as a chance to gain first-hand knowledge of how [partly] deregulated power markets function.” The consultancy went on to say that: “Italy represents a gateway to the pan-European electricity grid.” A statement on State Grid’s website described the Italian purchases as good deals, saying: “When we make overseas investment, we are not doing charity.” China’s interest shows no sign of waning. The State Administration of Foreign Exchange, which manages the country’s $4tn in reserves, snapped up 2 per cent stakes in Italian blue-chip companies Fiat Chrysler Automobiles, Telecom Italia and Prysmian, worth a total of about €670m in July. Those deals came after Safe had invested an estimated €2bn to buy stakes in state- controlled energy groups Eni and Enel earlier this year. Pier Carlo Padoan, Italy’s finance minister, says the country is well placed to act as a link in the process of “the internationalisation” of the communist country’s economy. The relationship will be on full display next week when Li Keqiang, China’s premier, attends the Asia-Europe summit in Milan. The US and resource-rich countries in Africa and South America remain the primary recipients of Chinese investment. By the middle of this year, total Chinese investment in sub-Saharan Africa was worth $150.4bn, investment into North America totalled $124bn while Europe received $104bn, according to the Heritage Foundation. But European bankers who have negotiated deals say Chinese investors are keen to reassure that theirs is a collaborative approach, seeking large minority stakes – such as the 35 per cent in Italy’s grid network – rather than controlling ones. Or, as with private companies such as Huawei hiring Italians at a time when the jobless rate among young people hovers at 40 per cent, to emphasise that they are contributing rather than just “buying” in to the country. Individual Chinese businessmen, interviewed by FT reporters across Italy, Spain and Portugal, say they are heading to Europe armed with better skills and intent on buying companies At the end of 2012, 195 small and midsized Italian companies, with combined total revenues of €6bn and 10,000 employees, had been wholly or partly taken over by Chinese or Hong Kong investors, according to Fondazione Italia-Cina, a not-for-profit group that promotes relations between the two countries.

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Such enterprises are predominantly in the classic “Made in Italy” manufacturing sectors of clothing, furnishings, motorcycles and yachts. Hong Kong Chinese investors largely acquired telephone and perfumery businesses, according to data from the organisation. The Chinese move into Europe has not just involved money and acquisitions. An EU Commission-funded report in 2013 suggested that Chinese low-income and illegal migration may have slowed after the eurozone crisis as entry-level opportunities dried up. But national statistics from individual countries show that legal Chinese migration, especially in the periphery, appears to be on the upswing, if at a slower pace. Official data from Italy’s national statistics agency shows the Chinese population tripled to more than 200,000 between 2003 and 2013. The interior ministry puts the figure higher at over 300,000. Spain and Portugal have seen similar increases. Alfonso Giordano, an expert in migration at the University of LUISS in Rome, says that Chinese workers are still finding opportunities in Italy because they are “young and work hard”. They took up the slack from an ageing population and, he says, they are willing to do what some Italians have refused to do: accept lower pay and fewer benefits during the downturn. “Italians need to lower their expectations about the labour market. And they have not done this. The Chinese have therefore come in to take their place, particularly in the lower wage market,” says Mr Giordano. Carlo Calenda, Italy’s vice-minister for economic development, describes the Chinese as “serious investors” who did not flinch at the economic woes spilling across Europe. “I don’t have any problem with the Chinese coming in to buy,” he says. “We have had many industrial crises and the solution has come from outside of Italy”. . . . Nonetheless, China’s push into Europe is causing tension. Lorenzo Stanca, managing partner for Mandarin Capital, which advises Italian and German companies on entry to China, says Chinese companies have found it difficult to make European acquisitions. “The culture gap means there are problems with handling human resources, and also in dealing with banks,” he says. “It is not easy for Chinese companies to have success in Europe.” Furthermore, bankers and business leaders complain that a lack of governance and transparency in Chinese actions causes tensions in deal making. But their main concern is that the new Silk Road is going just one way. Safe is now the second-largest shareholder after the Italian state, which owns 30 per cent, in Enel. Patrizia Grieco, Enel’s chairman, says Chinese investors are welcome – “benvenuti”, she says – with a caveat, widely shared in Europe: “They are welcome, but . . . they should improve their transparency and governance in order for Europeans to invest in China, too.”// Additional reporting by Jamil Anderlini in Beijing, Peter Wise in Lisbon, Kerin Hope in Athens, Tobias Buck in Madrid, and Gavin Jackson and Robin Kwong in London// http://www.ft.com/cms/s/0/1bd60160-4496-11e4-bce8- 00144feabdc0.html#axzz3FXYKTmcL

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Economic Research

FRBSF ECONOMIC LETTER 2014-30 October 6, 2014 Has China’s Economy Become More “Standard”? John G. Fernald, Eric Hsu, and Mark M. Spiegel Financial liberalization in China has broad implications, including changing how its central bank’s monetary policy affects the nation’s economy. An estimate of Chinese economic activity and inflation based on a broad set of indicators suggests that the way policy is transmitted to China’s economy has become more like Western market economies in the past decade. Although Chinese monetary policy may actually have exacerbated its economic downturn during the global financial crisis, a move toward stimulatory policy has helped ease its slower growth more recently. China’s economy has experienced remarkable structural and institutional changes in recent decades. These changes may alter the efficacy of countercyclical monetary and fiscal policy on Chinese economic activity and inflation. Many studies (for example, Geiger 2006 and He et al. 2013) have found that market-oriented policies, such as changes in interest rates and reserve requirements, were relatively less important in China than more direct credit policies, such as “window guidance” for commercial bank lending levels. However, ongoing developments in China’s financial sector should, at some point, lead China’s monetary transmission mechanism to look more similar to that in the U.S. and other Western market economies (as described in, say, Bernanke and Blinder 1992). Motivated by the evolving financial system, a recent study by Fernald, Spiegel, and Swanson (FSS 2014) re-examines the Chinese monetary transmission mechanism. FSS use a statistical model developed by former Federal Reserve Chairman Ben Bernanke and others to analyze U.S. monetary policy (Bernanke and Boivin 2003 and Bernanke, Boivin, and Eliasz 2005). Known as a FAVAR model, this approach uses numerous related data series to alleviate concerns that individual data might suffer measurement error or be inconsistently available. Using this approach with recent data, FSS find that interest rates and reserve requirements are more important than direct quantity measures of lending, in contrast to earlier findings. In this Economic Letter, we summarize the findings in FSS. We then extend the data sample to assess Chinese monetary policy during the country’s recent modest economic slowdown. Our results indicate that policy has played a stimulatory—and hence

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smoothing—role during the slowdown. Challenges of using Chinese data A challenge when examining China’s monetary transmission mechanism is the quality of Chinese data, which are often considered questionable (Holz 2008, Nakamura et al. 2014, and Fernald, Hsu, and Spiegel 2014). The approach in FSS overcomes this obstacle by using a large number of economic indicators to estimate two unobserved factors that drive the systematic component of the data, representing output and inflation. This allows the incorporation of data series with potentially large measurement errors, and it minimizes ad hoc decisions about which data best capture the true movements in the Chinese economy. Indeed, Bernanke and Boivin (2003) and Bernanke et al. (2005) found that this approach provided better empirical estimates for the U.S. economy by incorporating the wide variety of output and inflation measures available. In addition, because of the rapid institutional and structural change in China, it is important to focus on recent data. For example, data from the 1990s may not be relevant for understanding the current Chinese economy. FSS focus on data since 2000. Importantly, that includes the global financial crisis as well as the first half of 2014. Evolution in China’s monetary transmission mechanism In a country with well-developed financial markets, monetary policy affects the economy through market-oriented channels. For example, when the Federal Reserve adjusts its target for the interest rate on overnight loans between banks, all market rates throughout the economy adjust. Those changes, in turn, influence economic activity and, eventually, prices. In contrast, in China during the 1990s, market-based monetary policy instruments—including changes in interest rates—were generally considered inadequate to control China’s economy due to the slow pace of reform in the banking and financial sectors. As a result, studies of this period suggest that interest rate policies pursued by the People’s Bank of China (PBOC) had little, if any, impact on the real side of the Chinese economy (see Geiger 2006 and He et al. 2013). Instead, policymakers used more direct credit policies, such as “window guidance” by the PBOC, under which credit expansion was managed by direct control over the volume of commercial bank lending. As the 1990s came to a close, however, financial liberalization in China appeared to increase the impact of monetary policy—particularly interest rate policies—on the real side of the Chinese economy. The impact of nonmarket policies such as window guidance may diminish as the financial sector develops, in favor of more standard instruments, such as policy interest rates. Still, financial liberalization is incomplete, in that China still sets ceilings on bank deposit rates and floors on lending rates (Liao and Tapsoba 2014). Thus, how standard China’s monetary transmission mechanism currently is remains an open question. The FAVAR approach To investigate this issue, FSS incorporate estimates of the Chinese output and inflation factors into a standard statistical model of how monetary policy affects the economy,

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known as a vector-autoregression (VAR). The combination is known as a factor- augmented VAR, or FAVAR. Under this approach, we use a statistical method known as principal components to boil down a relatively large number of data series into two factors corresponding to economic activity and inflation. Creating these summary indexes greatly simplifies the statistical analysis of how changes in policy affect the economy over time. We update the set of 34 indicators used by FSS for Chinese output and inflation with data through June 2014. In addition to economic activity and inflation factors, we include three PBOC “policy variables”: the quantity of bank lending, bank reserve requirement levels, and a benchmark short-term interest rate set by the PBOC. The first variable captures changes in the PBOC’s window guidance. In principle, changes to any variable can affect all the other variables, but some respond more quickly than others. These differences help us identify policy changes. For example, we allow lending to respond immediately to changes in economic activity or prices, but changes in reserve requirements or interest rates affect lending only with a time lag. We assume changes in lending that are not explained by current activity, inflation, or lags of other variables reflect policy changes. In contrast, changes in short- term interest rates can respond immediately to all other variables. So monetary policy “shocks” to interest rates are those rate movements not explained by current or lagged changes in other variables, or by lagged changes in the rates themselves. Figure 1 Indicators of economic activity in China

Sources: CEIC, Bloomberg, Haver, and authors’ calculations. Figure 1 presents estimates of our Chinese economic activity factor measured from detrended monthly changes in underlying indicators. The figure also shows China’s GDP growth, reported as four-quarter growth rates, and monthly growth rates for industrial production. For the latter two, we removed a slow-moving trend and rescaled them to have the same standard deviation. Clearly, all three series move together, albeit imperfectly. For example, although industrial production is one of the variables used to

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construct the economic activity factor, changes in industrial production before 2008 were only weakly related to economic activity or GDP growth. Our factor captures well China’s slowdown during the 2007–09 global financial crisis and its subsequent recovery. It is apparent that, while China weathered the economic downturn better than most countries, it also was hard-hit by the global downturn. Implications for Chinese monetary policy Figure 2 Economic activity factor: Actual vs. estimate

Sources: CEIC, Bloomberg, and authors’ calculations. Our model allows us to analyze the role of countercyclical policy during and since the global financial crisis. In Figure 2, the solid line shows the economic activity factor; the dashed line shows our model’s predictions of how that factor would have evolved had we “turned off” the monetary policy shocks, namely the innovations to the short-term interest rate and reserve requirements. Surprisingly, we find that China’s relatively strong performance during the global financial crisis was not attributable to countercyclical monetary policy. That is, when we remove our estimated interest rate and reserve ratio innovations, our model predicts that China’s economy actually would have performed better during the crisis. The reason is timing: China was tightening monetary policy early in 2008. Given that changes in monetary policy feed through to the underlying economy with a lag, the contractionary effects hit the economy between late 2008 and 2009—exacerbating the effects of the global financial crisis on China. This illustrates the challenges of countercyclical monetary policy. More recently, many commentators have noted China’s slowing economy. The dashed line shows that from about mid-2013 through the end of our sample in mid-2014, Chinese monetary policy has been modestly stimulatory. That is, monetary policy appears to have mitigated the depth of the country’s slowdown, in that our model

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predicts that economic activity would have been lower without monetary policy intervention. This stimulus comes primarily from changes in reserve requirements, since interest rates were unchanged from December 2010 through June 2014. Conclusions This Letter extends the statistical methods in Fernald, Spiegel, and Swanson (2014) to assess the impact of Chinese monetary policy on its economy. This FAVAR model addresses the data quality challenges posed by the Chinese economy, allowing us to incorporate a broad variety of poorly measured data. This method also allows us to examine the dramatic recent changes in the Chinese financial and economic systems, as it can be estimated on short data series. According to our model, China’s monetary transmission mechanism is beginning to look more standard relative to Western market economies. In particular, interest rate and reserve requirement policies appear to play a more substantive role in determining both real economic activity and prices. As China continues to liberalize its financial sector, these standard monetary policy instruments are likely to gain further importance. We also use our model to assess how Chinese monetary policy has affected its economic activity. We find that monetary policy exacerbated the severity of China’s modest downturn during the global financial crisis, primarily because the PBOC appears to have tightened policy just before the crisis hit. This illustrates the challenges faced in pursuing countercyclical policy. Nevertheless, we find that Chinese monetary policy has become more stimulatory recently, which may have helped ease its recent modest downturn in economic activity. John G. Fernald is a senior research advisor in the Economic Research Department of the Federal Reserve Bank of San Francisco. Eric Hsu is a research associate in the Economic Research Department of the Federal Reserve Bank of San Francisco. Mark M. Spiegel is a vice president in the Economic Research Department of the Federal Reserve Bank of San Francisco. References Bernanke, Ben, and Alan Blinder. 1992. “The Federal Funds Rate and the Channels of Monetary Transmission.” American Economic Review 82(4), pp. 901–921. Bernanke, Ben, and Jean Boivin. 2003. “Monetary Policy in a Data-Rich Environment.” Journal of Monetary Economics 50, pp. 525–546. Bernanke, Ben, Jean Boivin, and Piotr Eliasz. 2005. “Measuring the Effects of Monetary Policy: A Factor-Augmented Vector Autoregressive (FAVAR) Approach.” Quarterly Journal of Economics 120(1), pp. 387–422. Fernald, John, Eric Hsu, and Mark M. Spiegel. 2014. “Is China Fudging Its Figures? Evidence from Trading Partner Data.” Unpublished manuscript, Federal Reserve Bank of San Francisco. Fernald, John, Mark M. Spiegel, and Eric Swanson. 2014. “Monetary Policy

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Effectiveness in China: Evidence from a FAVAR Model.” Forthcoming, Journal of International Money and Finance. Geiger, Michael. 2006. “Monetary Policy in China (1994–2004): Targets, Instruments, and Their Effectiveness.” Wurzburg Economic Papers 68. He, Qing, Pak-Ho Leung, and Terence Tai-Leing Chong. 2013. “Factor-Augmented VAR Analysis of the Monetary Policy in China.” China Economic Review 25, pp. 88– 104. Holz, Carsten A. 2008. “China’s 2004 Economic Census and 2006 Benchmark Revision of GDP Statistics: More Questions than Answers?” The China Quarterly 193(March), pp. 150–163. Liao, Wei, and Sampawende Tapsoba. 2014. “China’s Monetary Policy and Interest Rate Liberalization: Lessons from International Experiences.” IMF Working Paper WP/14/75. Nakamura, Emi, Jón Steinsson, and Miao Liu. 2014. “Are Chinese Growth and Inflation Too Smooth?” NBER Working Paper 19893.

http://www.frbsf.org/economic-research/publications/economic- letter/2014/october/china-chinese-monetary-policy-financial-liberalization/

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mainly macro Comment on macroeconomic issues

Monday, 6 October 2014 More asymmetries: Is Keynesian economics left wing? In the textbooks it is suggested that Keynesian economics is what happens when ‘prices are sticky’. Sticky prices sound like prices failing to equate supply and demand, which in turn sounds like markets not working. Hence whether you believe in Keynesian theory depends on whether you think markets work, so it obviously maps to a left/right political perspective. Reality is rather different. Suppose we start from a position where firms are selling all they wish. Aggregate demand equals aggregate supply. If then aggregate demand for goods falls, perhaps because consumers or firms are trying to rebuild their balance sheets after a financial crisis, producers of these goods will start to reduce output, and lay off workers. The idea that they would ignore the fall in demand and just carry on producing the same amount is ludicrous. So output appears to be influenced by aggregate demand at least in the short run, which is at the heart of what most economists think of as Keynesian theory. So where do sticky prices come in? Here we have to go back to the textbooks, and to an imaginary world where the monetary authority fixes the money supply. Firms, in an effort to stimulate demand for their goods, cut prices. Lower prices mean people do not need to hold so much money to buy goods. However if the nominal money supply is fixed, interest rates will fall to encourage people to hold more money. The textbooks encourage us to think of a market for money, with interest rates as the price that equates supply and demand. Lower interest rates provide an incentive to consumers and firms to increase demand, which in turn raises output. Now suppose that firms carry on cutting prices as long as they are selling less than they would like. The process just described will continue, with interest rates getting lower and aggregate demand rising in response. The process stops when firms stop cutting prices, which means aggregate demand has increased back to its original level. Suppose further that prices adjusted very quickly. This mechanism would work very quickly, so we would only observe aggregate demand being below supply for very short periods. If prices were extremely flexible, we could ignore aggregate demand altogether in thinking about output. Hence aggregate demand matters only if ‘prices are sticky’. Note that this correction mechanism is quite complex, and some way from the simple microeconomic world of the market for a single good. But we need to move back to the real world again. Monetary authorities do not fix the money supply; they fix short term interest rates. So they are directly in charge of the correction mechanism that is at the heart of this story. If central banks had some way of knowing what aggregate supply was, and also had perfect knowledge of aggregate demand and how interest rates influenced it, they could make sure aggregate demand equalled supply without any need

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for prices to change at all. Equally, if prices were very flexible but the monetary authority always moved nominal rates in such a way as to fail to stimulate aggregate demand, aggregate demand and therefore output would not return back to equal aggregate supply. Demand would still matter, even with flexible prices. Once you see things as they are in the real world, rather than as they are portrayed in the textbooks, the importance of aggregate demand (and therefore of Keynesian theory) is all about how good monetary policy is, and not about sticky prices. If monetary policy was perfect, thenKeynesian theory would only be used by central banks in order to be perfect, and everyone else could ignore it. Of course for many good reasons monetary policy is not perfect, and so Keynesian theory matters. We could re-establish the link between Keynesian theory and price flexibility by assuming the monetary authority follows a rule which would make policy perfect if and only if prices moved very fast, but the key point remains. The importance or otherwise of Keynesian theory depends on monetary policy. It is not about market failure. Keynesian economics is not left wing, but it is about how the economy actually works, which is why all monetary policymakers use it. It is also common sense, which is why I’m often perplexed by those who dispute Keynesian ideas. Now maybe they are confused by the strange world portrayed in textbooks, but even if they think it is all about ‘sticky prices’,the evidence that prices are slow to adjust is overwhelming, so it is hard to dispute Keynesian theory on those grounds. Yet a whole revolutionin macroeconomic theory was based around a movement that wanted to overthrow Keynesian ideas, and build models where this correction mechanism I described happened automatically. The people who built these models did not describe them as assuming monetary policy worked perfectly: instead they said it was all about assuming markets worked. As a description this was at best opaque and at worst a deliberate deception. So why is there this desire to deny the importance of Keynesian theory coming from the political right? Perhaps it is precisely because monetary policy is necessary to ensure aggregate demand is neither excessive nor deficient. Monetary policy is state intervention: by setting a market price, an arm of the state ensures the macroeconomy works. When this particular procedure fails to work, in a liquidity trap for example, state intervention of another kind is required (fiscal policy). While these statements are self-evident to many mainstream economists, to someone of a neoliberal or ordoliberal persuasion they are discomforting. At the macroeconomic level, things only work well because of state intervention. This was so discomforting that New Classical economists attempted to create an alternative theory of business cycles where booms and recessions were nothing to be concerned about, but just the optimal response of agents to exogenous shocks. So my argument is that Keynesian theory is not left wing, because it is not about market failure - it is just about how the macroeconomy works. On the other hand anti- Keynesian views are often politically motivated, because the pivotal role the state plays in managing the macroeconomy does not fit the ideology. Is this asymmetry odd? I do not think so - just think about the debate over climate change. Now of course it is true that there are a small minority of scientists who do not believe in manmade climate change and who are not politically motivated to do so, and I’m sure the same is true for 274

Keynesian theory. But to claim that the majority of anti-Keynesian views were innocent of ideological preference would be like – well like trying to pretend that monetary policy has no role in stabilising the business cycle. There are of course many differences between climate change denial and anti- Keynesian positions. One is the extent to which the antagonism has infiltrated the subject itself. Another is the extent to which the mainstream wants to deny this influence. I do wonder if the unreal view of monetary policy that remains in the textbooks does so in part so as to not offend a particular ideological position. I do know that macroeconomics is often taught as if this ideological influence was non-existent, or at least not important to the development of the discipline. I think doing good social science involves recognising ideological influence, rather than pretending it does not exist. http://mainlymacro.blogspot.com.es/2014/10/more-asymmetries-is-keynesian- economics.html

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Weren’t Alarm Bells Ringing? Paul Krugman October 23, 2014 Issue The Shifts and the Shocks: What We’ve Learned—and Have Still to Learn—from the Financial Crisis by Martin Wolf Penguin, 466 pp., $35.00 1. Almost nobody predicted the immense economic crisis that overtook the United States and Europe in 2008. If someone claims that he did, ask how many other crises he predicted that didn’t end up happening. Stopped clocks are right twice a day, and chronic doomsayers sometimes find themselves living through doomsday.

Martin Wolf; drawing by James Ferguson But while prediction is hard, especially about the future, this doesn’t let our economic policy elite off the hook. On the eve of crisis in 2007 the officials, analysts, and pundits who shape economic policy were deeply, wrongly complacent. They didn’t see 2008 coming; but what is more important is the fact that they even didn’t believe in the possibility of such a catastrophe. As Martin Wolf says in The Shifts and the Shocks,

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academics and policymakers displayed “ignorance and arrogance” in the runup to crisis, and “the crisis became so severe largely because so many people thought it impossible.” Did supposed experts really think that nothing like what did happen could happen? Yes. In his 2003 presidential speech to the American Economic Association, Robert Lucas of the University of Chicago, the most influential macroeconomist of the late twentieth century, asserted that “the central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades.” What he meant was that modern policymakers wouldn’t repeat the mistakes that, according to the prevailing wisdom, made the Great Depression possible. In particular, Milton Friedman had convinced many economists that depression prevention is actually a fairly simple task, which can be carried out by technocrats at the central banks that control national money supplies. According to Friedman, the Great Depression occurred only because the Federal Reserve failed to do its job in the 1930s; if it had acted to rescue troubled banks and prevent a fall in the money supply, catastrophe would have been avoided. At a celebration of Friedman’s ninetieth birthday, Ben Bernanke, an eminent monetary economist and Depression scholar who would become Fed chairman a few years later, accepted this verdict: “You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.” Then crisis struck, and major central banks—the Fed under Bernanke’s leadership, the European Central Bank, the Bank of England—did everything Friedman said they should have done in the 1930s. Troubled banks were rescued; money supplies were sustained. And we got a depression all the same. True, in the United States we can comfort ourselves slightly with the observation that, bad as our experience has been, it hasn’t been as bad as the 1930s; but in Europe, where a weak recovery stalled in 2011, and growth between 2007 and 2014 was slower than between 1929 and 1936, they can’t even say that. How could such a thing happen? If you try to follow the economic debate by listening to the talking heads on TV, or even from press reports, it can seem like a cacophony of voices with no clear theme. That impression isn’t entirely wrong: the crisis has revealed deep cleavages over economic doctrine that were papered over during the good years. But many economists and financial officials (although not as many politicians) have converged on a broadly consistent view about what went wrong—a sort of Standard Model, to make an analogy with physics—that seems to make sense of the mess we’re in. The Shifts and the Shocks is, I’d argue, best viewed as an extended, learned, and well-informed exposition of this Standard Model and what it implies about where we should go from here. Since the new sort-of consensus is clearly much more realistic than the pre-crisis complacency, Wolf, the chief economics commentator of the Financial Times, has performed a very useful service by putting it all together in one readable book. But is the sort-of consensus the whole story? And are policy recommendations based on this consensus likely to solve our problems? My answers would be “No, not entirely” and “Doubtful.” Before I get there, however, let’s talk about Wolf’s vision of what happened.

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2. The Shifts and the Shocks opens with a long quotation from the late Hyman Minsky, a heterodox economist who had little influence on mainstream economists and policymakers during his lifetime, but whose analysis is now central to the Standard Model. Minsky’s ideas have been cited by monetary officials including Janet Yellen, by business economists like Pimco’s Paul McCulley, and by many academics, myself included. You could say that we are all Minskyites now. What did Minsky bring to economics? In part, he argued that conventional views of financial crisis were too narrowly focused on the specific issue of bank runs. In Minsky’s vision, excessive leverage—too much reliance on borrowed money—creates a risk of crisis whoever the borrower. Banks, which in effect borrow money short-term from their depositors but invest in assets that can’t easily be converted to cash, may be especially vulnerable. But business and household debt also expose the economy to the possibility of a self-reinforcing downward spiral. Minsky was not, of course, the first to make this observation; during the Great Depression the great American economist Irving Fisher, in a paper that reads remarkably well to this day, argued that the economy was suffering from “debt deflation,” in which borrowers of all kinds were trying to pay down their debts at the same time, which led to plunging prices of assets and a severe economic slump, which made their debts even less supportable and led to further pullbacks. What Minsky added, however, was the notion that deflation as a result of excessive debt is fated to happen every once in a while, that periodic financial crises are a more or less unavoidable feature of capitalism. According to his “financial instability hypothesis,” eras of economic stability carry within themselves the seeds of their own downfall. If there hasn’t been a financial crisis for many years, both borrowers and lenders will become complacent, underestimating the risks of high levels of debt. Leverage will rise, year after year. Inevitably, however, there will come a point when something goes wrong—a financial bubble bursts, a major financial institution fails, whatever—and people will start worrying about debt again. This is the “Minsky moment” (a term coined by Pimco’s McCulley), and it is followed by a nasty case of debt deflation that is very hard for policymakers to fight. Mapping this story onto the past few decades of US economic history is easy and persuasive. From the mid-1980s to 2007 the US economy did indeed experience an era of relative economic calm, and this in turn induced a very bad case of complacency, not least among policymakers. In 2004 Ben Bernanke gave an influential speech lauding the economy’s “great moderation,” which he argued was likely to be a lasting phenomenon, in part because it reflected the excellence of modern macroeconomic policy. “This now seems quaint,” remarks Wolf; I would have used a stronger word. What we now know, and should have been obvious even at the time, was that the surface stability of the US economy rested on an unsustainable rise in debt. The graph below, which reproduces one of Wolf’s charts, tells the tale: private-sector debt grew and grew, making the economy ever more vulnerable to a Minsky moment. And the moment came. In retrospect, the complacency of both policymakers and investors in the face of the trend visible in this chart is remarkable. Why weren’t alarm bells ringing?

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One answer was a fallacy of misplaced concreteness: the economics establishment, to use Wolf’s term, identified financial crisis with old-fashioned bank runs by depositors—and such bank runs are a thing of the past thanks to deposit insurance. Yet by 2008 depository institutions were no longer the dominant form of banking. Instead, finance increasingly relied on “shadow banking” (another Paul McCulley coinage): institutions like money market funds and investment banks that are reliant on overnight loans had come to make up more than half the US banking system. And these institutions were both unsecured and unregulated, making them highly vulnerable to panic.

Another answer was vastly excessive faith in the wisdom of the financial industry. Major policymakers convinced themselves and the rest of the world that “financial innovation” was making the system more stable as well as more efficient. Far from opposing or seeking to limit the rapid growth of finance, they sought to promote it; the most important reason instability like that of the 1930s returned to markets, says Wolf, “was simply financial liberalization.” Finally, policymakers convinced themselves that they could easily contain any major economic fallout from financial disruption, as Milton Friedman claimed the Fed could have done in the 1930s. Indeed, over the course of 2007–2008 official assurances that troubles in the mortgage market had been “contained” were made so frequently that they became a joke. As it turned out, containing the effects of financial crisis is very hard indeed. This, then, is the Standard Model of the crisis. A long period of relative economic stability fueled complacency in both the private and public sectors, leading to an unsustainable rise in debt. Meanwhile, free-market ideology blinded policymakers to the dangers of growing financial debt, as with the vast number of underfunded mortgages, and in fact led them to dismantle many of the protections we had. And there

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was, inevitably in retrospect, a day of reckoning, in which the bubble of complacency burst and the fragility of our financial system turned that bursting bubble into catastrophe. Now, the story I’ve just told is somewhat US-centric, and Wolf argues rightly that a fuller picture requires paying attention to the wider world. This complicates his account in a couple of important ways. First, as Wolf says, developments in emerging markets, especially in Asia, have in some ways been a mirror image of developments in advanced economies. While the United States was experiencing its “great moderation,” emerging markets were being whipsawed by huge inflows and outflows of capital (made possible by the widespread dismantling of capital controls). It’s interesting to ask why the Asian financial crisis of the late 1990s, which brought Great Depression–level slumps to several economies and pushed Japan into prolonged stagnation and deflation, didn’t shake the policy complacency of Western economists. But it didn’t. (Full disclosure: I did indeed see that crisis as an omen, and published a book to that effect, The Return of Depression Economics, in 1999.) What it did do was convince emerging markets that they needed huge foreign currency reserves as insurance against future crises. And the enormous accumulation of overseas assets meant that the Chinese and many others were, in effect, lending large sums at very low interest to advanced economies, the United States in particular. In another influential speech, Ben Bernanke dubbed this phenomenon the “global savings glut.” At the time (2005), this analysis was meant to be reassuring: Bernanke was telling his audience not to worry too much about large-scale US borrowing from abroad. But Wolf argues that the savings glut interacted with unsound finance to make America even more vulnerable to crisis. If the 1990s were an era of crisis in developing countries, the years since 2010 have been an era of crisis in Europe. In a general sense the euro crisis follows the Minsky schema. There was a complacency-fueled rise in debt, followed by a severe slump as many debtors were forced to retrench at the same time. In the European case, however, complacency came not so much from the experience of stability as from the false belief that a shared currency, the euro, eliminated lending risks. Borrowing costs in Spain, for example, plunged in the late 1990s, as it became clear that Spain would indeed share a currency with Germany. Low interest rates, in turn, helped inflate an enormous housing bubble. And when this bubble burst, Spain and other borrowers—with no currencies of their own—found themselves with no room for maneuver, forced into fiscal austerity that deepened their slumps. While the special circumstances of emerging markets and the euro area complicate the narrative, however, Wolf’s essential story remains that of Minsky’s financial instability hypothesis: stability begets complacency, complacency begets carelessness and hence fragility, and fragility sets the stage for crisis. It’s a good story. But is it good enough? 3. One of the great temptations one faces in writing about financial crises is the urge to turn it all into a morality play—to emphasize the lurid excesses of the boom, and accept the painful slump that follows as the necessary wages of sin. Liquidationism, the

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doctrine that policymakers should let a depression run its course, had powerful advocates in the 1930s. Friedrich Hayek, for example, warned against the use of “artificial stimulants” to boost a depressed economy, arguing that policymakers should “leave it to time to effect a permanent cure.” Wolf is no liquidationist. In fact, he decries the reemergence of “liquidationist folly” at some major international institutions, notably the Bank for International Settlements. Yet I don’t think I’m being unfair if I suggest that in his book, at least, he shows more energy and passion in discussing lax regulation and misplaced worship of the invisible hand than he does in lamenting the inadequacy of post-crisis policies and the damage wrought by austerity. He addresses, briefly, the case for debt relief in economies that, according to his own account, are being dragged down by excess debt, but it almost seems like an afterthought. Or if that wasn’t his intention, it is nonetheless how I suspect the book will be read—mainly as a plea for reining in runaway finance, overshadowing the case for more monetary and fiscal stimulus and more relief for struggling debtors when the economy is depressed. Emphasizing the need to reduce financial fragility makes sense if you believe that the legacy of past financial excess is the reason we’re in so much trouble now. But are we sure about that? Let me offer two reasons to be skeptical. First, while the depression that overtook the Western world in 2008 clearly came after the collapse of a vast financial bubble, that doesn’t mean that the bubble caused the depression. Late in The Shifts and the Shocks Wolf mentions the reemergence of the “secular stagnation” hypothesis, most famously in the speeches and writing of Lawrence Summers (Lord Adair Turner independently made similar points, as did I). But I’m not sure whether readers will grasp the full implications. If the secular stagnationists are right, advanced economies now suffer from persistently inadequate demand, so that depression is their normal state, except when spending is supported by bubbles. If that’s true, bubbles aren’t the root of the problem; they’re actually a good thing while they last, because they prop up demand. Unfortunately, they’re not sustainable—so what we need urgently are policies to support demand on a continuing basis, which is an issue very different from questions of financial regulation. Wolf actually does address this issue briefly, suggesting that the answer might lie in deficit spending financed by the government’s printing press. But this radical suggestion is, as I said, overshadowed by his calls for more financial regulation. It’s the morality play aspect again: the idea that we need to don a hairshirt and repent our sins resonates with many people, while the idea that we may need to abandon conventional notions of fiscal and monetary virtue has few takers. This, in turn, brings me to the further concern I have with the Minskyite interpretation of the post-2008 depression. Even if you believe that financial excess set the stage for the slump that followed—and despite my sympathy for the secular stagnation view, I guess I mostly do—there was still no good reason why the slump had to be as terrible as it was. Containing the fallout from a financial crisis isn’t nearly as easy as Milton Friedman misled economists into believing, but it’s not impossible. In particular, although you’d never know it from the news media, which play down any success of Obama’s, there’s an overwhelming consensus among economists that the 2009 Obama stimulus substantially reduced unemployment relative 281

to what would have happened otherwise. Given the extremely low interest rates that have prevailed all along, that stimulus could easily have been bigger and gone on longer. What we got instead, however, was a wrongheaded obsession with deficits and unprecedented fiscal austerity, which greatly deepened and extended the slump. European nations had fewer options, because they were and are trapped in a dysfunctional monetary system, but there too the slump was made much worse by wrongheaded policies. The point is that focusing, as Martin Wolf does, on the measurable factors—the “shifts”—that increased our vulnerability to crisis is incomplete. Yes, rising levels of private debt, increased reliance on shadow banking, growing international imbalances, and so on helped set the stage for disaster. But intellectual shifts—the way economists and policymakers unlearned the hard-won lessons of the Great Depression, the return to pre-Keynesian fallacies and prejudices—arguably played an equally large part in the tragedy of the past six years. Say’s Law—the false claim that income is automatically spent—made a comeback. So, incredibly, did liquidationism, the view that any effort to ameliorate the pain of depression would postpone needed adjustment. It’s true that conventional economic analysis fell short in the face of crisis. But when policymakers rejected orthodox economics, what they did by and large was to reject it in favor of doctrines like “expansionary austerity”—the unsupported claim that slashing government spending actually creates jobs—that made the situation worse rather than better. And this makes me a bit skeptical about Wolf’s proposals to avert “the fire next time.” The Shifts and the Shocks is an excellent survey of how we arrived at the mess we’re in, and Wolf’s substantive proposals at the end, especially for reform of the euro system— system-wide deposit insurance, higher inflation so that the burden of adjustment is better shared, among other reforms—are all worthy and laudable. But the gods themselves contend in vain against stupidity. What are the odds that financial reformers can do better? Related

Why the Experts Missed the Recession Jeff Madrick Does He Pass the Test?/ Paul Krugman How Austerity Has Failed/ Martin Wolf http://www.nybooks.com/articles/archives/2014/oct/23/why-werent-alarm-bells- ringing/?insrc=hpma

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Remarks by Governor Ben S. Bernanke At the meetings of the Eastern Economic Association, Washington, DC February 20, 2004 The Great Moderation One of the most striking features of the economic landscape over the past twenty years or so has been a substantial decline in macroeconomic volatility. In a recent article, Olivier Blanchard and John Simon (2001) documented that the variability of quarterly growth in real output (as measured by its standard deviation) has declined by half since the mid-1980s, while the variability of quarterly inflation has declined by about two thirds.1 Several writers on the topic have dubbed this remarkable decline in the variability of both output and inflation "the Great Moderation." Similar declines in the volatility of output and inflation occurred at about the same time in other major industrial countries, with the recent exception of Japan, a country that has faced a distinctive set of economic problems in the past decade. Reduced macroeconomic volatility has numerous benefits. Lower volatility of inflation improves market functioning, makes economic planning easier, and reduces the resources devoted to hedging inflation risks. Lower volatility of output tends to imply more stable employment and a reduction in the extent of economic uncertainty confronting households and firms. The reduction in the volatility of output is also closely associated with the fact that recessions have become less frequent and less severe.2 Why has macroeconomic volatility declined? Three types of explanations have been suggested for this dramatic change; for brevity, I will refer to these classes of explanations as structural change, improved macroeconomic policies, and good luck. Explanations focusing on structural change suggest that changes in economic institutions, technology, business practices, or other structural features of the economy have improved the ability of the economy to absorb shocks. Some economists have argued, for example, that improved management of business inventories, made possible by advances in computation and communication, has reduced the amplitude of fluctuations in inventory stocks, which in earlier decades played an important role in cyclical fluctuations.3 The increased depth and sophistication of financial markets, deregulation in many industries, the shift away from manufacturing toward services, and increased openness to trade and international capital flows are other examples of structural changes that may have increased macroeconomic flexibility and stability. The second class of explanations focuses on the arguably improved performance of macroeconomic policies, particularly monetary policy. The historical pattern of changes in the volatilities of output growth and inflation gives some credence to the idea that better monetary policy may have been a major contributor to increased economic stability. As 283

Blanchard and Simon (2001) show, output volatility and inflation volatility have had a strong tendency to move together, both in the United States and other industrial countries. In particular, output volatility in the United States, at a high level in the immediate postwar era, declined significantly between 1955 and 1970, a period in which inflation volatility was low. Both output volatility and inflation volatility rose significantly in the 1970s and early 1980s and, as I have noted, both fell sharply after about 1984. Economists generally agree that the 1970s, the period of highest volatility in both output and inflation, was also a period in which monetary policy performed quite poorly, relative to both earlier and later periods (Romer and Romer, 2002).4 Few disagree that monetary policy has played a large part in stabilizing inflation, and so the fact that output volatility has declined in parallel with inflation volatility, both in the United States and abroad, suggests that monetary policy may have helped moderate the variability of output as well. The third class of explanations suggests that the Great Moderation did not result primarily from changes in the structure of the economy or improvements in policymaking but occurred because the shocks hitting the economy became smaller and more infrequent. In other words, the reduction in macroeconomic volatility we have lately enjoyed is largely the result of good luck, not an intrinsically more stable economy or better policies. Several prominent studies using distinct empirical approaches have provided support for the good- luck hypothesis (Ahmed, Levin, and Wilson, 2002; Stock and Watson, 2003). Explanations of complicated phenomena are rarely clear cut and simple, and each of the three classes of explanations I have described probably contains elements of truth. Nevertheless, sorting out the relative importance of these explanations is of more than purely historical interest. Notably, if the Great Moderation was largely the result of good luck rather than a more stable economy or better policies, then we have no particular reason to expect the relatively benign economic environment of the past twenty years to continue. Indeed, if the good-luck hypothesis is true, it is entirely possible that the variability of output growth and inflation in the United States may, at some point, return to the levels of the 1970s. If instead the Great Moderation was the result of structural change or improved policymaking, then the increase in stability should be more likely to persist, assuming of course that policymakers do not forget the lessons of history. My view is that improvements in monetary policy, though certainly not the only factor, have probably been an important source of the Great Moderation. In particular, I am not convinced that the decline in macroeconomic volatility of the past two decades was primarily the result of good luck, as some have argued, though I am sure good luck had its part to play as well. In the remainder of my remarks, I will provide some support for the "improved-monetary-policy" explanation for the Great Moderation. I will not spend much time on the other two classes of explanations, not because they are uninteresting or unimportant, but because my time is limited and the structural change and good-luck hypotheses have been extensively discussed elsewhere.5 Before proceeding, I should note that my views are not necessarily those of my colleagues on the Board of Governors or the Federal Open Market Committee. The Taylor Curve and the Variability Tradeoff Let us begin by asking what economic theory has to say about the relationship of output volatility and inflation volatility. To keep matters simple, I will make the strong (but only temporary!) assumption that monetary policymakers have an accurate understanding of the 284

economy and that they choose policies to promote the best economic performance possible, given their economic objectives. I also assume for the moment that the structure of the economy and the distribution of economic shocks are stable and unchanging. Under these baseline assumptions, macroeconomists have obtained an interesting and important result. Specifically, standard economic models imply that, in the long run, monetary policymakers can reduce the volatility of inflation only by allowing greater volatility in output growth, and vice versa. In other words, if monetary policies are chosen optimally and the economic structure is held constant, there exists a long-run tradeoff between volatility in output and volatility in inflation. The ultimate source of this long-run tradeoff is the existence of shocks to aggregate supply. Consider the canonical example of an aggregate supply shock, a sharp rise in oil prices caused by disruptions to foreign sources of supply. According to conventional analysis, an increase in the price of oil raises the overall price level (a temporary burst in inflation) while depressing output and employment. Monetary policymakers are therefore faced with a difficult choice. If they choose to tighten policy (raise the short-term interest rate) in order to offset the effects of the oil price shock on the general price level, they may well succeed-- but only at the cost of making the decline in output more severe. Likewise, if monetary policymakers choose to ease in order to mitigate the effects of the oil price shock on output, their action will exacerbate the inflationary impact. Hence, in the standard framework, the periodic occurrence of shocks to aggregate supply (such as oil price shocks) forces policymakers to choose between stabilizing output and stabilizing inflation.6 Note that shocks to aggregate demand do not create the same tradeoff, as offsetting an aggregate demand shock stabilizes both output and inflation. This apparent tradeoff between output variability and inflation variability faced by policymakers gives rise to what has been dubbed the Taylor curve, reflecting early work by the Stanford economist and current Undersecretary of the Treasury John B. Taylor.7 (Taylor also originated the eponymous Taylor rule, to which I will refer later.) Graphically, the Taylor curve depicts the menu of possible combinations of output volatility and inflation volatility from which monetary policymakers can choose in the long run. Figure 1 shows two examples of Taylor curves, marked TC1 and TC2. In Figure 1, volatility in output is measured on the vertical axis and volatility in inflation is measured on the horizontal axis. As shown in the figure, Taylor curves slope downward, reflecting the theoretical conclusion that an optimizing policymaker can choose less of one type of volatility in the long run only by accepting more of the other.8 A direct implication of the Taylor curve framework is that a change in the preferences or objectives of the central bank alone--a decision to be tougher on inflation, for example--cannot explain the Great Moderation. Indeed, in this framework, a conscious attempt by policymakers to try to moderate the variability of inflation should lead to higher, not lower, variability of output. How, then, can the Great Moderation be explained? Figure 1 suggests two possibilities. First, suppose it were the case, contrary to what we assumed in deriving the Taylor curve, that monetary policies during the period of high macroeconomic volatility were not optimal, perhaps because policymakers did not have an accurate understanding of the structure of the economy or of the impact of their policy actions. If monetary policies during the late 1960s and the 1970s were sufficiently far from optimal, the result could be a combination of output volatility and inflation volatility lying well above the efficient frontier defined by the Taylor curve. Graphically, suppose that the true Taylor curve is the solid curve shown in Figure 1, 285

labeled TC2. Then, in principle, sufficiently well executed policies could achieve a combination of output volatility and inflation volatility such as that represented by point B, which lies on that curve. However, less effective policies could lead to the economic outcome represented by point A in Figure 1, at which both output volatility and inflation volatility are higher than at point B. We can see now how improvements in monetary policy might account for the Great Moderation, even in the absence of any change in the structure of the economy or in the underlying shocks. Improvements in the policy framework, in policy implementation, or in the policymakers' understanding of the economy could allow the economy to move from the inefficient point A to the efficient point B, where the volatility of both inflation and output are more moderate. Figure 1 can also be used to depict a second possible explanation for the Great Moderation, which is that, rather than monetary policy having improved, the underlying economic environment may have become more stable. Changes in the structure of the economy that increased its resilience to shocks or reductions in the variance of the shocks themselves would improve the volatility tradeoff faced by policymakers. In Figure 1, we can imagine now that the true Taylor curve in the 1970s is given by the dashed curve, TC1, and the actual economic outcome chosen by policymakers is point A, which lies on TC1. Improved economic stability in the 1980s and 1990s, whether arising from structural change or good luck, can be represented by a shift of the Taylor curve from TC1 to TC2, and the new economic outcome as determined by policy is point B. Relative to TC1, the Taylor curve TC2 represents economic outcomes with lower volatility in output for any given volatility of inflation, and vice versa. According to the "shifting Taylor curve" explanation, the Great Moderation resulted not from improved practice of monetary policy (which has always been as effective as possible, given the environment) but rather by favorable structural change or reduced variability of economic shocks. Of course, more complicated scenarios in which policy becomes more effective and the underlying economic environment becomes more stable are possible and indeed likely. With this bit of theory as background, I will focus on two key points. First, without claiming that monetary policy during the 1950s or in the period since 1984 has been ideal by any means, I will try to support my view that the policies of the late 1960s and 1970s were particularly inefficient, for reasons that I think we now understand. Thus, as in the first scenario just discussed (represented in Figure 1 as a movement from point A to point B), improvements in the execution of monetary policy can plausibly account for a significant part of the Great Moderation. Second, more subtly, I will argue that some of the benefits of improved monetary policy may easily be confused with changes in the underlying environment (that is, improvements in policy may be incorrectly identified as shifts in the Taylor curve), increasing the risk that standard statistical methods of analyzing this question could understate the contribution of monetary policy to the Great Moderation. Reaching the Taylor Curve: Improvements in the Effectiveness of Monetary Policy Monetary policymakers face difficult challenges in their efforts to stabilize the economy. We are uncertain about many aspects of the workings of the economy, including the channels by which the effects of monetary policy are transmitted. We are even uncertain about the current economic situation as economic data are received with a lag, are typically subject to multiple revisions, and in any case can only roughly and partially depict the underlying economic reality. Thus, in practice, monetary policy will never achieve as much

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reduction in macroeconomic volatility as would be possible if our understanding were more complete. Nevertheless, a number of economists have argued that monetary policy during the late 1960s and the 1970s was unusually prone to creating volatility, relative to both earlier and later periods (DeLong, 1997; Mayer, 1998; Romer and Romer, 2002). Economic historians have suggested that the relative inefficiency of policy during this period arose because monetary policymakers labored under some important misconceptions about policy and the economy. First, during this period, central bankers seemed to have been excessively optimistic about the ability of activist monetary policies to offset shocks to output and to deliver permanently low levels of unemployment. Second, monetary policymakers appeared to underestimate their own contributions to the inflationary problems of the time, believing instead that inflation was in large part the result of nonmonetary forces. One might say that, in terms of their ability to deliver good macroeconomic outcomes, policymakers suffered from excessive "output optimism" and "inflation pessimism." The output optimism of the late 1960s and the 1970s had several aspects. First, at least during the early part of that period, many economists and policymakers held the view that policy could exploit a permanent tradeoff between inflation and unemployment, as described by a simple Phillips curve relationship. The idea of a permanent tradeoff opened up the beguiling possibility that, in return for accepting just a bit more inflation, policymakers could deliver a permanently low rate of unemployment. This view is now discredited, of course, on both theoretical and empirical grounds.9 Second, estimates of the rate of unemployment that could be sustained without igniting inflation were typically unrealistically low, with a long-term unemployment rate of 4 percent or less often being characterized as a modest and easily attainable objective.10 Third, economists of the time may have been unduly optimistic about the ability of fiscal and monetary policymakers to eliminate short-term fluctuations in output and employment, that is, to "fine-tune" the economy. What I have called inflation pessimism was the increasing conviction of policymakers in the 1960s and 1970s, as inflation rose and remained stubbornly high, that monetary policy was an ineffective tool for controlling inflation. As emphasized in recent work on the United States and the United Kingdom by Edward Nelson (2004), during this period policymakers became more and more inclined to blame inflation on so-called cost-push shocks rather than on monetary forces. Cost-push shocks, in the paradigm of the time, included diverse factors such as union wage pressures, price increases by oligopolistic firms, and increases in the prices of commodities such as oil and beef brought about by adverse changes in supply conditions. For the purpose of understanding the upward trend in inflation, however, the most salient attribute of cost-push shocks was that they were putatively out of the control of the monetary policymakers. The combination of output optimism and inflation pessimism during the latter part of the 1960s and the 1970s was a recipe for high volatility in output and inflation--that is, a set of outcomes well away from the efficient frontier represented by the economy's Taylor curve. Notably, the belief in a long-run tradeoff between output and inflation, together with an unrealistically low assessment of the sustainable rate of unemployment, resulted in high inflation but did not deliver the expected payoff in terms of higher output and employment. Moreover, the Fed's periodic attempts to rein in surging inflation led to a pattern of "go-

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stop" policies, in which swings in policy from ease to tightness contributed to a highly volatile real economy as well as a highly variable inflation rate. Wage-price controls, invoked in the belief that monetary policy was ineffective against cost-push forces, also ultimately proved destabilizing. Monetary policymakers bemoaned the high rate of inflation in the 1970s but did not fully appreciate their own role in its creation. Ironically, their errors in estimating the natural rate and in ascribing inflation to nonmonetary forces were mutually reinforcing. On the one hand, because unemployment remained well above their over-optimistic estimates of the sustainable rate, they were inclined to attribute inflation to outside forces (such as the actions of firms and unions) rather than to an overheated economy (Romer and Romer, 2002; Nelson, 2004). On the other hand, the view of policymakers that exogenous forces largely drove inflation made it more difficult for them to recognize that their estimate of the sustainable rate of unemployment was too low. Several years passed before policymakers were finally persuaded by the evidence that sustained anti-inflationary monetary policies would actually work (Primiceri, 2003). As you know, these policies were implemented successfully after 1979, beginning under Fed Chairman Volcker. Better known than even the Taylor curve is John Taylor's famous Taylor rule, a simple equation that has proved remarkably useful as a rule-of-thumb description of monetary policy (Taylor, 1993). In its basic form, the Taylor rule relates the Federal Reserve's policy instrument, the overnight federal funds interest rate, to the deviations of inflation and output from the central bank's desired levels for those variables. Estimates of the Taylor rule for the late 1960s and the 1970s reflect the output optimism and inflation pessimism of the period, in that researchers tend to find a weaker response of the policy rate to inflation and (in some studies) a relatively stronger response to the output gap than in more recent periods.11 As I will shortly discuss further, an insufficiently strong response to inflation let inflation and inflation expectations get out of control and thus added volatility to the economy. At the same time, strong responses to what we understand in retrospect to have been over- optimistic estimates of the output gap created additional instability. As output optimism and inflation pessimism both waned under the force of the data, policy responses became more appropriate and the economy more stable. In this sense, improvements in policymakers' understanding of the economy and the role of monetary policy allowed the economy to move closer to the Taylor curve (or, in terms of Figure 1, to move from point A to point B). Improved Monetary Policy or a Shifting Taylor Curve? Improvements in monetary policy that moved the economy closer to the efficient frontier described by the Taylor curve can account for part of the Great Moderation. However, several empirical studies have questioned the quantitative importance of this effect and emphasized instead shifts in the Taylor curve, brought about by structural change or good luck. For example, in a paper presented at the Federal Reserve Bank of Kansas City's annual Jackson Hole conference, James Stock and Mark Watson (2003) use several alternative macroeconomic models to simulate how the economy would have performed after 1984 if monetary policy had followed its pre-1979 pattern. Although inflation performance after 1984 would clearly have been worse if pre-1979 monetary policies had been used, Stock and Watson find that output volatility would have been little different. They conclude that improved monetary policy does not account for much of the reduction in output volatility since the mid-1980s. Instead, noting that the variance of the economic shocks implied by

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their models for the 1970s was much higher than the variance of shocks in the more recent period, they embrace the good-luck explanation of the Great Moderation. Interesting research by Timothy Cogley and Thomas Sargent (2002) and by Shaghil Ahmed, Andrew Levin, and Beth Anne Wilson (2002) likewise find a substantial reduction in the size and frequency of shocks in the more recent period, supporting the good-luck hypothesis. Both the structural change and good-luck explanations of the Great Moderation are intriguing and (to reiterate) both are no doubt part of the story. However, an unsatisfying aspect of both explanations is the difficulty of identifying changes in the economic environment large enough and persistent enough to explain the Great Moderation, both in the United States and abroad. In particular, it is not obvious that economic shocks have become significantly smaller or more infrequent, as required by the good-luck hypothesis. Tensions in the Middle East, often blamed for the oil price shocks of the 1970s, have hardly declined in recent years, and important developments in technology and productivity have continued to buffet the economy (albeit in a more positive direction than in the 1970s). Nor has the international economic environment become obviously more placid, as a series of financial crises struck various regions of the world during the 1990s and the powerful forces of globalization have proceeded apace. In contrast, following the adverse experience of the 1970s, changes in the practice of monetary policy occurred around the world in similar ways and during approximately the same period. Certainly, stability-enhancing changes in the economic environment have occurred in the past two decades. However, an intriguing possibility is that some of these changes, rather than being truly exogenous, may have been induced by improved monetary policies. That is, better monetary policies may have resulted in what appear to be (but only appear to be) favorable shifts in the economy's Taylor curve. Here are some examples of what I have in mind. First, monetary policies that brought down and stabilized inflation may have led to stabilizing changes in the structure of the economy as well, in line with the prediction of the famous Lucas (1976) critique that economic structure depends on the policy regime. High and unstable inflation increases the variability of relative prices and real interest rates, for example, distorting decisions regarding consumption, capital investment, and inventory investment, among others. Likewise, the high level, variability, and unpredictability of inflation profoundly affected decisions regarding financial investments and money holdings. Theories of "rational inattention" (Sims, 2003), according to which people vary the frequency with which they re-examine economic decisions according to the underlying economic environment, imply that the dynamic behavior of the economy would change-- probably in the direction of greater stability and persistence--in a more stable pricing environment, in which people reconsider their economic decisions less frequently. Second, changes in monetary policy could conceivably affect the size and frequency of shocks hitting the economy, at least as an econometrician would measure those shocks. This assertion seems odd at first, as we are used to thinking of shocks as exogenous events, arising from "outside the model," so to speak. However, econometricians typically do not measure shocks directly but instead infer them from movements in macroeconomic variables that they cannot otherwise explain. Shocks in this sense may certainly reflect the monetary regime. For example, consider the cost-push shocks that played such an important role in 1970s' thinking about inflation. Seemingly unexplained or autonomous movements in

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wages and prices during this period, which analysts would have interpreted as shocks to wage and price equations, may in fact have been the result of earlier monetary policy actions, or (more subtly) of monetary policy actions expected by wage- and price-setters to take place in the future. In an influential paper, Robert Barsky and Lutz Kilian (2001) analyze the oil price shocks of the 1970s in this spirit. Barsky and Kilian provide evidence that the extraordinary increases in nominal oil prices during the 1970s were made feasible primarily by earlier expansionary monetary policies rather than by truly exogenous political or economic events. Third, monetary policy can also affect the distribution of measured shocks by changing the sensitivity of pricing and other economic decisions to exogenous outside events. For example, significant movements in the price of oil and other commodities continued to occur after 1984. However, in a low-inflation environment, with stable inflation expectations and a general perception that firms do not have pricing power, commodity price shocks are not passed into final goods prices to nearly the same degree as in a looser monetary environment. As a result, a change in commodity prices of a given size shows up as a smaller shock to output and consumer prices today than it would have in the earlier period. Likewise, there is evidence that fluctuations in exchange rates have smaller effects on domestic prices and economic activity when inflation is less volatile and inflation expectations are stabilized (Gagnon and Ihrig, 2002; Devereux, Engel, and Storgaard, 2003). Fourth, changes in inflation expectations, which are ultimately the product of the monetary policy regime, can also be confused with truly exogenous shocks in conventional econometric analyses. Marvin Goodfriend (1993) has suggested, for example, that insufficiently anchored inflation expectations have led to periodic "inflation scares," in which inflation expectations have risen in an apparently autonomous manner. Increases in inflation expectations have the flavor of adverse aggregate supply shocks in that they tend to increase the volatility of both inflation and output, in a combination that depends on how strongly the monetary policymakers act to offset these changes in expectations. Theoretical and empirical support for the idea that inflation expectations may become an independent source of instability has grown in recent years.12 As I mentioned earlier, a number of researchers have found that the reaction of monetary policymakers to inflation has strengthened, in that the estimated coefficient on inflation in the Taylor rule has risen from something less than 1 before 1979 to a value significantly greater than 1 in the more recent period. If the policy interest rate responds to increases in inflation by less than one- for-one (so that the real policy rate does not rise in the face of higher inflation), economic theory tells us that inflation expectations and the economy in general can become unstable. The problem arises from the fact that, if policymakers do not react sufficiently aggressively to increases in inflation, spontaneously arising expectations of increased inflation can ultimately be self-confirming and even self-reinforcing. Incidentally, the stability requirement that the policy rate respond to inflation by more than one-for-one is called the Taylor principle (Taylor, 1993, 1999)--the third concept named after John Taylor that has played a role in this talk. The finding that monetary policymakers violated the Taylor principle during the 1970s but satisfied the principle in the past two decades would be consistent with a reduced incidence of destabilizing expectational shocks.13 Support for the view that inflation expectations can be an independent source of economic volatility has also emerged from the extensive recent literature on learning and

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macroeconomics (Evans and Honkopohja, 2001). For example, Athanasios Orphanides and John C. Williams (2003a, 2003b) have studied models in which the public must learn the central bank's underlying preferences regarding inflation by observing the actual inflation process.14 With learning, inflation expectations take on a more adaptive character; in particular, high and unstable inflation will beget similar characteristics in the pattern of inflation expectations. As Orphanides and Williams show, when inflation expectations are poorly anchored, so that the public is highly uncertain about the long-run rate of inflation that the central bank hopes to achieve, they can become an additional source of volatility in the economy. An analysis that did not properly control for the expectational effects of changes in monetary policy might incorrectly conclude that the Taylor curve had shifted in an adverse direction. Figure 1 Monetary Policy and the Variability of Output and Inflation

Conclusion The Great Moderation, the substantial decline in macroeconomic volatility over the past twenty years, is a striking economic development. Whether the dominant cause of the Great Moderation is structural change, improved monetary policy, or simply good luck is an important question about which no consensus has yet formed. I have argued today that improved monetary policy has likely made an important contribution not only to the reduced volatility of inflation (which is not particularly controversial) but to the reduced volatility of output as well. Moreover, because a change in the monetary policy regime has pervasive effects, I have suggested that some of the effects of improved monetary policies may have been misidentified as exogenous changes in economic structure or in the distribution of

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economic shocks. This conclusion on my part makes me optimistic for the future, because I am confident that monetary policymakers will not forget the lessons of the 1970s. I have put my case for better monetary policy rather forcefully today, because I think it likely that the policy explanation for the Great Moderation deserves more credit than it has received in the literature. However, let me close by emphasizing that the debate remains very much open. Although I have focused on its strengths, the monetary policy hypothesis has potential deficiencies as well. For example, although I pointed out the difficulty that the structural change and good-luck explanations have in accounting for the rather sharp decline in volatility after 1984, one might also question whether the change in monetary policy regime was sufficiently sharp to have had the effects I have attributed to it.15 The consistency of the monetary policy explanation with the experience of the 1950s, a period of stable inflation during which output volatility declined but was high in absolute terms, deserves further investigation. Moreover, several of the channels by which monetary policy may have affected volatility that I have mentioned today remain largely theoretical possibilities and have not received much in the way of rigorous empirical testing. One of my goals today was to stimulate further research on this question. Clearly, the sources of the Great Moderation will continue to be an area for fruitful analysis and debate. REFERENCES Ahmed, Shaghil, Andrew Levin, and Beth Anne Wilson (2002). "Recent U.S. Macroeconomic Stability: Good Policies, Good Practices, or Good Luck?" Board of Governors of the Federal Reserve System, International Finance Discussion Paper 2002-730 (July). Albanesi, Stefania, V.V. Chari, and Lawrence Christiano (2003). "Expectation Traps and Monetary Policy," Federal Reserve Bank of Minneapolis, Research Department Staff Report 319 (August). Barsky, Robert, and Lutz Kilian (2001). "Do We Really Know That Oil Caused the Great Stagflation? A Monetary Alternative," in Ben Bernanke and Kenneth Rogoff, eds., NBER Macroeconomics Annual, Cambridge, Mass.: MIT Press for NBER, pp. 137-82. Bernanke, Ben (2003). "'Constrained Discretion' and Monetary Policy," before the Money Marketeers of New York University, New York, New York, February 3. Bernanke, Ben (2004). "Fedspeak," at the meetings of the American Economic Association, San Diego, California, January 3. Blanchard, Olivier, and John Simon (2001). "The Long and Large Decline in U.S. Output Volatility," Brookings Papers on Economic Activity, 1, pp. 135-64. Bullard, James, and Stefano Eusepi (2003). "Did the Great Inflation Occur Despite Policymaker Commitment to a Taylor Rule?" Federal Reserve Bank of Atlanta, working paper 2003-20 (October). Chatterjee, Satyajit (2002). "The Taylor Curve and the Unemployment-Inflation Tradeoff," Federal Reserve Bank of Philadelphia, Business Review, (Third Quarter), pp. 26-33. Clarida, Richard, Jordi Gali, and Mark Gertler (2000). "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," Quarterly Journal of Economics, 115, pp. 147-80.

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Cogley, Timothy, and Thomas Sargent (2002). "Drifts and Volatilities: Monetary Policies and Outcomes in the Post-WWII U.S.," working paper, Arizona State University and New York University (August). DeLong, J. Bradford (1997). "America's Peacetime Inflation: The 1970s," in Christina Romer and David Romer, eds., Reducing Inflation: Motivation and Strategy, Chicago: University of Chicago Press for NBER. Devereux, Michael, Charles Engel, and Peter Storgaard (2003). "Endogenous Exchange- Rate Pass-through when Nominal Prices Are Set in Advance," National Bureau of Economic Research working paper 9543 (March). Evans, George and Seppo Honkopohja (2001). Learning and Expectations in Macroeconomics, Princeton, N.J.: Princeton University Press. Friedman, Milton (1968). "The Role of Monetary Policy," American Economic Review, 58 (March), pp. 1-17. Gagnon, Joseph, and Jane Ihrig (2002). "Monetary Policy and Exchange-Rate Passthrough," Board of Governors of the Federal Reserve System, International Finance Discussion Paper 2001-704 (latest version March 2002). Goodfriend, Marvin (1993). "Interest Rate Policy and the Inflation Scare Problem, 1979- 1992," Federal Reserve Bank of Richmond, Economic Quarterly, 1 (Winter), pp. 1-23 (on the Federal Reserve Bank of Richmond web site). Judd, John, and Glenn Rudebusch (1998). "Taylor's Rule and the Fed: 1970-1997," Federal Reserve Bank of San Francisco, Economic Review, 3, pp. 3-16. Kahn, James, Margaret McConnell, and Gabriel Perez-Quiros (2002). "On the Causes of the Increased Stability of the U.S. Economy, " Federal Reserve Bank of New York, Economic Policy Review, 8, pp. 183-202. Kim, Chang-Jin, and Charles Nelson (1999). "Has the U.S. Economy Become More Stable? A Bayesian Approach Based on a Markov-Switching Model of the Business Cycle," Review of Economics and Statistics, 81, pp. 608-16. Kim, Chang-Jin, Charles Nelson, and Jeremy Piger (2003). "The Less Volatile U.S. Economy: A Bayesian Investigation of Timing, Breadth, and Potential Explanations," Journal of Business and Economic Statistics, forthcoming. Lansing, Kevin (2002). "Learning about a Shift in Trend Output: Implications for Monetary Policy and Inflation," Federal Reserve Bank of San Francisco, working paper (July). Lucas, Robert, Jr. (1976). "Econometric Policy Evaluation: A Critique," Carnegie- Rochester Conference Series on Public Policy, 1, pp. 19-46. Mayer, Thomas (1998). Monetary Policy and the Great Inflation in the United States: The Federal Reserve and the Failure of Macroeconomic Policy, 1965-79, Cheltenham, United Kingdom: Edward Elgar. McCarthy, Jonathan, and Egon Zakrajsek (2003). "Inventory Dynamics and Business Cycles: What Has Changed?" Federal Reserve Bank of New York and Board of Governors of the Federal Reserve System, working paper (June).

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McConnell, Margaret, and Gabriel Perez-Quiros (2000). "Output Fluctuations in the United States: What Has Changed since the Early 1980s?" American Economic Review, 90, pp. 1464-76. Mehra, Yash (2002). "The Taylor Principle, Interest Rate Smoothing, and Fed Policy in the 1970s and 1980s," Federal Reserve Bank of Richmond, working paper 02-3 (December). Nelson, Edward (2004). "The Great Inflation of the Seventies: What Really Happened?" Federal Reserve Bank of St. Louis, working paper (January). Orphanides, Athanasios (2003). "The Quest for Prosperity Without Inflation, " Journal of Monetary Economics, 50 (April), pp. 633-63. Orphanides, Athanasios, and John C. Williams (2003a). "Imperfect Knowledge, Inflation Expectations, and Monetary Policy," forthcoming in Ben Bernanke and Michael Woodford, eds., Inflation Targeting, Chicago: University of Chicago Press for NBER. Orphanides, Athanasios, and John C. Williams (2003b). "Inflation Scares and Forecast- Based Monetary Policy," Board of Governors of the Federal Reserve System, Finance and Economics Discussion Series 2003-41 (August). Primiceri, Giorgio (2003). "Why Inflation Rose and Fell: Policymakers' Beliefs and U.S. Postwar Stabilization Policy," Princeton University, working paper (November). Romer, Christina, and David Romer (2002). "The Evolution of Economic Understanding and Postwar Stabilization Policy," Rethinking Stabilization Policy, Federal Reserve Bank of Kansas City, pp. 11-78. Sims, Christopher (2003). "Implications of Rational Inattention," Journal of Monetary Economics, 50 (April), pp. 665-90. Stock, James, and Mark Watson (2003). "Has the Business Cycle Changed? Evidence and Explanations," prepared for the Federal Reserve Bank of Kansas City symposium, "Monetary Policy and Uncertainty," Jackson Hole, Wyoming, August 28-30. Taylor, John B. (1993). "Discretion versus Policy Rules in Practice," Carnegie-Rochester Conference Series on Public Policy, 39, pp. 195-214. Taylor, John B. (1998). "Monetary Policy Guidelines for Employment and Inflation Stability," in Benjamin Friedman and Robert Solow, eds., Inflation, Unemployment, and Monetary Policy, Cambridge, Massachusetts: MIT Press. Taylor, John B. (1999). "A Historical Analysis of Monetary Policy Rules," in John B. Taylor, ed., Monetary Policy Rules, Chicago: University of Chicago Press for NBER, pp. 319-40. Warnock, M.V. Cacdac, and Francis Warnock (2000). "The Declining Volatility of U.S. Employment: Was Arthur Burns Right?" Board of Governors of the Federal Reserve System, International Finance Discussion Paper no. 677 (August). Willis, Jonathan (2003). "Implications of Structural Changes in the U.S. Economy for Pricing Behavior and Inflation Dynamics," Federal Reserve Bank of Kansas City, Economic Review (First Quarter), pp. 5-27.

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Footnotes 1. Kim and Nelson (1999) and McConnell and Perez-Quiros (2000) were among the first to note the reduction in the volatility of output. Kim, Nelson, and Piger (2003) show that the reduction in the volatility of output is quite broad based, affecting many sectors and aspects of the economy. Warnock and Warnock (2000) find a parallel decline in the volatility of employment, especially in goods-producing sectors. Return to text 2. The United States has experienced only two relatively mild recessions since 1984, compared with four recessions--two of them quite deep--in the fifteen years before 1984. Indeed, according to the National Bureau of Economic Research's monthly business cycle chronology, which covers the period since the Civil War, the 120-month expansion of the 1990s was the longest recession-free period the United States has enjoyed, and the 92-month expansion of the 1980s was the third longest such period. Return to text 3. McConnell and Perez-Quiros (2000) and Kahn, McConnell, and Perez-Quiros (2002) make this argument. McCarthy and Zakrajsek (2003) provide an overview and evaluation of this literature; they conclude that better inventory management has reinforced the trend toward lower volatility but is not the ultimate cause. Willis (2003) discusses structural changes that may have contributed to reduced variability of inflation. Return to text 4. Using more formal econometric methods, Kim, Nelson, and Piger (2003) also found that structural breaks in the volatility and persistence of inflation occurred about the same times as the changes in output volatility. Return to text 5. Stock and Watson (2003) provide a recent overview of the debate. Return to text 6. Strictly speaking, according to standard models, policymakers face a tradeoff between volatility of inflation and volatility of the output gap, the difference between potential output and actual output. If the economy's potential output grows relatively smoothly, variability in the output gap will be closely related to variability in actual output. Return to text 7. Chatterjee (2002) provides an overview of the Taylor curve and its implications. For an exposition by Taylor himself, see Taylor (1998). Return to text 8. The policy tradeoff between the variability of inflation and the variability of output implied by the Taylor curve is reminiscent of an older proposition, that policymakers could achieve a permanently higher level of output (and thus a permanently lower level of unemployment) by accepting a permanently higher level of inflation. However, for both theoretical and empirical reasons, this older idea of a long-run tradeoff between the levels of inflation and output has been largely discredited, and the Taylor curve tradeoff is in some sense its natural successor. Return to text 9. Friedman (1968) provided a major theoretical critique of the idea of a permanent tradeoff. Scholars disagree about when and to what degree U.S. monetary policymakers absorbed the lessons of Friedman's article. Return to text 10. Orphanides (2003) has emphasized the importance of poor estimates of potential output and the closely associated concept of the natural rate of unemployment for explaining the inflationary policies of the 1970s. He notes the difficulty that policymakers of the time faced in distinguishing the productivity slowdown of the period from a cyclical decline in output. Analytical support for the view that confusion between the cyclical and secular aspects of 295

the 1970s' slowdown had inflationary consequences is provided by Lansing (2002) and Bullard and Eusepi (2003) Return to text 11. See, for example, Judd and Rudebusch (1998), Taylor (1999), Clarida, Gali, and Gertler (2000), Cogley and Sargent (2002), and Mehra (2002). Orphanides (2003) argues that, if one takes account of policymakers' mis-estimates of the output gap in the 1970s, the same Taylor rule that describes policy after 1979 applies to the 1970s as well. The debate is an important one, but it may bear more on what policymakers actually thought they were doing--and thus on the history of ideas--than on the question of whether monetary policy was in fact inefficient or even destabilizing during the period. There seems to be little doubt that it was. Return to text 12. See Bernanke (2003, 2004) for more extensive discussions. Return to text 13. In a similar spirit, Stefania Albanesi, V.V. Chari, and Lawrence Christiano (2003) have shown that when the central bank's commitment to fighting inflation is perceived to be weak, as may have been the case during the 1970s, self-confirming increases in expected inflation are possible and will tend to destabilize the economy. Return to text 14. See Bernanke (2004) for additional discussion. Return to text 15. Stock and Watson (2003) make this point. Supporting their argument, in Bernanke (2004) I present evidence that even today inflation expectations may not be anchored as well as we would like. Return to text http://www.federalreserve.gov/boarddocs/speeches/2004/20040220/

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Remarks by Governor Ben S. Bernanke At the Sandridge Lecture, Virginia Association of Economists, Richmond, Virginia

Governor Bernanke presented similar remarks with updated data at the Homer Jones Lecture, St. Louis, Missouri, on April 14, 2005.

March 10, 2005 The Global Saving Glut and the U.S. Current Account Deficit On most dimensions the U.S. economy appears to be performing well. Output growth has returned to healthy levels, the labor market is firming, and inflation appears to be well controlled. However, one aspect of U.S. economic performance still evokes concern among economists and policymakers: the nation's large and growing current account deficit. In the first three quarters of 2004, the U.S. external deficit stood at $635 billion at an annual rate, or about 5-1/2 percent of the U.S. gross domestic product (GDP). Corresponding to that deficit, U.S. citizens, businesses, and governments on net had to raise $635 billion on international capital markets.1 The current account deficit has been on a steep upward trajectory in recent years, rising from a relatively modest $120 billion (1.5 percent of GDP) in 1996 to $414 billion (4.2 percent of GDP) in 2000 on its way to its current level. Most forecasters expect the nation's current account imbalance to decline slowly at best, implying a continued need for foreign credit and a concomitant decline in the U.S. net foreign asset position. Why is the United States, with the world's largest economy, borrowing heavily on international capital markets--rather than lending, as would seem more natural? What implications do the U.S. current account deficit and our consequent reliance on foreign credit have for economic performance in the United States and in our trading partners? What policies, if any, should be used to address this situation? In my remarks today I will offer some tentative answers to these questions. My answers will be somewhat unconventional in that I will take issue with the common view that the recent deterioration in the U.S. current account primarily reflects economic policies and other economic developments within the United States itself. Although domestic developments have certainly played a role, I will argue that a satisfying explanation of the recent upward climb of the U.S. current account deficit requires a global perspective that more fully takes into account events outside the United States. To be more specific, I will argue that over the past decade a combination of diverse forces has created a significant increase in the global supply of saving--a global saving glut--which helps to explain both the increase in the U.S. current account deficit and

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the relatively low level of long-term real interest rates in the world today. The prospect of dramatic increases in the ratio of retirees to workers in a number of major industrial economies is one important reason for the high level of global saving. However, as I will discuss, a particularly interesting aspect of the global saving glut has been a remarkable reversal in the flows of credit to developing and emerging-market economies, a shift that has transformed those economies from borrowers on international capital markets to large net lenders. To be clear, in locating the principal causes of the U.S. current account deficit outside the country's borders, I am not making a value judgment about the behavior of either U.S. or foreign residents or their governments. Rather, I believe that understanding the influence of global factors on the U.S. current account deficit is essential for understanding the effects of the deficit and for devising policies to address it. Of course, as always, the views I express today are not necessarily shared by my colleagues at the Federal Reserve.2 The U.S. Current Account Deficit: Two Perspectives We will find it helpful to consider, as background for the analysis of the U.S. current account deficit, two alternative ways of thinking about the phenomenon--one that relates the deficit to the patterns of U.S. trade and a second that focuses on saving, investment, and international financial flows. Although these two ways of viewing the current account derive from accounting identities and thus are ultimately two sides of the same coin, each provides a useful lens for examining the issue. The first perspective on the current account focuses on patterns of international trade. You are probably aware that the United States has been experiencing a substantial trade imbalance in recent years, with U.S. imports of goods and services from abroad outstripping U.S. exports to other countries by a wide margin. According to preliminary data, in 2004 the United States imported $1.76 trillion worth of goods and services while exporting goods and services valued at only $1.15 trillion. Reflecting this imbalance in trade, current payments from U.S. residents to foreigners (consisting primarily of our spending on imports, but also including certain other types of payments, such as remittances, interest, and dividends) greatly exceed the analogous payments that U.S. residents receive from abroad. By definition, this excess of U.S. payments to foreigners over payments received in a given period equals the U.S. current account deficit, which, as I have already noted, was on track to equal $635 billion in 2004--close to the $618 billion by which the value of U.S. imports exceeded that of exports. When U.S. receipts from its sales of exports and other current payments are insufficient to cover the cost of U.S. imports and other payments to foreigners, U.S. households, firms, and governments on net must borrow the difference on international capital markets.3 Thus, essentially by definition, in each period U.S. net foreign borrowing equals the U.S. current account deficit, which in turn is closely linked to the imbalance in U.S. international trade. That the nation's imports currently far exceed its exports is both widely understood and of concern to many Americans, particularly those whose livelihoods depend on the viability of exporting and import-competing industries. The extensive attention paid to the trade imbalance in the media and elsewhere has tempted some observers to ascribe the growing current account deficit to factors such as changes in the quality or composition of U.S. and foreign-made products, changes in trade policy, or unfair foreign competition. However, I

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believe--and I suspect that most economists would agree--that specific trade-related factors cannot explain either the magnitude of the U.S. current account imbalance or its recent sharp rise. Rather, the U.S. trade balance is the tail of the dog; for the most part, it has been passively determined by foreign and domestic incomes, asset prices, interest rates, and exchange rates, which are themselves the products of more fundamental driving forces. Instead, an alternative perspective on the current account appears likely to be more useful for explaining recent developments. This second perspective focuses on international financial flows and the basic fact that, within each country, saving and investment need not be equal in each period. In the United States, as in all countries, economic growth requires investment in new capital goods and the upgrading and replacement of older capital. Examples of capital investment include the construction of factories and office buildings and firms' acquisition of new equipment, ranging from drill presses to computers to airplanes. Residential construction-- the building of new homes and apartment buildings--is also counted as part of capital investment.4 All investment in new capital goods must be financed in some manner. In a closed economy without trade or international capital flows, the funding for investment would be provided entirely by the country's national saving. By definition, national saving is the sum of saving done by households (for example, through contributions to employer-sponsored 401k accounts) and saving done by businesses (in the form of retained earnings) less any budget deficit run by the government (which is a use rather than a source of saving)5. As I say, in a closed economy investment would equal national saving in each period; but, in fact, virtually all economies today are open economies, and well-developed international capital markets allow savers to lend to those who wish to make capital investments in any country, not just their own. Because saving can cross international borders, a country's domestic investment in new capital and its domestic saving need not be equal in each period. If a country's saving exceeds its investment during a particular year, the difference represents excess saving that can be lent on international capital markets. By the same token, if a country's saving is less than the amount required to finance domestic investment, the country can close the gap by borrowing from abroad. In the United States, national saving is currently quite low and falls considerably short of U.S. capital investment. Of necessity, this shortfall is made up by net foreign borrowing--essentially, by making use of foreigners' saving to finance part of domestic investment. We saw earlier that the current account deficit equals the net amount that the United States borrows abroad in each period, and I have just shown that U.S. net foreign borrowing equals the excess of U.S. capital investment over U.S. national saving. It follows that the country's current account deficit equals the excess of its investment over its saving. To summarize, I have described two equivalent ways of interpreting the current account deficit, one in terms of trade flows and related payments and one in terms of investment and national saving. In general, the perspective one takes depends on the particular analysis at hand. As I have already suggested, most economists who have offered explanations of the high and rising level of the U.S. current account deficit and the country's foreign borrowing have emphasized investment-saving behavior rather than trade-related factors (and I will do the same today). Along these lines, one commonly hears that the U.S. current account deficit is 299

the product of a precipitous decline in the U.S. national saving rate, which in recent years has fallen to a level that is far from adequate to fund domestic investment. For example, in 1985 U.S. gross national saving was 18 percent of GDP, and in 1995 it was 16 percent of GDP; in 2004, by contrast, U.S. national saving was less than 14 percent of GDP. Those who emphasize the role of low U.S. saving often go on to conclude that, for the most part, the U.S. current account deficit is "made in the U.S.A." and is independent (to a first approximation) of developments in other parts of the globe. That inadequate U.S. national saving is the source of the current account deficit must be true at some level; indeed, the statement is almost a tautology. However, linking current-account developments to the decline in saving begs the question of why U.S. saving has declined. In particular, although the decline in U.S. saving may reflect changes in household behavior or economic policy in the United States, it may also be in some part a reaction to events external to the United States--a hypothesis that I will propose and defend momentarily. One popular argument for the "made in the U.S.A." explanation of declining national saving and the rising current account deficit focuses on the burgeoning U.S. federal budget deficit, which in 2004 drained more than $400 billion from the national saving pool. I will discuss the link between the budget deficit and the current account deficit in more detail later. Here I simply note that the so-called twin-deficits hypothesis, that government budget deficits cause current account deficits, does not account for the fact that the U.S. external deficit expanded by about $300 billion between 1996 and 2000, a period during which the federal budget was in surplus and projected to remain so. Nor, for that matter, does the twin-deficits hypothesis shed any light on why a number of major countries, including Germany and Japan, continue to run large current account surpluses despite government budget deficits that are similar in size (as a share of GDP) to that of the United States. It seems unlikely, therefore, that changes in the U.S. government budget position can entirely explain the behavior of the U.S. current account over the past decade. The Changing Pattern of International Capital Flows and the Global Saving Glut What then accounts for the rapid increase in the U.S. current account deficit? My own preferred explanation focuses on what I see as the emergence of a global saving glut in the past eight to ten years. This saving glut is the result of a number of developments. As I will discuss in more detail later, one well-understood source of the saving glut is the strong saving motive of rich countries with aging populations, which must make provision for an impending sharp increase in the number of retirees relative to the number of workers. With slowly growing or declining workforces, as well as high capital-labor ratios, many advanced economies outside the United States also face an apparent dearth of domestic investment opportunities. As a consequence of high desired saving and the low prospective returns to domestic investment, the mature industrial economies as a group seek to run current account surpluses and thus to lend abroad.6 Although strong saving motives on the part of many industrial economies contribute to the global saving glut, the saving behavior of these countries does not explain much of the increase in desired global saving in the past decade. Indeed, in a number of these countries-- Japan is one example--household saving has declined recently. As we will see, a possibly more important source of the rise in the global supply of saving is the recent metamorphosis of the developing world from a net user to a net supplier of funds to international capital markets. 300

Table 1 provides a basis for a discussion of recent changes in global saving and financial flows by showing current account balances for different countries and regions, in billions of U.S. dollars, for the years 1996 (just before the U.S. current account deficit began to balloon) and 2003 (the most recent year for which complete data are available). I should note that these current account balances of necessity reflect realized patterns of investment and saving rather than changes in the rates of investment and saving desired from an ex ante perspective. Nevertheless, changes in the pattern of current account balances together with knowledge of changes in real interest rates should provide useful clues about shifts in the global supply of and demand for saving. The table confirms the sharp increase in the U.S. current account deficit, about $410 billion between 1996 and 2003. (Data from the first three quarters of 2004 imply that the current account deficit rose last year by an additional $140 billion at an annual rate.) In principle, the current account positions of the world's nations should sum to zero (although, in practice, data collection problems lead to a large statistical discrepancy, shown in the last row of table 1). The $410 billion increase in the U.S. current account deficit between 1996 and 2003 must therefore have been matched by a shift toward surplus of equal magnitude in other countries. Which countries experienced this change? As we can infer from table 1, most of the swing toward surplus did not occur in the other industrial countries as a whole (although some individual industrial countries did experience large moves toward surplus, as we will see). The collective current account of the industrial countries declined more than $388 billion between 1996 and 2003, implying that, of the $410 billion increase in the U.S. current account deficit, only about $22 billion was offset by increased surpluses in other industrial countries. As table 1 shows, the bulk of the increase in the U.S. current account deficit was balanced by changes in the current account positions of developing countries, which moved from a collective deficit of $88 billion to a surplus of $205 billion--a net change of $293 billion-- between 1996 and 2003.7 The available data suggest that the current accounts of developing and emerging-market economies swung a further $60 billion into surplus in 2004. This remarkable change in the current account balances of developing countries raises at least three questions. First, what events or factors induced this change? Second, what causal relationship (if any) exists between this change and current-account developments in the United States and in other industrial countries? Third, to the extent that the movement toward surplus in developing-country current accounts has had a differential impact on the United States relative to other industrial countries, what accounts for the difference? In my view, a key reason for the change in the current account positions of developing countries is the series of financial crises those countries experienced in the past decade or so. In the mid-1990s, most developing countries were net importers of capital; as table 1 shows, in 1996 emerging Asia and Latin America borrowed about $80 billion on net on world capital markets. These capital inflows were not always productively used. In some cases, for example, developing-country governments borrowed to avoid necessary fiscal consolidation; in other cases, opaque and poorly governed banking systems failed to allocate those funds to the projects promising the highest returns. Loss of lender confidence, together with other factors such as overvalued fixed exchange rates and debt that was both short-term and denominated in foreign currencies, ultimately culminated in painful financial crises, including those in Mexico in 1994, in a number of East Asian countries in 1997-98, in

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Russia in 1998, in Brazil in 1999, and in Argentina in 2002. The effects of these crises included rapid capital outflows, currency depreciation, sharp declines in domestic asset prices, weakened banking systems, and recession. In response to these crises, emerging-market nations either chose or were forced into new strategies for managing international capital flows. In general, these strategies involved shifting from being net importers of financial capital to being net exporters, in some cases very large net exporters. For example, in response to instability of capital flows and the exchange rate, some East Asian countries, such as Korea and Thailand, began to build up large quantities of foreign-exchange reserves and continued to do so even after the constraints imposed by the halt to capital inflows from global financial markets were relaxed. Increases in foreign-exchange reserves necessarily involve a shift toward surplus in the country's current account, increases in gross capital inflows, reductions in gross private capital outflows, or some combination of these elements. As table 1 shows, current account surpluses have been an important source of reserve accumulation in East Asia. Countries in the region that had escaped the worst effects of the crisis but remained concerned about future crises, notably China, also built up reserves. These "war chests" of foreign reserves have been used as a buffer against potential capital outflows. Additionally, reserves were accumulated in the context of foreign exchange interventions intended to promote export-led growth by preventing exchange-rate appreciation. Countries typically pursue export-led growth because domestic demand is thought to be insufficient to employ fully domestic resources. Following the 1997-98 financial crisis, many of the East Asian countries seeking to stimulate their exports had high domestic rates of saving and, relative to historical norms, depressed levels of domestic capital investment--also consistent, of course, with strengthened current accounts. In practice, these countries increased reserves through the expedient of issuing debt to their citizens, thereby mobilizing domestic saving, and then using the proceeds to buy U.S. Treasury securities and other assets. Effectively, governments have acted as financial intermediaries, channeling domestic saving away from local uses and into international capital markets. A related strategy has focused on reducing the burden of external debt by attempting to pay down those obligations, with the funds coming from a combination of reduced fiscal deficits and increased domestic debt issuance. Of necessity, this strategy also pushed emerging-market economies toward current account surpluses. Again, the shifts in current accounts in East Asia and Latin America are evident in the data for the regions and for individual countries shown in table 1. Another factor that has contributed to the swing toward current-account surplus among the non-industrialized nations in the past few years is the sharp rise in oil prices. The current account surpluses of oil exporters, notably in the Middle East but also in countries such as Russia, Nigeria, and Venezuela, have risen as oil revenues have surged. For example, as table 1 shows, the collective current account surplus of the Middle East and Africa rose more than $40 billion between 1996 and 2003; it continued to swell in 2004 as oil prices increased yet further. In short, events since the mid-1990s have led to a large change in the collective current account position of the developing world, implying that many developing and emerging-market countries are now large net lenders rather than net borrowers on international financial markets. Of course, developing countries as a group can increase their current account surpluses only 302

if the industrial countries reduce their current accounts accordingly. How did this occur? Little evidence supports the view that the motivation to save has declined substantially in the industrial countries in recent years; indeed, as I have noted already, demographic factors should lead the industrial countries to try to save more, not less. Instead, the requisite shift in the collective external position of the industrial countries was facilitated by adjustments in asset prices and exchange rates, although the pattern of asset-price changes was somewhat different before and after 2000. From about 1996 to early 2000, equity prices played a key equilibrating role in international financial markets. The development and adoption of new technologies and rising productivity in the United States--together with the country's long-standing advantages such as low political risk, strong property rights, and a good regulatory environment--made the U.S. economy exceptionally attractive to international investors during that period. Consequently, capital flowed rapidly into the United States, helping to fuel large appreciations in stock prices and in the value of the dollar. Stock indexes rose in other industrial countries as well, although stock-market capitalization per capita is significantly lower in those countries than in the United States. The current account positions of the industrial countries adjusted endogenously to these changes in financial market conditions. I will focus here on the case of the United States, which bore the bulk of the adjustment. From the trade perspective, higher stock-market wealth increased the willingness of U.S. consumers to spend on goods and services, including large quantities of imports, while the strong dollar made U.S. imports cheap (in terms of dollars) and exports expensive (in terms of foreign currencies), creating a rising trade imbalance. From the saving-investment perspective, the U.S. current account deficit rose as capital investment increased (spurred by perceived profit opportunities) at the same time that the rapid increase in household wealth and expectations of future income gains reduced U.S. residents' perceived need to save. Thus the rapid increase in the U.S. current account deficit between 1996 and 2000 was fueled to a significant extent both by increased global saving and the greater interest on the part of foreigners in investing in the United States. After the stock-market decline that began in March 2000, new capital investment and thus the demand for financing waned around the world. Yet desired global saving remained strong. The textbook analysis suggests that, with desired saving outstripping desired investment, the real rate of interest should fall to equilibrate the market for global saving. Indeed, real interest rates have been relatively low in recent years, not only in the United States but also abroad. From a narrow U.S. perspective, these low long-term rates are puzzling; from a global perspective, they may be less so.8 The weakening of new capital investment after the drop in equity prices did not much change the net effect of the global saving glut on the U.S. current account. The transmission mechanism changed, however, as low real interest rates rather than high stock prices became a principal cause of lower U.S. saving. In particular, during the past few years, the key asset-price effects of the global saving glut appear to have occurred in the market for residential investment, as low mortgage rates have supported record levels of home construction and strong gains in housing prices. Indeed, increases in home values, together with a stock-market recovery that began in 2003, have recently returned the wealth-to- income ratio of U.S. households to 5.4, not far from its peak value of 6.2 in 1999 and above

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its long-run (1960-2003) average of 4.8. The expansion of U.S. housing wealth, much of it easily accessible to households through cash-out refinancing and home equity lines of credit, has kept the U.S. national saving rate low--and indeed, together with the significant worsening of the federal budget outlook, helped to drive it lower. As U.S. business investment has recently begun a cyclical recovery while residential investment has remained strong, the domestic saving shortfall has continued to widen, implying a rise in the current account deficit and increasing dependence of the United States on capital inflows.9 According to the story I have sketched thus far, events outside U.S. borders--such as the financial crises that induced emerging-market countries to switch from being international borrowers to international lenders--have played an important role in the evolution of the U.S. current account deficit, with transmission occurring primarily through endogenous changes in equity values, house prices, real interest rates, and the exchange value of the dollar. One might ask why the current-account effects of the increase in desired global saving were felt disproportionately in the United States relative to other industrial countries. The attractiveness of the United States as an investment destination during the technology boom of the 1990s and the depth and sophistication of the country's financial markets (which, among other things, have allowed households easy access to housing wealth) have certainly been important. Another factor is the special international status of the U.S. dollar. Because the dollar is the leading international reserve currency, and because some emerging-market countries use the dollar as a reference point when managing the values of their own currencies, the saving flowing out of the developing world has been directed relatively more into dollar-denominated assets, such as U.S. Treasury securities. The effects of the saving outflow may thus have been felt disproportionately on U.S. interest rates and the dollar. For example, the dollar probably strengthened more in the latter 1990s than it would have if it had not been the principal reserve currency, enhancing the effect on the U.S. current account. Most interesting, however, is that the experience of the United States in recent years is not so nearly unique among industrial countries as one might think initially. As shown in table 1, a number of key industrial countries other than the United States have seen their current accounts move substantially toward deficit since 1996, including France, Italy, Spain, Australia, and the United Kingdom. The principal exceptions to this trend among the major industrial countries are Germany and Japan, both of which saw substantial increases in their current account balances between 1996 and 2003 (and significant further increases in 2004). A key difference between the two groups of countries is that the countries whose current accounts have moved toward deficit have generally experienced substantial housing appreciation and increases in household wealth, while Germany and Japan--whose economies have been growing slowly despite very low interest rates--have not. For example, wealth-to-income ratios have risen since 1996 by 14 percent in France, 12 percent in Italy, and 27 percent in the United Kingdom; each of these countries has seen their current account move toward deficit, as already noted. By contrast, wealth-to-income ratios in Germany and Japan have remained flat.10 The evident link between rising household wealth and a tendency for the current account to shift toward deficit is consistent with the mechanism that I have described today. Economic and Policy Implications I have presented today a somewhat unconventional explanation of the high and rising U.S.

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current account deficit. That explanation holds that one of the factors driving recent developments in the U.S. current account has been the very substantial shift in the current accounts of developing and emerging-market nations, a shift that has transformed these countries from net borrowers on international capital markets to large net lenders. This shift by developing nations, together with the high saving propensities of Germany, Japan, and some other major industrial nations, has resulted in a global saving glut. This increased supply of saving boosted U.S. equity values during the period of the stock market boom and helped to increase U.S. home values during the more recent period, as a consequence lowering U.S. national saving and contributing to the nation's rising current account deficit. From a global perspective, are these developments economically beneficial or harmful? Certainly they have had some benefits. Most obviously, the developing and emerging- market countries that brought their current accounts into surplus did so to reduce their foreign debts, stabilize their currencies, and reduce the risk of financial crisis. Most countries have been largely successful in meeting each of these objectives. Thus, the shift of these economies from borrower to lender status has provided at least a short-term palliative for some of the problems they faced in the 1990s. In the longer term, however, the current pattern of international capital flows--should it persist--could prove counterproductive. Most important, for the developing world to be lending large sums on net to the mature industrial economies is quite undesirable as a long- run proposition. Relative to their counterparts in the developing world, workers in industrial countries have large quantities of high-quality capital with which to work. Moreover, as I have already noted, the populations of most of these countries are both growing slowly and aging rapidly, implying that ratios of retirees to workers will rise sharply in coming decades. For example, in the United States, for every 100 people between the ages of 20 and 64, there are currently about 21 people aged 65 or older. According to United Nations projections, by 2030 the population of the United States will include about 34 people aged 65 or over for each 100 people in the 20-64 age range; for the Euro area and Japan, the analogous numbers in 2030 will be 46 and 57, respectively. Over the remainder of the century, the populations of other major industrial countries will age much more quickly than that of the United States. In 2050, for example, the number of retirees for each 100 working-age people in the United States should be about the same as in 2030, about 34, but the number of retirees per 100 working-age people is projected to increase to about 60 in the Euro area and about 78 in Japan. We see that many of the major industrial countries--particularly Japan and some countries in Western Europe--have both strong reasons to save (to help support future retirees) and increasingly limited investment opportunities at home (because workforces are shrinking and capital-labor ratios are already high). In contrast, most developing countries have younger and more-rapidly growing workforces, as well as relatively low ratios of capital to labor, conditions that imply that the returns to capital in those countries may potentially be quite high.11 Basic economic logic thus suggests that, in the longer term, the industrial countries as a group should be running current account surpluses and lending on net to the developing world, not the other way around. If financial capital were to flow in this "natural" direction, savers in the industrial countries would potentially earn higher returns and enjoy increased diversification, and borrowers in the developing world would have the funds to make the capital investments needed to promote growth and higher living standards. Of course, to ensure that capital flows to developing countries yield these 305

benefits, the developing countries would need to make further progress toward improving conditions for investment, as I will discuss further in a bit. A second issue concerns the uses of international credit in the United States and other industrial countries with external deficits. Because investment by businesses in equipment and structures has been relatively low in recent years (for cyclical and other reasons) and because the tax and financial systems in the United States and many other countries are designed to promote homeownership, much of the recent capital inflow into the developed world has shown up in higher rates of home construction and in higher home prices. Higher home prices in turn have encouraged households to increase their consumption. Of course, increased rates of homeownership and household consumption are both good things. However, in the long run, productivity gains are more likely to be driven by nonresidential investment, such as business purchases of new machines. The greater the extent to which capital inflows act to augment residential construction and especially current consumption spending, the greater the future economic burden of repaying the foreign debt is likely to be. A third concern with the pattern of capital flows arises from the indirect effects of those flows on the sectoral composition of the economies that receive them. In the United States, for example, the growth in export-oriented sectors such as manufacturing has been restrained by the U.S. trade imbalance (although the recent decline in the dollar has alleviated that pressure somewhat), while sectors producing nontraded goods and services, such as home construction, have grown rapidly. To repay foreign creditors, as it must someday, the United States will need large and healthy export industries. The relative shrinkage in those industries in the presence of current account deficits--a shrinkage that may well have to be reversed in the future--imposes real costs of adjustment on firms and workers in those industries. Finally, the large current account deficit of the United States, in particular, requires substantial flows of foreign financing. As I have discussed today, the underlying sources of the U.S. current account deficit appear to be medium-term or even long-term in nature, suggesting that the situation will eventually begin to improve, although a return to approximate balance may take some time. Fundamentally, I see no reason why the whole process should not proceed smoothly. However, the risk of a disorderly adjustment in financial markets always exists, and the appropriately conservative approach for policymakers is to be on guard for any such developments. What policy options exist to deal with the U.S. current account deficit? I have downplayed the role of the U.S. federal budget deficit today, and I disagree with the view, sometimes heard, that balancing the federal budget by itself would largely defuse the current account issue. In particular, to the extent that a reduction in the federal budget resulted in lower interest rates, the principal effects might be increased consumption and investment spending at home rather than a lower current account deficit. Indeed, a recent study suggests that a one-dollar reduction in the federal budget deficit would cause the current account deficit to decline less than 20 cents (Erceg, Guerrieri, and Gust, 2005). These results imply that even if we could balance the federal budget tomorrow, the medium-term effect would likely be to reduce the current account deficit by less than one percentage point of GDP. Although I do not believe that plausible near-term changes in the federal budget would eliminate the current account deficit, I should stress that reducing the federal budget deficit is still a good idea. Although the effects on the current account of reining in the budget 306

deficit would likely be relatively modest, at least the direction is right. Moreover, there are other good reasons to bring down the federal budget deficit, including the reduction of the debt obligations that will have to be serviced by taxpayers in the future. Similar observations apply to policy recommendations to increase household saving in the United States, for example by creating tax-favored saving vehicles. Although the effect of saving- friendly policies on the U.S. current account deficit might not be dramatic, again the direction would be right. Moreover, increasing U.S. national saving from its current low level would support productivity and wealth creation and help our society make better provision for the future. However, as I have argued today, some of the key reasons for the large U.S. current account deficit are external to the United States, implying that purely inward-looking policies are unlikely to resolve this issue. Thus a more direct approach is to help and encourage developing countries to re-enter international capital markets in their more natural role as borrowers, rather than as lenders. For example, developing countries could improve their investment climates by continuing to increase macroeconomic stability, strengthen property rights, reduce corruption, and remove barriers to the free flow of financial capital. Providing assistance to developing countries in strengthening their financial institutions--for example, by improving bank regulation and supervision and by increasing financial transparency-- could lessen the risk of financial crises and thus increase both the willingness of those countries to accept capital inflows and the willingness of foreigners to invest there. Financial liberalization is a particularly attractive option, as it would help both to permit capital inflows to find the highest-return uses and, by easing borrowing constraints, to spur domestic consumption. Other changes will occur naturally over time. For example, the pace at which emerging-market countries are accumulating international reserves should slow as they increasingly perceive their reserves to be adequate and as they move toward more flexible exchange rates. The factors underlying the U.S. current account deficit are likely to unwind only gradually, however. Thus, we probably have little choice except to be patient as we work to create the conditions in which a greater share of global saving can be redirected away from the United States and toward the rest of the world--particularly the developing nations.

Footnotes 1. As U.S. capital outflows in those three quarters totaled $728 billion at an annual rate, gross financing needs exceeded $1.3 trillion.Return to text 2. I thank David Bowman, Joseph Gagnon, Linda Kole, and Maria Perozek of the Board staff for excellent assistance.Return to text 3. For simplicity, I will use the term "net foreign borrowing" to refer to the financing of the current account deficit, though strictly speaking this financing involves the sale of foreign and domestic assets as well as the issuance of debt securities to foreigners. As illustrated by the data in footnote 1, U.S. gross foreign borrowing is much larger than net foreign borrowing, as gross borrowing must be sufficient to offset not only the deficit in current payments but also U.S. capital outflows.Return to text 4. This definition of capital investment ignores many less tangible forms of investment, such as research and development expenditures. It also ignores investment in human capital, such 307

as educational expenses. Using a more inclusive definition of investment could well change our perceptions of U.S. saving and investment trends quite substantially. I will leave that topic for another day. Return to text 5. The Bureau of Economic Analysis treats government investment--in roads or schools, for instance--as part of national saving in the national income accounts. Thus, strictly speaking, national saving is reduced by the government deficit net of government investment, not by the entire government deficit. The difference between domestic investment and national saving is not affected by this qualification, however, as government investment and the implied adjustment to national saving cancel each other out. Return to text 6. By "high desired saving" I mean a supply schedule for saving that is shifted far to the right. Actual or realized saving depends on the equilibrium values of the real interest rate and other economic variables. Return to text 7. The statistical discrepancy also increased substantially, by $96 billion on net. As asset accumulation in developing countries may be less completely measured than in industrial countries, a significant part of the change in the discrepancy may represent an additional movement toward surplus in developing-country current accounts. Return to text 8. In pointing out the possible effects of strong global saving on real interest rates, I do not mean to rule out other factors. For example, a lowering of risk premiums resulting from increased macroeconomic and monetary stability has likely played some role. Return to text 9. Greenspan (2005) notes a strong correlation between U.S. mortgage debt and the U.S. current account deficit. Return to text 10. These data are from Annex Table 58, OECD Economic Outlook, vol. 76, 2004, p. 226. The latest year for which data are available is 2003 for Germany and the United Kingdom, 2002 for France, Italy, and Japan. Return to text 11. China is an important exception to the generalization that developing countries have young populations. The country's fertility rate has declined since the 1970s, and its elderly dependency ratio is expected to exceed that of the United States by midcentury. Return to text

References Erceg, Christopher, Luca Guerrieri, and Christopher Gust (2005)."Expansionary Fiscal Shocks and the Trade Deficit." International Finance Discussion Paper 2005-825. Washington: Board of Governors of the Federal Reserve System (January). Greenspan, Alan (2005). "Current account." Speech at Advancing Enterprise 2005 Conference, London, February 4.

Table 1. Global Current Account Balances, 1996 and 2003 (Billions of U.S. dollars) 308

Countries 1996 2003 Industrial 46.2 -342.3 United States -120.2 -530.7 Japan 65.4 138.2

Euro Area 88.5 24.9 France 20.8 4.5 Germany -13.4 55.1 Italy 39.6 -20.7 Spain 0.4 -23.6

Other 12.5 25.3 Australia -15.8 -30.4 Canada 3.4 17.1 Switzerland 21.3 42.2 United Kingdom -10.9 -30.5

Developing -87.5 205.0 Asia -40.8 148.3 China 7.2 45.9 Hong Kong -2.6 17.0 Korea -23.1 11.9 Taiwan 10.9 29.3 Thailand -14.4 8.0

Latin America -39.1 3.8 Argentina -6.8 7.4 Brazil -23.2 4.0 Mexico -2.5 -8.7

Middle East and Africa 5.9 47.8 E. Europe and the former Soviet Union -13.5 5.1

Statistical discrepancy 41.3 137.2

http://www.federalreserve.gov/boarddocs/speeches/2005/200503102/

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Making Finance Safe Stephen G. Cecchetti & Kermit L. Schoenholtz October 06, 2014 Walter Wriston, Citicorp’s chief for nearly two decades until 1984, used to argue that banks’ didn’t need much, if any, capital. The global financial crisis put that view to rest. Today, we know that if banks are going to be able to absorb large unforeseen losses that would otherwise threaten financial stability, they need to finance themselves with equity, not just debt. But how much capital do banks need to have to ensure the financial system is safe? Even after the financial crisis, answers to this question range widely, making it the single most contentious source of debate among bankers, regulators, and academics. At one extreme, narrow banking advocates call for depository institutions to finance anything but riskless assets with 100% equity capital. Others, like Nobel Prize winner Eugene Fama, have called for equity capital of up to 50%. Admati and Hellwig, in their forceful book and other influential writings, argue that banks should operate with equity capital of 20% to 30% of their total assets, unadjusted for risk. The Basel Committee on Banking Supervision, which sets standards for internationally active banks, endorsed a sharp rise in capital requirements (Basel III) compared to abysmal pre-crisis standards (Basel II). Basel III requires capital of 8% to 10% of risk-weighted assets for the largest systemic banks. Using the tighter Basel III definition of capital, we estimate that the effective pre-crisis Basel II requirement was less than ¾% of risk-weighted assets (see table below)!

Comparing Basel III and Basel II Capital Requirements (Share of Risk-weighted Assets) for the Largest Systemic Banks: Impact of Basel III Capital Definition

Basel III range 8% to 10% Basel II Baseline 4% Adjustment for hybrid capital -2% Adjustment for goodwill, intangibles, deferred tax assets, etc. -1% Adjustment for changes in resk weights -0.25% Effective Basel II converted to a Basel III basis < 0.75% Source: Basel Committee on Banking Supervision (2010) and authors' calculations. We cannot directly compare the Basel risk-weighted standard (with its reliance on a broad definition of capital) to a pure leverage requirement based on the ratio of common equity to unweighted total assets. However, many big non-U.S. banks applying the Basel III standards are likely to end up with a requirement that common equity be in the

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range of only 3% of total assets. Interestingly, the Federal Reserve already has indicated plans to hike capital requirements on systemic U.S. banks beyond the Basel III standard. So, what is the correct answer? What share of their assets should banks be required to finance with equity or equity-like instruments? No one really knows for sure. That said, we share the view that existing standards are inadequate and should be raised significantly beyond current U.S. levels (and, therefore, even further above those in place for most European and Japanese banks). A large capital buffer is both the principal mechanism to limit systemic risk and the most effective response to the “too big to fail” problem. At the same time, we have argued in a previous post that narrow banking (100% capital requirements) would not make the financial system safer: instead, it would shift risk- taking to nonbanks that, depending on their design, would be prone to runs and panics that trigger government intervention. We also argued previously that some measure of risk sensitivity – however imperfect – is needed if regulators are to prevent banks from concentrating in the riskiest assets that they are permitted to hold. [For large systemic banks, this means relying on models that are designed to compute the riskiness of asset portfolios, not the “Basel standardized approach” that sets risk weights on a fixed asset- by-asset basis.] In this respect, a leverage ratio alone is insufficient to offset the bad incentives created by the explicit and implicit government guarantees for big intermediaries. To summarize our view thus far, we believe that the right level of capital is neither 0% nor 100%, but somewhere in between; and we support a risk-sensitive measure of assets. Saying more than that requires that we delve into the role that societies expect financial systems to play in their economies and the details of how those systems operate. This means balancing the costs of imposing higher capital requirements against the benefits of reducing the otherwise devastating economic losses associated with financial crises. Nevertheless, we can do a bit of revealing analysis. Let’s start with what is one of the fundamental ideas of corporate finance – the Modigliani-Miller (MM) theorem. Subject to several key assumptions, MM elegantly showed more than 50 years ago that the value of a firm is independent of how it is financed. Put differently, how a firm divides its stream of future profits into payments to equity and payments to debt doesn’t alter the total value of those profits. Miller once made the analogy to cutting a pizza into four or eight slices: the size of the pie doesn’t change. That makes the firm indifferent between equity and debt finance. [For a parable that mirrors the classic MM “neutrality result,” see here.] To the extent that the MM assumptions hold, raising bank capital requirements would be costless for everyone. So why, in practice, do banks view equity capital as so costly? Why do bank managers – like Walter Wriston – aim to minimize it? The reason is that some of the MM assumptions – which include no taxes or subsidies, no bankruptcy costs, and no principal-agent problems – are violated in practice. On this, everyone agrees. The key questions are precisely why and to what extent the MM assumptions are wrong.

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Admati and Hellwig argue that observed MM violations arise almost exclusively from government-induced subsidies for bank debt – for example, through the differential tax treatment of debt and equity, and through the subsidy for those banks viewed as “too big to fail.” These factors can easily explain why banks view equity finance as more costly than debt finance. Yet, if these were the only drivers of MM deviations, then regulators could raise capital requirements without social cost. Higher capital requirements would simply offset market distortions created by other government practices. That view makes Admati and Hellwig comfortable with their simple remedy: much higher capital requirements. What about banks’ “special” role in finance? Would higher capital requirements limit banks’ provision of key services? Perhaps, but we are as yet unaware of any effort to quantify these specific costs. Various theories distinguish banks from other firms by focusing on the synergies of deposit-taking with other banking activities. A prominent one treats banks as a device to buffer illiquid firms from liquidity-seeking investors: In this view, bank capital limits financial instability at the cost of reducing the supply of liquidity. In another model, banks are portrayed as efficient managers of liquidity risk – including the uncertainty about withdrawals (on the liability side of the balance sheet) and about takedowns of off-balance sheet loan commitments. Estimating the cost of capital using such banking theories requires calibrating complex dynamic models – work that remains in its infancy. (An example is here.) Recent academic studies use rougher, less cumbersome, methods to estimate the impact of higher capital requirements on bank funding costs. In these analyses, researchers conclude that equity capital is modestly to moderately more costly for banks than debt. Estimates are in the range of a 3- to 9-basis-point increase in funding costs for each percentage point increase in capital requirements. (See the studies here and here.) If this is correct, the cost of higher bank capital requirements is far from prohibitive. Even if banks were to pass on these costs fully to borrowers, their impact could be easily offset by monetary policy that is somewhat more accommodative on average. That is, the tightening of financial conditions implied by higher bank capital requirements could be neutralized by a lower target policy interest rate. At the same time, these additions to bank funding costs could reduce financial safety. With funding so critical for competitiveness, increased costs may drive even more intermediation from banks to risky shadow banks; something regulators are having a difficult time addressing effectively (see, for example, this earlier post on U.S. money market mutual funds). What to do? Being pragmatists, we think regulators should continue to ratchet up bank capital requirements until the tradeoff between banking efficiency and financial safety shifts appreciably in favor of the latter. Importantly, as capital levels rise, we will be able to measure the costs, in terms of increased lending spreads, reduced loan volumes, and shifts of activity to less-regulated intermediaries. Over time, these responses will give us the information we need to determine the desirable level of capital requirements. And, during this transition, the safety of the financial system will be on the rise. In the case of bank capital, it is surely better to be safe than sorry. http://www.moneyandbanking.com/commentary/2014/10/6/making-finance-safe

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10/06/2014 05:52 PM Bungle Bungle Italy's Failed Economic Turnaround By Hans-Jürgen Schlamp Ever since Matteo Renzi became Italy's new prime minister, officials in Berlin and Brussels have had newfound belief that Italy's deep-seated economic problems are being tackled. But that won't happen until the country stops deceiving itself. Mirko Lami, a portly 50-year-old, has demonstrated, gone on strike, and quarreled with people on TV talk shows and in marketplaces. He's even gone on a seven-day hunger strike. Anything to save his job. He still has a "solidarity contract" -- a fixture in Italy designed to avoid full redundency -- which provides him with €950 in exchange for a few days of work per month. But that will be over soon too, and then he will face unemployment, as do his 2,000 co- workers at La Lucchini in Piombino. The Tuscan town of 34,500 has a port from which tens of thousands of tourists head to the islands of Elba or Sardinia annually. It also has an ironworks plant with a gray and rusting coking plant, a relic from the industrial Stone Age. Now an Indian steel baron intends to take over the plant, but only wants to retain 700 of the employees. Another thousand jobs among the companies that supply the plant are also in jeopardy, and there are already "for sale" or "for rent" signs on almost 100 businesses in Piombino. The crisis looms over the city. And it's not just Piombino. Stores are closing, tradespeople are being let go and manufacturing is collapsing all over Italy, especially in the south. Many young academics are leaving the country. While productivity elsewhere has climbed over the past two decades, it has stagnated in the Italian manufacturing industry. There has been hardly any growth for at least as long. The crisis has struck an economy that was already ailing: Since the summer of 2007, Italy's overall level of industrial production has declined by a quarter. Italy's managers and company-owning families, meanwhile, have padded their wallets, both legally and illegally. Fired Ferrari head Luca di Montezemolo was given a €27 million farewell. Managers and the "brokers" of an oil deal with Nigeria reportedly stashed away €200 million. Prominent business figures are facing embezzlement charges everywhere. Many ownership families have preferred to take money out of their companies instead of reinvesting. "Not even Superman," says economic expert Salvatore Bragantini about Telecom Italia, could ever save that company from the "hole in which Telecom stakeholders have thrown it." Deep Systemic Problems After Berlusconi was sidelined and the boring Enrico Letta was replaced by the sympathetic and purposeful 39-year-old Matteo Renzi as the head of government, many thought that Italy was finally on the right track. But it's not. 313

On the contrary: The land is stuck in a recession. Its levels of sovereign debt, the number of bankruptcies and the rate of unemployment are perpetually setting new records. As a result, some Italian political leaders have long sought a multi-billion euro growth stimulus program -- a call that new European Commission President Jean- Claude Juncker is likely to heed. The magnitude and form of such a program, however, still needs to be determined so that it at least maintains the illusion of conforming with the Stability and Growth Pact. But without many other changes in Italy, including its grasp on reality, simply injecting money isn't likely to change much. "For 20 years," economic expert Daniel Gros told La Repubblica newspaper recently, Italy has been claiming that others need to "give it another year, then you will see our wonderful reforms." And even Mario Draghi -- the Italian president of the European Central Bank, which has been flooding the continent with cheap money, especially in crisis flashpoints like Italy -- bluntly admonished the country in August for failing to implement substantive structural reforms But it's not that Italy is even lacking in money. The assets of Italian banks and insurance companies have risen by over €1.2 trillion since 2008. But manufacturing asset bases have, by contrast, fallen by €200 million. It's a grim distribution: the one sector doesn't seem to want to invest, while the other is unable. Italians themselves face a similar situation. On average, every Italian has about €4,000 more in net assets than the average German, but wealth is even less evenly distributed in Italy than it is in Germany, weakening domestic demand: The rich have everything, the poor can't afford anything. Overly High Taxes Many of Italy's current problems stem from pre-crisis times: Taxation on business income, for example. The World Bank ("Paying Taxes 2014") estimates Italian companies' tax burden at 65.8 percent. Only France (64.7) and Spain (58.6) approach those drastic levels, and they face similar problems. The European average is dramatically lower, at 41.1 percent, while Italy's neighbors, Switzerland and Croatia, have extremely low rates of 29.1 and 19.8 percent respectably. Given that, who would want to invest in Italy? "Having Europe's highest business taxes is ruining us," Massimo Giuliani, 55, the mayor of Piombino, agrees. Ha also argues that energy costs are much too high and that infrastructure is shoddy. But the mayor is convinced that now everything is going to be much better. The port is currently being dredged, and soon giant freighters with six or seven-times the current permissable capacity will be able enter and exit while carrying, for example, steel from La Lucchini. The government wants to spend €50 million to modernize the steelmaking plant, and a new power plant is supposed to provide cheap electricity. In short, Giuliano says, there is "no better place in Italy for steel production." But he may occasionally want to look at the large, colorful map that hangs on the wall of his office. It stems from his predecessor and portrays the "City of the Future 2015," as carefully conceived by architects.

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In it, the highly modern-looking Lucchini site is surrounded by a technology park, an iron and steel museum, music and dance stages, energy-saving houses, parking spots and green areas. Everything is wonderfully designed, a communal dream on 2,500 acres. The dream stems from the year 2008 -- its fulfillment was to cost €50 million. Over the course of three years, the project was advised, conceived, discussed, but then it became clear: There is not and will not be any money for it. Basta. And that too is typical of Italy. Wasted Money In Italy, projects are endlessly planned, designed and then cancelled -- sometimes before, sometimes after construction. Several billion euros have been invested in half- finished hospitals, sports facilities, theaters, bridges and highway sections that are now slowly falling apart. EU money -- with which things could be built, researched, taught -- is not accessed because the national, provincial, communal, environmental, economic and social authorities often cannot agree who is to do what where and how with the money. As a result, Pompeii, a designated World Heritage Site, is crumbling even though Brussels had declared itself willing to provide about €80 million for its upkeep. And when EU money does flow, things often take a strange course. Take for example the €7 billion training project, half financed by Brussels' social fund, that was meant to help young Italians find jobs. A study found that, although several thousand courses were taught, only 233 people ultimately found a job as a result. This means that every job cost about €30 million. In the Mezzogiorno, the country's impoverished south -- which has seen an influx of €4,000 from Brussels per person over the past seven years -- EU money is trickling away almost without a trace. Adriano Giannola, the president of an organization for economic development, sees the "prettying up of a square here, a restauration there, usually of poor quality." People are using the money only to provide a bit of work to their voters, their friends, their business partners. He says he has not seen any projects that truly foster growth. The state in Italy is not the solution, but part of the problem. Because the state doesn't work very well, work is becoming an increasingly rare commodity. Why does a civil or business lawsuit take an average of 2,992 days in Italy, while 900 days suffice in Germany? Why do private citizens and entrepreneurs need to deal with about one hundred new tax laws every year -- the statistical equivalent of two new laws per week? Why is the state refusing to pay the over €75 billion in outstanding bills from deliverers and contractors, thus pushing many people into ruin? Why are 16,000 administrators and 12,000 inspectors receiving regal salaries to lead thousands of publically-owned companies, most of which have nothing to do with public services and only create deficits? Italy's manufacturers' association has calculated that €13 billion could be saved in the public sector alone. One egregious example stems from the national tourism agency, which commissioned a project to globally showcase Italy's beauty by displaying seven

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photos around the world. After one and a half years, the seven photos were complete but because there wasn't enough money left for the planned TV and online ads or posters, no potential tourist ever saw them: The budget of €5 million had been entirely used to pay the salaries of the people involved. Renzi Faces Obstacles To end, abolish, change all that -- that's what Prime Minister Renzi said he intended to do when he took power. He intended to "scrap" the old guard that controlled the state, remove the old cliques and fundamentally change the country from the ground up. He started off forcefully, sending to the parliament a new election law and a constitutional amendment that would abolish the provinces and the second chambers of parliament. And a tax cut on top of that. He has charged his ministers with elaborating reforms in the education and health sectors, a modernization of labor law, the dismantling of bureaucracy and much more. Every month a reform, the slogan went. A few months ago. But of this, little has been implemented. Most of it is stuck in parliament, in the cabinet or in party disputes. The Italians are used to it: About 250 bylaws of the Mario Monti government (November 2011 to April 2013) still haven't come into effect. But Renzi wanted to do everything differently, quickly and immediately. That's why he replaced his lame predecessor and fellow party member, Letta. But he has begun talking about needing "one thousand days" for his work. The majority of Italians still support him, but his approval rating is rapidly crumbling from 69 percent in June to 54 in September. The philosopher and former mayor of Venice, Massimo Cacciari, is already talking about a disease that has afflicted Renzi: "Proclamationitis." URL: • http://www.spiegel.de/international/europe/matteo-renzi-struggling-to-solve- italian-economic-crisis-a-995558.html Related SPIEGEL ONLINE links: • 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 • France and Friends: Merkel Increasingly Isolated on Austerity (09/03/2014) http://www.spiegel.de/international/europe/the-anti-austerity-camp-is-growing-as- merkel-becomes-more-isolated-a-989357.html • More Money Please: A New Plan to Boost Europe's Straggling Investments (07/01/2014) http://www.spiegel.de/international/business/a-new-plan-to-boost-european- investment-to-avoid-recession-a-978357.html

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• The Downfall of Rome: Can a New Mayor Stop the City's Decline? (04/25/2014) http://www.spiegel.de/international/europe/new-mayor-in-rome-seeks-to-prevent- further-decline-in-city-a-965806.html

Dietro le quinte La battaglia di Padoan sui calcoli europei Si tenta la strada delle misure espansive Sensini Mario, Pagina 02 (06 ottobre 2014) Il Tesoro contesta i metodi usati dalla Commissione per valutare il bilancio. Pronto un dossier tecnico arricchito dalle analisi della Bundesbank Draghi Anche il presidente della BCE ha espresso qualche perplessità sulla procedura ROMA I metodi usati dalla Commissione UE per valutare le condizioni della finanza pubblica dei Paesi membri, ed avviare le eventuali procedure d?infrazione, non sono affidabili. Il ministro dell?Economia, Pier Carlo Padoan, lo ha ripetuto spesso nelle ultime settimane, sottolineando anche in Parlamento «le gravi debolezze» degli strumenti della sorveglianza europea, che comportano anche il rischio serio di un «avvitamento» delle politiche economiche in una spirale recessiva. Nell ‘Aggiornamento al DEF, trasmesso a Bruxelles, il governo ha fatto un altro passo avanti, alzando i toni di quella che suona quasi come una sfida alla UE. Secondo Padoan, «il saldo di bilancio corretto per il ciclo è in condizioni significativamente migliori di quanto non risulti dalle previsioni», viziate, si legge nel documento, «dalla rilevante sottostima» di alcuni fattori. Nel mirino del Tesoro c’è il calcolo del prodotto potenziale, la crescita dell’economia che si può ottenere con il massimo impiego dei fattori produttivi e senza creare inflazione, e del conseguente output gap : la differenza tra il potenziale e la crescita reale. Sono grandezze non osservabili direttamente. E vengono calcolate con metodi che, secondo il Tesoro, presentano forti «criticità», tanto che vengono continuamente riviste a posteriori, in misura anche molto ampia. Ma sono numeri con una valenza politica enorme nelle regole europee perché, filtrando e depurando l?impatto del ciclo economico, danno in automatico la misura delle condizioni strutturali del bilancio, quelle che contano ai fini delle procedure per deficit eccessivo. Il nostro prodotto potenziale, dice Padoan, è «sottostimato». Il differenziale, l’ output gap, è molto più grande di quello che emerge dai numeri della UE, che il governo usa per convenzione. E lo stato di fondo del bilancio è molto migliore di quello che appare. Tanto da giustificare misure espansive, anticicliche, ed evitare manovre restrittive che ci farebbero «avvitare» nella recessione. Per sostenerlo, il Tesoro è pronto a portare la recente, copiosa e autorevole letteratura sulla fallacità dei metodi di calcolo del prodotto

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potenziale, a partire dagli studi della Bundesbank.1 Anche il nuovo Ufficio Parlamentare di Bilancio, che convalida le previsioni del Tesoro, avrebbe dubbi e dedicherà al calcolo dell? output gap la prima Nota Metodologica, a giorni. Anche il presidente BCE, Mario Draghi, ha espresso qualche perplessità, sottolineando la tendenza della Commissione a sovrastimare la componente strutturale della disoccupazione, che impatta tanto sul calcolo del prodotto potenziale. Anche la disoccupazione strutturale non è osservabile e viene stimata dalla UE, in più con sistemi diversi da un Paese all’altro. Per l’Italia, calcolata dalla Commissione come quella di equilibrio, che non crea tensioni sui prezzi (e siamo in deflazione), la disoccupazione strutturale è quasi all’11%, contro il 12,3% reale, ed il 6-7% di prima della crisi. Come se l’impatto della congiuntura non ci fosse. Tre economisti del CER calcolano che se la disoccupazione strutturale fosse al 9%, il bilancio strutturale italiano sarebbe in pareggio già da quest’anno. Il Tesoro questo non lo dice. Ma non ha dubbi: quei dati «sono difficilmente spiegabili da un punto di vista teorico ed empirico».© RIPRODUZIONE RISERVATA - Corriere della Sera http://archiviostorico.corriere.it/2014/ottobre/06/battaglia_Padoan_sui_calcoli_europei_ co_0_20141006_bf1c6742-4d1f-11e4-90a9-d9dfcf4f50d3.shtml

1 http://www.bundesbank.de/Redaktion/EN/Downloads/Publications/Monthly_Report_Articles/2014/2014_ 04_output_gap.pdf?__blob=publicationFile

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Politics

Michael Spence// a Nobel laureate in economics, is Professor of Economics at NYU’s Stern School of Business, Distinguished Visiting Fellow at the Council on Foreign Relations, Senior Fellow at the Hoover Institution at Stanford University, and Academic Board Chairman of the Fung Global Institute in Hong Kong. He was the chairman of the independent Commission on Growth and Development, an international body that from 2006-2010 analyzed opportunities for global economic growth, and is the author of The Next Convergence – The Future of Economic Growth in a Multispeed World. SEP 19, 2014 Europe’s Bargain MILAN – In July, the European Commission published its sixth report on economic, social, and territorial cohesion (a term that can be roughly translated as equality and inclusiveness). The report lays out a plan for substantial investment – €450 billion ($583 billion) from three European Union funds – from 2014 to 2020. Given today’s difficult economic and fiscal conditions, where public-sector investment is likely to be crowded out in national budgets, this program represents a major commitment to growth-oriented public sector investment. The EU’s cohesion strategy is admirable and smart. Whereas such investment in the past was heavily tilted toward physical infrastructure – particularly transport – the agenda has shifted to a more balanced set of targets, including human capital, employment, the economy’s knowledge and technology base, information technology, low-carbon growth, and governance. That said, one can ask what the economic and social returns on these investments will be. True, sustaining high growth rates requires sustaining high levels of public investment, which increases the return to (and hence the levels of) private investment, in turn elevating output and employment. But public investment is only one component of successful growth strategies. It will do some good in all scenarios, but its impact will be much larger beyond the short term if other binding constraints are removed. Three complementary issues seem crucial. One, mainly the province of the European Central Bank, involves price stability and the value of the euro. The second is fiscal, and the third is structural. Inflation rates, now well below the ECB’s 2% annual target, are in the deflationary danger zone. Because deflation drives up the real burden of sovereign debt and public non-debt liabilities such as pension systems, its emergence would undermine the already fragile state of many countries’ public finances and kill growth. 319

In a post-crisis environment of aggressive and unconventional monetary policy in other advanced countries, the ECB’s less aggressive policies (owing to its more restrictive mandate) have resulted in an exchange rate that has damaged competitiveness and the growth potential of many eurozone economies’ tradable sectors. This is crucial, because most economies experienced pre-crisis growth patterns characterized by unsustainably high levels of domestic aggregate demand. So rebalancing requires shifting toward the tradable sector and external demand. A weakening euro will help. The ECB understands this, and, without being explicit about it, is expanding its asset- purchase programs to elevate inflation and bring down the euro. ECB President Mario Draghi has been clear that restoring target inflation and weakening the currency is not a growth strategy. Difficult reforms are needed to put many national economies’ fiscal affairs in order and to increase their structural flexibility. The ECB cannot do it alone. On the fiscal side, sovereign-debt levels are too high and still rising. But the bigger challenge is the unfunded non-debt liabilities in pension funds and social-security systems, which are estimated to be four times or more the size of sovereign debt. It is clearly necessary to implement credible plans to arrest the growth of these liabilities.

But these liabilities also have to be reduced, because they are already imposing a crushing fiscal burden, largely owing to rapid aging, with rising longevity a major contributor. The US has a similar problem, though it is more distant. A recent analysis for the US suggests that entitlements programs’ liabilities will hit the public budgets in

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about ten years. By contrast, in Italy, for example, with its less favorable demographics, they have already hit. Growth would reduce this burden, but growth in the short and medium term is highly problematic. Inflation would reduce the real value of both debt and other non-indexed non-debt liabilities. But even controlled inflation at higher levels has been ruled out; again, the current risk is deflation. Governments could raise taxes to cover a larger fraction of the required expenditures. But that is not likely to help growth, and it imposes the burden on the workforce and the young who are trying to enter it, a valuable subset of whom are mobile and could simply leave. Likewise, issuing more debt to cover the portion of liabilities coming due would merely shift the composition of liabilities without reducing them. The only other alternative is direct reduction. For sovereign debt, that means default, which will happen only in extreme circumstances; for non-debt liabilities, it means changing systemic parameters – for example, increasing the retirement age – which is contentious and exceptionally difficult to do politically. The third missing ingredient is structural flexibility, which is needed for two reasons. First, most advanced economies have maintained the unbalanced growth patterns that led to the global crisis in 2008. Restoring growth requires structural changes. In the US, though growth remains well below potential, data suggest that about half of the recovery in growth has resulted from a shift in capital and labor to the tradable side of the economy, with shale gas providing a big boost. That is either not occurring or happening at a glacial pace in southern European economies, where structural rigidities in labor and services markets need to be addressed. The exception is Spain, which initiated labor-market reforms in late 2012. Perhaps as these reforms’ impact becomes more visible, reform momentum will increase in other countries. Even without crisis-related imbalances, structural flexibility in all economies is necessary to adapt to the shifts caused by globalization and the labor-saving and skill- biased technological shifts associated with the rising value of digital capital. In the past 30 years, the global economy added 1.5 billion new connected workers in developing countries, with three billion new consumers in sight. Digital technologies have eliminated millions of routine white- and blue-collar jobs, and we are rapidly entering the realm of cognitive-based employment. If investment in human capital is to keep up with the changing composition of employment, structural flexibility is needed. Europe has a real chance to conclude a bargain: member countries implement fiscal and structural reforms in exchange for short-run relaxation of fiscal constraints – not to increase liabilities, but to focus on growth-oriented investments to jump-start sustained recovery. Private investors would take note, accelerating the recovery process. The challenge now is to seize the opportunity. https://www.project-syndicate.org/commentary/michael-spence-calls-for-eurozone- members-to-cut-public-sector-liabilities-while-hiking-public-sector-investment

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wsj Markets Pimco Rehires Former Senior Executive Paul McCulley McCulley Taking Newly Created Role as Pimco's Chief Economist Kirsten Grind and Gregory Zuckerman Updated May 27, 2014 7:32 p.m. ET

Paul McCulley, above in 2011, returns to Pimco after turmoil at firm. Reuters After a turbulent few months marked by a management shake-up, lackluster performance and client withdrawals, Pacific Investment Management Co. is turning to a familiar face to help soothe nervous investors. The money manager, based in Newport Beach, Calif., said it had rehired Paul McCulley, a former senior executive for the bond-fund behemoth. Mr. McCulley, 57 years old, will fill a newly created role of chief economist. He also will serve on Pimco's investment committee and travel the country to meet with big clients. Pimco's move comes five months after the firm put in place a revamped executive structure featuring a new generation of fund managers, following the abrupt departure of its former chief executive, Mohamed El-Erian. Clients have continued to pull billions

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from the firm, and some analysts said the hiring appears to be designed to placate such anxious investors. Bill Gross, chief investment officer and co-founder of Pimco, said, "We thought that Paul would be the unifying force, so to speak," of the firm's new structure, which includes six deputy chief investment officers. Mr. Gross said he believes clients will welcome Mr. McCulley's return. "This announcement may be a surprise to them, but it will certainly be positive because of his history" at the firm, Mr. Gross said. Investors have pulled about $55 billion from Pimco's $230 billion flagship Total Return BOND +0.05%PIMCO Total Return ETFU.S.: NYSE Arca $109.34 +0.05+0.05% Oct. 8, 2014 4:00 pm Volume (Delayed 15m) : 1.11MAFTER HOURS $109.34 0.00% Oct. 8, 2014 4:01 pm Volume (Delayed 15m) : 107 P/E Ratio N/AMarket Cap N/A Dividend Yield 3.02% Rev. per Employee N/A109.40109.20109.0010a11a12p1p2p3p 09/24/14 Has Bill Gross Been Replaced

a...09/24/14 The Fuzziness Behind Some Fund...07/16/14 As Pimco's Bill Gross

Does Bet...More quote details and news » bond fund since last May, and the firm, with about $2 trillion under management, has seen billions of dollars in redemptions across its other funds. It isn't clear how much the hiring will affect the firm's fortunes. Mr. McCulley won't be managing money and won't work more than 100 business days a year, Pimco said. Instead, he will take on a public role at the firm. In addition to writing research papers and meeting with clients, he will appear on television speaking about the company's perspective on the markets and the economy, Mr. Gross said. Several investors and analysts welcomed the news of Mr. McCulley's return. "It soothes the fear that Pimco is losing its way after the departure of Mohamed El-Erian," said Jeff Tjornehoj, head of Lipper Americas Research. Mr. McCulley, who left Pimco in 2010, is perhaps best-known for coining the term "shadow banking" during the financial crisis, and the "Minsky moment," a term used to describe a sudden collapse of asset values, which was a phenomenon examined by the economist Hyman Minsky. Mr. McCulley also was identified by a long mane of hair, which he said he cut last August, before he began talking to Mr. Gross about returning to the firm. "This new role allows me to do the things that I love—thinking, writing and speaking with colleagues that I deeply respect and enjoying working with, with a firm that is Camelot to me," Mr. McCulley said in an interview. Since leaving Pimco, Mr. McCulley has focused on philanthropy and angel investing, and he has been chairman of the Global Society of Fellows at the Global

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Interdependence Center, a Philadelphia-based nonprofit organization that encourages the expansion of global trade. Mr. McCulley's most recent stint at Pimco began in 1999 as a portfolio manager. He later became a member of the firm's investment committee. Mr. McCulley also had worked at Pimco earlier in the 1990s. Pimco's Total Return fund had $3.1 billion in net outflows in April, its 12th month in a row of redemptions, according to fund-research firm Morningstar Inc. The outflows sparked investors in Pimco's parent company, Allianz SE, ALV.XE +0.24%Allianz SEGermany: Xetra €124.75 +0.30+0.24% Oct. 9, 2014 9:45 am Volume (Delayed 15m) : 262,972 P/E Ratio 9.28Market Cap€57.20 Billion Dividend Yield 4.25% Rev. per Employee €668,259125.50125.00124.50124.0010a11a12p1p2p3p4p5p 10/08/14 Janus Fund

Managed by Bill Gro...10/07/14 Florida Pension Fund Significa...10/03/14 Bond

Titan Bill Gross’s Job Sw...More quote details and news » to voice concerns at its annual meeting in Germany earlier this month. The Pimco Total Return fund has returned 3.1% this year, compared with 3.5% for its benchmark, the Barclays U.S. Aggregate bond index, although Mr. Gross said the fund's strong performance in May has put it ahead of all but 2% of its peers for the month. Mr. McCulley said he was aware of reports about tension between Mr. Gross and Mr. El-Erian before Mr. El-Erian's departure and says he plans to spend time talking to people within Pimco to get a read on the new structure. "I'll want to embed myself with open ears in this organization and learn how I can be most useful," he said. Roger Hewins, of Hewins Financial Advisors in San Mateo, Calif., which has $3.3 billion in assets under management and about $160 million invested in the Total Return fund, said Mr. McCulley has always been perceived well by the market. Mr. Hewins said he welcomed his return. "I'm not surprised they tried to lure him back at a time like this," Mr. Hewins said. Write to Kirsten Grind at [email protected] and Gregory Zuckerman at [email protected] http://online.wsj.com/news/articles/SB100014240527023048119045795880613195504 26

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How to Balance the Austerity Agenda 24th May 2013 What are the long term economic impacts of short term solutions to debt? Academic Council Chairman Michael Spence examines looks at the implications of austerity and stimulus policies in the context of the European debt crisis. In a recent set of studies, Carmen Reinhart and Kenneth Rogoff used a vast array of historical data to show that the accumulation of high levels of public (and private) debt relative to GDP has an extended negative effect on growth. The size of the effect incited debate about errors in their calculations. Few, however, doubt the validity of the pattern. This should not be surprising. Accumulating excessive debt usually entails moving some part of domestic aggregate demand forward in time, so the exit from that debt must include more savings and diminished demand. The negative shock adversely impacts the non-tradable sector, which is large (roughly two-thirds of an advanced economy) and wholly dependent on domestic demand. As a result, growth and employment rates fall during the deleveraging period. In an open economy, deleveraging does not necessarily impair the tradable sector so thoroughly. But, even in such an economy, years of debt-fuelled domestic demand may produce a loss of competitiveness and structural distortions. And the crises that often divide the leveraging and deleveraging phases cause additional balance-sheet damage and prolong the healing process. Thanks in part to research by Reinhart and Rogoff, we know that excessive leverage is unsustainable, and that restoring balance takes time. As a result, questions and doubts remain about an eventual return to the pre-crisis trend line for GDP, and especially for employment. What this line of research explicitly does not tell us is that deleveraging will restore growth by itself. No one believes that fiscal balance is the whole growth model anywhere. Consider southern Europe. From the standpoint of growth and employment, public and private debt masked an absence of productivity growth, declining competitiveness in the tradable sector, and a range of underlying structural shortcomings – including labour- market rigidities, deficiencies in education and skills training, and underinvestment in infrastructure. Debt drove growth, creating aggregate demand that would not have existed otherwise. (The same is true of the United States and Japan, though the details differ.)

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Government is not the sole actor in this. When the deleveraging cycle begins, the private sector starts to adjust structurally – a pattern clearly seen in the data on growth in the tradable side of the US economy. Muted wage growth increases competitiveness, and underutilised labour and capital are redeployed. How fast this happens partly depends on the private sector’s flexibility and dynamism. But it also depends on the ability and willingness of government to provide a bridging function for the deficiency in aggregate demand, and to pursue reforms and investments that boost long-term growth prospects. If public-sector deleveraging is not a complete growth policy – and it isn’t – why is there so much attention on fiscal austerity and so little action (as opposed to lip service) on growth and employment? Several possibilities – not mutually exclusive – come to mind. One is that some policymakers think that fiscal balance really is the main pillar in a growth strategy: Deleverage quickly and get on with it. The belief that the fiscal multiplier is usually low may have contributed to underestimation of the short-run economic costs of austerity policies – and thus to persistently optimistic forecasts of growth and employment. Recent research by the International Monetary Fund on the context-specific variability of fiscal multipliers has raised serious questions about the costs and effectiveness of rapid fiscal consolidation. Estimates of the fiscal multiplier must be based on an assumption or a model that says what would have happened in the absence of government spending of some type. If the assumption or the model is wrong, so is the estimate. The counterfactual needs to be made explicit and assessed carefully and in context. In some countries with high levels of debt and impaired growth, fiscal stimulus could raise the risk premium on sovereign debt and be counterproductive; others have more flexibility. Countries vary widely in terms of household balance-sheet damage, which clearly affects the propensity to save – and hence the multiplier effect. Uncertainty is a reality, and judgment is required. Then there is the time dimension. If infrastructure investment, for example, generates some growth and employment in the short to medium term and higher sustainable growth in the longer term, should we rule it out because some estimates of the multiplier are less than one? Similarly, if fiscal stimulus has a muted effect because the recipients of the income are saving to restore damaged household balance sheets, it is not clear we want to discount the accelerated deleveraging benefit, even if it shows up in domestic demand only later. Policymakers (and perhaps financial markets) may have believed that central banks would provide an adequate bridging function through aggressive unconventional monetary policy designed to hold down short- and long-term interest rates. Certainly central banks have played a critical role. But central banks have stated that they do not have the policy instruments to accelerate the pace of economic recovery. Among the costs and risks of their low-interest-rate policies are a return to the leveraged growth pattern and growing uncertainty about the limits of a central bank’s balance-

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sheet expansion. In other words, will the elevated asset values caused by low discount rates suddenly reset downward at some point? No one knows. Countries are subject to varying degrees of fiscal constraint, assuming (especially in the case of Europe) a limited appetite for unlimited, unconditional cross-border transfers. Those that have some flexibility can and should use it to protect the unemployed and the young, accelerate deleveraging, and implement reforms designed to support growth and employment; others’ options – and thus their medium-term growth prospects – are more constrained. All countries – and policymakers – face difficult choices concerning the timing of austerity, perceived sovereign-credit risk, growth-oriented reforms, and equitable sharing of the costs of restoring growth. So far, the burden-sharing challenge, along with naive and incomplete growth models subject to varying degrees of fiscal constraint, assuming (especially in the case of Europe) a limited appetite for unlimited, unconditional cross-border transfers. Those that have some flexibility can and should use it to protect the unemployed and the young, accelerate deleveraging, and implement reforms designed to support growth and employment; others’ options – and thus their medium-term growth prospects – are more constrained., may have contributed to gridlock and inaction. Experience can be a harsh, though necessary, teacher. Growth will not be restored easily or quickly. Perhaps we needed the preoccupation with austerity to teach us the value of a balanced growth agenda. http://www.fungglobalinstitute.org/en/how-balance-austerity-agenda

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TIMETIME Financial Regulation 25 Years Later: In the Crash of 1987, the Seeds of the Great Recession By Christopher Matthews Oct. 22, 2012

Scott Eells / Bloomberg / Getty Images RELATED// Black Monday: The 1987 Market Crash Revisited Yahoo Finance// 10 lessons from the 1987 stock market crash MarketWatch “History doesn’t repeat itself, but it does rhyme.” This quote, often attributed to Mark Twain, resonates with us for its pithy description of an irony we encounter everyday: In a world marked by rapid technological, political and social change, certain themes remain eternal. Wall Street is not immune to this phenomenon. There have been few periods in its history that have been more dynamic than the past quarter century. Since the 1980s, Wall Street has seen the emergence of computerized trading, the application of advanced mathematical techniques and theories to trading, and the total upheaval of the very structure of the markets on which securities are traded. Yet even with all these changes, the essence of The Street has stayed the same. 328

This may be best illustrated by the great crash of October 1987. Twenty-five years ago this week, American stock markets suffered one of its largest three-day declines in history, with the S&P 500 loosing 28.5% of its value between October 14 and 19. The total loss of wealth over that period was approximately $1 trillion, according to a Presidential Task Force report on the crash. At first glance the convulsions in the market in 1987 bear little resemblance to the financial problems we face today. The 1987 crash was not the result of a financial crisis, nor did it lead to a prolonged recession. Look more deeply at the causes and repercussions of the crash, however, and you find many that “rhyme” with those of the 2008 crisis. (PHOTOS: Occupy Wall Street, One Year Later: Protesters Return to the Movement’s Roots) For instance, some of the main causes of the 1987 crash were new and untested financial instruments deployed in the market by computer programs. In addition, it was the first modern economic crash to be a truly international phenomenon, as it spread from New York across the globe almost instantaneously. Finally, the crisis of 1987 was coincidental with Alan Greenspan taking over the Federal Reserve — and Greenspan’s attitude towards crisis management and regulation greatly influenced the 2008 panic. With these themes in mind, I spoke with Charles Geisst, a professor of finance at Manhattan College and author of Wall St: A History, to discuss what the 1987 crash says about the stock market today. It’s impossible to pin down for certain the cause of the ’87 market crash, but the most important ingredient was an overvalued stock market. The years leading up to the crash had seen incredible gains in the market. But as a Federal Reserve paper from 2006 puts it: “The macroeconomic outlook during the months leading up to the crash had become somewhat less certain. Interest rates were rising globally. A growing U.S. trade deﬁcit and decline in the value of the dollar were leading to concerns about inﬂation and the need for higher interest rates in the U.S. as well.” According to Geisst, there were two triggers, in addition to an overvalued market and deteriorating macroeconomic environment, that led to an initial market break on October 17 and then a more-than 20% decline in the S&P 500 a couple days later on the 19. One was the rumor of imminent interest rate hikes in defense of the dollar by the new Fed chairman, Alan Greenspan. “The market had experienced very high interest rates between 1980 and 84, and was spooked by talk of a return to those rates,” says Geisst. (PHOTOS: The Recession of 1958) Another cause of the initial break was legislation filed by the House Ways and Means Committee that would have eliminated tax breaks on debt used for mergers and acquisitions. Tax laws figure very prominently into valuations of companies, and this caused investors to reconsider the value of their holdings. Complex Financial Instruments These factors caused investors to reevaluate their holdings, but one of the main reasons this market correction turned into a full-fledged crash was the arrival of new, complex 329

financial instruments on the scene. As during the run-up to the financial crisis of 2008, Wall Street was in the 1980s growing enamored with new methods for hedging risks. The shiny new financial instrument back then was a derivative called a stock index future, which is tied to the value of stocks that make up the S&P 500 and other indexes. Money managers would use these index futures as a means to hedge their portfolios, through the use of computer programs that would automatically sell index futures if the market declined. But these new techniques hadn’t been tested in volatile conditions. The automatic selling of the computers, combined with the efforts of other traders to take advantage of precipitous declines in the market, helped create an atmosphere of panic which eventually led to so much loss of wealth. “It’s a parallel with 2008,” says Geisst. “There was new stuff being developed like stock index futures and the techniques of arbitraging between them and developing portfolio insurance — that stuff did not fall under regulation. That was the outer edge of regulation and nobody saw it and all of a sudden in causes an enormous problem.” (PHOTOS: The Global Financial Crisis) Computerized Trading It wasn’t just that the derivatives being traded were themselves poorly understood by many market participants. The fact that computer programs were being used to trade them was also a prime contributor to the crash. And twenty-five years later, computers continue to play a crucial but controversial role on Wall Street. In fact, some estimate that upwards upwards of 75% of all trades made on a given day are initiated by computers. This so-called high-frequency trading has caused numerous problems in the markets over the past two years – from the 2010 flash crash to an incident earlier this year that nearly caused the broker Knight Capital to go bankrupt. International Financial Markets We now take it for granted that financial markets are global. Multinational banks dominate the landscape and investors can buy stocks and bonds across borders with relative ease. But this was not always the case. It was in the 1980s that stock markets around the world became deeply interconnected, with American companies increasingly searching for capital abroad and vice versa. According to Geisst, the 1987 crash spread internationally in “a matter of hours,” and was quickly a global phenomenon. Global regulations and standard practices increasingly allowed “trading stocks away from their home exchanges,” Geist says. This internationalization of the capital markets, of course, has only accelerated. One need only look to Europe — and to the fear with which bankers and policy makers eye the possibility of financial contagion spreading from European to American banks — to see how this issue remains a problem today. Central Bank Intervention Alan Greenspan assumed the role of Federal Reserve Chairman in August 1987, just a few months before the crash. The dollar had been declining for several years due to an international agreement in 1985 to devalue the dollar in order to help American exporters. Fearing that the dollar had fallen too far, Greenspan took measures to raise 330

interest rates to defend the dollar. According to Geisst, this action spooked the markets, which had gone through a painful period of high rates in the early 80s. “Greenspan learned his lesson,” Geisst says. “He didn’t want to get blamed for something like that again.” (MORE: Are We Already Planting the Seeds of the Next Financial Crisis?) Greenspan and the Federal Reserve attacked the panic aggressively, issuing public statements confirming their commitment to stabilizing the markets, and adjusting interest rates downwards. In fact, over the years, Greenspan developed a reputation for aggressively combatting recessions and market convulsions — so much so that traders began to feel that the Federal Reserve would bail them out whenever the going got rough. As a report in 2000 from The Financial Times described the phenomenon: “Some stock traders now call it the Greenspan put. It is a label borrowed from the world of options trading for a widely held view: when financial markets unravel, count on the Federal Resere and its chairman Alan Greenspan (eventually) to come to the rescue.” The 1987 crash was the debut of the “Greenspan Put,” and some critics argue that the complacency it fostered in market participants — economists call it moral hazard — helped foment the sort of risk taking that led to the 2008 crash. Back to the Future The Wall Street of 1987 was surely a very different place than it is today. Computers were an auxillary tool in the late 1980s, while today they dominate every aspect of the business. “Complex” financial instruments have only become more so — financial engineering the in late ’80 looks quaint to the hypereducated “quants” of today’s Street. And financial markets across the globe are interconnected in a way that would have seemed inconceivable twenty five years ago. At the same time, all panics are essentially made of the same stuff. No matter how much the Street changes, there will always be a tug of war between overconfident traders armed with new hedging mechanisms and the regulators tasked with keeping them in check. Increasingly, humans will struggle with how to deploy computers to make markets more efficient without having those computers hijack the process. And central banks will walk a tightrope between protecting the public from economic calamity and distorting natural market mechanisms. Sure, nobody will ever accuse Wall Street of being overly poetic, but even this industry full of hard-nosed capitalist does, on occasion, rhyme. MORE: Are We Already in A Recession? http://business.time.com/2012/10/22/25-years-later-in-the-crash-of-1987-the-seeds-of- the-great-recession/

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Global economy set to remain sluggish There is little evidence of willingness on the part of politicians, policymakers, and the public to reduce current consumption further via taxation in order to create room for expanded growth-oriented investment Michael Spence theguardian.com, Friday 14 September 2012 15.17 BST

Supermarket in Shenyang in northeast China's Liaoning province. With the exception of China, fiscal positions around the world are currently weak. Photograph: AP The world's high-income countries are in economic trouble, mostly related to growth and employment, and now their distress is spilling over to developing economies. What factors underlie today's problems, and how appropriate are the likely policy responses? The first key factor is deleveraging and the resulting shortfall in aggregate demand. Since the financial crisis began in 2008, several developed countries, having sustained demand with excessive leverage and consumption, have had to repair both private and public balance sheets, which takes time – and has left them impaired in terms of growth and employment. The non-tradable side of any advanced economy is large (roughly two-thirds of total activity). For this large sector, there is no substitute for domestic demand. The tradable 332

side could make up some of the deficit, but it is not large enough to compensate fully. In principal, governments could bridge the gap, but high (and rising) debt constrains their capacity to do so (though how constrained is a matter of heated debate). The bottom line is that deleveraging will ensure that growth will be modest at best in the short and medium term. If Europe deteriorates, or there is gridlock in dealing with America's "fiscal cliff" at the beginning of 2013 (when tax cuts expire and automatic spending cuts kick in), a major downturn will become far more likely. The second factor underlying today's problems relates to investment. Longer-term growth requires investment by individuals (in education and skills), governments, and the private sector. Shortfalls in investment eventually diminish growth and employment opportunities. The hard truth is that the flip side of the consumption- led growth model that prevailed prior to the crisis has been deficient investment, particularly on the public sector side. If fiscal rebalancing is accomplished in part by cutting investment, medium- and longer- term growth will suffer, resulting in fewer employment opportunities for younger labour-market entrants. Sustaining investment, on the other hand, has an immediate cost: it means deferring consumption. But whose consumption? If almost everyone agrees that more investment is needed to elevate and sustain growth, but most believe that someone else should pay for it, investment will fall victim to a burden-sharing impasse – reflected in the political process, electoral choices, and the formulation of fiscal-stabilisation measures. The core issue is taxes. If public-sector investment were to be increased with no rise in taxation, the budget cuts required elsewhere to avoid unsustainable debt growth would be implausibly large. The most difficult challenge concerns inclusiveness – how the benefits of growth are to be distributed. This is a longstanding challenge that, particularly in the United States, goes back at least two decades before the crisis; left unaddressed, it now threatens social cohesion. Income growth for the middle class in most advanced countries has been stagnant, and employment opportunities have been declining, especially in the tradable part of the economy. The share of income going to capital has been rising, at the expense of labour. Particularly in the US, employment generation has been disproportionately in the non- tradable sector. These trends reflect a combination of technological and global market forces that have been operating over the last two decades. On the technology side, labour-saving innovations in network-based information processing and transactions automation have helped to drive a wedge between growth and employment generation in both the tradable and non-tradable sectors. In the tradable part of advanced economies, manufacturing automation – including expanding robotic capabilities and, prospectively, 3D printing – has combined with the integration of millions of new entrants into rapidly evolving global supply chains to limit employment growth. Multinational companies' growing ability to decompose these global supply chains by function and geography, and then to reintegrate them at ever

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lower transaction costs, removes the labor-market protection that used to come from local competition for workers. This challenge is particularly difficult, because economic policy has not focused primarily on the adverse distributional trends arising from shifting global market outcomes. And yet the income distributions across advanced economies, presumably subject to similar technological and global market forces, are, in fact, startlingly different, suggesting that a combination of social policies and differing social norms does have a distributional impact. Although the theory of optimal income taxation directly addresses the tradeoffs between efficiency incentives and distributional consequences, the appropriate equilibrium remains a long way off. A healthy state balance sheet could help, because part of the income flowing to capital would go to the state. But, with the exception of China, fiscal positions around the world are currently weak. As a result, deleveraging remains a clear priority in a range of countries, reducing growth, with fiscal countermeasures limited by high or rising government debt and deficits. Thus far, there is little evidence of willingness on the part of politicians, policymakers, and perhaps the public to reduce current consumption further via taxation in order to create room for expanded growth-oriented investment. In fact, under fiscal pressure, the opposite is more likely. In the US, few practical measures that address the distributional challenge appear to be part of either major party's electoral agenda, notwithstanding rhetoric to the contrary. To the extent that this is true of other advanced economies, the global economy faces an extended multi-year period of low growth, with residual downside risk coming from policy gridlock and mistakes in Europe, the US, and elsewhere. That scenario implies slower growth – possibly 1-1.5 percentage points slower – in developing countries, including China, again with a preponderance of downside risk. Copyright: Project Syndicate, 2012. http://www.theguardian.com/business/economics-blog/2012/sep/14/global-economy- sluggish/print

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What's the Single Best Explanation for Middle-Class Decline?

DEREK THOMPSONAUG 20 2012, 6:22 PM ET Here's one answer: In the age of globalized profits, all job creation is local. Reuters

Median household income is in the middle of its worst 12-year period since the Great Depression. David Leonhardt and the New York Times have launched a feature to investigate the hardest question: Why? I don't know! Or at least, I have no confidence that I understand exactly which issues had exactly what effect on the stagnation. The flat-lining of middle class wages is probably the most important long-term economic story in the United States, and its roots stretch deep into such far-flung themes as how technological changes hurt unions and how the subsidy for employer-provided insurance contributed to escalating health care costs. When I write about income stagnation apart from the Great Recession, I typically rely on a trio of explanations: Globalization, technology, and health care. Competition drives down costs. Shoppers understand this, intuitively. One reason that flat-screen TV prices have fallen so much in the last ten years is that so many electronics companies have gotten efficient at making them. Similarly, competition for jobs in tradable goods and services -- manufacturing that could be done in China; retail that's simpler on Amazon -- competes down the price employers pay workers in those industries. It makes many workers borderline-replaceable and nothing borderline- replaceable is expensive. Those forces drove down wages, and employer-side health care costs gnawed at the rest of it. But these are fairly predictable answers. So here's something weirder and more colorful: As economics went global, job creation went local. That sounds totally backward. But it's true.

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Here's a graph of job creation by industry since 1939. The graph tells a lot of stories, but I'll call out two. Manufacturing -- a strong force for unions and median income growth - - really starts to collapse just as our current 12-year slump commences. That can't just be a coincidence. But now look at "Ed/Med" which is the education and health care industries. Uniquely among sectors, this segment defy the laws of cyclicality. It just goes up!

About half of the jobs created between 1990 and 2008 (before our current downturn) were created in education, health care, and government. What do those sectors have in common? They're all local. You can't send them to Korea. As Michael Spence has explained, corporations have gotten so good at "creating and managing global supply chains" that large companies no longer grow much in the United States. They expand abroad. As a result, the vast majority (more than 97%, Spence says!) of job creation now happens in so-called nontradable sectors -- those that exist outside of the global supply chain -- that are often low-profit-margin businesses, like a hospital, or else not even businesses at all, like a school or mayor's office. It is both ironic and unavoidably true that the era of globalized profits has dovetailed with the era of localized job creation in low value-added industries, and that the upshot of this has been massive gains at the top and slow overall income growth for the rest of us. http://www.theatlantic.com/business/archive/2012/08/whats-the-single-best- explanation-for-middle-class-decline/261355/ 336

vox

Research-based policy analysis and commentary from leading economists A case for balanced-budget stimulus Pontus Rendahl 26 April 2012 Many developed economies are in a liquidity trap with interest rates at or near zero. Many also have high unemployment that looks set to persist. This column argues that it is times like these when governments should be spending more, not less – they just have to be careful how they do it. With debt-levels hitting record highs and growth running low on steam, European policymakers have found themselves facing a grim dilemma: should government spending be increased at the risk of reawakening the wrath of the sovereign bond markets? Or should austerity instead assume the political mantra with the hope of merely muddling through? True, substantial theoretical and empirical evidence lend support to the idea that a deficit-financed expansion in public spending may raise output and speed up the recovery. And the most recent experience in Europe has shown with terrifying clarity that high levels of debt may provoke yet another round of sovereign debt crises. But there is little, if any, support in the current macroeconomic literature for the view that expansionary fiscal policy must come at the price of ramping up debt. In fact, contemporaneously tax-financed spending might do the trick equally well. And inasmuch as a ‘balanced-budget stimulus’ can set the economy on a steeper recovery path, the long-run sustainability of debt may well improve, and not deteriorate (DeLong and Summers 2012). The reasoning underlying these ideas is known as Ricardian equivalence (Barro 1974). Yes, the same theorem that allegedly bears responsibility for putting a “nail in the coffin” of the Keynesian multiplier (Cochrane 2009) also suggests that spending will have the same effect independently of its source of financing. Ricardian equivalence states that, under certain conditions, financing a given level of spending through debt (ie future taxes), or through current taxes, is irrelevant. Yet while Ricardian equivalence might have put a nail in the coffin of the Keynesian multiplier, it has certainly not pre-empted the underlying idea: that an increase in government spending may provoke a kickback in output many times the amount initially spent. Indeed, a body of recent research suggests that the fiscal multiplier may be very large, independently of the foresightedness of consumers (Christiano et al 2011, Eggertson 2010). And in a recent study of mine (Rendahl 2012), I identify three crucial conditions under which the fiscal multiplier can easily exceed 1 irrespective of the mode of financing. These conditions, I argue, are met in the current economic situation.

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Three conditions for a large balanced-budget multiplier Condition 1. The economy is in a liquidity trap … When interest rates are near, or at, zero, cash and bonds are considered perfect substitutes. As the intertemporal price of money fails to adjust further, a disequilibrium emerges in which the demand for assets exceeds the supply. A dollar lent is no longer a dollar borrowed, and cash is instead hoarded. Figure 1 illustrates the evolution of US banks’ cash reserves held at the Federal Reserve from 2003 until today. While money, of course, is a very elusive concept, the skyrocketing rise of bank cash reserves suggests that liquid means are being pulled out of circulation. Figure 1.

Under these peculiar circumstances the laws of macroeconomics change. A dollar spent by the government is no longer a dollar less spent elsewhere. Instead, it’s a dollar less kept in the mattress. And the logic underpinning Say’s law – the idea that the supply of one commodity must add to the immediate demand for another – is broken. In a liquidity trap, the supply of one commodity (eg labour) may rather add to the immediate demand for cash, and not to any other real commodity per se (Mill 1874). From merely being a means of payment, cash turns into a means of storage. Condition 2. … with high unemployment … So while a dollar spent by the government is not a dollar less spent elsewhere, it is not immediate, nor obvious, whether this implies that government spending will raise output. The second criterion therefore concerns the degree of slack in the economy.

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If unemployment is close to, or at, its natural rate, an increase in spending is unlikely to translate to a substantial rise in output. Labour is costly and firms may find it difficult to recruit the workforce needed to expand production. An increase in public demand may just raise prices and therefore offset any spending plans by the private sector. But at a high rate of unemployment, the story is likely to be different. The large pool of idle workers facilitates recruitment, and firms may cheaply expand business. An increase in public demand may plausibly give rise to an immediate increase in production, with negligible effects on prices. Crowding-out is, under these circumstances, not an imminent threat. Combining the ideas emerging from Conditions 1 and 2 implies that the fiscal multiplier – irrespective of the source of financing – may be close to 1 (cf Haavelmo 1945). Condition 3. … which is persistent But if unemployment is persistent, these ideas take yet another turn. A tax-financed rise in government spending raises output, and lowers the unemployment rate both in the present and in the future. As a consequence, the increase in public demand steepens the entire path of recovery, and the future appears less disconcerting. With Ricardian or forward-looking consumers, a brighter outlook provokes a rise in contemporaneous private demand, and output takes yet another leap. Thus, with persistent unemployment, a tax-financed increase in government purchases sets off a snowballing motion in which spending begets spending. Where does this process stop? In a stylised framework in which there are no capacity constraints and unemployment displays (pure) hysteresis, I show that the fiscal multiplier is equal to the inverse of the elasticity of intertemporal substitution, a parameter commonly estimated to be around 0.5 or lower. Under such conditions, the fiscal multiplier is therefore likely to lie around 2 or thereabout. Collecting arguments To provide more solid grounds to these arguments, I construct a simple DSGE model with a frictional labour market.1 A crisis is triggered by an unanticipated (and pessimistic) news shock regarding future labour productivity. As forward-looking agents desire to smooth consumption over time, such a shock encourages agents to save rather than to spend, and the economy falls into a liquidity trap. In similarity to the aforementioned virtuous cycle, a vicious cycle emerges in which thrift reinforces thrift, and unemployment rates are sent soaring. Figure 2 illustrates the associated fiscal multiplier (y-axis) under a range of news shocks, stretching from a 7% decline in labour productivity to a 3% increase. The unemployment rate is given in brackets. There are three important messages to take away from this graph. • First, for positive or small negative values of the news shock, the multiplier is zero. The reason is straightforward: With only moderately pessimistic news, the nominal interest rate aptly adjusts to avert a possible liquidity trap, and a dollar spent by the government is simply a dollar less spent by someone else. • Second, however, once the news is ominous enough, the economy falls into a liquidity trap. The multiplier takes a discrete jump up, and public spending

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unambiguously raises output. Yet, in a moderate crisis with an unemployment rate of 7% or less, private consumption is at least partly crowded-out. • Lastly, however, in a more severe recession with an unemployment rate of around 8% or more, the multiplier rises to, and plateaus at, around 1.5. Government spending now raises both output and private consumption, and unambiguously improves welfare. Figure 2.

Conclusions Pessimism and uncertainty about the future fuels fear, and fear is, as we know, a powerful thing. • A gruesome outlook can set the economy on a downward spiral in which fear reinforces fear; thrift reinforces thrift; and unemployment rates are sent soaring. But the same mechanisms that may cause a vicious circle can also be turned to our advantage. • A tax- or debt-financed expansion in government spending raises output and sets the economy on a steeper path to recovery. Pessimism is replaced by optimism and spending begets spending. But these times are also fragile. Without a credible plan for financing, an increase in government spending will come at the price of debt. And a rise in debt may contribute

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to further rounds of pessimistic expectations. To be successful, therefore, the tax and spending policy advocated in this column must not magnify people’s insecurities. References Barro, Robert (1974), “Are Government Bonds Net Wealth?”, Journal of Political Economy, 82(6). Christiano, Lawrence, Martin Eichenbaum, and Sergio Rebelo (2011), “When is the Government Spending Multiplier Large?”, Journal of Political Economy, 119(1). Cochrane, John (2009), “Are We All Keynesians Now?”, The Economist. DeLong, Bradford, and Lawrence Summers (2012), “Fiscal Policy in a Depressed Economy.” Brookings, March. Eggertson, Gauti B (2010), “What Fiscal Policy is Effective at Zero Interest Rates?”, NBER Macroeconomics Annual, 25(1). Federal Reserve Economic Data (FRED), Data, http://research.stlouisfed.org/fred2/ Haavelmo, Trygve (1945), “Multiplier Effects of a Balanced Budget”, Econometrica, 13(4). Mill, John S (1874), Some Unsettled Questions of Political Economy, London: Longmans, Green, Reader and Dyer. Rendahl, Pontus (2012), “Fiscal Policy in an Unemployment Crisis”, University of Cambridge Working Paper, February.

1 DSGE model = Dynamic Stochastic General Equilibrium model. http://www.voxeu.org/article/time-spend-new-insights-multiplier-effect

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Books Michael Spence’s “The Next Convergence: The Future of Economic Growth in a Multispeed World

By Daniel Gross August 11, 2011 The World is Flat! China is the Future! America is Finished! Many of our most celebrated econopundits traffic in such oversimplified, sensationalized rhetoric, especially in times of market turmoil and economic uncertainty. But the global economy is too complicated for slogans. Which is one reason why Michael Spence’s new book is so refreshing. Spence, who shared the Nobel Prize in economics with Joseph Stiglitz in 2001, has systematically investigated the origins of hypergrowth, the process through which national economies rise from poverty to relative prosperity. In “The Next Convergence,” he presents a nuanced, highly readable argument on the symbiotic, fraught relationship between today’s booming developing markets and the seemingly stagnant developed ones. In 2011, the global economy doesn’t stand at the dusk of one era, or at the dawn of another. Rather, we’re smack in the middle of the “third century of the Industrial Revolution.” Until roughly 1750, the world economy was a stagnant cesspool of poverty and misery. But after two centuries of innovation and growth, the handful of nations that followed the United Kingdom into industrialization prospered mightily. By 1950, Spence writes, “the average incomes of people living in these countries had risen twenty times, from about $500 per year to over $10,000 per year.” Unfortunately, these places housed just 15 percent of the globe’s population. The author points out that in the decades since 1950, as political, social and technological barriers fell, the growth virus spread to populous nations such as China and India. And it’s still spreading like Groupon. By 2050, Spence argues, our descendants will inhabit a world “in which perhaps 75 percent or more of the world’s people live in advanced countries.” In the future, we’ll all be comparatively rich, and the gulf separating the typical American consumer from the typical Indian one won’t be quite so large. “The huge asymmetries between advanced and developing countries have not

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disappeared, but they are declining, and the pattern for the first time in 250 years is convergence rather than divergence.”

‘The Next Convergence: The Future of Economic Growth in a Multispeed World’ by Michael Spence. Farrar Straus Giroux. 296 pp. $27 (Farrar, Straus & Giroux) The formula for success seems simple: Unleash the spirit of capitalism and plug into the vibrant world of globalization and trade. As an open nation, capitalist South Korea saw its GDP per-capital rise from a pathetic $350-$400 in 1960 to $20,000 in 2005. By comparison, walled-off North Korea hasn’t enjoyed any growth in the past half-century. But Spence notes that convergence isn’t a matter of flipping a switch. For a country to boost per capita income from $500 to $20,000, it takes 50 consecutive years of 7 percent annual growth. And in the last half century, only 13 nations (mostly Asian countries, plus Brazil and Botswana) have managed to notch 25 straight years. Nor is that formula for success quite as simple as many free-market economists would have us believe. Adhering to the rules of supply and demand and competing in international markets are important. But factors that typically don’t enter the glossary of Econ 101 textbooks can play a larger role, including leadership, governance, institutions and politics. While many economists profess disdain for the softer social sciences, Spence taps liberally into sociological and psychological factors. Human curiosity is a “very powerful, and largely noneconomic, force,” he writes. “Inclusiveness turns out to be an essential part of sustaining growth.” Ironically, democracy is one factor that Spence says is not necessarily required to get rich. Countries whose authoritarian governments take 343

economic performance and growth seriously generally act competently and offer a significant amount of economic freedom to make the transition. (Nihao, China!) But Spence is not a China bull in the bookshop. The world’s most populous country has entered uncharted territory, growing (collectively) rich as it remains (individually) poor. Never before in history has a country with such a low per capita income played such a central role in the global economy. Departing from much of the economic consensus, Spence argues that China faces significant hurdles in powering through its awkward adolescence. Countries that have thrived as low-cost labor hubs lose out to poorer countries as they grow richer. In time, China (and India) will inevitably see their impressive growth rates slow. “Advanced countries do not grow at 6-10 percent a year.” From here on out, Spence writes, China’s growth will depend on major political and social decisions. And he’s skeptical as to whether Beijing can engineer a smooth transition from manufacturing to services. He is more optimistic about India’s prospects, despite that nation’s deficiencies in infrastructure, education and planning. (Readers will get a sense that Spence is rooting for India because it is a democracy.) Convergence doesn’t just hinge on how well the poor countries can manage their progress. It also rests on how well the already rich minority can cope with and abet the process. Protectionism is on the rise in advanced economies that see their relative advantage slipping away, he notes. And the U.S. consumer’s insatiable demand for goods, which helped propel a great deal of developing-world economic growth, is now a fading force. Spence’s use of data and history is as impressive as his avoidance of empty sloganeering. Rather than offer deterministic and hopelessly naive bromides, Spence offers deep insights with a winning, refreshing humility rarely seen in Nobel Prize-winning economists. He seems to have taken to heart the advice of another Nobel laureate, the Danish physicist Neils Bohr, who famously said, “Prediction is very difficult, especially about the future.” While Spence has written a book about what will happen in 2050, he concludes by similarly conceding that all crystal balls are hazy. “We do not know, and probably cannot calculate, what the medium-term destination will be,” he writes. “It is not that the principles and forces aren’t understood. It is rather that the system is too complex to lend itself to forecasting.” Daniel Gross , a columnist at Yahoo! Finance, is working on a book about the post-crisis U.S. economy. http://www.washingtonpost.com/entertainment/books/michael-spences-the-next- convergence-the-future-of-economic-growth-in-a-multispeed- world/2011/06/27/gIQAagtU9I_story.html

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A response to: Is the era of cheap Chinese labour over? Jul 16th 2010 Chinese wage convergence has a long way to go Stephen Roach our guest wrote on Jul 18th 2010, 21:35 GMT

NOTWITHSTANDING all the hype over surging Chinese wages, it is entirely premature to declare an end to the global labour cost arbitrage that has long worked in China's favour. Actually, the recent outbreak of minimum wage hikes is, in large part, going according to script as stipulated by China's 2004 labour reforms, which required local governments to raise minimum wages at least every other year. In the depths of the Great Crisis in late 2008, when Chinese exports were under severe downward pressure, the government ordered a deferral of scheduled increases in minimum wages in an effort to combat mounting recessionary risks. In the face of a more stable global climate and impressive resilience in the Chinese economy, that emergency policy is now being relaxed. In that important respect, recent increases in minimum wages are a catch-up from previously slated hikes that had been foregone in the crisis.

Nor do the data on international wage comparisons point to dramatic deterioration in China's wage advantage. According to research published in the Monthly Labour Review of the US Bureau of Labour Statistics in April 2009, compensation of Chinese manufacturing workers was only $0.81 per hour in 2006—just 2.7% of comparable costs in the US, 3.4% of those in Japan, and 2.2% of compensation rates in Europe. While these figures are now out of date by nearly four years, they underscore the magnitude of the gap between China and the developed world—and how difficult it would be to close that gap even under the most excessive of Chinese wage inflation scenarios.

For example, even if Chinese manufacturing wages increased at an average annual rate of 25% over the 2007-10 period—highly unlikely for reasons noted below—the hourly compensation rate would be just $1.98 in 2010. That would boost Chinese compensation to only about 4% of US pay rates—barely making a dent in narrowing the arbitrage with major industrial economies. A similar, albeit unsurprisingly less dramatic, comparison would be evident with the developing world. At $1.98 per hour in 2010, Chinese hourly compensation in manufacturing would still be less than 15% of that elsewhere in East Asia (ex Japan) and only about half the pay rate in Mexico.

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It is important to stress that this 25% hypothetical wage-inflation scenario is well beyond the outer bound of any conceivable outcome for China. While minimum wage gains in some provinces may well be rising at such a clip, there is good reason to believe that between one-third and one-half of all Chinese manufacturing employees are currently paid above the minimum wage. Inasmuch as higher paid workers would be largely unaffected by recent actions, total wage increases would be considerably less than those accruing to the low end of the Chinese pay scale.

At the same time, it is equally important to put Chinese labour compensation pressures in the context of rapidly increasing worker productivity. Based on data from the World Bank, annualised productivity growth in the Chinese manufacturing sector appears to have been running in the 10% to 15% range since 1990—not all that dissimilar from gains in real hourly compensation. That would imply only marginal upward pressure on unit labour costs—suggesting little underlying deterioration in Chinese competitiveness. Moreover, the impact of rising wage pressures also needs to be judged in the context of other dimensions of China's competitive advantage—namely, scale, infrastructure, pan-Asian supply-chain logistics, and the relatively recent installation of state-of-the-art production technologies. China has lost little, or none, of the edge in those areas.

Finally, it is important to note that increasing worker compensation is a key ingredient of China's pro-consumption growth strategy. The shortfall in the growth of consumer purchasing power is an important outgrowth of an unusually low 40% share of personal income currently prevailing in the Chinese economy—down over ten percentage points from the 51% reading in 2000. To the extent that compensation increases outstrip the growth in GDP, the labour income share will rise—setting stage for increases in household purchasing power, which are critical for pushing China's consumption share of its GDP up from the rock-bottom 36% reading in 2009. Rather than bemoaning the end of low Chinese labour costs, the global debate should focus more on the constructive implications of this development for the long-awaited pro- consumption rebalancing of the Chinese economy.

Other active discussions about this question:

Tyler Cowen our guest wrote on Jul 16th 2010 19:34 GMT//The important thing is Chinese productivity is rising(8)

Yang Yao our guest wrote on Jul 16th 2010 15:08 GMT//No, the Lewisian turning point has not yet arrived(7)

Ricardo Hausmann our guest wrote on Jul 19th 2010 19:59 GMT//Adjusted for product mix, Chinese labour is still cheap(2) http://www.economist.com/economics/by-invitation/guest- contributions/chinese_wage_convergence_has_long_way_go 346