The Taylor Rule for Greece

Posted by on May 13, 2012 2 comments

One of the things we’re doing for a paper is to compare monetary policy in the euro zone with what would, ideally, have happened in Greece. Applying a simple Taylor Rule — as scheduled out by Fernanda Nechio – with the average yearly ECB rate we get that, leading up to the crisis, ECB’s interest rate policy was way too loose to curb inflation in Greece. The NAIRU we used was from OECD’s database. Here’s the graph:

Picture 1 The Taylor Rule for GreeceThe monetary policy of the ECB was way too loose for a long time. The NAIRU of Greece is insanely high (often above 10 %), thus making inflation more of an issue (in this model). It is one of the big problems now: Competitiveness. Greek wages rose too much (like Spain) and they are now less productive, needing huge deflation relative to the rest of the euro.

And yes, ECB has a single mandate, making it all the more troublesome that monetary policy was not curbing inflation, at least in Greece.

EUR/CHF = Pegged?

Posted by on May 6, 2012 No comments

A follow-up on my last post, Bruce Krasting says that the CHF is now, effectively, pegged to the euro. It has been held up because the SNB has been buying CHF, but that means their reserves has dwindled, making up room for further selling of CHF, which would increase their reserves (they create CHF and sell them for foreign assets).

So on the one hand, the SNB has been buying into a market that has largely been speculating whether the floor will be changed to 1.25 (or 1.30). It feels a little like Jedi Economics (or reverse Jedi Economics?), because the SNB has actually fuelled some of the rumors (or not denied them). There is still speculation whether the floor will be raised.

Central banks in the developed world (ECB, BoJ, the Fed, BoE, SNB) have resorted to this kind of positioning and communication strategy, because they can’t do much else.

Anyway, it is just interesting. If one just looks at the EUR/CHF chart, one wouldn’t expect that all sorts of stuff is happening behind the scenes. Or maybe one would. I guess that’s the game now. Not just in FX.

Will the SNB keep defending its floor?

Posted by on May 1, 2012 1 comment

One of the curiosities since September has been the EUR/CHF exchange rate. As most know, the SNB has a “floor” that the exchange rate is allowed to trade to. From 1.20, the SNB stands ready to sell unlimited quantities, because people were buying CHF in high volumes, driving the price of their currency up. This meant cheap imports and, consequently, made it harder to export. Here is the EUR/CHF exchange rate via the ECB for the last year:

Picture 5 300x207 Will the SNB keep defending its floor?

So, as is evident, the exchange rate hasn’t really been that volatile as of late, mostly because it is trading very closely to the floor.

I would say that the reasons it hasn’t been touching 1.21 — apart from the fact that the SNB stands ready to buy in unlimited volume at 1.20 — could be that 1) the SNB is in the market, 2) market-makers know that the SNB stands ready with huge buy-orders and would front-run any attempt, 3) easy arbitrage whenever the rate approaches 1.20 (because hedge funds know the SNB won’t let it go through), or 4) that the inflow of money into Switzerland is cooling off.

Of those, I see #4 as unlikely. The (lack of) volatility in price itself is remarkable, and the odds of it stabilizing at exactly 1.20 is ridiculous.

We’re, thus, left with the fact that the central bank is keeping the currency artificially low. That’s perfectly fair, especially for a country such as Switzerland where exports count for more than 50 % of GDP, according to the World Bank. A currency driven higher by massive inflows would make them uncompetitive (although reserves are nice).

Can the SNB keep the floor to 1.20? Theoretically, yes. A floor is easy to maintain when one controls the currency (and the printing press). The SNB will just stand ready to sell CHF in unlimited quantity at 1.20. Some, however, say this is not viable, because there is upward pressure on the currency. Here’s Bruce Krasting:

The EURCHF has been trading at less than 1/8th percent away from the intervention level of 1.2000 for over a month. This is an accident waiting to happen. It looks very quiet on the charts, but there is a steam kettle with a hot fire underneath this chart. If the French election goes against Sarkozy, I have to believe the kettle is going to blow a few rivets.

Indeed, it looks a little too risky. Here’s today’s price via Bloomberg:

Picture 7 Will the SNB keep defending its floor?A little too tight.

The floor has been tested. Now, the SNB (supposedly) has standing orders to buy at the major banks that have credit lines at the SNB. A few trades happened below 1.20, but it wasn’t because the SNB wouldn’t buy — it was because the FX market is much more decentralized than other markets.

It is certainly one of the main issues to watch in the coming months. Let’s just speculate and say that the euro crisis is not over, major panics start , increasing interest rates in the periphery, bank deleveraging causing further recessions, Holland and Merkel going head-to-head, and all the other issues currently unresolved in the euro will unfold. Will the SNB have to actively defend its floor? Worth a look.

Finally, here’s the exchange rates for the other major currency pairs via the SNB:

Picture 71 Will the SNB keep defending its floor?

Politicians and Game of Thrones

Posted by on April 28, 2012 No comments

Sober Look did a post on French politicians versus their U.S. counterparts. I thought this Saturday would therefore make a good time to post this hilarious picture on U.S. politicians and their Game of Thrones counterparts (click to enlarge, source unknown to me):

577586 10150778790365688 692205687 9767484 819022638 n 166x300 Politicians and Game of ThronesSomehow, I feel a strong resemblance to the (awesome) dwarf.

Yes, Sweden’s floating currency helped them

Posted by on April 23, 2012 No comments

I thought this was very persuasive from Brad DeLong on the Swedish economy, a lecture on how not to discuss economics. Something for the Danish politicians to think about:

Listening to Sweden’s Finance Minister Anders Borg on Charlie Rose was, I found, quite frightening.

At least where I sit, the biggest piece of Sweden’s response to the downturn was an aggressively expansionary monetary policy that lowered the value of the kroner by 15% just as the downturn hit and switched a lot of European demand into Sweden:

Yes, Swedens floating currency helped them

In a small open economy like Sweden, even small declines in the value of the currency can generate large increases in aggregate demand. That was what kept the rise in the Swedish unemployment rate at a mere 2% points, compared to 5% points here in the United States:

Yes, Swedens floating currency helped them

But Borg was, instead, parroting the Alesina-Ardagna line akrateros, claiming that tight fiscal policy had worked wonders in Sweden–and that the reason that Germany had a smaller downturn than the U.S. was that Germany had undertaken less expansionary fiscal stimulus.

First of all, that claim simply is not true: the differences in discretionary fiscal stimulus undertaken by Germany and the U.S. were trivial:

Yes, Swedens floating currency helped them

Second, if it were to be true, it would have been because less fiscal stimulus in Germany would have boosted confidence, generated greater declines in interest rates, and so boosted private investment spending. But the declines in interest rates in Germany and the U.S. during this crisis have been equivalent: both are creditworthy governments benefitting from a flight to quality:

Yes, Swedens floating currency helped them

Yes, Swedens floating currency helped them

Why oh why can’t we have better European finance ministers?

Target2, flow of funds, and liquidity providing banks

Posted by on April 21, 2012 2 comments

The debate is still going on whether Target2 is a big problem or nothing more than an aberration. I tend to be in the first camp. What I see as the problem is that, because of Target2 imbalances, monetary policy is less effective and limits the political flexibility. Here are my reasons:

1) The excess liquidity that flows into mostly German banks make monetary policy harder, because it distorts the usual interest rate mechanism by which the ECB can influence rates, thus leaving repo-rates and the liquidity channel to target.

2) People say that it is only a problem if the eurozone breaks, at which point we’ll have more problems than Target2 imbalances. Not so. The mere existence of Target2 imbalances make a break-up much less likely, because the bigger the liabilities, the more the core would stand to lose in a break-up.

3) It provides an interesting view of the actual money flows in the eurozone.

Case in point of the last one is here. The ECB’s Eurosystem Oversight Report. Buried on page 49 is a graph of how important banks function as ‘liquidity providers’ within communities of the eurosystem. In the ECB’s words:

A clear view of the network of payments is useful to overseers for various reasons. It helps to identify banks which are “central” from a liquidity circulation point of view. It can reveal possible dependencies between banks in terms of liquidity provision. Moreover, observing the network over time can reveal trends or anomalies. If these lead to stress events, the anomalies may be used as early warning indicators.

Therefore, liquidity can be viewed as flowing between the big consolidated banks and, from these, to the smaller banks.

Graphed that looks like this:

Picture 3 262x300 Target2, flow of funds, and liquidity providing banksPicture 4 233x300 Target2, flow of funds, and liquidity providing banksPicture 5 269x300 Target2, flow of funds, and liquidity providing banks

If I understand it right, a few large banks are thus — now more than ever — too big to fail, because an important part of the payment system runs through the large banks.

Target2 gives insight to the flow of funds in the eurozone. If I read that right, this is a strong argument against a break-up of the eurozone, because the technical consequences would be large, in addition to the assets the Bundesbank would lose, as a Greek exit (to pick randomly) would probably mean a default on those obligations.

It is going to be interesting to see the Target2 flows from Spain in the coming months. If we see a continued outflow of funds, and thus a rise in liabilities, it could, ironically, reduce the risk of a break-up. What a big-bank bankruptcy would do is left with no answer..

What We’re Reading

Posted by on April 17, 2012 No comments

A couple of long reads and a couple of short ones.

The long ones (yes, I’m writing an exam on the topics):

Short ones:

Picture 1 300x229 What Were Reading

Why democracy sucks

Posted by on April 16, 2012 2 comments

Business Insider leads us to this by Richard Koo from Nomura:

democracy Why democracy sucksChurchill once said, “The best argument against democracy is a five minute conversation with the average voter”. He also said, “democracy is the worst form of government except all those other forms that have been tried from time to time”.

It does present some challenges.

Accountability on TV2 News

Posted by on April 13, 2012 No comments

A couple of months ago, Greek “expert” Tom Kristensen was on TV2 News talking nonsense. I know, because I wrote about it at the time.

Now a little Monday-morning quarterbacking. How is that banking crisis going that you ensured would come if Greece defaulted? Well, did anyone notice?

Now, I have a problem, because I can’t show you the clip. I’d like to, because he has been on tv claiming all kinds of nonsense at least two times in regard to the financial troubles of Greece. TV2 News — please upload video clips like other news organizations so we can hold people accountable for what they say.

Too many people get to talk without being called on the facts.

Graphs and graphs and more graphs

Posted by on April 12, 2012 No comments

Wow, Alphaville sends me to Thomson Reuters who gives a preview on their Datastream.

This is, indeed, the most scary one:

chart9 Graphs and graphs and more graphs