Killer Acquisition Theory in the Digital Age

https://www2.slideshare.net/mberre/berre-petit-2020-killer-acquisition-theory 

Max Berre and Nicolas Petit

This paper seeks to contribute to the growing literature on killer acquisitions and to the debate contextualizing the emergence of the Big-Data industry, in order to enrich and inform the debate, proposing threshold ideas for purposes of abuse of dominance and merger control. To that end, it takes a different approach, deconstructing the killer acquisition narrative. Because killer acquisitions are defensive in nature, serving to protect the market-share of incumbent firms.   

Overall, the debate can be approached via the examination of the relative likelihoods of competing acquisition objectives, effects, and contextual realities. Testing these may yield viable examination tools which could be put to use in real-world policy, advisory, or litigation contexts. The killer acquisition narrative is based on several conjectures that must be critically examined and rigorously tested prior to undertaking policy reform. This paper’s contribution is to provide a framework for said critical examination.

The 21^st-century emergence of the fourth-industrial-revolution has given rise to new technological and economic realities. The Big-Data and Internet of Things (IoT) industries in the digital marketplace has given rise to heated and lively debate concerning market-structure and competition-policy ramifications going forward as the 21^st century develops.

Because traditional measures and dynamics are fundamentally challenged by both the technology and the associated economic dynamics of 21^st century digital markets, exploration of the market-structure measures and dynamics of industries related to the fourth-industrial-revolution is increasingly necessary as new market-realities evolve. 

What is called for in a practical sense, is an examination of the various ways in which start-up acquisitions in the digital market-space can be examined, approached and weighed, for purposes of ex-ante or export investigation of mergers, acquisitions, and abuse of dominance.  

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Max Berre is an economist at Audencia Business School who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.

Nicolas Petit is a professor EU Competition Law based at the European University Institute, and is Joint Chair in Competition Law at the Department of Law and at the Robert Schuman Centre for Advanced Studies. He is also invited Professor at the College of Europe in Bruges. 

COHERENT STRESS TESTING: A BAYESIAN APPROACH TO SCENARIO ANALYSIS AND STRESS TESTING

https://www2.slideshare.net/mberre/hoffman-berre-coherent-stress-test 

Hoeffman and Berre

In January 2009, during the depths of the financial crisis, the Basel Committee on Banking Supervision published its view that the bank stress-testing which had so-far taken place across Europe and the US was insufficient for a number of reasons.

While the financial market had grown considerably more complex and less transparent since the previous round of financial crises at the end of the 20^th century, stress-testing had not kept up with the times. Forward-looking information was not-being taken into account. 

Rather, stress-test so far has been undertaken in the so-called frequentist way, meaning that purely quantitative and statistical approaches have been used. By definition, this way of doing things only examines historical data. Subjective data, which, in expert hands could be used to detect when it is that the current circumstances are likely to change -perhaps even in a heretofore unseen way- is overlooked. Also overlooked is forward-looking information of any kind. Nassim Taleb's famous book The Black Swan swan points to precisely this sort of thinking as being a major weakness in daily wisdom of financial economists prior to the start of the crisis. The idea that the situation might change was not appreciated. Nor was the idea that we may need to update our information to take into account current happenings.

In 2009 and 2010 Committee of European Banking Supervisors (CEBS) implemented the first and second EU-wide stress tests which were conducted along frequentist lines, examining at first only the largest 22 banks in Europe and later all of the systemically most important bank at the national level in Europe. Not surprisingly, the first two European stress-tests were widely considered failures. In 2011, the newly commissioned European Banking Authority (EBA) has thus taken to the task. Because the European stress tests tried to answer the question of what would happen in the event of both current loss expectations as well as a worst-case scenario whereby losses far exceeded current loss expectations but overlooked the possibility of multi-stage economic shocks, they represented the frequentist point of view. Essentially, they do not revise losses in a dynamic way. Thus, they have left something to be desired, irrespective of the number of banks or percentage of GDP investigated. 

Many experts now consider that the key missing ingredient from stress testing procedures is a solid way of capturing the co-relationships between the various stress events. With this in mind, the Bayesian net can help us understand the relationship between some of the key events. Consider for example the relationship between events A and C. 

The Bayesian Net

WHAT IS NEEDED IN STRESS TESTING?

The most important aspect needed in stress testing in order to overcome black swan events is a forward-looking element. Subjective probability is a plausible way in which this can be achieved. A subjective probability is essentially an opinion – hopefully a well-informed one – regarding the probability distribution of an event occurring. While there is no mathematical proof behind the answer, one can expect that in addition to historical probability distribution, a subjective probability might be influenced by expectations, indicators as to what may occur in the future, and indicators as to why this time might be different. The most significant upsides to this approach are the incorporation of a wide range of indicative and qualitative data, as well as the non-reliance on vast and often difficult-to-obtain amounts of data. The latter factor would render this approach particularly valuable during scenarios involving one or more extremely rare (statistical tail) events.

Another important issue which needs to be addressed in stress testing is correlation of shocks. In many stress tests, this has truly come to be a key missing ingredient. The simple fact that a financial institution survives an economic shock may might not be perfectly indicative of bank-survivability when the economic shock in question might also set off (or might otherwise be associated with) a chain reaction of economic shocks.  

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About the Authors:

-Max Berre is an economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.
-Kevin Hoefman is a lecturer of software programming at Hogeschool West-Vlaanderen and a former software engineer and video game programmer. 

What Makes a Credible Minimum Wage Study?

http://escholarship.org/uc/item/3hk7s3fw#page-1

A study released earlier this year by the University of California's Institute for Research on Labor and Employment takes a nuanced view of recent studies which have been published about the labor-market effects of the minimum wage. 

Because minimum wage policy has recently become a highly-contentious policy issue in both the US and Europe, the academic debate has also intensified, with much of the discussion focusing on the underlying empirical methodology to be used for examination of the minimum wage. At stake is the accurate determination of the effect of minimum wage policy. 

The study considers use of spatially-related control variables to be essential, due to both structural and cyclical differences between and among states, cities, regions, and counties. A valid minimum wage study should also, according to the authors, differentiate between different segments of the labor force and should be able to measure actual effects on wages of minimum wage statutes. Overall, labor-market heterogeneity is not taken into effect as much as it should be. Failure to do so can and has clouded empirical results in minimum wage studies.

Abstract

We assess alternative research designs for minimum wage studies. States in the U.S.with larger minimum wage increases differ from others in business cycle severity, increased inequality and polarization, political economy, and regional distribution. The resulting time-varying heterogeneity biases the canonical two-way fixed effects estimator. We consider alternatives including border discontinuity designs, dynamic panel data models, and the synthetic control estimator. Results from four datasets and six approaches all suggest employment effects are small. Covariates are more similar in neighboring counties, and the synthetic control estimator assigns greater weights to nearby donors. These findings also support using local area controls.
http://escholarship.org/uc/item/3hk7s3fw#page-1

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Max Berre is an economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.

OXFAM: Austerity Failed in Africa, Latin Am, Asia. Europe No Different

http://www.oxfam.org/sites/www.oxfam.org/files/bp174-cautionary-tale-austerity-inequality-europe-120913-en_1.pdf

Last month, Oxfam published a scathing report comparing Europe's post-2008 austerity policies, to those imposed by the IMF on Asia, Africa, and Latin America in the 1980s and 90s. While austerity in Europe have been guided by a certain naivete and blissful ignorance regarding the details and outcomes of austerity politics and structural adjustment in Asia, Africa and Latin America, the reality on the ground is that austerity programs in Europe, as in Asia two decades ago, have begun dismantling the very mechanisms responsible for reducing inequality and promoting stable, sustainable economic growth. Results were rising poverty and stagnant growth. 

As a result of austerity measures, Europe has begun seeing similar results, including slowest growth of all of the world's major economic regions, and slowest crisis recovery. Deficits have also risen as a percentage of GDP due to economic contraction. Moreover, according to Oxfam, European countries are suffering record levels of long-term and youth unemployment. Nearly one in ten working households in Europe now lives in poverty. Effects are most severe in countries that have undertaken the most aggressive spending cuts. Much like in the developing world, the dismantling of social cohesion has also lead to a rise in unrest in Europe. After policy failures in Asia and Latin America, traditional leading proponents of austerity in the developing world, the IMF and World Bank, have begun to formally recognize that austerity has stunted both economic growth and equality in much of the developing world. Unfortunately, it appears that Europe's policy circles failed learn that lesson from events in the developing world.

The Oxfam report makes policy recommendations focusing on investment in human capital development, expansion in public services, strengthening of institutional democracy and tax reform aimed at counteracting tax avoidance, as well as establishing a more progressive tax code. 

Abstract

European austerity programmes have dismantled the mechanisms that reduce inequality and enable equitable growth. With inequality and poverty on the rise, Europe is facing a lost decade. An additional 15 to 25 million people across Europe could face the prospect of living in poverty by 2025 if austerity measures continue. Oxfam knows this because it has seen it before. The austerity programmes bear a striking resemblance to the ruinous structural adjustment policies imposed on Latin America, South East Asia, and sub-Saharan African in the 1980s and 1990s. These policies were a failure: a medicine that sought to cure the disease by killing the patient. They cannot be allowed to happen again. Oxfam calls on the governments of Europe to turn away from austerity measures and instead choose a path of inclusive growth that delivers better outcomes for people, communities, and the environment. 

http://www.oxfam.org/sites/www.oxfam.org/files/bp174-cautionary-tale-austerity-inequality-europe-120913-en_1.pdf

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Max Berre is an economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.

NPR Piece: Can Human Genes Be Patented?http://www.npr.org/blogs/health/2013/04/15/177035299/supreme-court-asks-can-human-genes-be-patented

US Supreme Court Decision on Human Genome Patents http://www.supremecourt.gov/opinions/12pdf/12-398_1b7d.pdf

UK Supreme Court Decision on Human Genome Patents http://www.supremecourt.gov.uk/decided-cases/docs/UKSC_2010_0047_Judgment.pdf

ROI & The Economic Importance of Public Support of Scientific Research

Last month, academic advocate Zack Kopplin debated the importance of maintaining funding for scientific research, even in the face of other economic priorities. Kopplin argued that the Return on Investment reaped from the results of such research far outweigh both any costs associated with said research, and borrowing costs. 

Stephen Moore, a former fellow of both the Heritage Foundation and the Cato Institute, two prominent Washington DC-based free-market think-tanks provided the counter-point to Kopplin's argument. While at first arguing that the debt takes precedent over scientific funding, Moore resorted to mocking Kopplin's views via anecdotal mention of publicly-funded research on snail mating habits. "You are not a scientist" responded Kopplin. The host then chimed in to say that anecdotal arguments really have no place in a serious policy debate. 

We can all bring up anecdotes which, while not scientific, representative, typical, underline one's point of vies in the argument. In response to Moore's mention of funding for snail mating habits, I can also submit seemingly questionable research: on Oyster Glue.

2013 Story About Research on Oyster Glue
2010 Story About Research on Oyster Glue

For the past 13 years, research has been ongoing at Indiana's Purdue University, on exactly how Oysters, Mussels, Barnacles and other mollusks glue themselves to underwater surfaces. If this research doesn't seem relevant to society overall, think again. 

Although oyster glue research seems unorthodox, this research may very well yield an organic non-toxic glue, which can be used as an underwater construction material, or even to glue broken bones still inside a patient's body. From the economic point of view, the potential returns are enormous. So, we all have our anecdotes.

All jokes and anecdotes aside, the link between support for scientific research, and future economic growth is enormous, and simply cannot be downplayed or overlooked. 

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Max Berre is an economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.

LSE Study: Self-Fulfilling Crisis of Eurozone Sovereign Debt

Self-Fulfilling Crises in the Eurozone: An Empirical Test

In an empirical study on Eurozone sovereign debt published at LSE and at CEPS, an EU-financed economic policy think tank, has found definitive evidence of the fragility of Eurozone-member-nation debt vis-a-vis non-eurozone EU debt. In particular, the study finds that aggressive growth in Eurozone sovereign bond spreads since 2010 have been generally disconnected from key market fundamentals. Just outside of the Eurozone meanwhile, standalone countries have faced a much lower degree of sovereign bond volatility, despite having similar Debt-to-GDP ratios as their Eurozone counterparts.

What this all means is that the credibility and competence of the European institutions behind the Euro, are being called into question by the market, as panicky investors flee the Eurozone, and countries that are hit by the resulting liquidity crises are forced apply stringent, recession-causing austerity measures. While Greece had indeed accumulated an unsustainable Debt-to-GDP ratio, other Eurozone countries that were hit by the crisis had Debt-to-GDP levels, which were certainly not worse than the of the US and the UK. What is needed, LSE argues, are pro-liquidity policies aimed at preventing the spread of sovereign debt liquidity polices from one country to the next. Exactly the sort of the thing Merkel and her henchmen are against.

The study's main author, Professor Paul De Grauwe, a former Belgian senator, is widely considered to be Belgium's most renowned economist █

Abstract

We test the hypothesis that the government bond markets in the Eurozone are more fragile and more susceptible to self -fulfilling liquidity crises than in stand -alone countries. We find evidence that a significant part of the surge in the spreads of the PIGS countries in the Eurozone during 2010-11 was disconnected from underlying increases in the debt to GDP ratios and fiscal space variables, an d was the result of negative self -fulfilling market sentiments that became very strong since the end of 2010. We argue that this can drive member countries of the Eurozone into bad equilibria. 

We also find evidence that after years of neglecting high government debt, investors became increasingly worried about this in the Eurozone, and reacted by raising the spreads. No such worries developed in stand -alone countries despite the fact that debt to GDP ratios and fiscal space variables were equally high and increasing in these countries.
http://www.ceps.eu/ceps/dld/7085/pdf 

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Paul De Grauwe is a Professor in European Political Economy and head of the European Institute at the London School of Economics. He is also professor emeritus in international economics at KU Leuven and former member of the Belgian Federal Parliament.

US Congressional Study: Is Copyright the Free Market at Work?

http://www.publicknowledge.org/files/withdrawn_RSC_Copyright_reform_brief.pdf

In November 2012, the Congressional Republican Study Committee briefly launched - and subsequently retracted - an ideologically-unusual study casting skepticism on the state of American intellectual property law. While the study focuses on Copyright law, its conclusions are valid for intellectual property law at large. Overall the, the study challenges three standing ideas about IP law. 

1. The purpose of copyright is to compensate the creator of the content:

According to the study, purpose of the copyright system is to “promote the progress of science and useful arts.” IP law is supposed to incentivize innovation. To the extent that IP law fails to do so -as  has been the demonstrable case in the IT industry- IP law is not fulfilling its constitutionally-intended purpose. 

2. Copyright is free market capitalism at work:

In fact, IP law currently entitles the IP holder to a guaranteed, state-enforced monopoly. The retarding effect of this on the progress of economic growth cannot be overstated. 

3. The current copyright legal regime leads to the greatest innovation and productivity:

This echoes the claims many of economists who conclude that current IP stifles innovation and encourages rent-seeking, while interfering with productive participation in the economy as new information is systemically prevented from ever entering the public domain. Productive parties must deal with hampered access to useful knowledge, even decades after the initial discoveries.   

Ruffled Feathers

Responding to protests from congressional Republicans, the RSC removed the brief from its website in less than 24 hours and fired Derek Khanna, the study's constitutional strict-constructionist author. Khanna, a Yale Law Fellow, has subsequently become a contributor for Forbes. 

What Can Be Done?

A package of solutions was also proposed by the study. Currently, US has no disincentive against bogus IP claims, which do not actually have innovation behind them (such as attempts to copyright or patent traditional, folkloric knowledge). This could be reformed. Fair Use should also be expanded, and damages awarded for infringement should also be reformed. These measures would serve to discourage anti-competitive patent-trolling. 

The most significant reform that Khanna proposes, is to limit the length and renewability of IP protection, restoring IP protection to the competition-favoring, industrial-revolution-era version of itself. 

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Max Berre is an economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.

Warren and Bernanke on Addressing Too Big to Fail in US Banking Sector

http://www.kc.frb.org/Publicat/Reswkpap/PDF/RWP07-05.pdf

During a hearing of the Senate Banking Committee on February 26, Senator Elizabeth Warren interviewed Federal Reserve Chairman Ben Bernanke on the status of the US' largest banks. The central topic of the discussion was the "Too Big To Fail" issue. According to Warren, the TBTF  problem has actually gotten worse since the crisis began. Bernanke, agrees with the specification of TBTF problem. The plan apparently is to develop institutional mechanisms by which America's large systemic banks can be wound-down, should they fail. 

TBTF is toxic to the incentive structure underpinning a well-working financial market because it creates expectations that banks and other economic actors which are large enough to be systemic to a country's economy, and whose collapse would cause severe negative knock-on effects, making the consequences of bank failure disastrous to the economy as a whole. Market expectations are therefore, that the state would bail the banks out in case of failure, thereby dis-incentivizing prudent risk-management within the largest banks.

According to empirical research conducted by the Federal Reserve, banks are willing to to pay billions in added premiums associated with M&A costs in order to acquire TBTF status. What this should tell us is that American banks are definitely able to detect economic rents from becoming so large. 

Abstract

This paper examines an important aspect of the “too-big-to-fail” (TBTF) policy employed by regulatory agencies in the United States. How much is it worth to become TBTF? How much has the TBTF status added to bank shareholders’ wealth? Using market and accounting data during the merger boom (1991-2004) when larger banks greatly expanded their size through mergers and acquisitions, we find that banking organizations are willing to pay an added premium for mergers that will put them over the asset sizes that are commonly viewed as the thresholds for being TBTF. We estimate at least $14 billion in added premiums for the nine merger deals that brought the organizations over $100 billion in total assets. These added premiums may reflect that perceived benefits of being TBTF and/or other potential benefits associated with size.

http://www.kc.frb.org/Publicat/Reswkpap/PDF/RWP07-05.pdf

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Max Berre is an economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.

Are Tax Cuts Good for Growth?

http://www.dpcc.senate.gov/files/documents/CRSTaxesandtheEconomy%20Top%20Rates.pdf

Just before the 2012 US federal elections, a bi-partisan congressional study investigated the economic effect of tax cuts found their effects to be of limited usefulness. While proponents of higher tax rates argue that revenues are necessary for sovereign debt reduction, and that higher rates on the rich mitigate income inequality, the conservative camp argues that low tax rates are positive for investment, innovation and growth.

Nevertheless, the study found higher tax rates to be correlated with slightly higher GDP per capita growth rates. Meanwhile, the effect tax cuts on GDP growth is either small, or non-significant.“The reduction in the top tax rates appears to be uncorrelated with saving, investment and productivity growth. The top tax rates appear to have little or no relation to the size of the economic pie. However, the top tax rate reductions appear to be associated with the increasing concentration of income at the top of the income distribution,” concluded the report.

Senate Republican leader Mitch McConnell protested the study's ideological bias. It was subsequently removed from circulation by the Library of Congress.

Tax Reductions and Their Spending Cuts

http://www.imf.org/external/pubs/ft/wp/2006/wp0616.pdf

Against this evidence the effect of cuts must be considered. According to an empirical study undertaken by the IMF, spending cuts are useful for reducing sovereign risk spreads. Nevertheless, gains realized via reductions in sovereign risk spreads are short-lived and subject to market-bias. In 2011, the IMF launched another empirical study casting a skeptical light on the merits of using reductions in sovereign debt service costs due to cuts as an economic growth strategy. 

http://www.imf.org/external/pubs/ft/wp/2011/wp11158.pdf

Public expenditure returns on investment must be weighed against potential gains due to reductions in debt service costs. Taking all three studies into consideration, depending on tax cuts to deliver economic growth  yields little little-to-no long-term growth, while aggravating income inequality and increasing sovereign debt  - and private debt- service costs. In addition, the associated cuts generally lead to a contraction in GDP.   

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Max Berre is an economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.

Iceland Takes a Different Course

Fitch Ratings Full Report

We are perhaps all familiar with the meme in which Icelandic President Ólafur Ragnar Grímsson says that Iceland has been successful because it "Bailed its people out and put its bankers in jail". However, beyond the meme, what did Iceland's policy response actually look like?

As a result of Iceland's banking crisis, the country's sovereign debt stood at a staggering 240% of GDP. As Iceland's economy collapsed, the country suffered a 6.7% GDP contraction in 2009. Since then, sustained GDP growth between 2.5% and 3.0% has made-up for lost ground. 

In 2009, President Geir Haarde was indicted along with the CEOs of Iceland' three largest banks, Glitnir, Kaupthing, and Landsbanki. Thereafter, Iceland's policy response was partial forgiveness of home-owner debt, currency controls to contain risk, and a takeover and re-establishment of the domestic operations of Iceland's three main banks. According to Fitch's February 2012 Full Rating Report, "Iceland‟s unorthodox crisis policy response has succeeded in preserving sovereign creditworthiness at a price; capital controls continue to block repatriation of USD3bn- 4bn of non-resident investment in ISK instruments". Due to measures taken by Iceland, it has been largely unaffected by the Eurozone crisis. According to Fitch, Iceland's sovereign debt returned to investment-grade a year ago. Furthermore, future sovereign risk is considered minimal. 

In this clip, President Grímsson (Haarde's successor) was briefly interviewed at Davos. He cautions against a financial system combining privatized profits and tax-payer held losses, which bailing out the banks has led to. 

Last month, Iceland won a case at the court of the European Free Trade Association over disputes concerning tax-payer funded outlays to UK and the Netherlands stemming from collapse of Iceland's main banks, whose combined balance sheets stood at nine times Iceland's GDP.

Fitch's Full Rating Report
EFTA Court Judgement
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Max Berre is an economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.

IMF: Austerity Has Failed Europe

http://www.imf.org/external/pubs/ft/wp/2013/wp1301.pdf
In a recently published working paper, IMF chief economist Olivier Blanchard acknowledged that the IMF under-estimated the size of the macroeconomic multiplier. The result is that the negative economic effects of austerity in the Eurozone have also been under-estimated.  Whereas, the IMF estimated a GDP contraction of $0.50 for every dollar of spending cuts, the real contraction was in fact $1.50 for every dollar of spending cuts. According to the Washington Post, this amounts to an earthquake in policy circles. The allegations are that the IMF intentionally under-estimated the negative effects that austerity would have on Greece and its Eurozone neighbors.

Washington Post Wonkblog

Notwithstanding, words of caution were first issued by the IMF in a 2011 study which contested the idea of expansionary austerity, calling studies that support the concept biased in favor of over-estimating the expansionary effects that brought on by expanded private consumption expected to result from spending reductions.
http://www.imf.org/external/pubs/ft/wp/2011/wp11158.pdf

At the center of the IMF's under-estimation, is an overlooking of the fact that multipliers change over time. In its conclusion, the study cautions that, in general, multipliers grow during a crisis. "It seems safe for the time being, when thinking about fiscal consolidation, to assume higher multipliers than before the crisis." According to the study's conclusion, this change in multiplier size is due in part to changes in credit availability. Apparently, due to unexpected changes in the size of the multiplier, the paradox of thrift was - at least in this specific case - true after all.

Abstract:

This paper investigates the  relation between growth forecast errors and planned fiscal consolidation during the crisis. We find that, in advanced economies, stronger planned fiscal  consolidation has been associated with lower growth than expected, with the relation being  particularly strong, both statistically and economically, early in the crisis. A natural  interpretation is that fiscal multipliers were substantially higher than implicitly assumed by  forecasters. The weaker relation in more recent years may reflect in part learning by forecasters and in part smaller multipliers than in the early years of the crisis.
http://www.imf.org/external/pubs/ft/wp/2013/wp1301.pdf

http://www.imf.org/external/pubs/ft/wp/2011/wp11158.pdf

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Max Berre is an economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.

The Election of Shinzo Abe: Voters Mull over Monetary Policy

http://www.telegraph.co.uk/finance/economics/9751609/Japans-Shinzo-Abe-prepares-to-print-money-for-the-whole-world.html

http://www.ft.com/intl/cms/s/0/7e64027c-2f04-11e2-b88b-00144feabdc0.html#axzz2FguSUj9z

http://www.ft.com/intl/cms/s/0/a14281d8-2266-11e2-8edf-00144feabdc0.html#axzz2FguSUj9z

In the world's top creditor nation, a change in policy might soon be in store. Last week, hawkish opposition leader Shinzo Abe was elected to his second term. Abe's first term in 2006-2007 collapsed in the aftermath of Agricultural Minister Toshikatsu Matsuoka's suicide. Adopting an overtly expansionist economic stance for this election, Abe called for "unlimited" monetary policy easing in order to combat deflation and higher spending on both public works and national defense last month.

Among the key issues in the election, was the general timidity on the part of the BOJ to aggressively pursue inflation targets. Japan's financial markets, as well as its overall economy has been consistently undermined by deflation over the past 15 years.  

What it comes down to is there has been a feeling among the Japanese electorate, that monetary policy should be more aggressively expansionist. So far there have been five rounds of monetary stimulus in Japan. In February of this year, the BOJ set a short-term inflation goal of 1% and a long-term inflation goal of 2%. A move referred to as "meaningless" by Abe. 

BOJ's Independence

The Bank of Japan's independence is being called into question. Although a 1997 reorganization of the BOJ granted the central bank more independence, making the BOJ one of the last central banks in the world to gain independence, this electoral cycle saw both political parties campaigning on monetary policy issues. Both parties promised to call for more monetary easing. 

The new government has the power to appoint a majority bloc to the BOJ's policy board. It is likely this will happen. Furthermore, Abe has threatened to revise the Bank of Japan Act. 

What Does this Mean for Japan's Economy?

In general, there is a consensus that Japan must combat its deflation at all costs if indeed it is going to regain its lost economic growth and dynamism. 

While some may talk of structural reforms, the fact that Japan has an extremely high median age is -and thus a high dependency ratio- is a fact that cannot easily be maneuvered around. On the other hand, three prominent features of Japan's economy are its deflation rate, its extremely high savings rate, and the fact that Japan's investors have massive amounts invested overseas, making Japan the world's largest creditor. Expansionary monetary policy might be a positive step in addressing these issues.

Monetary stimulus would also help reduce the price of export-dependent Japan's currency on international markets, providing a boon to Japanese manufacturers.  

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Max Berre is an economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.

A Thought About Greek Austerity

Time to Scrap a Failed Policy. Time for Greece to Stand up for Itself

These days, we are living in the middle ages of economics, where we still treat headaches by drilling in to the head.. and we treat flesh wounds by hack-sawing limbs.... but at least we as a profession are (hopefully) starting to realize how foolish it all is.

This story is one where austerity demands lead to a full-on dismantling of the Greek GDP.. ostensibly to help things. Of course, if the GDP gets worse, then the Debt-to-GDP ratio will also get worse.. leading to yet another round of austerity (complete with the promise that *THIS TIME* it really is the last round of austerity). Greece has seen six rounds to far, and the situation only gets worse.

http://en.wikipedia.org/wiki/Greek_government-debt_crisis

When it's all said and done.. it will all seem as foolish as when the Austrians printed money in the 1920s in an attempt to alleviate hyperinflation. At the time, only Hayek saw the foolishness of it. Prescribing austerity to a country whose economy is collapsing is equally foolish.  In 20 years, we'll all look like idiots for not having known any better.

Results of Austerity

So far, Greek unemployment has tripled is this time in 2008, when the Greek crisis emerged, while interest rates on government bonds have reached 177%. If ever an economic policy failed, German-backed Greek austerity failed. To quote the BBC (a news source which is not sympathetic to any party in the eurozone crisis),

"The new Greek budget foresees a deepening of the worst recession of any country in modern history, our correspondent says.

The national economy is expected to shrink next year by 4.5% and public debt is likely to rise to 189% of GDP, almost double Greece's national output. This year, public debt stood at 175%.

The head of Syriza, a left-wing opposition party, said the latest budget cuts would leave Greeks unable to afford essential goods this winter."

http://www.bbc.co.uk/news/world-europe-20293058

Greek Left Detects the Pattern

Alexis Tsipras was quoted by NPR "I wouldn't be surprised if you were back again in a few months, asking for more cuts. Because these measures are going to bring a deeper recession and we'll have bigger debts." For some reason, this result  common to almost all austerity budgets that ever were, certainly true of Argentina, was not immediately obvious earlier.

http://www.npr.org/2012/11/08/164669209/greeks-in-store-for-more-austerity-cuts

What Should Be Done? 

As a matter of National Interest, Greece should realize the pattern being played out and act accordingly. The idea of the Greek government so beholden to foreign (German) economic interests that it is only able to survive by surrounding itself with increasingly massive security cordons is utter foolishness. The Greek government should come to its senses before it turns into the Argentine government. given both the current events, and the direction of things, that is evidently not far off. The looming threat is one of a complete loss of market confidence in Greek markets and Greek debts. But then we must ask... "Has this not already happened?" On the other hand, continuing with austerity will only exacerbate the already desperate economic situation. At this point, Greek citizens have nothing to lose but their chains.

As for economists, we should realize how ridiculous this all is.  Prescribing austerity to a country whose economy is collapsing is pure foolishness and we should see it for the quackenomics that it is.

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Max Berre is an economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.

Education's Return on Investment

OECD Education at a Glance 2012 Report

In this era of austerity, it must be remembered that expenditures by the state are not unilaterally expenses. Funds dispensed by the state are also investments, which yield a measurable return on investment. According to the OECD's Education at a Glance 2012 report, education-related expenses grant massive returns on investment at both public and private levels. The OECD reports that the Net Present Value of public and private premium for completing secondary and tertiary education is $388,300 for men and $250,700 for women across the 28 OECD member nations. The net public return for tertiary education is two to three times public investment level. 

Unfortunately, this is not the way that this issue has progressed. Education expenditures have recently become and issue for the wrong reasons in several places, such as the UK, Quebec and the Netherlands. 

A Question of Externalities

Another interesting aspect of the OECD report is the discussion over public and private returns to educational expenditures. Private returns on education are comprised by a measurable earnings gap as well as an unemployment gap. Public returns on education include tax revenue, an unemployment gap, and social contribution effects (which are housing benefits and social assistance that does not have to be paid by the taxpayer). In addition, higher education rates are directly causally linked to increased economic growth.

While costs are borne mostly by the individual, benefits are divided between the individual and the public. The combination of (partially) public gains and (mostly) private financing can cause a  costs-benefits mismatch which might lead to lower-than-optimal investment in education under laissez-faire, despite high returns, public benefits, and economic growth effects which education causes. 

While education is 31% privately financed in the UK, it is 97% publicly financed in Finland. In 2009, the US spent 2.6% of its GDP on tertiary education. More than half of this figure was comprised by private expenditures. 

What Should Be Done?

Expenditures of the state should be evaluated taking potential Return on Investment into consideration. For policy markers, this should mean that GDP growth, revenue growth, and growth levels in other relevant measurable metrics should be considered.  

The debate then shifts from asking "Can we afford to spend more on education?" to "How can we best spend on education in order to maximize future revenue growth?" and "How can educational expenditures help reducing other social costs, such as unemployment, housing subsidy, incarceration, and healthcare costs?"

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Max Berre is an economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.

Germany Restricts High-Frequency Trading, Chicago Fed Recommends Same

WSJ Article: Germany to Tap Brakes on High Frequency Trading
NYT Article: Germany Act to Increase Limits on High Speed Trades

Late last month, New York Times and WSJ reported on Germany's intention to restrict High Frequency Trading.  High Frequency Trading is the use of proprietary algorithms to trade securities rapidly and at high speed. The idea is to capture fractions of a penny per trade. 

Chicago Fed's Concern About HFT

Earlier this month, the Chicago Fed published an essay on the risks of HFT for financial markets. Every exchange it investigated has had problems attributable to errant algorithms and software malfunctions. The worst was the 2010 Flash Crash which caused a 700 point drop in the Dow within seconds. 

At fault is insufficient risk controls, a phenomenon due to the competitive time pressures involved. The Chicago Fed found that exchanges that impose pre-trade risk checks increase latency. Furthermore, investor confidence in the markets has also been adversely affected and the markets have seen a rise in volatility. 

In order to control risks associated with HFT, the Chicago Fed has recommended:

•               Limits on the number of orders that can be sent to an exchange within a specified period of time;

•               A “kill switch” that could stop trading at one or more levels;

•               Intraday position limits that set the maximum position a firm can take during one day; 

•               Profit-and-loss limits that restrict the dollar value that can be lost.

Chicago Fed Letter: How to Keep markets Safe in the Era of high-Speed Trading

Germany Acts to Restrict HFT

Draft legislation on the matter was approved by the German parliament. Proposed measures include requiring that all high-frequency traders be licensed, clear labeling of all financial products traded by HF algorithms without human intervention, and a limit to the number of orders that may be placed without a corresponding trade.

According to a press conference by the German Finance Ministry, as much as 40 percent of all trading sales can be attributed to HFT. Germany's goal in acting are essentially to limit the identified risks associated with HFT. If the bill becomes law, "excessive use" of trading systems would come with added fees. Traders also would have to maintain a balance between orders and executed transactions.

While France has already imposed a tax on high-frequency trades, legislation is also under consideration at the European Parliament and may become the basis for governmental legislation on HFT across the EU.

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Max Berre is an economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.

Zero Lower Bound: When Interest Rates Can't Drop Any Further

http://www.princeton.edu/~ceps/workingpapers/201sims.pdf

Recently, a new issue has emerged in the unfolding drama of the global financial crisis. After four years of reducing interest rates and increasing money supply at central banks of virtually all of the world's major economies, both academia and the media have started to mention a new obstacle, the Zero Lower Bound.

The underlying challenge of the Zero Lower Bound is that because interest rates are at zero, they cannot usually be lowered any further. Moreover, the context is typically one in which the economy is sluggish and stimulus is needed. In such circumstances, monetary policy has to proceed by unconventional means. Otherwise, a liquidity trap might develop along the lines of the situation Japan has been stuck in for nearly two decades. The question is of particular relevance today, since both the ECB and Fed have had their policy rates hovering around zero since 2008-2009. 

The Policy Alternatives

In 2010, the ECB published a working paper outlining the two ways that ZLB can be confronted are via a change in the way monetary policy is conducted, or via stimulatory changes in fiscal policy. 

http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1254.pdf

In any case, whenever ZLB has been confronted in the recent past, some unorthodox monetary measures have been tried, with varying degrees of success:

• Quantitative Easing: This can always be done, no matter how low interest rates are. This has been recommended for the case of Japan.

• Switching the way monetary policy is conducted. Switching to inflation targeting is the rhetoric of choice now. In the 1990s, it was exchange-rate targeting. The downfall of this approach is credibility. If markets don't buy the idea that the central bank will commit to either exchange rate targeting or inflation targeting, the plan will run into difficult terrain. Since it has taken central banks decades to build the credibility of their current low-inflation path, a change in course might be difficult to establish credibly. At least overnight. 

• Changing the distribution mechanism. Last year, the Fed engaged in "Operation Twist", an effort to engage in quantitative easing by injecting liquidity along various points on the yield curve. 

• Negative Interest Rates: During the Swedish crisis in 1991, the Swedish central bank forced policy rates into negative territory temporarily by charging banks a premium for storage of funds within the central bank, as well as for access to LOLR services. This encouraged banks to actually lend funds which they were being issued. 

• Reliance on Fiscal Policy: Market confidence can also be affected by changes in revenue and expenditure. Unfortunately, during hard times, the capability of the state to credibly increase its expenditure is limited. This is especially the case where central banks have the commitment not to monetize deficits. 

During the WWI and WWII eras the British tried a somewhat different take on this approach. In 1914, for example,  Keynes recommended direct monetary intervention to compensate losses in the international trade finance sector caused by the sudden German embargo. In concept, the idea is similar to the US' Troubled Asset Relief Program, a fiscal measure to directly intervene in the failed derivative market in 2008-2009. 

Concluision:

Regardless of the approach (or combination of approaches) used, the issue of maintaining an expansionary stance in the face of ZLB is one of the more challenging issues in monetary economics and central banking. It may be quite some time before a policy consensus develops in this area. One thing is certain however: central banks will all need to develop adequate ZLB tactics at one point or another. 

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Max Berre is an economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.

Middle-Class Squeeze: Wages are Down, but we Aren't More Competitive

http://www.theatlantic.com/business/archive/2012/08/our-low-wage-recovery-how-mcjobs-have-replaced-middle-class-jobs/261839/

American wages and labor conditions have been continuously deteriorated since the 1980s. Since the start of the 21st century however, this trend has become especially pronounced. Known as the Middle Class Squeeze, this phenomenon has been particularly pronounced in the US, while real wages expanded strongly in European OECD countries such as the UK, France, Italy and Germany, as well as in the BRIC countries since 2000. It has become a major issue in both the 2008 and 2012 presidential elections. In 2008, the House Committee on Government Reforms published a brief study which concluded that median real household income dropped by almost $1,300 while real household expenses increased by nearly $5,000 over the 2000-2008 period.

http://www.democraticleader.gov/pdf/MCS.pdf

How it Happens

Essentially, the deterioration of incomes on the US labor market has emerged in two ways:

1: The large-scale loss of high-skilled, high value added mid-wage employment, to be replaced by low skilled, low value-added, and low-wage employment. According to the National Employment Law Project, 

sixty percent of of US job losses experienced during the recession, while comprising only around twenty  percent of the jobs gained during the current recovery period. Low-skilled jobs meanwhile made up only around twenty percent of the jobs lost during the recession  but nearly sixty percent of the jobs recovered thus-far in the recovery.

2: Declining real incomes: The maintenance of median wage and salary levels in the face of increased price levels and cost of living. Healthcare and energy costs have especially increased, as has education. To compound this trap, the new millennium has seen the rise of household debt to try to cover the difference. The debt-to-income ratio reached its highest level in 24 years for middle class households, while Bush-era bankruptcy reform has made the debt trap considerable more difficult to climb out of. In 2010, the Levy Institute published a study showing that both household debt and the US GINI coefficient spiked upwards since 2000.

http://www.levyinstitute.org/pubs/wp_589.pdf

Why This is Problematic

According to the standard ruling paradigm in labor market economics, low wages are helpful to a country's economic competitiveness. But, this only begs questions such as:

• How much wage deterioration is enough and when will the US's wage levels become "competitive"? Do wages and labor standards have to sink to those of China? 
• What will happen to consumer demand as a result of this trend?
• If wages are supposed to equal the marginal productivity of labor, how can the replacement of mid-wage, high-skilled jobs with low-skilled Mcjobs possibly be a positive development for our labor market?

Setting aside the ominous ethical significance to what is perceived as the US' core traditional values posed by the progressively increasing American wealth gap, there are long term economic side-effects which we have also seen emerge. 

Among these are a weaker, more debt-dependent consumer market, lower growth in productivity levels within the American workforce. All of this will hurt the progress of the American economic recovery, and will undermine long-term economic health. 

What Can Be Done

Unfortunately, the Middle Class Squeeze has no magic overnight solutions. Addressing this issue would take a package of policy solutions. We can start by asking what the rest of the OECD countries have done in order to promote real income growth. We also take measures to counteract the primary immediate causes of the short-term squeeze.

• More attention needs to be focused on increasing our labor force's productivity level. This means not only improving the educational level, but securing access to mid-career and between job training as well. In policy terms, it means that our school systems must perform better, university education must be cheaper, and employer training has to be incentivized. 
• Healthcare costs have to be tamed. 
• Consumer debt markets have to be reformed and Bush-era bankruptcy reforms need to be scrapped. The growing debt-trap is a large component of the middle class squeeze. It also undermines both short and long term consumer confidence and household savings, two key ingredients to healthy, sustainable economic growth. Climbing out of the debt trap has got to be made easier if the American economy will continue to succeed in the long-run. 
• High-skilled employment clusters have to be constructed and defended. Essentially this means that the long-term survival of clusters such as Detroit and Silicon Valley have got to be treated as issues of national interest.

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Max Berre is an economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.