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.

ECB Swings into Action - Markets Jump Accordingly

http://www.bbc.co.uk/news/business-19499950

http://www.nytimes.com/reuters/2012/09/06/business/06reuters-ecb-eurozone-seniority.html?_r=1&smid=re-share

The  ECB Bond-Buying Plan

Last week, ECB chief Mario Draghi launched and ECB bond-buying plan, sparking a dramatic rally in the world's financial markets. "Economic growth in the Euro Area is expected to remain weak, with the ongoing tensions in financial markets and heightened uncertainty weighing on confidence and sentiment" said Draghi. Faced with pressure to prevent the collapse of Europe's monetary union, Draghi finally launches a monetary plan which amounts to more than merely a bandage has finally been set in place. Due to proximity of interest rates to the Zero-Lower-Bound, further reduction of interest rates would essentially be of limited effectiveness. More unorthodox monetary measures are therefore needed. Unfortunately, since this move is late in emerging, potential costs are much higher than they otherwise could have been. The bond-buying plan makes use of Outright Monetary Transactions (OMTs) and focuses on sovereign bonds maturing within three years. According to Draghi, OMTs will only be used in conjunction with the EFSF or the ESM.

Role of the Central Bank

Despite fears of inflation - and above the opposition of Bundesbank chief Jens Weidmann (who also represents the German voice in the ECB's governing council), the plan went ahead due to support from all other members of the ECB's governing council. During recessions, a focus on price stability is not only of limited relevance but also wholly insufficient as a policy response, given anemic growth prospects. Moreover, the nature of the ECB's delay to respond to turmoil in the markets had contributed greatly to the generalized lack of investor confidence and poor growth so far. A fact which will undoubtedly increase the cost of this maneuver to both the ECB and the European taxpayer. 

While there are voices that feel that the ECB should not be in the business of helping stabilize sovereign bond spreads and foster growth, one must consider exactly where the sovereign interest of the EU and that of most of the Eurozone members lies. "OMTs will enable us to address severe distortions in government bond markets, which originate from, in particular, unfounded fears on the part of investors of the reversibility of the Euro" said Draghi. It must also be remembered that this takes place against the backdrop of Germany's role in the Eurozone. While it is the single country which has benefited the most from the Euro given the currency's boost for German exports due low low currency prices which Germany could never enact on its own , it has also been the first -and most frequent- country country to violate the convergence criteria. 

The Potential Downside

With all of the bond-buying plan's upsides, and its long overdue nature, the plan does cast a dark shadow for the economic sovereignty of the Eurozone member nations, as outlined in the UK press. In a structure similar to that of the IMF, access to potentially unlimited funding is likely to be made conditional on potentially severe austerity measures which will actually be monitored by the IMF. In other words, as if it weren't bad enough that three years of austerity measures have already failed to reduce debt-to-GDP ratios in the PIIGS, the same failed model will likely be forced onto any member-nation which runs into economic trouble in the future. It paints a picture mimicking the worst days of the IMF.

http://www.telegraph.co.uk/finance/comment/9531764/Carthaginian-terms-for-Italy-and-Spain-threaten-Draghi-bond-plan.html

Market Response

Markets responded immediately, sending the S&P 500 and the Nasdaq to multi-year highs not seen since 2008 and 2000 respectively, while the Euro climbed 0.3% against the US dollar in a matter of hours. Yields on Italian and Spanish bonds also dropped dramatically. One can only wonder what markets might look like by now had the ECB only decided act sooner. 

http://www.reuters.com/article/2012/09/06/us-markets-stocks-idUSBRE88308620120906

http://www.bbc.co.uk/news/business-19516323 

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About the Author: 

Max Berre is a financial-regulatory 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.