Greece should have had short hair the whole time

It is always good to read up on Willem Buiter’s papers in times of crisis. For instance his 2005 paper with Anne Sibert: How the Eurosystem’s Treatment of Collateral in its Open Market Operations Weakens Fiscal Discipline in the Eurozone. First of all, it is good to know that Willem Buiter is also fallible:

Another reason for a common default risk premium throughout the EMU could be that the political arrangement called EMU implies that the government of any EMU member country threatened with default would be bailed out by the collective called the EMU … We reject the implicit and intentional bail-out guarantee explanation of the uniform (low) sovereign default risk premia in the Eurozone. … There is not one iota of evidence that the sovereign debt of all 12 Eurozone countries … is, or is perceived by anyone in a position of fiscal responsibility and authority in the EMU, to be a collective responsibility of the Eurozone …

Oh well, the financial crisis was also inconceivable to most observers. What is more interesting is their suggestion that something else might explain the much too narrow spread between German bonds and the bonds of countries with much higher default risks:

Despite significant fundamental differences among the default risks associated with the euro-denominated debt issued by the 12 national governments of the Eurozone, all these euro-denominated sovereign debt instruments can defacto be used as collateral in Eurosystem Repos on the same terms as the default risk-free debt certificates issued by the Eurosystem itself.

They suggest to use haircut policies more aggressively. As a short explanation: when a central bank accepts a bond as collateral for refinancing operations, it usually calculates the market value minus a valuation haircut, as the final value of that collateral. By failing to use this tool appropriately, the ECB sent the wrong signal: suggesting that default risk was equal across all government bonds, which it clearly wasn’t.

That proposal could be extended (in the spirit of Markus Brunnermeier) to create an ECB-induced counter-cyclical fiscal and regulatory policy. Let’s assume the ECB monitors inflation and credit in a given country to assess whether the economy in that region is overheating and/or bubbly. In practice, the indicators would be more sophisticated than that. But both suggest clearly that something was terribly wrong – at least in retrospect (data: Eurostat):

Spain increased the volume of credit 5-fold since the end of 1997, Ireland 6-fold, Portugal 4-fold while France and Austria doubled theirs. In Germany, the volume of credit hardly increased at all for reasons explained elsewhere. Inflation provides another clear indication that the economic development in some places in Europe was unsustainable – which should have been clear that the time as well:

So imagine the ECB had introduced a haircut policy on government debt that was related to such overheating/bubble measures: when your country overheats, your government’s bonds take an extra valuation haircut when checking in at the ECB hotel. This would have made these governments’ bonds less attractive and might have induced governments to take a more restrictive fiscal policy and regulatory stance in the build-up of the Euro crisis. To take this proposal to the extreme for the sake of argument: if inflation is more than 0.5% above target, or credit above a resonable level of GNP, the bonds of that country become ineligible as collateral at the ECB.

What would have happened to bond prices? It remains an open question whether bond prices would have dropped sufficiently to induce a counter-cyclical fiscal or regulatory response. But banks would have been forced to use other instruments as collateral, making them a little less vulnerable to a solvency crisis in their home country. Could that be a contributing factor to the Eurozone’s future stability? Let me know what you think.

Of course, the proposal is politically difficult to implement, but it has one advantage: because it punishes inflationist countries, the Germans will love it.

HT: Markus Brunnermeier


  1. matt_us schreibt:

    “To take this proposal to the extreme for the sake of argument: if inflation is more than 0.5% above target, or credit above a resonable level of GNP, the bonds of that country become ineligible as collateral at the ECB.”

    Billiant idea. Except, why not charge a premium on any further credit granted to the country from another country in the EU? So any further lending to Greece would cost the lender from Germany an addtitional tax, until it becomes uneconomical to lend to the country. (The more inflation in Greece, the higher the tax!) That would immediately punish one of the culprits of the current crisis, the lenders who lend too much money. And dampen demand, leading to lower inflation.

    A policy such as this would, of course, have prevented the current crisis, had it been implemented at the inception of the Euro.

    Collateral to the ECB only becomes relevant in times of crisis. Otherwise the inter-bankmarket functions perfectly and collateral is, on the whole, not a limiting factor when applying for ECB funding. When the crisis hits, it becomes of course very relevant. However, then it is too late.

    Preventing the crisis must be the cure!

  2. Daniel schreibt:

    @ kantoos
    very interesting. If we want to keep the monetary union, if we don’t want a significantly stronger fiscal integration, then this sounds like a reasonable approach to enhance stability and to improve the functioning of EMU (and, if EMU survives this crisis, to reduce the scale of the next one).

  3. Daniel schreibt:

    well, even irrespective of whether closer fiscal integration becomes reality, the eurosystem should think hard about the proposal. This may be a very useful tool in its “macroprudential” toolkit, but of course, it would have been incredibly unpopular to implement in countries which experience a boom. Ireland also serves as an example that this is likely to be no panacea. Banks had no shortage of collateral in the midst of the property boom, I guess.

  4. Johannes schreibt:

    Correct me if I am wrong, but this proposal would it it works properly even harmonize inflation, right? Obviously if that could be succesfully acomplished even Hainer Flassbeck would agree to that.

    @ kantoos
    So am I right, that you also consider different inflation paths within a currency union as not sustainable?
    If I understood it correct, you see inflation as a indicator for potential missallocations?

  5. Daniel schreibt:

    @ johannes
    1. The proposal would not completely harmonize inflation rates across economies in the Eurozone. That would be impossible. Some heterogeneity in inflation rates will always be there and is not necessarily bad. You have inflation differentials between different regions in a given country, e.g. US. But the proposal is supposed to avoid inflation from surging in a country that is already booming by increasing the costs of borrowing for that country. Then, hopefully, domestic demand would be a bit lower, thereby reducing inflation.
    2. Different inflation paths are insofar dangerous as they may reflect a fundamental real exchange rate misalignment (defined by the HCPI in this case). Some real exchange rate movements may be desirable if fundamentally justified. For instance, countries with low productivity may catch up with more productive countries. This is usually accompanied by real exchange rate appreciation (Balassa Samuelson effect). So, yes, high inflation differentials can be sign of danger, but they do not have to be.
    I apologize for extensive use of economese.

  6. Dietmar Tischer schreibt:

    @ Kantoos

    >What would have happened to bond prices?>

    Bonds becoming ineligible as collateral at the ECB means downgrading them – the ECB acts like a rating agency. These bonds must fall in price.

    Leaving aside whether the directors of the ECB could ever have agreed on binding criteria for such an evaluation, I don’t believe we would have seen a development much different in results from the one that actual happened.

    Just consider the two players:

    Governments would have done what they ever do – raising the debt level to escape fiscal restrains even at the cost of higher interest payments. Lenders, on the other hand, also would have done what they ever do – adding lower rated bonds to their portfolios to improve profitability by higher interest rates.

    This would not create problems as long as there was a market for trading such bonds. Problems would arise, if a country was considered in difficulties ever to repay its debt and/or if banks would not accept such bonds as collateral.

    If the latter situation led to a liquidity crisis, the ECB would have done what they did from 2010 on when such a crisis kicked off by Greece evolved: accepting any guest checking in regardless of valuation.

    The problem of the EMU was never an ECB problem and cannot be solved by the ECB. It is a political problem from the beginning and politics must solve it in the end.

  7. Johannes schreibt:

    @ David
    Thank you for the clarification. The language is ok for me since I am studying economics since 2 terms.

    I still have problems with the second argument. The Balassa Samuelson effect is also the reason why currency unions with fast and slow growing countries should have higher inflation targets. However, I am wondering how this will work in the long run. Even if the appreciation is somehow justified, it still needs to come back down eventually. Most of the fast catching up countries (e.g. Tiger States) where depreciating their currencies repeatedly in order to reverse the appreciation effect through inflation. (And even if it is no very much liked in this blog to say it like this, to stay “competitive” haha)

    I mean within countries this is usually dealt with by redistributing and with movements of labor. Redistribution is not an option, and large scale unidirectional labor movements between countries are not only desirable…

  8. Johannes schreibt:

    @ David or Kantoos
    It would be nice if someone could explain to me how the neoclassical theory deals with justified appreciations in one country (e.g. because of the Balassa Samuelson effect)? I can only guess, that this will make investments less attractive and capital flows will turn backwards?

  9. rubycon schreibt:

    the right man in the right time?

    “The literature on central bank
    independence (CBI) looks at correlations over periods from 10 to 40
    years in length. Over such long periods, it seems most reasonable that
    social preferences and political forces determine inflation rates, whereas
    over one business cycle or electoral cycle institutions may well have an effect.
    Stanley Fischer disagreed with Posen’s conclusion that the financial
    sector’s opposition to inflation completely determines inflation outcomes.
    He conceded that the issue is quite complicated but argued that
    law and the institutions chosen by society can make a difference for
    inflation performance.”

  10. matt_us schreibt:

    “Thank you for the clarification. The language is ok for me since I am studying economics since 2 terms.”

    Time to find another subject to study, other than economics. You know enough as you need to in order to determine how economies work. Everything else will befuddle you, I suspect. (Just joking, but think about it as it gets more theoretical, does this really add anything to the subject?)

    Now to the Balassa Samuelson effect. Because of Greek proudctivity growth and more investment the higher inflation rate would have been justified. It looks enormously higher on the graph, but if you look from 2001 to 2011 Greek inflation over the period was roughly the 15% more than Germany, 1,5% a year.

    That seems a very small change, which in a 3 years can be adjusted, if German inflation is 3% and Greek prices fall by 2% p.a.. (Theoretically – so it took 10 years to drive the prices apart, but could be adjusted in 3!)

    Then, the really relevant number to concentrate on is wage costs, which will need to drop further in relation to Germany. Then prices will eventually fall. And realignment will take place. That might take longer than 3 years. But it is already starting. Basics economics really – not ideologically driven. We just have to be patient.

    Could we habe prevented that? Of course, by imposing an automatic measure which stops credit money flowing to the country. If your current account deficit is more that 2%, every 1% over makes credit more expensive by 1%, for example.

    So a country could raise loans in the rest of the EU, if its current account deficit is less than 2% at 4% interest cost.
    If the current account deficit is 3%, the lender would have to pay a penalty of 1% making the cost to Greece, 5%.
    At a deficit of 4% Greek loans will cost 6% to the borrower. if the money comes from EU ocuntries. And so on.

    The average current account deficit over the last 10 years was over 9%. It would have made loans to Greece (funded by other EU countries) more expensive, raising the cost of EU finance for the Greeks to 11%. Greece would clearly have borrowed less under this system, not leading to the past excesses which are now causing the current problem.

    What would interest me, is whether the people think that kantoos’ or my plan would have been a better way to prevent excessive current account deficits in Greece, which lie behind its current problems?

    My plan is to prevent the problem. Kantoos’ plan is dealing with an aggravated situation, once the problem has been recognized, by making central bank security more expensive.

  11. Johannes schreibt:

    @ matt_us
    I have some sympathy for your suggestion. Wasn’t Lagarde suggesting to limit capital outflows? I mean obviously France has an interest to not “punish” inflows since it is a deficit country, but at the end it is not that different.
    I mean setting random values by politics is not very much liked by economists in order to deal with problems. Nevertheless if you look at chances and risks it is probably still better than the first best solution which fails all the time because markets doesn’t seam to deal appropriate with macroeconomic risks. :)

    I would be interested if Kantoos would agree that Germany should inflate more.
    For me it is clear that this would go via wages. But maybe someone suggests that we should decrease our wages in order to make “our” capital come back voluntarily. :)

    This raises for me the question weather suggesting us to decrease our wages in the first place was so smart, when in retrospect, large shares of our capital outflows were based on market failure.

    • kantoos schreibt:

      @ matt, Joh

      I like your discussion. However, what you, matt, are suggesting is outright capital controls, something that runs against everything the EU stands for. I think this is politically unacceptable, and may also be economically harmful – not all capital went into consumption and useless real estate. But it might be interesting to extend my proposal to credit given to people in a country, something that Markus Brunnermeier is proposing. I have a post almost finished on this issue, we could take up this discussion then. My suggestion in this post were a mild little step in this direction.

      Regarding wages and inflation, of course Germany needs to inflate more than the periphery, as long as unemployment is at a low level (note that German wages need to be at market-clearing levels, regardless of where wages in Greece are). But you, Joh, are drawing a wrong conclusion here, I think: even though capital outflows were in part done for the wrong reasons, what would higher German wages have implied? Even more capital outflows for the wrong reasons?

  12. Johannes schreibt:

    @ Kantoos
    I see the flaw in my argument. Maybe it is because I am not really convinced that our wages in the export industry were to high, since exports and profits were skyrocketing. And if it comes to non-tradables overall lower wages also decrease demand and can therefore make investments less attractive.

    And your argument with the unemployment level is flawed from my point of view. First of all we have hardly no problems with unemployment right now. I once read a study that 8.000.000 people in Germany would like to work / to work more. And even if you consider only the 3.000.000 official unemployed, opinions are divided whether this can be considered what you call “market-clearing level”. So imagine if politicians think no, and we decide not to inflate, than how is Greece supposed to depreciate. Hence as long as unemployment is a Eurozone-wide problem there is some potential “beggar thy neighbour” effect.

  13. matt_us schreibt:

    “I mean setting random values by politics is not very much liked by economists in order to deal with problems.”

    Let me press my random number generator button: 3, 60, 42, 2, 44, 25

    Now allocate at random to the following variables: inflation target, deficit target, government debt target, top income tax rate, tax on return of financial asset tax, social security payments on Labour (employee/employer)

    “However, what you, matt, are suggesting is outright capital controls, something that runs against everything the EU stands for. ”

    Let me press my button once again: 1

    now lets find a variable which we can allocate that number to – here it is: European Stability tax factor, multiplies the (LB defitcit -2%) and adds it as a tax p.a. to each inter-European cross-border loan

    Its not capital controls, its a tax. Like a tax on cigarettes it encourages good behaviour.

    • kantoos schreibt:

      @ matt

      Well, that is semantics. Your approach would be a heavy interference with free capital movement. I am not saying that it is necessarily wrong, but it surely is politically infeasible (but you rarely care about that, do you? :)

      Moreover, it is not necessarily sensible to tax capital inflows in general, only those that could be harmful, like credit expansion for useless real estate or government consumption. That would drive up credit and inflation, that is why I prefer these measures. Germany, as an ageing society, should run a CA surplus because it should (realtively speaking) save more than young countries like the US or Turkey, and dissave later. In 15 years’ time, when all the babyboomers retire, we should see a reversal of this. There is no economic rationale for taxing that, it is exactly what should happen to maximize social welfare. Overheating measures are better.

  14. rubycon schreibt:

    @ Johannes
    Here are the actual random settings by politics for BR Deutschland (Bund) :;jsessionid=43073EDE35F0A9094C95C841D5D392FD?__blob=publicationFile

    Dealing the problem in the Federal States will bring the clash.
    The Communes are used to handle their fiscal situation.

  15. rubycon schreibt:

    @ matt_us

    Hast das Symposium ja gut überstanden!
    Da morgen Feiertag ist müssen wir wohl die Dosis erhöhen – bei den Zinsen wie beim Alkohol deshalb
    Rakı bzw. Oύζο
    “Die Frage, wann und wo der erste Ouzo gebrannt wurde, ist nicht abschließend geklärt. Der Ouzo entstand wahrscheinlich aus dem Tsipouro bzw. Rakı, der bereits seit dem 15. Jahrhundert sowohl von der griechischen als auch von der türkischen Bevölkerung im Osmanischen Reich gebrannt wurde. Der Ouzo wurde ab dem 19. Jahrhundert produziert.
    Als es 1922 im Verlaufe des Griechisch-Türkischen Krieges zum Exodus der Griechen aus der Türkei kam, brachten die Flüchtlinge viele Rezepte griechisch-türkischer Küche ins Mutterland, vermutlich ist auch die Ouzo-Herstellung beeinflusst worden.”

    aus wikipedia

  16. matt_us schreibt:

    Pfingstmontag gibt es nicht in England: ;-(

    Es lebt nicht jeder im Feiertagsparadies Deutschland!

    Also weiter nur Nuechternes zur Arbeitsproduktivitaet:
    Hier nuechterne Zahlen aus dem Zufallsgenerator, zu Lohnstueckkosten:
    Seite 41.
    Griechenland hat ueberschossen 2001 bis 2010 um 1,4% im Schnitt pro Jahr (also +14%)
    Deutschland hat unterschossen 2001 bis 2010 um 1,2% im Schnitt pro Jahr (also -12%)
    Europaeischer Durchschnitt 1,8% p.a..
    Beide gleich Schuld am Dilemma!

    Deutsche Loehne muessten 12% hoeher sein und griechische 14% niedriger, und wir haetten sozusagen das EU Paradies auf Erden – oder so aehnlich!

    Bevor jetzt kantoos kommt, und sagt das geht so nicht. Kantoos, bring bitte eine Statistik mit die Volksvermoegenverteilung Lohn- und Kapitaleinkommen in Deutschland aufzeigt, und Entwicklung derselben im gleichen Zeitraum.

    Was wuerde passieren wenn Loehne in Deutschland nur um 2,6% steigen wuerden pro Jahr, fuer die naechsten 10 Jahre, und in Griechenland gar nicht. Das wuerde die 30% Differenz ausgleichen. (Das Flassbeck Argument)

    Es koennte aber auch sein dass Griechenland produktiver wird. Mehr produziert pro Arbeitsstunde. Wie ginge das? Wie waere es mit einem Gratisurlaub fuer Deutsche fuer die Touristennebensaison in Griechenland. Volle Kapazitaetsauslastung in der Nebensaison wuerde die Arbeitsproduktivitaet unheimlich ansteigen lassen. Die Lohnstueckkosten wuerden fallen in Griechenland, obwohl die Loehne die gleichen blieben. Somit koennte die Differenz vielleicht in 3 – 5 Jahren abgebaut werden.

    Noch ein Grund um fuer Gratisurlaub in der Peripherie zu sein!

    (darauf dann aber doch mal einen doppelten Jameson’s – Irish Whiskey – die haben ja auch Probleme!)

  17. rubycon schreibt:

    @ kantoos

    The differentiation between consumption and investment is only by time, in the long run all investments are consumed, depreciated.
    Therefore since 2011 the new “Struktureller Finanzierungssaldo” insteat of old Art.115 GG.
    In den Jahren 2008 bis 2010 weist die Kennziffer die Nettokreditaufnahme und der Schwellenwert die Höhe der Investiven Ausgaben analog zur investitionsbezogenen Regel des alten Artikel 115 GG aus (in Mrd. €).

  18. rubycon schreibt:

    @ katoos

    You are wrong – there exist no “Generationengerechtigkeit” – Think it over from the cradle to your personal heaven.

    Much more the same with countries, because they are responsible in and for every moment of their doing.

    It takes a little time and three generations to understand.

  19. matt_us schreibt:


    A capital control is the state saying you cannot do x or y. That’s bad.

    A tax is a control mechanism. Tax influences consumer choice in petrol consumption, cigarettes, alcohol, and pollution. That is a good tax. The state does not forbid its citizenz something, it just alters the framework, trying to steer behaviour. To the behaviour which presents it with the biggest common good. That is what a state should do. Whilst prserving liberty of choice. That is good.

    Politically infeasible? Nothing is politically infeasible. Who could obstruct a democratically elected body as the EU to decide something like that?

    It is up to then up to the Greek banking sector, which by and large allocates commercial loans to decide what is a good or bad investment, based on ever rising cost of loans, as the current account deficit increases. Or it might not increase, as risiing interest rates will deflect savings away from consumption into bank deposits. Foreign Direct investments, that is capital inflows of risk capital would not be affected, only loan capital. Loans would become scarcer and thus more expensive. Inflation would be dampened.

    Banks have to decide, though. How else would anyone distinguish between useless and useful real estate investments, It has to be up to the banks.

    As for the “surplusses now are savings for the future” argument. I would agree with that, if reality had not disproved that. About 3 years’ current account surplusses have been devalued by the Bad Banks of HRE, West LB, IKS. The same could happen to the surplusses invested in the periphery, if we do, what you propose, a restructuring of debt. We could end up having worked and exported 6 years for free! Current Account savings devalued, turned to dust. A haircut for our savings, first through the bank crisis of 2008 now through the Eurocrisis of 2011.

    I prefer to spend my money here and now, and get my state pension paid by the younger ones, who should in due course pay taxes to finance it. ;-)

    • kantoos schreibt:

      “Capital controls are measures such as transaction taxes and other limits or outright prohibitions, which a nation’s government can use to regulate the flows into and out of the country’s capital account.” Wikipedia. Well, I don’t really mind to call yours capital movement tax, instead of capital controls. But it is the economics that matter. And you want to tax each and every CA deficit, and there is no rationale for doing that. If you link it to inflation or credit or other bubbly measures it would make more sense.

  20. Johannes schreibt:

    @ kantoos and matt
    Obviously it is more difficult to find the right overheating measures than just setting a limit and tax everything above that. So maybe it is the best to actually estimate the need for Germany’s capital exports in order to deal with the demographic changes and tax everything above. I am quite sure this value is much lower than 1% of GDP (not sure if the amount of trade is the right reference point then).

    And we should also consider that most of our capital exports belong to a relatively small group of people who doesn’t contribute much to our pension system. On the other hand will the lower wages due to capital exports weaken our pension system. (If capital income would contribute to our pension system that point would obviously be voided)

    @ matt
    Your point is well taken, “random” number setting is done a lot. haha

  21. matt_us schreibt:

    Let’s just think what the current problem is in the EU. The accumulated current account deficits (net investment position) are not financed by the capital markets anymore.

    So it makes sense to target that as a measure. Current account deficits.

    But what were the current account deficits for the problem countries, before joining the Euro, at its highest values aroung 2007-8 ,and now (as percentage of GDP),

    Greece: -4%, -15%, -8%
    Ireland: +2%, -5%. +1%
    Portugal: -6%. -11%, -8%
    Spain: -1%, -10%, -5%

    So targeting current account deficits would not have prevented the property bubble in Ireland. Lending accelerated well before the peak current account deficit was reached there in 2008. So interest rates would not have been much higher until it was too late.

    Targeting lending growth probably would have been better. Kantoos is right.

    Average lending growth in Ireland was about 15% a year to its peak in 2008, compared to the more sustainable 6% in France and Austria.

    6% would have doubled everyone’s lending instead of increasing it 6fold for Ireland, 5 fold for Spain and 4 fold for Portugal and Greece.

    What would that mean though, if the credit growth in these countries had been constricted to not much more than 6% (again through taxes on credit money coming in), and not much more than a doubling in the period shown? GDP in Europe would have been much lower in the last 10 years, maybe decreasing GDP by about 5% in the eurozone area.

    That would mean kantoos’ straight trend line he keeps drawing for Nominal GDP growth in Europe would be much less steep, and we would now be much closer to out potential GDP, than the kantoos’ line indicates. In other words, the European economy overheated unsustainably in the years 2003 to 2008, and Kantoos’ nominal GDP graph should be adjusted, and become less steep. What do you think, kantoos?

    How are these trend lines drawn, kantoos, in nominal GDP targeting? Who decides where the trend is.

  22. matt_us schreibt:

    Targeting inflation?
    As long as asset prices are not taken into account for inflation, no point. It’s the asset price inflation (property prices) which let to the lending growth in Ireland and Spain. Also very fiddly, as very small numbers. In other words, would it make sense to raise cost of credit in Ireland if inflation is only 0,5% above European average?

    Targeting capital exports?
    Who decides that 1% or 2% or 5% is the right measure? Ok, let me press my random number generator again ;-)

    • kantoos schreibt:

      @ matt

      Well, I think you are wrong, of course. :)

      Inflation was much higher in Greece, IRE, ESP, POR than in the core. Even without asset prices, it is a useful measure. And I am not sure, including asset prices is a good idea, anyway.

      The trend line of NGDP would have been just as steep, by the way, because the ECB would have reacted to lower inflation pressures from the periphery by lowering interest rates. And some of the RGDP growth might have shifted to other countries, which probably would have been a good thing.

  23. matt_us schreibt:

    “The trend line of NGDP would have been just as steep, by the way, because the ECB would have reacted to lower inflation pressures from the periphery by lowering interest rates.”

    That is the problem with that NGDP approach, I just do not believe it. If the interest rate had been lower in Germany, we would have had a 5% higher GDP, making up for the lost GDP in the periphery?

    Interest rates were less than 3% from the end of 2002 to 2006. If they had been 1% we would have seen a boom in Germany, whch would have increased GDP by 5%? Would companies and people have invested in factories and houses, because of the 2% lower rate?

    Companies do not sit around and say: I would build a factory, if interest rates were not so unbelievably high at 5%. If they were only 3% my investment plan will go ahead. But as they are 5%, I will lose money on my investment and I will not invest. Your Return on Investment would be influenced by that cost, but by less than 1%.

    Lets say you are looking to spent 200.000 (half credit) and hope for a ROI of 10% with a loan at 5%. The ROI with a loan at 3% would be 10,6%

    Same with individuals. Nobody postpones a housebuilding plan because interest rates at 5% are just too much. They only build a house if the cost of credit is 3%.

    That there would have been some beneficial effect, sure, but not to the extent to make up for the lost credit bubble in the periphery. No way.

    • kantoos schreibt:

      @ matt

      That happens when you see interest rates as the only transmission channel of monetary policy. There are many more and by the way, it is not a zero-one argument, but a marginal one.

  24. matt_us schreibt:

    “That happens when you see interest rates as the only transmission channel of monetary policy. There are many more and by the way, ….”

    I look into my old Samuelson (1985) and find.

    “How does money affect output:…
    M up -> i down -> I up -> AD up -> real GNP, P up”

    Any other mechanism which had not been discovered in 1985?

    However, what you probably like to hear is this from Samuelson (writing in 1985), though:

    “Today, many economists instead [of targeting M growth] would recommend that the government target nominal GNP”

    • kantoos schreibt:

      @ matt

      Well, yes, a book from 1985 is maybe not the best guide for monetary policy. Check out a recent textbook and you will find a whole chapter devoted to the tranmission mechnisms, both theoretically and empirically.

  25. matt_us schreibt:

    “Check out a recent textbook …”

    I haven’t got one here, so I have to think of an additional monetary transfer mechansism myself:

    How about this. The indebted parts of the population are the ones with the lowest income. They do not have any savings – they (as a decile (10%) of the population) have only debt.

    Only when you get to the 9th richest decile, is the indebtedness of the decile as a whole balanced by the savings. No net indebtedness. So 80% have net debt, 10% have a balance of debt and savings. Only the top 10% in fact have, (the top income decile of the population) net savings.

    So what would happen if interest rates fall?

    The top 10% get less money on their savings, and the interest cost of the 80% of the population who have more loans than savings becomes less. Less money to pay off loans, means more money for 80% of the population for consumption. C goes up. GDP goes up. (The top 10% of the population did not consume that money anyway – they will hardly miss it.)

    So lower interest rates is a mechanism to redistribute wealth from the top 10% to the bottom 80%.

    Well, if it is that easy, to jump start the economy, why do we not use fiscal policy to do the same? Redistribute from the top 10% to the bottom 80%. Once interest rates are at the bottom. As they are now.

    We could introduce a wealth tax, which would have exactly the same effect. Move money away from the top 10% who do not need it anyway, and give it to the state. Who could then give it to the lower income groups who are sure to spend it. Or lower scial security cost on labour for for the bottom 80%. (additional benefit -> lower labour costs -> more jobs -> less unemployment -> more GDP). In either case, more consumption. More consumption, more economic growth. More GDP. A virtuaous circuit, just by introducing a bit of wealth tax. What do you think kantoos?

    If monetary policy is not working anymore, it is time to get out the fiscal policies out again. Lets get these LM-IS curves shifting again. Do they still have them in the modern economic text books? It does not look like it.

  26. matt_us schreibt:


    I just saw that: I wrote in a comment above: “Kantoos is right”
    And your answer is “Well, I think you are wrong, of course. :) ”

    So could we target inflation? If inflations is too high in a country, a punitive tax is introduced on the EU banks who give the money to other EU countries, making the loans more expensive.

    Would that have helped in periphery? The inflation rates were on average (2001 – 2006)

    Greece 3,5%
    Spain 3,3%
    Ireland 3,3%
    Portugal 3,2%

    For comparison

    What should the penalty have been? To be effective, perhaps 0,3% tax on foreign credit coming in for each 0,1% the inflation rate is over the 2% norm. That would have made Greek loans cost 4,5% more expensive (if financed entirely from abroad.) So instead of of borrowing for 8% (without a tax), Greeks could have borrowed for 12,5% (with a tax)

    It would have helped to dampen the bubble. There is no doubt. Whether it would have prevented the whole of the excessive credit creation is doubtful. Credit would still have expanded, perhaps by a factor of 3 where it was 5 before. When a sustainable increase would have been a factor of 2. We don’t know with hindsight. It would have helped, but we do not know by how much.

    However, the whole of the southern periphery, which was used to much higher inflation, would have considered a 3,5% inflation rate after entering the Euro a huge success. Inflation would have been much higher before entering the Euro. The dangers of the slight excesses were not recognised by anyone in Europe.

    We are cleverer with hindsight. The ECB and the national central banks should have targeted inflation in each country, instead of targeting it in the Euro area as a whole. There is no reasoon why they do not do it. (What would have also worked is nominal GDP targeting in each country, as the trend line drawn before the EU entry would have immediately been exceeded by the economic growth in each country after the EU entry, making interest rates more expensive straight away, and dampening demand)

    I think both, targeting inflation, or targeting credit creation would have worked. And making credit coming from other EU countries more expensive, the higher these values would have been. It would have made the current Eurocrisis smaller. Perhaps even prevented it.

    Also, let us not forget that the tax raised could have been substantial. And should, of course be paid to the government of the countries which receive the bank loans. In which case they would habe had smaller debt.

    On the other hand, why was the credit bubble tolerated. Unemployment came down in these due to these credit booms. Substantially. In Spain, which had always had huge unemployment, they thought the EUro helped them to solve that problem. Unemployment would have been higher, if the Euro periphery credit bubble had not been there. We would have solved one problem, excessive credit, but created another, excessive unemployment.

    Now Spain and Greece have youth unemployment of 45%. What do we do now?


  1. [...] Greece should have had short hair the whole time von kantoos (Draufklicken um zu [...]

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