Archive for the 'Financial Markets' Category

The Blanchard Danger

September 1, 2014

by Roger Koppl

Oliver Blanchard tells us “Where Danger Lurks”  in the macro-finance world.

The big theme is nonlinearity, which is a profoundly conservative move: DSGE modeling is just fine and we don’t need to rethink it at all. We just need to add in some nonlinearities. Blanchard does not tell how to calibrate a model with extreme sensitivity to initial conditions. But if the system is chaotic, it is also unpredictable, so how can you pretend to merely add nonlinearities to DSGE models?  It seems like a pretty direct contradiction to me. I mean, you can have the model in a trivial sense, of course. But calibration is an empty exercise that will not let you look around corners.

Blanchard’s second main message is alarming: We do need theoretical innovation, however, in measuring systemic risk. In the modern network literature on financial markets and cascades, one key point is risk externality. My portfolio choice makes your portfolio riskier. We need two things to fix this market failure. First, we need Pigou taxes, which cannot be calculated unless everyone tells the regulator his portfolio so that it can measure systemic risk and calculate a separate Pigou tax for each financial institution. Second, we need to reduce systemic risk. (“[S]teps must be taken to reduce risk and increase distance” from the “dark corners” of the macro-finance system.) In the network literature I suspect Blanchard is alluding to, this is to be done (at least in some of the articles) by having the regulator directly control the portfolios of financial institutions. (Names include: Acharya 2009; Beale et al. 2011; Caccioli et al. 2011; Gai, Haldane,and Kapadia 2011; Haldane and May 2011; and Yellen 2009, 2011)

I take a rather different view of both economic theory and the crisis in my recent IEA Hobart paper From Crisis to Confidence: Macroeconomics after the Crash.

Overall, Blanchard’s message is meant to be reassuring: We the smart macro-finance experts have now got the message on nonlinearities. So no further need to worry, we’ve got the situation in hand. To keep the system out of the “dark corners,” however, we will need more discretionary authority. You don’t mind trading off a bit of financial freedom for greater financial safety do you?

The Euro: a Step Toward the Gold Standard?

April 22, 2013

by Andreas Hoffmann (University of Leipzig)

In a recent piece Jesus Huerta de Soto (2012) argues that the euro is a proxy for the gold standard. He draws several analogies between the euro and the classical gold standard (1880-1912). Like when “going on gold” European governments gave up monetary sovereignty by introducing the euro. Like the classical gold standard the common currency forces reforms upon countries that are in crisis because governments cannot manipulate the exchange rate and inflate away debt. Therefore, to limit state power and to encourage e.g. labor market reforms he views the euro as second best to the gold standard from a free market perspective. Therefore, we should defend it. He finds that it is a step toward the re-establishment of the classical gold standard.

There has been much criticism of the piece that mainly addresses the inflationary bias of the ECB. I actually agree with much of it. In particular, imperfect currency areas have the potential to restrict monetary nationalism. This can be welcomed just as customs unions that allow for free trade (at least in restricted areas). But I have some trouble with De Soto’s conclusions and the view that adhering to the euro (as did adhering to gold) gives an extra impetus for market reform – in spite of the mentioned e.g. labor market reforms in Spain. Read the rest of this entry »

Government Revenues from Low-Interest Rate Policies

December 19, 2012

by Andreas Hoffmann and Holger Zemanek*

Over the last two years Carmen Reinhart and Belen Sbrancia have published a series of papers on financial repression and its historical role in financing government debt. They show that throughout the Bretton Woods period governments in many advanced economies repressed financial markets to liquidate the high levels of debt that had been accumulated by the end of World War II.

During this period, low policy rates reduced debt servicing costs. Financial repression raised the attractiveness of government bonds relative to other investments. Inflation liquidated government debt. The authors report an annual debt liquidation effect for, e.g., the US and UK government debt of about 3 – 4 percent of GDP (Reinhart and Sbrancia 2011).

Today government debt levels in many countries are comparable to those after the Second World War II! After all, good politicians do not need a World War. There are plenty of other ways to spend. But in the light of the European debt crisis, governments are feeling the need to correct the spending-revenue misalignments in order to make debt-service sustainable. Read the rest of this entry »

Money and Government

November 25, 2012

by Jerry O’Driscoll  

The 30th annual Cato monetary conference was held in Washington, D.C. on November 15th. The theme was “Money, Markets, and Government: The Next 30 Years.” It was heavily attended in Cato’s new state-of-the-art Hayek auditorium. Jim Dorn has ably directed it over its entire history.

Because of the conference’s breadth and depth, I can only provide some highlights.

Vernon Smith gave a brilliant Keynote Address on the history of bubbles. It was rich in slides, which filled the giant screen in the auditorium. It was a tour de force, and I look forward to seeing it in the Proceedings. Read the rest of this entry »

Hundred Years of Bailouts

July 11, 2012

by Chidem Kurdas

After all that’s been said and written about financial crises, it is rare to come across useful insights.  Financing Failure. A Century of Bailouts by Vern McKinley documents a major continuity with past policy making. He shows that policies intended to prop up failing companies are nothing new—the same basic pattern has recurred time and again.

But there is one notable change: the bailouts grew ever larger and the agencies concerned with them ever more numerous. Anyone thinking about recent crises and future prospects would do well to keep these points in mind.  Read the rest of this entry »

Remember Those Oil Speculators?

June 5, 2012

by Chidem Kurdas

Less than two months ago, President Obama claimed that speculators were (or at least might be) artificially driving up the price of oil—a notion that some politician or pundit  brings up every time gasoline looks expensive. The idea fades when the market changes direction. Thus in recent weeks, economies worldwide took a turn for the worse and the price of oil came down a notch. Read the rest of this entry »

Euro Crisis from Long Perspective

May 31, 2012

by Chidem Kurdas

The European crisis, in progress for years and still showing no sign of resolution, is largely the result of elite hubris. To create the euro and ram it down the throats of populations that, left to their druthers, would have stayed with their old currencies—this was a massive, top-down social engineering project. Read the rest of this entry »

Krugman on Banks and Romney

May 23, 2012

by Chidem Kurdas

Regulation advocates seem to regard the JP Morgan loss as the best thing since sliced bread. Thus Paul Krugman gleefully bawls out Mitt Romney for refusing to see it as a sign for greater government intervention.

Krugman repeats the by now well-known argument on banks, as a riff on “It’s a Wonderful Life.” The Jimmy Stewart character makes “a risky bet on some complex financial instrument,” loses the money and causes his bank to collapse. The moral: banks should not be allowed to take on much risk because “they put the whole economy in jeopardy” and “shouldn’t be allowed to run wild, since they are in effect gambling with taxpayers’ money.”

The fact is, banks make money by taking risk. That’s always been the business model. Even Bailey Building and Loan in “It’s a Wonderful Life” makes risky home loans—one might think of them as subprime. Read the rest of this entry »

Bank Hedges and Social Justice

May 21, 2012

by  Chidem Kurdas

To hedge or not to hedge? That’s the question for many an endeavor. Farmers hedge by selling their harvest ahead of time. Building managers hedge by locking in a price for heating oil or natural gas—last year many got it wrong, blindsided by the decline in the price of gas. Most hedges we don’t hear much about.

Until last week, the most infamous hedge was the set of complex trades put on by Goldman Sachs as protection against losses in mortgage securities in the property bust. Financially this worked and Goldman Sachs escaped the 2008 crisis relatively unscathed. Thereupon it became an object of loathing and mockery in the media, inspiring calls for higher taxes and greater regulation.

Now we have the failed trades with resultant loss of $2-$3 billion at JP Morgan Chase. This also inspired calls for greater regulation, in particular of bank trading, which appears to be offensive whether it makes money or loses money. Read the rest of this entry »

Should Banks Just Buy Treasuries?

May 15, 2012

by Chidem Kurdas

There’s a widespread impression that the $2 billion-plus trading loss JP Morgan Chase announced a few days ago strengthens the case for more regulation of banks.  Below  Jerry O’ Driscoll makes this argument more thoughtfully than I’ve seen any where else.

Two basic facts are worth remembering.

Fact number one is that in 2010 Congress passed the gigantic Dodd-Frank financial regulation law, which is being translated to thousands of specific rules by coteries of government bureaucrats. The Volcker rule against bank proprietary trading is the least of it. There are numerous new rules. None of these could have prevented the JP Morgan loss or even moderated it, as best I can tell. Read the rest of this entry »

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