MA Macroeconomics

This is the class website for University College Dublin module MA Macroeconomics (ECON 41990) in  Autumn 2014.

Information and Assessment

A syllabus for the course is available here.

The midterm will take place on Wednesday October 22 between 2.30 and 3.30 in Newman Theatre 1, which is in the basement of the building.

 Lecture Notes

1. The IS-LM Model. (From MIT Open Courseware)

2. The AS-AD Model. (From MIT Open Courseware)

3. Introducing the IS-MP-PC Model. Slides here.

4. Analysing the IS-MP-PC Model. Slides here.

 

Readings

John Hicks (1937). Mr. Keynes and the Classics: A Suggested Interpretation

Mark Bils and Peter Klenow (2004). Some Evidence on the Importance of Sticky Prices

Alvarez et al (2005). Sticky Prices in the Euro Area

Carl Walsh: Teaching Inflation Targeting: An Analysis for Intermediate Macro

Milton Friedman: The Role of Monetary Policy.

John Taylor: Discretion Versus Policy Rules in Practice

Bank of England: State of the Art of Inflation Targeting

 

The ECB and Non-Standard Policies: Too Little Too Late?

The latest round of briefing papers for the Economic and Monetary Affairs committee’s monetary dialogue can be found here. Click on 14.07.2014.  The papers discuss the strength of the euro and non-standard monetary policies. My paper is “The ECB and Non-Standard Policies: Too Little Too Late?”  Click here for a version without the nasty “Draft” watermark. The paper contrasts the ECB’s approach to monetary policy in recent years with the that of the Federal Reserve. It also discusses the actions taken at the June Governing Council meeting and addresses issues relating to potential future asset purchase programmes. The abstract for the paper is as follows:

The ECB has been slower to cut interest rates and to consider asset purchase programmes than the other major central banks even though the euro area economy has performed worse than its comparators. This failure to act has not stemmed directly from the ECB’s price stability mandate. Indeed, by not acting sufficiently strongly, the ECB is now failing to meet its own definition of price stability. The measures introduced at the ECB’s June Governing Council meeting will have only a modest positive effect on the euro area economy. Large asset purchase programmes – of both sovereign bonds and private asset-backed securities – are overdue.

Options for Ireland’s Legacy Bank Debt

Prior to the recent European elections, I was commissioned by the Labour Party to write a briefing document outlining the nature of Ireland’s “legacy” bank debt and to discuss the potential options for reducing the burden associated with this debt.  The document has now been publicly released by the Labour Party and is available here.

With the two-year anniversary of the 2012 Eurosummit coming up in a few weeks, it is a good time to re-examine the commitments made by Euro area heads of state on this issue and for Ireland’s government to make the case for action.

Europe’s Bank Assessment: A Worrying Preview From Ireland

The most important thing happening in the European economy over the next year is the ECB’s comprehensive assessment of large euro area banks.  This process will involve an asset quality review, a supervisory risk assessment and a stress test followed by the requirement that banks be recapitalised to address weaknesses that are found.  Yesterday, we got a preview from Ireland as to how this process might work and it wasn’t at all pretty. In fact, it was pretty shambolic.

English: Central Bank of Ireland located on Da...

Central Bank of Ireland located on Dame Street in Dublin. (Photo credit: Wikipedia)

Because Ireland’s banking sector played a major role in sending the country into an EU-IMF program, the troika decided that Ireland’s bank assessment should begin prior to the other countries. So yesterday, the three Irish banks involved in the European bank assessment announced that they had received the results of a “balance sheet assessment” of their accounts of June 2013 from the Central Bank of Ireland (the terminology in relation to the comprehensive assessment changed over the course of the year but this balance sheet assessment appears to be what the ECB now calls an “asset quality review”.)

The timing of these announcements now looks a bit awkward. Originally, the idea seemed to be to have the announcements take place just prior to the ECB’s process for other countries but the timeline on the ECB’s assessment has slipped. It will now review bank balance sheets as of December 31, 2013, so interpreted strictly the Irish banks will need another balance sheet assessment again early next year.  This begs the question why the Central Bank of Ireland (and ECB, who must have been involved) bothered to release the assessment of the June 2013 books at all.

If the timing of the balance sheet assessment was bad, the handling of the announcements was far worse.  As of yet, the Central Bank of Irelandhas made no statement whatsoever on the balance sheet assessments. (Here is its list of press releases.)  Instead, the three banks involved all released their own statements with varying amounts of information disclosed.

Revealing the most information was Bank of Ireland.  This bank released a sheet of information (“Schedule 1”) that looked like something provided to it by the Central Bank of Ireland.  The sheet showed that the Central Bank believed capital was lower and risk-weighted assets higher than the bank’s own accounts showed.

Calculated according to the 2014 regulatory capital rules, the Central Bank believes Bank of Ireland had a common equity tier 1 capital ratio of 9.85% in June while the bank’s own accounting treatment showed a figure of 13.8%.  This 9.8% is still above the 8% ratio that will be required by the ECB following next year’s exercise.  However, it would be below the 10.5% requirement that the Central Bank of Ireland has itself set in recent years.  By this year’s regulatory capital rules, the Central Bank views Bank of Ireland’s common equity tier 1 ratio as 10.6% which is just above this requirement.

Does this mean that Bank of Ireland’s capital ratio is about to be written down by four percentage points? The Central Bank is its regulator so you might imagine that this would be the case.  However, Bank of Ireland’s statement contains a number of criticisms of the Central Bank’s calculations.  Indeed, the bank “remains confident in its own methodologies, calculations and impairment provisions” and the statement merely says the results will “remain subject to ongoing engagement” with the Central Bank.

The Central Bank certainly has the powers to compel Bank of Ireland to raise capital on the basis of its own assessment and this may be what happens.  But it is not clear to me whether Bank of Ireland will be forced to release year-end accounts calculated in line with the methodologies preferred by the Central Bank of Ireland.

All told, it’s hard to know what Bank of Ireland’s reported capital ratios will be in its next report. However, the fact that a stress test has to be done next year and that this exercise will involve further (yet to be determined) capital requirements suggests that the bank will probably need to raise more capital.

If things are a little unclear with respect to Bank of Ireland, the situation is clear as mud when it comes to the other two banks that made announcements yesterday.

Allied Irish Banks (AIB) put out a terse announcement unaccompanied by a Schedule 1 sheet.  It stated

AIB has been advised of the findings of this review which it will consider in the preparation of the bank’s year end December 2013 provisions and financial statements.

Based on an initial assessment of the findings of the BSA, the Bank believes it continues to be well capitalised and in excess of minimum regulatory requirements.

You might be tempted to read that statement and conclude that AIB’s “Schedule 1” sheet showed that it was well-capitalised and did not need to raise new capital. I think that’s a bit optimistic.  AsBill Clinton might say, it depends on what the meaning of “Bank” is.

Given that the “Bank” in question had to do “an initial assessment of the findings” to come up with the “belief” that it is well capitalised, then my interpretation is that the “Bank that believes” is AIB. (The capital B being an affectation the bank (all lower case) likes to use in press releases.)

So the bank (or Bank …) believes that it’s well-capitalised. Well good for them. But remember that Bank of Ireland also disagreed with the Central Bank and believe their own figures are better.  So there’s a lot of subjective beliefs floating around here. Most likely, AIB’s Schedule 1 sheet shows that it requires more capital.

Then there’s the most tight-lipped of the three banks, Permanent TSB, who provided no figures and simply stated

Based on the communicated results the outcome confirms that the capital position of permanent tsb plc is above minimum regulatory requirements.

What this means depends upon whose notion of “minimum regulatory requirements” you’re thinking of.  It could mean above the Central Bank of Ireland’s guidelines of 10.5% or it could mean above the current European CRD4 minimum common equity ratio of 3.5%.  A cynic might suggest that if it was the former then the bank would have released the results. Perhaps modest PTSB (who describe themselves without using a single upper-case letter) are hiding a set of fantastic results. Perhaps not.

The Central Bank of Ireland and the ECB should remember that the purpose of this exercise is to bring clarity to bank balance sheets. Yesterday’s events achieved the exact opposite with people scratching their heads interpreting strangely-worded statements and wondering about the figures that were not reported.

The ECB needs to use yesterday’s events as a lesson. It would not be acceptable for this kind of shambles to be repeated whenever the first stage of the ECB’s comprehensive assessment is completed. Either all banks involved in the process reveal the details of their assessment or else the whole exercise should be conducted in secret.  Allowing stronger banks to report results while we are left wondering about the weaker ones is a recipe for financial instability.

So What’s So Special About Bitcoin?

I received a number of thoughtful comments on yesterday’s article on Bitcoin and wanted to follow up on a couple of important points that they raised and provide some new information.

Some of the pro-Bitcoin enthusiasts were keen to emphasize the difference between Bitcoin and previous potential sources of private money.  It’s digital, so doesn’t have physical production or storage issues and it’s hard to melt down a Bitcoin and pass it off as two Bitcoins, thus perhaps ruling out the role governments played in verifying and securing money in the past.

However, commenters were also keen to emphasize that Bitcoin is special because it can only be created according to a special algorithm that ultimately limits the total number of Bitcoins to 21 million and guarantees that payments are anonymous and irreversible.

The fact that Bitcoin advocates rely so heavily on the niftiness of its underlying algorithms and protocol is one of the best reasons to predict its demise.  If all you have going for you is a cool algorithm, then at some point there will be someone else out there with an even cooler algorithm. And then someone else.

Indeed, there is evidence that this process is already underway. If you don’t want to use Bitcoin, you can always try Litecoin. It promises to be

a peer-to-peer Internet currency that enables instant payments to anyone in the world. It is based on the Bitcoin protocol but differs from Bitcoin in that it can be efficiently mined with consumer-grade hardware. Litecoin provides faster transaction confirmations (2.5 minutes on average) and uses a memory-hard, scrypt-based mining proof-of-work algorithm to target the regular computers and GPUs most people already have. The Litecoin network is scheduled to produce 84 million currency units.

And if you’re in it for the speculation, Litecoin is showing some nice bubbly movements as well.

Or maybe you could go with Primecoin, an

experimental cryptocurrency that introduces the first scientific computing proof-of-work to cryptocurrency technology. Primecoin’s proof-of-work is an innovative design based on searching for prime number chains, providing potential scientific value in addition to minting and security for the network.

Supporting private money and adding scientific value, what’s not to like?

Perhaps though, you are kept awake at night worrying about a 51% attack (no it doesn’t involve aliens or Area 51). In that case, perhaps Peercoin is for you

Peercoin’s major difference from Bitcoin is that it uses a proof-of-stake/proof-of-work hybrid system for coin generation. With this system, coins are generated based on proof-of-stake blocks in addition to proof-of-work blocks. In other words, someone holding 1% of the currency will generate 1% of all proof-of-stake coin blocks.

Proof-of-stake block generation could reduce the risk of 51% attacks ….

This little tour of crypto-currencies (and there’s plenty more) should be enough to convince you that one of these outfits will probably produce a currency that is widely seen as superior to Bitcoin along most dimensions, perhaps attracting lots of supporters on websites and Russian-government-sponsored TV shows.

What happens then to your Bitcoins then?  Even Bitcoin’s own FAQ is clear about the uncertainties surrounding its future.  A brief excerpt:

Can bitcoins become worthless?

Yes. History is littered with currencies that failed and are no longer used, such as the German Mark during the Weimar Republic and, more recently, the Zimbabwean dollar. Although previous currency failures were typically due to hyperinflation of a kind that Bitcoin makes impossible, there is always potential for technical failures, competing currencies, political issues and so on.

So even if private crypto-currencies are the future, that doesn’t mean that Bitcoins will feature in that future. It’s a bit like investing all your money in IBM in the 1970s because you’re sure computers are the next big thing even though you haven’t yet heard of Microsoft or Apple. Or taking a punt on Pets.com in 1999 because the Internet is the future and sure people will still have pets in the future.

The difference in this case is that private currencies are probably not the future.  The very fact that no single private currency can be relied on to have the necessary unique features to become a useful source of value is likely to undermine the whole idea. Like it or not, the US federal government is going to be with us for the foreseeable future, printing dollars, requiring tax payments in those same dollars and enforcing the requirement that creditors must accept dollars as legal tender. Dollars are not going to be dislodged by Bitcoin, Primecoin, Karlcoin or whatever.

Of course, commenters did note another advantage of Bitcoins. They may possibly help to facilitate illegal activities and tax evasion. If that’s why you’re buying Bitcoins, all I can say is good luck with that. Uncle Sam is watching you.

How Is Bitcoin Different From The Dollar?

As Bitcoin goes through another day of crazy price fluctuations and huge publicity, this time courtesy of the U.S. Senate, I recommend two readings for those interested in putting the Bitcoin phenomenon in historical context.

The first is this article by my colleague Stephen Kinsella. Stephen’s key point:

Bitcoin has no use value, only exchange value, and because it is has no worth in use other than what others are willing to pay for it, it is always in a bubble: these happen when prices of assets get dislodged from their fundamental value. So Bitcoin is the perfect bubble.

Now the obvious question that this raises is the following: Is Bitcoin so different from the dollar? A dollar bill also has no use other than what people are willing to pay for it. And if people decide they wish to trust the people who create Bitcoins more than their own government, then perhaps it could be an alternative medium of exchange.

Stephen partially gets at the answer as to why Bitcoin differs from the dollar. It is “a currency not backed by any state – meaning nobody has to take it as payment.” The fact that the U.S. government requires payment in dollars in itself creates a direct demand for dollars that cannot be replicated by Bitcoin.

History shows, however, that the state’s involvement in money goes deeper than merely requiring tax payments in its chosen currency and this history is useful for understanding the likely limits to “private monies” like Bitcoin.

My favorite article on this topic is Two Concepts of Money written in 1998 by legendary British economist Charles Goodhart. I strongly recommend that people interested in Bitcoin read it.

Goodhart argues that states have essentially always been in control of monetary systems. He emphasizes that governments have always viewed seigniorage as a useful form of revenue and are unlikely to allow this source of revenue to be replaced by a private source of money.

Right now, Bitcoins are effectively irrelevant when compared with the larger payments system, but those who anticipate it expanding to be widely used might ask how sure they are that private monies of this type would actually remain private. Once big enough to be termed a success, any such currency would attract more attention from governments than a cursory Senate hearing.

Goodhart also shows the theory that private money can emerge as a solution to the inefficiencies of barter has little historical backing. For example, while people often believe that precious metals were adopted over time by the private sector as a useful medium of exchange, in practice people could not be sure whether the metallic content of coins were equal to stated amounts.

Only when governments standardized and verified such coins – and provided security for mints – were coins widely used as a medium of exchange. Goodhart notes that much of the Roman empire went from a monetary economy back to barter after the empire’s decline. Bitcoin enthusiasts may believe that problems with security and verification are less likely to affect a digital currency. Time will tell us the extent to which that is true.

Advocates of Bitcoin enthuse about its commitment to limiting its supply of virtual coins. Goodhart’s paper discusses whether such commitments from private providers of money can actually be credible. He concludes such commitments probably run against the interest of those who control these currencies and so they should not be trusted. Blind trust in the people behind Bitcoin may turn out to be no more sensible than blind trust in the U.S. government, and quite possibly less so.

There’s no doubt that Bitcoin is an interesting invention, useful at a minimum for provoking good classroom discussions in Money and Banking courses about what exactly is the meaning of money. But people should be wary of investing large amounts of their savings in Bitcoins. History provides plenty of reasons to suspect that private money is unlikely to work. Maybe this time is different. Usually it’s not.

Ireland Exits Bailout With No Backstop: A Good News Story?

After years of turmoil, Europe seems to finally have a good news story. Ireland will be the first of country to exit a “troika” program and yesterday its government announced that it would not even be seeking a “precautionary” credit line from Europe’s bailout fund, the ESM.  But is this quite the good news story that most people think it is? I’m not so sure. Indeed, I suspect yesterday’s announcement illustrates how political problems may undermine Mario Draghi’s plans to save the euro.

There is certainly some good economic news coming from Ireland. Targets laid down in the program for the budget deficit were met and while economic growth has been minimal and unemployment is high, employment is now growing again and a large stock of over €20 billion of cash has been built up via borrowings from financial markets and the troika. By the very low bar set by the recent economic performance of the euro area, Ireland is something of a success.

For these reasons, yesterday’s announcement that Ireland would not need a new bailout was not news. This has been known for some time. The news element here was the announcement that there would be no precautionary credit line. But is that actually good news?

Irish government politicians have been keen to claim that there is some good economic news in this announcement, that it “provides clarity” and “reduces uncertainty”.  In fact, the opposite is the case.

A precautionary credit line is something that doesn’t have to be used. Anything that can be done without a precautionary credit line can also be done with one.  However, without such a credit line, the Irish government run the risk of running out of funds and having to negotiate a new bailout or credit line under far less positive circumstances than currently prevail.  This adds to the uncertainties facing Ireland in the coming year, particularly given the possibility that Irish banks may need further recapitalisation next year.

Ireland’s finance minister, Michael Noonan, acknowledged yesterday that economic conditions may not be so benign next year. This should be seen as an argument for negotiating a credit line now but, strangely, Noonan used this observation as an argument for not seeking a credit line.  He seemed to be struggling to find anything better than weak talking points to explain the benefits of not having a credit line.

There is, of course, a narrow political benefit to the Irish government from this “clean” exit, because it allows them to triumph about the full restoration of “sovereignty.”  However, I don’t think they are so cynical as to have made this decision purely for that populist reason.  Instead, my assessment is that the precautionary credit line could not be arranged now because it was politically impossible and that the Irish government are merely putting a brave face on what is a bad outcome.

The political problem is that credit lines from ESM require the approval of all euro area member states and this was not going to be possible now. Germany still does not have a government as Angela Merkel’s CDU continue negotiations with the SPD to form a coalition. During these negotiations, the SPD has regularly insisted that they would not support an ESM credit line for Ireland unless the country followed a series of highly specific policy recommendations.

SPD requirements for approval of a credit line included raising the corporate tax rate and introducing a financial transaction tax. The SPD also ruled out any deal that involved used funds from the credit line to recapitalize banks.

This kind of micro-managing of other people’s economies was not what most people had expected ESM conditionality to look like. Given the existing raft of EU monitoring programs that exist (the six pack, the two pack, the macroeconomic imbalances) a sensible approach would be to require that a country seeking a credit line from ESM commit itself to meeting the recommendations on macroeconomic policy of the European Commission.

When Germany finally has a government and SPD politicians are firmly ensconced in ministerial Mercs, I suspect the desire to micro-manage Ireland’s affairs will recede. However, the damage may well be done. Having sold the Irish public on the idea that the credit line was something to be avoided, it seems unlikely that the government can change its mind next Spring.

This is the odd aspect of yesterday’s decision. Why not announce that Ireland was exiting the program without a precautionary credit line but that discussions about this issue were ongoing? One unattractive possibility is that Ireland’s leaders were asked by their German colleagues to make this announcement to remove it as an issue in the government formation negotiations.

Missed in yesterday’s discussion is that these developments have implications for the ECB’s Outright Monetary Transactions (OMT) program. This is the program announced by Mario Draghi after his “whatever it takes” speech last year.  Under this program, the ECB can purchase unlimited quantities of a country’s government bonds. However, the ECB decided that countries could only avail of OMT if they had an agreement with ESM for a bailout program or precautionary credit line.

Ask yourself this: If star pupil Ireland couldn’t negotiate a precautionary credit line based on reasonable conditionality, what chance is there that a credit line of this sort for Italy will be approved by all countries in the euro area? OMT may have been cast as the plan to save the euro but getting it up and running may not be so easy.

Resolving Europe’s Banking Crisis

I’m giving a presentation tomorrow afternoon at the annual Dublin Economics Workshop conference in Limerick. (For those of you who don’t know these things, the Dublin Economics Workshop’s annual conference has always been held outside of Dublin ….)

The presentation is titled “Resolving Europe’s Banking Crisis” and provides facts and figures on Europe’s credit crunch, explanations for the sources of this problem and scenarios for the upcoming European banking stress tests.