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10 августа 2015, 11:52

The decline in market liquidity

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Authors: Jérémie Cohen-SettonWhat’s at stake: There has been a plethora of stories on the apparent decline in trading or market liquidity over the past few months with a growing number of analysts pointing out that it has become harder for buyers and sellers to transact without causing sharp price movements. While the Fed remains unimpressed with these developments, several commentators have argued that the next crisis might come from an abrupt and dramatic re-rating of stocks and bonds. The problem with illiquid markets Robin Wigglesworth writes that Wall Street’s latest obsession is bond market liquidity.  Lael Brainard writes that these concerns are highlighted by several episodes of unusually large intraday price movements that are difficult to ascribe to any particular news event, which suggest a deterioration in the resilience of market liquidity. Nouriel Roubini writes that investors’ fears started with the “flash crash” of May 2010, when, in a matter of 30 minutes, major US stock indices fell by almost 10%, before recovering rapidly. Then came the “taper tantrum” in the spring of 2013, when US long-term interest rates shot up by 100 basis points after then-Fed Chairman Ben Bernanke hinted at an end to the Fed’s monthly purchases of long-term securities. Likewise, in October 2014, US Treasury yields plummeted by almost 40 basis points in minutes. The latest episode came in May 2015, when, in the space of a few days, ten-year German bond yields went from five basis points to almost 80. These events have fueled fears that, even very deep and liquid markets – such as US stocks and government bonds in the US and Germany – may not be liquid enough. Charlie Himmelberg and Bridget Bartlett write that market liquidity is the extent to which investors can execute a fixed trade size within a fixed period of time without moving the price against the trade (which should not be confused with monetary liquidity, access to short-term funding, or liquid assets held on company balance sheets). Steve Strongin writes that one $10 million trade that historically may have taken a day to get done now needs to be split into 20 $500,000 trades that take a week or two to execute. From an investor’s standpoint, that is very uncomfortable because we live in a 24-hour news cycle so information is flowing much faster, but your ability to execute trades is now much slower. It also means that certain types of investment strategies—such as arbitrage strategies that rely on the ability to quickly identify and act on market dislocations—no longer work nearly as well, if they work at all. Has liquidity decreased? In its latest monetary report to Congress, the Federal Reserve writes that despite these increased market discussions, a variety of metrics of liquidity in the nominal Treasury market do not indicate notable deteriorations. David Keohane writes that measuring liquidity is by necessity slippery — pick your preferred measure of liquidity (bid-ask, price impact, decline in net-dealer inventories) and we are pretty sure we can point you to a problem with it. But the chart below, on growing market size versus declining turnover, is tantalizing.  Source: Goldman Sachs Technology, regulations and liquidity Nouriel Roubini sees several reasons why the re-rating of stocks and especially bonds can be abrupt and dramatic. First, when high-frequency traders are inactive, equity markets are in fact illiquid with few transactions. Second, fixed-income assets are illiquid because they’re mostly traded over the counter and are held in open-ended funds that allow investors to exit overnight. Before the crisis, banks used to hold large inventories of these assets, thus providing liquidity and smoothing excess price volatility. But, with new regulations punishing such trading (via higher capital charges), banks and other financial institutions have reduced their market-making activity. So, in times of surprise that move bond prices and yields, the banks are not present to act as stabilizers. Matt Levine writes that Volcker, capital requirements, etc., drive up the cost of immediacy, but they don't increase the risk of a crash, because bond dealers were never in the business of buying all the bonds all the way down. Lael Brainard writes that reductions in broker-dealer inventories occurred prior to the passage of the Dodd-Frank Act, suggesting that factors other than regulation may also be contributing. In assessing the role of regulation as a possible contributor to reduced liquidity, it is important to recognize that those regulations were put in place to reduce the concentration of liquidity risk on the balance sheets of the large, highly interconnected institutions that proved to be a major amplifier of financial instability at the height of the crisis. Risks of amplification Lael Brainard writes that a reduction in the resilience of liquidity at times of stress could be significant if it acted as an amplification mechanism, impeded price discovery, or interfered with market functioning. For instance, during episodes of financial turmoil, reduced liquidity can lead to outsized liquidity premiums as well as an amplification of adverse shocks on financial markets, leading prices for financial assets to fall more than they otherwise would. The resulting reductions in asset values could then have second-round effects, as highly leveraged holders of financial assets may be forced to liquidate, pushing asset prices down further and threatening the stability of the financial system. Robin Wigglesworth writes that scarred by the financial crisis, retail investors gravitated towards the supposed safety of fixed income. But their funds have bought increasingly illiquid bonds while still offering investors the opportunity to pull out whenever they want. If losses spook investors to do that, asset managers will sell bonds in order to pay investors their money back, the type of scenario that can quickly become a fire sale. Read more...

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07 августа 2015, 12:07

Los trémulos cimientos del 'plan Juncker'

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Authors: Grégory ClaeysTras semanas de negociaciones con la Comisión Europea y el Consejo, el parlamento europeo adoptó el 24 de junio el texto que establece el Fondo Europeo para Inversiones Estratégicas (FEIE), instrumento neurálgico del plan de inversiones del presidente de la Comisión. El objetivo del plan (abordar la drástica caída de las inversiones que afecta a Europa desde el principio de la crisis) es sin duda loable. El nivel anual de inversiones en la UE se sitúa actualmente un 10% por debajo de su tendencia sostenible a largo plazo, lo que supone una losa importante para el empleo y el crecimiento, y frena el potencial de crecimiento de Europa a largo plazo. En ese sentido, el plan es un paso en la dirección correcta. El presidente Juncker ha recalcado la inversión como una de sus grandes prioridades y el plan de inversiones fue el primer proyecto bandera de la nueva Comisión. Aun así, el plan se apoya en dos pilares trémulos: la reorganización de una pequeña cantidad de fondos y la asunción de que el Banco Europeo de Inversiones (BEI) será capaz de alejarse de su cultura adversa al riesgo para financiar proyectos de alto riesgo y rendimiento. Desde el punto de vista económico, la respuesta óptima a la caída de las inversiones habría sido un plan masivo de inversiones públicas europeas que aprovechara los tipos de interés en mínimos históricos. Al contrario, la solución propuesta por la Comisión indica que la mayoría de los Estados miembros no tienen ganas de establecer un plan así y eso se refleja en la pequeña cantidad de dinero en juego. Los fondos destinados al proyecto bandera de inversiones de la Comisión se reducen a 8.000 millones de euros del presupuesto de la UE y 5.000 millones de euros del BEI, y se supone que generarán otros 315.000 millones de euros en inversión privada en los tres próximos años. Pero el plan no cuenta con dinero nuevo: la aportación de 5.000 millones de euros del BEI procede de beneficios antiguos, que se habrían usado igual para financiar proyectos nuevos, y los 8.000 millones de la reorganización de los presupuestos de la UE de 2015 a 2020 se extraerán sobre todo de los grandes programas de I+D e infraestructuras de transporte de la UE. Además de denotar la poca fe de la Comisión en sus propios programas, surgen costes de oportunidad importantes de sacar dinero de estos programas y depositarlo gradualmente en un fondo de garantías que puede o no usarse para compensar al BEI por pérdidas potenciales. Dada la limitación de los fondos implicados, la idea inicial de la Comisión era emplearlos para ofrecer garantías a inversores privados adversos al riesgo y animarles a financiar inversiones de más riesgo. Cuando se desveló el plan parecía una idea astuta, siempre y cuando se ofreciese la garantía a inversiones que no encontraran financiación. Sin embargo, si nos fijamos en los detalles del plan, hay buenas razones para ser escéptico sobre su impacto en el crecimiento y el empleo. Primero, aunque el Fondo Europeo de Inversiones Estratégicas (FEIE) se presente como un fondo auténtico, será solo una etiqueta para nuevos activos del BEI. Esa etiqueta se otorgará a proyectos que el BEI se había negado a financiar por considerarlos demasiado arriesgados y que ahora se beneficiarán de la garantía de la UE (aunque el BEI está bien capitalizado en estos momentos y ya se beneficia de una garantía de todos los estados miembros de la UE). En consecuencia, el plan adoptado se basa en el audaz supuesto de que la creación del FEIE conducirá a un cambio en la forma en que el BEI opera. Tanto es así que, para que el plan sea efectivo, el BEI tendrá que asumir más riesgos y alejarse de su selección de proyectos excesivamente prudente y financiar proyectos viables que no consigan financiación a día de hoy. Además, el plan asume que el BEI aceptará exponerse más que sus co-financieros para reducir notablemente los riesgos asumidos por los inversores privados. El BEI deberá asimismo financiar una parte más pequeña de cada proyecto para no dejar fuera a los inversores privados. La participación actual del BEI, entre un tercio y la mitad, disminuiría a una quinta parte hasta llegar al multiplicador de 15 que asume el plan y alcanzar los 315.000 millones de euros prometidos. Si se cumplen estas condiciones, incluso si el plan Juncker no resulta ser el gran plan de inversión que se ha vendido al público, estimularía al menos un cambio bienvenido en la forma en que el BEI funciona. Dicho eso, un mero recordatorio del consejo de gobernadores del banco (formado por todos los ministros de hacienda de la UE) sobre la misión esencial de la entidad de emplear sus recursos para limar fallos del mercado podría haber bastado para que se produjese el cambio, sin la necesidad de involucrar a la Comisión o el presupuesto europeo. En general, la Comisión, al depender de la disposición del BEI a cooperar totalmente, se ha arriesgado a que su plan bandera de inversión no sea el agente transformador anunciado y a que sus repercusiones en términos de crecimiento y empleo sean muy limitadas.Read more...

06 августа 2015, 15:03

Wolfgang Schäuble, Debt Relief, and the Future of the Eurozone

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Authors: Ashoka ModyThe German Finance Minister Wolfgang Schäuble has had enough. Greece, he says, cannot receive debt relief from European creditors because European official creditors are forbidden by European treaties to grant relief. But this cannot be true. Once a loan has been made, any lender exposes himself to a default risk. The reason Schäuble is concerned is that the carefully constructed but fragile crisis management system—intended to insulate Germany from paying the bills of others—is now under threat. If Greece creates a precedent, then either the crisis management system goes, or a transfer union is effectively in place, with Germany on the hook. Hence his call for Greece’s exit is accompanied by an equal vigorous effort to control the budgets the euro area sovereigns. Acrimony is bound to follow, creating deeper divisions in Europe. The Legality of European Bailouts Creditors forgive debt because both the creditor and the debtor gain. For that reason, it is both economically right and legally correct to forgive some claims. Karl Whelan and Armin von Bogdandy, Marcel Fratzscher and Guntram Wolff make the mistake of arguing the case for debt relief on the basis of European law.  Despite their thoughtful arguments, the authority granted under Treaty on the Functioning of the European Union (TFEU) for member states to loan funds to other member states and for the ECB to conduct its Outright Monetary Transactions (OMT) has a fragile legal basis. That authority skirts the limits of the Treaty and goes against the intent of original signatories. The authority was created as a response to the crisis and Greek debt relief threatens to unravel that structure. Article 125 of the TFEU says that a member state cannot pay another’s debts. This is the “no bailout” clause that was agreed to at Maastricht. Its meaning was self-evident to the signatories. That was also true for Article 123, which prohibits monetary financing of a sovereign by the ECB.  Put simply, if they had disagreed, there would have been no euro. When the Irish parliamentarian Thomas Pringle challenged the European Stability Mechanism (ESM), the European Union’s bailout fund, the European Court of Justice (the ECJ) agreed that Article 125 prohibits a member state’s debts being paid by another. But the ECJ allowed that a member state could receive a loan from other member states, provided it was repaid “with an appropriate rate of return.” It is the repayment with an appropriate rate of return that protects the ESM from violating Article 125. The European authorities can determine what the “appropriate rate of return” is since the Court provided no guidance. Presumably, we can all agree that if the net present value of debt owed to European creditors is reduced to zero, then Article 125 would be violated. So, the only question is how much can it be plausibly lowered. If the creditors would have received €100 five years from now if their money were invested in U.S. Treasuries and they were to instead receive €50 euros, would that be “appropriate?” How about €30 euros? The Court did not recognize that risk of default is inherent in a debt contract. And so did not comment on—or provide for—the contingency of default. von Bogdandy, Fratzscher and Wolff argue that debt relief now in return for GDP-linked returns in the future skirts the Court’s criterion of an appropriate rate of return. Merely exchanging payments through financial engineering does nothing if the net present value is not reduced. (We are now mercifully past the point where, for months, commentators insisted that Greece needed only liquidity support, not debt relief.) If relief is to be provided, extending maturities is a more transparent and reliable mechanism of reducing net present value. von Bogdandy et al. also argue that the ECJ’s June 2015 decision allows for the possibility that the ECB can make losses on its Outright Monetary Transactions operations. This, they say, creates an opening for losses on lending by sovereigns. That interpretation would create a cascade of losses. Recall that the OMT can only be activated if an ESM program with a sound economic recovery strategy is in place. Such a program would—it is hoped—make the likelihood of a loss on the ECB’s operation negligibly small. If that presumption is valid, the ECJ says, the OMT would not be financing operation. This is crucial because, unlike the ESM, the ECB is not even allowed to provide financing to euro area sovereigns. The OMT, protected by ESM financing and policy conditionality, is a monetary policy operation, much as its multitude of daily transactions. Losses on monetary operations are permissible, not on loans to sovereigns. If von Bogdandy et al. are right that the ECB can make losses on its holdings of sovereign bonds, then this is the perfect moment for the ECB to forgive much of its claims through Greek bonds purchased under the Securities Markets Program. In practice, the ECB has added one further layer of protection. In its so-called quantitative easing operation, the burden of first loss on the ECB’s purchase of national sovereign bonds falls on the national central banks. If this is so for QE, then it must be all the more so for OMT, which is decidedly a more risky venture. The steady debt forgiveness of Greek debt since the European Council meeting on July 21, 2011 has steadily lowered the rate of return to creditors. When the legality of the Greek bailout is tested before the ECJ—as it inevitably will be—the ECJ will, at the very least, need to add: “creditor beware.” If so, ESM programs will come under a further cloud and so will the OMT. If that makes the possibility of debt relief a material risk, then will the ESM, in effect, be frozen? Bundesbank President Jens Weidmann has already raised questions about the future use of the ESM in view of recent developments. The exact same concern has been raised by the German Council of Economic Experts. The German Interest Debt relief for Greece creates the risk for Germany that an activist ECJ will make unlimited losses legally acceptable.  A conflict with the German constitution would follow. The German Federal Constitutional Court has been clear that open-ended and unpredictable demands on the German budget, which are triggered by the decisions of other sovereigns, are not compatible with the German Basic Law. The Federal Court’s rulings, therefore, limit the scope for Germany’s intergovernmental guarantees to specific designs and limited amounts (Schorkopf, 2009 and Mayer, 2012). For this reason, Germany has stood steadfastly against any concept of Eurobonds. In effect, now, if Article 125 says that significant losses on ESM lending are possible, we have a Eurobond by the backdoor. Put aside the legality for a minute, such a change in mindset would require a political revolution in Germany. Seen either from the European or German perspectives, Schäuble knows exactly what is at stake. The Schäuble Proposition For this reason, the real goal for Schäuble is to change the way the eurozone functions. And he has returned to another old theme. In the Intergovernmental Conference to negotiate the Maastricht Treaty, the “no bailout provision” was uncontroversial but the proposition that countries would face sanctions if they mismanaged their fiscal affairs was extraordinarily contentious. Even Jacques Delors, for whom the monetary union was the ultimate goal, rebelled against the idea of sanctions. Delors’ biographer, Charles Grant describes the negotiations: “The Germans continued to argue for sanctions against countries with ‘excessive deficits.’ Only the strange alliance of Delors and [Norman] Lamont [British Chancellor of the Exchequer] argued against centralization of fiscal policy. Delors claimed that EC sanctions would breach subsidiarity and be unnecessary. …Lamont argued that markets would discipline profligate governments by demanding higher rates of interest.” In practice, sanctions have been on the book but have never been triggered because a group of peers will not sanction another for fear that roles may be reversed. Schäuble’s goal—under the framework of a European budget commission—is to create a system of enforceable sanctions. What was not achieved at Maastricht must now be completed for the necessary fiscal discipline will ensure a viable monetary union. To be clear, although the Schäuble idea is sometimes referred to as a “fiscal union,” there can be no presumption that fiscal transfers will be part of the deal. This politically divisive system of fiscal rules and sanctions has little economic merit. The essential dynamics of divergence under a single monetary policy will remain intact. ECB Vice President Vitor Constâncio has explained that this crisis is the result of imbalances in the private sector; fiscal policy played a limited role during the years when the imbalances were building up. Even with the additional procedures instituted after the crisis, the current unworkable structure binds divergent nations too tightly. This or any other system cannot wish away a future crisis just as it was wished away when the monetary union was originally constructed. The economic logic says that there are two different problems. Greece needs debt relief and the eurozone does not work. That requires two instruments. If the IMF is true to its word, then it should forgive Greek debt—not least to be accountable for its serial mistakes in the conduct of the Greek program and for delaying by six precious months a transparent discussion of a necessary debt relief. This would force the European authorities to contribute their share of further debt relief and may even induce them to repay the Fund on Greece’s behalf. The solution to the eurozone’s more fundamental problem requires deeper reflection. French President François Hollande has invoked the vision of Delors to move Europe closer to a political union, a theme that has been reiterated by Italian Finance Minister Pier Carlos Padoan. Schäuble, in contrast, has made it politically legitimate to discuss the breakup of the euro area. The German Council of Economic Experts has now added its voice to that idea, suggesting that exit from the euro area now become integral to the way the euro area works (paragraph 8 of the Executive Summary). But if a euro break up is now open to discussion, some would argue the least disruptive way to do so is by Germany exiting from the eurozone. That will open up many possibilities for a new configuration. Of course, the most likely outcome is that Greece will continue to borrow new money from the creditors to pay its old debts to those creditors. As it undertakes more austerity, Greek output and prices will fall, making its debt burden greater. That will be blamed on Greek intransigence. More weekends of high drama will lead to driblets of debt relief. The Greek tragedy and euro area fragility seem destined to continue. References Grant, Charles, 1994, “Delors: Inside the House that Jacques Built,” London: Nicholas Brealey Publishing. Mayer, Heidfeld, 2012, “Verfassungs- und europarechtliche Aspekte der Einführung von Eurobonds,” Neue Juristiche Wochenschrift 422, February. Schorkopf, Frank, 2009, “The European Union as An Association of Sovereign States: Karlsruhe’s Ruling on the Treaty of Lisbon,” German Law Journal 10: 1219-1240. Read more...

05 августа 2015, 12:30

Greece’s debt burden can and must be lightened within the Euro

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Authors: Armin von Bogdandy, Marcel Fratzscher, Guntram B. WolffPerhaps the greatest damage caused by the confrontation with Greece is a general loss of confidence. If we want to get Greece back to growth, people, companies and investors have to regain confidence in the viability of the country. For this to work, a legitimate and competent government as well as an efficient administration and judiciary are essential. Yet the issue of debt sustainability is still central, even if the debt servicing costs are negligible in the short term. No one doubts the IMF’s analysis that the sustainability of Greek government debt constitutes a key precondition for recovery. The third program, which is now being negotiated, aims to put Greece back where it stood at the end of last year: with growth expectations of almost 3%. This third programme is intended to be the exact opposite of a transfer program. It aims to strengthen the Greek economy and thereby protect the loans and guarantees provided by the creditors. A large part of the disbursements will go into debt repayments to official creditors. This is important, but not enough. The current link between debt servicing and membership of the single currency leads to a vicious circle that increases uncertainty, weakens growth and makes full debt repayment less likely. There will be no confidence and no growth in Greece without a solution to the debt problem. We suggest breaking this vicious cycle by tying the interest rates on the loans to the growth rate of the Greek economy, together with a conditional debt moratorium. A Greece without growth should not pay any interest or make any repayments. The stronger the growth rate, the higher the interest and repayments to European creditors. The debt moratorium would mean that Greece could push back the repayments if it has not reached a certain level of GDP by 2022, when it is scheduled to begin servicing its debts to the European creditors. Such a solution would end the uncertainty and recognise the fact that Greek growth is a joint European concern and a prerequisite for Greece to service its debts. Stability and confidence could return. Much of the cause for the current political confrontation would be gone. Meanwhile, such an approach would not reduce the incentives for reform. It is in the self-interest of any Greek government to pursue growth-friendly reforms. Of course, it will be necessary to design the plan in such a way as to avoid moral hazard; yet this is possible and the conditions are favourable. Such a solution would also be advantageous for the creditors. Some form of debt relief is inevitable. The main advantage of our proposal is that creditors would benefit if growth resumes and thereby reclaim more of their loans than otherwise possible. At the same time, our proposal has only a negligible impact on the creditors’ current budgets and would thus have no meaningful consequences for the constitutional debt limits of member states. A payment moratorium, essentially a way to restructure Greece’s debt to its official creditors - the other member states of the euro area, the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM) - is legally permissible within the Euro. The opinion of the German finance ministry, that only a temporary Grexit allows any restructuring, is unconvincing. In the 2012 Pringle case the European Court of Justice (ECJ) decided that Article 125 of the Lisbon Treaty, often wrongly termed the ‘no-bailout clause’, “does not prohibit the granting of financial assistance by one or more Member States to a Member State…provided that the conditions attached to such assistance are such as to prompt that Member State to implement a sound budgetary policy.” Of course it was financial support and not debt restructuring that was the subject of this ruling. However, the ECJ then decided that even the European Central Bank (ECB) could take on significant financial risk in its Outright Monetary Transactions, as long as it acted in accordance with its mandate. Although the ECJ did not explicitly rule that the ECB could participate in a debt restructuring, it can be surmised from the rationale of its reasoning that the ECB can accept such a restructuring so long as it is vital for monetary policy to take the original risk. The ECB’s legal framework is especially strict because of the ban on monetary financing. Nevertheless, if the ECB is allowed to accept a restructuring, then a restructuring of Greek debt held by other member states, the EFSF and the ESM cannot be considered to breach Article 125 – so long as it aims to achieve budgetary stability in Greece. From an outcomes-oriented perspective, this argument also covers the conditional debt moratorium suggested here. In much the same way, domestic constitutional law does not prohibit such a solution. For example, the German Constitutional Court focusses on the need for any financial risk to be manageable for the Federal Republic, and for the budgetary independence of the Bundestag to be protected. Of course many constitutional questions have yet to be answered, but our suggestion moves within the scope and along the path of previous decisions. The permissibility of any such debt moratorium has two conditions. Firstly, a restructuring must be needed for the preservation of the euro area, which the IMF has proven in the case of Greece. Secondly, it must be accompanied by a programme of structural reforms aiming at budgetary discipline and effective institutions. This will hopefully be agreed upon for the third programme. The conditions for a far-reaching modernisation of the Greek state have never appeared so favourable: the government is starting to implement reforms; the country has declared itself open to rigorous oversight; the Greek population has just lived through a ‘near death experience’. There are no firm legal arguments against tying Greek debt servicing to growth rates of the Greek economy, or against a conditional debt moratorium. From an economic perspective such a solution will not just improve the chances of repayment. It would also show that Germany and the other creditors have an interest in helping Greece and guaranteeing the stability of the Euro. Armin von Bogdandy is Director of the Max Planck Institute for Comparative Public Law and International Law Marcel Fratzscher is President of the German Institute for Economic Research - DIW Berlin Guntram Wolff is Director of the economics think tank Bruegel    Read more...

04 августа 2015, 13:42

Delhi’s children deserve quality education

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Authors: Ritika Katyal, Ashoka ModyIn the recently announced Delhi government budget, the newly elected Aam Aadmi Party (AAP)—the self-styled representative of the common man—has increased by 50 percent the funds allocated to education, raising the proposed outlay for the coming year to ₹98 billion. But money has not held up educational advancement either in Delhi or in India more generally. Delhi’s education budget has risen steadily. Indeed, the worry is that the increased budget will once again be hijacked by glamorous but wasteful projects, including in higher education. Successive national and state governments have been seduced by higher education—and while some achievements have been valuable—the nation’s educational foundation has remained shaky. Primary education is the foundation of a country’s progress. The East Asian growth miracles ensured education for all from the very start, which was central to their phenomenal economic development. Today, China boasts of some of the best schools in the world. But nearly 70 years after independence, high quality primary education is out of reach for a vast majority of India’s population. Today, over 40% of Indian children drop out before finishing primary school. Delhi’s Shame In spite of advantages as the nation’s capital and its elite colleges, Delhi’s schools lag even the generally dismal quality of India’s primary and secondary education. In 2013, Delhi’s Class III students were significantly below the national average in language achievement and in mathematics according to the National Achievement Survey conducted by National Council of Educational Research and Training (see accompanying chart). For Class VIII students, the performance of Delhi students was well below the national average in Mathematics, Science and Social Science. Delhi is lag relative to Kerala is stark. These differences almost entirely reflect the quality of education in government-run schools.    National Achievement Survey Class III (2014)National Achievement Survey Class VIII (2012)Source: National Achievement Survey, National Council of Educational Research and Training, New Delhi, 2014Source: Source: National Achievement Survey, National Council of Educational Research and Training, New Delhi, 2013 Other surveys corroborate Delhi’s poor standing. A 2014 survey by the Annual Status of Education Report (ASER) found that only 55% of Delhi’s government school children in Classes III-V could read at least a Standard I level text.  Only 24% of children in Classes III-V could subtract. Even in Patna, the capital of a state often considered the symbol of stunted development, not only government but even private school children performed substantially better than in the national capital. In the Ministry of Human Resource Development’s Educational Development index, Delhi was ranked 31st on outcomes at the primary school level.  In fact, central Delhi was included in the list of 419 special focus districts (SFDs) characterized by educational backwardness for 2012-13 under the National Sarva Shiksha Abhiyan. The AAP Challenge The AAP government plans to appoint 20,000 new teachers, install CCTV cameras in all classrooms, build 236 new schools and improve education quality by focusing on teacher training and developing replicable “model schools.” If this is to be more than words, here are some guideposts. Teachers’ incentives are crucial. Teachers do not show up—and they serve as role models for students. When they do show up, they do not teach. And, if they do teach, are they good teachers? The AAP initiative of installing CCTV cameras in schools will bring teachers to class, but who is going to monitor the CCTV cameras? Economists Lant Pritchett and Rinku Murgai propose a “career ladder” so that teachers—appropriately screened at entry—compete for the better paid permanent posts.  Appraisal and rewards based on 360 degree feedback from students, parents, supervisors, and peers would help keep teachers focused on performance.  A School Management Committee or another independent body could carry out random checks to increase accountability. An online database of teachers, where they can be rated anonymously, could create necessary social pressure. At the same time, giving teachers time and targeted training for professional development, and keeping teacher morale high by acknowledging good performance, both in monetary and non-monetary terms, will help.  A mindset change in how teachers in India are perceived and how they perceive themselves is essential. Similarly, students require incentives to study. Mid-day meals, better infrastructure and motivated teachers can get students to the classroom, and, to some extent, create incentives to learn. But more ambitious effort is needed. A UNESCO 2014 study finds that India has one of the lowest frequencies of curriculum reform—having updated its curriculum only 3 times since 1950 as compared to 8 times in South Korea. An updated curriculum with a more practical and learning-by-doing orientation can help make school fun. Contract teachers can be hired for remedial after school teaching to underprivileged children, with (performance based) opportunity to progress to a permanent job. Finally, AAP’s lemming-like pursuit of higher education initiatives is a mistake.  In 2010, Delhi’s colleges and universities awarded 17% of all Ph.Ds across India. Yet, the focus on higher education—in Delhi and in India—seems to have run into low and diminishing returns. The amount of original research being carried out in Indian academic institutions is abysmally low. The Stakes are High AAP represents the yearning of Delhi’s citizens for relief from the daily indignities of life. But its leader, Arvind Kerjiwal has acted repeatedly to dash those hopes. After AAP was first elected to power on a wave of popular protest in December 2013, the new government made irresponsible populist promises that would have hurt rather than helped Delhi. The government then resigned, 49 days after being in office, when its anti-corruption bill was blocked by the opposition in state assembly. At that point, instead of regrouping, Kerjriwal chose to contest a national election, in which his party was rightly obliterated.   But such is the revulsion against the traditional parties that AAP was voted back into power in Delhi in February 2015 with the kind of majority that only dictators in rigged elections can aspire to. But once again Kerjriwal and the AAP leaders are intent on throwing away the opportunity with self-indulgent infighting. AAP’s emergence comes at a critical juncture, and history is trying to convey an urgent message. Delhi has the opportunity to plant a seed that could flower across the country. After decades of neglect, a stronger primary education system will lead to superior student achievement, the ability to pursue higher education, and quality domestic research and entrepreneurship. “Make in India” will become more than a slogan. More widespread opportunity for primary education will create a playing field for competitive medical, engineering, and other entrance tests, which—for better or for worse—are life altering opportunities for Indian students. Economically disadvantaged children will finally have real reason to believe in a better future.   Primary education may be the single policy initiative that can do as much for growth as it does for equity. Education is also the only real antidote to the corrosive daily humiliation of corruption and the despicable sense of civic responsibility. If AAP’s only achievement with its stunning mandate is to promise a serious start in life to every child in Delhi, it would have honored the aspirations that brought it to power. The winners will be not just the children of Delhi, but millions of children throughout the country as the governments of other states are compelled to follow. Does Mr. Kerjiwal understand why the stakes are so high?      Read more...

03 августа 2015, 18:44

Europe must wake up before Iran falls into the arms of Russia and China

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Authors: Alicia García-HerreroEverybody seems to be greedily eyeing potential business deals with Iran after the nuclear deal reached with six world powers. This is no surprise. Iran’s economy is larger than Australia’s and twice as large as Iran’s successful neighbour, the UAE. More importantly, Iran is set to grow even faster. In fact, even under the most conservative projections (before the deal was signed), Iran was set to contribute nearly as much as Italy to global growth in the next decade: some $270bn. Beyond its large and starved domestic market after so many years of sanctions, Iran’s oil and gas reserves are the jewels in the crown.European companies expect to be at the forefront of the gold rush. Europe’s relationship with Tehran has been less confrontational than that of the US. Europe also has a history as a major oil importer from Iran. Pre-sanctions, Europe’s oil bill was some 600,000 barrels a day, with most going to Italy, Greece and Spain. Furthermore, Iran’s gas reserves, the second biggest in the world, could eventually make their way to Europe, reducing the continent’s dependence on Russia. While there are many obstacles to an Iran-to-Europe pipeline, there are cheaper alternatives, such as shipping liquefied natural gas. More generally, modernising Iran’s oil industry requires huge investment, estimated at $100bn. Machinery and plant construction will be needed, areas in which Germany is the global leader.Beyond energy, a wealth of other opportunities could be grasped by European companies, especially on consumer goods, German and French car makers could be big winners since there is huge untapped demand after years of sanctions. In the same vein, the aviation industry should also benefit, because at least 300 aircraft will need to be renewed over the next decade. This could be a big shot in the arm for Airbus.Unfortunately, European leaders seem to have been caught somewhat off-guard as regards Iran’s opening up. The Greek saga alone could explain this. The problem is that other competitors have already stolen a march and this is not the US, as it could appear as first sight by looking at the newspaper headlines. Europe’s key competitors to make business with Iran are Russia and China.Although Iran’s historical relationship with Russia has not always been cordial, President Vladimir Putin has become more of a partner as both countries fight against Sunni insurgent groups, such as the Islamic State. Furthermore, Russia was one of the key players pressing for a positive outcome from the nuclear negotiations and there seems to be no doubt that Iran will be grateful.Europe’s main rival, however, could prove to be China. China is much more complementary to Iran than Russia, thanks to China’s insatiable thirst for energy. In fact, Chinese-Iranian trade reached $44bn in 2014, almost a third of Iran’s total foreign trade and a fourfold increase from 2005. Beyond trade, foreign direct investment is probably even more relevant, although no official figures exist. Anecdotal reports indicate that Chinese FDI spans transportation, power generation, mining, the auto industry and oil and gas.From the west’s perspective, China’s involvement in Iran during the embargo years could be seen as non-compliant with international agreements. In the eyes of the Iranian government, though, Chinese trade and investment provided a badly-needed economic lifeline to Iran during the long years it suffered under unfair sanctions. One of the rewards for such support is already in China’s hands: billions of dollars in oil infrastructure projects. Beyond the money, Chinese-Iranian ties are reinforced because they both have long histories and ancient cultures, and the shared sense that they are both victims of western imperialism. Oil is only one of the sectors that will link both economies. Many more will appear with China’s “Belt and Road” initiative, which is becoming an increasingly relevant project for Chinese infrastructure corporations in the light of China’s slowdown.In summary, the west possesses the technology that Iran will need to rebuild its shattered economy, but there is a trust deficit. Although Europe is on better terms with Iran than the US, Europe’s close adherence to US foreign policy makes it hard for Europe to compete with Russia and China for Iran’s trust. It was Russia and China that worked to blunt the west’s hawkish demands and ease sanctions.If Europe wants its slice of the pie, it should urgently come up with a strategy to build up trust with Iran. I wonder whether anybody in Brussels will be listening.Read more...

30 июля 2015, 15:35

Now you see it, now you don’t

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Authors: Silvia MerlerOn the 17th July, the Italian authorities began the liquidation of Banca Romagna Cooperativa (BRC), a small Italian mutual bank that had been in trouble since 2013. In the BRC resolution process, equity and junior debt have been bailed in. The case has passed largely unnoticed abroad, but this is effectively the first instance of a bail-in in Italy. Percentage of bank bonds in total bond portfolios of Italian Households Source: elaboration based on data from Central Bank of Italy The need to carry out a preliminary bail in in bank resolution cases was established in the amended state aid rules, which constitute the transition framework to the new recovery and resolution regime that will be in force from 2016. The amended state aid framework prescribes that a bail in of junior debt must be carried out before any public money can be injected into the bank. The rules will be toughened starting in January 2016, when the bail-in tool foreseen under the Bank Recovery and Resolution Directive (BRRD) will become operative. The spirit of this provision is to ensure that the private sector bears a share in the recapitalisation, restructuring or resolution of troubled banks and to avoid the burden being entirely shifted onto the public sector balance sheet, thus reinforcing the sovereign-banking vicious cycle that the creation of Banking Union is supposed to counteract.   In a press release assessing the case, Fitch Ratings said that the initial plan in the Italian case was to use funds from Italy's Deposit Guarantee Insurance Fund to make up for the capital shortfall. But under the amended state aid, a preliminary bail-in of junior debt is mandatory. Therefore, junior bondholders have been bailed in. And yet they haven’t. Despite the bail-in, in fact, no loss was suffered by retail bondholders as the Italian mutual sector's Institutional Guarantee Fund decided to reimburse them in full to “preserve the reputation of the sector”. The Institutional Guarantee Fund is technically not public money (it’s financed contributions from banks) but this still looks like a circuitous way to do what was initially planned, i.e. to avoid placing losses on private creditors. A few months ago a similar case (Carife - Cassa di Risparmio di Ferrara) also resulted in a "creative" solution being proposed, with the Italian deposit guarantee scheme Fondo interbancario di tutela dei depositi (FITD) possibly bailing out the bank and becoming the sole shareholder with the intention to sell it  in the future. The reason behind this is that all junior debt in BRC was actually held by retail depositors. This is by no means exclusive to BRC, but it points to a broader issue that could raise problems in the future. Households in Italy are relatively exposed to bank debt, which accounted for over 40% of the total bond assets held by  households in the first quarter of 2015 (down from a peak of almost 60% in 2011/12). According to Fitch, the BRC case highlights generally“poor conduct by Italian banks in raising subordinated and hybrid debt through their retail branches”. The Bank of Italy recently warned about the risks of institutions placing their own debt to retail buyers under the changed resolution landscape. Italy is among the countries that failed to comply with the January 2015 deadline for implementing the BRRD into national law, but its transposition will limit the degrees of freedom over “creative” solutions like BRC and CARIFE. This may turn out to be a non-negligible problem for those smaller Italian banks that have relied heavily on retail customers to invest in less secure funding instruments.    Read more...

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23 июля 2015, 16:49

Griechenlands Schuldenlast kann und muss im Euroraum erleichtert werden

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Authors: Armin von Bogdandy, Marcel Fratzscher, Guntram B. WolffDer wohl größte Schaden der Konfrontation mit Griechenland ist ein allgemeiner Vertrauensverlust. Damit Griechenland wieder wachsen kann, müssen die Menschen, Unternehmen und Investoren wieder Vertrauen in die Zukunftsfähigkeit des Landes fassen. Hierzu bedarf es natürlich einerseits einer legitimen und kompetenten Regierung sowie einer effizienten Verwaltung und Gerichtsbarkeit. Aber auch die Frage der Schulden ist zentral, selbst wenn kurzfristig der Schuldendienst derzeit vernachlässigbar ist. Niemand bezweifelt die Analyse des IWF, dass die Nachhaltigkeit der griechischen Staatsschulden eine Schlüsselvoraussetzung für eine Gesundung bildet. Das dritte Programm, das nun verhandelt wird, hat soll zunächst Griechenland dahin zurückzubringen, wo es am Ende des vergangenen Jahres stand, als es eine Wachstumserwartung von fast 3 % gab. Das dritte Hilfsprogramm ist daher genau das Gegenteil von einem Transferprogramm: es soll die griechische Wirtschaft stärken und die Kredite und Garantien der Gläubiger schützen. Ein Großteil der Zahlungen wird in die Umschuldung gehen. Doch dies reicht nicht aus: Die derzeitige Verknüpfung von Schuldendienst mit der Mitgliedschaft in der Währungsunion führt zu einem Teufelskreis, der die Unsicherheit erhöht, das Wachstum schwächt und damit eine Rückzahlung der Schulden unwahrscheinlicher macht. Es wird kein Vertrauen und kein Wachstum in Griechenland ohne eine Lösung des Schuldenproblems geben. Wir schlagen vor, diesen Teufelskreis durch eine Bindung der Kreditzinsen an das Wachstum der griechischen Wirtschaft mit einem zusätzlichen konditionellen Schuldenmoratorium zu durchbrechen. Ein Griechenland ohne Wachstum soll keine Zinsen und keine Tilgung zahlen. Je stärker das Wachstum, desto höher die Zinsen und Rückzahlungen an die europäischen Gläubiger. Das Schuldenmoratorium bedeutet, dass Griechenland im Jahre 2022, wenn es nach der derzeitigen Regel den Schuldendienst an seine europäischen Gläubiger aufnehmen muss, die Rückzahlung verschieben und die Zinslast senken kann, wenn es nicht ein bestimmtes Niveau des Bruttoinlandsproduktes erreicht haben sollte. Eine solche Lösung würde die Unsicherheit beenden und griechisches Wachstum als europäisches Anliegen sowie Voraussetzung für seinen Schuldendienst anerkennen. Stabilität und Planungssicherheit kehrten zurück. Der derzeitigen politischen Konfrontation würde der Nährboden entzogen. Ein solcher Ansatz nimmt keineswegs alle Anreize für Reformen. Eine Regierung wird stets ein großes Interesse an wachstumsfördernden Reformen haben, um etwa Arbeitslosigkeit abzubauen. Natürlich wird viel Sorgfalt erforderlich sein, das Programm so zu formulieren, dass es kontraproduktive Anreize vermeidet. Dies ist möglich und die Bedingungen hierfür sind günstig. Eine solche Lösung wäre auch für die Gläubiger von Vorteil, da bei geringem Wachstum ein Schuldenschnitt unausweichlich ist, bei starkem Wachstum, wie z.B. in Irland, man aber einen Schuldenschnitt nicht rechtfertigen kann. Eine solche Lösung würde die Haushalte der Gläubiger nur geringfügig belasten und hätte somit keine nennenswerten Konsequenzen für die deutsche Schuldenbremse. Ein solches Zahlungsmoratorium, ökonomisch eine Art Restrukturierung der griechischen Schulden gegenüber den öffentlichen Gläubigern, also den anderen Mitgliedstaaten der Eurozone, EFSF und ESM, ist in der Eurozone rechtlich zulässig. Die Ansicht des Bundesfinanzministeriums, die dafür einen temporären Grexit verlangt, überzeugt nicht. Denn in der Rechtssache Pringle entschied der Europäische Gerichtshof zu Art. 125 AEUV, dass Mitgliedstaaten einem Mitglied der Eurozone eine „Finanzhilfe gewähren (dürfen), vorausgesetzt, die daran geknüpften Auflagen sind geeignet, ihm einen Anreiz für eine solide Haushaltspolitik zu bieten.“ Gewiss, dieses Urteil hatte keinen Schuldenschnitt, sondern nur Hilfen zum Gegenstand. Dann entschied der EuGH  zur OMT-Politik der EZB aber, dass sogar die EZB ein „erhebliches Verlustrisiko“ eingehen darf, soweit sie im Rahmen ihres Mandats handelt.  Zwar hat der EuGH auch dort nicht explizit entschieden, dass die EZB an einer Restrukturierung teilnehmen dürfe. Nach der Begründungslogik liegt es aber nahe zu folgern, dass sie einen Schuldenschnitt letztlich hinnehmen kann, sofern dies für die einheitliche Geldpolitik notwendig ist. Wenn dies für die EZB gilt, deren Rechtsrahmen wegen des Verbots der monetären Staatsfinanzierung besonders streng ist, dann kann eine auf Wiedererlangung der Haushaltsstabilität angelegte Restrukturierung der von anderen Mitgliedstaaten, EFSF und ESM gehaltenen griechischen Staatsschulden nicht gegen Art. 125 AEUV verstoßen. Bei einer ergebnisorientierten Betrachtungsweise umfasst dies das hier vorgeschlagene konditionelle Schuldenmoratorium. Ebenso wenig verbietet das Grundgesetz prinzipiell eine Restrukturierung. Den Ausführungen des Bundesverfassungsgerichts zur Einrichtung des ESM lässt sich entnehmen, dass das finanzielle Risiko der Hilfsprogramme für die Bundesrepublik beherrschbar und die Haushaltsautonomie des Bundestags gewahrt bleiben müssen. Dies ist bei dem ESM der Fall, weil der ESM-Vertrag den finanziellen Risiken für die Bundesrepublik eine Obergrenze setzt. Die Möglichkeit eines Schuldenschnitts wurde dabei durchaus gesehen, wenngleich seine verfassungsrechtliche Zulässigkeit nicht explizit erwähnt wird. Gewiss sind viele verfassungsrechtliche Fragen noch nicht letztlich geklärt, aber unser Vorschlag bewegt sich im Rahmen und dem Pfad der bisherigen Entscheidungen. Die Zulässigkeit eines solchen Schuldenmoratoriums hat zwei Bedingungen. Eine Restrukturierung muss erstens zum Erhalt der Eurozone dringend erforderlich sein, was der IWF bei den griechischen Staatsschulden bescheinigt. Und zweitens muss die Restrukturierung von einem auf Haushaltsdisziplin und nachhaltige Veränderungen gerichteten Strukturreformprogramm begleitet sein. Das wird jetzt im dritten Programm hoffentlich vereinbart. Die Voraussetzungen einer grundlegenden Modernisierung des griechischen Staates erscheinen dabei so günstig wie nie: Sie würden von einer neuen Regierung angeordnet, das Land hat sich zu massiver Kontrolle bereit erklärt und die griechische Bevölkerung hat eine „near death experience“ durchlebt. Rechtliche Gründe widersprechen also nicht einer Bindung der Schuldenlast an das griechische Wachstum oder einem konditionellen Schuldenmoratorium. Aus ökonomischer Sicht wird eine solche Lösung nicht nur die Rückzahlungswahrscheinlichkeit erhöhen. Sie wird insbesondere auch zeigen, dass Deutschland und die anderen Gläubiger ein Interesse daran haben, Griechenland zu helfen und die Stabilität der Eurozone zu garantieren.Read more...

20 июля 2015, 10:15

Blogs review: Understanding the Neo-Fisherite rebellion

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Authors: Jérémie Cohen-SettonWhat’s at stake: Neo-Fisherism is on the blogs again. The idea that low interest rates are deflationary – that we’ve had the sign on monetary policy wrong! – started as a fringe theory on the corners of the blogosphere 3 years ago. Michael Woodford has now confirmed that modern theory, indeed, implies the Neo-Fisherian view when people’s expectations are infinitely rational. For Woodford, this is however a paradox of perfect foresight analysis, rather than something actually relevant for monetary policy.   Are low interest rates deflationary? Noah Smith writes that over the last three years, a quiet rebellion seems to have sprung up in macroeconomic circles. For some time, it was limited to a few whispers, a couple of papers, and the odd blog post or dinner speech, but it represents a striking break from conventional thinking and is being now addressed by leading New Keynesian authors. The rebellious idea is that low interest rates cause deflation, and high interest rates cause inflation. Noah Smith writes that the Neo-Fisherite idea doesn't just discount the effectiveness of monetary policy (like RBC models do, or like the MMT people do) - it stands that whole monetary policy universe on its head. If the Neo-Fisherites are right, then not only is the Fed massively confused about what it's doing, but much of the private sector may be reacting in the wrong way to monetary policy shifts. Tony Yates writes that this discussion is not of purely academic interest, though it sounds nerdy and pointless.  Recall where it started. Core inflation is sliding in the US and the ECB. Does this mean that central banks should double down and keep rates lower for longer, or is low inflation, by contrast, caused by the low rates?  It’s pretty crucial to settle this. The discussion connects with recent efforts by central banks to stimulate the economy by announcing that rates will be held low, and fixed, at their natural floors, for long periods of time, before eventually rising, a policy they have dubbed ‘Forward Guidance’.  Ryan Avent writes that the basic logic of the argument is as follows. The economy has an equilibrium real, or inflation-adjusted, interest rate. The real interest rate is essentially the nominal interest rate minus the inflation rate. So if the central bank pushes nominal interest rates down to a low level, then over the long run the inflation rate must inevitably move toward a level consistent with the long-run equilibrium real rate. That is, inflation must fall. Otherwise, the economy would be out of equilibrium forever, which is not how economies work.  John Cochrane writes that in response to the interest rate rise, indeed in the short run inflation declines. But if the central bank were to persist, and just leave the target alone, the economy really is stable, and eventually inflation would give up and return to the Fisher relation fold. Source: John Cochrane Noah Smith writes that the opening shot of the Neo-Fisherite rebellion was fired by Minneapolis Fed President Narayana Kocherlakota, in a speech in 2010. The second outbreak of the rebellion came when Steve Williamson wrote a paper in which QE is deflationary and the blog debates it sparkled. The third outbreak happened this month when Michael Woodford directly tackled the Neo-Fisherite view at the NBER Summer Institute. Michael Woodford’s response: A Paradox of Perfect-Foresight Analysis Mariana Garcia Schmidt and Michael Woodford address two questions in their latest analysis: 1.     Is-it true that “modern theory” — deriving aggregate demand and supply relations from intertemporal optimization — implies the neo-Fisherian view? 2.     Can one maintain the orthodox view — that maintaining a lower nominal rate for longer should cause higher inflation and capacity utilization — while having a view of expectations that implies that central-bank commitments regarding future policy should have any effect? Mariana Garcia Schmidt and Michael Woodford write that “modern theory” — deriving aggregate demand and supply relations from intertemporal optimization — implies the neo-Fisherian view when perfect foresight is assumed. The long-run inflation rate is lower the lower level interest rates are pegged to. Thus one can argue that permanently maintained low nominal interest rates must (at least eventually) bring about correspondingly lower inflation rate. Mariana Garcia Schmidt and Michael Woodford write that people are at least somewhat forward-looking; this is why commitments regarding future policy matter. The assumption of perfect foresight is nonetheless very strong — especially in the context of a novel policy regime, and the anticipated effects of policies announced for many quarters in future Perfect Foresight Equilibrium (PFE) predictions are relevant only to the extent that the PFE is the limit of an iterative process of belief revision and this process converges fast enough for the limit to well approximate the outcome from a finite degree of reflection. But if the process doesn’t converge, the PFE prediction may be quite different from what this model of expectation formation would imply, even if the process of reflection is carried quite far. When considering the case where interest rate is expected to be fixed indefinitely, the authors show that belief revision dynamics don’t converge. John Cochrane writes that what he can glean from the slides is that Garcia Schmidt and Woodford agree: Yes, this is what happens in rational expectations or perfect foresight versions of the new-Keynesian model. But if you add learning mechanisms, it goes away. His first reaction is relief -- if Woodford says it is a prediction of the standard perfect foresight / rational expectations version, that means I didn't screw up somewhere. And if one has to resort to learning and non-rational expectations to get rid of a result, the battle is half won.Read more...

17 июля 2015, 19:53

Greece budget update

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Authors: Silvia MerlerAs discussion continue in the Greek parliament and in Bruxelles on the next steps towards the third Greek programme, the Greek finance ministry published the latest budget execution bulletin, with data up to June and comparing the actual outcomes with the estimates presented in the 2015 budget. The state budget primary balance picked up again in June, compared to the previous month. Greece recorded a primary surplus of 1.9 billion euros over the first five months of the year, against an expected primary deficit of 1.2 billion euros. In cumulative terms, the state primary balance has therefore exceeded its target by 3.1 billion euros (figure 1).  Source: Ministry of Economy and Finance, Greece Revenues appear to have picked up in June, after the dismal performance in May (Figure 2). For the month of June alone, net revenues amounted to 3.2 billion euros, 360 million euros short of the monthly target. State budget net revenues amounted to a cumulative 21.8 billion euros for the period January-June 2015, still missing the target by 906 million euros. The ministry of Finance does not offer any explanation for the behaviour of revenues in June. Last month, it had said that the big shortfall in revenues recorded in May was partly attributed to the fact that the first installment of corporate income tax was not received (worth an estimated 555 million euros), so this may have come in in June and be partly responsible for the improvement. Ordinary budget net revenues amounted to 19.8 billion Euros, 1.7 million lower than the target on a cumulative terms. For the month of June in particular, ordinary net revenues were 701 million Euros below target.   Source: author’s calculations based on MEF bulletin As it has become the norm for Greece since the beginning of the year, expenditures have been lower than expected. For the month of June, state budget expenditures amounted to 3.2 billion euros, i.e. an impressive 1.5 billion lower than the target, with ordinary budget expenditures under performing by 1.1 billion. Over the period January-June 2015, cumulative state budget expenditures amounted to 23.2 billion euros, 4 billion lower than the target. Ordinary Budget expenditures amounted to 22 billion euros and decreased by 3 billion against the target, again mostly due to the reduction of primary expenditure by 2.6 billion euros.  Source: Ministry of Economy and Finance, Greece In June, the Greek primary balance has picked up compared to the dismal performance in May. However, this was once again the result of  severe cuts in primary expenditure, most of which reflects arrears, according to local news report. Revenues have increased in June (although part of the increase may be due to the coming in of corporate income taxes that had been missed i May) but they continue to underperform both on a monthly and on a cumulative basis.   June data do not yet include the impact of the capital controls which had to be introduced at the end of the month when Prime Minister Tsipras called the referendum on the potential agreement with Greece’s creditors. Data for July will incorporate the full effect of the capital controls and will be key to watch because, as previously shown and as evident in figure 4, it is the most important month for revenues formation in Greece. The European Commission has already revised its estimates of real GDP growth for Greece downwards, between -2% to -4.0% in 2015, compared to the +2.9% projected in Autumn '14 forecasts and +0.5% in Spring 2015 forecast. this will certainly hamper the feasibility of the previously discussed fiscal targets, which is probably the reason why there is still no primary surplus target specified in the text of the preliminary agreement.Read more...

17 июля 2015, 13:49

Five Lessons on Greece

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Authors: Marek DabrowskiThe agreement reached at the Eurosummit in the early hours of on July 13[1] marks yet another dramatic turning point in the five-year history of attempts to avoid Greece’s sovereign default and its potential exit from the euro area. It is too early to say whether it will be successful or not. Many important details such as fiscal targets, other conditionalities, the scale of emergency financing, resolution of Greece’s large public debt and distressed banking sector will have to be negotiated in the coming weeks and months. On the other hand, the political commitment and administrative capacity of the current government of Greece to deliver on such an ambitious reform program remains in question. Nevertheless, perhaps it is the right time to look back and reflect on the experience of Greece and other countries who have implemented rescue programs and reformed their economies in distress to draw lessons. These may help in future policy choices. Below I offer five but it is not a complete list. Lesson 1: Fiscal Sustainability Constraints Hold Similarly to microeconomic agents (enterprises, households), governments cannot endlessly spend more than they receive in the form of tax and other revenue. They can do so only temporarily as long as there are creditors ready to lend. If a government goes too far it risks sovereign insolvency. Once it becomes bankrupt, a government must start running a balanced primary budget even if it totally negates on its outstanding liabilities to creditors. The reason is simple: no fresh financing is available. In most cases, this requires drastic fiscal policy tightening (elimination of a primary deficit). This is an elementary piece of fiscal arithmetic frequently forgotten in the debate in the Greece situation. Greece overspent for decades, running fiscal deficits well in excess of the 3% Maastricht criterion (Figure 1) and building its public debt up to an evidently unsustainable level (Figure 2). The bust came in 2010 when private creditors refused further lending at reasonable price. They were replaced and partly bailed out by the official creditors (see Lesson 5) and Greece could continue public borrowing. In fact, the subsequent rescue programs monitored by the ‘Troika’ allowed Greece slowing the pace of its fiscal adjustment as compared with a scenario of no rescue program (as noted by Olivier Blanchard[2]) in exchange for promise of reforms, which have never been fully implemented (see Lesson 3).  In spite of its numerous weaknesses (see Lesson 3), Greece’s rescue programs started to bring positive results in 2014, including a primary fiscal surplus, some improvement in competitiveness[3] and the beginning of economic recovery. However, after negation of the ongoing rescue and reform program by the Syriza government (validated by the results of July’s referendum – see Lesson 4) the official creditors lost their appetite for further support - at least on the same conditions. Figure 1: Greece: GG fiscal balance, % of GDP, 1980-2014 Source: IMF WEO, October 2014 Figure 2: Greece: GG gross public debt, in % of GDP, 1980-2014 Source: IMF WEO, October 2014 Because other euro area countries are not ready to offer Greece unconditional transfers the country faces two choices: either accept the creditors’ conditions and receive a third bailout program, or default, allowing the banking to sector collapse and probably leaving the Euro[4]. However, the second scenario will not make macroeconomic and fiscal choices easier. The Greek authorities will have to run at least a primary fiscal balance and tight monetary policy to avoid hyperinflation. The reforms required by the creditors will have to be carried out anyway. Lesson 2: The role of trust During the dramatic negotiation of 11-13 July 2015, many commentators pointed to the lack of trust between the government of Greece and its creditors - and rightly so. This trust has never been strong given numerous past episodes of statistical misreporting and the slow pace of Greek reforms (see Lesson 3). But it has definitely been devastated by the erratic behaviour of the Prime Minister Alexis Tsipras and the former Minister of Finance Yanis Varoufakis over the course of almost half a year of negotiations on extending the previous rescue program, including its sudden breaking off, calling a referendum and agitating for the “No” vote. However, the trust has been lost not only in relations with official creditors. Business and market confidence has been also damaged by the Syriza government as evidenced by the returning recession in the first half of 2015, the decline in tax collection and massive capital flight. The government has become cut off from any form of market borrowing again, even short term. Breaking off negotiations with creditors and calling the referendum triggered a run on banks at the end of June which led to suspending most of their activities, limits on cash withdrawals and capital controls. Most importantly, the populist ploy with the referendum and then a total negation of its result has undermined trust between the Prime Minister and large parts of the Greek population, including his own political supporters (see Lesson 4). When trust is devastated and a country is bankrupt the idea of continuing counter-cyclical fiscal fine-tuning to boost growth, as advocated by the anti-austerity zealots such as Paul Krugman[5] and Joseph Stiglitz[6], does not make much sense. In fact it looks like an evident misreading of Keynesian theory. In the case of Greece, slower fiscal adjustment means two things: (i) slower pace of important structural and institutional reforms (overhaul of VAT, pension reform, privatisation) which are important for growth; (ii) an even higher public debt burden, which undermines business and consumer confidence and, therefore, kills growth prospects. Thus, rebuilding trust in all the above-mentioned dimensions is the absolute priority for Greece and a precondition to return to economic growth and financial stability. It requires among other things radical changes in the way in which economic policy has been conducted (see Lesson 3). Lesson Three: Speed of Reforms and Their Ownership A month ago, I wrote on the slow-reform trap in the context of Ukraine[7]. However, all arguments used then (changing expectations, producing visible reform results early enough, political economy) apply to Greece too. As documented by Anders Aslund[8], Latvia, which was also hit by a severe financial crisis in 2008-2009, managed to overcome its negative consequences and return to rapid growth in 2011 and to fiscal surplus in 2012. This was possible due to a frontloaded large-scale fiscal adjustment and a comprehensive package of structural and institutional reforms.  In fact, the election victory of Syriza in January 2015 was a product of slow reforms. Since 2010, the Greek people has had to absorb the pain associated with the crisis and reforms (slower reforms do not mean less pain) but without clearly visible gains. This made many of them receptive to populist arguments and promises. A slow pace of reforms usually signals the limited political commitment of the government. In this context, Kenneth Rogoff[9] underlines importance of the so-called country ownership of a reform program. If such ownership is lacking, even the best-designed rescue program and its conditionality will not work. In case of Greece, ownership of reforms has been always problematic. I am afraid this could also pose the biggest challenge for the new program. Even if Greek society is ready to accept some unpopular measures to stay in the euro area and regain access to its bank accounts, such support will not be automatically translated into a new parliamentary majority able to form effective pro-reform government. Greece may face months of political instability and uncertainty. On the other hand, the high-degree of intrusiveness of the new program (which can be seen as creditors’ insurance against a doubtful reform commitment from the Tsipras government) may easily produce a new wave of populist backlash once the danger of immediate Grexit disappears. Lesson Four: Democracy Must Involve Responsibility The referendum of 5 July 2015 raised huge excitement as a supposed evidence of Greece’s vibrant democracy and aspiration to regain a sovereignty compromised by the bailout programs. Joseph Stiglitz went even further in suggesting “Europe’s Attack on Greek Democracy” [10]. Indeed, a referendum can be one of the instruments of a direct democracy. However, in the discussed case it was heavily abused. First, it was organised in a rush and, most probably, breaching the constitution of Greece which (rightly) does not envisage possibility of referenda on financial matters. Second, the question asked was too long, unclear and not easy to understand for the general public. Third, the government information campaign was not fair, i.e., it did not present a real choice faced by the country. In fact, the Prime Minister offered society “you can have your cake and eat it too”. Fourth and most important, the day after the referendum the same Prime Minister negated its results and accepted (or even went further than) the deal which he recommended (successfully) to reject. Thus, the 5 July referendum did not serve to strengthen Greek democracy but, somewhat naively, to impose pressure on creditors. Obviously, populist games of this kind can only undermine democracy. More generally, democracy must involve responsibility for the decision taken, including all hardships associated with wrong choices - in particular if they have been repeated several times as in the case of Greece. In this context, it is difficult to accept Barry Eichengreen’s view that “Greece deserves better. It deserves a program that respects its sovereignty and allows the government to establish its credibility over time” [11]. Who is going to pay for this better program? Here we touch another important question: democratic mechanisms and decisions must respect limits of their jurisdiction. They cannot burden other countries with the consequences of their own choices. Governments of those other countries must follow preferences and limits on their actions imposed by their own electorates (see comment of Dani Rodrik[12]). The Greek society and its political elites must accept the unpleasant fact that the range of available economic choices for a bankrupt country is more limited in comparison with a solvent one and think how to reform Greece’s political systems to avoid repeated incidences of economic mismanagement in the future. Lesson Five: Rules Are Important The first rescue program for Greece meant circumventing an important market discipline rule written into Article 125 of the Treaty on the Functioning of the European Union (TFEU). The so-called “no bailout” clause was replaced by the quite complicated mechanism of conditional bailout, i.e. financial assistance in exchange for fiscal adjustment and structural and institutional reforms. Article 123 of the TFEU, which prohibits European Central Bank (ECB) and national central banks to finance governments has been also compromised by a large ECB exposure to Greece sovereign bonds and the mechanism of Emergency Liquidity Assistance (ELA) which supports Greek banks against the guarantees of their insolvent government. At the same time, as noted by my colleagues Ashoka Mody[13] and Guntram Wolff[14], the International Monetary Fund (IMF) breached two of its operational principles, i.e. lending only against the program, which offers a convincing solvency perspective (regaining market access) in its life horizon and so-called private sector involvement, i.e. participation of commercial creditors in debt restructuring. None of these conditions was met in May 2010 but some corrections (debt restructuring deal with private creditors) came in 2011-2012 with the second bailout program.  Whatever has been the reason to breach both EU and IMF rules (primarily, the fear of market contagion in a situation when most EU governments remained heavily over-indebted and large European banks are heavily exposed to the sovereign debt of peripheral euro area countries) now the official creditors must pay a heavy price for that. First, there is a classical moral hazard problem, both for private creditors and sovereign borrowers. As demonstrated by the behaviour of Syriza government (and demand of populist parties in other European countries) this is not a hypothetical threat.  Second, as in the experience of many federal states (for example, Argentina, Brazil or Russia in the 1990s) lack of discipline on a sub-federal level may easily lead to a fiscal crisis on a federal level and destabilise a common currency. Fortunately, the EU/EMU did not get to this point yet. Third, if the federal level lends to a distressed and undisciplined sub-federal entity it quickly becomes its financial and political hostage. This is indeed the most dramatic dilemma faced by the euro area countries and the ECB today: allow Greece to go bankrupt and accept loses on the outstanding claims on Greece, or continue lending and increase their exposures, even if chances of debt repayment remain highly problematic. The July 13 agreement can be seen as a dramatic attempt to keep Greece afloat but at least partly reinforce rules. It remains to be seen whether this attempt has any chance to succeed. Finally, despite the declared solidarity with Greece (and other euro area countries in distress) the subsequent bailout programs did not increase the degree of political cohesion within the EU and EMU. On the contrary, it provoked a distributional conflict between creditor and debtor countries (especially in the case of Greece) and waves of nationalism and populism in various countries. Solidarity is perhaps a nice idea but not necessarily in the realm of inter-governmental fiscal relations. [1] www.consilium.europa.eu/en/press/press-releases/2015/07/pdf/20150712-eurosummit-statement-greece/ [2] blog-imfdirect.imf.org/2015/07/09/greece-past-critiques-and-the-path-forward/ [3] www.bruegel.org/nc/blog/detail/article/1647-is-greece-destined-to-grow/ [4] See http://www.bruegel.org/nc/blog/detail/view/1662/ [5] http://krugman.blogs.nytimes.com/2015/07/15/an-unsustainable-position/?module=BlogPost-Title&version=Blog%20Main&contentCollection=Opinion&action=Click&pgtype=Blogs®ion=Body [6] http://www.project-syndicate.org/commentary/greece-referendum-troika-eurozone-by-joseph-e--stiglitz-2015-06 [7] http://www.bruegel.org/nc/blog/detail/article/1649-the-slow-reform-trap/ [8] http://www.case-research.eu/sites/default/files/publications/S%26A477.pdf [9] http://www.project-syndicate.org/commentary/why-the-greek-bailout-failed-by-kenneth-rogoff-2015-07 [10] http://www.project-syndicate.org/commentary/greece-referendum-troika-eurozone-by-joseph-e--stiglitz-2015-06 [11] http://www.project-syndicate.org/commentary/greece-debt-agreement-risks-by-barry-eichengreen-2015-07 [12] http://www.project-syndicate.org/commentary/greece-referendum-nationalism-democracy-by-dani-rodrik-2015-07 [13] http://www.bruegel.org/nc/blog/detail/article/1681-professor-blanchard-writes-a-greek-tragedy/ [14] http://www.bruegel.org/nc/blog/detail/article/1680-olivier-blanchard-fails-to-recognise-two-major-imf-mistakes-in-greece/ Read more...

16 июля 2015, 10:13

Huawei vs ZTE judgement: a welcome decision?

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Authors: Mario Mariniello, Francesco SalemiToday the European Court of Justice (ECJ) will rule on a dispute between Chinese tech companies Huawei and ZTE regarding a patent “essential” to the “Long Term Evolution” (LTE) wireless broadband technology standard.  The legal dispute originates in the Düsseldorf District Court (Landgericht Düsseldorf), where Huawei sought an injunction against ZTE after attempts between the two companies to find an agreement on fair, reasonable, non-discriminatory (FRAND) terms were unsuccessful. This ruling is highly anticipated since it is likely to bring some clarity over what are to be considered in Europe anticompetitive conducts in relation to Standard-Essential Patents (SEPs), an area where several high-profile cases (e.g. Samsung and Google/Motorola Mobility) have been recently investigated by the European Commission. Standards foster economic development. They reduce transaction and production costs; they increase efficiencies, limit asymmetric information between producers and consumers, make it more viable to invest in innovation and reduce the level of uncertainty about the outcome of R&D investment. Standards ensure network interoperability: to be sure, when you pick up your mobile phone and call a friend, you are happy that your devices can easily interconnect through the same network technology. But standards are tricky matters for antitrust authorities. Once competing technologies are eliminated in favour of the selected technology, the owners of patents essential to that standard might try to extract monopolistic rents from users of the technology. To avoid this, standard-setting organisations usually require patent owners to commit to charge a FRAND price once the standard has been adopted (see Mariniello 2013). This is what the European Telecom Standardisation Institute did when the 4G LTE standard was adopted. The main question the ECJ judgement is supposed to provide a reply to is under which conditions a SEP-holder seeking an injunction is abusing its (presumed) dominant position. The Advocate General’s opinion published last November, while non-binding, is likely to provide a preview of the content of the ECJ ruling. In the Advocate General’s opinion, a SEP-holder seeking an injunction is not breaking its FRAND commitment and abusing its dominant position if, before seeking the injunction:                         i.         it notified the alleged infringer that it was infringing some of its SEPs and                          ii.         it engaged in negotiations by presenting the alleged infringer with a written offer on FRAND terms specifying all terms and conditions that are part of a normal licensing contract in the sector, including the royalty rate to be applied and the way it is calculated. In turn, a prospective licensee must respond to that offer in a diligent and serious manner in order not to be considered “unwilling” to reach an agreement. If the prospective licensee does not accept the SEP’s offer, it must promptly come up with a reasonable counterproposal. Even in cases in which an agreement between the two parties could not be ultimately found, the alleged infringer’s behaviour should still be considered willing to reach an agreement if it offers to have the FRAND terms of the licensing contract determined by a Court or an arbitration tribunal. Finally, the prospective licensee conduct should not be considered as dilatory or not serious if it reserves the right to challenge the validity of the patent in court. This is good, as there is a public interest in having “bad” patents (i.e. patents which should not have been issued in the first place) invalidated and prospective licensee should not be forced to give up this right in order to have access to technology the licensor has promised to provide under FRAND terms. If the alleged infringer does not follow these steps and its conduct can be characterised as purely tactical, dilatory or not serious, the request for an injunction by a SEP-holder does not constitute an abuse of dominant position, according to the Advocate General. In practice, for the Advocate General both the SEP holder (licensor) and the alleged infringer (prospective licensee) should comply with their duty of good will and engage in a constructive negotiation in order to achieve a mutually satisfactory solution. The framework proposed by the Advocate General therefore balances the interests of prospective licensees, which made standard-specific investments relying on the licensors’ promise of giving access to the technology on “fair, reasonable and non-discriminatory” terms and may see these investments “held up” by the SEP-holder, and the ones of licensors whose already-sunk own R&D investments could be “reverse held up” by a “tactical” licensee. In so doing, this opinion is welcome. The opinion also briefly discusses whether holding a SEP should immediately imply a dominant position, arguing that while the essential nature of the patent is likely to make dealing with a SEP-holder indispensable for any prospective licensees, this presumption should be rebuttable if sufficient evidence of the contrary is provided.[1] Once again the opinion seems to strike the right balance between preserving the rights of patent holders while protecting potentially locked-in licensees. [1]                 The right time when to evaluate the indispensability, and therefore whether the SEP-holder is to be considered dominant, is the time when the agreement was sought. It would be mistaken to determine that a SEP-holder was not dominant because ex-post the patent is discovered to be invalid or not essential to the standard, since the prospective licensee, at the time of the negotiation might have been unable to foresee such an occurrence and would have likely negotiated under the presumption that the patent was both valid and essential.Read more...