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It is a privilege to work so close to Tim Congdon particularly since I was appointed Director of the Institute of International monetary Research (IIMR) in January 2016. Tim is the Chairman of the Institute and indeed a leading reference for those who want to understand monetary economics and central banks’ policy decisions; and in particular the role played by changes in the amount of money in circulation on changes in prices (all prices, CPI and asset prices) and nominal income along the business cycle. Changes in the amount of money do lead to portfolio decisions made by households, financial institutions and non-financial companies. The rationale is quite straightforward: in normal times agents tend to keep a rather stable cash to total assets ratio in their portfolios, so the greater the amount of money in the hands of (say) banks and insurance companies, the greater their willingness to invest it in other assets such as real estate, bonds (either long term or short term maturity bonds, or public or private bonds) or equity looking for a greater remuneration. And, should the creation of more and more money continues, it will eventually lead to an increase in the demand of consumption goods and services. Consequently asset prices (and CPI prices, though to a lesser extent) will change as a result of the greater demand for assets in the market and thus higher prices. The new equilibrium in the economy will be reached when agents have got rid of the excess in cash balances in their portfolios so now they keep again their desired cash to asset ratio. As a result of it all the amount of money in the economy will be greater and so will be the price level. M. Friedman and A. Schwartz explained it as clear as marvellously in the 1960s and it remains valid today as a theoretical framework to assess inflation and changes in nominal income.

This is in a nutshell the core of the explanation of monetarism; of course the process by which a greater amount of money in circulation ends up in higher asset and CPI prices can be more complex and, particularly when applied to a policy scenario, it will require a more detailed explanation. Of course there are lags in the transmission of money changes onto prices, as agents take time to assess the market conditions and make their own portfolio adjustments. In addition, institutions matter so a more regulated (less free) economy will require more time to reflect the new monetary conditions on the price level. On top of that the central bank and other financial regulators may interfere further in markets by making new monetary policy decisions, or even changing regulation regarding banks’ capital and/or liquidity ratios. This will make the picture given above more nuanced but by no means invalid; what we know, and there is plenty of evidence about it, is that a sustained increase in the amount of money over the increase in the supply of goods and services in the economy (say the GDP growth) will over time lead to higher prices.

On the 20th of April at the University of Buckingham I had the privilege to discuss with Tim Congdon on (1) what monetarism means nowadays, (2) which are the common criticisms of monetarism and (3) the relevance of monetarism for investment and monetary policy decisions. In fact, in the last few minutes in the video Tim sets up very clearly what it can well be labelled as an operational monetary policy rule for central banks to make policy decisions.

Many will find monetarism a not very fancy or topical term; call it instead rigorous monetary analysis then. As long as we focus on the impact of changes in the amount of money on prices and nominal income I do not think we should pay too much attention to labels. Unfortunately there is virtually a vacuum in this field in our days, as most central banks (not all) and financial regulators have seemed to forget or even disregard the valuable information provided by the analysis of changes in the amount money (and how it is created) for monetary policy purposes.

Enjoy the video with the interview below; comments, as ever, very much welcome.

Juan Castañeda

PS. You can find further videos on money and central banking at the IIMR Youtube channel

 

 

Should the allegations published by the BBC (on Panorama programme) last week be confirmed, this news brings very serious concerns for the credibility of the Bank of England (BoE) and also the trust of the general public in the banking sector. Ours is a fractional reserve monetary system with no ‘metallic anchor’, but purely based on trust and the record and effectiveness of the BoE and the rest of the banking sector. The alleged pressure of the government and the Bank of England to keep LIBOR (London Interbank Overnight Rate) artificially low back in the Autumn of 2008 (in an effort to send the message that banks and money markets were not that disrupted) erodes the sound functioning or markets and the formation of interest rates, which are key signals for households and companies in planning their decisions.

 

But why messing with LIBOR?! Central banks have plenty of monetary weaponry to tackle a liquidity crisis

Instead of interfering in the functioning of the interbank market (as alleged), should the Bank of England had wanted to prevent the contagion of a panic in the banking sector after the fall of Lehman Brothers in the Autumn of 2008, it could have done it much more promptly and effectively by being a more active (last resort) lender of the banking sector: i. e. by extending the maturity of the loans and increasing the amount of the loans given to the banks. Following Walter Bagehot´s seminal narrative of the way the Bank of England should step in if a liquidity crisis occurs, it should do so by (1) lending promptly as much as money as needed, (2) against collateral and (3) at a penalty rate (usually at a higher rate than the main policy rate). Before 2007, the Bank of England had been acting as the lender of last resort of the British banks very successfully for more than two hundred years, and there had not been major bank collapses in the UK; at least when compared with the record of other central banks. The application of this more active and timely lending of last resort policy at the time would have been a much more efficient, effective and indeed transparent way to prevent the banking crisis from escalating further; and also a more effective way to send the message to the public the Bank of England was actively responding to the crisis.

I was quoted in an article published by S&P Global Market Intelligence (Sohia Furber) about the allegations of the rigging of the LIBOR in 2008 (see more at http://www.mv-pt.org/latest-news).

 

Juan Castañeda

PS. You can read the piece published by S&P on the 12th of April at: http://www.snl.com/web/client?auth=inherit#news/article?id=40298030&cdid=A-40298030-11831

 

 

Esta es la charla que di el 23 de Marzo de 2017 en una de las sesiones del ‘Free Market Road Show’ organizado por el Circulo Liberal Bastiat en Sevilla. Hablé de las bases del comercio internacional y recordé con ello lo que para muchos serán obviedades, y para muchos otros ideas revolucionarias. Por lo oído en los últimos meses tras la victoria de D. Trump en EEUU, así como las posiciones de unos y otros en el debate de Brexit y las negociaciones que ya se apuntan entre el Reino Unido y el resto de la Unión Europea, los fundamentos del comercio internacional que durante décadas eran conocidos por todos, y casi diría que sus beneficios eran reconocidos por la mayoría de los economistas, han pasado a estar en entredicho. Es frecuente oír a líderes políticos (en incluso a economistas, lo que es de echarse a temblar!) de ambos lados del Atlántico que los puestos de trabajo del país deben ser para los nacionales así como ha de favorecerse a la producción nacional, incluso cuando ésta es más cara e ineficiente que la producida en el exterior.

Dicen los contrarios a la globalización que la protección de la producción nacional beneficia al país que la aplica; y lo hacen sin fundarlo en absoluto en evidencia empírica alguna, ni presentar una explicación teórica alternativa del comercio y sus efectos. Esto no es sólo intelectualmente muy pobre y desolador, sino que la aplicación de su nacionalismo económico llevaría a nefastas políticas económicas que sabemos bien en que terminan; porque se han aplicado repetidamente en varias ocasiones a lo largo del la historia y siempre acabaron en: (1) menos desarrollo de la economía y la riqueza a escala mundial y (2) más pobreza para los países que restringen más el comercio (mayores precios de los bienes y servicios, subsidio de empresas nacionales ineficientes, meso dinamismo e innovación, …). Los bien intencionados parecen no querer aprender y se empecinan en restringir el comercio todo lo que pueden … . Otros, aún a sabiendas de sus efectos sobre la mayoría de la población apoyan estas medidas porque les benefician (me refiero a los sectores productores nacionales menos competitivos que presionan cual ‘lobbies’ al gobierno de turno en búsqueda de protección comercial). De verdad hace falta otra contracción del comercio como la de los años 1930 para dares cuenta de sus efectos tan perjudiciales para todos?

Como digo, es lamentable si bien muy necesario tener que insistir una vez más en los efectos perniciosos para la economía provocados por la imposición de políticas proteccionistas. El nacionalismo económico siempre ha conducido al empobrecimiento de las naciones, y en algunas ocasiones al enconamiento de las rivalidades y conflictos políticos entre naciones que nunca acabó bien … . Recordemos algunas de esas obviedades en cuanto al comercio internacional que cuento en más detalle en la presentación:

(1) El comercio beneficia a las dos partes:

  • No se impone, se acuerda
  • La imposición de aranceles y otras trabas al comercio:
    • Perjudica a los consumidores: encarecimiento de los bienes y servicios
    • Sostiene una industria nacional ineficiente, necesitada de proteccion
    • Aumenta los ingresos del Estado (en el corto plazo)
    • Supone, al final, un impuesto a los exportadores nacionales: menos competitiva en mercados internacional.

(2) Comercian personas y empresas:

  • No hacen falta tratados para comerciar
    • Los tratados comerciales suponen la politización del comercio
    • Son el instrumento de los Estados para dar entrada a ‘grupos de interés’ en la mesa de negociación
  • Los acuerdos generales de comercio multilateral son más eficientes que los acuerdos bilaterales entre Estados

(3) A partir de ello, lo que propongo para el Reino Unido y el resto de la UE es lo siguiente:

  • Reino Unido: Declaración unilateral de libre comercio con el resto de Europa
    • No importa lo que haga el resto de Europa: beneficia a los consumidores y productores británicos
    • Y si el resto de Europa impone aranceles? Perjudicara a los consumidores Europeos
  • Ventajas:
    • Fin a una hipotética ‘guerra comercial’ que perjudicaría a todos
    • Fin a interminables y costosos tratados comerciales …
    • Evita la actuación de grupos de presión que solo buscan intereses corporativos
  • No soy nada original. Esta es la propuesta reciente hecha por Patrick Minford (2016) ‘No Need To Queue: The benefits of free trade without trade agreements’. IEA. London

 

Aquí podréis ver el video con mi presentación. Como siempre, vuestros comentarios serán muy bienvenidos.

Juan Castañeda

 

On the 13th of March (IEA, London) I had the pleasure to participate in the launch of the new MSc in Money, Banking and Central Banking (University of Buckingham, with the collaboration of the Institute of International Monetary Research), starting in September 2017; and I did it with two of the professors who will be teaching in the MSc, indeed two excellent and very well-known experts in the field: Professors Geoffrey Wood and Tim Congdon. I have known them both for long and shared research projects and co-authored works in money and central banking; and it was a privilege for me to have the chance to  introduce the new MSc, as well as to engage in a fascinating dialogue with them on very topical and key questions in monetary economics in our days: amongst others, ‘How is money determined? And how does this affect the economy?’; ‘Is a fractional reserve banking system inherently fragile?’; ‘Does the size of central banks’ balance sheet matter?’; ‘If we opt for inflation targeting as a policy strategy, which should be the variable to measure and target inflation?’; ‘Why the obsession amongst economists and academics with interest rates, and the disregard of money?”; ‘Who is to blame for the Global Financial Crisis, banks or regulators?’; ‘Does tougher bank regulation result in saver banks?’; ‘Is the US Fed conducting Quantitative Tightening in the last few months?’.

You can find the video with the full event here; with the presentation of the MSc in Money, Banking and Central Banking up to minute 9:20 and the discussion on the topics mentioned above onwards.  Several lessons can be learned from our discussion, and however evident they may sound, academics and policy-makers should be reminded of them again and again:

  • Inflation and deflation are monetary phenomena over the medium and long term.
  • Central banks‘ main missions are to preserve the purchasing power of the currency and maintain financial stability; and thus they should have never disregarded the analysis of money growth and its impact on prices and nominal income in the years running up to the Global Financial Crisis.
  • A central bank acting as the lender of last resort of the banking sector does not mean rescuing every bank in trouble. Broke banks need to fail to preserve the stability of the banking system over the long term.
  • The analysis of both the composition and the changes in central banks’ balance sheets is key to assess monetary conditions in the economy and ultimately make policy prescriptions.
  • The analysis of the central banks’ decisions and operations cannot be done properly without the study of the relevant historical precedents: to learn monetary and central banking history is vital to understand current policies monetary questions.
  • Tighter bank regulation, such as Basel III new liquidity ratios and the much higher capital ratios announced in the midst of the Global Financial Crisis, resulted in a greater contraction in the amount of money, and so it had even greater deflationary effects and worsened the crisis.

These are indeed key lessons and principles to apply should we want to achieve both monetary and financial stability over the medium and long term.

I hope you enjoy the discussion as much as I did. As ever, comments and feedback will be most welcome.

Apply for the MSc here!

Juan Castaneda

Tuve el placer de visitar la Universidad Francisco Marroquín (UFM) en Guatemala el pasado mes de Febrero e impartir unas charlas sobre moneda y banca; lo que me permitió conocer mejor a sus estudiantes así como los programas que desarrollan en las áreas de economía y finanzas. Es una universidad muy exitosa y totalmente independiente del gobierno, lo que le da la autonomía financiera y profesional para seleccionar sus alumnos, profesorado y los programas que ofrece a los mismos. Solo así se puede ser realmente responsable como institución y aspirar a la excelencia académica.

Una de las ventajas de operar en un país donde el Estado no ha crecido tanto como en la vieja Europa es que da oportunidades a la iniciativa privada para innovar y prosperar de maneras difícilmente previsibles ni controlables por el regulador; aunque sólo sea porque no tiene una maquinaria administrativa lo suficientemente desarrollada como para poder intervenir de manera más activa (no es porque no quiera es porque no puede!). Esto ha sido una bendición para quienes pusieron en práctica en su día, y lo continúan desarrollando y expandiendo en la actualidad, el proyecto de una universidad independiente y comprometida con la educación y formación de personas libres y responsables de sus decisiones, en una una economía de libre empresa. Acostumbrado a vivir en países donde el Estado ‘llega a todo’, fue un gusto comprobar cómo proyectos distintos e innovadores pueden desarrollarse y asentarse de manera tan exitosa. Como la UFM, la Universidad de Buckingham es una institución verdaderamente independiente del Estado, que no por casualidad está a la cabeza de la excelencia docente en el Reino Unido.  He trabajado 14 años en una universidad estatal y desde 2012 en Buckingham y puedo dar fe de las diferencias entre ambos ‘modelos’ institucionales; uno representativo de una universidad altamente burocratizada donde se desincentiva la innovación, y el otro donde la iniciativa individual y la buena docencia son premiadas.

Entrevista sobre dinero y banca central

Durante mi estancia en la UFM, Luis Figueroa y yo mantuvimos una entrevista sobre moneda y banca central; en concreto, hablamos de la posibilidad de tener un sistema monetario sin un banco central estatal y de como reformar la política monetaria a la luz de los errores que condujeron a la crisis financiera de 2007/08. Aquí podéis encontrar el contenido completo de la entrevista para el canal online ‘NewMedia UFM’: http://newmedia.ufm.edu/video/es-posible-un-sistema-monetario-sin-banca-central/. Para aquellos interesados en el tema, podeis leer mi entrada en el blog del mes pasado sobre la viabilidad de un sistema monetario con un banco central privado (entrevista con Standard and Poor’s).

Como siempre, los comentarios y críticas sobre el contenido de la entrevista serán muy bienvenidos.

Juan Castañeda

 

 

 

On March 2nd (Fundación Rafael del Pino, Madrid) I had the pleasure to join a panel on the future of the European Banking Union (EBU) (and on Brexit) with very distinguished colleagues and friends: Jose Manuel Gonzalez Paramo (BBVA and former member of the ECB Executive Committee), David Marsh (OMFIF, London) and Pedro Schwartz (UCJC, Madrid) (see the video of the seminar here). During the  event I also had the opportunity to launch in Madrid the book I co-edited last year on the European Banking Union. Prospects and Challenges (Routledge). The book is a collection of essays on the EBU by central banks’ analysts, academics and practitioners from different jurisdictions. Each of them addresses the topic from a different perspective, either legal or economic, and highlights the pros and cons of the EBU as well as its expected challenges over the next few years.

It is obvious to all now, but also to many experts at the time of the launch of the euro, that the institutional architecture of the euro was, at the very least, weak and incomplete (see some of the articles in the 1990s written by W. Buiter, C. Goodhart, P. Schwartz, T. Congdon or G. Wood, amongst others). No currency union has survived for long without a political union or a supranational Treasury, with enough powers and policies to back the currency. And this is particularly true in the case of an area, such as the Euro area, which is far from being a flexible and fully functioning monetary area. You may want to check out the results of the research report just published by the Institute of International Monetary Research on the measurement of the integration of the euro area or its ‘optimality’ as a single currency.

The reference to the classical gold standard (1870s – 1913) as a comparison with the current euro standard deserves some attention. We should be aware of the differences between both standards: the gold standard was indeed a monetary union, where member economies fixed their currencies against gold; whereas the euro standard is a currency union, where countries get rid completely of their national currencies and adopt a single currency for all. The latter is much more rigid and demanding during a crisis, since member states have no room to alter the parity of the currency (there is no national currency!), nor to abandon the parity on a temporary basis. Under a currency union member countries have effectively no central bank of issue, as this function has been fully delegated to a supranational central bank. We have experienced since 2008 how demanding this monetary system becomes under a crisis, much more a severe financial crisis, as countries have no other option but to cut costs and prices in an effort to regain competitiveness (the so-called ‘internal devaluation’). This is an option to sort out the crisis, but it has proven to be a painful one our economies (and even more, our populations) seem not to be ready to implement or even to accept.

In a nutshell, the EBU implies the following (more details on the presentation here):

  • The establishment of the European Banking Authority (EBA), which overseas the implementation of the new (much higher) Basel III banks’ capital ratio and the new liquidity ratio across the EU.
  • The establishment of a single banking regulator under the ‘Single Supervisory Mechanism‘ (SSM) for big banks or transnational banks in the Eurozone (around 80% of all), in the hands of the European Central Bank in Frankfurt. In addition the new Single Resolution Mechanism (SRM) has been stablished to deal with the recovery or resolution of a bank (see more details below).
  • According to the new EU Recovery and Resolution Directive (RRD), every bank must draft a resolution plan to be approved by the regulator, in order to resolve the bank if needed be in an orderly and timely manner. In addition, should a bank under the SSM need to be resolved, the government will not use taxpayers’ money in the first place. Actually the resolution or recovery process is going to be handled by the SRM. And only when the bank’s shareholders and creditors’ money has been (mostly) exhausted (so they have absorbed losses of at least 8% of the total liabilities), the bank can benefit from other sources of funding to pay its debt or conduct other operations (such as the Resolution Fund, see below). This is what the literature calls a bail-in rather than the bail-outs of the banks with taxpayers’  money we have seen in the recent crisis.
  • In addition, all member states have agreed to guarantee the deposits up to 100,000 euros per person per bank (however there is not yet a pan-EU deposit guarantee scheme but national schemes).
  • Finally, the EBU would not be complete should we not pay attention to the role of the ECB and the National Central Banks as the lenders of last resort in the Euro area. Modern central banks (particularly since the 19th century, but also earlier in the case of the Bank of England) were established to support the banks in case of a liquidity crisis. If a bank is solvent but illiquid, and thus cannot pay its deposits temporarily, the bank can always request extraordinary lending to the central bank (as W. Bagehot put it in his famous 1873’s seminal book: unlimited lending but always against collateral and at a penalty rate). However, this competence is still in the hands of the National Central Banks in the Euro zone which, provided there is no objection of the ECB, can lend money to the national bank in crisis at request. This division of competences between the ECB and the National Central Bank should be better coordinated so no banking crisis is artificially ‘hidden’ or postponed under the provision of liquidity by the national central bank.

The ‘Euro 2.0’

As Jose Manuel Gonzalez Paramo put it, the European Banking Union is a sort of ‘Euro 2.0‘ as it comes to remedy (at least some) of the Euro 1.0 institutional problems and weaknesses. In this regard, I agree it is an improvement as it helps to create a more consistent and credible institutional setting (*); however it does not tackle important aspects I will just briefly mention below:

  • First of all, the EBU and the new Resolution Fund (paid for by the banks, its amount will be no less than 1% of banks’  guaranteed deposits) will not be completed until 2024. So, should a banking crisis occurs in the meantime the banking sector will not have enough funds to pay for the banks’ liabilities on its own or to fund and implement the decisions made by the SRM.
  • Secondly, if a bank needs to be assisted and finally resolved, a complicated coordination between many actors of divorced nature and aims (political, national and supranational) is required in a question of days/hours. Of course the test to this procedure will come when we experience the next banking crisis (see more details on chapter 2 by T. Huertas, see book mentioned above).
  • But finally and most importantly, in my opinion, the EBU does not resolve the fundamental problems of the Euro zone; which are the abysmal internal asymmetries amongst member states in terms of competitiveness, public finances or costs (see some measurements here), as well as the actual lack in internal and cross-border flexibility as regards labour and good and services markets. Just a view of the asymmetries in Target-2 member states’ balances is as striking as self-explanatory.

The EBU adds consistency and predictability to the supervision and resolution of banks. In this sense, it is an improvement. It also makes banks pay for the losses before applying any other funding, even less taxpayers money; but we are yet to see the robustness of the new institutions established as well as the political commitment to the bail-in option in reality. The EBU is in my view another ‘patch’ on the euro’s structural weaknesses.

 

Juan Castañeda

Notes:

(*) However more consistent, I do not think this type of euro currency, very much centralised and linked to an increasingly powerful supranational State, is the best we could have established to preserve the purchasing power of the euro; I will elaborate further on the alternatives in next posts.

Within the launch event of the new MSc in Money, Banking and Central Banking (hosted by the Institute of Economic Affairs in London, 13th March, 12:00-14:00), I will be delighted to introduce two of the teaching staff of the programme, Professors Tim Congdon and Geoffrey Wood, who will be discussing the major topics covered in the programme: such as policies aimed at achieving price stability and financial stability, as well as the current debates on alternative central banks’ strategies and the effects of tighter bank regulation in a post-crisis era. A key question is to assess whether central banks should shrink their balance sheets and, if so, the strategy to do it so economic recovery is not harmed by a shortage in the amount of money. Ins this regard, the US Fed’s Quantitative Tightening policy in recent months will be discussed (see a more detailed analysis here: http://www.mv-pt.org/monthly-monetary-update) along with other alternatives.

This is a new MSc focused on how money is created in modern economies and on how changes in the amount of money affect prices (all prices, consumer and asset prices!) as well as income along the cycle. In addition emphasis is given to the functions, operations and monetary policy strategies of major central banks, so we can understand better the way monetary policy makers actually make a decision. Surprisingly enough, this very classical approach to money and central banking has become quite distinct and unique,  since monetary analysis has been labelled as ‘out-fashioned’ and has somehow been disregarded in the last two decades. The MSc is offered by the University of Buckingham and you can find more on the programme and how to apply here: https://www.buckingham.ac.uk/humanities/msc/money-banking .

Places for the launch event are still available. Should you want to attend RSVP to enquiries@mv-pt.org or call Gail Grimston on 01280 827524. For those who will not be able to make it we will be recording the presentation and the debate and upload it on the Institute of International Monetary Research‘s website (http://www.mv-pt.org/index).

All welcome!

Juan Castaneda

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