On the performance of the Euro vs. the US dollar (video presentation)

Those who follow this blog will know that I have already published an entry on the index of performance of the euro (1999 – 2018); I commented on the outcomes of an overall index of macroeconomic dispersion among the Eurozone Members States, which can be split up into four (sub) indices: business cycle, competitiveness, public finance and monetary dispersion. I have also reported on the same metrics calculated for the US, so we could compare then with those of the Eurozone. The results are somehow expected, but nevertheless very revealing.

• Overall macroeconomic dispersion in the US is much smaller than in the Eurozone.
• Macroeconomic asymmetries within the US states did exacerbate in the crisis years and also in the pre-crisis years, but in the US have quickly returned to pre-crisis levels and remained fairly stable since 2010; whereas in the Eurozone we still have a long way to go.

Of course, some caveats apply in this instance: the US dollar has been a single monetary area for more than 150 years, and indeed a banking union and a fiscal union (with a meaningful federal-central budget) for a long time too. Even with these caveats in mind, what it is very revealing is not that the size of macroeconomic dispersion or internal asymmetries are much larger in the Eurozone, but how differently macroeconomic dispersion has evolved after the crisis: In the case of the Eurozone, particularly as regards monetary and competitiveness dispersion trends, they  show a very strong persistence, revealing (among other things) a more rigid functioning of the price system in goods and services and labour markets as compared to those in the US. The caveats mentioned above may well explain the difference in levels of dispersions, but the changes in trends reveal underlying/structural problems in the way in which markets adjust to crisis in the Eurozone.

We are now extending the results of the project to include the index of dispersion among regions and nations within the UK sterling area, and the (provisional) results confirm the same pattern: the poorer performance of the Eurozone (as measured by internal dispersion) as compared to both the US dollar monetary area and the UK sterling one. We may disagree on the solutions to this problem but we should not simple ignore the facts. ‘All and sundry’ claim that a fiscal union and a pan-EU central budget should be adopted, so counter-cyclical policies can diminish the negative effects of ‘lateral shocks’ (those affecting some MSs considerably more than others) in the future. I do advocate for a different solution, one that requires no further integration, but the devolution of fiscal discipline to the national level. Here it is a the report with my proposal for the re-balancing of the Eurozone.

Here you will find the video to the presentation of the index of the Euro performance (2019) at the European Parliament, in an event organised by the Institute of International Monetary Research in Brussels (29/10/2019). Feedback most welcome.

Juan Castañeda

 

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How has the euro performed as compared to the US$, 1999-2018?

An optimality index of the single currency: internal asymmetries within the Eurozone and the USA since 1999

We have measured the macroeconomic dispersion within the Eurozone (see further details here on the indicators we have used) and this is in a nutshell how the euro (12 and 19) has performed since its launched in 1999.

 

As shown in the chart above we have added Target2 balances in the calculation of the (overall) index of internal dispersion; which is in fact an index of divergence within the Eurozone. The empirical conclusions are quite revealing, and somehow the expected ones: (1) in the good years (1999-2007), overall dispersion increased quite notably (it doubled!); (2) after the 2008-09 crisis, divergence deteriorated much more sharply and, leaving Target2 balances aside, the trend has been reversed and the index shows signs of improvement (though at a very slow pace).

We have also calculated an index of macroeconomic dispersion for the (mainland US) dollar area, using the same methodology. The chart below shows the trends in dispersion/internal asymmetries in this two major monetary areas:

 

There are many questions to discuss on this issue: among others, I will just mention three: (1) should we or should we not add Target2 balances to the calculation of the index of dispersion? (effectively, do Target2 balances matter?); (2) since the US is indeed a banking union, should we factor in monetary dispersion across States?; and (3) do the charts above suggest that the policies implemented during the recent crisis are the right ones in order to achieve a greater degree of convergence in the Eurozone?

We will discuss these questions and the charts above, and what they mean for the interpretation of convergence trends in the Eurozone, in a two-day conference at the University of Buckingham this week (21-22 February): The Economics of Monetary Unions. Past Experiences and the Eurozone. If you cannot make it, you will be able to follow the presentations live online. More information on the full programme here and how to follow it at the Institute of International Monetary Research social media.

All welcome.

 

Juan Castañeda

 

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Index of internal asymmetries within the Eurozone

How has the Euro performed? Are the economies of the Eurozone countries more homogeneous today than in 1999?

The 2017 optimality index 

Professor Pedro Schwartz and myself have conducted a research to (1) assess the trend in macroeconomic imbalances within the Eurozone since 1999 and (2) compare it to those in the US dollar monetary area. This is an extension of the research paper published last year in Economic Affairs (October, 2017), ‘How Functional is the Eurozone? An Index of European Economic Integration Through the Single Currency’. We have collected 10 different economic indicators per country (that is, for the 19 Eurozone Member States and 50 US states plus Washington DC) to measure how homogeneous or asymmetric the Eurozone Member States’ economies are, and calculated an overall index of economic dispersion, as well as four separate sub-indices to measure for asymmetries as regards (1) cycle synchronicity, (2) public finances, (3) competitiveness and (4) monetary and credit growth. The overall index can be interpreted as a measure of macroeconomic dispersion and thus of the asymmetries existing within the currency area.

In a nutshell, what the calculations and indices tell us is the following:

1. Overall, the economies of the Eurozone Member States are less homogeneous today than in 1999. Integration did deteriorate even during the ‘good years’ (the expansionary phase of the cycle; specifically, a 86% accumulated increase in macroeconomic asymmetries from 1999 to 2006.
2. During both the Global Financial Crisis and the Eurozone Crisis asymmetries escalated, in particular those regarding differences in competitiveness across Member States. Since 2015 the overall index of dispersion had shown a slight recovery: the new fiscal measures adopted at the EU level, along with the adjustment in costs and prices in those Member States mostly affected by the crises, seem to have been effective. In addition, the new programme of Quantitative Easing by the ECB, which began in 2015, has also helped, by reducing monetary growth dispersion across the Member States.
3. However, this positive trend has been reversed in 2017, due to a deterioration in the competitiveness and monetary dispersion indices. This raises concerns about the stability of the Eurozone, since it shows that the return to macroeconomic stability and integration to something like pre-crisis levels is not an easy task even in times of economic growth. It also shows that the changes introduced in the euro architecture during the crisis have not been as effective as hoped.

For further details, you can access the summary of our project here: https://www.mv-pt.org/staff-research. You can also access the tables and figures with the comparison with the indices of dispersion in the USA here. These indices are now part of the research agenda of the Institute of International Monetary Research (IIMR) and an update with new figures will be published every year.

Note: Euro-12 and Euro-19 overall index of dispersion, 1999=100  (https://www.mv-pt.org/staff-research). The higher the value of the index the greater asymmetries are.

A full academic article by Pedro Schwartz and myself with further explanations on the figures and the calculations will follow soon. As always, comments most welcome!

Juan Castañeda

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MONEY TALKS, by IIMR

‘Money talks’ is a series of mini-videos the Institute of International Monetary Research (IIMR) will start to release every week on the 18th of June, Monday.

The name of the series says it all: experts in money and central banking will be covering key concepts to understand better monetary economics in less than two minutes long videos. Tim Congdon (Chairman of the IIMR) and Geoffrey Wood (IIMR Academic Advisory Council) along with myself and many others to come will be addressing the fundamentals in money and banking to be able to understand how our monetary systems work and which are the roles and functions of modern central banks.

The topics address include the following:

Episode 1: What is Money?

Episode 2: What is the Central Bank?

Episode 3: What is the Monetary Base?

Episode 4: What is the Money Multiplier?

Episode 5: What does Monetary Policy consist of?

Episode 6: What is Central Bank Independence?

Episode 7: The Central Bank as the Lender of Last Resort

Episode 8: Bail outs and Bank Failures

Episode 9: Basel Rules

Episode 10: What os ‘Narrow Banking’?

Episode 11: Fiat Money

Episode 12: What is a monetary policy rule?

Episode 13: What is Monetarism?

Episode 14: Monetary Policy Tasks

But of course, these are just the ones we are starting with. The list will be expanded in the next few weeks and the aim is to produce a library of mini-videos that could be a good reference to search for short definitions on money, banking and central banking.

If you are interested in this project, please subscribe to the IIMR YouTube channel (https://www.youtube.com/playlist?list=PLudZPVEs3S82iu2zb-QZfcK7pqnrHfPgO) to stay tuned.

As ever, comments and feedback most welcome!

 

Juan Castañeda

 

 

 

 

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Is the central bank a bank at all? The case for a privately-owned central bank

Last month I had the pleasure to contribute to the IIMR/IEA annual monetary conference (8 November 2017) in London, ‘Has Financial Regulation Gone Too Far? And do banks really need all the extra capital?‘. I gave a short talk in session 3, ‘The role of the central bank in financial regulation‘, chaired by Charles Goodhart (LSE), on the essential nature of central banks as banking institutions. It may sound silly to state the obvious but, as my good friend, mentor and excellent colleague – Pedro Schwartz – always reminds me, we should not take for granted the fundamentals in economics, even less in money and central banking. Let me then start by saying that modern central banks were established to cope with two major tasks: (1) to be the bankers of the State (the Bank of England and other continental European central banks are good examples of this, see here) but also (2) to become the bankers of the banks in monetary systems operated under a fractional reserve (again, the Bank of England is the first modern central bank in this regard); the latter is what we call the lender of last resort function of central banks.

In the early years of the establishment of central banks, with the running of the gold standard, strictly speaking, there was no monetary policy nor the pursue of a macroeconomic target as we understand it now; but a bank of issue with a privilege position in the monetary market, and mainly focused on maintaining the convertibility of its currency at the pre-announced rate. It was only quite recently (historically speaking), after the abandonment of the gold standard in the interwar years, that central banks have explicitly adopted or given other tasks, and indeed macroeconomic tasks, such as keeping price stability or achieving economic growth.

But we should not forget that central banks are at the core of the monetary system and the banking sector, providing financial services to a ‘club’ of commercial banks which create money in the currency issued by the central banks. Which money? ‘Bank money’, that is, bank deposits under a fractional reserve system. This money constitutes the bulk of the money supply in modern economies, and it is vital for the central bank to keep a steady growth of the amount of money in circulation to preserve stable and long term economic growth; thus avoiding too much money during the expansion of the economy or too little in a banking crisis. What I state in my talk is that privately-owned central banks are genuinely interested in maintaining financial stability, and thus will be willing to intervene in a liquidity crisis much more promptly and efficiently than a central bank under the shadow – if not the control – of the State. This is something I have supported in other articles (recently in this article), and my colleague at the IIMR, Tim Congdon, has written on (see chapter 7 in ‘Central Banking in a Free Society‘).

This is the video of the talk:

Comments are very welcome as ever!

 

Juan Castañeda

PS. To the best of my knowledge the characterisation of central banks as the bankers of a ‘club’ was first coined by Charles Goodhart in his seminal 1988 book, ‘The Evolution of Central Banks‘, a book anyone interested in the history and functions of central banks must read. However, unlike Goodhart’s position in his book, I do not see a conflict of interest for a self-interested central bank to become a lender of last resort in times of crisis. Actually, central banks did make a profit when lending in times of crisis, such as the Bank of England in several banking crises in the 19th century.

 

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Tighter bank regulation won’t stop boom and bust, but it will damage growth and prosperity

This is the title of an article written with my colleague, Tim Congdon (Institute of International Monetary Research and University of Buckingham), published in CityAM on 27/10/2017.

Our main point is that more regulation won’t make banks safer and is counterproductive. It is a sort of an instinctive reaction by politicians, policy-makers and regulators to respond to a crisis with more and tighter regulation, in an effort to tackle the ‘excesses’ in the market economy left of its own will. This is both very naive and irresponsible, as much as empirically and theoretically wrong. The recent announcement and approval of the Basell III tighter bank capital ratios is an example of it: this tougher set of regulations was announced and approved in the midst of a severe financial crisis (2008-2010), and resulted in banks shrinking their balance sheets even more; with the expected dramatic fall in money growth and nominal spending.

It is again a dire example of the running of the law of the unintended consequences of regulation; which would recommend the need to assess in advance the expected consequences of regulation, rather than quickly and desperately calling for more and tougher laws on banks and the rest of the financial system.

As we put it in the article:

‘Far too many people believe that “better” regulation is the answer to financial crises. But further regulation involves an expansion of the power of the state, and a loss of freedom for the financial system. Remember that Britain had no explicit official rules on bank capital until the 1980s, yet no British bank suffered a run on its deposits over the preceding century. Crucial to the success of British banking in the decades before the Northern Rock fiasco was the Bank of England’s willingness to lend to solvent banks if they were having difficulty funding their assets. Good central banking helped Britain’s commercial banks to run their businesses efficiently and profitably, and to the benefit of their customers.’

There was a time, not that far away, when regulation was not that prominent and financial markets flourished; and when a banking institution failed, that occasionally they did, there were solid policies and institutions willing to intervene in an decisively and orderly manner (the Bank of England had been an example of that, at least until the collapse of Norther rock in the recent crisis).‘

You will find the article in full here: http://www.cityam.com/274672/tighter-bank-regulation-wont-stop-boom-and-bust-but-damage.

Comments, even more if critical, most welcome!

Juan Castañeda

PS. We will be discussing these issues with the member of the Bank of England’ s Financial Policy Committee, Martin Taylor, in the IIMR Annual Public Lecture on the 7/10 in London: https://www.mv-pt.org/events/public-lecture-the-committee-of-public-safety-the-work-of-the-financial-policy-committee-by-m

 

 

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The assessment of the eurozone: a measurement of its optimality (1999 – 2016)

‘How functional is the Eurozone? An index of European economic integration through the single currency’

This is the title of the paper I have just written with my good friend and colleague, Professor Pedro Schwartz (Camilo Jose Cela University in Madrid and University of Buckingham), which will be published in Economic Affairs (October issue, 2017).

We deal with a quite straight forward question: How can we measure the optimality of a currency area? When does it become more and more difficult to run a single monetary policy? If there are internal asymmetries in the currency area, how do they evolve? To answer, if only tentatively, these questions we have developed the method to calculate the index of optimality of a currency area, which we have split up in four major categories and components: (1) fiscal synchronicity, (2) public finance, (3) competitiveness and (4) monetary. Both the overall index and the above partial indices will inform us about the performance of the currency union and how internal asymmetries have increased or decreased. We have applied it to the eurozone, from 1999 to 2016. The results and calculations give us a metric to identify the building up of internal tensions in the running of the single monetary policy since the inception of the euro in 1999.

If only a chart, this is the summary of what we found in our research; in a nutshell, the adoption of the euro has not increased convergence among eurozone economies. The overall index of dispersion increased by 25% from 1999 to 2005 (see figure below),  and so asymmetries amongst member states even during an expansionary cycle. Of course, as expected, internal dispersion soared during and immediately after the outbreak of the Global Financial Crisis. This increase in dispersion in the crisis years ‘s not a symptom of the malfunction of the euro; what we should rather focus on is on the time taken for asymmetries to resume pre-crisis levels. Overall, even after 10 year since the start of the recent crisis, the optimality index still shows the Eurozone has a long way ahead to resume pre-2007 crisis levels (such as 1999 levels, when even countries joining the Eurozone were far from convergence).

 

 

This is the abstract of the paper:

‘This is a step in empirically assessing how near the Eurozone is to becoming an ‘optimal currency area’, as originally defined by Mundell (1961). For this purpose we have compiled ten indicators, organised them in four chapters, and summarised them in an overall indicator of ‘optimality’. The resulting picture is mixed, with zone optimality not increasing when circumstances were favourable but the trend towards integration returning after the 2008-2014 crisis. The suggestion is that dis-integration during the crisis, rather than an evidence of failure of the Eurozone when the going was tough, showed a self-healing mechanism at work. However our measurements and indices show that optimality is much lower than that in 1999.’

Feedback most welcome, as ever.

Juan Castañeda

 

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‘The new regulatory wisdom: good of bad?’

This is the title of the second research paper published by the Institute of International Monetary Research (IIMR), by Adam Ridley. This is a brief summary extracted from the paper, which is fully available at http://www.mv-pt.org/research-papers:

‘Output growth in the leading Western economies has been weaker since the Great Recession of 2008 and 2009 than at any time since the 1930s. According to the International Monetary Fund’s database, advanced economies’ gross domestic product was flat in 2008 and dropped by 3.4 per cent in 2009. Although 2010 enjoyed a rebound with 3.1 per cent growth, the next three years saw output advancing typically by a mere 1 ½ per cent a year. This was well beneath the pre-2008 trend.

In the leading Western nations the official response to the Great Recession has had a number of well-known and familiar common features, although policy has been far from stable or easy to predict. The elements of this response constitute what might be termed the “New Regulatory Wisdom” (NRW). How is to be defined? What has been its impact so far? And what will be its effects if it is maintained into the future?’

 

Video on changes in bank regulation during and after the Global Financial Crisis

You can also find a video below with further insights on this fundamental topic to understand the collapse in broad money growth in the midst of the Global Financial Crisis, and thus the aggravation of the crisis. The effects of tightening bank capital regulation are quite straight forward; in order to comply with higher capital to assets ratios, banks would have to sell their assets and thus reduce the amount of deposits (bank money) in the economy. This means a contraction in banks’ balance sheets and in turn a fall in deposits (broad money). The effects of such contractionary regulation is addressed in detail in Money in the Great Recession (Ed. Tim Congdon. 2017). In view of recent proposals to even increase capital ratios further the IIMR will hold a conference in this topic in november 2017 (more information with the programme and speakers to follow after the summer)

Comments welcome.

Juan Castañeda

 

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Assessment of the monetary strategy of the ECB: 1999 – 2014

Following up my last post on the eurozone crisis and the monetary policy of the ECB (see IIMR esearch Paper 3: Have Central Banks forgotten about money? by my colleague Tim Congdon and myself), please find below a video with further details on the changes made to the monetary strategy of the ECB since its establishment.

What I claim in the video is that the ECB did give a prominent role to the analysis of the changes in broad money up to 2003, when it reviewed its strategy, and not surprisingly it led to a higher rate of growth of money in the Eurozone in the years running up to the Global Financial Crisis. Just to be clear, I do not support that any central bank should adopt a ‘mechanistic’ monetary growth policy rule, by which the bank adheres to an intermediate M3 (or broad money) rate of growth target come what may. The link between money and prices and nominal income is indeed very strong over the medium and long term, but it is of course affected by other variables/phenomena in the short term that need to be properly considered and taken into account by policy makers. So rather than a mechanistic approach to such a monetary target, changes in money growth should be given a primary role in assessing inflation and nominal income forecasts, and thus in the making of monetary policy decisions; and this is precisely what the ECB did from 1999 to 2003 under its two-pillar strategy. So when money growth continuously exceeds the rate deemed to be compatible with monetary stability, this would signal inflationary pressures and even financial instability the central bank would eventually tackle by tightening its monetary policy. This rationale would show the commitment of the central bank to both monetary and financial stability over the long term, and the use of a broad monetary aggregate would serve as a credible indicator to make monetary policy decisions and as a means to transmit the central bank’s expectations on inflation and output growth.

As ever, comments very welcome.

Juan Castañeda

PS. More videos on the IIMR YouTube channel

 

 

 

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Have Central Banks forgotten about money?

This is the title of a research paper I have written with my colleague and leading monetarist, Professor Tim Congdon, and published by the Institute of International Monetary Research (IIMR). This is a brief summary extracted from the paper, which is fully available at http://www.mv-pt.org/research-papers:

The quantity of money matters in the design of a monetary policy regime, if that regime is to be stable or even viable on a long-term basis. The passage of events in the Eurozone since 1999 has shown, yet again, that excessive money growth leads to both immoderate asset price booms and unsustainably above-trend growth in demand and output, and that big falls in the rate of change in the quantity of money damage asset markets, undermine demand and output, and cause job losses and heavy unemployment. This is nothing new. The ECB did not sustain a consistent strategy towards money growth and banking regulation over its first decade and a half. The abandonment of the broad money reference value in 2003 was followed in short order by three years of unduly high monetary expansion and then, from late 2008, by a plunge in money growth to the lowest rates seen in European countries since the 1930s. The resulting macroeconomic turmoil was of the sort that would be expected by quantity theory- of-money analyses, including such analyses of the USA’s Great Depression as in Friedman and Schwartz’s Monetary History of the United States.

This paper argues, from the experience of the Eurozone after the introduction of the single currency in 1999, that maintaining steady growth of a broadly-defined measure of money is crucial to the achievement of stability in demand and output. The ECB did not sustain a consistent strategy towards money growth and banking regulation over its first decade and a half.

The chart below illustrates our point very well:

 

 

 

 

 

 

 

 

 

 

 

As ever, comments very welcome.

Juan Castañeda

 

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