Interesting papers – September 2018
The recent IFWSAS conference at Cass saw a highly interesting set of papers. Herewith just a small set:
In “Can Technology Undermine Macroprudential Regulation?” Fabio Braggion, Alberto Manconi and show that peer-to-peer lending platforms can help retail borrowers get around loan-to-value caps and thus macroprudential regulations aimed at smoothing house price and credit cycles. Using detailed borrower and funder data from one Chinese P2P platform, they show that the tightening of LTV caps in some but not all Chinese cities in 2013 resulted in an increase in P2P lending in the affected cities, consistent with borrowers tapping P2P credit to circumvent the regulation.
Jannic Cutura assesses the effect of the new bail-in rule under BRRD for market discipline in the Eurozone. Exploiting the difference between yields of bonds maturing before 2016 and maturing later (where only the latter would be subject to the bail-in rule) before and after it became clear that the bail-in rule would be introduced he finds evidence for a higher yield differential after markets realised that the bail-in rule was for real. I have still lots of question on specification and exact timing of different events, but clearly an interesting and highly relevant paper.
Does access to finance help with labour market mobility and employment? Yes, according to Bernardus Van Doornik, Armando Gomes, David Schoenherr and Janis Skrastins who exploit random variation in the allocation of motorcycles through lotteries among participants in a financial savings product in Brazil. They find that individuals exhibit higher employment, earnings, and business ownership, and commute further after obtaining a motorcycle compared to participants who did not yet win a motorcycle. And these effects are persistent rather than temporary.
Right after the conference I went for a seminar at Bocconi. These visits do not only allow one to receive valuable comments on one’s own work but one also learns about other people’s work. In Milan, I met Thorsten Martin, whose job market paper looks at the introduction of steel futures. There are lots of concerns that this just enables financialisation and speculation. But Thorsten shows that the creation of future markets increased price transparency in product markets. Higher price transparency reduced producer surplus and customer material costs. This higher price transparency ultimately increased the market share of low-cost steel producers and thus aggregate productivity. This is really important work that shows that financial markets (here derivative markets) help economic growth not through investment but rather by improving resource allocation, which is very consistent with an extensive body of work in the Finance and Growth literature.
14. September 2018
Basel standards in developing countries
As reported earlier, I was part of a research project on the determinants of adoption of international regulatory standards in emerging and developing economies. My colleagues have now put together an excellent website with lots of important information, not just for academics, but also analysts of regulatory frameworks and policy makers wanting to look across their borders. The website shows which elements of Basel II/III have been adopted by which countries and explores the factors that explain why different countries have chosen specific adoption strategies, including several highly insightful case studies from Asia, Africa and Latin America. Also, on the website are two policy notes, one directed at regulators in EMDEs concerning their approach to adoption of Basel II/III and one directed at international institutions (including the Basel Committee) to ensure that such international standards are more appropriate for developing countries.
But the main focus of the project has been the factors explaining of why different developing countries have chosen different paths towards the adoption of international regulatory standards. To summarise the findings
Basel II and III adoption in developing countries is widespread but selective. While some might see this as slacking, this can also be interpreted as a signal of a cautious approach by developing countries regulators to international standards to which most had no input and which might not fit the needs of their economies.
Three key actors shape Basel standards adoption in specific countries: regulators, politicians, and domestic banks, consistent with the political economy literature on financial sector development – to understand cross-country variation in financial sector policies, in this case, regulatory frameworks, one has to understand the politics behind the adoption/implementation of such frameworks and the interests and relative powers of different groups.
You might wonder what is new – well, to my best knowledge this is the first time researchers have taken a systemic look at the adoption of international banking standards – a cross-country approach combined with a number of detailed and diverse case studies that shows different models, ranging from no adoption (Ethiopia) over mock compliance (Vietnam) to selective adoption to foster financial development and a financial centre approach (Nairobi). The different case studies helped identify very different reasons for adoption:
As I had discussed earlier, I am also co-leading (with Liliana Rojas-Suarez at the Center for Global Development) a Taskforce on Basel III adoption in emerging and developing markets, where the focus is more on identifying specific recommendations to improve the fit of such international regulatory standards for these markets. The report is not due until next year, but understanding the reasons of why or why not countries adopt Basel III can certainly help in the analysis.
12. September 2018
Keep walking? Islamic bank borrowers don’t mind distance
Now accepted by the Journal of Corporate Finance, a paper by Ilkay Sendeniz-Yuncu, Steven Ongena and yours truly. “Keep Walking? Geographical Proximity, Religion, and Relationship Banking” has nothing to do with my love for Blended Whiskey and all with the distance between borrowers and lenders across conventional and Islamic banks in Turkey. Combining data on borrower-bank relationships from Kompass and branch location data of all Turkish banks, we find that Islamic banks are geographically more distant from to their borrowers. We also find that the probability for a firm to connect to a bank substantially decreases in distance, but that if the bank in the vicinity is an Islamic bank, distance plays a more muted role. The higher distance between borrower and bank in the case of Islamic banks is stronger in cities with a higher conservative party vote and higher trust in religious institutions. As we control for many other firm characteristics and also control for within-firm variation (for firms with both conventional and Islamic lenders), this difference seems to be driven more by demand than supply-side differences.
What do we learn from these findings? Distance is far from dead and matters for which bank a borrowers links up with. Second, Islamic financial products are sufficiently attractive for certain borrowers that they are willing to take into account longer distances to access these banking products.
9. August 2018
Handbook of Finance and Development
Fresh off the print – the Handbook of Finance and Development, co-edited by Ross Levine and yours truly!. It has been 25 years since Bob King and Ross published the two seminal papers that kicked off the empirical finance and growth literature, so a good moment to take stock. While these two papers established partial correlations between financial and economic development using cross-country regressions, the literature has subsequently focused on controlling for different endogeneity concerns, including reverse causation, omitted variable bias and measurement bias and has used an array of different data sources. More recently, non-linearities in the finance-growth literature have been explored as well as the trade-off between growth and stability. At the same time, economic historians have explored the development of financial systems in major economies and how they have interacted with economic development. Over the past decade or so, financial inclusion and microfinance have become more important, with new data sources opening up, as well as randomized control trials being used.
This handbook includes 20 chapters by leading economists and historians in the field, who give an overview of different aspects (theory, empirics, growth vs. stability, historical accounts, political economy of finance, financial inclusion, SME finance etc) and look forward to future research. The handbook has been in the making for quite some time, but Ross and I are very happy with the outcome and think that this can be a major reference for anyone interested in this area.
26. July 2018
Interesting papers – July 2018 issue
Before heading off into my summer holiday, some interesting papers I recently read:
My PhD student Mikael Homanen has gained quite some media attention with his paper on the Dakota Access Pipeline. He shows that protests against the banks funding this project ultimately resulted in deposit outflows for these banks, a powerful role for depositors in forcing banks to internalise the negative externalities (in this case of environmental nature) of their lending decisions. Among many others, the FT picked up on his paper.
Ahmed Tahoun and Laurence van Lent have an interesting paper on the role of personal wealth of politicians in bail-out decisions, now forthcoming in the Review of Finance. Controlling for many other factors, they find that Representatives with financial wealth interests in the banking system were more likely to vote in favour of the 2008 Emergency Economic Stabilization Act, even controlling for political beliefs and lobbying.
Also forthcoming in the Review of Finance, a recent paper by Marcel Fratzscher and Malte Rieth, documenting the two-way spill-over between bank and sovereign risk in the Eurozone. The recent non-standard monetary policy by the ECB, on the other hand, has contributed to lowering both risks.
23. July 2018
Generosity and privileges of big countries
I recently attended a very interesting roundtable in Kuala Lumpur on the lessons from the Global Financial Crisis. Lots of interesting topics were touched upon, but it was one issue that really caught my attention: have the US been generous to the rest of the world by committing itself as leader of the Free World, with corresponding high military expenses, and is this generosity now going away under Donald Trump? This is not only the narrative of Donald Trump, but many other observers who point to the costs of the leadership role the U.S. have been taking over the past 75 years. What is sometimes forgotten, however, is that this leadership role also comes with privileges, most prominently, the ability to issue the reserve currency of the world. A recent paper by Barry Eichengreen, Arnaud Mehl and Livia Chitu, which will be presented at the next Economic Policy panel meeting in Vienna in October, shows that to a certain extent it is military alliances and support that explain why a country’s currency is used by other countries as reserve currency (thus providing it with the equivalent of seigniorage gains). The fact that the U.S. has a leadership role in the West can thus explain why the US dollar is so popular as reserve currency and guarantees lower interest costs for the US government. A back-of-the-envelope calculation by the authors shows that the benefit of issuing the reserve currency of the world is larger than the costs of military alliances and support the US provides to its allies.
By the way, these findings might also explain why the Euro has not become a major reserve currency around the world – contrary to the hopes and expectations of Europeans. As the Eurozone and the European Union are primarily economic unions and have no military ambitions, the findings of Eichengreen et al. suggest that the Euro will not be able to convert itself into a major reserve currency.
One might be able to make a similar argument about privileges vs. generosity about Germany within the Eurozone, though less in military and more in political terms. The Euro is effectively a foreign currency for most Eurozone countries, with the notable exception of Germany. Political or economic uncertainty in periphery countries resulting in an increase in sovereign bond yields pushes down the German Bund yield as the result of a run into safety. And it is Germany, which benefits more than from that than any other core country (e.g., Netherlands), given the size and liquidity of the German sovereign bond market. This also relates to the scarcity of safe assets in the Eurozone, which again puts Germany in a privileged position. These benefits if not privileges from being the core country of the Eurozone make a strong economic but also political argument for taking more financial responsibilities within the Eurozone (aka as “generosity”), ultimately sharing the benefits of this privileged position with the rest of the Eurozone. While some in Germany might have recognised this point, there is no broad consensus on this yet and it might take another generation or so to get there, hopefully before the Eurozone breaks apart. But even if there were such a consensus, we have learned from the Trump presidency that a generation-long consensus can be questioned in a rather powerful way.
23. July 2018
More thoughts on Brexit
When the Brexit referendum was called, I was struggling to understand why anyone would advocate or even vote for Brexit: after all, economic self-interest would force to UK to stay inside Custom Union and Single Market without being able to influence the rules. Well, I was obviously very wrong, although I agree with many observers that the vote was actually not about EU membership but long-run frustrations built up in parts of the British electorate, which could not be voiced in General Elections.
The last couple of days and weeks have seen quite some developments in the Brexit debate and process. Unlike more professional bloggers (among my favourites: Simon Wren-Lewis and Ian Dunt), I cannot follow up on a high-frequency basis. But here are some more general thoughts about Brexit now that Theresa May is no longer trying to kick the can down the road and has come up with a plan and thus a basis for negotiations with Brussels.
So, coming back to my introductory remark, the economically ideal solution for the Brexit process will leave the UK in almost the same economic position as now, but with reduced political power. The politically preferred solution for many Brexiters sees the UK economically worse off as well as politically. Which makes one wonder yet again: why Brexit in the first place?
23. July 2018
Italy and Euro – can’t live with it, can’t live without it
I attended a very interesting half-day conference on What Next for Italy, organised by the Brevan Howard Centre at Imperial College with presentations and discussion by both economists and market participants as well former IMF staff Ashok Mody introducing his new book. There was quite a variety of views, which I will discuss in the following, with my own ones added (the event was under the Chatham rule).
The good news first - both market participants and some economists are rather sanguine about the current situation, especially when compared to 2011 (when rising Italian spreads caused - among other events - Mr. Draghi's famous "whatever it takes" and subsequently the OMT announcement). There seems to be some fiscal space to at least partly implement the new government's campaign promises (maybe 1.5% of GDP), which would still leave some primary surplus left. Italian sovereign debt seems more sustainable now than seven years ago, even after implementing these fiscally rather "damaging" promises. Non-performing loans in the banking system have been decreasing with the secondary market in non-performing assets picking up.
Unfortunately, that is where the good news stops. There are some obvious risks, including rising interest rates and shocks to current growth, which could turn Italian quickly again unsustainable or would require a higher primary surplus. The global trade war that has just started can provide one very obvious negative growth shock. Possible domestic shocks, related to political uncertainty are another source. There could be a major confrontation between Brussels and Rome, related to either fiscal policy, migration or some other policy field, possibly resulting in a "Syriza moment" (to the cliff and back) or a step beyond the cliff towards Italexit. There could also be accidents, such as a wrong policy response to a major shock, e.g., in the financial markets. The "opportunities" for accidents are plenty, unfortunately!
However, this rather short-term view is overshadowed by longer-term growth constraints: decoupling again retirement age and life expectancy will put the sustainability of the pension system under threat; in addition, long-term sustainability of the pension system requires more (rather than less) inflow of migrants. But ultimately, it is the low productivity growth (related to inefficient resource allocation and credit constraints, as very nicely summarised by Martin Sandbu), which has driven low Italian growth over the past 20 years. And while demand-side policies might not have been sufficiently used during the Eurozone crisis and sluggish recovery, I find it doubtful if a major fiscal expansion, funded either by the ECB or by mini-BOTs, issued by the Italian government as "parallel currency", can be helpful. The chance to use fiscal policy in a major way (such as in the US in 2009) seems too late and the delay in monetary expansion by the ECB (due to political constraints) is water under the bridge.
Which brings us to the long-term if not historic picture. The idea that the Euro could serve as external constraint to force the Italian economy and policy-making to modernize has obviously failed. While not as bad as in Greece, all governance indicators point to Italy having substantial gaps in the control of corruption, quality of judiciary and rule of law, and the efficiency of government. Most observers agree that Italy (for its own benefit and that of the Eurozone) should have never entered the Eurozone in the first place, even if it might be catastrophic to leave.
Where does this leave Italy - leaving the Euro (be it intentionally or by accident) would come at an enormous cost - for the whole Eurozone if not global economy, but especially and primarily for Italy. Even those who advocate that Italy leave, such as Joe Stiglitz, acknowledge the high costs of doing so. And many economists – including this one - would disagree that Italy would be really better off outside the Euro (the most hilarious idea seems to me that the new currency could be purely electronic, in a country that seems to very much like cash for a variety of reasons). Staying in the Euro, however, might just push Italy further down the vicious cycle of low growth resulting in migration of skilled young labour and more populism, which in return depresses growth further.
What are the options? Simply moving towards full fiscal union and turning national sovereign debt into joint sovereign debt is politically neither feasible nor desirable at this stage (while it might be to the liking of populists across the debtor countries of the Eurozone it would strengthen substantially populists in the creditor countries, especially the AfD in Germany, who are again screaming and yelling about the mis-understood Target 2 imbalances). Only baby steps can be taken towards fiscal union. But a solution for the high degree of Italian debt has to be found. While observers point to high local holdings of Italian sovereign bonds as buffer against creditor runs, these holdings are again in the banking system - the sovereign-bank doom loop is very much alive and kicking!
So, there are no obvious easy solutions. But there are steps policy makers can take - ranging from (i) addressing the unhealthy concentration of government bonds on banks' balance sheets through concentration limits, (ii) expanding the supply of safe assets through ESBies, and (iii) moving away from national banking markets to a European banking market, which requires both the completion of the banking union but also a more open attitude towards cross-border mergers of "national champions" within the Eurozone. All of this can help reduce credit constraints especially in the periphery countries and reduce the denomination fear for bank depositors. Most importantly, progress on other dimensions of the European project - migration crisis, standing up to Bully Trump in the transatlantic trade war, and getting a head start into a Eurozone budget – can be helpful to reduce political tensions and reduce uncertainty.
More than ever, however, political unity and comity in finding solutions and rekindling the European spirit is critical. At a time, when outside (Trump and Putin) and inside forces (populists across the block) are doing everything in their power to push the European Union towards break-up, the value of the European Union for its citizens has to be shown. Easier said than done, but that is where political leadership comes in.
9. July 2018
Global Findex in London
This past Tuesday saw a presentation by my former colleague Leora Klapper of the latest Global Findex report at Imperial College in London, sponsored by the Brevan Howard Centre. A fascinating amount of data (available to researchers and others), with several main messages coming through: Financial inclusion is rising globally, partly driven by (mobile) technology. However, the gender gap continues (more on this below). But there are still many gaps in financial inclusion across the globe, including in Africa but also some large emerging markets. Finally, having an account does not necessarily imply using it – yet another challenge!
Following Leora’s presentation we had a fascinating discussion that also included Ruth Goodwin-Groen from the Better than Cash Alliance and Andrew Rzepa from Gallup. The audience and yours truly, as moderator, asked lots of questions, which resulted in interesting (and sometimes surprising) answers. Here are some of them (I am paraphrasing the responses and include my own take on them):
What drives cross-country differences in advances in financial inclusion? It seems that one size does not fit all. A mix of factors come in, including reducing regulatory barriers, competition but also government initiatives as in India. Setting goals for financial inclusion can be useful. Certainly a research topic for years to come and one that I am planning to take on with researchers and some additional data from the Alliance for Financial Inclusion.
Should we construct a composite indicator of financial inclusion to rank countries and measure progress? Behind headline or composite indicators are often very different stories, as Leora also illustrated with some examples, so having an array of indicators capturing different dimensions (account ownership, account use, different types of services and products, different delivery channels etc.) gives a much more accurate and complete picture of financial inclusion. Not having one headline indicator only (and a ranking based on it) might also avoid that we have artificial competition between countries to increase their inclusion ranking on paper rather than in reality.
The use of formal payment services has seen the largest increase, courtesy of the digital transformation of financial service provision. But there are critical voices against the drive against cash, though – as Ruth pointed out – these are mostly based in advanced rather than developing countries and might have very different motives in mind than financial inclusion. Though why would we expect so many to give up cash in favour of formal (and thus monitorable) financial services? I would argue because the better and cheaper availability of formal financial services moves the cost-benefit trade-off of working and living in the formal economy towards the benefits. Where some see Big Brother looming, most of us see the benefits of participating in the modern formal market economy and society.
As Gallup surveys people across many different topics, the question arises whether there is something special about asking individual about their financial habits. And yes, indeed, people are more reluctant to talk about finance. But as, importantly, there many local differences, not just in products and service providers, but also habits, which requires a rather careful “localisation” of the survey questions across the globe.
Finally, where will be in 2020, when the next Global Findex survey will go into the field? We all hope for further rises in financial inclusion, though the increase might be not as steep as over the past six years. The role of technology will certainly increase further. Among the challenges, the gender gap might be harder to narrow – value questions asked by Gallup seem to point to persistent gender biases among both men and women in some countries when it comes to joint account ownership and financial decision-taking. Finally, there are the unknown unknowns – as the first members of Generation Z reach adulthood and the Millennials will increasingly dominate the bankable and banked population across the globe, especially in developing countries, there might be further changes in habits and outreach efforts by providers (and some of these providers will be new). Certainly, exciting times are ahead!
22. June 2018
Brexit – kicking the can down the road
A few years ago I compared the Greek debt crisis to a Groundhog day scenario – reliving the same situation again and again, with the can of resolving the Greek sovereign debt crisis being kicked down the road. Now, we can see something similar happening in the UK with the government refusing to clearly state its position on the future relationship between the UK and the EU.
Ultimately, it all comes back to what I called the Brexit trilemma – out of three objectives – no hard border in Ireland, no border in the Irish sea and the UK leaving the customs union and Single Market – only two can be achieved at the same time. The backstop solution now proposed by some in the UK government (the UK as a whole staying for a transition period in the customs union and maybe even Single Market for goods) seems like a reasonable compromise until a miraculous technology has been found to guarantee a soft border in Ireland with the UK having its own custom regime, but it violates red lines in Brussels that a non-EU member cannot pick and choose only some of the four freedoms (goods, services, capital and people). More importantly, it seems rather unacceptable to the hardcore Brexiters who fear (correctly!) that such a transitional arrangement might turn into a permanent state, ultimately making the UK a “vassal state” of the EU.
One can interpret the kicking the can down the road in different ways. One is that Ms. May still sees the need to keep negotiating within her own cabinet and shifting the consensus slowly towards the option mentioned above. Another is that she wants to kick the can so far until it hits a wall, in the sense that the EU will force her to sign whatever is considered reasonable by the EU lest the UK crash out of the EU (for which it is not prepared in any way). It might be a politically cheap way out for Ms. May, as she can deliver Brexit (selling anything the EU forces her to sign as transitory) as promised next March, delaying any further discussions on the permanent settlement between the UK and the EU for later (possibly after her premiership). A final interpretation would be that we have an incompetent government trying to muddle through, from one day to the next, from one deadline to the following. It is a scary thought, but probably the most realistic explanation!
8. June 2018
Italexit?
A lot has already been written about the new Italian government and the possibility of a new Eurozone crisis, so it is hard to be very original. However, in the following I will try to bring several different dimensions to this problem together.
As I wrote about a year ago in the context of an early evaluation of the banking union, “the future of the Eurozone might very well go through Italy.” Well, here we are at another cross-roads, with financial markets finally waking up to the reality of Italian sovereign debt unsustainability, continuous banking fragility, and a high degree of political uncertainty if not outright instability. Another prediction that I have made is that the next big shock will be a political one (even though the shock is the result of long-running economic trends, in the case of Italy the lack of growth over the past decade or so).
2016 was the big shock to liberal democracy on both sides of the Atlantic and to European integration, with the Brexit referendum and the election of Donald Trump. 2017 seemed to offer a relieve, with the election of Mr. Macron in France and confirmation of mainstream governments in Netherlands and Germany. 2018 has seen a swing back towards populism, with populists entering government in Austria and an illiberal government confirmed in Hungary. The populist wave has clearly not receded. And while Italy is thus only one more “populist revolt” against liberal democracy and the European project, it could turn out to be the fatal one, given the twin problems of sovereign and bank fragility and their close links.
It was interesting to see the very different reactions to the rejection by president Matarella of the suggested finance minister Paolo Savona, which then led to M5S and Lega withdrawing from government formation and aiming for new elections (side note: I met Paolo Savona a few years ago at a conference dinner and was struck by the rather strong anti-German sentiments he expressed. Given that it was a social setting I decided not to engage him on his views). Many Italian observers point to the constitutional right of the president to veto individual minister appointments and the sound reasoning by the president that an accidental or intentional Euro-exit had not been part of the election campaign. On the other hand, the veto of the president against Mr. Savona was interpreted by many non-Italian observers as strategic blunder, strengthening the hand of the populists. Well, the president might have played his cards well after all, as M5S and Lega gave in and suggested someone with less outspoken views, though Mr. Savona will still be part of the government, as minister of EU Affairs – one wonders what his role exactly will be.
While the markets have shown nervousness, we are not quite in a crisis yet (and might never get there), but such a crisis might get triggered by an aggressive expansionary fiscal policy by the new government. How can such a crisis work out? Based on experiences from previous Eurozone crises, there are several scenarios. One would be that the Italian government can no longer tap funding at a reasonable cost and would issue IOUs as form of payment, effectively a parallel currency. Another “entry point” into the crisis could be a depositor run or walk as reaction to continuous rumours on an imminent exit of Italy from the Eurozone. And with Italian government bonds (still held by Italian banks) experiencing more and more haircuts, there might at the end only be the option of capital controls as banks run out of collaterizable assets to gain access to liquidity (as in the case of Greece and Cyprus). Yet another option might be another bank failure, which could result in depositor panics across Italy, with brings us back to the scenario above.
Many observers point to the ECB as ultimate backstop, but to which extent can the ECB step in? Yes, the ECB has many tools available to serve as backstop for banks and, ultimately, even governments and has been creative in creating additional tools over the past 7 years. However, there are important constraints. One, the OMT (introduced after Draghi’s whatever it takes but never used) is contingent on a government working with the ESM – but would a populist government be willing to do so? Two, there has been a backlash against the ECB in Germany (and to a certain extent in other core/creditor countries) against “bail-outs” of periphery/debtor countries and an accommodation of populist government in Italy might lead to a rise in right-wing populism in Germany and other countries, which again might restrict the appetite of the ECB to underwrite the Italian government and banks for long.
Which brings me to the next point – a lot has been written and argued about the populist revolt in the periphery countries, but the past days have seen a similar populist backlash in Germany, quite ferocious if not rather tasteless. While primarily playing out in the media, some German economists are fuelling this and providing intellectual fodder for this. It is very obviously the wrong reaction to increase tensions further, even though it won’t only be the Germans who will complain that they might have to indirectly pay for pension increases in Italy and minimum income, while some of the creditor countries (e.g., in Central Europe) have lower levels of income and wealth than Italy. This will narrow the space for compromise within the Eurozone even further!
This new flare-up of the Eurozone crisis has made clear that the chance to complete the Eurozone architecture over the past years has not been used properly. The lack of a sovereign restructuring mechanism, the incomplete banking union and the failure to more aggressively address the links between government and bank fragility are coming back to haunt the Eurozone. And it is in Italy that the failure to address such problems are most obvious. In addition is the failure to address legacy problems, both in the banking system but also in terms of sovereign overindebtedness.
Not talking about the high Italian debt burden (as suggested by some well-meaning Italian officials) no longer helps! As pointed out by Barry Eichengreen and Ugo Panizza in this Economic Policy paper in 2016, it is politically improbable to expect a democratically elected government to run the large primary surpluses needed to reduce the high debt burden. Here, we are a few years later, with exactly the result that the new populist government has no intention whatsoever to maintain the necessary fiscal discipline and rather focuses on higher expenditures (courtesy of the basic income proposed by M5S) and lower taxes (courtesy of flat tax proposed by Lega)
Where do we go from here? First, looking yet again to the ECB as lender-of-last-resort would be dead-wrong! The ECB has been already overburdened in the last 8 years. This is not just an economic, but a political crisis – a legitimacy crisis of the Italian state and legitimacy and governance crisis of the Eurozone. Political solutions are called for! And as pointed out by others, the Eurozone reforms proposed by Macron do not really address the Italian problem. This is not about risk-sharing, rather than about low productivity growth and structural problem, including a high NPL burden.
Ultimately, what Italy needs are reforms originating in Italy, but with support from its European partners (sorry if I use this rather political term, but maybe it helps moving away from the war-like language that has started to creep into the Eurozone debate). Structural reforms have acquired somewhat a bad taste, but are still necessary. And they can work, as shown in this recent Economic Policy paper. And as we have learned from the German experience, accompanying such reforms with fiscal loosening can be helpful and it is here that flexibility from the European Commission is called for. Which leaves us with the sovereign overindebtedness and NPL overhang. For both, solutions have been proposed, for the sovereign overindebtedness as well as the NPL problem. None of these are politically easy to achieve as it involves painful political compromises on the European level and might not be easy to sell in any of the debtor or creditor countries. But it might turn out the only viable option. And it will require political leadership!
Finally, all this doomsday talk might be seen as yet another “crying wolf” by overconcerned economists. But even if Italy and the Eurozone might somehow muddle through this “situation”, the structural problems of the Eurozone architecture continue – and will come to light during the next political shock!
8. June 2018
Basel III – unintended consequences for emerging markets
As previously mentioned I am co-chairing a task force on “Unintended Consequences of Basel III in Emerging Markets”, together with Liliana Rojas-Suarez from the Center for Global Development (CGD). We have now finalized the first part of this project, producing a document that lists different unintended consequences drawing on the expertise of the very diverse task force, as well as analysis and data where available. Liliana and I have published the main findings in the form of blogs on the CGD web-site. In the following the punch lines of these five blogs, with respective links:
In addition, the process of implementation of Basel III in global banks might bring about several unanticipated, adverse consequences to financial stability in the countries that host subsidiaries from global banks, including the potential decreased role of global banks in local government bond markets.
While the immediate and direct effects of implementing Basel III regulatory reforms in emerging markets and developing economies are in these countries’ banking systems, there might also be effects beyond them on other segments of the financial system, including risk management and capital market development.
23. May 2018
Bitcoin, blockchain and the future of money
While not my area of research, over the past few weeks, I have kept “running” into this topic on and off. First, and really unexpected, when I invited Ecobank’s London office head Tedd George to talk about Pan-African banking to my MBA class on International Financial Management. His presentation focused on the usefulness of Blockchain to enable Pan-African platforms, including a new platform within Ecobank for payments across the 33 countries on the continent where it is active. One interesting side benefit is that such transactions no longer have to through correspondent banking and US dollar accounts, which lowers the burden of KYC.
Second, I was asked to give a presentation to the Economics Society at the City of London Boys School – not an academic talk, but more focused on putting Bitcoin in the overall debate on money and currencies and making clear that students understand the critical difference between Bitcoin (for me, the 21st century version of Tulip mania) and Blockchain as decentralized and secure platform. As expected, while I could teach the 6th form students something on economics (well, I have a 30 years head start) there were several student who were lightyears ahead of me when it came to knowledge on the technical aspects of bitcoin and blockchain.
Finally, a conference on cryptocurrencies and central banking in Kuala Lumpur, this time from the central banks and regulators’ viewpoint. There was a clear consensus that the current generation of cryptocurrencies such as Bitcoin do not fulfil the functions of a currency (medium of exchange, unit of account, store of value), though future versions that are either issued by central banks or linked to such a central bank backed currency might very well. But is the current generation of cryptocurrencies a threat to financial stability? No, as currently they are not linked back to the financial system.
In summary, blockchain and the idea of encrypted, decentralized payment systems are an exciting idea (and while Blockchain seems to be rather slow, new and quicker systems are being developed I have been told). While the current generations of cryptocurrencies seem to be purely speculative asset classes, the underlying concept is an interesting and an area to be watched.
Some additional links:
Great and concise recent Vox column on this topic: https://voxeu.org/article/making-some-sense-cryptocurrencies
A BIS piece on cryptocurrencies, which provides a great framework for understanding different forms of money: https://www.bis.org/publ/qtrpdf/r_qt1709f.htm
10. May 2018