By Rok Spruk, on May 13th, 2010
The $140 billion rescue package to Greece is a milestone in the European Monetary Union. A lively debate on recent macroeconomic imbalances in the weakest economies of the Euroarea – Greece, Italy, Spain and Portugal – in the Eurozone has reopened the old debate on whether the Eurozone is an optimum currency areas (here, here, here and here). The idea of optimum currency areas was first proposed by Nobel-winning economist Robert Mundell. In general, if several countries form a currency union, they should have at least four common macroeconomic features as essential framework of the currency union. In this article, I’ll review the labor market criteria and fiscal adjustment criteria in the light of a recent imbalances in the Euroarea, and leave production diversification and export criteria for future discussion.
First, there should be a high degree of labor mobility between countries in the currency union. The basic idea behind the labor mobility criteria is that the lack of labor mobility triggers divergence of productivity growth rates and asymmetric adjustment of wages. If inter-country productivity divergence persists, there is an upward pressure on wages adjustment given the lack of exchange rate adjustment since the countries share a common monetary policy. The formation of the currency union in the United States was relatively straightforward given the fact that labor mobility between the states is very high. In Europe, the level of labor mobility is relatively low. The lack of labor mobility has a lot to do with labor market institutions in European countries. Workers from the European periphery can hardly move to Germany, Netherlands or Denmark as they do not speak the same language. The lack of inter-country mobility resulted in significant wage premiums and rise in rents since European labor markets share a pretty high degree of monopoly power since European workers can’t switch easily between labor market structure. The resulting outcome of the lack of labor market competition was a significant “union capture” of the labor market, leading to rigid wage determination and high market switching costs.
Paul Krugman recently argued (link) that the major problem behind the European Monetary Union is the lack of common fiscal policy. To a very large extent, the absence of common fiscal policy seriously affects the future prospects of the European Monetary Union. Common fiscal policy could easily absorb asymmetric shocks withing the Euroarea. However, instituting the policy could not alter the trade-off between fiscal autonomy and asymmetric shock intensity. In other words, the main problem of the Euroarea right now is the free-riding of Eurozone’s most problematic countries on a common monetary policy using disrectionary fiscal policy. Before the economic crisis, Spain had a budget deficit while, at the moment, the 2010 budget deficit forecast is more than 8 percent of the GDP. The estimate Greece’s balooning public debt in 2009 ranges from 110 to 115 percent, depending on the consensus forecast. If the EMU countries unified a fiscal policy, the countries would not have an incentive to free-ride on discretionary fiscal policy and further increase the stock of public debt. The major impediment on the recovery and long-term economic outlook of Eurozone countries is largely dependent on how these countries will reform the pension systems in the light of a growing old-age dependence and a near fiscal insolvency of the pay-as-you-go (PAYG) pension schemes. It will be impossible to reverse the aging population and its persistent pressure on an increasing public debt. The integration of fiscal policy would require a sizeable harmonization of taxes given high costs of coordination and sufficient incentives for moral hazard. Without the reversion of long-term public debt pressure from aging, discretionary spending and entitlements, countries such as Greece, Spain and Portugal would leave the Eurozone.
By B.P.T., on May 13th, 2010
At 8:30 AM EDT, the U.S. government will release its weekly Jobless Claims report. The consensus is that there were 440,000 new jobless claims last week, which would be slightly less than the number reported last week, and would continue the trend of slightly improving employment statistics.
Also at 8:30 AM EDT, the monthly Import and Export Prices index for April will be released, providing some data that can be used to monitor the threat of inflation.
At 10:00 AM EDT, the weekly Energy Information Administration Natural Gas Report will be released, giving an update on natural gas inventories in the United States.
At 12:30 PM EDT, Federal Reserve Chairman Ben Bernanke will speak at the Philadelphia Federal Reserve Bank’s conference on community development withDeputy Chairman Jeremy Nowak.
At 4:30 PM EDT, the Federal Reserve will release its Money Supply report, showing the amount of liquidity available in the U.S. economy.
Also at 4:30 PM EDT, the Federal Reserve will release its Balance Sheet report, showing the amount of liquidity the Fed has injected into the economy by adding or removing reserves.
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By Ajay Shah, on May 12th, 2010
Israel graduated into OECD. Theirs is an interesting saga.
In 1977, they liberalised the capital account, and got themselves into a mess. This opening of the capital account was then reversed.
In the 1990s, they got back to this issue, and by this time, the `impossible trinity’ was better understood. By 2003, all capital controls had been removed, alongside a shift to a floating exchange rate and inflation targeting. Capital outflows were liberalised as well, so their typical configuration involves large capital inflows alongside large capital outflows, which avoids one-way pressures on the exchange rate.
The next few `accession candidate countries’ for OECD are Estonia, Russia and Slovenia. Here is the list of existing members.
By Eldon Mast, on May 12th, 2010
Back in July 2009, Intel asserted that the young recovery of 2009 would be anything but lackluster.
On Tuesday, the leaders of the chip giant re-asserted their claims for 2010 and beyond.
Paul Otellini, Intel’s CEO, told analysts that its earnings per share and revenue should grow at an average annual rate in the “low double-digits” over the next few years. “We are on top of a growth engine,” Mr. Otellini said.
You may remember that last year — in the face of a global financial crisis — Intel chose to spend $7B in new U.S R&D facilities, while competition retrenched in the face of credit woes. Intel can now exploit those technological advantages and continue to deliver new products with much higher performance and lower power consumption. Otellini stated that those advances now drive the company’s products into a plethora of new devices such as cellphones, digital TVs, car electronics, cameras, and other consumer electronics.
“Intel has a unique set of attributes that no one can replicate,” Mr. Otellini said. “This stuff gets harder to do and we are going to get better at it.”
For Intel, it looks like 2010 (and perhaps 2011) will also be anything but lackluster.
By Ajay Shah, on May 12th, 2010
While everyone is pondering the ways in which Eurozone is not an optimal currency area, I found myself worrying about the ways in which Rupeezone is not an optimal currency area. In the Financial Express today, I have a column: Addressing the problems of Rupeezone.
Here are interesting materials on Greece which set the stage for this:
This is an interesting demo of economics happens today: an interleaving between journal articles, newspaper columns and blog posts.
By B.P.T., on May 12th, 2010
The Mortgage Bankers’ purchase index was released at 7:00 AM EDT, and there was a week to week decrease of 9.5% last week, since the second financial stimulus program for home sales came to a close in the previous week.
At 8:30 AM EDT, the International Trade report for March will be released. The consensus is a deficit of $41 billion, which would be a increase of $1.3 billion over February. The expected increase in the trade gap is being attributed to higher oil prices.
At 10:30 AM EDT, the weekly Energy Information Administration Petroleum Status Report will be released, giving investors an update after a volatile week for oil prices.
At 2:00 PM EDT, the Treasury budget for April will be released. The consensus is a deficit of $40 billion, after a deficit of $65.4 billion in March due to spending on stimulus projects and TARP outlays. Historically, the U.S. Treasury runs a surplus in April.
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By Bron Suchecki, on May 11th, 2010
Extract from Gold Standards and the Real Bills Doctrine in U.S. Monetary Policy by Richard Timberlake. The references to “Bernanke 1993″ are to Ben Bernanke’s 1993 article “The World on a Cross of Gold” in the Journal of Monetary Economics.
Ben Bernanke, in a laudatory review of Golden Fetters, agrees with its main thesis. “Eichengreen,” Bernanke states, “has made the case that the international gold standard, as reconstituted following World War I, played a central role in the initiation and propagation of the worldwide slump” (Bernanke 1993, 252). “In this masterful new book,” he notes approvingly, “Barry Eichengreen has gone well beyond his previous work to marshal a powerful indictment of the interwar gold standard, and of the political leaders and economic policy-makers who allowed themselves to be bound by golden fetters while the world economy collapsed.” The United States, especially, absorbed and sterilized gold, “largely reflecting conscious Federal Reserve policy. . . . Monetary policy became tight in the U.S. in 1928. . . . High returns on both bonds and stocks attracted gold into the U.S., but the Fed, intent on its domestic policy goals, sterilized the inflows” (Bernanke 1993, 253-258).
Bernanke’s words, much like Temin’s and Eichengreen’s, contradict his argument. If central banks could absorb and sterilize gold, “reflecting conscious Federal Reserve policy,” the central bank, not the gold standard, was running the show.
…
Bernanke finally poses a very apt question that he leaves unanswered. “Why was there such a sharp contrast between the stability of the gold standard regime of the classical, pre-World War I period and the extreme instability associated with the interwar gold standard?” (Bernanke 1993, 261).
Here are two commentaries that may help answer his question. The first is from Lionel D. Edie, a prominent economist of the time. At a conference of economists in early 1932, he stated,
The Federal Reserve Act cut the tie which binds the gold reserve directly to the credit [money] volume, and by so doing automatically cut off the basic function of the gold standard . . . in an essential respect we abandoned [the automatic money supply function] some time ago. . . . We are not now on the gold standard . . . and we have not been for some time . . . it is time to recognize that the Federal Reserve mechanism does not constitute an automatic self-corrective device for perpetuating a gold standard. (Edie1932, 119-128)
And Leland Yeager in 1966 described the “gold standard” of the 1920s in these words:
The gold standard of the late 1920s was hardly more than a façade. It involved extreme measures to economize on gold. . . . It involved the neutralization or offsetting of international influences on domestic money supplies, incomes, and prices. Gold standard methods of balance of payments equilibrium were largely destroyed and were not replaced by any alternative. . . . With both the price and income and the exchange-rate mechanisms of balance of payments adjustment out of operation, disequilibriums were accumulated or merely palliated, not continuously corrected. (Yeager 1966, 290)
These commentaries provide the answer to Bernanke: “The” interwar gold standard was not a gold standard. It was an entirely different system than the pre-1914 gold standard that had existed for 100 years.
Also quoted in the article is the following from Joseph Schumpeter’s 1954 History of Economic Analysis:
An ‘automatic’ gold currency is part and parcel of a laissezfaire and free-trade economy. It links every nation’s money rates and price levels with the money-rates and price levels of all the other nations that are ‘on gold.’ It is extremely sensitive to government expenditure and even to attitudes or policies that do not involve expenditure directly, for example, to foreign policy, to certain policies of taxation, and, in general, to precisely all those policies that violate the principles of [classical] liberalism. This is the reason why gold is so unpopular now [1950] and also why it was so popular in a bourgeois era. It imposes restrictions upon governments or bureaucracies that are much more powerful than is parliamentary criticism. It is both the badge and the guarantee of bourgeois freedom—of freedom not simply of the bourgeois interest, but of freedom in the bourgeois sense. From this standpoint a man may quite rationally fight for it, even if fully convinced of the validity of all that has ever been urged against it on economic grounds. From the standpoint of etatisme and planning, a man may not less rationally condemn it, even if fully convinced of the validity of all that has ever been urged for it on economic grounds. 
By Eldon Mast, on May 11th, 2010
“The message has gotten through: the euro zone will defend its money,” French Finance Minister Christine Lagarde told reporters in Brussels early Monday.
With massive resolve after a 14 hour meeting, 16 euro nations agreed to offer financial assistance worth as much as 750 billion euros ($962 billion) to countries under attack from speculators. The European Central Bank (ECB) will counter negative and “severe tensions” in “certain” markets by purchasing government and private debt.
Marco Annunziata, chief economist at UniCredit Group in London, quickly released a statement following the ECB announcement: “This truly should be more than sufficient to stabilize markets in the near term, prevent panic and contain the risk of contagion.”
“I think they will have bought themselves a significant amount of time to do the right thing,” said Barry Eichengreen, an economics professor at the University of California, Berkeley.
“This sets a precedent for the rest of the life of the Central Bank and will have likely surprised even the most seasoned observers,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland Group. “The ECB’s intervention was necessary to short circuit the negative feedback loop…”
The swift and united action will likely now turn most eyes back onto the fundamentals of a worldwide economic recovery that is accelerating.
By B.P.T., on May 11th, 2010
At 7:45 AM EDT, the weekly ICSC-Goldman Store Sales report will be released, giving an update on the health of the consumer through this analysis of retail sales.
At 8:55 AM EDT, the weekly Redbook report will be released, giving us more information about consumer spending.
At 10:00 AM EDT, the Wholesale Trade report will be released for March, showing inventory levels for wholesalers in the United States.
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By Winton Bates, on May 10th, 2010
I have been a supporter of resource rent taxes for as long as I can remember. More precisely, my view has been that taxes on rents are better than most other taxes because they extract funds with minimal distortion to production and investment decisions.
I think the best way to think your way around the question of resource rent taxes is to imagine initially that you are the sovereign of a territory in which there has been no previous mining or exploration. You want to obtain revenue from the minerals in your territory by the inducing mining firms to use their expertise to explore and to mine.
One way of obtaining revenue from minerals is to auction off mining rights and promise mining companies that there will be no further taxes on the minerals they find. A major problem with such a ‘finders keepers’ policy is that on the basis of past experience mining firms have good reason to be skeptical that sovereigns will keep their promises to let them keep what they find. When valuable resources are found sovereigns (and democratic governments) have a habit of changing their minds and wanting more revenue. As a consequence of this ‘sovereign risk’, mining companies are not likely to be willing to pay anything like what an exploration lease would be worth to them if they could believe the sovereign’s promise of finder’s keepers.
Another way that governments can obtain revenue from minerals is through a system of royalty payments based on the volume or value of minerals extracted. This is like imposing an additional cost on mining activities and can deter mining that would otherwise be commercially viable.
By contrast, under a well-designed resource rent tax the sovereign is, in effect, a silent partner in the venture. The sovereign shares in the rents and risks of the project without distorting investment and production decisions in the process.
So far so good, but Australia is not a country in which there has been no previous mining or exploration. There is currently a great deal of mining being undertaken in this country under long-established systems in which state governments obtain revenue from royalties. In that situation it becomes important to consider how to make the transition from royalty payments systems to a resource rent tax without disturbing the reasonable expectations of miners of rewards that they are entitled to receive for the risks that they have taken. If the transition to a new tax is used by the government to grab a larger slice of rents from successful mines, the miners are likely to perceive that they have under-estimated sovereign risk in this country. They will also perceive that there is a chance that the rate of resource rent tax could be increased in future, particularly if there are further increases in mineral prices. If they factor that into their calculations of expected returns they will reduce their investment in further exploration and new mines – even if the structure of the new tax minimizes disincentives to investment.
As is well known, the Australian Government has recently announced the introduction of a resource rent tax and its intention to grab a substantial additional slice of mining profits on top of revenue raised from existing mining royalties. The main source of this sovereign risk, Kevin Rudd, has defended the tax grab on the grounds that ‘what we are doing is to recover national sovereignty over our own resources’. Actually, I must confess that I don’t think Mr Rudd has actually used those words. Those words were used by Hugo Chavez, president of Venezuela. As far as I can see, however, the main difference is that Hugo is less verbose than Kevin. Here is what Kevin Rudd has been saying:
‘Over the last decade the mining companies generated $80 billion in higher profits. At the same time governments, on behalf of the Australian people, received only an additional $9 billion over that period of time. What we’re saying is that the mining companies deserve a fair return on their investment – that’s important – but we also believe the Australian people deserve a fair return on the resources which they themselves own, and remember, these companies- you mention in your introduction BHP and Rio. BHP’s 40 percent foreign owned. Rio Tinto’s more than 70 percent foreign owned. That means these massively increased profits, the $80 billion that I referred to before, built on Australian resources, are mostly in fact going overseas’ (Interview on AM, ABC radio, 3 May, 2010).
Why is the percentage of foreign ownership of BHP and Rio relevant to the issue of resource rent taxation? The unmistakeable message is that Kevin Rudd views foreign investors as fair game. Tax reform has become a cover for expropriation of rents from assets owned by foreigners. All we can hope is that the more sensible members of the Australian government will encourage second thoughts about the rate of resource rent tax that should be imposed – and urge Kevin to restrain his rhetoric – before too much harm is done to Australia’s reputation as a safe location for investment.
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