The General Theorist

With Chancellor Sunak offering new direction for the macroeconomy next week, some friends and I rose to the challenge in the March Budget that “it’s important that we update our fiscal framework to remain at the leading edge of international best practice.”

Link.

The paper is in two parts. The first recalls the traditional debt sustainability “rules” were evolved in the 1980s and 1990s in a period when theory relied on the assumption that i > g. This was reasonable then, but is unrealistic today for reasons noted recently.

Instead, we suggest the overall fiscal stance should lean on the OBR’s assessment of debt sustainability, relying on a projection of the overall interest rate paid on government debt relative to nominal growth. 

If the interest on government debt, taken from financial markets for future coupons, is below the projected nominal growth rate, then fiscal “consolidation” can be moderated. But if the average interest rate drifts higher, the primary balance would have to adjust.

Armed with this “independent” analysis, the overall fiscal envelope would therefore be determined and within which the government would function. 

The second part of the paper examines historical cases where the UK faced seemingly insurmountable debt burdens. It suggest that we have been here before, and there is no need to panic.

In other words, the fiscal rule needs to be modified to the needs to private saving, and not pre-empt some unlikely debt crisis that exists only in the minds of politicans.

There are a number of curious similarities between Nigeria’s macroeconomic challenge and Argentina’s only a few years ago—making it a subject of additional interest to those familiar with the latter’s experience.

First, the Central Bank of Nigeria (CBN) has been propping up gross international reserves by borrowing from abroad—whereas in Argentina Lebacs were sought by non-residents for their yield in 2017/18, artificially driving up reserve assets, in Nigeria of late, according to the IMF, “almost half of [international reserves] were the counterpart of short-term naira debt issued to non-residents at high rates by the Central Bank of Nigeria.” International reserves of around USD37bn is only 50% of the IMF’s reserve adequacy metric (¶2), also comparable with Argentina. But since USD14.8bn of these reserves at end-Dec owe their existence to non-resident short-term claims, reserve adequacy is further compromised—although these non-resident claims had fallen nearly in half by end-March. Continue reading “Nigeria and the IMF”

Amongst several others, Bolivia recently requested and received 100% of quota purchase—that is, “loan”—from the IMF’s Rapid Financing Instrument* (RFI) to provide budget support in the aftermath of the COVID-19 Crisis. This is about SDR240 million—USD327 million (0.8% of GDP)—due to be repurchased between 2023 and 2025. With interest payments of about USD3½ million per year (around 1% rate) this is an important source of financial support at an exceptional time.

Glancing through the Staff Report, a number of observations stand out. Continue reading “Bolivia and the IMF’s Rapid Financing Instrument”

To give President Lagarde substantial credit, since her “close the spreads” gaff on March 12^th she has acted aggressively and proactively to support euroarea asset prices while working to persuade fiscal policymakers of the urgent need to find a unified response to a common shock. The Franco-German Recovery Fund proposal initiated the hopes for an ambitious EU budget, including a borrowing instrument, reflected in the Commission’s proposal last week. And today Lagarde hit the monetary sweet spot with a policy announcement that both supported peripheral assets and—in a nod to improved euro area prospects more generally—helped push the euro higher.

The central message from today’s meeting can be found in ECB staff revised forecasts. To be precise, these were joint forecast by the Eurosystem and ECB staff, who now predict a post-COVID recovery which leaves the level of real GDP by 2022 substantially below that expected in March and still below the 2019 level. There will be a recovery, but this will be far from v shaped. Continue reading “Proportionately Lagarde”

The tenth anniversary of the Troika’s intervention in Greece passed barely noticed amidst the COVID-19 tragedy. It was May 2010 when the Greek program was agreed—initially for EUR110bn, including financing from the IMF and EU. The occasion ought not pass without comment, however. In fact, today’s Coronavirus challenge demands an honest reflection upon failings past. The international monetary system is creaking under the virus, and a thoughtful response by the international community is needed to avoid unnecessary damage. We cannot afford politically-influenced rather than analytically-driven responses. To this end, casting a critical eye on the work of the IMF is more important than ever before. Continue reading “The IMF and the crucifixion of the Greeks”

Argentina’s reliance on persistent monetary financing of the fiscal deficit continues despite obvious deleterious consequences, reminiscent of the Einstein’s notion that “the definition of insanity is doing the same thing over and over and expecting different results.”

Reflecting upon the plan initiated by the incoming Macri administration in 2015, former BCRA Governor Federico Sturzenegger recently explained how the “speed of disinflation … was constrained by the fact that it was agreed that part of the fiscal deficit would be monetized in order to diminish the need of debt financing during the transition to a healthier fiscal result…” And this could not be sterilized owing to the “weakness” of the BCRA balance sheet. Continue reading “Monetary madness in the Pampas”

All national central banks (NCBs) within the Eurosystem are equal. But one is substantially more equal than the rest.

Indeed, Deutsche Bundesbank (Buba) plays at least three unique roles in the structure and evolution of the Eurosystem: (i) in the creation of currency in circulation—that is, physical euro cash-in-hand; (ii) as reservoir for surplus claims of non-euroarea reserve managers—that is, as a substitute for Bunds when global safe assets run short; and (iii) as final destination, particularly in periods of stress, for excess liquidity created across the euroarea. Continue reading “Three Unique Roles of the Bundesbank within the Eurosystem”

Not quite the fireworks of March, the Bank of Italy balance sheet in April nevertheless provides a puzzle for understanding the pace of ECB asset purchases and the support for BTPs throughout the month.

The table below updates a decomposition on the change in TARGET2 balance used last month. The only difference being the change in currency in circulation has been improved to fully reflect Italy’s share in total flows for the month. The March numbers have been adjusted also. Continue reading “Banca d’Italia balance sheet: April 2020”

What a mess.

Today’s ruling by the German Constitutional Court (GCC), or Bundesverfassungsgersicht—even the name sits like some poison on the tongue—resembles a fishing exhibition to find some technicality to trip up the ECB’s public sector purchase program (PSPP).

Indeed, it feels like a marginal offside decision taken by the recently instituted Video Assistant Referee (VAR) in Association Football (aka Soccer). Though part of the striker’s shoulder had indeed drifted beyond the defender, it was a perfectly timed and bended run. The striker’s feet were clearly onside. Is it the offside rule that needs changing? Or should VAR be disbanded?

To wit, GCC couldn’t quite find anything wrong on ECB monetary financing or decisions potentially encroaching on the budgetary responsibility of Bundestag—crucial as these are. They instead picked holes in the “principle of proportionality”—the idea that EU institutions should only take necessary action within their remit, and not exceed their respective powers. More on this shortly. Continue reading “The German Constitutional Court ruling, the ECB, and the offside rule”