Thursday, May 24, 2012

The Misunderstood Monetary Union

One of the fields where mainstream economics is unable to match history and current events is in its applications to monetary unions. Much has been said for example about the Eurozone these days that is not only wrong but that is so evidently "selectively forgotten" when applied to equally imperfect currency areas such as China, Brazil and even the US. Berka, Deveraux and Engel provide more evidence on how clueless pop economists have been:
"It is often suggested that currency unions unduly inhibit the efficient adjustment of real exchange rates. Recently, this has been seen as a key failure of the Eurozone. This paper presents evidence that throws doubt on this conclusion. Our evidence suggests that real exchange rate movement within the Eurozone was at least as compatible with efficient adjustment as the behavior of real exchange rates for the floating rate countries outside the Eurozone. This interpretation is consistent with a model in which nominal exchange rate movements give rise to persistent deviations from the law of one price in traded goods."

Wednesday, May 16, 2012

Guy Sorman on the Political Throwback into the Sixties

Guy Sorman, less optimistic than usual, discusses the French election in the context of political trends in Europe and, I would add, in the rest of the world too:
In other words, Hollande will try to entice other European leaders with a vision for a world that no longer exists. This politics of nostalgia is troubling, not only because France and Europe confront severe economic challenges, but also because France and other democracies are confronted with real challenges to their legitimacy.

Monday, May 14, 2012

Too Big to Fail and Moral Hazard

JP Morgan gambles with other people's money because it's sure that it's "too big to fail," meaning, that governments will come to its rescue whenever needed.

Those who yet believe that moral hazard in banking is not important or does not even exist should listen to James Hamilton:
In any case, we would want to weigh any potential social benefits of such trades against their possible social costs. Is JP Morgan "too big to fail"? I think so...
If nothing else, this week's news should remind us that more needs to be done to ensure financial stability and that the incentives of private participants align with the public's best interests.

Thursday, May 3, 2012

John Taylor on the Folly of QE

Excellent interview with John Taylor where he uses plain old good sense to explain how the foolishness of current monetary policies will cost us dearly later:
You don't believe purchases by the Fed have any long-lasting influence?

Let's suppose something even more misguided: For QE3, the Fed decides to buy the stock of publicly traded companies in order to lift stock prices. Equity prices would rise. But how long could that last, unless the earnings of these companies rise proportionately? Price-earnings ratios would become unsustainably high, and the market would soon correct for the Fed's aberrational influence. The same dynamics work for the bond market.

Apart from not helping, quantitative easing has also hurt?

Speaking of the stock market, notice that stock prices have become sensitive to whether or not the Fed will implement QE3. I see no reliable relationship between equity prices and quantitative easing, but the fact that many people believe in it is at least a source of concern. Another important concern is just how the Fed will manage to sell off all the mortgage-backed securities and medium-term government bonds it now holds on its balance sheet without causing disruptions in the market.