Wednesday 3 July 2013

The NZAE conference - Maurice Obstfeld's excellent keynote speech

This morning's presentation, "Finance at Center Stage: lessons from the Euro Crisis", by Maurice Obstfeld from the University of California, Berkeley, more than maintained the recent track record of the NZ Association of Economists in attracting the global leaders of the profession to address our local conference. And full marks to the Reserve Bank, Treasury, Statistics New Zealand and the University of Auckland Business School in providing the sponsorship that made this happen.

Obstfeld's presentation isn't up on the NZAE website yet, but when it is, give it a go. There is a lot being learned, the hard way, about the links between macroeconomics and finance, and his speech brings you to the latest thinking on financial sources of macroeconomic instability and possible responses.

The key takeaway, for me, was that the Eurozone authorities face a trilemma akin to Milton Friedman's old formulation (you can have only two off a three-item menu, where the choices are the interest rate you'd like, the exchange rate you'd like, and the balance of payments capital flows you'd like). Any two determine the third, which you're stuck with.

Obstfeld (and others he cited) have cited a similar trilemma, or even quadrillema if there is such a thing, for the Eurozone authorities, where the choices include the likes of monetary policy independence, fiscal policy independence, local financial oversight, and Eurozone financial stability. You can have some of these, and have to live with the necessary implications for the others, but Obstfeld also argued that Europe hasn't even managed to nail down the choices it can influence. It left you with a queasy feeling that the Eurozone could yet lay an even larger egg than the ones already laid by the PIIGS (Portugal, Ireland, Italy, Greece, Spain).

There were some specific points I found especially interesting, and I'll elaborate a little more on them when I can put up Obstfeld's graphs, but here they are for now.

One, the Eurozone (like many other parts of the world in the early to mid 2000s) had large and in some cases clearly unsustainable booms in house prices. Most of these unwound messily afterwards, with two main exceptions thus far - France, and Belgium. It's true that the underlying demand/supply dynamics of the French market, in particular, mean that more of the French house price bubble is due to genuine fundamentals (the ongoing attraction for many people of Paris as a place to live, set against severe constraints on new supply) and less to the musical chairs buying frenzy that occurs when monetary policy is too lax for too long. But you are still left with the uneasy feeling that the French banks' housing-related assets may not scrub up too well as events play out.

Two, and while this isn't new news, Obstfeld documented it well, the PIIGS have had very mixed results at getting their competitiveness (which had deteriorated badly in the years up to the recent Eurozone problems) back into fighting trim. Ireland is the outstanding example of achieving results, through outright cuts in public sector pay and social welfare benefits, for example. The others are showing decidedly mixed outcomes, ranging from ineffective execution to unwillingness to execute in the first place. In passing, I think Obstfeld was a bit kind to pre-crisis Ireland, in that he said that their fiscal stance pre-GFC was respectable, when it wasn't on a cyclically adjusted basis. The headline Irish fiscal numbers had been flattered by the tax take of the 'Celtic Tiger' years: in structural reality, they were a mess.

You're left with the feeling that Eurozone banking and debt issues haven't yet reached the endgame, and Obstfeld argued that you probably won't be able to feel comfortable about an eventually happy outcome until you see some genuine centralised Eurozone institution with the authority to wade into problem banks and with the funds to enable it to take on the role effectively. That's still not on the political horizon: Obstfeld cited a recent column in the FT (I'm pretty sure it's this one) that the sums supposedly available currently (60 billion Euros) are a tiny fraction of the potential capital losses to be met.

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