Home > crisis, RWER > The Pope, Vernengo and Pérez-Caldentey Discussion

The Pope, Vernengo and Pérez-Caldentey Discussion

from Robin Pope,  Matías Vernengo and Esteban Pérez-Caldentey

Below is an extremely interesting exchange between the authors of two papers in the current issue of the Real-World Economics Review.

Matías Vernengo and Esteban Pérez-Caldentey, “The euro imbalances and financial deregulation: A post-Keynesian interpretation of the European debt crisis” http://paecon.net/PAEReview/issue59/VernengoPerez59.pdf

and

Robin Pope,  “Public debt tipping point studies ignore how exchange rate changes may create a financial meltdown” (co-author Reinhard Selten) http://paecon.net/PAEReview/issue59/PopeSelten59.pdf 

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Here is an exchange on the paper, “The euro imbalances and financial deregulation: A post-Keynesian interpretation of the European debt crisis”

Robin, Matías, Esteban Interchange, collated 9th May 2012
order:
1) Robin comments on Matías and Esteban’s RWER article and relatedly adds a 2nd comment on Trond Andresen’s RWER article
2) Matías responds
3) Robin rejoinders
4) Esteban objects to austerity
5) Robin agrees austerity is the wrong policy
6) Esteban objects to austerity for Spain
7) Robin makes concrete for Spain the non-austerity proposal presented in her joint RWER Tipping Points paper with Reinhard Selten
8) Esteban objects to Robin highlighting a basic similarity in the modeling of him and Matías with that of Ken Rogoff
9) Robin is intransigent
10) Esteban sees the problem as external trade imbalances
11) Robin models with reverse causation to Esteban and Matías and Ken Rogoff – sees the problem as bubble finance causing unhealthy trade imbalance
12) Esteban holds by the current account imbalance as the causal direction
13) Robin grants that there is some two-way causation
14) Esteban sees a deficit balance of payments as a constraint
15) Robin sees no hard constraints
16) Robin beckons RWER readers to her and Reinhard Selten’s verdict in favour the imperfect euro and the dangers of not shifting to an imperfect single world currency
17) Esteban argues for making the euro feasible
18) Robin argues for the euro already being feasible
19) Matías and Esteban’s 4-point Position Summary with Robin’s responses

1 Robin Pope
In their RWER paper on Euro c, Matías Vernengo, Esteban Pérez-Caldentey propose that non-core Eurozone countries need a “real depreciation” to compensate for Germany having implemented after the introduction of the euro, a “real depreciation … [which was a] “beggar thy neighbour” policy. The words in quotation marks are from page 90 of their paper, but the point is also in their abstract, on p84, and in their conclusion on p99. Trond Andresen makes the more extreme proposal that countries like Greece and Ireland would benefit from getting this depreciation by exiting the euro, I disagree with both proposals. In explaining why, I end with a critique of Matías Vernengo’s and Esteban Pérez-Caldentey use of a close relative of the old guard IMF exchange rate model. Matías and Esteban’s model is a vast improvement on the old guard IMF model in three respects; 1) it recognises the need for fiscal stimuli in a time of high unemployment; 2) it seeks changes cooperatively within the euro, not by nationalistic isolationism of quitting the euro to acquire a national currency; and 3) highlights that financial deregulation is dangerous, citing for instance how major German banks had increased to a leverage of 40 by 2007. These three features render their paper illuminating.
My critique below concerns primarily a fourth feature of Matías and Esteban’s, a depreciation panacea feature that it shares with numerous economic models, including that of old guard IMFers and that is currently widely promulgated by ex IMFer Ken Rogoff in his 2012 blogs. My critique seeks to entice you, Matías and Esteban and the extensive number of other economists and non-economists who employ this fourth feature, that it is empirically false. It is so aggregative it is internally inconsistent. It precludes trade – it implies no imports, no exports, no “imbalances” to scapegoat and accuse of having caused the crisis. It is internally inconsistent since trade is assumed to exist, and assumed to avoid “imbalances” whenever exports = imports). Use of this internally inconsistent feature 4, diverts policy from what is needed. It diverts policy from A) the danger of an exchange rate global meltdown and B) engineering the needed transfer of resources out of the bubble finance/construction sector – that caused the current tragedy – into socially productive employment activities, as warned by me and Reinhard Selten in our RWER Tipping points paper. This misleading feature 4 moreover, with its simplistic objective, exports = imports, results in Matías and Esteban treating capital inflows as automatically bad. Matías and Esteban fail to discriminate between capital inflows fuelling destructive bubble activities, and those enabling communally welfare enhancing activities as regards both borrowing and lending countries. Such communally enhancing investments as can be facilitated through the anti-bubble regulatory measures recommended by me and Reinhard Selten in our RWER Tipping Points paper.
Before detailing what is wrong with Matías and Esteban’s particular variant of the depreciation panacea, I critique one of its more extreme versions, that of Trond Andresen who seeks to use parallel monies to break up the euro. The existing community monies and credits mentioned in my 17th April comment beneficially counter-cyclically complement official currency. Some, such as the Swiss WIR, in downturns provide small and medium sized businesses with working capital when the monetary authorities fail to entice or force the commercial banks to do enough lending. Such parallel financial instruments thereby complement (improve) the effects of the official currency. By contrast, pointing me to his blogs on http://www.guardian.co.uk/business/2012/apr/03/wolfson-prize-shortlist-eurozone-breakup, Trond Andresen emails me on April 19 that he has been advocating parallel currencies in the belief that parallel currencies would achieve his aim of destroying an official currency, the euro. In his email to me, however, he mentions his desire to think the matter over. I entice him to reverse his aim as below.
A case for preserving the euro, indeed a case for moving to a single world currency, is made by me and Reinhard Selten in our Tipping Points paper in this current RWER issue. In sections 3 and 4, on pages 7-15, we identify six fallacies in the view that national currencies and thus exchange rate changes are harmless or neutral, and give six examples of the awful wreckage wrought by exchange rate changes. More examples, including entire nations wrecked by exchange rate changes, are supplied in the above Guardian blog by Joe McCann who provides exceptional insight on the costs to capital and trade flows of instituting or re-instituting national currencies. I thus recommend the blog to all RWER readers.
Only one of Joe McCann’s points in his 31 page long interchange with anti-euro commentators seems to me too brief and warrants elaboration here. This is Joe McCann’s elliptical response to Trond Andresen’s opinion that Britain did better by having depreciated and not being in the Euro. Perhaps because Trond Andresen had not said why he thought Britain had done better, Joe McCann simply replied that it is easy to say this with hindsight. A reason for hindsight to make it easy, is that an anti (or pro) euro person can selectively choose beginning and end-points of particular data, as we note in our RWER Tipping Points paper on pages 9-11. To illustrate, I just now googled for OECD real wages, and used the first site offered, http://www.oecd.org/document/22/0,3746,en_2649_33927_43221014_1_1_1_1,00.html. It has real wages for 2000 and 2010, beginning and end dates close to the euros first decade. Over that decade, inside the eurozone, average real wages rose by 26% in Ireland, by 12.5% in Greece, and by 9.5% in Portugal. For the UK outside that zone, over this same decade, average real wages rose only by 8.6%, “evidence” of the UK’s mistake. I could stop here, with my pro-euro point “proved”, or likely make it stronger, by locating non-finance sector median real wage data and showing how in the UK this growth was way less than in those euro countries. But the above is arbitrary hindsight bias, not solid evidence or proof that joining the euro would have been better for the UK. I could have selected readily other countries or data or end-points with hindsight, to proffer “evidence or “proof” of the reverse conclusion namely that the UK’s benefits in staying out of the euro.
Forming a meaningful appraisal of what Britain lost involves estimates of what the UK has lost and will lose from having its exchange rate unpredictable against the Eurozone to which it exports well over double of what it exports to the next biggest currency bloc, and from capital flows hazards as regards the Eurozone. The new guard line in the IMF (such Rupa Duttagupta et al 2010) that we cite in our RWER Tipping points paper, allows for some of the complexities of exchange rates, recognises the wasteful private sector financial bubble at the heart of current problems, and reaches the conclusion that a single world currency could aid in world macroeconomic management.
By contrast, some in the old guard of the IMF advocate even more currencies than at present, for example, former IMFer Ken Rogoff in his recent blog – http://globalpublicsquare.blogs.cnn.com/2012/04/04/rogoff-a-centerless-euro-cannot-hold/. Ken Rogoff, like Paul Krugman and Trond Andresen, offers the IMF depreciation advice of the 1980s and 1990s to troubled countries, and thus that joining the euro was a mistake for these countries. Matías Vernengo and Esteban Pérez-Caldentey offer this same depreciation remedy for non-core countries, though seek it to happen without breaking up the euro. They advocate the same depreciation remedy as Ken Rogoff, because they simplistically equate a depreciation (or a so-called real depreciation) with a change in relative wages. Thus Matías and Esteban argue, page 90 of their RWER paper on Euro Imbalances, that Germany engaged in a “real depreciation … [by means of] a beggar thy neighbour” policy of by letting its wages rise hardly at all in comparison to the big wage rises of non-core countries. Matías and Esteban propose that the solution to current troubles involves a reverse “real depreciation” for the likes of Greece and Ireland. They propose that this “real depreciation” be achieved by raising demand and thereby wages in Germany (and other core eurozone countries).
Such depreciation advice for countries like Greece and Ireland is based on an excessively simple, excessively aggregative, static Meadian/Mundellian model. It has an equilibrium of exports = imports. It sees no benefits from net capital inflows to the host country, not even from ones that are outright gifts – intercountry fiscal transfers – for productive activities like expanding the host country’s infrastructure. It instead assumes that all net capital flows are bad, destroying equilibrium.
This Meadian/Mundellian model treats the finance housing bubble that caused the problem as irrelevant to its solution, except insofar as it arose from borrowing from other countries. This Meadian/Mundellian model omits all uncertainty implications of a depreciation and analyses as if there is no depreciation risk premia escalating interest rates of the poor borrowing country, and as if there were only one traded good. Were this true, there would be no reason to trade, autarchy. But users of the simplistic model ignore this internal inconsistency.
Users of this simple, excessively aggregative, static Meadian/Mundellian model conclude that anything Germans make and export would be made by the likes of Greece and Ireland, if only Greek and Irish wages went down, or German wages went up. Now, it would be good for German wages to rise – to reduce the shameful growth in income inequality that Germany has experienced in the last ten years. But those Irish construction workers (in 2007 20% of the workforce) now unemployed by Ireland’s finance-construction bubble bursting never did the German apprenticeship training in machine tooling. These Irish cannot be employed in either Ireland or Germany to make the ultra high tech machine tools in which Germans specialise. Those Irish skilled in construction are in the tragic situation of a burst bubble of having acquired a skill in oversupply in western Europe. This is not a problem of relative wages soluble by lowering the wages of one group. It is a problem of one group having acquired skills no longer demanded after the bubble burst – the difficult problem of re-skilling adults.
The heart of the problem is thus the creation of massive private bubbles, whose damage to democracy and law and order is magnified by the gains from these destructive bubbles being highly concentrated, as highlighted by Edward Fullbrook in this issue of RWER. To economists taught that the benevolent frictionless neoclassical equilibrium is attained by removing government regulation, as discussed by Wilson Sy in this issue of RWER, there is a risk that to economists the bubbles remain invisible. The currently inadequate clean up from the financial bubble risks becoming a repeat of the failed attempted clean-up of the burst of the US-German financial bubble of the 1920s in the form of competitive depreciations and wars for employment stimuli, because of the overly simplistic ways economists are taught to analyse exchange rates and stay blind to private sector bubbles.
Our RWER Tipping Points paper alerts readers to incorporate into their analyses the two massive bubbles, still inadequately pricked, let alone dissolved, in the finance and prescription drugs industries. Helping troubled countries like Ireland and Greece thus involves helping them institute the government measures that we itemised in sections 3.1 and 6 to 9, pages 9-10 and 17-29: 1) an orderly elimination of the bubble components of the prescription drugs and finance industries, including lowering their salaries to match actual productivity, and so releasing resources into other communally beneficial sectors; 2) imposition of a wealth/finance tax to retrieve much of the income and wealth accumulated by a minute upper echelon – accumulated importantly from these wasteful bubbles; 3) collection of taxes illegally unpaid by the wealthy through government connivance in nearly every country, a connivance that creates government debt when over the last thirty years nearly all the income increase has gone to this non-tax paying upper echelon; and 4) introducing regulations to mitigate future bubbles in these sectors. Measures such as 1)-4) go to the heart of the problem facing not only Greece, but every democracy. In turn this means that the heart of the problem has nothing to do with the euro. Likewise the heart of the problem has nothing to do with fiscal redistribution, even if such redistribution within the euro zone can be highly desirable on other grounds, and moreover would be partially merely a pseudo redistribution in that it would aid the donors’ private sector firms who unwisely lent and invested in bubble activities in their troubled neighbours).
In summary, admit and deal with the bubbles and their associated concentration of wealth in the non-taxpaying upper echelon. Admit too exchange rate complexities and the costs of unpredictable exchange rate changes in the discerning manner, Matías Vernengo, that you did in your original thinking earlier about unpredictable interest rate hikes. In that anti old guard IMF Challenge article you perceptively diagnosed that unanticipatable world interest rate doubling of the early 1980s lay behind government debt burdens in that era, not profligate government projects. Be consistent, exchange rates gyrate even more than interest rates. Start imagining the havoc of exchange rate unpredictability that you would be visiting on those troubled countries if they really did take your advice and exited the euro. Start imagining that havoc by reading our and Jo McCann’s historical depreciation catastrophes. Then think how, through unpredictable depreciation risk premia, that exchange rate unpredictability will initiate unpredictable interest rate rises whose debt effects you discerningly presented in that Challenge article. Then consider the laboratory evidence we supply on how eliminating exchange rate change complexities improves a country’s government’s capacity to maintain international competitiveness in the face of shocks. This can render salient to you the economic benefits of shifting to a single world currency in reducing uncertainty in business and government planning problems and in international relations, as discussed on pages 28-29 in section 8.2 of our RWER Tipping Points paper.2 Matías Vernengo
First, I don’t think we say that Greece and Ireland should leave the euro, although it is clear that the way the euro is organized makes it impossible for those countries to develop. Our point in fact, is that if fiscal transfers or even simpler if the ECB bought bonds from peripheral countries, all could be solved. In the absence of a solution, the only alternative will be the collapse of the euro or the exit of some countries. Mind you as a student of Wynne Godley (a strong defender of Europe, but not the way the euro was organized), I am by no means in favor of destroying the European project. The last remark seems unfair to me. If you check our model (in the Levy Institute longer version of the paper) you will see that there is no PPP, or natural rate implicit in our model. I can’t possibly imagine how you reached that conclusion.
I don’t think that lumping me and Esteban with Rogoff and Krugman is very helpful. Our views are very different on a theoretical level. They work with models in which there is a tendency to full employment, and they view the problems of the euro, as being temporary caused by price and wage rigidities. Not us. We think in terms of demand driven growth and emphasize balance of payments constraints of peripheral countries, faced with the German Neomercantilist policies. However, if the euro is a straitjacket that does not allow for fiscal expansion, and if depreciation is not possible, the only solution will be contraction. I think that’s the only point of contact with all the critics of the ECB. The IMF, by the way, has pushed for more adjustment (fiscal tightening and lower wages, cum labor market flexibilization). You’ll be at pains to find anything like that in our paper.

3 Rejoinder of Robin Pope
I am glad, Matías, that you and Esteban, seek to preserve the euro. Your bottom line is that troubled Eurozone countries need what you term on page 90 a “real depreciation”, meaning a fall in their relative wages. This shared conclusion with Rogoff and Krugman arises because, despite important differences in your model from theirs, all three of your (implicit) models share the trait I delineated in my comment of 26th April – 1 good produced by homogeneous labour. That same good with the same sort of labour is produced in every country. To recognise this, note that your paper highlights country real wage differences and country-wide aggregate demand. These aggregate (country-wide) features would be irrelevant without your 1 good 1 skill type implicit model across every eurozone country. This aggregative approach has no finance sector.
By contrast, in our RWER tipping points Reinhard Selten and I disaggregate and can focus on what caused the crisis – the finance bubble, arguing that governments should institute incentives for resources to shift out of the bubbles into non bubble activity. In the 1930s and today price incentives for bankers are too much in the wrong direction. It took thirty years after the 1930-31 financial bubble burst (till 1950) for the price incentive of banker salary to fall to its non-bubble level. One does not speed this process up (of getting the desirable fall in banker salaries and rise in real sector salaries) by inflating every troubled country as you propose, or by deflating every troubled country as Claude Hillinger in his RWER paper proposes.
Reinhard Selten and I propose measures that really can speed it up. We propose forcing the deflation on the bubble (the finance construction sector in many countries) by measures such as tax collection on the wealthy and imposition of new wealth taxes, new regulations and government orchestrated downsizing of the overblown financial sector. We propose using these released resources to entice non-bubble private and public sector activities.
Reinhard Selten and I share your interest in governments fostering aggregate demand in this era of private sector deleveraging. But we emphasise that it ought to be engineered from disaggregate analysis to facilitate stimuli in socially productive job creation – to avoid jobless bubble aggregate demand growth (as was the US story this millennium up to the crash. To get such policy recommending stimuli in socially productive job creation therefore requires a disaggregate approach, lacking in your model.
We entice new modeling to include downsizing the cancerous bubbles in the finance and prescription drugs sectors, and diverting their jobs and capital into the socially productive activities. Accomplishing this diversion involves modeling tax revenue disaggregately– to include the scope to radically shifting tax revenues to the wealthy (who have paid essentially none over the last thirty years but grown too wealthy to have spent most of their untaxed gains). Such disaggregation as regards goods, labour and sources of tax revenue is required to admit that a bubble in a particular private sector caused the crisis, and to quit thinking that changing average relative wages is the solution. For these reasons, disaggregation is a major theme of Reinhard Selten and me in our RWER tipping points paper and in our extensive research, therein referenced, on how disaggregating overturns conclusions about exchange rates derived from simplistic models.
In summary, I find Matías (and Esteban) your analysis every bit as aggregative in these three senses, and thus beside the point, as those of Ken Rogoff and Paul Krugman. This is despite the fact that your modeling is decidedly more realistic than theirs in other respects. You are part of the problem that most economists, from the far right to the far left of the spectrum, are caught in the rut of aggregate output aggregate labour modeling of an economy – skipping for the sake of algebraic tractability the non-real financial sector and its bubbles plus the real sector bubbles, par excellence that in prescription drugs.

4 Esteban Pérez-Caldentey Opposing Austerity
As Matías points out, we never say in the article that Greece and Ireland would benefit from leaving the Euro (or even suggest that they should leave the Euro).
We implicitly argue that the EU should reform its Treaties and part of that is allowing greater flexibility and also coordinated expansionary policies. We argue like Keynes for an expansionary union not a contractionary union as is the case right now. So we believe that fiscal austerity is the wrong solution.

5 Robin Pope explains the non-Austerity thrust of Tipping Points
I agree Esteban with you and Matías that fiscal austerity when the private sector is deleveraging makes the situation worse. With this part of your paper I have no objection, instead wholehearted agreement. The euro’s Maastricht treaty embodied unwise constraints on government deficits and debt. But despite these unwise euro rules, leaving the euro and depreciating would be even worse. This is so even in the unfortunate case wherein Angela Merkel and other eurozone leaders fail to recognise that while the private sector deleverages from its finance sector bubble, government debt and deficit ratios need to rise. On this score Paul Krugman also is completely right in his verdict that now is a wrong time for virtually any country in the world to impose fiscal austerity.
I fear that the IMF demise of Strauss-Kahn may have diminished the influence of the new guard in the IMF that sees advantage in a single world money, but may have diminished also the influence of the new guard IMF expressing caution on austerity. We seem to be almost back to the old guard IMF practice of rescuing instead the lenders and refusing to admit that the lenders importantly create the recurrent bubbles and crises.
Reinhard Selten and I in our RWER Tipping Points paper advocate fiscal stimuli targeted to non-bubble activities, and coordinated with downsizing bubble components and collecting the bubble accumulated wealth in taxes. Countries are suffering badly in having gone on for 30 years with so much wealth going to an upper echelon that pays virtually no taxes and grows so wealthy as to damage law and order and democracy

6 Esteban Pérez-Caldentey Opposing Austerity for Spain
I am a national from Spain, and I have no idea how with an ongoing process of private sector deleveraging anyone in their right mind can argue that the solution is fiscal austerity. Unless a significant expansion in the external sector takes place, the austerity numbers don’t match. I am also very surprised that ministers of finance still don’t understand that the Debt to GDP is a ratio so that the increase in GDP is a possibility.

7 Robin Pope: Tipping Points applied to Spain
I feel for you Esteban. I should hate to be a Spaniard just now when in Spain there is such a phenomenal environmental destruction from almost a decade and a half of overbuilding. Spain is about as damaged as Ireland in terms of around 20% of its workers skilled only in construction. In Spain as elsewhere there is a lot of tappable upper echelon wealth not yet spent that should be taxed in the emergency and used to generate community valuable jobs.
Spain’s government should withdraw its underwriting foreign and local banks who lent unreasonably for Spanish construction. These lenders were partially responsible for the construction bubble and their size needs to be rationalised down, my guess is to one tenth or less of what they are now in some types of banking. The continuing pressure from the finance sector plutocracy for European governments to go into more debt in order to underwrite their private banks needs to end. Governments, including Spain’s, should excise the bubble in their financial sector. By withdrawing its underwriting of this bubble activity, the Spanish government has funds without expanding its debt to engage in beneficial fiscal stimulus.
A lesson for Spain is to do the opposite to what my city Bonn did for its community bank, the Koeln-Bonn Sparkasse. My city of Bonn is almost bankrupt from taxpayers giving that bank 60 million euro. A far larger sum was likely given by the taxpayers of Koeln (Cologne). These taxpayer contributions were to cover losses incurred by its community bankers’ foolish investments and for beginning to build itself big plush new quarters on prime Bonn real estate.
Bonn city council ought to have sacked those exorbitantly paid upper echelon bankers and scrapped their planned new building (whose construction had not even started). The 60 million euro ought to have created community valuable real sector jobs for its unemployed. Instead Bonn city has thrown into unemployment community valuable low paid workers like kindergarten teachers and kept un-needed bubble generating overpaid bankers on the payroll. Those upper echelon Bonn bankers being subsidised by Bonn taxpayers are so wealthy they will moreover hardly be spending any of the salaries anywhere in Europe. So keeping them employed will not be improving Europe’s aggregate demand in the current crisis.
Further the German Federal Government has failed to employ more in its tax office to pursue tax fraud. This is despite reports that each German tax officer so employed, earns 100 times his salary. With this failure to pursue wealth tax dodgers, Germany’s public sector will likely not get even legally due taxes from these tax subsidised upper echelon Bonn bankers.
The Spanish government needs to follow a reverse path from the city of Bonn in Germany therefore. It might also look to the proposals on page 11 of the RWER Tipping Points paper of Reinhard Selten and me, for averting hot money flows from raising its sovereign interest rate risk premium, should it not receive adequate assistance from the European Central Bank in this respect.

8 Esteban Pérez-Caldentey Opposing Rogoff
I would prefer not be bundled up with Rogoff. He wrote the Foundations of International Macro where money and finance appear only in page 600 something. Never understood anything about finance until the crisis. I also don’t think we are Mundellians. The Mundell Flemming model where you devalue and contract public expenditure was the favorite tool of a few European countries prior to the Euro (Spain 1982 is one case I remember). We are in favor of a monetary union but not in the Mundell sense. Regarding Krugman: I appreciate his recent turnaround but he also bears responsibility regarding the weak state of economics.

9 Robin Pope Intransigent
I for my part am deliberately being provocative by pointing out the similarity in order to entice you to drop that plank in your policy package of thinking that a depreciation, an inter-country relative price change, will do more than mischief. It is flaming an already lively danger of countries moving to the miserable autarchy in goods and capital flows trade of the 1930s.

10 Esteban Pérez-Caldentey External Balance
As Matías indicates we think that the Euro Crisis was provoked by a balance of payments imbalance rather than fiscal profligacy. We also think that as in the case of the US private indebtedness was a big source of disequilibrium.

11 Robin Pope Reverse Causation
Agreed – the crisis was not caused by fiscal profligacy. By definition, the more bubble capital flows into a country, other things equal, the fewer goods and service exported from that country. I contend that the causal direction is from the bubble financial inflow to an excess of imported goods and services over exported ones. In other words I disagree with you both and Ken Rogoff, who also focuses on goods trade, also presumes it the cause of the illness and also presumes that the cure is a change in wage relativities.
By contrast, I see the goods trade deficit in Spain and Ireland and like countries as the response to the bubble finance inflow. That inflow cannot arrive in its destination country without this reverse trades goods imbalance. Once more, my thrust is, look at the cause of the crisis, and fix it up. Do not cast around for scapegoats and miss fixing up the cancerous bubble.

The bubble capital inflow went into the non-traded sector (eg construction) in Ireland, Spain and so forth, and this will mean it does not serve to expand infrastructure and skills for use in exports. According to those fascinating Citibank plutocracy documents to which Edward Fullbrook alerted us in this RWER, a rising income in the upper echelon entices dis-saving in the form of importing more than exporting, as the plutocrats run down their assets on conspicuous consumption. Some of that may be going on – suggesting all the more that governments need to start pouncing on and taxing that plutocratic wealth before more goes up in private jets, yachts and whatever. However I doubt that the plutocrats are consuming at anything like the rate to be dis-saving, that is that this part of the paper Citigroup’s Kapour, Macleod and Singh (2005) is likely wrong.

12 Esteban holds by the current account imbalance as the causal direction
We agree in the sense of bubble finance as being a big part of the problem. We don’t necessarily view the causation running from finance (capital and financial account) to a trade imbalance. I at least, Matías has to corroborate this, see the causation from, current account imbalance requiring finance which was in part ‘short term finance’

13 Robin grants that there is some two-way causation
I was simplifying for brevity. There is ever dual causation. Untangling the extent of each stream would need detailed disaggregate analysis for every country and time period to get a reasonable estimate of the proportions in each direction – something not amenable to econometrics which needs constant coefficients over a reasonable time span.

14) Esteban sees a deficit balance of payments as a constraint
It’s actually a balance of payments constraint to growth problem.

15) Robin sees no hard constraints
This is a key matter you raise. To illustrate, Germany’s unemployment jump giving rise to Hitler as we note in our Tipping Points paper, came from the abrupt cessation of US short term private bubble finance. As far as I know moreover that bubble finance was spent in a far less bubbly manner than that of say Ireland and Spain over the last fifteen years.
The matter of replacing private bubble activity with socially desirable activity needs initially government orchestration as the private sector has taken fright, and is also overall deleveraging. This, other things, equal raises government debt and government interest rates no matter what currency regime. Our Tipping Point paper points to regulations many a country had prior to neoliberalism to limit that interest rate rise for the government. Indeed the regulations can be made tough enough to eliminate any government interest rate rise.
Our Tipping Points paper further points to the immediately available financial and real wealth accumulated over the last 30 years by the upper echelon that, for multiple reasons, ought be in large measure transferred to government coffers. We noted there only a couple of the vast array of measures for retrieving that illegally sequestered (taxes undeclared). On an estimate of the financial wealth and tax needed to get government coffers partially restored, we reference in our RWER Tipping Points paper, that of Boston Global Consulting. Taxing adequately upper echelon wealth may well be sufficient for government coffers even to go into surplus provided that there are stringent collection measures like seized passports, and electronic monitoring, and harsh measures against tax havens, to avert wealthy citizen flight. Unfortunately efforts start to collecting reasonable taxes from the wealthy have yet to begin. Almost every major political party depends on election donations of these wealthy, and hence needs mighty pushes to start taxing them.

16 Robin Pope: A Beckon 26th April 2012
The joint position of me and Reinhard Selten is that the euro’s rules are imperfect, as too the European Central Banks conduct of monetary policy within those rules. But the alternative is far worse – eurozone members being buffeted by exchange rate changes generated by 17 imperfect national central banks of the 17 eurozone countries. Likewise, since humans are imperfect, there would be imperfections in the rules and conduct of the world central bank’ that we advocate getting formed. But this will be far far more efficient and safer, economically and politically, than countries continuing to be buffeted by the drastic damage of unpredicted exchange rate gyrations. Our RWER Tipping Points paper beckons you all to work toward a single currency. Our paper warns of the risk of our economies otherwise slipping off the cliff, as occurred when the 1920s global financial bubble burst in 1931 ushered in a disastrous decade of beggar-thy-neighbour competitive depreciations.

17) Esteban argues for making the euro feasible
We don’t address this issue [single world currency] in our paper. We address in a sketchy way how to make the Euro a feasible arrangement.

18) Robin argues that the euro is already feasible
The euro is feasible without radical changes, but of course becomes far better if its rules and their interpretation evolve to put centre-stage Eurozone aggregate demand (a matter over which montetary policy has far more control than over inflation), and the Euro-zone having an appropriate financial sector so that the European Central Bank helps orchestrate a rational downsizing of the Eurozone’s (public plus private) wildly overblown bubble financial sector. There is vast scope to do almost everything concerning the euro by reinterpretation, as the rules are ultra permissive. A major need is for Eurozone government finance ministers to endorse the European Central Bank in undertaking welfare enhancing measures for their own real sectors and undertake themselves complementary measures, and quit being seduced by the financial sector lobby – that, to date, Eurozone finance ministers have excessively bailed out with taxpayer funds (in like manner to the excessive bailouts of finance ministers in most other western countries).

19) Matías and Esteban’s 4-Point Position Summary with Robin’s Responses

MATÍAS AND ESTEBAN’S SUMMARY POINT 1
The Euro crisis is not a fiscal crisis. It was brought about by an imbalance between Core and Non-core countries that is inherent in the euro economic model. It has been building up since the implementation of the Euro and the process of financial liberalization.

Robin on point 1a) financial liberalization
On the damage of financial liberalization, we agree with you. Reinhard Selten and I in our RWER Tipping Points paper recommend to every country the excision of wasteful private sector bubbles in the finance and prescription drugs industry and listed measures needed to deter their recurrence. Our recommendations include cutting back to size the overblown salaries in the financial sector, devoting two pages to Philippon and Reshev’s graphs documenting salaries 4 times others comparably educated and subject to comparable risks. Banks, with often 40% of their costs wages, survive overblown – propped up in the eurozone with taxpayer funds instead of, as we recommended on pages 23 to 25, governments rationalizing down the size of the financial sector in each country, and shifting these bubble resources into non-bubble activities.

Robin on point 1b) crisis’ origin
On the origin of current troubles, the view of Reinhard Selten and me is that it stems from the bursting of the financial bubble and had nothing to do with implementing the euro. Thus we agree that the crisis’ origin was not fiscal, but disagree with your blaming it on a faulty economic model for implementing the euro. As I stated at the beginning of this interchange, you, Paul Krugman and the IMF old guard (represented in some of Ken Rogoff’s recent blogs), share the view that the euro has been faultily implemented (a bad currency union) since wages in the non-core countries grew faster than in core ones. You state on page 90 that this was “beggar thy neighbour” policy of core countries giving them an unsustainable advantage of a “real depreciation”. The words in inverted commas are yours. The only difference is that the old guard IMF accuses the non-core of letting wages grow too fast, while you put it in reverse, and accuse the core of not letting their wages grow fast enough. You share the Mundell 1961 optimal currency perspective.
As I pointed out near the beginning of this interchange, you both, like Paul Krugman and Ken Rogoff, model as if there were only one good in world trade and only one sort of labour – even though this would mean no reason for trade. All of you then declare the euro in crisis. On this point you all have the same labour and goods and export model. Reinhard Selten and I criticize it as too simplistic to understand the euro and exchange rates.

MATÍAS AND ESTEBAN’S SUMMARY POINT 2
Core countries were able to grow and expand through export led growth (based mainly on cost competitiveness). Non-core countries expanded through internal demand and mounting disequilibria in the external sector and private debt.

Robin on point 2a Cost competitiveness is not average relative wages
This is just relative wages in the simplistic 1 good, 1 sort of labour shared modelling of the IMF old guard, of Paul Krugman, and of you two. In my initial comment I gave you examples to show how over overly simplistic and patently incorrect is your shared modeling. But you fail to comment on my examples. I gave them, and in our joint Tipping Points paper you find references of detailed theoretical and econometric studies corroborating that your shared 1 good, 1 sort of labour model is false. Indeed so false that it has meant that the old guard IMF recommendation to countries to depreciate out of trouble to revive their manufacturing has quite routinely wiped out manufacturing. My comment was to entice you both to quit this aspect of your modelling. Your modelling is in some other aspects is admirable – but not in its simplistic notion of external balance, as below.

Robin on point 2b An Import surplus is not necessarily a disequilibrium and bad
I disagree with your static Meadian/Mundellian equilibrium model that demands exports to equal imports in each country, or the euro zone gets into crisis. Why not require exports to equal imports for every suburb – or even every household. That nobody ever borrows or lends, is the logical conclusion of a good euro zone under your modelling.
In my birth country Australia, there has been about 230 years of white settlement in the states that eventually joined to form the country. Over the time, where were probably only three decades in which we did not have an excess of imports over exports. Australia being perpetually in debt has typically worked out reasonably. It has not invariably been good. By the 1860s and continuing into the1880s, the Australian state of Victoria boasted by far the richest city in the world, marvelous Melbourne. But from the mid 1880s, it entered a finance/construction boom in real estate and railways that, at its height, had land prices doubling every few weeks. Melbournians and other Australians (though their multinational banks), resumed being net borrowers from abroad within a decade plus of this catastrophe, and having learned their boom-bust lesson well, had real income and employment growth roughly comparable to export surplus countries. There is scope to question the distribution of these net inflows across industries, and whether a higher or a lower net capital inflow would have been better, but no solid evidence that zero net inflows would have been ideal, quite the contrary.
Many Eurozone non-core countries behaved like Melbourne in its later 1880s finance/construction bubble, while many Eurozone core country banks frothed the bubble with massive capital inflows to the non-core Eurozone countries. With hindsight the foreign (and local) banks were foolish to have lent so much, just as with hindsight the UK banks were foolish to lend to Victoria’s government and private sectors in the 1880s. The moral of this tale is that borrowing (imports bigger than exports) can be either catastrophic (for bubble activities), or beneficial (for non-bubble activities such as the infrastructure projects in which the Irish government is currently soliciting domestic and foreign lenders).

MATÍAS AND ESTEBAN’S SUMMARY POINT 3
We don’t argue that European countries should abandon the Euro or devalue. We argue that a reform of the Euro architecture is needed. Growth in the Eurozone requires coordinated macro policies. The Eurozone should be built on Keynesian principles rather than Mundellian ones.

Robin on point 3a of your proposal
Your reform proposal aims at every euro country having exports equal imports. I disagree with this as discussed above in my response to your point 2b where my example of Australia above, reveals that being in debt more or less continuously for a couple of centuries has left her real income and employment comparable to other developed countries, and indeed, on some benchmarks, may have aided her. Today, countries in the Eurozone with an older workforce and more developed infrastructure, need less infrastructure investment and less income now, more income in the future, than those with a younger population or less infrastructure. These factors may render it beneficial for there to be decades in which within the Eurozone some countries are net lenders and others net borrowers, just as within a single country this happens between age groups, and between expanding and contracting cities. The tragedy of borrowing countries like Ireland, Spain and Portugal – and for their lenders – is not that the non-core countries have been net importers from other Eurozone countries. The tragedy is that they borrowed and others lent for bubble activity, when so many valuable investments could have been done in non-bubble activities.

Robin on point 3b your claim for Keynes
Let me stake a counter claim, that of the Keynesian mantle bestowed on me by Vivian Walsh on pp56, 62-65 in his 1996 book, Rationality, Allocation and Reproduction, Clarendon Press, Oxford. Walsh there stated that my epistemic decision theory under risk and uncertainty that I have subsequently christened SKAT, the Stages of Knowledge Ahead Theory, formalises Keynesian uncertainty of living in chronological time with all its irreversibilities. My SKAT dissolves the complementarity paradox that thwarted von Neumann and Morgenstern’s desire to go beyond expected utility theory, a theory that Keynes rightly rejected as too narrow. I claim the mantle of being Keynesian in this deep respect, that of incorporating Keynesian uncertainty into trade, capital flows and exchange rate effects. My Keynesian uncertainty mantle leads beyond those many aspects of your modelling that implicitly involve a certain uncomplicated future in a simple economy. I entice you into this new complicated uncertain world also.

MATÍAS AND ESTEBAN’S SUMMARY POINT 4
We also argue that fiscal austerity will not lead to recovery but to further recession and unemployment, especially in the face of private sector deleveraging, and it might even cause the derailment of the European project. The recovery of the old European project of unity, which was not a neoliberal project for financial integration and permanent austerity, and was more akin to an European New Deal to promote the catch up of peripheral parts with the center must be brought back to the center of the European agenda.

Robin on point 4
I agree with everything said here. There is moreover a glimmer of hope of its happening with talk of a Marshall plan for Europe! In our RWER Tipping Point paper, Reinhard Selten and I warn of the rise of Hitler and the arms build up used to solve unemployment when there was insufficient fiscal stimulus in the 1930s.

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