The Euro and Taylor rule

The Taylor rule (see is a formula to estimate the best interest rate for a central bank. I don´t believe very hard in it. But I think that it is useful in comparing the different cycle of economies members of a monetary union.  If we use the same parameters calculating the optimal interest rate for different countries, the  interpretation of the result can only be straightforward.

Taylor rule  says that the optimal interest rate is a function of the differences between the current growth rate ant the desired one, and between current inflation and the desired inflation.

In the figure, I suppose a optimal GDP growth of 2% for Germany and a 2,5% for Spain. For both an optimal inflation 2%. Dotted line is the actual rate of ECB.

Easy is  to see that the euro has been very pro-cyclical for both countries! but for opposed reasons, indeed: except when the crisis arrived in 2007

The ECB rate has been to high for Germany and too low for Spain before 2006. In 2006, the ECB rte is too low for both countries; after 2007, to high…

(I´m sorry not to be able to get a better image)


US economy today

We ´ve known today that the IV quarter  GDP (black line) rose a 3,2% (annualised). In the graph, some indicators that show the US economy is rising gently (Nominal GDP, Industrial Prod), but a lot of productive capacity (red dashed line) is idle.

At the same time, unemployment is falling (red solid line), and external imbalance (green line) is stable at a manageable level.

The signs of idle capacity and high unemployment talk about a certain margin before inflation pressures could appear. Similary, the controlled net imports means that the external finance are in order.

Before the crisis, the Fed did not use to look closely for external disequilibrium. If we enter the variable in the model, probably the potential output would be quite lesser than it is supposed. That is the reason to follow closely BoP: Deficit are financed by foreign capital, which has been a main factor of the crisis through MBS an other toxic products.

FRED Graph

very good post


Portugal and other “casual” facts

Portugal´s government, on the verge of loosening the confidence from opposition. Perhaps that trigger an intervention of EU.
This week end, Great Summit of European leaders to decide crucial questions on euro, as the new Bail out mechanism (ESM) . Meanwhile, some countries as France leading air attacks on Libia, without clear targets
Will Portugal & Libia wreck the Summit?
Too many strings for a violin?

“Causal line”

For the sake of precision, the beginning of the Great Recession was of financial origin, as  you can see  in graph below.

In august 2007, well before the recession (obscured area) the  3 month Interbank Offered Rate (red line), or  LIBOR,  the rate at which banks lend between them) began its abnormal behaviour, exceeding for the first times in the history a significant spread respect to fed funds rate (blue line), the basic interbank rate offered by the Fed. Usually, the Fed and Libor rates carry a very little spread. The reason of the more pronounced spread was the crisis of Mortgage Based Security ((MBS).

This spread was only briefly reduced at the beginning of 2008, until the crisis rise and in september, 2008, Lehman Brothers collapsed. The spread reached more of 400 bp over the Fed fund rate.

This was the moment in which Bernanke began his QE1, as you can see in the dotted line (monetary base). Until this time, Bernanke have only reduced the level of FF rate to 0,25%.

The question is: Could  have Bernanke prevent the crisis of Lehman injecting more money before (f.i., at the beginning of recession? It is very difficult to answer, because the interbank market collapsed well before the recession began. So, we don´t lnow how banks had reacted to mor liquidity.  Probably  the assets markets fall had been less pronounced, and the recession would have been less prone, but nor very much. – seeing the rest of the world.

In any case, the “causal line” is from financial to real crisis. I don´t believe that a huge money injection at the beginning of 2008 had prevent the recession. The spread between FF and Libor rate decease only very slowly after the QE1 was implemented; and I don´t believe that the main reason of the crisis was the fall in GDP – as few quasi monetarist  pundits (Scott Sumner & Al) defend.

FRED Graph

Simmilar comments could be said if we include in the graph the house prices index, as in the following figure: it was not the fall in house prices the cause of the crisis, since it began after the financial crisis.

FRED Graph


Very good posts

On the future of euro. Very sad


On the future of global economy. Very convincing


Measuring money demand

David Beckworth has got a very fine measure of the intensity with which people is hoarding money.  Very simple and useful, it is the liquidity assets hoarded by Corporate and household in relation to the total assets of both sectors. Here the result:

As you can see, in the IV quarter the non financial sectors kept up a high level of liquidity assets, but it began to decline. At the same time, M3 velocity has begun to rise. So, it is clear that the QE2 was plenty justified, and that it has worked.

%d bloggers like this: