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

– http://www.ft.com/cms/s/0/32b76182-5343-11e0-86e6-00144feab49a.html

On the future of global economy. Very convincing

– http://www.mckinsey.com/mgi/publications/farewell_cheap_capital/pdfs/MGI_Farewell_to_cheap_capital_full_report.pdf

Measuring money demand

David Beckworth http://macromarketmusings.blogspot.com/2011/03/metric-you-should-be-watching-but-arent.html 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.

Macro & Money

The macro exist because money exist. If we lived in a barter society, without money, there would be inefficient assignment of resources, but not macro problems.

The Keynesian diagnosis of unemployment is false. If there is an insufficient demand, that is because there is an excess of demand for money. Keynes was going in the right direction, but suddenly, he decided to deviate through fiscal case. His Liquidity trap was a good argument, but the problem is that he applied it to any case of recession.

Nick Rowe has written an excellent, very clever, piece on the case.  Read it here.


The “problem” of the Yen

The yen has rebound and reached its highest level in many years,  against the intuition says. Why in a catastrophe of this size, the money of the affected country would only not fall,  bur rise ?

The fact is difficult to explain. I´ve red several explanation, none convincing me.

The best I´ve heard is in a comment in the blog of Gavyn Davies in http://blogs.ft.com/gavyndavies/2011/03/17/the-case-for-co-subordinarte-yen-intervention/: as says “Equivocation”

“If you believe in the endogenous theory of money. This rise in the Yen is easily explained. As financial institutions pare down risk, they close out positions and thus reduce monetary supply. Lower supply equates to a higher price.”

I can imagine the banks (and people) hoarding money to face the certitude.

So, it is no needed any intervention of foreign government – as several voices have asked  to pare down the yen. Only the minimal normalization of circumstances could low down it. A huge intervention of other Central banks only do things worse, strengthening the odd that the yen, sooner or later, will fall.

The problem is, as “Equivocation” says:

The Yen has been a funding currency for almost 2 decades and is particularly susceptible. Is this dangerous for the world economy? Of course!! Many of these carry trades are only marginally profitable and a 4% spike in the Yen would cause billions in losses to international banks.

That is: the yen has carried  so low-interest rates during so many years, that banks have profit to speculate with other currencies, borrowing in yen and buying dollars (carry trade): You borrow in low-cost money and invest in other high-yielding. Obviously, if yen rise during the operation, the loss could  be very high… that is the source of interest in central bans intervention to low down yen. If yhe yen doesn´t low, endebted banks in yen most return much more monet than they have estimated.

The problem of yen is the problem of banks that have been caught in carry trade operation, so profitable few days ago.

needed a minimum inflation rate?

All the Central Bank admit this hypothesis: any economy needs a low but constant rate of inflation to work sweetly.

This position is firmly contested by libertarians: for them, a cero constant price level, or a  decreasing one, is perfectly compatible with robust growth.

In few occasions we can prove this stuff. Except the fears to deflation, there is not an empirical model that proves this assert or its opposite.

Japanese economy  (which is struggling with its tragedy), offers perhaps a clue about the necessity of inflation. See the graph where I plot the (annual) evolution in Japan of Real GDP, Prices (CPI), and employment.

It is quite clear that the prices have fallen in the last decade, while the GDP growth was low, and employment followed a down trend.

That is not as proof at all: it os only a clue… But it doesn´t refute the hypothesis of a minimum positive inflation for an economy working well.

FRED Graph

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