Some proposals formally before the G20

While I was, along with others, speaking in Berlin on Sunday at a public event, a member of the audience asked, during the Q&A, what was the most hopeful thing that we speakers had come across. I replied that I had been depressed a few weeks ago, but that over the last couple of weeks I had come across several small signs that key things that need to be done to solve the crisis may well be taken seriously by the G20 after all.

One of these is a new ebook, available for download free of charge at www.VoxEU.org: MACROECONOMIC STABILITY AND FINANCIAL REGULATION: KEY ISSUES FOR THE G20, is published by Centre for Economic Policy Research, which describes itself as "the leading European research network in economics" and boasts of some 700 economists as members.

The book brings together papers, initial versions of which were discussed at a seminar with G20 Deputies and private sector representatives hosted by HM Treasury and the Bank of England on 31 January 2009.

Some of the policy proposals emerging from the book overlap interestingly with mine. So, on the proposals, here are my comments IN CAPITALS. If you wish to read the detailed arguments used to support the CEPR proposals, you have of course to go to the book.

1. The book continues to argue that one of the key reasons for the crisis is "global imbalances and capital flows". I ARGUE, BY CONTRAST, THAT THE PRINCIPAL REASON FOR THE CRISIS WAS THE DEFLATION OF THE HOUSING BUBBLE, AS A RESULT OF THE BUBBLE IN OIL AND COMMODITY PRICES, WITH KNOCK-ON EFFECTS ON THE UNTHINKABLY LARGE MOUNTAIN OF EXOTIC FINANCIAL INSTRUMENTS (WHICH IS SOMETIMES NOWADAYS REFERRED TO AS "THE SHADOW ECONOMY" AS THAT ECONOMY IS SO MANY TIMES THE SIZE OF THE REAL ECONOMY). The book proposes that "global imbalances and capital flows" be attended to by two principal means:

a. by creating credible insurance mechanisms for countries that forego reserve accumulation and stimulate domestic expansion, along three possible lines: more central bank swap lines; ‘reserve pooling'; and a major expansion of IMF resources, together with IMF emphasis on a large, flexible, fast-disbursing facility that would come with little or no conditionality to countries that are adversely affected by global shocks. IN OTHER WORDS, INSTEAD OF MY PROPOSAL THAT THE INSURANCE RELATE TO THE INSURANCE COMPONENT OF THE ACTUAL DEALS IN THE SHADOW ECONOMY, THE BOOK'S EMPHASIS IS ON RATHER MORE TRADITIONAL MATTERS. IT IS NOT CLEAR TO ME WHETHER THERE ARE ENOUGH RESERVES IN THE WORLD TO INSURE MANY WHOLE COUNTRIES THROUGH OLD-FASHIONED MECHANISMS SUCH AS CENTRAL BANK SWAP LINES AND RESERVE POOLING, OR WHETHER EVEN $500 BILLION IN THE IMF'S KITTY WOULD BE ENOUGH TO STABILISE THE NUMBER OF COUNTRIES THAT ARE LIKELY TO BE HIT BY THE CURRENT CRISIS. THIS IS APART FROM: (i) THE PRACTICAL QUESTION OF WHERE 500 BILLION IS TO COME FROM; (ii) THE FUTURE-ORIENTED QUESTION OF THE INFLATIONARY EFFECTS OF THIS "MONEY"; AND (iii) THE MORAL QUESTION OF WHETHER IT IS RIGHT TO SIMPLY HAND OUT MONEY WITHOUT ANY CONDITIONS TO COUNTRIES THAT MAY BE BANKRUPT OR IN DANGER OF BANKRUPTCY.

B. bY accelerating the development of financial systems in emerging markets, in particular local currency bond markets and foreign currency hedging instruments, and by promoting regional cooperation in the design of common institutional standards for financial market development and working to lift barriers to cross-border asset trade within regions. THIS IS GOOD STUFF AND SHOULD BE DONE IN ANY CASE WITHOUT REGARD TO THE CRISIS, THOUGH I AM NOT PERSUADED THAT THIS SPECIFIC SET OF STEPS WILL MAKE ANY CONTRIBUTION TO ADDRESSING THE CRISIS.

2. The book argues that macroeconomic policy should be used to meet any threat of deflation promptly, before it takes hold, with a zero interest rate policy (ZIRP) and quantitative easing, recommending an inflation target so as help to avoid expectations of deflation. WE ARE ALREADY NEAR ZERO INTEREST RATES, AND GOVERNMENTS ARE DOING ALL THEY CAN TO PRINT MORE AND MORE MONEY - WITH THE CONSEQUENCE THAT WE WILL HAVE HYPERINFLATION AS SOON AS THE ECONOMY DOES GET MOVING. The book acknowledges that a global ZIRP will not benefit all countries, because not all can benefit from the stimulus provided by exchange-rate depreciation. Specifically, it asks any country with large trade surpluses and positive GDP growth (think China) to refrain from intervention to prevent the appreciation of its currency, because that would be a beggar-thy-neighbour policy. WHILE THIS MAY BE MORALLY RIGHT, IT DOES NOT GIVE THE COUNTRY CONCERNED ANY SPECIFICALLY ECONOMIC REASON WHY THAT COUNTRY SHOULD NOT FOLLOW A "BEGGAR-THY-NEIGHBOUR" POLICY. IN FACT SUCH A POLICY MAY QUITE SUIT CERTAIN COUNTRIES' POLITICAL PRIORITIES AT CERTAIN TIMES. The book also argues that fiscal stimuli should be done by international cooperation. AS FAR AS I CAN MAKE OUT, THIS IS ALREADY BEING DONE - AND IT IS HAVING VERY LITTLE EFFECT SO FAR, BEYOND PROVIDING A SORT OF FLOOR TO THE CRISIS (THOUGH THAT IS ITSELF WORTH A LOT OF COURSE).

3. The book argues that pro-cyclicality needs to be countered by adjusting the Basel II capital requirements using a simple multiplier that depends on the deviation of the rate of growth of GDP from its long-term average. THIS IS ENTIRELY IN LINE WITH WHAT I HAVE PROPOSED.

4. The book continues to argue the need for creating a centralised clearing counterparty for CDS trades and encourages requiring CDS to be exchange-traded and consider prohibiting naked CDS (those that do not insure a holder of the underlying asset). THESE ARE ANALYSES IN LINE WITH MINE, EXCEPT THAT I HAVE CONSISTENTLY ARGUED FOR MULTIPLE EXCHANGES SPECIFICALLY DEVOTED TO EXOTIC FINANCIAL INSTRUMENTS. I REPEAT THAT HAVING A SINGLE EXCHANGE IS A RECIPE FOR A SERVICE THAT WILL BECOME MORE AND MORE EXPENSIVE, AS WELL AS LESS AND LESS EFFICIENT, OVER TIME - AS HAPPENS IN ALL MONOPOLY SITUATIONS. WE BELIEVE IN COMPETITION. LET US HAVE COMPETITION HERE TOO, IN ORDER TO ENSURE THAT EFFECIENT AND ECONOMICAL SERVICES ARE PROVIDED. Further, the book argues that credit rating agencies (CRAs) need to be genuinely independent, rather than dependent (as they are at present) on the prospect of future business with issuers. The book also encourages the G20 to require greater disclosure of information about the underlying pool of securities for structured instruments. THESE ARE ALSO IN LINE WITH MY SUBMISSIONS.

5. The book draws attention to the need to establish a harmonised bankruptcy regime for banks, based on US-style 'prompt corrective action', giving an independent, well-staffed supervisor strong powers to limit the freedom of bank managers (and possibly remove them) and shareholders (and possibly expropriate them) before the bank is technically insolvent. THIS IS ALL VERY WELL BUT THE PROBLEM HAS BEEN THAT EVEN IN THE U.S.A., WHICH THE AUTHORS ARE HAPPY TO CONSIDER AS SOME SORT OF MODEL, THE EXISTENCE OF RULES HAS NOT FORCED THE U.S.A. TO ACTUALLY BANKRUPT THE LARGEST OF COMPANIES, WHETHER FINANCIAL OR OTHER. THIS IS BECAUSE THESE "LARGEST" COMPANIES ARE CONSIDERED "TOO BIG TO FAIL". THIS SIMPLE FACT IS DOWNPLAYED BY THE BOOK. IN MY OPINION, NO COMPANY SHOULD BE ALLOWED TO BECOME "TOO BIG TO FAIL" IN THE FIRST PLACE, AND THE SIMPLE MECHANISM TO ACHIEVE THIS IS TO REQUIRE ALL COMPANIES THAT APPROACH SAY 0.5% OF GDP TO SPIN OFF PART(S) OF THEIR ACTIVITIES INTO SEPARATE COMPANIES. The book also argues for the creation of an International Financial Stability Fund that takes equity positions in the financial institutions of participating countries and monitors their activities. THIS WOULD BECOME ENTIRELY UNNECESSARY IF MY PROPOSAL (JUST ABOVE) WERE FOLLOWED INSTEAD.

TO SUM UP: THE BOOK REGRETFULLY CONTINUES TO FOCUS ON THE QUESTION OF BLOCKAGES IN THE SUPPLY OF CREDIT (WHICH *IS* PART OF THE CRISIS), BUT DOES NOT FOCUS ON THE UNDERLYING *FINANCIAL CAUSE* OF THE CRISIS, WHICH WAS NON-TRANSPARENT GAMBLING, NOT ONLY WITH ALL THE MONEY THAT ORGANISATIONS HAD, AND NOT ONLY WITH ALL THE MONEY THAT THEY COULD ENTICE PEOPLE TO LEND THEM, BUT EVEN WITH MONEY THAT THEY HAD NO HOPE OF ENTICING ANYONE TO LEND TO THEM.

NATURALLY, THE BOOK MAKES NO MENTION OF THE SOCIAL AND MORAL CAUSE OF THE CRISIS: THE RISE OF THE BABY-BOOMER GENERATION, WHICH DID NOT WANT ANY RULES (MORAL OR REGULATORY) TO PLACE LIMITS ON THEIR ACTIVITIES, AND WHICH WAS RATHER DEVOTED TO SELF AND SELF-INDULGENCE THAN TO SOCIAL RESPONSIBILITY. Sphere: Related Content