Monthly Archives: May 2008

The case for the UK shedding sterling and adopting the euro has never been clearer.

From a conventional macroeconomic perspective (asymmetric shocks, cyclical convergence, the 39 tests or whatever), there is no reasonable argument for a small, highly open economy like Britain to retain monetary independence. The belief that an independent national monetary policy allows you greater greater scope for effective macroeconomic stabilisation is an example of the monetary fine-tuning fallacy. With a high degree of international financial integration, the exchange rate does not function as a buffer against asymmetric shocks, permitting a less costly adjustment of international relative costs and prices than would have been possible at an irrevocably fixed nominal exchange rate. Instead it becomes a source of extraneous, uncessessary noice and volatility and of at times persistent misalignment.

Seen in the 12th floor men’s room at the New York Fed, right above the urinals, the following sign:

Report All Leaks to

extension 5619

I was sorely tempted to report a recent leak to extension 5619. Somehow I refrained (visions of my mother, my wife and my daughter all shaking their heads). Pity.

On Thursday 29 May and Friday May 30, the New York Fed and Columbia Business School are organising a conference, at the New York Fed, on The Role of Money Markets. On the second day of the conference, I will be presenting a paper titled Lessons from the North Atlantic Financial Crisis. It is a much-revised and expanded version of an earlier paper of mine, Lessons from the 2007 Financial Crisis, which was published by the Centre for Economic Policy Research as CEPR Policy Insight No. 18 on December 19, 2008.

The new paper focuses extensively on the performance of the three most affected central banks: the Fed, the ECB and the Bank of England. It evaluates their performance using three criteria: (1) macroeconomic stability; (2) effectiveness in dealing with the immediate financial crisis; and (3) the impact of the pursuit of macroeconomic stability and putting out immediate financial stability fires on the likelihood and severity of future financial crises. I conclude that although the Fed did a reasonable job dealing with the immediate financial crisis, it did significantly worse than the other two central banks as regards macroeconomic stability and the prevention or mitigation of future financial crises.

This blog is a meditation on the old truth stated by Lord Acton: “All power tends to corrupt; absolute power corrupts absolutely.”

Governments that have been in power for more than about eight years begin to smell – rather more slowly than fish left on the counter, but with equal certainty. Heads of government (or heads of state where this office is not just an empty symbolic box) embody this political putrification process, regardless of how bright and shining the light in their eyes when office was first gained.

In the UK there are many examples, even in recent times, of what goes wrong when an incumbent prime minister or incumbent party holds office/power for the equivalent of two full terms of office or more. Margaret Thatcher went funny – some would say bonkers. She developed delusions of grandeur and displayed an increasingly imperious personal manner – to the point of talking about herself in the third person (“we have become a grandmother”). Her growing paranoia about all things German became a threat to the UK’s standing in Europe and in the world.

Tony Blair ‘s fresh-faced idealism and enthusiasm had decayed into the cynical routine use of deceit by the time account had to be given of the reasons for invading Iraq a second time, and during the Hutton Inquiry into the death of Dr. David Kelly in 2003.  The assault on civil liberties, under the fig-leaf of anti-terrorism, that started on his watch continues under the leadership of Prime Minister Brown today.

The original Greenspan-Bernanke position that the regular monetary policy instrument, the official policy rate, should not be used to tackle asset booms/bubbles is sound. To the extent that asset booms have implications for the distribution of future outcomes for the macroeconomic stability objectives (price stability or price stability and economic growth), they will, of course, already have been allowed for under the existing approaches in the US, the Euro Area and the UK.

But the official policy rate should not be used to ‘lean against the wind’ of asset booms and bubbles beyond that, that is, in their own right. It would overburden the official policy rate and, since going after an asset boom/bubble with the official policy rate is like going after a rogue elephant with a pea shooter, Mundell’s principle of effective market classification suggests that the official policy rate not be targeted at asset booms/bubbles in their own right.

Iceland is to resume commercial whaling. Fisheries Minister Einar Kristinn Guðfinnsson has issued an order allowing 40 minke whales to be hunted.

Mr. Gunnar Bergmann Jonsson, head of an Icelandic minke whaling association, sees no problem. He argued that whaling was important to the Icelandic fishing community, which had been hit by quota cuts for cod and capelin. He also said: “There are around 50,000 whales in the waters surrounding Iceland now, and I don’t believe that the fishing of 40 will make any difference for the stock.”

I like that argument. Let’s modulate on this theme: “There are about 300,000 people in Iceland now, and I don’t believe the culling of 40 of them will make any difference for the stock”.

Central bankers talk about inflation more than a teenage boy thinks about sex. Perhaps they talk about it too much. In contrast to teenage boys, for whom less action would probably be a good thing, central banks would be well advised to talk less and act more. In the US, the Euro Area and the UK, the track record of inflation during the past few years has deteriorated to the point that a material loss of credibility may well be imminent for all three central banks involved – the Fed, the ECB and the Bank of England.

Those of you with time on your hands and a interest in spending some it it in a basement being beaten with a rubber hose, may want to take a look at my recent Centre for Economic Policy Research Policy Insight No. 24, “Can Central Banks Go Broke?”

In that paper, I ask whether it matters if a central bank suffers a large capital loss. Can the central bank become insolvent? How and by whom or by what institution should the central bank be recapitalised, if its capital were deemed insufficient? These are relevant questions not just in Zimbabwe and Tajikistan today, but wherever central banks have taken on or may be asked to take on large exposures to private credit risk. This includes the USA, the Euro Area, the UK, Iceland and many other advanced industrial countries.

What is inflation?

Inflation is rising just about everywhere. Why is this and what can be done about it?

To get some basic concepts clear: inflation is a sustained rise in the general price level. Both the words ‘sustained’ and ‘general price level’ are imprecise and in need of operationalisation. By general price level I mean a broad, representative index of consumer prices. That excludes the (headline) CPI in the UK because, like the other EU harmonised price indices, it excludes housing costs (that is, the rental cost of housing services or the imputed rental paid by owner occupiers). This makes the CPI/HICP indices unrepresentative, unless either the relative price of housing services and the goods and services included in the CPI/HICP remains constant or UK/EU citizens live in cardboard boxes provided free of charge by the Salvation Army. It may come to that, but not yet. The UK’s RPI and RPIX indices would be more representative.

The UK Chancellor of the Exchequer, Alistair Darling, is fighting the good fight on policy towards the EU’s agricultural sector. Effectively, he has called for the abolition of the Common Agricultural Policy, the EU’s Welfare State for Farmers – a costly, distortionary, inefficient and inequitable arrangement overdue for the scrap heap.

Maverecon: Willem Buiter

Willem Buiter's blog ran until December 2009. This blog is no longer active but it remains open as an archive.

Professor of European Political Economy, London School of Economics and Political Science; former chief economist of the EBRD, former external member of the MPC; adviser to international organisations, governments, central banks and private financial institutions.

Willem Buiter's website