Monthly Archives: June 2008

The consistent lack of manners of the Treasury

The Treasury – shorthand for its political leadership and the politicised section of its permanent establishment – is institutionally nasty.  It ever was thus.  The Treasury is ruthless, and at times unprincipled and unscrupulous in the pursuit of what it wants.  Its indifference to the collateral damage this may cause to people’s reputations, self-esteem and feelings is legendary and well-documented.  Recent examples include letting former Governor of the Bank of England, Eddie George and current Governor Mervyn King twist slowly in the wind – unnecessarily dragging out the decision on their reappointment when they were up for reappointment at the end of their first terms as Governor.  Apart from being rude and kak-handed, it also did nothing to promote financial stability, especially in the case of Mervyn King’s reappointment, which came at the high of the North Atlantic area financial crisis.

The US Supreme Court – that most intensely partisan-political and utterly unaccountable branch of the US Federal government – has overturned the District of Columbia’s 32-year ban on handguns, declaring it to be unconstitutional. The decision and opinions can be found here. By a 5 to 4 vote (the usual lunatic fringe – Chief Justice John Roberts and Justices Samuel Alito, Antonin Scalia and Clarence Thomas – plus the swing voter Anthony Kennedy, who this time joined the Dark Side) the Supreme Court decided that the the Second Amendment to the US Constitution: “A well regulated militia, being necessary to the security of a free state, the right of the people to keep and bear arms, shall not be infringed.” implies that “The Second Amendment protects an individual right to possess a firearm unconnected with service in a militia, and to use that arm for traditionally lawful purposes, such as self-defense within the home.” Apparently it also implies (in the words of Justice Scalia who wrote the majority opinion) that the Constitution does not permit “the absolute prohibition of handguns held and used for self-defense in the home.”

I don’t now what Justice Scalia and the other members of the majority were smoking when they wrote the majority opinion, but I would really like some of it. The statement “There seems to us no doubt, on the basis of both text and history, that the Second Amendment conferred an individual right to keep and bear arms” is no more than an assertion, supported not even by the selective reading of history cited in support of this view, or by the apparent mind-reading abilities of the Justices when it comes to the original intent of the framers of the Amendment. In truth, their opion is supported only by the simple arithmetic of a 5 against 4 headcount.

At its regular meeting yesterday, the Fed opted to keep the target for the Federal Funds rate unchanged at 2.00 percent. With the most recent figure for headline CPI inflation coming in at 4.2 percent yoy, US monetary policy continues to be strongly stimulating.

From a macroeconomic stability perspective – price stability and the highest sustainable levels of employment and growth – monetary policy is far too expansionary. Inflation has been persistently above the Fed’s comfort zone for years. Inflation expectations have now moved up sharply. Dislocating these inflationary expectations will require either a period of low inflation brought about by excess capacity and high unemployment or a miracle. The Fed apparently believes in miracles. I only hope and pray for miracles. I don’t consider them a substitute for the right policies.

The effective fulfillment of the lender-of-last-resort function of the central bank requires that during a liquidity crisis the central bank lend freely to an institution that is illiquid but not  insolvent (if assets can be held to maturity), against collateral that would be good during normal times but that may have become illiquid during disorderly market conditions, and at a penalty rate.  The requirement that lender-of-last-resort facilities are only offered on punitive terms is key to the minimisation of moral hazard and thus to discouraging future imprudent, reckless lending and borrowing.

The same principle of providing assistance to illiquid but solvent institutions only on punitive terms applies when market illiquidity rather than funding illiquidity is the problem facing the troubled private financial institution and the central bank intervenes as market maker of last resort.

Any illiquid assets the central bank accepts as collateral in repos, at the discount window or at any of the more recently created special liquidity facilities, such as the Term Securities Lending Facility and the Primary Dealer Credit Facility in the USA or the Special Liquidity Scheme in the UK, must be valued or priced in a way that ensures that the transaction does not involve a subsidy from the central bank to the borrowing institution.  The repo, collateralised loan or swap should earn the central bank an appropriate risk-adjusted rate of return.  The same would apply if the central bank purchased illiquid private securities outright from a financially challenged private financial institution.  There is nothing wrong in principle with the central bank taking credit risk onto its balance sheet, as long as it earns a rate of return that adequately compensates it for that risk.

There is a growing suspicion in the markets that the ECB is subsidizing some euro area banks that are eligible counterparties at its discount window (the Marginal lending facility) or in repos, by overvaluing or overpricing illiquid collateral offered to the Eurosystem by these euro area banks.

In 1994 Robert Mugabe, President of Zimbabwe, was made an honorary Knight Commander of the Order of the Bath by Queen Elizabeth II.  This means he can put the letters KCB behind his name, but cannot use the title “Sir”.  Since then, Robert Mugabe has gone from freedom fighter and leader of a liberation movement to dictator, despot, thug and tyrannical leader of one of the most brutal and murderous regimes in the world.

His economic mismanagement has ruined a once-prosperous country.  Hyperinflation and, on conservative estimates, a 60% decline in real GDP are but two indicators of the massive decline in living standards suffered by the vast majority of the population.  Poverty and malnutrition have exploded.  Life expectancy has collapsed beyond even what could have been expected because of the regional incidence of HIV/Aids. Millions of Zimbabweans have become refugees, many of them in South Africa, where their arrival has caused large-scale riots by poor native South Africans who view them as competitors for jobs and housing.

French President Nicolas Sarkozy has blamed Peter Mandelson, the EU trade commissioner, for the Irish ‘no’ vote in the referendum on the Lisbon Treaty.  I yield to no one in the strength of my belief that the EU commissioners have super-human powers.  Even so, Sarkozy’s has to be an unusual mind to reach that conclusion. Why not blame the French and Dutch voters who in 2005 rejected the Treaty establishing a Constitution for Europe?  Without their ‘no’ vote there might not have been any need for a Lisbon Treaty – and it would have been such fun to have a referendum in the UK.

I am pleased to be able to bring you another wonderful piece of writing by Uwe Reinhardt.  In some ways it is a a sequel to his earlier piece on this blog “I hate mom (and the government too)”, but it also stands very well on its own.  This article was first published in The Daily Princetonian, on Tuesday, April 29th, 2008.  The marine referred to in the column is Uwe’s youngest son, Mark (aka Hsiao Hoo or Little Tiger).  I knew him as a tiny tot, when he used to hang around the pool and fountain next to the Woodrow Wilson School at Princeton University.

In his open letter to the Chancellor of the Exchequer, Alistair Darling, Mervyn King, Governor of the Bank of England, has given his explanation of why inflation in the UK has increased since last year. The open letter procedure is a useful part of the communication and accountability framework of the Bank of England. It requires the Governor to write an open letter to the Chancellor whenever the inflation rate departs by more than 1 percent from its target (in either direction). In that letter the Governor, on behalf of the Monetary Policy Committee (MPC) gives the reasons for the undershoot or overshoot of the inflation target, what the MPC plans to do about it, how long it is expected to take until inflation is back on target and how all this is consistent with the Bank’s official mandate. The current inflation target is an annual inflation rate of 2 percent for the Consumer Price Index (CPI). With actual year-on-year inflation at 3.3 percent in May 2008, it was time to sharpen the official quill and write an open letter.

I am distinctly underwhelmed by the Governor’s explanation of the reasons for the increase in CPI inflation. In the intermediate undergraduate macroeconomics courses I used to teach, his would have been a failing answer to the question: “What caused inflation to rise in the UK during the first half of 2008?”

Dear Chancellor,

There it is: 3.x%, with x > 0. What can I say? As that great philosopher Forrest Gump said: “shit happens”.

I won’t insult your intelligence the way both of us have at times seen fit to insult the intelligence of the British public – by claiming that the rising world prices of energy, food and other commodities lie behind the increase in the rate of inflation in the UK, the USA, the Eurozone and most of the rest of the world. When the currency floats, as is the case for sterling, central banks make inflation. To be even more precise, whatever else drives inflation in the short term, central banks can drive inflation towards its target level in the medium term. Short run price level and inflation blips are beyond our control, but over a horizon of more than a year or so, the buck (or should that be the quid?) stops at Threadneedle street.

The voters of the Republic of Ireland have rejected the Lisbon Treaty (officially the Treaty of Lisbon amending the Treaty on European Union and the Treaty establishing the European Community) in the referendum held on June 12. According to the rules of the EU, as found in the Nice Treaty, this means that the Lisbon Treaty cannot come into effect, as the unanimous ratification of the Treaty by all EU member states is required for this.

No point moaning that 4 million Irish cannot be permitted to thwart the will of 490 million other Europeans. That argument is bogus and dangerous, even if the 8 remaining EU member states that have not yet reached a formal decision on the Lisbon Treaty were to ratify it – something that is by no means a done deal. The rules for ratification of the Treaty were clear. To change the rules when you are losing is a violation of the rule of law. Respect for the rule of law is even more important than the fate of the Lisbon Treaty.

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