Like most authors, I tend to cringe when I read something I wrote more than a few years ago.  But while engaging in some authorial auto-archeology recently when preparing the index for a new paper (after all, if I don’t cite myself, who will?), I was pleasantly surprised with a few bits from a paper I wrote in 1999 and published in 2000 in the Bank of England’s Quarterly Bulletin, titled “The new economy and the old monetary economics”.

The paper takes aim at the assertion, rampant in 1999, that the behaviour in recent years of the world economy, led by the United States, could only be understood by abandoning the old conventional wisdom and adopting a ‘New Paradigm’. Prominent among the structural transformations associated with the New Paradigm were the the following: increasing openness; financial innovation; lower global inflation; stronger competitive pressures; buoyant stock markets defying conventional valuation methods; a lower natural rate of unemployment; and a higher trend rate of growth of productivity.

I argue, first, that the New Paradigm has been over-hyped. “…Unfortunately, the ‘New Paradigm’ label has been much abused by professional hype merchants and peddlers of economic snake oil.”

Second, I argue that, to the extent that we can see a New Paradigm in action, its implications for monetary policy have often been misunderstood.

I was particularly pleased that I had written following about financial innovation:

Last week the Eurosystem performed a €442bn injection of one-year liquidity into the Euro Area banking system.  They did this at the official policy rate – the Main refinancing operations (fixed rate) – of 1.00 percent, against the usual collateral accepted for Longer Term Financing Operations, effectively anything euro-denominated, not based on derivatives and rated at least BBB-.  It was a fixed-rate tender, that is, the ECB was willing to meet any demand at the 1 percent interest rate, as long as eligible collateral was offered; 1121 banks participated in the operation.

You will not be surprised to hear that this was the largest one-day ECB/Eurosystem operation ever.  Even more remarkable than its scale are the terms on which the one-year funds were made available.  There can be no doubt that this operation represents both a subsidy and a gift from the Eurosystem to the banks that participated in the operation.  I hope to clarify the distinction between a subsidy and a gift in what follows.

Whenever the cumulative effect of the daily observation, looking out of my window or into the mirror, of human inequity and wretchedness brings me to the point that I am convinced the human race is an evolutionary dead end, something incredible happens to restore my faith that a hunger for freedom and an unquenchable thirst for justice and fairness are part of our genetic code. Crowds often become mobs and mobs are mostly ugly and destructive. The sight of large numbers of unarmed people, most of them young, facing heavily armed police, regular army, militia or other armed thugs is awe-inspiring.

To think I believed I had seen it all as regards creative uses and abuses of credit default swaps (CDS).  But then came Amherst Holdings.

A credit default swap written on a security (a bond, say) is a contract that pays the owner a given amount when there is a default on that security. In the simplest case, the owner of the CDS receives from the issuer or writer of the CDS the face value of the bond that is in default.  The writer of the CDS sells insurance against an event of default.  The insurance premium is the price of the CDS.  The buyer of the CDS buys insurance against default.  If the default does not occur, the writer of the CDS wins, because he has received the insurance premia, but has not had to pay out on the insurance policy.

To those of you prone to apoplexia gravis, a word of caution: this post does not advocate smoking anything, other than possibly herring.  Nor does it represent a defence of tobacco companies or other enterprises dedicated to the challenge of profiting from the sale of highly addictive toxic substances.  It is instead a plea not to abandon reason and the careful use of language when writing about stuff we strongly disapprove of.  Overstating a strong case often hurts it. It is also dishonest.

I am fortunate in that my kids, when they were mere tots, bullied me into giving up smoking.  As soon as I lit up in their vicinity, they would cry out “daddy, you are going to die!”.  Worse than that, they used to rat me out to my wife when I snuck outside for a quick smoke behind the shed.  It was a battle I could not win, so I quit.  Filthy habit.

You must have seen headlines stating something like “Smoking ‘kills five million a year’” (the year in question was 2000).  What does this mean?  Is this a bad thing or a good thing? Does it mean that five million people who died in 2000 would not have died when they did?  That they would not have died ever, if only they had not smoked? That they would have died later (if so, by how many years or months), and that the manner of their dying would have been more comfortable that their smoking-caused deaths?

The headline in question really ought to have read: “Smoking-related illness and disease caused the premature deaths of five million people worldwide in the year 2000.  Average life spans were -reduced by N years. If they had not smoked, the five million would not have died of smoking-related illnesses and diseases – cancer (lung, throat, mouth, larynx oesophagus, lung, kidney, bladder, pancreas, stomach, blood and cervix), diseases of the cardiovascular system (atherosclerosis, stroke, heart disease, aneurysms of the aorta and peripheral vascular disease), diseases of the respiratory system (emphysema, bronchitis and pneumonia), increased health risk and risk of death to the unborn from smoking pregnant women, periodontal disease, brittle bones, cataracts, ulcers.  Instead they would have died, had they not smoked, at some later date, of cardiovascular diseases, infectious and parasitic diseases, ischemic heart disease, assorted cancers, strokes, lower respiratory tract infections, respiratory infections, respiratory diseases, unintentional injuries, HIV/AIDS, chronic obstructive pulmonary disease, perinatal conditions, digestive diseases, diarrheal diseases, intentional injuries (suicide, violence, war, etc), tuberculosis, malaria, road traffic accidents, neuropsychiatric disorders, diseases of the genitor-urinary system, cirrhosis of the liver, nephritis/nephropathy, Alzheimer’s disease and other dementias, musculoskeletal diseases, hepatitis B, Parkinson’s disease, alcohol use, drug use, upper respiratory infections, skin diseases, hepatitis C, Huntington’s disease, multiple sclerosis, motor neurone disease or some other condition.

In my discussion of the Cap & Trade scheme for carbon dioxide equivalent (CO2E) emissions (greenhouse gases) proposed by U.S. Reps. Henry Waxman, D-Calif., and Edward Markey, D-Mass. (the American Clean Energy and Security (ACES) Act of 2009), I argue that the two key issues are (1) the size of the overall quota and (2) the enforcement of the rule that without a permit, you cannot emit.

Prima facie, the scheme looks tough.  The Discussion Draft Summary of the American Clean Energy and Security Act of 2009 reads: “The draft establishes a market-based program for reducing global warming pollution from electric utilities, oil companies, large industrial sources, and other covered entities that collectively are responsible for 85% of U.S. global warming emissions. Under this program, covered entities must have tradable federal permits, called “allowances,” for each ton of pollution emitted into the atmosphere. Entities that emit less than 25,000 tons per year of CO2 equivalent are not covered by this program. The program reduces the number of available allowances issued each year to ensure that aggregate emissions from the covered entities are reduced by 3% below 2005 levels in 2012, 20% below 2005 levels in 2020, 42% below 2005 levels in 2030, and 83% below 2005 levels in 2050.”

In fact, the scheme is a total con.  It permits the US to increase CO2E emissions until 2020.  The escape mechanism used – carbon offsets or carbon credits – suggests that for the period 2020 – 2050 also, the supposed intent of the Act – to reduce CO2E emissions in the US – will be neutered. 

How the business cycle is browning America

In politics, the urgent but not necessarily terribly important always trumps the important but not palpably urgent.  In the US today, getting out of the economic downturn is urgent, but not a matter of life and death.  Moving towards sustainable energy use and cutting back on man-made contributions to global warming is a matter of life and death, but not immediately so in the US.  When there is a conflict between a speedy exit from the recession and saving the environment, the environment therefore loses.

Since the crisis hit, it has been clear that the only pro-environment policies that have a chance, in the US and possibly elsewhere too, are those that involve increased public spending.  In this case environmental and Keynesian demand-boosting imperatives point in the same direction.  Examples are grants for home insulation, support for R&D and environmentally friendly infrastructure expenditure such as public transport improvements.  When environmental logic demands policy measures that increase costs to the private sector, however, the fact that such measures impose a financial burden on an already groaning private sector means that such measures will at best be watered down, at worst not implemented at all.

We have just seen two examples of this – the strange and deeply uninformed debate about a cap & trade scheme for CO2E emissions recently introduced in the House of Representatives, and the admission by the US Secretary of Energy, Dr. Steven Chu that bringing US fuel taxes (especially taxes on gasoline/petrol) is politically out of the question for the time being.

Old papers never die, they just get recycled.  The Den Uyl lecture I gave in Amsterdam on 15 December 2008 has been under continuous redevelopment since then.  Its latest outing was as background paper for a lecture I gave at the 25th anniversary Workshop ” The Global Financial Crisis: Lessons and Outlook”, of the Advanced Studies Program of the IFW, Kiel, Germany, on May 8/9, 2009. The whole current enchilada can be found here.  For those with lives, I reproduce below the Introduction, Section 1, the Conclusion and the 16 recommendations in between.


“Never waste a crisis. It can be turned to joyful transformation”. This statement is attributed to Rahm Emanuel, US President Barack Obama’s White House Chief of Staff.  Other versions are in circulation also, including “Never waste a good crisis”, attributed to US Secretary of State Hilary Clinton.  The statement actually goes back at least to that fount of cynical wisdom, fifteenth century Florentine writer and statesman Niccolo Machiavelli “Never waste the opportunities offered by a good crisis.” Crises offer unrivalled opportunities for accelerated learning.

I believe that the current crisis teaches us two key lessons.  The first concerns the role of the state in the financial intermediation process and in the maintenance of financial stability.  The second concerns the role of private and public sector incentives in the design of regulation.  Unless these lessons are learnt, not only will the current crisis last longer than necessary, but the next big crisis, following the current spectacular example of market failure, will be a crisis of state ‘overreach’ and of government failure.  Central planning failed and collapsed spectacularly in Central and Eastern Europe and the former Soviet Union.  The next socio-economic system to fail, after the Thatcher-Reagan model of self-regulating market capitalism with finance in the driver’s seat – finance as the master of the real economy rather than its servant – may well be a stultifying form of state capitalism, with initiative-numbing over-regulation and overambitious social engineering.

The spinelessness and moral cowardice of the Obama administration know no bounds.  The Bush-Cheney  team ordered the torture and abuse of prisoners in Guantánamo Bay Naval Base and assorted other locations abroad – offshore detention without trial as well as torture by US officials or persons acting under their instructions being permitted by Article VIII of the United States Constitution, as confirmed in the XXVIIIth Amendment to the US Constitution.

Candidate Obama declares he abhors torture and deplores what went on in Gitmo and in secret detention centres around the world, but President Obama decides that the Camp may have to remain open for another year, as he doesn’t seem to know what to do with the prisoners.  The right thing to do would have been to send a plane to Guantánamo Bay Naval Base on the day of his inauguration, to move all the prisoners to the US.

President Obama then also decides not to prosecute those who committed the crimes of torture or abuse of prisoners or were responsible for these crimes. The president’s excuse was was that he sought to turn the page on “a dark and painful chapter”.  It was a “time for reflection, not for retribution”, he said.

He is quite wrong.  Reflection complements the law.  It is not a substitute for it.  Those who can be charged with these offences should be tried and, if found guilty, punished according to the law.  If among the guilty parties are CIA agents and former vice-president Dick Cheney, then so be it.  If you cannot do the time, you should not do the crime.  This is not vengeance, it is justice – and it is the law.  Justice must be done and must be seen to be done before healing and reconciliation can start.


I know of ethical systems that hold all interest to be sinful.  Riba, interest on money, is forbidden by the Quran.  I don’t know what Sharia scholars would have to say about negative nominal interest rates.  If if were viewed as a gift from the lender to the borrower it might even be condoned.  Perhaps an extra-credit question on the next Islamic finance examination?  Medieval Christianity also banned ‘usury’,  which meant any ‘interest’ rather than outrageous interest rates – its modern meaning.

Interest is viewed by some as immoral because it represents an increase in capital without any services being provided.  I don’t share the sense of moral outrage at interest per se, but I can understand where it comes from – something for nothing ain’t right.  However, I know of no ethical system that attaches opprobrium to an intertemporal relative price that is greater than unity but not to an intertemporal relative price that is less than unity – or vice versa.

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