Arnold Kling  

Today on the Eurozone Crisis

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Felix Salmon writes,

The best case scenario is that those countries bite the bullet and restructure their debt now, since to delay is to make any restructuring much more painful and expensive than it needs to be.

Pointer from Mark Thoma.

Salmon complains that as far as the latest plan is concerned, "the commitment is still vague." What I want to suggest is that for the politicians, vagueness is a feature rather than a bug. This reflects a fundamental misalignment between political incentives and economic requirements.

What markets and the economy need are policies that resolve uncertainty. That way, people know who is going to take a hit. Most important, they know where they can invest with confidence going forward.

What politicians need are vagueness and opacity. Having a clear, well-defined policy exposes the politician to the people who are hurt by that policy. Thus, instead of producing a balanced budget today, you produce a plan to produce a plan to balance the budget down the road. Instead of restructuring sovereign debt, you make a commitment that everyone will be made whole, without explaining how that commitment will be honored.

For example, the United States managed to make its insolvent banks whole (for now, at least), using a massive subsidy from the Fed. I agree with David that the best analysis of this comes from Jon Stewart. Naturally, this subsidy was made as vague and opaque as possible. The Fed will tell you that this was necessary to prevent runs on the weakest banks. But in fact the motivation was much more that the Fed wanted to avoid the political resistance that would have built up had people actually known what it was doing.

In the Eurozone crisis, the political leaders face a delicate challenge. If they are too vague, the markets will be skeptical, and the crisis will continue. If they are too precise, they will expose themselves to backlash from the public. So far, they have erred on the side of vagueness. This may surprise people who expect technocratic excellence, but it is a natural outcome, just as the failure of the U.S. to fix its budget problems is a natural outcome.

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CATEGORIES: Eurozone crisis

COMMENTS (4 to date)
Yancey Ward writes:
Most important, they know where they can invest with confidence going forward.

And I would argue this is the part that concerns the political economists more than any other. Restructuring of debts will recast the risk profile of sovereign debts, and make it far harder, and much more expensive to spend beyond tax revenues for some time to come.

Randy writes:

Re; "...for the politicians, vagueness is a feature rather than a bug."

Funny, I was just thinking along the same lines this morning, that politics is confusing, and that the creation of the confusion is deliberate. Being a tech guy, I like your line better.

Mark Michael writes:

When I heard that the Fed had "bought" $7.5 trillion in dodgy securities from the banks on a dollar-for-dollar basis, it sparked the recollection of the televised congressional hearings in which Bernanke, Hank Paulson, et al, were debating how they were going to price those dodgy securities under the TARP.

Congress persons asked them, "How do you figure out how much they are worth? There's no real market for them. They're illiquid." Bernanke looked really serious, stroked his chin, and came up with some oddball method which escapes me now.

We now know it was all a charade! He had no intention of negotiating some market price. Innocent question: Why couldn't he have at least insisted on a nominal discount, say 10% or 20%? Or, asked for the heads of the top management once the panic was ended. Is this just a case of how government bureaucrats behave when they're using other people's money?

What are the real skills in central banking? Is it maybe monitoring the risk-level of the banks for which it is serving as "bank of last resort" - while the "party is still going on"? I'd put setting interest rates as 1% of their skill set and risk monitoring and management as most of the other 99%. In hindsight, it seems to me that the Fed officials just merrily watched our major banks take on more & more risk during the housing bubble and said, "The market will handle it. We can twiddle our fingers, or play cards."

Will McChesney Martin said that taking away the punch bowl when the party gets going is the job of the Fed w.r.t. monetary policy. How about coming up with some pithy phrase about raising the "price" of buying risky loans added to the job of the Fed?

Hmm. As a investor and depositor in banks, I, too, rely on FDIC insurance to relieve me of the task of personally assessing the risk of my bank. Ditto the Fed. Ditto those 3 rating agencies that handed out AAA ratings of those dodgy MBSs. So relying on the "marketplace" to discipline those banks/financial institutions is silly: We're paying big bucks to a bunch of big bureaucrats to monitor those institutions for us. Why should we do it ourselves, too? (Greenspan said he thought that market discipline would keep those money center banks from taking on too much risk.)

Jon writes:
I agree with David that the best analysis of this comes from Jon Stewart. Naturally, this subsidy was made as vague and opaque as possible.

As I explained on David's post, the report is a misleading insinuation. The Fed activities were about half as large as TARP not ten times the size.

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