Welfare losses for future German generations: Two interpretations

This DIW publication, which is unfortunately not available in English in full version, makes the point that Germany's foreign investments--which accumulate as flip side of the current account surplus--fared quite badly during the crisis. The report goes so far to say that "some of the net valuation losses of German firms and individuals could have been prevented if their savings had been invested in long-term assets either in Germany or abroad." Ouch! Slap in the face of the German saver!  First a word of caution. Valuation changes are calculated as the residual between year end stocks and flows, which is a fairly coarse measure. Breaking...

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Sovereign bank link? Bank sovereign link? Or linking banks to sovereigns?

The sovereign bank link and the imperative to break it is fairly ubiquitiuous in today's discussion how to improve the financial system. Like with so many overused and underthought buzz words, the sovereign bank link embeds several aspects which circumscribe different problems and solicit different solutions: Banks' preference for public over private lending: Public sector loans and sovereign bonds often enjoy privileged treatment, such as zero risk weight among other. This is often thought to bias banks towards lending to the public sector. However, competition will cause this benefit to accrue to the debtor, not the creditor: all else equal, the cost of funds for the public debtor becomes cheaper than for private debtors, resulting in a lower hurdle rate for public than for private investments. This can lead to an unhealthy allocation of savings indeed....

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Germany's current account surplus: Structural or cyclical?

A little discussed aspect of the recurring discussion about Germany's current account balance is the distinction between its structural versus cyclical nature, and the implications thereof. On one hand, the case for reigning in the current account surplus may not be given if it is driven by certain structural factors, such as demographics. On the other hand, it would be a grave policy mistake if structural measures were taken to moderate a cyclical current account surplus. As with policies that attempt to influence the cycle in general, applying the right dose at the right time is tricky, and has often proven ineffective. How can the structural...

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Policy responses to debt overhang: Asset price support

The role of sectoral balance sheets, and their linkages, is used oftentimes to explain the euro area crisis and the sluggish recovery. Richard Koo's holy grail narrative of balance sheet recessions experiences a post-academic renaissance. A recent Vox piece by Jorda, Schularick, and Taylor adds to the empirical analysis in this field. (Let me forgive them to cite the infamous 90 percent public debt-to-GDP threshold.) Their research shows that in advanced economies, balance sheets of the household and financial sectors empirically play a pivotal role in explaining the outbreak of crises and the speed of recovery. Strong government balance sheets, i.e. low public debt and a healthy structural balance (also coined "fiscal space"), help to mitigate a shock. These are all useful empirical insights, but what are the mechanics which need to be understood...

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A second Greek debt restructuring (2): A repeat?

Public debt is very high, public and private investment has collapsed, and the economy shrinks. Official lenders provide the financing needed to service debt. This situation describes not only Greece today, but also the many developing countries in the 1980s debt crises. This blog post applies the insights of that time provided by Krugman (1988, 1989) and Froot (1989) to the current situation in Greece. In a situation where the future repayment capacity is exogenous yet uncertain, creditors are better off never to grant debt relief. While the expected value of the repayment may be below the nominal value of debt owed--as is surely the case for Greece--the creditors' claim has some option value. As Krugman (1988) writes, creditors would be "foreclosing the possibility of benefitting from any later good fortune on part of the country." Creditors have thus the...

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A second Greek debt restructuring (1): when and how much?

Much is being said about this, over and again. Private bondholders have already received a haircut, and there is no rationale for official creditors (European partners and the IMF) to annul part of their claim as long as they provide for Greece's financing need in full. Financing under the current program lasts until 2016, although euro member states have pledged support longer if needed. The discussion about debt relief will only become ripe once Greece prepares for its re-entry into international financial markets. In addition to a sustainable debt ratio, investors likely require (i) solid economic growth; (ii) a revival of employment; and (iii) a healthy primary budget surplus. While the IMF projects these conditions to be in place from 2016, no market funding is penciled in at least until 2018 (the last year shown in the IMF's tables). At that point, financing...

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Foreign Invasion in German's Housing Market: A Blessing?

The recent house price jolt in some German cities reportedly coincides with strong buying interest by foreigners (see FT weekend edition from August 3). This trend is not so different from other global cities, such as London where three quarters of buyers are reportedly from abroad (dito). Are wealthy foreign buyers causing German cities to become unaffordable to German dwellers? Here is a view that could liven up your Stammtisch debate. First, compared to other countries, home ownership in Germany is exceptionally low and tenant regulations strong, limiting the impact of house price inflation on many German dwellers. Recent research has shown that low ownership rates are associated with lower unemployment, possibly as tenants are more mobile than home owners. This suggests that rental demand could be elastic enough to contain rent-to-income ratios, limiting the...

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