Ireland: The case for an adaptive approach to macromanagement

Gillian Edgeworth,  20 Nov 2017

Gillian Edgeworth of Wellington Management starts out with the story of how Ireland’s economy was able to converge with the rest of the EU in the period from the 1980s to the present. From 1990-2006 Ireland’s economy converged four times faster than did comparable emerging markets. It did this by taking advantage of the large increase in global trade which was seen during this period. With a corporate tax rate of only 12%, in this period Ireland became the base for many international corporations. Though this reliance on foreign cash flows allowed Ireland’s economy to grow, it also contributed greatly to Ireland’s vulnerability to the forces of the 2008 economic crisis.

The fact that Ireland had so much international economic involvement also meant that when it came time to handle its debt crisis, the Irish government had little say as the majority of the debt was owed to foreign creditors. Because Ireland is so heavily dependent on foreign cash flows experts worry that although it is currently successful it is particularly exposed to destabilizing changes in the international market.

Real estate and the great crisis: Lessons for macro-prudential policy

John Duca, 9 October 2017

John Duca, Deputy President of the Dallas Fed, spoke to PEFM in Balliol College on October 9 on macroprudential policy and the financial crisis. In his presentation Duca challenged the Rogov and Reinhart thesis that crises are caused by excessive build-ups of debt, arguing that crises are much more related to real estate booms and busts. These in turn were generated by massive relaxation of regulatory requirements in the period up to the crisis.

Duca argued that price trends in the US commercial and residential real estate markets are usually distinct, but unusually they were both booming in the run up to the crisis. He ascribed this to not only the well-known pervasiveness of low interest rates but, as importantly, the marked reduction in prudential requirements, as enforced through the risk-weighting on capital requirements, and the regulatory environment more generally. There was an underappreciation of the risks, particularly the tail risks, with no recognition of inter-connectedness. There was an illusion that mortgage-backed securities (MBS) were safe.

Until around 2000, the US financial system was regulated through a series of provisions largely enacted after the Great Depression. In 2000 it became possible to protect MBS through credit-default swaps; the market took when, under the Commodities Futures Modernization Act, derivatives contracts were to be honored before regular contracts in bankruptcy. As regards sub-prime mortgages, investors thought they were getting short term investment grade assets, when in fact they were getting junk. In 2004 capital requirements on banks were 8%, but risk-weights on bank holdings of MBS were slashed, so that the effective rate became just 1.6%. Issuances of MBS soared into the stratosphere.

Journal of Financial Regulation and Compliance: Policy responses to the Great Financial Crisis

Journal launch: Journal of Financial Regulation and Compliance: Policy responses to the Great Financial Crisis: edited by Charles Enoch (PEFM, St Antony’s, Oxford), Tom Huertas (Ernst and Young), David Llewellyn (Loughborough) and Maria Nieto (Bank of Spain)

On 29 September, 2017 PEFM hosted a conference to mark the launching of a double-number special edition of the Journal of Financial Regulation and Compliance (JFRC), looking at policy responses to the global financial crisis (GFC)—see programme attached. The event was co-sponsored by Ernst and Young and the JFRC, together with PEFM. Speakers were largely contributors to the special edition.

Tom Huertas, introducing the conference, noted that the volumes were divided into sections on firefighting, macro policy and micro responses. As to the first, the US and UK had provided solvency support. Through the G20 a comprehensive reform agenda was agreed at the Pittsburgh summit, and the Financial Stability Board (FSB) was enhanced as the overall coordinating body. As regards recovering the public costs incurred, in the US over $300 billion of restitution fees have been levied over the past five years.

Bilateral and regional trade agreements: A case for economic reform?

Speaker: Paul Gretton, Australian National University

Chair: David Vines, Balliol College, Oxford

In this PEFM seminar, Paul Gretton tackled one of the thorniest questions plaguing trade policy today –the implications of the shift from a multilateral system to a proliferation of bilateral and regional trade agreements (BTAs and RTAs). As global action through the Doha round has stalled and trade growth has significantly slowed down, countries have sought other instruments to advance trade liberalization. By far the most common approach has been to rely on preferential agreements, either of ‘hub-and-spoke’ nature such as the EU, or on a bilateral basis.

However, such preferential deals that liberalize trade between participants but not externally have created a phenomenon known as a ‘noodle bowl’ of agreements. Their proliferation has led to complexity through associated rafts of regulations necessary to enforce them and has eroded productivity by diverting trade from lowest cost suppliers. Thus, such BTAs and RTAs are increasingly viewed not as a stepping-stone to a global agreement, but as impeding trade liberalization.

Economic and Financial Challenges in South East Europe

Speaker: Gent Sejko, Governor, Bank of Albania
Chair: Othon Anastasakis, St Antony’s College, Oxford

Building on its long association with the Bank of Albania, PEFM was delighted to welcome its Governor, Mr. Gent Sejko, for a discussion on the role of central banks as guardians of price and financial stability. In his talk, he presented Albania’s experience in addressing the global financial crisis and its aftermath and highlighted some of the lessons learned from the perspective of a small South East European economy.

Governor Sejko began by presenting the general regional dynamics. Initially, strong financial integration with the EU benefited South East Europe, particularly through rapid credit growth. However, integration turned into a shock propagator in the aftermath of the global financial crisis. Inflation, previously a significant concern, fell across the Western Balkans. In addition, an increase in NPLs also contributed to lower growth, particularly in Albania and Serbia, while unemployment and emigration remain a challenge for the whole region. Finally, the crisis has had a structural impact on South East European economies, halving growth to 3.5% annually, and leading to declining productivity and investment rates.

An exposé of the Asset Management industry

Speaker: Ron Bird, University of Technology, Sydney

Chair: David Vines, Balliol College, Oxford

How can we explain the existence of a multi-trillion dollar industry that consistently underperforms? This is the provocative question that Prof. Bird addressed in his seminar talk for PEFM. In particular, he focused on asset managers, that is, those that invest other people’s funds. In this arrangement, risk stays with the fund owners who get the investment returns net of all costs, while managers charge an asset-based fee and may charge a performance fee.

The size of the industry is impressive – over 71 trillion USD worth of assets under management, with profits of 102 billion USD. The biggest division within is between active and passive management. Active managers seek to pick stocks that outperform relative to a benchmark index by overweighting better performing stocks. This is opposed to passive management, which is becoming more and more popular in recent years, accounting for up to one-third of US mutual funds.

The Changing Roles of Central Banks

Speaker: Prof. Charles Goodhart, LSE
Chair: David Vines, Balliol College, Oxford

Today there appears to be a cacophony of opinions about the future of central banks. To separate the signal from the noise, PEFM was privileged to host Prof. Goodhart. Taking a long-term view of the past and the future, he argued that the history of central banking has alternated between periods of consensus and uncertainty. Using this framework, he placed in context the many disparate debates taking place today in the world of central banking.

Prof. Goodhart began with the late Victorian consensus (1873-1914) focused on the gold standard and the real bill doctrine (the idea that the proper assets for commercial banks are bills of exchange focused on real activity). However, both of those broke down between 1914 and 1933 as they contributed to deflation and depression. Thus, a new consensus of fiscal dominance was born that lasted from 1934 to 1970. With the rise of Keynesianism and with central banks subject to financial ministries, the understanding emerged that financial instability is a result of excessive competition that squeezed profit margins and pushed banks towards riskier activities. However, between 1971 and 1990 the growth of technology and financial markets, stagflation and disputes about the appropriate anchor for monetary targets induced a period of uncertainty.

Technology and the future of the labour market

Speaker: Daniel Susskind, Balliol College, Oxford
Chair: Adam Bennett, St Antony’s College, Oxford

These days, it is hard to imagine a topic with more significant implications for the future than the impact of technology on the labour market. It is also hard to find people who have combined policy work with research on this topic, such as Daniel Susskind. In this seminar, he presented his insights, particularly regarding the role of ‘advanced’ capital in overturning traditional understandings of the relationship between technology and labour market skills.

Susskind begins by looking at historical data on the labour market. Thus, in the 20th century a ‘skills wage premium’ emerged based on increasing returns to college education. Strikingly, this premium remained even as more and more people were graduating from college due to the skill-biased nature of technological change, which meant demand for skilled labour to operate this new technology outpaced increasing supply. By contrast, in the 19th century, the industrial revolution appeared to have a bias toward increasing the demand for unskilled workers, displacing skilled workers (such as the luddites) with machines that could be operated by unskilled workers. Initial data from the 21st century suggest that today both things are happening at the same time, leading to more employment at the bottom and the very top of the skill distribution, but also to the ‘hollowing out’ the semi-skilled middle classes, which have thereby seen their wages stagnate.

Public debt in advanced countries: problems and solutions

Speaker: Carlo Cottarelli, IMF Executive Director for Italy

Chair: Charles Enoch, St Antony’s College

Following the global financial crisis, public debt spiked in many advanced countries. However, according to Carlo Cottarelli, the risks, which accompany living with high debt-to-GDP ratios, are not often discussed publicly. This has prompted him to write a book, What We Owe – Truths, Myths, and Lies about Public Debt, which forms the basis of his PEFM talk.

Cottarelli began with a striking chart demonstrating the level of public debt in advanced economies. As was clearly visible, after World War II there was an unprecedented build-up of debt in peacetime. Notably, these ratios do not include the hidden liabilities in terms of pension and healthcare entitlements, which are likely to rise, but are outside the focus of Cottarelli’s work.

Facing the pensions challenge: Lessons from Australia

Speaker: Nicholas Morris, University of New South Wales, Sydney

Chair: David Vines, Balliol College

It is hard to imagine a bigger long-term challenge for advanced economies than funding their pension systems going forward. To address this, many countries have introduced ‘defined contribution’ schemes through private pension funds. However, as Nicholas Morris highlights drawing on his research on Australia, such funds could also face complex management problems that lead them to underperform.

Prof. Morris begins by setting the context for his talk. Pension funds in Australia have accumulated assets worth over 100% of national GDP that are expected to grow to 7 trillion Australian dollars by 2035. As a result, complex industries have emerged to manage the funds, charging relatively high fees in comparison to international benchmarks. However, such funds have still underperformed for several key reasons despite no lack of scrutiny and reports. First, while they look diverse on the surface, they tend to only have limited competition in practice leading to oligopolistic behaviour. Second, splitting the regulator into five different agencies overseeing pensions has meant that nobody takes overall responsibility. Third, legal changes have weakened trust law protection, particularly by not forcing unregulated entities to report costs, which has often led to the outsourcing of management.

Aspects of the ECB’s monetary policy: State-of-play and future prospects

Greece and the Euro Zone: The IMF Perspective

Speaker: Poul Thomsen (Director, European Department, IMF)
Chair: Adam Bennett (St Antony’s College)

In the midst of ongoing negotiations with Greece over a third IMF financial assistance program, PEFM had the pleasure of hosting Poul Thomsen, the Director of the European Department at the IMF. Drawing on his extensive experience as mission head for IMF teams in Greece, Mr. Thomsen presented the Fund’s perspective on the problems that continue to plague the Greek economy and the way forward.

Mr. Thomsen began by offering some comments on the prospects of the euro area as a while. Overall, the recovery is gaining momentum and cyclical unemployment is low. This is partly due to fiscal relaxation, but most of it is happening in precisely the countries with the least fiscal space, leaving them potentially vulnerable to renewed shocks. More worrying still, the euro area long-term potential is limited because of structural problems that predate the euro crisis, particularly low productivity growth that was contributing to stalled convergence. Therefore, while there are missing elements of EMU architecture that clearly needed to be added or completed, the main problems were really at the national level. In a currency union that is not a political union the ability to deal with shocks depends on policies at the national level.

Ireland and Brexit

Speakers: Lord Jay of Ewelme (House of Lords), Kalypso Nicolaides (St Antony’s College), Cathryn Costello (St Antony’s College)
Chair: Graham Avery (St Antony’s College)

The ‘Irish question’ did not necessarily receive a lot of attention in the run-up to the Brexit vote, but has since then emerged as one of the hardest issues for Theresa May. It also resonates beyond the corridors of Whitehall as an overflowing crowd in attendance at the European Studies Centre made evident. In response, the three speakers sought to highlight some ways to manage the risks involved, but warned that the stakes are high.

Lord Jay, part of the House of Lords EU Select Committee, began the discussion by saying he fears the Irish dimension would be seen as a consequence of decisions taken on other grounds. He sees a risk that Brexit might bring into question the remarkable progress in the peace process in Northern Ireland. In particular, should the UK leave the Customs Union some kind of controls along the border become very hard to avoid. In turn, this is a serious issue for the nationalist communities along the border and is not impossible for some level of violence to re-emerge. 

Aspects of the ECB’s monetary policy: State-of-play and future prospects

Speakers: Iannis Mourmouras (Deputy Governor, Bank of Greece)

Chair: Charles Enoch (St Antony’s College, Oxford)

As the debate over ECB’s monetary policy continues, it was a pleasure to host a renowned policymaker and academic such as Iannis Mourmouras, Deputy Governor of Bank of Greece, at this joint PEFM-SEESOX event. Prof. Mourmouras drew on his experience to analyze the current targets and instruments of the ECB and offered some thoughts over the thorny question of ‘exit strategies’.

Prof. Mourmouras began his talk by discussing the track record of inflation targeting regimes over the last 15 years. Whereas they have been exceptionally successful in bringing inflation down, policymakers in Europe today face the challenge of how to push inflation back up given a persistent negative output gap. Prof. Mourmouras argues that low inflation is the symptom, not the cause of low nominal demand. The ‘suspects’ for the effect include demographic changes that lead to increased household saving, the legacy of the sudden stop and sovereign debt crisis in Southern Europe, and expectations for future low rates. Mario Draghi, the ECB president, argues further that there is insufficient investment demand to absorb all savings in the global economy.

Does IMF conditionality lead to political illiberalism? A comparative South East European perspective

Speaker(s): Merih Angin (Blavatnik School of Government, Oxford), Saliha Metinsoy (Wadham College, Oxford), Alex Kentikelenis (Trinity College, Oxford)

Chair: Charles Enoch (St Antony’s College, Oxford)

Political illiberalism, in South East Europe as well as across the world, is a topic of rising concern. However, is it possible we have overlooked an important driver – economic conditionality imposed by the IMF in crisis-hit countries? This was the provocative question posed to the three scholars who have focused their research on the IMF at this joint PEFM-SEESOX seminar. The picture that emerges does not provide for easy and clear cut answers, but these scholars argue that under particular conditions the IMF might inadvertently strengthen illiberal currents.

Merih Angin tackled the topic by looking at the role of the IMF in the AKP’s rise. In 2001, Turkey was hit by a financial crisis, leading to an agreement with the IMF. Shortly thereafter, the conservative AKP won parliamentary elections. However, during this period Dr. Angin describes the AKP as “in government but not in power”. Therefore, it had strong incentives to implement IMF conditionality given its need to overcome suspicions of its Islamist image in the West, as well as to generate economic growth, which was crucial to its domestic legitimation. Therefore, it ardently pursued the IMF program as it allowed it to accumulate power, gain external support, and undertake an extensive process of state transformation. Indeed, the AKP itself signed a new deal with the IMF in 2005, promising the privatization of the four largest state enterprises.

What does the FICC Standards Board do?

Rebuilding trustworthiness in financial markets

Speaker: Mark Yallop (Chair of FICC Markets Standards Board)

Chair: Adam Bennett (St Antony’s College)

One of the key questions in the aftermath of the global financial crisis is how to restore trust, especially in wholesale financial markets? A string of large-scale market manipulation scandals have made this discussion even more topical. Given its prominence, PEFM was delighted to host Mark Yallop, chair of the FICC Markets Standards Board, to share his analysis of the issue. In his talk Mr. Yallop identified some perennial problems with financial markets and advocated for a standards-led approach to rebuilding trustworthiness.

Mr. Yallop began his talk with two examples of market manipulation. In the later stages of the Napoleonic Wars, de Beringer and his associates sought to spread news of Napoleon’s demise in order to inflate gilt prices and sell their holdings at a profit. They were eventually discovered, and tried by the English courts in the first case of market manipulation in their history. Much more recently, Tom Hayes, an interest rate derivatives trader in Tokyo, was accused of using more modern means to the same goal. Through instant messaging, he was supposed to have communicated with the traders setting the daily Yen LIBOR rate, convincing them to slightly change their estimates in the direction that suited his portfolio. In 2015, Hayes was sentenced to prison in the most recent market manipulation case in front of British courts.