No subject
Fri Dec 14 00:29:05 UTC 2007
limiting and if possible reducing first the flow of greenhouse gas emission=
s
and ultimately the atmospheric concentration of greenhouse gas emissions
(the stock), it is necessary and sufficient to raise the opportunity cost o=
f
emitting an additional unit of carbon dioxide equivalent (CO2eq) and/or to
raise the opportunity cost of not cutting back greenhouse gas emissions by
an incremental unit.
Raising the opportunity cost of emitting an additional unit of CO2eq means
taxing greenhouse gas emissions. This can be achieved by imposing a unifor=
m
tax on each unit of emissions (as measured by say, a metric ton (Mt) CO2eq
units). Let's call it the uniform global CO2eq emissions tax or carbon tax
for short. For efficiency reasons, this carbon tax should be the same, if
the externality is the same, regardless of whether the emissions come from
the poor in Bangladesh or from the rich in St. Moritz. That's obviously
unfair.
Fortunately, efficiency and equity can both be served once we recognise tha=
t
the alternative to a common global tax per Mt of CO2eq emissions would be a
common subsidy per Mt of CO2eq not emitted. The uniform tax rate per unit o=
f
CO2Eq and the uniform subsidy rate should be the same. When emissions in a
developing country increase above their allowance, it would not have to pay
the tax, but there would be a progressive withdrawal of the subsidy. So th=
e
incentive to reduce greenhouse gas emissions at the margin would be the
same, but the distributional consequences would of course be quite
different.
The subsidies for CO2eq emissions reduction would have to be financed out o=
f
a global fund, the Global Warming Fund, or GWF, say. Taxes imposed by the
richer countries on greenhouse gas emissions could go into the GWF, althoug=
h
there is no logical reason for earmarking them like that. In principle, th=
e
GWF should be funded out of general revenues, in an amount sufficient to pa=
y
the subsidies required to achieve the desired reduction in greenhouse gas
emissions in poor countries.
*The carbon credits/ carbon offsets racket*
A carbon tax is hard to implement, because it requires, as with any tax,
that the authorities know and can observe the tax base. In this case this
means that the fiscal authorities must be able to monitor actual emissions
of CO2eq. These measurement problems are hard, but not insurmountable in th=
e
advanced industrial countries. With very weak tax administration and
enforcement capabilities, many industrial countries will find this a
formidable challenge. But that holds equally for all alternatives,
including subsidies and cap-and-trade. It would be helpful if the carbon
subsidy (or subsidy withdrawal) I propose could likewise be based solely on
the actual volume of emissions, and not on both the actual volume of
emissions *and* on the volume that would have been emitted in some
hypothetical counterfactual parallel universe. That is the problem that has
turned the carbon credit/carbon offsets generation and verification industr=
y
into such a cesspool of waste and corruption.
A carbon subsidy (that is, a subsidy for not emitting a given volume of
CO2eq), must be measured relative to some independently verifiable,
measurable benchmark. For practical purposes, this would have to be the
most recent historical level of emissions, or that verifiable number plus o=
r
minus some amount or percentage representing 'normal growth'. The problem
is that we really want to measure actual emissions relative to what they
would have been this very same period if the subsidy regime had not been in
effect. However, determining what that benchmark is requires the
observation, measurement and verification of a counterfactual number of
CO2eq units that would have been emitted in the alternative state of the
world where no subsidy regime was in effect but everything else would have
been the same. Observing, measuring and verifying that counterfactual is
impossible, even with the emergence, following the signing of the Kyoto
Protocol, of a massive and still growing Verification of Carbon Credits
Industry. The information problems associated with the verification of the
counterfactual CO2Eq savings associated with a typical carbon offset scheme
is insurmountable. Just try answering the following questions: (1) how many
Mt of CO2eq did you not emit in your aluminium smelter today? (2) How many
scrubbers did you install that would not have been installed without the
carbon credit incentive? (3) How many hardwood trees did you not cut down
today? (4) How many times did you not beat your partner today?
I am very aware of these problems, because in a previous life, as Chief
Economist of the European Bank for Reconstruction and Development, I was
involved in assessing the 'additionality' of projects the Bank was
considering undertaking. A project was additional if it would not have been
undertaken but for the EBRD's financing being available. As we were unable
to run history twice, once with the EBRD and once without it, the
determination of the additionality of a project required a host of
untestable 'identifying assumptions'. No matter how plausible these
assumptions were (from my perspective), someone would always propose anothe=
r
counterfactual for which additionality was present when I believed it to be
absent and *vice versa*.
It may seem that the subsidy withdrawal scheme does not require the
verification of a hypothetical counterfactual. The subsidy rate is *s* per
Mt of CO2Eq. Each year the country is set a benchmark level of emissions,
say, *B* Mt of CO2Eq*.* This could be last year's emissions plus some
increment for 'normal' emissions growth. Actual emissions during the year
are *E *Mt of CO2Eq* . *The amount of subsidy received, *S, * is given by
the larger of zero and *s(B =96 E)* . Thus, if actual emissions fall belo=
w
the target for the year, that is, for *B > E* , the subsidy is proportional
to the emission savings, with a marginal subsidy rate of *s. *It would be
possible to turn this into a combined tax and subsidy scheme by extending i=
t
to actual emission levels in excess of the benchmark, *B*, but this would
run into the familiar fairness problems. However, we have merely hidden th=
e
counterfactual problem in the benchmark *B. *Ideally, *B *would be the
volume of emissions the country would engage in with a zero marginal tax or
subsidy. Basing an estimate of what that would be on history plus some
estimate of 'normal' growth amounts to constructing an observable proxy for
the unobservable counterfactual. It may seem plausible, but it won't be
rocket science.
It is important to note that the possibility of manipulation of the choice
of the benchmark does not in itself undermine the efficiency-enhancing
properties of the subsidy-withdrawal scheme. Its incentive effects depend
only on the marginal subsidy rate, *s*, and not on the benchmark level of
emissions, *B, *as long as the benchmark, *B, *is independent of the actual
volume of emissions,* E. *The benchmark could be set at an arbitrarily hig=
h
level, so there would always be a large subsidy, without this affecting the
incentive for economizing on emissions. Manipulation of the benchmark
would, however, undermine the distributional legitimacy of the scheme.
Under the compromise reached in Bali (which actually was no more than talks
about talks or at best talks about negotiations), developing countries will
take on commitments to curb the growth of their emissions in exchange for
financial incentives. This rather sounds like the benefit withdrawal schem=
e
outlined above. This can only work, that is, be efficient and fair,
provided a reasonably neutral and non-manipulable mechanism is created for
setting the annual or multi-year benchmarks *B*, this could be part of an
efficient and fair solution.
So is there a tax-cum-subsidy solution? There is, but it involves
uncoupling the efficiency and equity parts of the equation. Every country,
rich or poor, would impose a uniform CO2Eq emission tax on the actual volum=
e
of emissions. No need for a counterfactual. Then the poor countries would
get, from the rich countries, a subsidy, or rather, aid, to compensate them
fully or in part for the welfare losses caused by the imposition of the
tax. Two problems with this 'solution' are, first, that the rich countries
are better at making aid commitments than at following through on these
commitments (and they are not even very good at making the commitments) and=
,
second, that in many poor countries, governments and public administrations
are so corrupt, incompetent and/or repressive, that aid often does more har=
m
than good.
*Cap-and-trade*
Cap-and-trade (a global ceiling on greenhouse gas emissions, implemented
through the issuance of a fixed global volume of CO2eq emission permits for
a given period) is to all intents and purposes equivalent to imposing a
uniform global carbon tax combined with a mechanism for distributing the
carbon tax revenues, as long as a uniform global price is established for
the permits in an efficient secondary market. The only difference concerns
the distribution of the scarcity rents. In the case of a carbon tax, the
revenue would go to the national fiscal authorities. In the case of
cap-and-trade, the distribution of the rents would depend on the way the
permits are initially distributed or sold. The efficiency-enhancing effect
of the cap-and-trade scheme will be there regardless of how the permits are
distributed, as long as the overall amount is chosen well and there is a
well-functioning secondary market. It is the presence of the market that
creates the opportunity cost for the would-be polluter/ emitter.
The distributional objectives achieved by taxing CO2eq emissions in rich
countries and subsidising the non-production of CO2eq emissions in poor
countries can be achieved in the cap-and-trade scheme without the need
for dodgy counterfactual scenario constructions, by allocating the poor
countries larger shares of the stock of emission permits. Distributive
justice would be served if the poorest countries got emission permit
allocations well in excess of their likely domestic emissions under
efficient abatement policies. They could then sell the surplus permits on
the open market. Both poor and rich countries would receive the right
marginal incentives for emission control from the uniform price established
for the permits. With cap-and-trade, the Global Warming Fund would have to
be replaced by a body (the Global Warming Body, say) deciding both the
overall size of the global emissions of CO2eq during a given period, and th=
e
initial distribution of the permits, either to the national authorities or
to the would-be emitters themselves. The initial allocation of the permits
could be sold rather than given away, which would turn the Global Warming
Body into a Fund. Such a Fund could have priorities other than greenhouse
gas emission management.
The main weakness of the cap-and-trade scheme is that it stands or falls
with the degree of efficiency of the secondary market for permits that woul=
d
be established. If that market were a textbook efficient market, I could
only cheer it on. All kinds of derivative products (futures markets,
options of various kinds) would soon be created and the opportunities for
trading and sharing risk would be enhanced. However, the events in global
financial markets since the beginning of the year, and especially since
August, may lead one to doubt the starry-eyed stories of market efficiency
that still dominate the teaching of finance in economics departments and
business schools. Taxes and (subject to the counterfactual problem)
subsidies are a viable alternative to cap-and-trade. The fact that
politicians prefer cap-and-trade because it is an invisible tax-cum-subsidy
scheme, that is, a quasi-fiscal construction, may be a further reason for
preferring taxes and subsidies.
*Conclusion*
Like so many before him, Mr Akram tries to leverage indignation, feelings o=
f
moral outrage and perhaps guilt about poverty and extreme inequality, into
an argument for allowing poor developing countries and emerging markets to
avoid their share of the burden of implementing an effective global strateg=
y
for combating climate change. Should he be successful, the effectiveness of
the strategy could be severely impaired. The notion that poverty gives yo=
u
a permit to pollute is a nonsense, and insults the poor. Efficient policies
to combat global warming require a uniform increase in the opportunity cost
of emitting greenhouse gases. This increase in opportunity cost should be
the same for the poor as for the rich. It can be implemented through a tax
on emissions by the rich and through the the withdrawal of a subsidy for
emission reduction by the poor. The construction of the benchmark relative
to which emission reductions are to be measured is deeply problematic, but
has to be faced through an open and transparent process.
Cap-and-trade on a global scale, with a single, integrated secondary market
for CO2eq emission permits would solve the efficiency problem. The initial
global allocation of permits can address many distributional concerns.
There ought to be no preferred treatment as regards the need to internalise
the externalities from greenhouse gas emissions, for countries like China,
which by some measures has already overtaken the US as the world's leading
producer of greenhouse gases and which on any measure will be in that
position in a handful of years, or India, which seems determined to catch u=
p
with China in the area of environmental vandalism. The fact that the rich
industrial countries have had a couple of centuries to add to the
concentration of greenhouse gases in the atmosphere, unencumbered by Kyoto
Protocols or Bali Declarations does not mean that it's now the developing
countries turn to pollute with impunity. However, there is an obligation o=
n
the rich countries (as on the rich living in poor countries) to ensure that
the necessary internalisation by developing countries of the global
environmental externalities from their production and consumption activitie=
s
does not place excessive burdens on the poor in these countries. The tools
are there. Let's hope the usual excuses for not using them won't be.
Friday, December 21, 2007 in
Chindia<http://blogs.ft.com/maverecon/chindia/index.html>,
Economics <http://blogs.ft.com/maverecon/economics/index.html>,
Environment<http://blogs.ft.com/maverecon/environment/index.html>,
Ethics <http://blogs.ft.com/maverecon/ethics/index.html> |
Permalink<http://blogs.ft.com/maverecon/2007/12/---page-margin.html>|
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Tuesday, December 18, 2007 Quasi-fiscal scoundrels, Part 2
Alan Greenspan is right (for once). He recently made the obvious but
important and oft-conveniently-forgotten point, that the least harmful way
of intervening to help US homeowners saddled with mortgages they cannot
afford when the early teaser rates on their mortgages re-set to much higher
levels, is to give them direct financial aid. This is the opposite of what
Treasury Secretary Hank Paulson is peddling. Paulson proposes an interest
rate freeze on some subprime loans, preventing the teaser rate resets for
five years. Greenspan's statement was very much to the point: "It's far les=
s
damaging to the economy to create a short-term fiscal problem, which we
would, than to try to fix the prices of homes or interest rates".
Paulson dismissed Greenspan's argument that it would be better to provide
cash aid to homeowners than freeze rates on subprime loans. "I don't think
what we need is a big government bail-out". The Greenspan - Paulson argumen=
t
pits the economics of Ann Raynd and Milton Friedman against those of Jozef
Stalin and Hugo Chavez. Raynd & Friedman win.
I argued in an earlier
contribution<http://blogs.ft.com/maverecon/2007/12/quasi-fiscal-sc.html>on
the US Treasury proposal for a quasi-fiscal bail-out of some of the US
subprime mortgage borrowers, that there were two things wrong with Paulson'=
s
proposal.
First, there is no valid argument based on poverty relief or on
fairness/distributive justice, for bailing out subprime mortgage borrowers.
They borrowed imprudently and took on home loans larger than they could
afford. They should live with the consequences. There are many Americans
who are poorer than these financially challenged subprime borrowers, but wh=
o
won't get a dime of financial relief in their Christmas stockings from uncl=
e
Sam. This includes the countless homeless in the US - those who have no roo=
f
over their head of any kind, owner-occupied or rented. If the government
wishes to help the poor, it ought to do so on budget. Even if some of those
who imprudently took on subprime loans are now threatened with the loss of
their homes, or even with poverty, this is no reason for rewarding and
subsidising this particular form of imprudence. There should be proper
assistance and relief for all the poor, but no special aid 'pots' for those
who are threatened with poverty because of their own greed and ignorance.
That would be both unfair and incentive-corrupting.
If there was mis-selling of subprime mortgages to unsophisticated borrowers
and if this amounted either to negligence by the originators or to deceptio=
n
or fraud, the civil or criminal courts are the places to deal with these
matters.
The same no bail-out argument applies to institutional borrowers like banks
and other financial institutions also, and not only in the US. Keeping
Northern Rock and its shareholders afloat at taxpayers' expense/risk is an
inexcusable misuse of UK public funds to avoid political embarrassment.
Second, if despite the previous argument you are going to engage in a
government bail-out, do it openly, transparently and on-budget, through
explicit cash payments to designated beneficiaries. Without the truth,
there can be no accountability. Don't hide the fiscal reality of a tax on
the subprime mortgage lender and a cash payment to the subprime mortgage
borrower, behind a government intervention in the price mechanism - a
prohibition of re-sets of teaser rates to the new scheduled higher levels.
The US Treasury proposal combines the transparency-enhancing miracle of
off-budget and off-balance-sheet financing with the incentive-improving
subtleties of Soviet central planning. It deserves a swift, disrespectful
burial.
Tuesday, December 18, 2007 in
Economics<http://blogs.ft.com/maverecon/economics/index.html>,
Financial Markets<http://blogs.ft.com/maverecon/financial_markets/index.htm=
l>,
Monetary Policy <http://blogs.ft.com/maverecon/monetary_policy/index.html>,
Politics <http://blogs.ft.com/maverecon/politics/index.html> |
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Sunday, December 16, 2007 How to restore stability to the 'North Atlantic
zone of financial instability'
I would like to use this blog to post a rather lengthy reply to
comments<http://blogs.ft.com/wolfforum/2007/12/the-coordinated.html#comment=
-93492902>of
Mr.
Krzysztof Rybinski <http://www.rybinski.eu/?p=3D543&language=3Den> on an ea=
rlier
post of mine <http://blogs.ft.com/wolfforum/2007/12/the-coordinated.html#>t=
o
the Financial Times' Economists' Forum, on the 12 December
announcement
of non-coordinated liquidity management policy changes by the Fed, the ECB,
the Bank of England, the Bank of Canada and the Swiss National Bank.
I agree with Mr. Rybinski, that the very fact that the five central bank
governors who made their simultaneous announcements on Wednesday December 1=
2
th did try to make this look like a substantive coordinated action, shows
how worried these central bankers are about financial stability and the ris=
k
of regional and global recession in 2008 and beyond. The point of my blog
was that because the substance of what was announced was a list of five
disjoint liquidity interventions, in the Euro zone, the USA, the UK, Canada
and Switzerland, it was both strange and rather worrying that the central
bank five governors tried to make their simultaneously announced individual
actions look like more than they were. This was a set of actions where the
whole was no more than the sum of the parts. To try to make it look like
more than it was in unwise. When those in charge of price stability and
market liquidity in much of the industrialised world engage in 'spin' of
this kind, I get concerned.
A swap between the Fed and the ECB of* X *US dollars for *Y* euros for 1
year, say, is equivalent to the ECB borrowing *X* US dollars for 1 year
and the Fed borrowing *Y* euros for 1 year, provided
* X =3D
eY(1+i)/(f(1+i*))*
where *e* is the spot euro-US dollar exchange rate (number of US dollars pe=
r
euro),* f *is the one-year forward exchange rate, *i* is the one-year dolla=
r
interest rate and *i** is the one-year euro interest rate. The authorities
chose to present their reciprocal borrowing of each other's currency as a
swap rather than as two loans. The private sector likes to do this because
swaps are off-balance sheet transactions, unlike loans. Surely the desire t=
o
keep their mutual support (and mutual exposure) off-balance sheet cannot
have been a factor in the three central banks' decision to proceed through
swaps rather than through explicit borrowing of foreign exchange?
More importantly, there was no need for either official swaps or official
borrowing to alleviate the liquidity crunch. All that was required was for
the ECB to make euro liquidity available in the Euro zone (through OMOs in
euros) and for the Fed to make US dollar liquidity available in the US
(through OMOs in US dollars. Because the foreign exchange market for the
euro and US dollar has remained spectacularly liquidity throughout this
crisis, Euro-zone banks who had obtained euro liquidity from the ECB could
have bought or borrowed US dollar liquidity through the foreign exchange
markets without any problems. The could (indeed probably would) have used
swaps to obtain the necessary US dollars, if they believed the need for
dollars in the Eurozone was likely to be short-lived. So the Fed and the
ECB did not materially improve the terms and other conditions of access to
US dollar liquidity for Euro-zone banks through this swap. This was
financial window-dressing. Why? Spin always ends up cutting the mouth tha=
t
spewed it.
I agree also agree with Mr. Rybinski that the monetary, regulatory and
fiscal authorities have to do more in the future to prevent the recurrence
of speculative excesses than they have in the past, including the most
recent credit orgy =96 that of 2003-2006. I believe, however, that the
preventative measures that are required will have to be designed and
implemented mainly by the regulators /supervisors of financial markets and
institutions and by the Treasuries/ministries of finance. Central banks wil=
l
not play a major part, unless they happen to also be regulators/supervisors
for the banking system and/or other financial institutions or markets.
In a world with unrestricted international financial capital mobility,
central banks have only one instrument with which to pursue their primary
objective, price stability. That instrument is either the short risk-free
nominal interest rate or the nominal spot exchange rate. Central banks have
additional instruments for influencing liquidity at various horizons,
ranging from overnight to one or at most two years. There
liquidity-oriented instruments include open market operations (collaterlise=
d
and non-collateralised or outright) at a range of maturities, reserve
requirements and discount window operations. Both OMOs and discount window
operations are multi-dimensional. The central bank defines the set of
eligible collateral, eligible counterparties and the term of the loans.
Foreign exchange market intervention is a special case of (outright) open
market operations and included in it.
If monetary policy, defined as the pursuit of price stability in the medium
term, is entrusted constitutionally and institutionally to an operationally
independent central bank, it makes sense to dedicate the short risk-free
nominal interest rate (say the target for the overnight interbank rate)
entirely to monetary policy. This is not because the short-run risk-free
nominal interest rate (the official policy rate) does not have any effect o=
n
liquidity. Nor is it because the other instruments of the central bank
(OMOs, discount window operations and reserve requirements) don't have an
effect on price stability in the medium term. The reason is a practical
political one, grounded in the need for institutional accountability, and
reinforced by an appeal to Mundell's 'Principle of Effective Market
Classification', which prescribes a division of labour between policy
instruments, or an assignment of responsibility for policy objectives to
instruments, based on a law of comparative advantage.
Clearly, the policies announced by the five central banks last Wednesday
will lower the spreads between the official policy rate and Libor at the
maturities for which interventions were announced (mainly one- month and
three months), relative to the levels they would have achieved without the
announcement. Since many loans to households and non-financial firms are
priced off 3-month Libor, this means that monetary conditions will be less
restrictive than they would have been without the announcement. The centra=
l
bank will have to allow for this in their setting of the official policy
rates, which as a result will be higher in the future than they would have
been without the announcement. They may, of course, still be lower in the
future than they are today. The effect of current liquidity policies on th=
e
level of the path of official policy rates most likely to achieve price
stability in the medium term is likely to be small, because the price level
effect of interest rate changes is subject to long, variable and uncertain
lags and of uncertain magnitude.
Likewise, although cuts in the official policy rate are an inefficient way
to boost liquidity under disorderly market conditions, it will have some
positive effect on liquidity. The five central banks, in their open market
operations, discount window policies and reserve requirements will have to
allow for the fact that the liquidity crunch will be eased a little by cuts
in the official policy rates.
But the regulators and the fiscal authorities will have to do most of the
job of (1) making a recurrence of destructive credit cycles less likely, an=
d
of (2) minimising the damage to the real economy caused by such episodes of
financial manic-depressive illness as are likely to occur despite the best
efforts of the authorities. Without more effective international
cooperation and coordination of regulatory standards and of the fiscal
treatment of international mobile financial institutions, instruments and
their owners, the risk of future credit booms and busts will increase.
Creating a single financial regulator for all of the EU (not just for the
Euro zone) would be a valuable contribution from the Eastern rim of the
North Atlantic zone of financial instability that has emerged this s
century. This nefarious contribution of the world's most developed nationa=
l
and regional financial sectors =96 Wall Street, the City of London, Zurich =
and
Frankfurt - to global financial and macroeconomic instability is in part du=
e
to the race to the bottom of regulatory and supervisory standards driven by
regulatory and tax arbitrage. The sooner this trend is halted and reversed,
the better.
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<h2 class=3D"date-header">Friday, December 21, 2007</h2><br><p><b><a href=
=3D"http://www.nber.org/%7Ewbuiter">About Willem Buiter</a></b><br>
<img src=3D"http://media.ft.com/cms/83e2a094-817d-11dc-9b6f-0000779fd2ac.gi=
f" border=3D"0"><br>
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.
</p>
Bali Schmali?<div class=3D"entry" id=3D"entry-43118860">
=09=09=09
=09=09=09<div class=3D"entry-content">
=09=09=09=09<div class=3D"entry-body">
=09=09=09=09=09=09
=09
=09
=09
<p lang=3D"en-GB">Is there a valid case for special treatment for poor
countries (developing nations and some emerging markets) in global
efforts to combat global warming?</p>
<p lang=3D"en-GB">Mr Munir Akram, spokesman for the 130-strong G77
group of developing nations believes he has fought the good fight in
Bali, by resisting pressures on developing countries to accept
obligations to make absolute cuts in their greenhouse gas emissions,
under the successor to the Kyoto Agreement that is now supposed to be
negotiated in the coming two years. In the Financial Times of
Saturday December 15, he is reported as saying that the developing
nations had come under pressure to agree to "commitments and
obligations on mitigation which in their dimension we feel are unfair
and unjust".=20
</p>
<p lang=3D"en-GB">There are three arguments Mr. Akram and other
spokespersons for the developing world make to support their claim
for special treatment for developing countries and emerging markets.=20
Two are partisan, confused and invalid, and should be rejected. The
third is valid and can and should be accommodated. =20
</p>
<p lang=3D"en-GB">The first invalid argument is that, however large the
aggregate volume of greenhouse gas emissions (and other
manifestations of environmental vandalism) in developing countries
such as China and India are today, their emissions are much lower
than those of wealthy industrialised countries if measured per
capita. Propositions can be both true and irrelevant. The
proposition that per capita emissions of greenhouse gases in China
and India are low and therefore not a problem, is as relevant as
would be the statement that the 6.9 percent inflation rate in China
is less of of problem than the 4.3 percent inflation rate in the US,
because per capita inflation in China is lower. The fact that <em>per
capita</em> emissions of greenhouse gases in China are much lower than
in the US is irrelevant as regards the damage done by these
emissions, and irrelevant for the design of effective and efficient
policies to reduce global greenhouse gas emissions. This is because
the science and bio-engineering of greenhouse gas emissions make it
abundantly clear, that a given volume of emissions damages the global
environment regardless of how, why, by whom, and by how many it was
emitted. The negative effect and the negative externality depend only
on the volume of emissions.=20
</p>
<p style=3D"margin-bottom: 0cm;" lang=3D"en-GB">An interesting implication
of the fact that the benefits from a given reduction in the volume of
greenhouse gas emissions is a pure public good =96 <em>non-rival</em>
and <em>non-excludable</em> =96 is that the countries with the larges=
t
populations like China and India in fact benefit more than countries
with smaller populations from any reduction in greenhouse gas
emissions anywhere. When there are more people, the per capita
benefit from a reduction in greenhouse gas emissions does not
decline. In fact, the value of the per capita benefit in many of the
poorest countries, including India and China, may well be higher than
in the richer countries, because the damage that will be caused in
the poorest countries by global warming, by flooding, desertification
etc. is likely to be much more severe than in the richer countries of
the world. (That would certainly be the case if you did not base the
cost-benefit analysis on willingness to pay, which is contingent on
ability to pay and therefore on the existing distribution of wealth
and income, but instead on a more Rawlesian, status-quo-blind
cost-benefit analysis). </p>
<p lang=3D"en-GB">The second invalid argument for special treatment for
poor countries is that, regardless of whether China has already
become the largest emitter of greenhouse gases, as some authorities
argue, or will only overtake the US in a handful of years as the
leading environmental bogeyman, the cumulative stock of past
emissions of the old industrial countries is much larger than that of
the developing countries and the emerging markets. This observation
too is correct but irrelevant. Since vacuuming past greenhouse gas
emissions out of the atmosphere is not a cost-effective method for
reducing atmospheric concentrations of greenhouse gases, the
appropriate response to this second correct but irrelevant
proposition ranges between: 'and?' and 'so what?'. It=
may induce
sufficient guilt feelings among past atmospheric polluters (or among
their descendants) to induce them to loosen the aid purse strings,
but it has no bearing on what is the most efficient way to combat
global warming.</p>
<p lang=3D"en-GB">The morally valid argument is that developing
countries and emerging markets are poorer on average than the old
industrial countries, and that it is unfair to put an equal burden
on the poor as on the rich. I agree. The question is, can we make
this value judgement in a 'green' way? It turns out we can.</=
p>
<p style=3D"border: medium none ; padding: 0cm; margin-right: 0.26cm; margi=
n-top: 0.26cm; margin-bottom: 0.26cm;" align=3D"justify" lang=3D"en-GB">
<strong>Efficient greenhouse gas emissions control</strong></p>
<p style=3D"border: medium none ; padding: 0cm; margin-right: 0.26cm; margi=
n-top: 0.26cm; margin-bottom: 0.26cm;" align=3D"justify" lang=3D"en-GB">
If excessive CO2Eq (carbon dioxide equivalent) emissions are a
problem, there are but two solutions. The first is
command-and-control methods: limit the scale of the activities
creating excessive CO2Eq emissions by administrative or regulatory
fiat. In the limit, ban them. This was done with chlorofluorocarbons
(contributors to the ozone hole over the Antarctic) which were phased
out by 1996. It can be effective if something is to be banned
completely. That is not possible with CO2Eq emissions. Any
conceivable future will have continued emissions of CO2Eq.
Bureaucrats are not very good at deciding who can produce how much
CO2Eq in tens of millions of activities and firms. Last time
something like that was tried we called it Central Planning.</p>
<p lang=3D"en-GB">From the perspective of an an effective policy to
combat global warming by limiting and if possible reducing first the
flow of greenhouse gas emissions and ultimately the atmospheric
concentration of greenhouse gas emissions (the stock), it is
necessary and sufficient to raise the opportunity cost of emitting an
additional unit of carbon dioxide equivalent (CO2eq) and/or to raise
the opportunity cost of not cutting back greenhouse gas emissions by
an incremental unit.=20
</p>
<p lang=3D"en-GB">Raising the opportunity cost of emitting an
additional unit of CO2eq means taxing greenhouse gas emissions. This
can be achieved by imposing a uniform tax on each unit of emissions
(as measured by say, a metric ton (Mt) CO2eq units). Let's call it
the uniform global CO2eq emissions tax or carbon tax for short. For
efficiency reasons, this carbon tax should be the same, if the
externality is the same, regardless of whether the emissions come
from the poor in Bangladesh or from the rich in St. Moritz. That'=
s
obviously unfair.</p>
<p lang=3D"en-GB">Fortunately, efficiency and equity can both be served
once we recognise that the alternative to a common global tax per Mt
of CO2eq emissions would be a common subsidy per Mt of CO2eq not
emitted. The uniform tax rate per unit of CO2Eq and the uniform
subsidy rate should be the same. When emissions in a developing
country increase above their allowance, it would not have to pay the
tax, but there would be a progressive withdrawal of the subsidy. So
the incentive to reduce greenhouse gas emissions at the margin would
be the same, but the distributional consequences would of course be
quite different.</p>
<p lang=3D"en-GB">The subsidies for CO2eq emissions reduction would
have to be financed out of a global fund, the Global Warming Fund, or
GWF, say. Taxes imposed by the richer countries on greenhouse gas
emissions could go into the GWF, although there is no logical reason
for earmarking them like that. In principle, the GWF should be
funded out of general revenues, in an amount sufficient to pay the
subsidies required to achieve the desired reduction in greenhouse gas
emissions in poor countries.=20
</p>
<p lang=3D"en-GB"><strong>The carbon credits/ carbon offsets racket</strong=
></p>
<p lang=3D"en-GB">A carbon tax is hard to implement, because it
requires, as with any tax, that the authorities know and can observe
the tax base. In this case this means that the fiscal authorities
must be able to monitor actual emissions of CO2eq. These measurement
problems are hard, but not insurmountable in the advanced industrial
countries. With very weak tax administration and enforcement
capabilities, many industrial countries will find this a formidable
challenge. But that holds equally for all alternatives, including
subsidies and cap-and-trade. It would be helpful if the carbon
subsidy (or subsidy withdrawal) I propose could likewise be based
solely on the actual volume of emissions, and not on both the actual
volume of emissions <em>and</em> on the volume that would have been
emitted in some hypothetical counterfactual parallel universe. That
is the problem that has turned the carbon credit/carbon offsets
generation and verification industry into such a cesspool of waste
and corruption. =20
</p>
<p lang=3D"en-GB">A carbon subsidy (that is, a subsidy for not emitting
a given volume of CO2eq), must be measured relative to some
independently verifiable, measurable benchmark. For practical
purposes, this would have to be the most recent historical level of
emissions, or that verifiable number plus or minus some amount or
percentage representing 'normal growth'. The problem is that =
we
really want to measure actual emissions relative to what they would
have been this very same period if the subsidy regime had not been in
effect. However, determining what that benchmark is requires the
observation, measurement and verification of a counterfactual number
of CO2eq units that would have been emitted in the alternative state
of the world where no subsidy regime was in effect but everything
else would have been the same. Observing, measuring and verifying
that counterfactual is impossible, even with the emergence, following
the signing of the Kyoto Protocol, of a massive and still growing
Verification of Carbon Credits Industry. The information problems
associated with the verification of the counterfactual CO2Eq savings
associated with a typical carbon offset scheme is insurmountable.
Just try answering the following questions: (1) how many Mt of CO2eq
did you not emit in your aluminium smelter today? (2) How many
scrubbers did you install that would not have been installed without
the carbon credit incentive? (3) How many hardwood trees did you not
cut down today? (4) How many times did you not beat your partner
today? =20
</p>
<p lang=3D"en-GB">I am very aware of these problems, because in a
previous life, as Chief Economist of the European Bank for
Reconstruction and Development, I was involved in assessing the
'additionality' of projects the Bank was considering undertaking. A
project was additional if it would not have been undertaken but for
the EBRD's financing being available. As we were unable to run
history twice, once with the EBRD and once without it, the
determination of the additionality of a project required a host of
untestable 'identifying assumptions'. No matter how plausible these
assumptions were (from my perspective), someone would always propose
another counterfactual for which additionality was present when I
believed it to be absent and <em>vice versa</em>.=20
</p>
<p lang=3D"en-GB">It may seem that the subsidy withdrawal scheme does
not require the verification of a hypothetical counterfactual. The
subsidy rate is <em>s</em> per Mt of CO2Eq. Each year the country is
set a benchmark level of emissions, say, <em>B</em> Mt of CO2Eq<em>.<=
/em>
This could be last year's emissions plus some increment for 'normal=
'
emissions growth. Actual emissions during the year are <em>E </em><sp=
an style=3D"font-style: normal;">Mt
of CO2Eq</span><em> . </em><span style=3D"font-style: normal;">The am=
ount
of subsidy received, </span><em>S, </em><span style=3D"font-style: normal;"=
>
is given by the larger of zero and </span><em>s(B =96 E)</em><span st=
yle=3D"font-style: normal;">
. Thus, if actual emissions fall below the target for the year, that
is, for </span><em>B > E</em><span style=3D"font-style: normal;"> , the
subsidy is proportional to the emission savings, with a marginal
subsidy rate of </span><em>s. </em><span style=3D"font-style: normal;=
">It
would be possible to turn this into a combined tax and subsidy scheme
by extending it to actual emission levels in excess of the benchmark, </spa=
n><em>B</em><span style=3D"font-style: normal;">, but this would run
into the familiar fairness problems. However, we have merely hidden
the counterfactual problem in the benchmark </span><em>B. </em><span =
style=3D"font-style: normal;">Ideally, </span><em>B </em><span style=3D"fon=
t-style: normal;">would be the volume
of emissions the country would engage in with a zero marginal tax or
subsidy. Basing an estimate of what that would be on history plus
some estimate of 'normal' growth amounts to constructing an
observable proxy for the unobservable counterfactual. It may seem
plausible, but it won't be rocket science. </span></p>
<p lang=3D"en-GB"><span style=3D"font-style: normal;">It is important to
note that the possibility of manipulation of the choice of the
benchmark does not in itself undermine the efficiency-enhancing
properties of the subsidy-withdrawal scheme. Its incentive effects
depend only on the marginal subsidy rate, <em>s</em>, and not =
on the benchmark level of emissions, <em>B, </em>as long as the benchmark, =
<em>B, </em>is independent of the actual volume of emissions,<em> E. =
</em>The
benchmark could be set at an arbitrarily high level, so there would
always be a large subsidy, without this affecting the incentive for
economizing on emissions. Manipulation of the benchmark would,
however, undermine the distributional legitimacy of the scheme.<br> </span>
</p>
<p lang=3D"en-GB"><span style=3D"font-style: normal;">U</span>nder the
compromise reached in Bali (which actually was no more than talks
about talks or at best talks about negotiations), developing
countries will take on commitments to curb the growth of their
emissions in exchange for financial incentives. This rather sounds
like the benefit withdrawal scheme outlined above. This can only
work, that is, be efficient and fair, provided a reasonably neutral
and non-manipulable mechanism is created for setting the annual or
multi-year benchmarks <em>B</em>, this could be part of an efficient
and fair solution.</p>
<p lang=3D"en-GB">So is there a tax-cum-subsidy solution? There is,
but it involves uncoupling the efficiency and equity parts of the
equation. Every country, rich or poor, would impose a uniform CO2Eq
emission tax on the actual volume of emissions. No need for a
counterfactual. Then the poor countries would get, from the rich
countries, a subsidy, or rather, aid, to compensate them fully or in
part for the welfare losses caused by the imposition of the tax. Two
problems with this 'solution' are, first, that the rich countries a=
re
better at making aid commitments than at following through on these
commitments (and they are not even very good at making the
commitments) and, second, that in many poor countries, governments
and public administrations are so corrupt, incompetent and/or
repressive, that aid often does more harm than good.</p>
<p lang=3D"en-GB"> </p>
<p lang=3D"en-GB"><strong>Cap-and-trade</strong></p>
<p lang=3D"en-GB">Cap-and-trade (a global ceiling on greenhouse gas
emissions, implemented through the issuance of a fixed global volume
of CO2eq emission permits for a given period) is to all intents and
purposes equivalent to imposing a uniform global carbon tax combined
with a mechanism for distributing the carbon tax revenues, as long as
a uniform global price is established for the permits in an efficient
secondary market. The only difference concerns the distribution of
the scarcity rents. In the case of a carbon tax, the revenue would go
to the national fiscal authorities. In the case of cap-and-trade, the
distribution of the rents would depend on the way the permits are
initially distributed or sold. The efficiency-enhancing effect of the
cap-and-trade scheme will be there regardless of how the permits are
distributed, as long as the overall amount is chosen well and there
is a well-functioning secondary market. It is the presence of the
market that creates the opportunity cost for the would-be polluter/
emitter.</p>
<p lang=3D"en-GB">The distributional objectives achieved by taxing
CO2eq emissions in rich countries and subsidising the non-production
of CO2eq emissions in poor countries can be achieved in the
cap-and-trade scheme without the need for dodgy counterfactual
scenario constructions, by allocating the poor countries larger
shares of the stock of emission permits. Distributive justice would
be served if the poorest countries got emission permit allocations
well in excess of their likely domestic emissions under efficient
abatement policies. They could then sell the surplus permits on the
open market. Both poor and rich countries would receive the right
marginal incentives for emission control from the uniform price
established for the permits. With cap-and-trade, the Global Warming
Fund would have to be replaced by a body (the Global Warming Body,
say) deciding both the overall size of the global emissions of CO2eq
during a given period, and the initial distribution of the permits,
either to the national authorities or to the would-be emitters
themselves. The initial allocation of the permits could be sold
rather than given away, which would turn the Global Warming Body into
a Fund. Such a Fund could have priorities other than greenhouse gas
emission management.</p>
<p lang=3D"en-GB">The main weakness of the cap-and-trade scheme is that
it stands or falls with the degree of efficiency of the secondary
market for permits that would be established. If that market were a
textbook efficient market, I could only cheer it on. All kinds of
derivative products (futures markets, options of various kinds) would
soon be created and the opportunities for trading and sharing risk
would be enhanced. However, the events in global financial markets
since the beginning of the year, and especially since August, may
lead one to doubt the starry-eyed stories of market efficiency that
still dominate the teaching of finance in economics departments and
business schools. Taxes and (subject to the counterfactual problem)
subsidies are a viable alternative to cap-and-trade. The fact that
politicians prefer cap-and-trade because it is an invisible
tax-cum-subsidy scheme, that is, a quasi-fiscal construction, may be
a further reason for preferring taxes and subsidies.</p>
<p lang=3D"en-GB"> </p>
<p lang=3D"en-GB"><strong>Conclusion</strong></p>
<p lang=3D"en-GB">Like so many before him, Mr Akram tries to leverage
indignation, feelings of moral outrage and perhaps guilt about
poverty and extreme inequality, into an argument for allowing poor
developing countries and emerging markets to avoid their share of the
burden of implementing an effective global strategy for combating
climate change. Should he be successful, the effectiveness of the
strategy could be severely impaired. The notion that poverty gi=
ves
you a permit to pollute is a nonsense, and insults the poor.=20
Efficient policies to combat global warming require a uniform
increase in the opportunity cost of emitting greenhouse gases. This
increase in opportunity cost should be the same for the poor as for
the rich. It can be implemented through a tax on emissions by the
rich and through the the withdrawal of a subsidy for emission
reduction by the poor. The construction of the benchmark relative to
which emission reductions are to be measured is deeply problematic,
but has to be faced through an open and transparent process.</p>
<p lang=3D"en-GB">Cap-and-trade on a global scale, with a single,
integrated secondary market for CO2eq emission permits would solve
the efficiency problem. The initial global allocation of permits can
address many distributional concerns. =20
</p>
<p lang=3D"en-GB">There ought to be no preferred treatment as regards
the need to internalise the externalities from greenhouse gas
emissions, for countries like China, which by some measures has
already overtaken the US as the world's leading producer of
greenhouse gases and which on any measure will be in that position in
a handful of years, or India, which seems determined to catch up with
China in the area of environmental vandalism. The fact that the rich
industrial countries have had a couple of centuries to add to the
concentration of greenhouse gases in the atmosphere, unencumbered by
Kyoto Protocols or Bali Declarations does not mean that it's now =
the
developing countries turn to pollute with impunity. However, there
is an obligation on the rich countries (as on the rich living in poor count=
ries) to ensure that the necessary
internalisation by developing countries of the global environmental
externalities from their production and consumption activities does
not place excessive burdens on the poor in these countries. The
tools are there. Let's hope the usual excuses for not using them
won't be.</p>
=09=09=09=09</div>
=09=09=09=09
=09=09=09=09
=09
=09=09=09=09
=09=09=09</div>
=09=09=09<p class=3D"entry-footer">
=09=09=09=09<span class=3D"post-footers">Friday, December 21, 2007 in <a hr=
ef=3D"http://blogs.ft.com/maverecon/chindia/index.html">Chindia</a>, <a hre=
f=3D"http://blogs.ft.com/maverecon/economics/index.html">Economics</a>, <a =
href=3D"http://blogs.ft.com/maverecon/environment/index.html">
Environment</a>, <a href=3D"http://blogs.ft.com/maverecon/ethics/index.html=
">Ethics</a> </span> <span class=3D"separator">|</span> <a class=3D"permali=
nk" href=3D"http://blogs.ft.com/maverecon/2007/12/---page-margin.html">Perm=
alink
</a>
=09=09=09=09=09=09=09=09=09| <a href=3D"http://blogs.ft.com/maverecon/2007/=
12/---page-margin.html#comments">Read and post comments (1)</a>
=09=09=09=09
=09=09=09=09=09=09=09=09=09| <a href=3D"http://blogs.ft.com/maverecon/2007/=
12/---page-margin.html#trackback">TrackBack (0)</a>
=09=09=09=09
=09=09=09</p>
=09=09</div>
=09
=09=09=09=09=09=09<h2 class=3D"date-header">Tuesday, December 18, 2007</h2>
=09=09
=09=09<div class=3D"entry" id=3D"entry-42972560">
=09=09=09=09=09=09=09<h3 class=3D"entry-header">Quasi-fiscal scoundrels, Pa=
rt 2</h3>
=09=09=09
=09=09=09<div class=3D"entry-content">
=09=09=09=09<div class=3D"entry-body">
=09=09=09=09=09<p>Alan
Greenspan is right (for once). He recently made the obvious but
important and oft-conveniently-forgotten point, that the least harmful
way of intervening to help US homeowners saddled with mortgages they
cannot afford when the early teaser rates on their mortgages re-set to
much higher levels, is to give them direct financial aid. This is the
opposite of what Treasury Secretary Hank Paulson is peddling. Paulson
proposes an interest rate freeze on some subprime loans, preventing the
teaser rate resets for five years. Greenspan's statement was very much
to the point: "It's far less damaging to the economy to create a
short-term fiscal problem, which we would, than to try to fix the
prices of homes or interest rates".</p>
<p>Paulson dismissed Greenspan's argument that it would be better to
provide cash
aid to homeowners than freeze rates on subprime loans. "I don't think
what we need is a big government bail-out". The Greenspan - Paulson
argument pits the economics of Ann Raynd and Milton Friedman against
those of Jozef Stalin and Hugo Chavez. Raynd & Friedman win.
</p>
<p> I argued in an earlier <a href=3D"http://blogs.ft.com/maverecon/2007/12=
/quasi-fiscal-sc.html">contribution</a>
on the US Treasury proposal for a quasi-fiscal bail-out of some of the
US subprime mortgage borrowers, that there were two things wrong with
Paulson's proposal.</p>
<p>First, there is no valid argument based on poverty relief or on
fairness/distributive justice, for bailing out subprime mortgage
borrowers. They borrowed imprudently and took on home loans larger
than they could afford. They should live with the consequences. There
are many Americans who are poorer than these financially challenged
subprime borrowers, but who won't get a dime of financial relief in
their Christmas stockings from uncle Sam. This includes the countless
homeless in the US - those who have no roof over their head of any
kind, owner-occupied or rented. If the government wishes to help the
poor, it ought to do so on budget. Even if some of those who
imprudently took on subprime loans are now threatened with the loss of
their homes, or even with poverty, this is no reason for rewarding and
subsidising this particular form of imprudence. There should be prope=
r
assistance and relief for all the poor, but no special aid 'pots' f=
or
those who are threatened with poverty because of their own greed and
ignorance. That would be both unfair and incentive-corrupting.</p>
<p>If there was mis-selling of subprime mortgages to unsophisticated
borrowers and if this amounted either to negligence by the originators
or to deception or fraud, the civil or criminal courts are the places
to deal with these matters. <br> </p>
<p>The same no bail-out argument applies to institutional borrowers
like banks and other financial institutions also, and not only in the
US. Keeping Northern Rock and its shareholders afloat at taxpayers=
9;
expense/risk is an inexcusable misuse of UK public funds to avoid
political embarrassment.</p>
<p>Second, if despite the previous argument you are going to engage in
a government bail-out, do it openly, transparently and on-budget,
through explicit cash payments to designated beneficiaries. Without
the truth, there can be no accountability. Don't hide the fiscal
reality of a tax on the subprime mortgage lender and a cash payment to
the subprime mortgage borrower, behind a government intervention in the
price mechanism - a prohibition of re-sets of teaser rates to the new
scheduled higher levels.</p>
<p> The US Treasury proposal combines the transparency-enhancing
miracle of off-budget and off-balance-sheet financing with the
incentive-improving subtleties of Soviet central planning. It deserve=
s
a swift, disrespectful burial. <br>
</p>
=09=09=09=09</div>
=09=09=09=09
=09=09=09=09
=09
=09=09=09=09
=09=09=09</div>
=09=09=09<p class=3D"entry-footer">
=09=09=09=09<span class=3D"post-footers">Tuesday, December 18, 2007 in <a h=
ref=3D"http://blogs.ft.com/maverecon/economics/index.html">Economics</a>, <=
a href=3D"http://blogs.ft.com/maverecon/financial_markets/index.html">Finan=
cial Markets
</a>, <a href=3D"http://blogs.ft.com/maverecon/monetary_policy/index.html">=
Monetary Policy</a>, <a href=3D"http://blogs.ft.com/maverecon/politics/inde=
x.html">Politics</a> </span> <span class=3D"separator">|</span> <a class=3D=
"permalink" href=3D"http://blogs.ft.com/maverecon/2007/12/quasi-fiscal--1.h=
tml">
Permalink</a>
=09=09=09=09=09=09=09=09=09| <a href=3D"http://blogs.ft.com/maverecon/2007/=
12/quasi-fiscal--1.html#comments">Read and post comments (9)</a>
=09=09=09=09
=09=09=09=09=09=09=09=09=09| <a href=3D"http://blogs.ft.com/maverecon/2007/=
12/quasi-fiscal--1.html#trackback">TrackBack (0)</a>
=09=09=09=09
=09=09=09</p>
=09=09</div>
=09
=09=09=09=09=09=09<h2 class=3D"date-header">Sunday, December 16, 2007</h2>
=09=09
=09=09
=09=09=09=09=09=09=09<h3 class=3D"entry-header">How to restore stability to=
the 'North Atlantic zone of financial instability'</h3>
=09=09=09
=09=09=09
=09=09=09=09<div class=3D"entry-body">
=09=09=09=09=09=09
=09
=09
=09
<p class=3D"western" style=3D"margin-bottom: 0cm;">
=09
=09
=09
</p>
<p class=3D"western">I would like to use this blog to post a rather lengthy=
reply to <a href=3D"http://blogs.ft.com/wolfforum/2007/12/the-coordinated.=
html#comment-93492902">comments</a> of <a href=3D"http://www.rybinski=
.eu/?p=3D543&language=3Den">
Mr. Krzysztof Rybinski</a> on <a href=3D"http://blogs.ft.com/wolfforum/2007=
/12/the-coordinated.html#">an earlier post of mine</a>
to the Financial Times' Economists' Forum, on the 12 December
announcement of non-coordinated liquidity management policy changes by
the Fed, the ECB, the Bank of England, the Bank of Canada and the Swiss
National Bank.</p>
<p class=3D"western" style=3D"margin-bottom: 0cm;">I agree with Mr.
Rybinski, that the very fact that the five central bank governors who
made their simultaneous announcements on Wednesday December 12<sup>th</sup>
did try to make this look like a substantive coordinated action,
shows how worried these central bankers are about financial stability
and the risk of regional and global recession in 2008 and beyond.=20
The point of my blog was that because the substance of what was
announced was a list of five disjoint liquidity interventions, in the
Euro zone, the USA, the UK, Canada and Switzerland, it was both
strange and rather worrying that the central bank five governors
tried to make their simultaneously announced individual actions look
like more than they were. This was a set of actions where the whole
was no more than the sum of the parts. To try to make it look like
more than it was in unwise. When those in charge of price stability
and market liquidity in much of the industrialised world engage in
'spin' of this kind, I get concerned.</p>
<p class=3D"western" style=3D"margin-bottom: 0cm;">A swap between the Fed a=
nd the ECB of<em> X </em>US dollars for <em>Y</em> euros for 1 year, =
say, is equivalent to the ECB borrowing <em>X</em> US dol=
lars for 1 year and the Fed borrowing=20
<u>Y</u> euros for 1 year, provided</p>
<p class=3D"western" style=3D"margin-bottom: 0cm;"><em> =
&nbs=
p; &=
nbsp; &nbs=
p; X =3D eY(1+i)/(f(1+i*))</em> </p>
<p class=3D"western" style=3D"margin-bottom: 0cm;">where <em>e</em> is the =
spot euro-US dollar exchange rate (number of US dollars per euro),<em> f </=
em>is the one-year forward exchange rate, <em>i</em> is the one-year dollar=
interest rate and=20
<em>i*</em>
is the one-year euro interest rate. The authorities chose to present
their reciprocal borrowing of each other's currency as a swap rather
than as two loans. The private sector likes to do this because swaps
are off-balance sheet transactions, unlike loans. Surely the desire to
keep their mutual support (and mutual exposure) off-balance sheet
cannot have been a factor in the three central banks' decision to
proceed through swaps rather than through explicit borrowing of foreign
exchange?</p>
<p class=3D"western" style=3D"margin-bottom: 0cm;">More importantly, there
was no need for either official swaps or official borrowing to
alleviate the liquidity crunch. All that was required was for the ECB
to make euro liquidity available in the Euro zone (through OMOs in
euros) and for the Fed to make US dollar liquidity available in the US
(through OMOs in US dollars. Because the foreign exchange market for
the euro and US dollar has remained spectacularly liquidity throughout
this crisis, Euro-zone banks who had obtained euro liquidity from the
ECB could have bought or borrowed US dollar liquidity through the
foreign exchange markets without any problems. The could (indeed
probably would) have used swaps to obtain the necessary US doll=
ars,
if they believed the need for dollars in the Eurozone was likely to be
short-lived. So the Fed and the ECB did not materially improve =
the
terms and other conditions of access to US dollar liquidity for
Euro-zone banks through this swap. This was financial
window-dressing. Why? Spin always ends up cutting the mouth tha=
t
spewed it.</p>
<p class=3D"western" style=3D"margin-bottom: 0cm;">I agree also agree with
Mr. Rybinski that the monetary, regulatory and fiscal authorities
have to do more in the future to prevent the recurrence of
speculative excesses than they have in the past, including the most
recent credit orgy =96 that of 2003-2006. I believe, however, that
the preventative measures that are required will have to be designed
and implemented mainly by the regulators /supervisors of financial
markets and institutions and by the Treasuries/ministries of finance.
Central banks will not play a major part, unless they happen to also
be regulators/supervisors for the banking system and/or other
financial institutions or markets. </p>
<p class=3D"western" style=3D"margin-bottom: 0cm;">In a world with
unrestricted international financial capital mobility, central banks
have only one instrument with which to pursue their primary
objective, price stability. That instrument is either the short
risk-free nominal interest rate or the nominal spot exchange rate.=20
Central banks have additional instruments for influencing liquidity
at various horizons, ranging from overnight to one or at most two
years. There liquidity-oriented instruments include open market
operations (collaterlised and non-collateralised or outright) at a
range of maturities, reserve requirements and discount window
operations. Both OMOs and discount window operations are
multi-dimensional. The central bank defines the set of eligible
collateral, eligible counterparties and the term of the loans.=20
Foreign exchange market intervention is a special case of (outright)
open market operations and included in it. </p>
<p class=3D"western" style=3D"margin-bottom: 0cm;">If monetary policy,
defined as the pursuit of price stability in the medium term, is
entrusted constitutionally and institutionally to an
operationally independent central bank, it makes sense to dedicate
the short risk-free nominal interest rate (say the target for the
overnight interbank rate) entirely to monetary policy. This is not
because the short-run risk-free nominal interest rate (the official
policy rate) does not have any effect on liquidity. Nor is it
because the other instruments of the central bank (OMOs, discount
window operations and reserve requirements) don't have an effect on
price stability in the medium term. The reason is a practical
political one, grounded in the need for institutional accountability,
and reinforced by an appeal to Mundell's 'Principle of Effective
Market Classification', which prescribes a division of labour between
policy instruments, or an assignment of responsibility for policy
objectives to instruments, based on a law of comparative advantage. </p>
<p class=3D"western" style=3D"margin-bottom: 0cm;">Clearly,
the policies announced by the five central banks last Wednesday will
lower the spreads between the official policy rate and Libor at the
maturities for which interventions were announced (mainly one- month
and three months), relative to the levels they would have achieved
without the announcement. Since many loans to households and
non-financial firms are priced off 3-month Libor, this means that
monetary conditions will be less restrictive than they would have
been without the announcement. The central bank will have to allow
for this in their setting of the official policy rates, which as a
result will be higher in the future than they would have been without
the announcement. They may, of course, still be lower in the future
than they are today. The effect of current liquidity policies on the
level of the path of official policy rates most likely to achieve
price stability in the medium term is likely to be small, because the
price level effect of interest rate changes is subject to long,
variable and uncertain lags and of uncertain magnitude. =20
</p>
<p class=3D"western" style=3D"margin-bottom: 0cm;">Likewise, although cuts
in the official policy rate are an inefficient way to boost liquidity
under disorderly market conditions, it will have some positive effect
on liquidity. The five central banks, in their open market
operations, discount window policies and reserve requirements will
have to allow for the fact that the liquidity crunch will be eased a
little by cuts in the official policy rates. =20
</p>
<p class=3D"western" style=3D"margin-bottom: 0cm;">But the regulators and
the fiscal authorities will have to do most of the job of (1) making
a recurrence of destructive credit cycles less likely, and of (2)
minimising the damage to the real economy caused by such episodes of
financial manic-depressive illness as are likely to occur despite the
best efforts of the authorities. Without more effective
international cooperation and coordination of regulatory standards
and of the fiscal treatment of international mobile financial
institutions, instruments and their owners, the risk of future credit
booms and busts will increase. Creating a single financial regulator
for all of the EU (not just for the Euro zone) would be a valuable
contribution from the Eastern rim of the North Atlantic zone of
financial instability that has emerged this s century. This
nefarious contribution of the world's most developed national and
regional financial sectors =96 Wall Street, the City of London,
Zurich and Frankfurt - to global financial and macroeconomic
instability is in part due to the race to the bottom of regulatory
and supervisory standards driven by regulatory and tax arbitrage.=20
The sooner this trend is halted and reversed, the better.</p>
=09=09=09=09</div>
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