GIPSIs playing with fire

There is another field of research, beyond my PhD on behavioral finance and retail credit markets, I’ve been working on recently. Me and Fernando Rey we have been working on a paper, ‘Playing with fire: Internal devaluation for the GIPSI countries’, where we suggest the policy European authorities are imposing to GIPSI countries exposes them to the risk of deflation, which would only make fiscal consolidation and sustainability of debt even harder to achieve.


We are still working on it, but a copy of the working paper is available now at, Abstract nº 2200176. We gratefully appreciate any comments you may make about it.


In the paper, we first analyze the main drivers of debt dynamics of GIPSI vs Eurozone core countries during the last decade, to show the effects of fiscal balance, growth and inflation. Then we implement a scenario analysis to analyze the effectiveness of a coordinated policy among Eurozone members, where core countries accept a 3% target for inflation and reduce the pace of their fiscal consolidation, while GIPSI countries focus on fiscal consolidation with a low (but positive) level of inflation. This coordinated policy might be a better option as it (i) increases the competitiveness of GIPSI countries while avoiding the risks of deflation, (ii) ensures stability of debt for both groups of countries without imposing an excessive inflation target from EU core countries, and (iii) introduces the possibility of a fiscal stimulus (of about 1% of core countries’ GDP).


(by the way, there at you may also find a copy of my paper on behavioral finance and retail credit markets. The definitive version is available under the Abstract nº 2198345 , and it is now under review for publication).

Austerity, defeated

Olivierd Blanchard and Daniel Leigh (IMF) issue ‘Growth Forecast Errors and Fiscal Multipliers‘ (Blanchard and Leigh, 2013). “Stronger planned fiscal consolidation has been associated with lower growth than expected, with the relation being particularly strong, both statistically and economically, early in the crisis. A natural interpretation is that fiscal multipliers were substantially higher than implicitly assumed by forecasters”.


Don’t be naïve: nothing will happen here. Neocon UE governments won’t change a word on their austerity policy. This is not about being honest and doing what is good for society as a whole: this is about imposing my IDEOLOGY and doing what is good for top 1% (read Stiglitz if you want to know more about it).


You don’t believe me? Watch this VIDEO, minute 17:40. Michelle Boldrin, of FEDEA, saying IMF estimations are ‘chorradas’ (stupidities).

A behavioral model of the credit boom

After more than 2 years working on my PhD., trying to come out with a theoretical and empirical approach to analyze whether behavioral biases (particularly ‘prospect theory’, and bank managers’ optimism and overconfidence) might explain the recent credit bubble in Spain (and elsewhere!), work begins to bear fruit.


Here it follows the abstract of the paper with tentative title ‘Informational efficiency of the banking sector. A behavioral model of the credit boom’ that we are about to yield. An empirical research is also now underway: “We examine informational efficiency in retail credit markets to test whether behavioral biases by participants in the banking industry might explain credit cycles. We offer a simple model of herding and limits of arbitrage in retail credit markets that follows the three-step approach of Shleifer (2000). We show why solely behavioral biases by participants in the industry could explain how a credit bubble might be feeded by the banking sector. According to our model, optimistic banks would lead the industry while it would be rational for unbiased banks to herd. We derive the conditions for rational banks to herd, and show the resulting credit boom of loans of low quality is welfare reducing for high quality borrowers and welfare increasing for low quality borrowers. An important finding is the role of limits of arbitrage in the industry: there would be no incentives for rational banks to correct the misallocations of their biased competitors. Informational efficiency, therefore, would rely solely on authorities.”


Open access to the original data in the paper and the possibility to try with alternative scenarios (Excel Solver would be required) is readily available at

Debt restructuring: a must

Take note on this. Two recent articles in suggest to me there is an increasing feeling among academics that the Eurozone crisis will require a debt restructuring for European countries (perhaps not only Greece):


‘Fiscal discipline in the Monetary Union’, Ch. Wyplosz. “For the euro to survive, public debts must be written down. (to avoid) the moral hazard problem, decentralised US-style fiscal discipline is needed”.

‘Restructuring sovereign debt, 1950-2010’, Das et al. An empirical analysis of past debt restructuring episodes to guide the ongoing debate on debt restructuring. They conclude “debt restructurings with close creditor consultations were often quicker and more orderly than those with no prior negotiations”.


Only time will tell. So far, the recent agreement between Ecofin and IMF to refinance Greek debt only has bought some more time.

Sandy, Keynes and war

I recently watched this 2-hours-long sort-of-debate between Krugman and Stiglitz that I strongly recommend (particularly the discussion about the economics of public health, at about min.55):


At some point, I think it was Krugman talks about the Great Depression and how WWII helped to overcome the crisis. That reminded me of a classical discussion when someone argues “it wasn’t Keynes that brought us out of the crisis, it was war!!”. A clear evidence of how far some people are from understanding anything about economics… For those who have common sense: of course it was war… and of course it was keynesianism too!! Because, what is it war -from a macroeconomic point of view- but a massive fiscal expansion? What makes us different is that, while some of us prefer keynesian expansions to be invested in hospitals, railroads, universities and research, the only kind of keynesianism that some others accept is war. Indeed, for some reason that kind of keynesianism really makes them feel excited about -horny, I would say.


Today this great webpage Economist’s view linkes another brilliant article. Indeed, I believe the title of David Callahan’s article is one of the best arguments I’ve heard supporting government intervention in the economy: “Why should government respond differently to natural vs. economic disasters?”. “In the wake of Hurricane Sandy, you won’t hear public officials saying that devastated towns should pull themselves up by their bootstraps. Why is it so controversial that we should also lend a helping hand during man-made economic disasters?”. Indeed, I guess Mitt Romney didn’t think governments should intervene in case of natural disasters either when he planned to dismantle the Federal Emergency Management Agency, FEMA. Now his brilliant idea might guarantee Obama’s reelection. A victory for those who believe there is rationale for governments to intervene for reasons beyond going to war.

The paradox of toil

Things in macroeconomics are quite often much more complex than in micro. Interesting examples are the so-called ‘fallacies of composition’. Here is one example: The paradox of toil -an interesting concept by Gauti Eggertsson (2010).



Imagine that everyone wakes up that same day with exactly the same idea: to look for some more work. At first blush, the pedestrian logic may seem to apply: everyone would work just a little more — on average — and presumably in the process create more aggregate employment and output. This paper is about a paradox: Under particular assumptions, and in a particular environment (zero nominal interest rates and downward pressure on inflation and output), if everyone tries to work more, this will in fact reduce aggregate employment in equilibrium. Everybody trying to work more in response to the intertemporal disturbance puts downward pressure on current and future wages. What happens? Firms cut their prices today and in the future and stand ready to supply whatever is demanded at those prices. Then what? This leads to expectations of deflation, which increase the real interest rate – the difference between the nominal interest rate and expected inflation – and the central bank can’t offset this by cutting the nominal rate because the rate cannot be below zero. Higher real interest rates lead to lower demand because people prefer to spend in the future rather than today, since prices are expected to be lower in the future (and thus the return on savings higher). Because of lower spending today, firms demand less labor. Thus, more labor supply leads to lower wages, more deflation, and higher real rates, which leads to less spending, which leads to less hiring of workers. Therein lays the paradox.


This is the paradox of toil. It corresponds to a classic fallacy of composition. Just looking at what one person does, holding everything constant, can be misleading once everything is aggregated. The reason for this is general equilibrium: When everybody does something, nothing is constant. In models of general equilibrium, it can be highly misleading to build intuition and draw inferences looking at only one individual in partial equilibrium.


Eggertsson, G. (2010), The paradox of toil, Federal Reserve Bank of New York Staff Report nº.433 is downloadable at

Prospect Theory

I’m working hard these days in learning how to calibrate the parameters of the piecewise value function and the probability weighting function according to Tversky and Kahneman’s (1992) Cumulative Prospect Theory. I guess probably most of you don’t know what I’m talking about, but no worries, it doesn’t matter. I’m just working hard for my thesis, and I saw this:



This is the number of academic papers about Prospect Theory in Economics, Finance and Social Sciences that can be found in Scopus database since Kahneman and Tversky’s (1979) “Prospect Theory: An analysis of decision under risk”, the most cited paper in ‘Econometrica’ and for which they were eventually granted with the Nobel prize in Economics in 2002 (well, actually only Kahneman because Tversky was dead already, but we all know the prize was a recognition for both researchers).


Until the 1990s Behavioral Finance (and particularly Prospect Theory) was a field only for ‘geeks’. Now it has changed. Well, that is true particularly in most Universities around the world, but not here! This is dedicated to all my mates in Universidade da Coruña and BBVA who still wonder “what is that you are working on? psychology or something?”


If you want to learn more about Behavioral Finance you may read this article (Noahpinion, “Behavioral finance people are doing experiments!”) if you have a couple of minutes, or watch this amazing documentary, ‘El poder del dinero’ (spanish)…



…if you have an hour or so.


(‘El poder del dinero’ is a documentary broadcasted by Documentos TV of RTVE, but it is not available there anynmore. I found it on the youtube and there you can see it if you click on the image above).

Public debt: how growth and inflation could help


Here I use the ‘Kiel Institute barometer of public debt’ (see Bencek and Klodt, 2012) to analyze how GDP growth and inflation could prevent the cost of Public Debt of European countries –particularly of Spain, Ireland, Portugal, Italy and Greece– to become explosive.


The barometer uses the primary surplus ratio (PSR, the difference between a country’s government revenues and expenditures, exclusive of interest, compared to GDP) to determine the sustainability of a country’s budget. The ratio must be equal or greater than the debt ratio (S) times the difference between the nominal interest rate (i) and the GDP nominal growth rate (g) for the debt ratio to remain stable:


PSR ≥ S (i – g)


Bencek and Klodt empirical assesment concludes “it is extremely difficult for a country to prevent its debt from increasing infinitely when the necessary PSR reaches a critical level of more than 5%”. Most countries that exceeded this level for some time eventually needed outside help to deal with their debt.


In this article I analyze the situation of the five European countries in jeopardy: Spain, Ireland, Portugal, Italy and Greece. Instead of using the same average projections for the nominal growth rate of all countries as Bencek and Klodt (2012) do, I use data of historic GDP growth and historic GDP deflator –both a long term (20 years average) and a short term (6 years average) rate for both variables- as well as data on levels of public debt and market interest rates. Six different scenarios of high, low and no growth and high, low and very low inflation are projected using those historic rates


The conclusions of the analysis are twofold. On one hand, it is an easy-to-understand picture of how growth and inflation could help European countries to relieve market pressures on their debt. On the other, it provides a ranking of these five countries’ ability to pay their debt according to their current levels of debt, historical levels of growth and inflation, and projections of future levels of debt and market interest rates. The ranking, from more ability to less ability to pay their debts, would be Spain, Ireland, Portugal, (surprisingly) Italy, and Greece.


Next we provide the results on a country-by-country basis. Complete information and excel files for the analysis in this article can be downloaded here at






Data: Spain exhibits a historic real GDP growth of 2,18% (last 20 years) and 0,03% (last 6 years), plus a GDP deflator of 3,32% (20y) and 1,73% (6y). Data on consumer inflation is also provided at the table but not used for calculation purposes. Besides, Spain has level of public debt of 61% GDP at the end of 2010, though I use an estimation of 70% for the end of 2011. Finally, Spain pays a mean interest rate on all its public debt of 4,1%, but has paid a higher 5,55% both on its new debt on primary market (nov-2011) and on 10y bonds on secondary markets (jan-2012).



Continúa lendo

Spanish Greater Depression

Paul Krugman notes in his article ‘The Worse-than Club‘ that British and Italian Great Recessions have gone on longer than the slump during the Great Depression. He shows both graphs using data from Angus Maddison webpage, which we gratefully acknowledge here for the superb work he has done on his ‘Historical statistics of the World Economy’, providing data on population and GDP of each country in the World since year 1 of our era. Krugman also notes Spain would be a third country in this ‘worse-than club’, but provides no picture. This would be the evidence, according to Maddison data (and IMF projections for 2012 and 2013):



During 2012, the Spanish crisis would become a ‘greater depression’, worst than the GD of the 30s. However, there was a crisis in the Spanish history that was even worst than GD and the present crisis: the Spanish Civil War of 1936-1939: the slump represented 30 points of GDP. You may read an interesting article today in El Pais (Spanish language) about the GD and the 2nd Republic in Spain, about how the Spanish 2nd Republic came after the 1929’s slump, and how General Franco declared war when the recovery was already underway (as you may see in the graph above). Spain needed 17 years to achieve the same GDP level, and about 40 to achieve democracy again.



However, I found some data that make me wonder whether Maddison data is OK for some years. It is well known that another relevant economic crisis in Spain took place between 1973 and 1982, approx. During this period the economy experienced very high levels of inflation (about 25% some years). Maddison data is supposed to be in 1990’s dollars, but according to the graph I dont think he has properly taken the Spanish hiperinflation those years into account.