The economics of publishing in economics

The following text was prepared for a conference organized by the Kiel Institute and the pure player journal E-conomics on “The future of scholarly publication in economics”. It was originally intended to be a full fledged paper, but I only got to page 2. If time permits, I will write a sequel containing suggestions on how to improve the system.

When I started my career as a professional economist in the 1990s, I naively believed that publications were the means by which economists were communicating their ideas and findings. I could not imagine that the papers published in  the journals were not actually meant to be read. I also naively thought that the final outlet of an academic paper did not matter so much – since the paper is read, it would get whatever influence and attention it deserves, regardless of where it is published, as long as it is a visible enough journal. Finally, I believed that the publication process resembled somewhat the publication process in a French book publishing house, with delays not exceeding three months. After all, it would not make any sense if it took years for a publication to be available to its public.

Of course I was wrong in all accounts. The publication process in economics is not a publication process, it is a validation process by which we acquire a certain rank in a certain pecking order. Submitting a paper to a journal has nothing to do with research dissemination, it is far more similar to taking an exam or participating in a sports competition. The actual dissemination takes place mostly orally, in seminars and conferences; these seminars and conferences are also important validation events, because they allow authors to signal some of their characteristics that may influence their position in the pecking order, while not being easy to infer from their papers.

Now, when you take an exam as a student, you are graded by your professor, not by a fellow student – who would be a competitor if this exam is actually a contest. If you participate in a tennis tournament, the referees do not participate themselves in the tournament. Would anybody take the winner of the French open seriously if in earlier round Federer had been eliminated by an arbitral decision made by Nadal?

Yet this is the way our own profession is organized. Each submission is “peer reviewed’, that is, it has to be accepted by anonymous referees who happen to be participating in the same beauty contest as the author(s), most often in the same subcategory. At a minimum, as believers of cost-benefit analysis, we should consider that the journal editors and referees themselves perform a cost-benefit analysis when deciding whether or not to publish a paper. I must say that if I apply such a theory to explain my own experience with acceptances and rejections, I easily get an R2 of 80 %.

So what are the costs and benefits of accepting a paper, when you maximize your own rank in the pecking order? The main cost is that if the paper is accepted, the author will gain ranks in the pecking order, and surely this cannot improve your own rank, at least if one focuses on a ranking by number of publications. You will be much more reluctant to accept a paper by somebody who is in the same league as you are, than a paper by an author who is much better or much worse ranked than you are[1]. If the author is similarly ranked as you are, his progress will typically harm you: if behind, he will be more likely to overtake you, if ahead, you will be less likely to overtake him.

Another cost is the opportunity cost: instead of publishing this paper, you may prefer to publish another one whose net benefits to you are greater.

On the benefit side, publishing a paper may improve your own career to the extent that you are cited in the reference list; however there may be a trade-off here. You do not want to publish a paper that displaces your own work. A typical such paper is a paper that proves that you did something wrong, or proposes a more elegant method to do what you already did. This paper will probably cite your work, but if displaces it as the new reference paper on the relevant topic, you end up losing citations in the long run. You much prefer a minor extension of your work, or a paper that makes use of a methodology that you introduced and applies it to a different problem (such papers generally cite your work as an ad autoritatem argument to justify the use of that methodology, therefore you will get more citations if the methodology is somewhat dubious).

The other benefit is quid pro quo. The most important example of that is that one may be fortunate enough to be in a cooperative equilibrium in the game played with the referees. Smith may accept the papers by Jones, and vice-versa. Together they progress in the pecking order at the expense of the others, despite that each individual acceptance of Jones by Smith harms Smith.  This is a standard case of repeated prisoner’s dilemma. While the referee reports are supposedly anonymous, it is very easy for Smith to signal to Jones that he wrote that favorable report: they meet each other all the time at conferences. And Smith’s reports generally cite the work of Jones with some emphasis.

Small subfields are better at solving the prisoner’s dilemma than large ones, because the same individuals match more often in the refereeing assignment game. Thus, the rumor has it that it is relatively easy to publish in the field of social choice, while macro is a cut-throat environment.

Such cooperative equilibria make it difficult for a researcher to change fields. First, you have no record of playing the game in the new field, and so you have to convince the incumbents that you will behave properly. Second, if you are perceived as a type who is likely to change fields, you may not be around any longer when it is time for you to reward your referees for having accepted your paper, by accepting theirs or otherwise. If you believe that it is a good thing for people to move across fields occasionally, this feature surely is a source of inefficiency.

There are other forms of quid pro quo. Some economists command resources, and they can offer in kind rewards to those who help them, for example by inviting them to very nice conferences in very nice places. The beauty of it is that this form of corruption is simply indistinguishable from good faith. After all, there is no reason why a conference would take place in an ugly, dangerous, and polluted city—it would harm the quality of the conference–and it is perfectly desirable to invite the most prominent people in the field, who also happen to control access to the best journals, a feature which is itself totally defensible on meritocratic grounds. It is also perfectly understandable for an economist who controls access to a nice conference in a nice place, not to invite as a keynote speaker somebody who sent him a nasty rejection letter[2]: There surely is some equally notable candidate that one may want to select instead.

[1] To the extent that the distribution of papers published across authors follows a power law, it is very unlikely for somebody to overtake the leaders, even if he is extremely well ranked, because the leader will have so many more publications than he has. That is, it is much more difficult for the 20th ranked economist to overtake the leader, than for the 250th ranked economist to overtake the 150th ranked one. Therefore, the leaders’ papers are more likely to be accepted, which reinforces the power law and path dependence aspect of the distribution. In essence, the leaders are not much of a threat. At the other end of the distribution, the fact that laggards and newcomers are also not much of a threat, generates a mechanism for upward mobility in the ranking.

[2] Although rejection letters usually start and end with ”I like your paper…”


New working paper

Bobos in Paradise: Urban Politics and the New Economy

The term “bobo” stands for “Bourgeois Bohème” and was coined by David Brooks (2000) in a famous book about the rise of a new knowledge elite. This new kind of bourgeoisie is generally considered as prevalent in globalized capital cities, and its lifestyle and political attitude stand in contrast to that of the traditional bourgeoisie. Furthermore, the bobos are generally viewed as a politically powerful group. They have been instrumental in bringing about left-wing governments in municipalities such as Berlin, Paris or San Francisco, despite the relatively high economic status of this social class.

Politically, the bobos are viewed as generally supportive of environmentalists and/or socialist parties. Their takeover of major cities has taken place in the context of sharply increasing house prices from the mid-1990s to the onset of the financial crisis, and led to policies that recognizably differ from the ones implemented both by the right and by the traditional left. These policies can be summarized as follows

∙  Greater investment in collective urban amenities and socialized recreational events.

∙  Reduced urban space for the automobile, generally coupled with a reduction in parking space, higher taxes and more stringent regulations and constraints for personal vehicles. More investment in public transportation and in dedicated areas for bicycles, skate-boards, roller skates, and so forth. Deregulation of the use of bicyles (authorization to use wrong ways and bus corridors). Public provision of cheap bike and electrical car rental, and dedication of public space to those devices.

∙  Promotion of “social mixity” and “diversity”, by means of transfer policies and/or subsidized housing that maintain a critical mass of lower class dwellers in the city center, while intermediate classes are eliminated and relocate themselves in the outer periphery

This paper provides some elements for understanding these developments from a “pure economic perspective”. By this I mean that I will attempt to explain them as a consequence of technological developments, instead of just assuming that bobos are a new kind of individuals with their own preferences. The paper focuses on the relative roles of, and conflict of interest between two kinds of bourgeoisie:  The skilled workers of the old economy versus the skilled workers of the new economy (bobos). The former work in activities that are more land intensive, while still preferring to live in a city centre. As a result they derive more utility from commuting and are less willing to raise commuting costs in order to improve urban amenities than the bobos. The paper shows that as the new economy grows faster than the old economy, the bobos overtake the cadres as the politically decisive group in the city. As a result, the level of urban amenities goes up and so do transportation costs.  I also show that it may be profitable for the decisive bobo class to subsidize location of lower class unskilled workers in the city, in absence of any altruism toward them or intrinsic taste for a socially diverse makeup of the city. This is because such subsidies allow to force the economy to settle in a “bunkerized” equilibrium in which the service providers to city dwellers are located in the city, so that the price of services no longer goes up with the amenity level. As a result, ex-post there is no cost to raising the amenity level in the city, and the resulting political equilibrium involves the highest possible level of amenities, while commuting has disappeared.

Finally, I provide evidence using French cities that those urban areas that have most invested in amenities are such that (i) had a greater employment share in the new economy initially, (ii) experienced the fastest growth in house prices, and (iii) tended to have a greater increase in service employment as well as the proportion of inhabitants in public rent-controlled housing.

Read it here

ELA, Grexit, and the technocrat turned politician.

The missing link between the Greek solvency problems and its membership of the eurozone is called liquidity. Absent liquidity problems, for example under 100% reserve banking, the two issues would be entirely disconnected, since the banking system would never need emergency liquidity assistance from the ECB.

I believe the doctrine of the ECB underlying ELA, is that ELA deals with a technical (as opposed to political) issue (The way ELA works is nicely described in this piece by The Economist). And this technical issue is what we call multiple equilibria.

According to this view, there exists a bad equilibrium where expectations of exit from the Eurozone and bank runs mutually reinforce each other. Under normal circumstances, banks can get fresh liquidity from the ECB at the going interest rate (which is very low), in exchange for collateral. This collateral has to be “good”. Assuming Greek banks hold Greek debt, the collateral becomes “worse”, the less solvent the Greek government. To the extent that Greek bonds are denominated in euros and owned by non-Greek residents, Grexit would either trigger a redenomination of those bonds in a depreciated drachma, or make it more difficult for Greece to pay them back, since it will presumably experience a substantial real depreciation. Therefore, expectation of Grexit makes Greek sovereign debt worse and Greekn banks less solvent. As depositors fear that their own bank could be liquidated, they run to the bank to get their cash back. Running to the bank delivers not a double dividend, nor a triple dividend, but a quadruple one:

First I am protecting myself against the bank’s bankruptcy. True, my deposit may be insured, but if the bank run is general the insurance system is undercapitalized and I may not get my money back.

Second I am converting the virtual euros of my bank account, that may be converted into drachmas any time, into actual euros that are physically the same as those circulating in Germany, and are much more difficult to convert except by extreme coercion.

Third, I am certain to have cash when I need it, instead of being rationed by bank holidays and controls on withdrawals.

Fourth, I am protecting my savings against a surprise capital levy that could be imposed by the troika on deposits in order to pay back creditors.

When faced with the bank run, the ECB has to do something. If it refuses to provide liquidity, say because the collateral is no longer acceptable, then the banking system in Greece collapses. And in order to provide liquidity to its banks, the Government will have no choice but to exit the Euro, making Grexit a self-fulfilling prophecy. The bank run equilibrium is a Grexit equilibrium, indeed expected Grexit acts as a catalyst for the bank run by reducing the market value of bank assets.

But it makes no sense for the ECB to value the collateral of Greek banks at its price under the Grexit equilibrium, if instead a better equilibrium can be enforced: that is, an equilibrium where the bank run does not occur. ELA is an attempt to enforce the good equilibrium by setting interest rates and haircuts at levels consistent with the good, not bad, equilibrium. If the good equilibrium is indeed an equilibrium, sufficient liquidity should be provided under those terms so as to “tame” the bank run and keep Greece within the Euro area.

The problem with this fairy tale is twofold.

First, technicality is not so easily distinguishable from politics. We see that the ELA tap is being shut by the ECB, because the Greeks are not accepting the conditions set by the troika. The banking crisis in Greece, initiated by the ECB, may bring the government down. There is no way Tsipras can decide, as the democratically elected ruler of Greece, to provide liquidity to banks despite the ECB veto, unless he exits the Eurozone immediately. Voters on Sunday may support the Yes vote because they believe banks will reopen sooner than if No wins. That is, the ECB can bring down a democratically elected government by stopping providing liquidity to its banks. In that respect, the similarity between Alexis Tsipras and Salvador Allende is striking; in both cases we have radical leftists heading a minority government. The difference stops in that instead of having a military coup (Pinochet and the CIA) we have a monetary coup (Draghi and the Troika/Eurogroup), and instead of the trucks blocking the roads, we have the banks blocking the transactions.

While closing the liquidity tap inevitably is a political coup against the Tsipras regime, keeping it open is another forced transfer from European taxpayers to Greek residents. In other words, regardless of the decision, the non-elected ECB cannot avoid doing politics.

Given the fiscal situation in Greece, the terms under which the ECB is accepting Greek bonds as collateral under ELA are probably too generous. Under ELA the ECB lends to Greece at 1.5 % and the haircuts are secret (See here and here on haircuts). Under the assumption that the ECB is successful at killing the bad equilibrium, the terms under which a Greek bank can borrow from the ECB should be the same as those in the market. Since Greece is tapping ELA it means that these terms are better, hence that there is a transfer. The transfer is larger, the larger the gap between the market prices the ECB is trying to achieve and actual market prices. If the ECB were fully credible in extending an infinite credit line to the Greek banking system, this gap would disappear. If the good equilibrium exists, the fiscal transfer to the Greeks is the mirror image of the ECB’s limited credibility and of the market view that the probability of getting to the good equilibrium is lower than 100%. The transfer, and the likelihood of the bad equilibrium, could then be eliminated by making the credit line infinite, killing any doubt by markets about the viability of Greek banks.

But, if the good equilibrium does not exist, Hans-Werner Sinn is right: The Greeks will take advantage of ELA to sell all the Greek debt to the ECB at an inflated price, converting their deposits into fresh and good euros, and leaving the ECB, that is, the taxpayers from solvent countries, with dubious claims on the Greek banks’ balance sheet. An unlimited credit line can no longer kill the bad equilibrium since it is the only one. It would simply raise the amount of money transferred to the Greeks by other euro area residents.

That the bank of Greece, not the ECB, is supposed to bear all the risk of ELA, is a cosmetic provision: ultimately, the bank of Greece accounts are implicitly consolidated with those of the bankrupt Greek government.

And it is hard to believe that the good equilibrium exists. That is, if the Euro were made as big a taboo as incest, the quadruple dividend from getting your money back would just become a triple dividend. Think about it. The benefits of having your money in a bank deposit rather than cash are quite small. The reason we keep it there is because it is the default option for most wage earners (they call it libertarian paternalism). So you only need a small cost of having your money deposited in a bank for it to be rational to withdraw your money. The asset side of the Greek banking system provides ample reasons to justify a bank run.

(The reason why the “good equilibrium” has existed for so long is that banks have been regularly provided with fresh cash by central banks, bailout money by governments, and deposits have been insured. But we may ask whether this form of financial intermediary makes sense. Perhaps the financial crises tell us that it is an evolutionary dead end and that banks should be eliminated. By saving them each time, public authorities are fighting against economic evolution and sowing the seeds of the following crisis.)

Post Scriptum — Here is an interesting piece by Dirk Niepelt. Clearly, the reason why governments would like to eliminate cash has everything to do with exercising discretionary control upon private savings — so as to implement a capital levy when needed, as advocated by Mrs Lagarde — and very little to do with “combating crime”. Virtual cash held at the monetary institute is also vulnerable to capital levy. In the long run, suppression of cash  by heavily indebted government will eventually harm them, as private means of payments (like bitcoin) will arise.

Two things I do not get about Greece

There are two things that baffle me about Greece.

First, the insistence on linking sovereign default with exiting the Euro area. Technically there is no relationship between the two. Greece can default on its debt and continue to use the single currency (in fact its seignoriage share could be confiscated by the creditors), just like many American states defaulted without stopping to use the dollar. Conversely, Greece could decide to exit the euro area and continue to meet its oligations. Indeed, there is talk in Finland of leaving the Euro and this has nothing to do with any looming sovereign default.

The Grexit ghost is a superstition which allows to mutualize the bailout among members of the eurozone in a way which is disconnected from their holding of Greek debt. Conversely, non euro area members contribute little or nothing to supporting Greece.

Second, the Grexit ghost is a way of manipulating public opinion in solvent euro area countries so as to make them accept the bailout. The implicit blackmail is that Greek default would trigger Grexit, then contagion and a collapse of the Eurozone, which would be a catastrophy. In order to avoid catastrophy, we are told, the taxpayer, not the holders of debt, should bear the cost of the Greek default. This blackmail is backfiring against its conceptors as Greece voted for a government which plans on reneging on austerity and live off other people’s money. This blackmail works well as the troika has just offered another 15 bn euros of our money to postpone a decision by five months. Presumably the Spaniards are taking due notice of this hilarious joke and will gladly adopt the Greek mutilated beggar strategy in the next elections.

Second, the lack of recognition that Greece suffers from a debt overhang problem. Despite falling wages the economy is not recovering, because firms expect that the profits they make will be taxed so as to meet the sovereign debt obligations. This is a well understood problem that has been identified decades ago in the context of similar crises and popularized by prominent economists such as Dornbusch, Krugman, or Sachs.

There is no difference between erasing a debt and lending to your debtor the interests he owes you: in both cases you do not get your money back. But in the second case the debt overhang problem destroys the economic incentives of the debtor. Instead of renewing the loans in exchange for fuzzy structural reforms that are unlikely to work because of the debt overhang problem, the troika should erase 75 % of Greek debt once and for all and stop any new institutional lending to the country. Greece will then be able to grow again for ten years. Private lending will resume relatively fast, as suggested by the historical experience.

This has little to do with Euro membership, except that once private lending resumes, another crisis may graduallybuild up. Greece will be too happy to live again with large twin deficits financed by capital inflow, because this will generate an economic boom driven by demand, a welcome substitute for the structural reforms its government is unwilling to do. It will accumulate the competitiveness problems and the debt overhang of the next crisis. For this reason it is not in the interest of Greece to remain in the Euro. Should it have its own currency it could supplement its insufficient fiscal receipts with seignoriage (as recently as 1990, inflation in Greece was 20 %, yielding perhaps 2-3 % of GDP in seignoriage revenues). It could devalue to boost its competitiveness (prices have fallen by 2 % in Greece and only very recently, despite then huge fall in GDP), maintaining external balance despite its tendency to create inflationary surprises so as to boost the economy. All these considerations are important, but they do not imply conditioning exit on default. If anything, it is the future defaults that the exit prevents.

Wealth, materialism and spirituality

I am half-way through the reading of Bobos in Paradise by David Brooks, and he traces the Bourgeois Boheme (aka bobo) lifestyle back to both the French “bohemian” rejection of bourgeois values in the nineteenth century as well as the American transcendentalist movement of Emerson, Alcott, and Thoreau. Presumably the intellectual heirs of that movement are the so-called post-materialistic philosophers, who have some influence on the bobo lifestyle.

So we have to figure out what is so despicable about the bourgeois ideal of competing, thriving, and accumulating wealth, and what makes the bohemian lifestyle desirable and praiseworthy. An immediate, naïve answer is that it is cool to be a rebel, even without a cause, but one has to go beyond such adolescent posturing.

Many would concur with Brooks that the original sin of the bourgeoisie against which the bohemians, the transcendentalists, the dandies, and the modern bobos react is its materialism. This brings forward three questions. In what sense is the bourgeoisie materialistic? Why is such materialism contemptible? And in what sense is the attitude of the bohemian crowd a deviation from materialism?

So what makes the traditional bourgeoisie materialistic? This is supposedly because of their excess taste for wealth and social status. If we consider the meaning of those words, we end up with a paradox. For neither wealth nor social status are material things. They are abstractions. It is true that wealth buys you material things, like a yacht or a plane, but the bourgeoisie against which the bohemians were rebelling was also noted for their relatively austere lifestyle. They might have impressive mansions, but while a mansion is a material object what really matters here is the impression. Therefore, we may want to keep in mind that materialism might not be the right word to qualify those bourgeois values. Another dimension that is discussed by Brooks is the fascination of the nineteenth century bourgeoisie for new technologies (railroads, electricity, and so forth), that the bohemians rejected as vulgar and dehumanizing. Again, what is remarkable about new technologies is that they witness human capacity to get rid of the constraints imposed upon us by our material condition, such as gravity. Therefore, fascination for technology hardly qualifies as materialism.

Nevertheless, it is likely that the bohemians reject such lifestyle because they deem it superficial and soulless. They of course have the right to conduct their life as they wish, but there seems to be a presumption that their lives are somewhat more worthy than those of the bourgeois, according to some reasonably accepted scale of values. So what is above technology, wealth, and social status in such a scale of values? Two common buzzwords are “Art” and “Spirituality”.

Spirituality is as elusive a concept as materialism. The origin of the word is religious; spirituality has to do with some invisible world, maybe the inner world, or the outer world. But, surely, spirituality cannot be defined as the absence of something. Not having wealth, not having a high social status, not being invited to cocktail parties, does not make you more spiritual. It can at best make you nihilistic, which does not qualify as spirituality. The claim by bohemians that they forsake a career in business to focus on their spirituality should therefore be evaluated upon the merits of their actions.

We can observe that most bohemians tend to live pretty secular lives, and in many cases are atheists. They are no Ignatius of Loyola, no Teresa of Avila. The French impressionists, for example, are a cliché of bohemian lifestyle. And their paintings were depicting trivial scenes, quite unlike the despised pompiers who were continuing to produce historical and religious paintings. A cornerstone of the bohemian lifestyle is enjoying daily pleasures without restraint, such as nice wine, dinner parties with friends, dancing in a guinguette, and casual sex. All of this seems pretty materialistic to me. More materialistic, in fact, than the life of an uptight WASP industrialist of the early twentieth century, simply because it resembles more the life of animals. In the 1920s, the American “lost generation” replicated the bohemian lifestyle in Paris and elsewhere, and by all accounts this was quite down to earth and unspiritual. In his novels, Hemingway frequently insists on details such as food, wine, and the like, to the point of having been accused of writing tourist guides. Rejecting the corset of bourgeois conventions may make you more relaxed and more “authentic”, but does not qualify as spirituality. What is going on here, is a false belief that if an individual is subject to less tight social control, he will be freer to express himself, and he will naturally express spirituality, as though humans in wilderness were ontologically more spiritual than civilized beings. Over and over again, we observe instead that this reduced level of self-restraint promotes animal instincts, not spirituality. Indeed, wilderness is a pretty materialistic environment, because survival is the main concern.

How about “art”? Here the implicit view is that the old style uptight bourgeois were incapable of appreciating art, stuck that they were in their vulgar and petty pursuits. In contrast, the bohemians, having freed themselves from material constraints, could fully enjoy the beauty of art, and of course many were artists themselves. It is true that the artists can afford the bohemian lifestyle, because their activity is not sensitive to organized interaction with other people.  It would be a disaster if the train driver, the hospital director, the pizza deliverer, the soldier, became bohemians. But the artist is much less bound by schedules and the need to cooperate. That being said, throughout the ages artists were not typically bohemian: think of Rubens, Bach or Tolstoi. Furthermore, just being a bohemian does not make you an artist. At best you are just mimicking some artists, and this hardly qualifies for a badge of moral or aesthetic superiority. Furthermore, the aesthetics are now self-referential. In the past, an artist was in fact an admirably skillful craftsman. The romantics came and popularized the view that an artist is some genious; art was no longer about beauty or skills, but about innovation. The impressionists are considered as superior to the pompiers, not because they are better painters, nor because their paintings are more beautiful, but because they invested a new way of painting. This avant-gardiste posture culminated of course with the Dada movement and Duchamp’s hanging of toilet bowls on exhibition walls. The end result is that there are no longer accepted criteria to define what art is. If anything, it seems that usefulness (a car design does not qualify as art) and popularity (Sinatra is less highly regarded than Duchamp) are at best irrelevant, as is beauty of course. Yet, as there are many things left that are new, uninteresting and useless, it would be suicidal if they were all considered as art. So only a subset of those artefacts qualify as art: those that are coopted by the self-appointed bohemian elite. An additional irony is that the reason why, historically, art is highly regarded, is because of its spiritual dimension. The Sixtine Chapel elicits emotions that may help connect the individual with some invisible, superior, truth. This can hardly be said of most of the Duchamp inspired contemporary art that is valued by hipsters and bohemians. Nothing is more materialistic than a toilet bowl. While the bohemian lifestyle may be more friendly to art, what passes for art nowadays has no external validity and has been stripped of any spirituality. There is therefore no reason to consider it more highly than any other human activity, such as a football match, a good dinner, or cleaning the (now mythical) toilet bowl.

We conclude that the claim of bohemians to moral and aesthetic superiority is largely bogus. The world they are promoting is in fact more materialistic than that of the despised bourgeois industrialists.

PS – I would speculate that the ideas above bear some relationship to Deirdre McCloskey’s Bourgeois Dignity, which I still have to read.

Euro Blackmail

The Greek election results are the perfect answer to the IMF’s, ECB’s and European Commission’s pledge to defend the eurozone at any cost, and their repeated claims that they are willing to exchange any asset against euros in order to reignite the anemic economies of the area and prevent another sovereign debt crisis. So, in effect, the Greeks are saying : you want to buy junk ? Here it is ! Where is the money ? It would be foolish of them to continue their painful austerity policies when they can instead get their deficits financed by using one of the facilities offered by the ECB under the “save the euro” motto. Conditionality is supposed to apply, but the ECB has given every hint that it would yield to blackmail, so why should the Greeks refrain from it ?

The relative lack of reaction of the euro/dollar exchange rate baffles me. Markets do not seem to understand the significance of the Greek election results.

The most favorable scenario would be Greece being kicked out of the Eurozone, defaulting on its debt, and starting over again at a depreciated exchange rate, with a balanced government budget (although Syriza would be unlikely to run a balanced budget) and a depreciated currency that would allow export demand to make up for the fall in domestic spending. Hopefully, after a couple of years of recovery and virtuous fiscal policies, Greece could borrow again on international markets, and even repay its original creditors a little bit. But the episode would set up a precedent, and bring about the possibility of renewed attacks on the sovereign debt of other euro area countries, under the belief that such attacks would lead to their exit from the currency area. This would be 2010-2011 all over again.

At the opposite of the spectrum, the troïka may yield to blackmail as Syriza reverts to primary deficits following a string of demagogical policy measures. The ECB will pose as responsible while running a Ponzi game, purchasing all the debt issued by the Greeks. The Greeks will do just fine, like a teenager, because they will be spending the taxpayer money from other European countries, through the mutualization scheme implicit in the ECB debt purchases. Things will eventually turn nasty as the electorate in other countries – Portugal, Spain, Italy, France – will conclude that blackmail works better than austerity and vote for their own populist parties. The ECB will find itself compelled to issue more money, and it will have lost any credibility regarding its ability to control the price level. Inflation will pick up and the euro will continue to fall. German consumers and pensioners will then increasingly favor a German exit, as it would occur at an appreciated exchange rate, thus improving solvency and purchasing power.

Finally, an intermediate scenario is that the troïka refuses to continue to purchase Greek debt unless the government goes ahead with austerity. This will be a casus belli, likely to trigger immediate default as the Greek government will revert to primary deficits. Since it will then be unable to borrow, it will want to exit the euro area so as to be able to monetize its own deficits.

I suppose the euro establishment believes that Syriza will turn out as  Lula or Menem style leftists, that is, they will renege on their most demagogical campaign promises and continue to pursue austerity.  They forget that Lula and Menem did not have a foreign entity with a wide open cheque book for them.