Interview With Jaume Ventura By Joana Duran Franch, Jacint Enrich, Julia Hoefer Marti and Georgios Petropoulos
Jaume Ventura is a Senior Researcher at CREI and Professor at UPF. Prior to joining CREI and UPF, he was a tenured associate professor at MIT. He has also taught at the University of Chicago, Northwestern University, London Business School, and INSEAD. Professor Ventura has worked full- time for the World Bank, and acted as a consultant for the Inter-American Development Bank. He is a Fellow of the European Economic Association, Faculty Research Fellow of NBER, and a Research Fellow of CEPR, where he has been Co-Director of the International Macroeconomics program (2007-11). He has been editor of the Economic Journal and associate editor of the Quarterly Journal of Economics, Review of Economics and Statistics, and Journal of the European Economics Association. His research specializes in Macroeconomics and International Economics. He is a member of the Barcelona GSE’s Academic Programs Committee and Director of the Barcelona GSE Master Program in International Trade, Finance and Development.
You received the prestigious ERC grant in 2010 for your project “Asset Bubbles and Economic Policy”. What can you tell us about your main find- ings up until now and how do you plan to extend your research?
The idea that we have pursued for quite a while now is to try to understand how these brusque changes in asset prices can affect the macroeconomy. So with the help mostly of my coauthor Alberto Martin, we have developed a series of models in which we show how the presence of bubbles affects the work- ings of the macroeconomy. And indeed it is quite appropriate that you ask here, because what we have done is to take a very old model from a professor of yours, from Jean Tirole. Jean Tirole built a model of asset bubbles back in the early 80s; in 1985 he published a paper which is a seminal paper on asset bubbles in an overlapping generations economy, into which he took the standard growth model and found that there are many equilibria in which prices have a bubble component.
Now, the model from the point of view of the theory was fascinating, because we didn't know that the neoclassical model had so many equilibria, and we didn't know what they looked like. But from the point of view of applied macro it was a little bit disappointing, because when the bubbles came in what they did was to crowd out capital; people, rather than investing, would buy the speculative investments, and then when the bubbles arose the capital stock and output would go down. So you would have a theory where there might be bubble episodes, but when these bubbly episodes take place, actually you are in a recession, and it is
when the bubbles col- lapses that the economy goes back into a boom, because the bubbly as- set disappears and then people start to invest and start to accumulate capital, and so on. The paper was very nice because these bubbles were rational and you could see how they worked, but obviously it was not a very good correlation. So what I've been working on is models where these same bubbles exist, but they have additional effects; and in particular, when you introduce financial frictions into the Tirole model, then you find that bubbles have two effects: on the one hand, they provide an alternative asset that has the effect that Jean Tirole worked out of crowding out. On the other hand, when you have bubbles, they relax credit constraints and allow some of the firms to borrow more. And that creates an expansionary impact. And all my work has been analysing what of the two effects works and what policies are appropriate under different circumstances. [laughs] I don't know if I answered your question too much.
So will you be continuing this line of research going forward?
That is the plan, yes.
Even after the end of the grant in 2015?
Presumably I haven't exhausted the things to say. To be honest, as long as I have things that I think are interesting I will continue doing that, so... hopefully yes.
Your research work has contributed a lot in the understanding of bubbly episodes and the introduction of bubbles as a main element of macro- economic models. Is it worth letting them exist or should we try to prevent their emergence?
In the models we have developed in this line of research, bubbles play a very important role: they help markets to function. Let me put it this way. Imagine that there are some firms that have very good investment opportu- nities but they are credit constrained. There are other firms that perhaps are investing because the costs of funds are cheap despite not having really good investment opportunities. These firms do not lend to the others because the market is not working well and it does so because these other firms do not have enough collateral. In our models, bubbles create wealth and create col- lateral and allow the financial market to work better, to transfer resources from the lower productivity to the higher productivity investors. When bubbles do that, in general, we find that bubbles are helping the economy to function. They are the ones that allow the best investments to take place and the highest growth to take place. So, in this sense, my research (or our research be- cause it is mostly with Alberto Martín) has led to the conclusion that actually the bubbles are not really the problem, the problem is their collapse.
The typical notion of the bubble outside of the academic market, shared by policy-makers and non-academic economists, is that bubbles are a mistake; markets are making a mistake. And if you have a mistake, the signals are scrambled. And when signals are scrambled, you make the wrong investments. And this is bad because it lowers productivity. And what you need to do is to set the signals right. In our work, that is not the case. In our work bubbles are rational pyramid schemes that provide wealth and help financial markets to work better. So, one of the things that we find is that sometimes governments have an important role helping to sustain these bubbles, not to eliminate them. That does not mean that there are not bad bubbles. But typically, the bad bubbles are contrac- tionary; they are not associated with economic growth.
So, it is no longer “let the markets do their job and do not invervene”.
Markets have lots of limitations. And indeed, in our research like in the early [ Tirole] research, bubbles appear because there is something wrong in the markets and they in part solve that problem.
Bubbles are fragile because they depend on expectations on the bubble component. For example, we think about bubbles in terms of an excess of equity prices so imagine that when you look at the net present value of a firm its value is 100, but it is triggered at 120. Why would that be? Well, because somebody expects the price to be also overvalued tomorrow. That is a bubble that is rational. But if somebody changes their mind, the overvaluation can change. So, bubbles are fragile. But when they exist they play a role.
Or a credit bubble. For example, a firm borrows in excess of the cash flows that it can generate. But why does the firm borrow? Because the creditors know that the firm will borrow tomorrow to pay them back. And tomorrow why new creditors will appear? Because they expect that the firm the following year will borrow to pay them back. These pyramids schemes or these Ponzi games that we usually think are bad, ac- tually they can be part of a competitive equilibrium in a market with rational traders. And actually they play a useful role.
How policy makers can react when bubbles explode?
They should try to sustain it. And if it is not possible, there is no way.
There is a common view that links the existence of the bubble with the fact that we are doing very poorly now, it is about “paying for the sins of the past”. I do not see hard evidence that supports this view.
The only thing that I see is that when the bubble was there we were growing a lot and we had a lot of intermediation. When the bubble collapses, we are not growing and there is no intermediation. And I look at the world and it is not fundamentally different. We have the same firms, the same people, the same human capital; we have the same in- stitutions... It is not like that suddenly we have an earthquake and we have lost half of our capital stock; or that we forget our education and the human capital in the economy has changed. We are basically the same but we are totally disorganized and I think that the bubble helps us to organize by pro- viding the collateral that the economy needs to work.
Let’s take a closer look to the Eurozone crisis. The initial rescue packages that were implemented in the Southern member states did not seem to perform very well and they had to be revised. Some people believe that these initial packages were mo- tivated by an element of punishment rather than incentives for recovery? Do you agree with this view? Could this be a reason for not performing as well as it was expected?
I agree very little with that. Actually, the punishment aspect was very small and I think that I personally would have made it larger to put it in this way. European economies or economies from industrial countries have been always telling poor countries that if they have a fiscal problem they have to adjust. We have used the IMF for that. We have given them programs which typically were very short like three years; there were penalty rates and very tough conditions. Now we have some problems in some European countries. The first programs were programs with the IMF and some European nations. For example, the first Greek one. Then, programs were designed in a more organized way with what is called the “Troika” and so on. The only one that kept putting some penalties was the part of the funding coming from the IMF. The other parts had no penalty rates. They were at very low market rates. And the conditions have been 10 years, 15 years, some of the Greek bonds that have been rescheduled are at 30 years. So the conditions are far better than anything we gave before to the countries that came to the IMF. Were we wrong before? Are we wrong now? I do not know. I do not think that this is the major problem. I think that there are a lot of reasons for which the countries are not recovering quickly.
The Euro crisis has exacerbated the movement for independence in Catalonia. You yourself are part of the Wilson Collective. What can you tell us about the economic foundations to the independence movement and about your work in this group? Do you think this separatist movement is com- patible with calls for greater European unity?
You are asking me various questions; let me go step by step. Fist, let me talk about the Wilson Initiative because pre- sumably many of your readers will not know what the Wilson Initiative is. As you know, there had been a lot of calls in Catalonia for having a referendum on whether Catalonia wants to remain within Spain or wants to have a new State on its own as an independent country. This has been a grassroots movement that has come from people and has been crystallized specially in a couple of very prominent demonstra- tions on our National day last year and this year as well. There was also a vari- ety of other popular demonstrations and the result of the elections of last November of the Catalan Parliament, where a majority of seats that were elected are in favour of having this sort of referendum; in particular 107 out of a 135 seats are from parties that call for having this referendum.
When this started, the Spanish press and a bunch of other establishments in Spain started to publish a number of studies that basically painted a very dark picture about what an indepen- dent Catalonia would look like. They mentioned things like that Catalonia’s GDP would fall 30%, that Catalonia would be unable to pay for the pen- sions, that Catalonia would be left outside of the international community and, as a result, not able to enjoy of all the treatments that we enjoy right now the Catalans as citizens of Spain, and so on. Most of this campaign and most of these claims are plenty wrong, absolutely wrong and, basically, from any academic view point. Yet, most of the population is sensitive to these sort of claims appearing in the press, being told by government officials and so on. So, there were few academics, in partic- ular six of us, five of us are economists and one of us is a political scientist, all of us have been tenured in top institutions in the United States and we are friends, and we talk, and we agreed on the need to do something, we need to, somehow, explain to the Catalan people what is the reality of this, what we know and what we don’t know, be- cause there is also a lot of uncertainty. That is why we created a webpage and we wrote a series of documents on a variety of topics related to the eco- nomic independence and also we have made ourselves available to the press and to various media outlets and they have, actually, taken that commitment seriously, so we participate actively in debates, discussions and so on. So that is what Wilson Initiative is.
Now, we will move to the second ques- tion. The Catalan independent move- ment it is not only economics. There is a lot of it which is about the treatment of Catalan culture within the Spanish legal system (a mistreatment, an indepen- dent Catalan would say). Since you are asking me about economics, I will not mention about the cultural part but I will tell you that it is as important or, for many Catalans, is much more important that the economic part of it.
We also think that Catalonia is mis- treated from an economic view point: over the last thirty years, Catalonia has made a transfer of an average between 8.5% of its GDP to the rest of Spain, which is the difference about what we pay in taxes and what is spent in Catalonia and we think that this is unfair, because we would do much better if we could spend part of this money in Catalonia. The other aspect is that most of this mistreatment does not come from the fact that Catalans are treated differently when it comes to paying taxes: we pay the same taxes, we receive the same pensions as the rest of Spain and we have the same unemployment compensation. Most of this mistreatment comes from the investments that the Spanish State makes in the different regions. Just to give an example, Catalonia has one of the highest capital/labour ratios in Spain and has the lowest stock of public capital per person in the whole of Spain. Last week, the Government announced the proposed budget for next year: Catalonia contributes close to 20% of the resources that Government has in terms of taxation but investment in Catalonia is only 9%, and this is slightly higher than the average of the last thirty years. However, when the Catalans complain, the answer from the Ministerio in Madrid is that Catalans should not cry, that now is the time to invest elsewhere. So, we think that this is unfair.
For the last question about the compat- ibility between a Catalonia separatist movement and the calls for a greater European unity, I will give two answers. The first is that I think that what we have to unite around is the values that underlay the European Union, values of human rights, democracy, respect of the individual and so on. And nothing will unite us more that having a dem- ocratic decision, not only on who we want to have as a leader, not only about a bunch of other things that we decide but also about which are the right bor- ders and which are the forms of State that we want. So, I think that a vote in which the Catalans can express freely what they decide would be something that unites us all because we are all democrats.
The second answer is a more technical answer: I think that there was a time (and this is something I’ve been thinking lately, it is something that I’m thinking about researching) in which the borders of the markets and the borders of the nations, in terms of cul- ture were very close. Having the same Government that takes care of the economic and cultural issues, where economic could mean having an own currency, regulating banks or the labour market and where culture could be the type of education that you want for your children, the type of civil law, the type of judicial system you desire, and so on. They matched each other and it makes sense to have Governments that have that size. As time went up, the market borders have expanded dramat- ically but the borders of culture have not expanded that much. There is a lot of global homogenization, that is true, but still you can differentiate different regions. As this happens the nation state expanded and, actually, you have Governements that they are too large vis à vis the cultural borders but too small vis à vis what it is the market. There comes a point where there is no reason why these two policies should be under the same Government. The whole concept of the Nation state may be obsolete now and, rather than have a singular jurisdictional that does ev- erything, what we need now is a set of overlapping jurisdictions. For example I am a totally believer about having a sin- gle European market, having a banking regulation and union, having a single currency, and so on; these are powers that should be going up. But, at the same time, I also believe that now, that we don’t need a single Government to protect our markets and protect us from external aggressions, we can devolve powers to the cultural units, because now, Catalonia, for instance, has the ability to enjoy the defence of the whole of Europe, the joined mar- kets of all Europe so it does not need to delegate its identity to the Government in exchange for this protection or these markets. I think that there will be a nat- ural tendency to create supranational institutions and to fragment the State.
Why are there so many debt problems around us (in Europe)? Is it because of bad governments? Because of financial markets that give wrong incentives? Because of the lack of efficient policy instruments such as structural reforms? Because of specu- lative strategies? Or because of bad economists?
I think it was because of a bad reaction to the financial crisis. The financial crisis initially led to a collapse in revenues. When the bubble collapses, activity collapses, revenues go down a lot on the part of the government. Then, the IMF, and all the authorities said “we think that this is a Keynesian style crisis, we need to have a fiscal expansion”. So, governments started spending a lot. And a lot of this spending was com- pletely in things that are absurd. For example, Spain spent a lot of money on public works that were worthless. And I think this was the case around the union. Then, banks could not sustain themselves and governments started pumping money to the banks. So, if we put together lower revenues, increasing public spending and transfers to the banks, we have a massive public debt. For me all these are decisions and these are bad decisions. So, my answer to your question is because of bad governments, probably, advised by bad economists. But this is another thing.
Why did economic models fail to predict the financial turmoil and the subsequent crisis? In what way can we improve them in order to be more prepared in the future?
This is an interesting thing that leads to a connection between our knowledge and the world. I write models in which individuals are surprised when crises come, because this is the real world. You asked me at the very beginning of the interview about my research on asset bubbles. My research on asset bubbles models bubbles as stochastic, so there is a probability that they collapse. Whether they collapse or not depends on what we call shocks to investors’ sentiments. What do shocks to investors’ sentiments mean? They are movements in the beliefs of the people that I cannot account for. At the mo- ment in which I have a theory for that, then, everybody will have a theory for that and these moments will not occur, they would be totally predictable. I do not think that with the current state of the theory we can predict these things. What we can do is to do some ad-hoc empirical models that in the past have shown that there are some correlations between some variables and the col- lapse of asset prices or what is investors’ sentiment. Perhaps, these ad-hoc empirical models can be redefined to give us some clue about what to do.
But I do not think economics is about that. You cannot predict the weather, you cannot predict a natural disaster. And I think that we cannot predict these changes in prices in the markets. What economics is about is that when this happens to know what to do. To react to it. I cannot tell you whether you are going to be sick or whether you are going to have an accident, but you are going to have a doctor that can fix it. I think this is what economic models should be doing. And I think this is also something in which we have failed. The first failing, of not predicting the crisis, I am not too worried about it, I am not ashamed of that. The second part, of not knowing what to do after it hap- pened is much more serious. Together with many others, I am trying to change that. For the next time.
Do you think that the worst period of the crisis has passed and we are moving towards the recovery, and what are the main dangers to watch out for on the path to recovery?
Well, I cannot predict whether things are going to turn for the worst or for the better. That is very difficult and I will not get into this because then I will just be guessing. Here what I see is that the fis- cal problems are very much extenuated and the social tensions are much larger. And I think that the probability of a serious social conflict is much higher now than at the beginning of the crisis. If a similar bad shock happens, we are going to be in a much worse situation to handle it. But, I do not know, I really cannot predict this.
12. The decision of the Eurogroup to have "haircuts" on deposits as a con- dition for the Cypriot bail-out shocked depositors all over Euro Area and was criticized by some economists. Do you think that it is possible for this to reoccur in another European country? Are you in favour of such a measure for insolvent banks?
I am not in favour and I don’t think that this is going to happen in other coun- tries. I have not followed in detail other than in the press but I think that the Cyprus case was a special case because most of the holders and depositors were foreigners, mostly Russians, and it was a way to make foreigners pay for the European crisis. I am a little bit surprised that European Union and the IMF allowed it.