Suchergebnisse

In the last few years the U.S. economy and a number of Eurozone countries have experienced a recession. One of the results of the recessions has been an increase in their budget deficits and national debts. Both in the U.S. and in Europe policies of austerity have gained momentum. It is questionable however, that in periods of recession austerity leading to reductions of aggregate spending is the answer. It can be argued that emphasis on growth may be a preferable alternative. A look at the U.S. economy in 1998, 1999, 2000, and 2001 we find that because of strong growth unemployment was about 4 percent and budget surpluses characterized all four years. In the case of Europe the countries with most difficulties are peripheral countries of the European Union, e.g., Italy, Spain, Portugal, Greece. This raises the question, on whether the integration of small and large countries and of different standards of living was a wise move. Concerns about this issue led the Single European Act of 1986 to emphasize the need for social and economic cohesion. An outcome of this was the use of structural funds primarily to the peripheral countries. Yet, we know that social value changes and economic development take time. Germany, the largest and richest country of the Union seems to be playing a dominant role currently in urging austerity for the peripheral countries which have large deficits and debts. Suggestions that the European Central Bank act as a bank of last resort by lending directly to the various governments in need and/or the creation of Eurobonds have been rejected by the Eurozone leadership. Leaders in Brussels have also voted recently for strict budget criteria for the Eurozone members. Among the peripheral countries in difficulty Greece is the worst case scenario. The Greek economy has shrunk by 7.5 per cent in the fourth quarter of 2011 and young people in Greece experience unemployment of 51 per cent. On February 9, 2012 the Greek government was able to convince private bondholders to accept a 75 per cent loss in the face value of bond holdings. The result of this was a reduction in Greece's debt by 100 billion Euros. At the same time the Eurozone and IMF are expected to provide Greece with a stopgap package of 130 billion Euros. These developments do not mean that Greece is out of the woods. Its indebtedness is now with Europe and the IMF. It's debt to GDP ratio would still be 151 per cent in 2012, the highest in Europe. The challenges facing the new government resulting from the elections of June 17, 2012 are staggering. Other countries, e.g., Italy and Spain are also facing economic declines and are potentially candidates for bailouts. It is because of this possibility that the Managing Director of the IMF has been urging Europe to raise at least $1 trillion in emergency funds. At this point, it is not clear how the European crisis will be resolved. Perhaps two basic questions may be raised: 1) would the strongest economies be willing to help more effectively the peripheral countries in trouble? 2) Would the "failed" policy of austerity in depressed economies be changed by more emphasis on growth? At present, it appears that a balanced policy including more emphasis on demand side economics makes sense in both the USA and Europe. ; peer-reviewed

The IMF must change its sanction and incentive systems so that the next crisis is more likely to be prevented. It should concentrate more on ex ante prevention, which can be done by clearly specifying the rules that will be applied ex post. It should also rely more on automatic mechanisms that operate through the market in order to get to the roots of a potential crisis. Ex post, i.e., when a currency crisis has already occurred, the IMF can only play a limited role in mitigating the crisis. The IMF cannot play the same role for sovereign creditors as national institutions do in the case of illiquidity of domestic banks and firms. It cannot take over the role of a bankruptcy court judge. The IMF cannot credibly play the role of a lender of last resort. First, the lender of last resort lends to financial institutions, while the IMF lends to national governments when they run into trouble. Second, the national lender of last resort can print money and can thus credibly stop a crisis. For the IMF, this is not possible. Therefore, the central banks will have to play the role of a lender of last resort in a coordinated action if a systemic crisis for the world economy develops. The IMF is involved only initially, somewhat easing the task of the true lender of last resort, the central banks. Ex post, the crisis has to be mitigated in such a way that dealing with the crisis does not generate processes and behavior that give rise to the next currency crisis. The IMF should avoid setting wrong incentives. -The IMF should not make up for national political mistakes and national institutional deficiencies. -The IMF should change its policy and not implicitly defend a pegged exchange rate. -The IMF should stop lending to countries that are in arrears to private creditors and bondholders (sovereign arrears) and should return to its previous policy. -The IMF should rule out credits to sovereign debtors if the government of a country takes over guarantees for nonperforming private loans, thus socializing private default risks. -The IMF should think about scaling down its level of operations. This recommendation is in stark contrast to the somewhat expansionist doctrine now being propagated by the IMF. Ex ante, some new rules should be established. In analogy to the "polluter-pays principle" of environmental economics, a "troublemaker-pays principle" should be used. This would hopefully internalize the social costs caused by countries behaving in a manner that generates instability and adds to the risk of a systemic crisis. - The IMF should improve its early warning system, create more transparency, and provide more information, including high-frequency debt-monitoring systems. The international community should intensify discussions on standards that countries would have to follow. -The IMF should specify the sanctions to be levied when standards are not respected. A penalty rate should be charged if additional credit is provided. Requiring collateral would also be a strong incentive to sovereign borrowers to build up assets. - The IMF should define the policy it would pursue in the case of a crisis more credibly. It should move away from the discretionary decisions of its case-by-case approach (favored by US pragmatism) and bind itself by rules (favored by the Europeans). One way to improve credibility of IMF policy would be to rely more on automatic mechanisms that internalize the external effects of national instability behavior. Thus, the IMF should not be a silent supervisor who deliberates behind closed doors. It is better to blow the whistle and apply the brakes before the train crashes. Involving the private sector in the case of a crisis is an important means of internalizing the social costs of instability. In contrast to the mostly used American-style bonds, British-style trustee deed bonds are more appropriate to manage crises as they include sharing clauses and majority rules.

Nuclear weapons aren't just a threat to human survival, they're a multi-billion-dollar business supported by some of the biggest institutional investors in the U.S. according to new data released today by the International Campaign to Abolish Nuclear Weapons (ICAN) and PAX, the largest peace organization in the Netherlands. For the third year in a row, globally, the number of investors in nuclear weapons producers has fallen but the overall amount invested in these companies has increased, largely thanks to some of the biggest investment banks and funds in the U.S."As for the U.S., while there is, like past years, indeed a dominance, and total financing from U.S.-based institutions has increased, the total number of U.S. investors has dropped for the third year in a row (similar to our global findings), and we hope to see this number will continue to fall in the coming years," Alejandar Munoz, the report's primary author, told Responsible Statecraft.In 2023, the top 10 share and bondholders of nuclear weapons producing companies are all American firms. The firms — Vanguard, Capital Group, State Street, BlackRock, Wellington Management, Fidelity Investments, Newport Group, Geode Capital Holdings, Bank of America and Morgan Stanley — held $327 billion in investments in nuclear weapons producing companies in 2023, an $18 billion increase from 2022.These companies are also profiting from the enormous government contracts they receive for developing and modernizing nuclear weapons. "All nuclear-armed states are currently modernizing their nuclear weapon systems," says the annual "Don't Bank on the Bomb" report from PAX and ICAN. "In 2022, the nine nuclear-armed states together spent $82.9 billion on their nuclear weapons arsenals, an increase of $2.5 billion compared to the previous year, and with the United States spending more than all other nuclear powers combined."American weapons companies are some of the biggest recipients of contracts for nuclear weapons. Northrop Grumman and General Dynamics are "the biggest nuclear weapons profiteers," according to the report. Combined, the two American weapons manufacturers have outstanding nuclear weapons related contracts with a combined potential value of at least $44.9 billion.Those enormous government contracts for nuclear weapons, alongside contracts for conventional weapons, have helped make nuclear weapons producers an attractive investment for American investment banks and funds. "Altogether, 287 financial institutions were identified for having substantial financing or investment relations with 24 companies involved in nuclear weapon production," says the report. "$477 billion was held in bonds and shares, and $343 billion was provided in loans and underwriting."The report notes that while the total amount invested in nuclear weapons has increased, the number of investors has fallen and trends toward firms in countries with nuclear weapons.ICAN and PAX suggest that concentration may be a result of prohibitions on nuclear weapons development for signatories to the Treaty on the Prohibition of Nuclear Weapons (TPNW), a 93 signatory treaty committing to the ultimate goal of the total elimination of nuclear weapons. The report says:The TPNW comprehensively prohibits the development, manufacturing, testing, possession, use and threat of use of nuclear weapons, as well as assistance with those acts. For companies that build the key components needed to maintain and expand countries' nuclear arsenals, access to private funding is crucial. As such, the banks, pension funds, asset managers and other financiers that continue to invest in or grant credit to these companies allow for the production of inhumane and indiscriminate weapons to proceed. By divesting from their business relationships with these companies, financial institutions can reduce available capital for nuclear weapon related activities and thereby be instrumental in supporting the fulfilment of the TPNW's objectives.Susi Snyder, managing director of the Don't Bank on the Bomb Project, told Responsible Statecraft that even U.S. banks, like Pittsburgh based PNC Bank, are facing shareholder pressure to divest from nuclear weapons and that the tide may be shifting as shareholders in U.S. companies grow increasingly sensitive to investments in nuclear weapons. "For three years shareholder resolutions have been put forward at PNC bank raising concerns that their investments in nuclear weapon producers are a violation of the Treaty on the Prohibition of Nuclear Weapons (TPNW), and that they are not in line with the bank's overall human rights policy guidelines," she said.

(An oped at Globe and Mail with Jon Hartley) Finance Minister Chrystia Freeland recently announced that the government of Canada  will no longer issue inflation-protected "real return" bonds. A kerfuffle erupted.The government may wish to avoid inflation-protected bonds, because it thinks inflation will get a lot worse than markets do. But betting in markets is not a responsible strategy.If the government won't do it, corporations, banks and financial institutions should issue these bonds themselves rather than just complain. Not every asset must be provided by the government.Real return bonds adjust both principal and interest for inflation. If inflation goes up, you get more money back. Nice. But when everyone expects inflation, you pay a commensurately higher price ahead of time.With 5-per-cent inflation, say, a real return bond might pay 1 per cent, so you get 6 per cent after inflation adjustment; but a regular bond will pay something like 6 per cent already. Like everything in finance, it's really about risk: Real return bonds protect against the risk that inflation will turn out worse than bond markets expect. Regular bonds have lost 11 per cent of their real value since January, 2021, because of inflation that markets did not expect. Those who bought real return bonds were protected from this risk.For this reason, long-term real return bonds are very useful, and ought to be more popular than they are. They can provide a steady stream of real payments immune from inflation or interest rate risk. As such, they can make an ideal component of any long-term portfolio, such as a retirement portfolio or an endowment. So, complain the members of the Canadian Fixed-Income Forum and other Canadian pension managers, it is a huge mistake for the government to stop providing this useful asset. Good point.The government answers that the bonds are not "liquid," meaning you can't always sell them quickly at a good price. But why does the government care about liquidity? The point of bonds to the government is to raise revenue at a good rate, and the point of long-term real return bonds to the investor is precisely to live off the coupons and not to trade them actively. Moreover, if liquidity is an issue, the government can easily improve it by issuing perpetuals and simplifying the bonds' tax treatment.So why stop issuing real return bonds? The government may suspect that inflation will go up a lot more, and it will then have to pay more to bondholders. Non-indexed debt can be inflated away if the fiscal situation worsens. The cumulative 11-per-cent inflation since January, 2021, has inflated away 11 per cent of the debt already. Argentines have seen a lot more.But issuing indexed debt makes sense if the government plans to be responsible. Tax payments and budget costs rise with inflation, and fall with disinflation, so the budget is stabilized if inflation-indexed bond payments do the same. And issuing indexed debt that can't be inflated away is a good incentive not to turn around and inflate debt away.Indexed debt is also a very useful signal, as it gives a market-based measure of inflation expectations.If the government won't do it, however, there is no reason that the government's critics can't issue them. Companies can issue real return bonds, as they already issue U.S. dollar bonds. Banks can offer real return accounts and certificates of deposit.If the government steps out of the market, there's all the more demand for private issuers to step in. Pension funds desperate to replace vanishing inflation-indexed government bonds are natural clients. Company profits rise and fall with inflation, so they have a natural incentive to issue bonds whose payments rise and fall with inflation. Even mortgage rates could rise and fall with an index of wages.Why not? Broadly, this reluctance seems one more symptom of an overleveraged, overregulated, government-dependent and not very competitive or innovative banking and financial system. Banks and other financial institutions only want to issue or expand a new product if they can quickly lay off the risk onto the government, and earn steady fees. The model of issuing equity to bear risk and then offering a profitable innovative product to consumers is too out of fashion.Bring on the real return bonds. And if government won't do it, make your own.

Economics is about solving lots of little puzzles. At a July 4th party, a super smart friend -- not a macroeconomist -- posed a puzzle I should have understood long ago, prompting me to understand my own models a little better. How do we get inflation from the big fiscal stimulus of 2020-2021, he asked? Well, I answer, people get a lot of government debt and money, which they don't think will be paid back via higher future taxes or lower future spending. They know inflation or default will happen sooner or later, so they try to get rid of the debt now while they can rather than save it. But all we can do collectively is to try to buy things, sending up the price level, until the debt is devalued to what we expect the government can and will pay. OK, asked my friend, but that should send interest rates up, bond prices down, no? And interest rates stayed low throughout, until the Fed started raising them. I mumbled some excuse about interest rates never being very good at forecasting inflation, or something about risk premiums, but that's clearly unsatisfactory. Of course, the answer is that interest rates do not need to move. The Fed controls the nominal interest rate. If the Fed keeps the short term nominal interest rate constant, then nominal yields of all bonds stay the same, while fiscal inflation washes away the value of debt. I should have remembered my own central graph: This is the response of the standard sticky price model to a fiscal shock -- a 1% deficit that is not repaid by future surpluses -- while the Fed keeps interest rates constant. The solid line is instantaneous inflation, while the dashed line gives inflation measured as percent change from a year ago, which is the common way to measure it in the data. There you have it: The fiscal shock causes inflation, but since the nominal interest rate is fixed by the Fed, it goes nowhere, and long term bonds (in this linear model with the expectations hypothesis) go nowhere too. OK for the result, but how does it work? What about the intuition, that seeing inflation coming we should see higher interest rates? Let's dig deeper. Start with the simplest model, one-period debt and flexible prices. Now the model comes down to, nominal debt / price level = present value of surpluses, \[\frac{B_{t-1}}{P_t} = E_t \sum_{j=0}^\infty \beta^j s_{t+j}.\] (If you don't like equations, just read the words. They will do.) With a decline in the present value of surpluses, the value of debt coming due today (top left) can't change, so the price level must rise. The price of debt coming due is fixed at 1, so its relative price can't fall and its interest rate can't rise. Or, this model describes a price level jump. We get bad fiscal news, people try to spend their bonds, the price level jumps unexpectedly up, (\(P_t\) jumps up relative to \(E_{t-1}P_t\), but there is no further inflation, no rise in expected inflation so the interest rate \(i_t = r+ E_t \pi_{t+1}\) doesn't change. Ok, fine, you say, but that's one period, overnight debt, reserves at the Fed only. What about long term bonds? When we try to sell them, their prices can go down and interest rates go up, no? No, because if the Fed holds the nominal interest rate constant, their nominal prices don't change. With long term bonds, the basic equation becomes market value of nominal debt / price level = expected value of surpluses, \[\frac{\sum_{j=0}^\infty Q_t^{(j)} B_{t-1}^{(j)}}{P_t} = E_t \sum_{j=0}^\infty \beta^j s_{t+j}.\] Here, \(Q_t^{(j)}\) is the price of \(j\) period debt at time \(t\), and \(B_{t-1}^{(j)}\) is the face value of debt at the beginning of time \(t\) that matures in time \(t+j\). (\(Q_t^{(j)}=1/[1+y^{(j)}_t)]^j\) where \(y^{(j)}_t\) is the yield on \(j\) period debt; when the price goes down the yield or long-term interest rate goes up. )So, my smart friend notices, when the present value of surpluses declines, we could see nominal bond prices \(Q\) on top fall rather than the price level \(P\) on the bottom rise.  But we don't, because again, the Fed in this conceptual exercise keeps the nominal interest rate fixed, and so long term bond prices don't fall. If the \(Q\) don't fall, the \(P\) must rise. The one-period price level jump is not realistic, and the above graph plots what happens with sticky prices. (This is the standard continuous time new-Keynesian model.) The intuition is the same, but drawn out. The sum of future surpluses has fallen. People try to sell bonds, but with a constant interest rate the nominal price of long term bonds cannot fall. So, they try to sell bonds of all maturities, pushing up the price of goods and services. With sticky prices, this takes time; the price level slowly rises as inflation exceeds the nominal interest rate. A drawn out period of low real interest rates slowly saps the value of bondholder's wealth. In present value terms, the decline in surpluses is initially matched by a low real discount rate. Yes, there is expected inflation. Yes, long-term bondholders would like to escape it. But there is no escape: real rates of return are low on all bonds, short-term and long term. So, dear friend, we really can have a period of fiscal inflation, with no change in nominal interest rates. Note also that the inflation eventually goes away, so long as there are no more fiscal shocks, even without the Fed raising rates. That too seems a bit like our reality. This has all been in my own papers for 20 years. It's interesting how hard it can be to apply one's own models right on the spot. Maybe it was the great drinks and ribs. 

The absence of sovereign bond issuances with World Bank guarantee support for almost 15 years and the customized application of the WB guarantee instrument led potential investors in the Ghana bond to ponder the best way to value the instrument. This paper provides guidance on this subject by presenting four ways to assess the value of a World Bank guarantee for debt capital market issues. The methodologies presented are: nominal weighted average yield; rolling nominal weighted average yield; discounted cash flow; and recovery analysis. The paper presents the methodologies by applying them to a fictional bond issuance by the government of Emergistan, a fictional low income country. Background information on the country and bond issuance has been kept to the minimum as the sole purpose of this example is to illustrate the results of each of the methodologies. It should be noted that World Bank guarantees can be structured in a number of ways depending on the issuer's objectives as well as country and market circumstances. For instance, guarantees could cover interest and/or principal payments of bonds. Coverage could be on a first loss or back-ended basis. Therefore, the most appropriate valuation method would depend on the specific features of the guarantee being considered.

Romina Boccia


The Menace of Fiscal QEBy George SelginThe Cato Institute, 2020, $14.95, 126 pages
George Selgin's book The Menace of Fiscal QE, published by the Cato Institute in 2020, is particularly relevant today following debt limit negotiations that demonstrated how reluctant U.S. politicians are to grapple with unsustainable federal spending. The book is about the potential dangers of using quantitative easing (QE) as a tool for financing government spending.
The dangers are manifold. Selgin warns against engaging in fiscal QE because it would undermine the Fed's independence and credibility, erode democratic oversight and transparency of fiscal policy, and could open the floodgates to backdoor spending. It might also relieve, at least temporarily, the pressure to deal with unsustainable entitlement programs – all while still resulting in higher inflation. The dangers of fiscal QE are great, the harms would be widespread, and the political temptation to use it will grow.
Selgin highlights dangerous precedents in U.S. history when policymaker used QE for non‐​monetary ends and details growing interest in fiscal QE among certain economists and politicians today who are looking for a "free lunch" government funding mechanism.
QE is the practice of the central bank buying large amounts of assets, such as government bonds or mortgage‐​backed securities, to inject money into the financial system. QE can help stimulate economic activity and prevent deflation in times of crisis when interest rates are at their zero lower bound and ordinary monetary policy tools can no longer be relied upon. However, QE also has costs and risks. It distorts asset prices and creates moral hazard, where investors take excessive risks to chase higher yields. Fiscal QE is when the Federal Reserve buys assets and expands the Fed's balance sheet when there is no compelling macroeconomic reason for doing so, primarily, or solely to support government spending objectives.
Congress's adoption of the Fiscal Responsibility Act (FRA), which raises the debt limit through 2024 in exchange for weak discretionary spending limits, unintentionally shows how politically tempting fiscal QE is. As the Congressional Budget Office pointed out, debt will still rise substantially, even assuming full implementation of the FRA's deficit reduction, to 115 percent of gross domestic product (GDP) by 2033. Had members of Congress been serious about controlling the growth in the debt before increasing the debt limit again, they would have adopted meaningful fiscal targets and a pathway to reforming federal health care and Social Security – the key drivers of federal spending growth. Instead, they will have an even bigger fiscal challenge on their hands next time the debt limit comes around, sometime in spring or summer of 2025. Political obstacles to reforming old age entitlement programs create a temptation to find unorthodox ways out of the fiscal mess for some politicians and big government advocates. It's no wonder some are considering resorting to fiscal QE.
Selgin shares examples of politicians and economists advocating for fiscal QE, including to finance student loan debt forgiveness and the Green New Deal. Selgin also identifies past examples of fiscal QE, including the Fed's purchase of mortgage‐​backed securities during and after the Great Recession, "not only to stimulate aggregate investment…but also to support the housing market,' and Congress raiding the Fed's surplus account to finance infrastructure as authorized in the 2015 Fixing America's Surface Transportation (FAST) Act. Selgin is not opposed to QE per se, recognizing that there are valid macroeconomic rationales for using it when interest rates are at their zero lower bound. Rather, Selgin only argues against using QE to pursue fiscal policy.
Fiscal QE proponents claim that it can provide a free lunch for the government, by allowing it to spend more without raising taxes or borrowing from the public. They also argue that fiscal QE can boost aggregate demand and economic growth more effectively than conventional monetary or fiscal policy. Selgin debunks both arguments, pointing out that fiscal QE would have inflationary consequences, shift risks from bondholders to taxpayers, and impair central bank independence. He also demonstrates that fiscal QE would not stimulate the economy more than conventional policy, but rather create distortions and inefficiencies in resource allocation and income distribution, including generating financial instability by encouraging excessive risk taking among investors. Selgin concedes that despite fiscal QEs downsides, it has great appeal largely due to fiscal illusion. He writes:
"[M]yopic politicians have long been tempted to exploit a central bank's lending powers even when doing so ultimately sponsors unwanted inflation. "Printing money" can be much easier than raising taxes, and less costly in the short run than competing with private sector borrowers for credit. Also, the public may not grasp the connection between fiscal QE and any inflation that follows."

While this author is squarely in the camp of those who believe that current government spending is unsustainable and threatens America's prosperity, Selgin's arguments should appeal to a broader audience. By enabling "backdoor" spending, that is, spending that bypasses congressional appropriations, resort to fiscal QE should also concern those who believe that the federal government isn't spending enough. Anyone who cares about democratic, transparent government, regardless of their views on the proper size and scope of federal spending, should find a Fed that blurs the lines between fiscal and monetary policy unacceptable.
Selgin urges the Fed to restore its pre‐​crisis operating procedures to limit the dangers of resorting to fiscal QE. Specifically, the Fed should return to a corridor system, where it sets a target range for the overnight interest rate and adjusts its supply of reserves accordingly. "A corridor system reform would guard against fiscal QE by constraining the size of the Fed's balance sheet," explains Selgin.
It wasn't until 2008 when the Fed began paying interest on reserves that the central bank inadvertently severed the link between the size of its balance sheet and inflation. Under the current floor system, the Fed can use QE without losing control of inflation by adjusting the rate of interest it pays on bank reserves. In the same vein that the Fed might be pressured by Congress to fund government spending via QE, it could be pressured to not raise rates when inflation takes hold to avoid an economic downturn.
Given congressional reluctance to reform entitlement programs that are the major drivers of increased spending and debt, it would be wise for the Federal Reserve to close off an avenue for fiscal QE before it's too late. The temptation to use the central bank balance sheet to fund federal government spending without having to resort to taxation or borrowing will only rise as the federal debt grows ever larger. Fed officials and others directly involved in Fed policy should heed Selgin's warning.
This piece previously stated that the Fed began paying interest on reserves in 2009. It was corrected to reflect this policy began in October of 2008

At the AEI fiscal theory event last Tuesday Tom Sargent and Eric Leeper made some key points about the current situation, with reference to lessons of history. Tom's comments updated his excellent paper with George Hall "Three World Wars" (at pnas,  summary essay in the Hoover Conference volume). Tom and George liken covid to a war: a large emergency requiring immense expenditure. We can quibble about "require" but not the expenditure. (2008 was a little war in this sense as well.) Since outlays are well ahead of receipts, these huge temporary expenditures are financed by issuing debt and printing money, as optimal tax theory says they should be. In all three cases, you see a ratcheting up of outlays after the war. That's happening now, and in 2008, just as in WWI and WWII. After WWI and WWII, there is a period of primary surpluses -- tax receipts greater than spending -- which helps to pay back the debt. This time is notable for the absence of that effect. We see that most clearly by plotting the primary deficits directly. The data update since Tom and George's original paper (dots) makes that clear. To a fiscal theorist, this is a worrisome difference. We are not following historical tradition of regular, full employment, peacetime surpluses. The two world wars were also financed by a considerable inflation. The important consequence of inflation is that it inflates away government debt. Essentially, we pay for part of the war by a default on debt, engineered via inflation. 1947 is an interesting case. As now, inflation broke out, the Fed left interest rates alone, and the inflation went away once it had inflated away enough debt. That too is an interesting episode in the debate whether the Fed must move rates more than one for one to keep inflation from spiraling away. The effect of inflation is clearer in the next graph, which plots the real return on government bonds: Yes, the inflation of 1920 did inflate away a lot of the WWI debt, though the deflation of 1921 brought a lot of that back. (This is an episode we would do well to remember more! The price level doubled from 1916 through 1920. It then retreated by a third in 1920-1921. There was a sharp recession, but the economy recovered very quickly with no stimulus or heroic measures. The conventional wisdom that wringing out WWI inflation caused the UK 1920s doldrums needs to consider this counterexample. But back to our point) This is also consistent with standard optimal tax theory, which says that in the event of a disaster that happens once every 50 years or so, it is right to execute a "state contingent default" (Lucas and Stokey), and inflation is a natural way to do it. But... "state contingent default" is supposed to happen at the beginning of a war. These inflations happened at the end of the war. How did governments sell bonds to people who should have expected them to be inflated away? Yes, there were some price controls and financial repression, but it's still an important puzzle to standard public finance theory.  My concern, of course, is that we've had two once in a hundred year events in a row (2008, 2020), I can think of lots more that might come soon, and you can only do this occasionally. Hit people over the head a few too many times and they start to duck. We will head to the next crisis with no history of steady surpluses in good times, 100% debt to GDP ratio, and a painful reminder of what happens if you lend to the US right in the rear view mirror. We start the H5N1/Taiwan war crisis with the same debt we had at the end of WWII. And who owns the debt leads to some fascinating speculation which I'll let you fill in with your chat GPT.  Tom closed by echoing my favorite bright idea for avoiding the debt limit: Since the limit applies to par value not market value, the Treasury can issue all the perpetuities it wants. That's far better than the trillion dollar coin, though I suspect the Supreme Court would take just as dim a view of it. Eric  brought up a great point from his super Recovery of 1933 paper with Margaret Jacobson and Bruce Preston. In 1933, we had a disastrous deflation. The gold standard is a lovely fiscal commitment device to try to contain inflation, but it has an Achilles heel. If there is a deflation, the government has to raise taxes to pay an unexpected real windfall to bondholders. In 1933, the Roosevelt Administration abrogated the gold standard. It was a default on the legal terms of the bonds. And look what happened to inflation! Eric also brought up a second central point of his 1933 paper: The Roosevelt Administration separated the budget into a "regular" budget, in which we should expect deficits to be paid back, and an "emergency" budget, unbacked (in our language) by expected surpluses. That cleverly allowed inflationary finance in 1933, but once the "emergency" was over in 1941, it preserved the US reputation for repaying wartime debts with subsequent surpluses, and allowed it to borrow for WWII. This loss of "back to normal," of expectations that we are now in "regular" not "emergency" finance is worrisome today. Finally, Eric brought some nice evidence to bear on the question, why 2020 but not 2008? Well, in part, we can look at statements of public officials. In 2008, they explicitly said, deficit now, repayment later. In 2020 they explicitly said the opposite. ("Offsets" is Washington-speak for "taxes" or later spending cuts.) Don't read a pejorative in this analysis. If you want to borrow, finance crisis expenditures and not create inflation, you "maintain the norm." If you want to create a "state contingent default" and pay for crisis expenditures by inflating away debt, you have to "violate the norm." That is darn hard -- ask the Japanese. How do you convince people you're not going to repay some part of the debt, despite a good reputation, but just some part, and if WWII comes along you're good for additional debts? Well, announcing your intentions helps!  And it worked. We very quickly inflated away the debt. Creating a state contingent default via inflation is not easy. Still to be seen though is whether we can return to "normal" "Hamilton norm" once it's over. Robert Barro also had great comments, but more directed at the book and with no great graphs to pass along. Thanks anyway!

Romina Boccia and Dominik Lett


Congress is in the midst of debating the annual defense spending bill and chances for completion before the August recess look bleak. The multitrillion‐​dollar increase in the debt limit, which Congress passed in early June following months of negotiations, established budget levels for defense and nondefense appropriations for the next two years. The parties remain divided on the details.
Spending debates that are contentious now will likely get worse in future years, as the current fiscal trajectory will place inevitable constraints on America's military. Without reforms to health care and retirement benefits, other domestic and defense priorities will be increasingly squeezed. As debt levels and associated interest costs rise, economic growth will suffer. And as the share of the budget dedicated to autopilot entitlement spending expands, reduced fiscal capacity will further increase budgetary conflict over the shrinking portion of discretionary spending that Congress allocates each year.
Congress only debates 28 cents of every dollar it spends; the vast majority of federal spending goes out without congressional deliberation, primarily funding programs like Medicare, Medicaid, and Social Security, among other entitlements. A new mechanism is needed to reform entitlement spending and avoid a future fiscal crisis before it's too late.
Erosion of economic power
According to the Congressional Budget Office's (CBO's) latest long‐​term budget outlook, publicly held debt will grow from 98 percent of gross domestic product (GDP) to 181 percent of GDP by 2053. Most economic research finds that excessive public debt reduces economic growth, with dampening effects kicking in around debt reaching 78 percent of GDP.
There are many benefits of a robust economy including a higher standard of living. A strong domestic economy is also critical for supporting national security. Prominent national security leaders, including former Secretaries of State, Defense, Treasury, and Homeland Security across eight Republican and Democratic administrations, were recently gathered by the Peterson Foundation's Coalition for Fiscal and National Security. They argue that:
"[L]ong-term debt is the single greatest threat to our national security…This debt burden would slow economic growth, reduce income levels, and harm our national security posture. It would inevitably constrain funding for a strong military and effective diplomacy, and draw resources away from the investments that are essential for our economic strength and leading role among nations."

Delaying responsible fiscal reforms in the face of growing federal debt invites economic and national decline. High and rising U.S. federal debt leads to suppressed private investment, reduced incomes, and increased risk of a sudden fiscal crisis. A weaker economy and growing concerns by international bondholders of U.S. treasuries about the government's ability and willingness to service its debt—without resorting to high inflation—will drive up interest costs and eventually impact America's international standing negatively.
While investors continue to gobble up U.S. debt, which now exceeds $25 trillion, the $114 trillion in additional deficits CBO projects over the next 30 years pose serious questions about whether there will be enough appetite for markets to absorb such high levels of government debt. Troubling too is how much productivity‐​enhancing private investments will suffer because of crowding out. The prudent choice is to restore fiscal sustainability during times of peace and economic strength, reversing America's unsustainable debt crisis while it's still possible.
National defense is a core responsibility of the federal government. To maximize Americans' safety and prosperity, prudence should guide both strategy and the budget. A dire fiscal crisis would erode the economic foundation of America's strength, limiting U.S. capacity to defend its vital interests at home and abroad.
Crowding out of defense spending as a budget priority
Entitlements are increasingly dominating the federal budget. Since 1962, Social Security, Medicare, Medicaid, and other income security programs such as food stamps have grown four times larger as a share of GDP and consume more than half of the federal budget. By comparison, defense spending declined by a factor of three as a share of GDP, from 9 percent of GDP in 1962 to 3 percent of GDP by 2022. Defense spending makes up less than one‐​fifth of the budget, despite growing in real, inflation‐​adjusted terms as entitlement spending has claimed an increasing share of the taxpayer burden. In real terms, annual defense spending has increased by nearly $200 billion between 1962 and 2022. Meanwhile, annual entitlement spending has grown by $3.3 trillion over the same timeframe. The graphic below shows how entitlements have grown to consume a greater share of total non‐​interest spending over time.











As entitlements consume a larger share of the budget, this exerts downward pressure on other budget priorities. Former Principal Research Scientist for Massachusetts Institute of Technology's Security Studies Program Cindy Williams explains,
"Absent significant reform or a major expansion of the total federal budget, the rising costs of Social Security, Medicare, and Medicaid will continue to crowd out defense spending. In the extreme, if federal budgets are held near today's levels as a share of GDP, nondefense discretionary spending is not reduced significantly, and mandatory spending is not brought under control, there will soon be no money left for defense."
Defense has also been a prime target for cuts across several congressional efforts to reduce government spending. The Manhattan Institute's Brian Riedl examined 14 major deficit‐​reduction negotiations since 1980. More than any other category, legislators tend to reduce defense spending during fiscal consolidation periods. Cuts to defense discretionary spending produced the largest savings in four of six deficit‐​reduction deals. Despite entitlements primarily driving rising deficits, mandatory spending reforms in these deals were modest at best. It seems politically easier to keep targeting discretionary spending for cuts than to tackle the key driver of rising spending: entitlements.
For those in favor of restraining the scope of U.S. military engagement, a fiscally restrained government may have some upside. Cato's Justin Logan and former Cato research fellow Ben Friedman argue that depressed economic growth and rising interest rates driven by high debt could make the defense budget an increasingly likely target for cuts. Logan and Friedman write,
"The U.S. military of the 2010s and 2020s will likely have a moderately less ambitious strategy and smaller budget than that of last decade. But the ambitions will still be hegemonic and the budget massive, hardly those of a normal country concerned chiefly with its own affairs. Unfortunately, the old Bolshevik saying, ''the worse, the better'' may apply for those seeking to rein in American military ambition. Ironically, we are left to push for military restraint while rooting against the conditions liable to produce it."

In this way, a smaller U.S. defense budget would put real limits on unnecessary and self‐​defeating American military activities overseas by, constraining American legislators. Paradoxically, some level of defense budget constraints could improve U.S. national security by reducing our involvement in military conflicts that are not in America's national interest.
Apply a defense savings mechanism to the broader budget
The United States' unsustainable fiscal trajectory is almost entirely driven by rising interest expenses and entitlement spending. Legislators must work together to reform the major entitlement programs to avoid a potential debt crisis, massive tax increases, and lagging economic growth. One idea gaining traction is a debt commission to assist legislators with adopting budget reforms to stabilize the growth in the debt.
The 1988 Base Realignment and Closure Act (BRAC) successfully addressed the politically thorny issue of closing military bases and can serve as a model for Congress's debt commission. BRAC established an independent commission to select military bases for closures, with recommendations that were approved by the President being adopted by default in Congress unless legislators successfully passed a resolution of disapproval. BRAC successfully bypassed special interest politics and congressional gridlock to free up funding for more essential defense priorities. Congress should consider establishing a BRAC‐​like, independent fiscal commission to recommend changes to stabilize the debt at no more than 100 percent of GDP over the next 10 years.
A well‐​designed commission will be composed of a diverse group of experts, guided by clear goals established by Congress, and whose recommendations will be self‐​executing after Presidential approval; benefitting from so‐​called fast‐​track authority. Asking members of Congress to affirmatively vote for entitlement reforms recommended by such a commission will most likely undermine the debt commission's recommendations from becoming law. Few legislators are willing to stick their necks out in support of necessary and yet unpopular changes to Medicare and Social Security.
Unsustainable fiscal policy imperils American economic and military strength. By reforming entitlement programs and reducing spending, legislators can prevent high debt from undermining America's prosperity and security. A well‐​designed debt commission can help Congress to see this through.

The authors build on the findings from an earlier analysis, adding to the evidence base for the notion that credit rating agencies contribute to fiscal sustainability. To do so, the authors focus on election periods when political pressures for fiscal expansions are heightened. The literature on political budget cycles documents the tendency for budget deficits to increase in election years as governments attempt to appear economically competent by strategically providing additional publicly financed goods or services, or by cutting taxes. A rating downgrade, however, signals the opposite of competence as it implies an increase in the probability of sovereign default. Since credit ratings are widely observed - by financial markets as well as voters - they in effect serve as a disciplining device for fiscal policy not to submit to short-term spending pressures, thus keeping it responsible. The authors find that: (1) governments going into an election year immediately after a rating downgrade are 27 percentage points more likely to lose at the polls; and (2) governments going into an election year with a negative rating outlook (indicating a higher likelihood of a near-term downgrade) run smaller budget deficits compared to cases with positive or stable outlooks. Ratings act like fiscal rules disciplining governments when they are more vulnerable to political pressures on the budget - as opposed to fiscal policies supporting longer-term economic growth and development objectives.

The Supreme Court is hearing a case with profound implications for the income tax. WSJ editorial here and good commentary from Ilya Shapiro here. This issue is naturally contorted into legalisms:  What the heck does "apportioned" mean? How is "income"  defined legally? I won't wade into that. What are the economic issues? What's the right thing to do here, leaving aside legalisms?Three general principles underlie taxation. The most important is: The government taxes what it can get its hands on. The economists' analysis of incentives comes much later: The government tries to tax in such a way that does not set off a rush to avoidance, either legal (complex structures to avoid taxes) or economic (don't do the thing that gets taxed, like earn income). So why does the government tax income? Because, circa 1913, income was easier to measure than sales, value added, consumption, or other economically better concepts. When money changes hands, it's relatively for the government to see what's there and take a share.  Tariffs really start from the same concept. It's relatively easy to see what's going through the port and demand a share, Adam Smith, David Ricardo and free trade be damned.  But the government wanted more money than tariffs could provide. So, even if it were a good idea to tax wealth, the problem is that there is not neceassarily any cash around where there is wealth or unrealized capital gains. When you sell an asset, you get some cash, and it's easy for the government to demand it. When you do not sell an asset, you have no extra cash. It's a "paper profit." What are you going to pay the government with? This comes up in practical terms with estate taxes. Yes, we have a 40% top marginal rate wealth tax right now. (If wealth taxes are unconstitutional, why isn't the estate tax number one on the chopping block? OK, I promised not to delve in to law, but I wish someone would answer it.)  But private businesses, family farms, and the like don't have 40% of their value sitting around in cash. Unless you carve out a Swiss cheese of loopholes, and complex legal structures, you have to break up or sell the business to get the cash. That's why the estate tax has said Swiss cheese. It also has happened in the news lately with internet titans who got big stock grants at the top of the market. The market crashes. They still owe tax on the value of stock when granted. Property taxes are another case. Yes, we have wealth taxes, in the form of property taxes. (They are state and local, not federal, and the issue is federal wealth taxes.) People sometimes can own a house but not have the money to pay the tax. Wealth and unrealized capital gains are also troublesome because in many cases it's hard to know exactly how much there is. Just what is the value of a house, a building, or a privately held business? Accountants can differ, especially if taxes are at stake. The minute you tax it,  accountants also can get creative about corporate structure to game valuation rules -- voting vs. non voting shares, debt with embedded options, options to buy that are never exercised, interlocking trusts, and so forth. See above estate tax Swiss cheese.Moreover, market values change. If I pay tax on unrealized appreciation this year, do I get my money back when the value goes down next year?So you can see it makes sense: If one wants to include "investment income" as "income." then tax it when there is a definite value -- the market sale price -- and  tax it when there is some cash around to grab; when it is realized. But now trouble perks up. It's reasonably easy to turn actual income into an unrealized gain. Suppose you have some income stream, and you don't plan to spend it right away. You want to reinvest it. Rather than pay income tax on the income, then additional income tax on the interest or dividends over time, and then more income tax on the appreciation of the final sale, create a corporation or other entity; let the income flow into the corporation which reinvests it. The "corporation" could just be a shell to receive income and put it in a mutual fund. Yes, you'll still pay capital gains tax when you sell, but that's a lot less. And delay is always great. Now you know why we have a corporate income tax at all. There is no economic point to corporate taxes, and "corporations pay their fair share" is nonsense. Every cent of corporate income tax comes from higher prices, lower wages, or lower payouts to stock and bondholders. We should tax those people. And if you want redistribution, taxing the "right" people, that's a lot easier to do when you tax people. But if there is no corporate tax, lots of people will incorporate to avoid income taxes. So, we tax corporate income and then your payout. Thousands of pages of tax law and regulation follow to plug one hole after another.  After 100 years of patchwork, including some taxing of unrealized gains, it sort of kept a balance, but people keep inventing new ideas. The case before the court involves domestic owners of a foreign corporation and the treatment of the income received into that corporation abroad. So, as revealed by the pro-tax arguments before the court, we have already stepped over the grab-it-while-it's-hot line and taxed a good deal of unrealized income. There was some sort of equilibrium of not overdoing it. But not overdoing it, obeying norms and gentlepersons's agreements, is going out of style these days. From WSJ:The Ninth Circuit's opinion opened up a freeway to tax wealth and property. And wouldn't you know, President Biden's budget this year includes a 25% tax on the appreciation of assets of Americans with more than $100 million in wealth....Justice Samuel Alito asked: "What about the appreciation of holdings in securities by millions and millions of Americans, holdings in mutual funds over a period of time without selling the shares in those mutual funds?" Ms. Prelogar replied: "I think if Congress actually enacted a tax like that, and it never has, that we would likely defend it as an income tax."Well, it's also called an estate tax, and we have it now!  There you have it. The Biden Administration believes the Sixteenth Amendment lets Congress tax the unrealized appreciation of assets. As Justice Neil Gorsuch noted, when the Supreme Court opens a door, "Congress tends to walk through it." The Justices should close the wealth-tax door. But it is also true that would upset the delicate balance above that allows the government to collect a lot of taxes. Someone has to pay taxes, so other rates would have to go up a lot. When one side overdoes it, the gentleperson's agreement explodes. Like corporate income, taxing investment income also makes no sense. You earn money, pay taxes on it, and invest it. If you choose to consume later rather than now, why pay additional tax on it? One of the main don't-distort-the-economy propositions is that we should give people the full incentive to save, by refraining from taxing investment income.So why take investment income? Again, because once you tax income, many people can shift labor income to investment income. If you run a business, don't take a salary, but pay yourself a dividend. If you're a consultant, incorporate yourself and call it all business income. In the 1980s even cab drivers incorporated to get lower corporate tax rates. The income tax is the original sin. Taxing income made no sense on an economic basis. The government only did it because it was easy to measure and grab, at least before people started inventing a century's worth of clever schemes to redefine "income."  It leads inescapably to more sins, the corporate tax and the tax on investment income. And now the repatriation tax on accumulated foreign earnings. What's the solution? Well, duh. Tax consumption, not income or wealth. Get the rich down at the Porsche dealer. Leave alone any money reinvested in a company that is employing people and producing products. Now we can do it. And we can then throw out the income tax, corporate tax, and estate tax. Income is really meaningless. You earn a lot of income in your middle years, but little early and late. The year you sell a house, you're a millionaire, but then back to low income the rest of the time. Yet our government hands out more and more benefits based on income as if it were an immutable characteristic. It is not. Consumption is a lot more meaningful! The case brings up another uncomfortable question. The couple invested their money, and then the IRS changed the rules and told them to pay taxes now on decades worth of past earnings. While we're playing lawyer, laws generally cannot penalize past behavior. Surely if they knew this rule, the couple would have arranged their business differently. Here there is an uncomfortable principle of taxation. Unexpected, just this once and we'll never do it again wealth taxes are economically efficient. The problem of taxation is disincentives. If you announce a wealth tax in the future, people respond by not accumulating wealth. Go on round the world private jet tours instead. (I hear UAE is nice this time of year, and all the smart people are there.) But if you tax existing wealth, and nobody knew it was coming, there is no disincentive. This is, however, one of the most misused propositions in economics. That promise never to do it again isn't credible. If the government did it once, why not again? And it feels horribly unfair, doesn't it? Grabbing wealth willy nilly unpredictably is not something responsive rule-of-law democracies can or should do. (This  issue came up with the corporate tax cut. There was a lot of effort not to reward past investment. That's the same principle as trying to tax that past investment now that it is made. I prefer stable rules.) Thus, I actually hope that the Supreme Court does blow up the tax system. It's a bloated crony-capitalist mess. Most people suspect that others with clever lawyers are getting away with murder, which is corrosive to democracy.  If the friends of the court are right that the tax system will not survive a narrow definition of income, that  might force a fundamental reckoning. We need a ground up reform. Not every decision taken in 1913 has to last forever. Let the income tax implode, and bring on a consumption tax. (Instead, not as well as!) I doubt it will happen though. The court is really good at constitutional law, but not at first-principles economics. With the continued political assault on their legitimacy, they will surely find a way to decide this narrowly, and wait to strike down the wealth tax when and if it is enacted.  But who knows, it's interesting that they took it in the first place. 

Inhaltsangabe:Introduction: General Definition and Justification of Issues and Objectives: The publication of the Modigliani and Miller (MM) capital structure irrelevance theorem in 1958 and the subsequent preference of purely debt financing due to tax advantages in 1963, was in contradiction to traditional approaches which suggested an optimal capital structure. Meanwhile the theories of MM are academically accepted and out of competition with other approaches, since the underlying assumptions, especially the existence of perfect capital markets, is considered as unreal. However, in every economic boom, when access to capital becomes easier, financial markets seem to come close to the conditions of perfect markets, characterised by high competition and prosperity. It is found that the western economic order is marked by asset bubbles that resulted in over one hundred crises over the last three decades and which bring companies back to reality with a hard landing. Access to capital becomes extremely restricted and uncertainty dominates as the collapse of Lehman Brothers in September 2008 showed. Although signs were evident in 2007, the change from prosperity to depression can come overnight, where free market policy shows its true face, with unpredictable damages deeply wounding in the economy, and seeming to paralyse even the most experienced economists. Since liquidity becomes a scarce resource and consumption declines, free cash flows that were previously available to finance an amply corporate structure, dividends and bonuses, are likely to fall. As debt, if any, must still be paid back – often to worse conditions than before – corporations might run out of liquidity, as has happened to major US companies during the last twelve months. Also, investments that ought to ensure future profits are likely to be reduced or to come to a still stand, sending firms and the economy in a downward spiral. However, as experienced and predicted by Copeland and Greenspan, systematic organisations which are considered as 'too-big-to-fail' are offered bail-outs at the cost of society. This work aims to investigate the impact of the capital structure on the profitability of large capitalised US companies. It does not, therefore, aim to test existing theories, nor does it try to find a model to predict one or another capital structure, since numerous attempts have previously been made that have so far struggled to capture the full complexity of the real world. Rather, it focuses on correlations between capital structure and profitability and major profitability-associated measures that can have an impact on a firm's survival, i.e. liquidity, dividends, investments and the impact of an industry-related target gearing ratio as a potential systematic risk. Thus, this work is supposed to contribute to the understanding of how resistant companies are to financial distress, and it provides evidence on the extent to which vulnerability can be reduced to prevent major systemic crises by means of their capital structure adjustments through the awareness of shareholders and corporate governors. Research Questions and Methodology: The basis of this research project is a selection of secondary performance data over the period from 2004 to 2008 of firms listed in the Standard Poor's 500 index (SP 500) in January 2004. The index represents the 500 largest capitalised US companies among ten sectors that reflect the whole US market. The combination of the US market and the SP 500 companies, who have access to the widest range of financial sources, is expected to give a highly reliable result to find empirical evidence for the following research questions. Question 1. According to the MM theorem and the pecking order theory that relies on information asymmetry between insiders and investors, leverage should not depend on the industry a firm is in. However, evidence suggests that firms in different industries operate with different capital structures. Thus, the first hypothesis (H1) is to verify whether industry-specific leverage exists. Question 2. Since revenues are likely to decrease in an economic downturn, this reduces a firm's ability to meet debt payments, which is expected to have a negative impact on profitability. The second and central hypothesis (H2) is, therefore, that a negative correlation between gearing ratio and profitability exists, i.e. higher geared firms are less profitable. As this research question is the centre of attention, it merits a deeper investigation than all other hypotheses, especially for the years 2007 and 2008. Question 3. Most of the companies are affected by financial distress, not because they are not unprofitable, but because they have no liquidity. If cash inflows decline, firms are likely to be unable to finance current expenses, including the interests on debt. Hence, the third hypothesis (H3) is the existence of a correlation between gearing ratio and liquidity. Higher geared firms are supposed to have lower cash positions, especially in 2008. Question 4. Investments in RD are crucial for survival and competitiveness of firms within some industries. Since higher geared firms must concentrate more to the avoidance of financial distress, they may tend to reduce expenses in long-term RD projects that have no immediate effects. The aim of the fourth hypothesis (H4) is to prove whether a correlation between gearing ratio and RD expenditure exists, especially in 2008, that is expected to have a negative influence on future profits. Question 5. Highly geared companies are encouraged to pay out higher dividends by transferring wealth from bondholders to shareholders, although managers should have an incentive to reduce them if liquidity becomes a scarce resource. The fifth hypothesis (H5) is, therefore, to find evidence of the existence of a correlation between gearing ratio and dividend policy, especially in 2008. Overview and Organisation of Chapters: This dissertation is organised into seven sections, each with a brief statement at the beginning and the end of the issues previously and subsequently discussed. Although this might seem repetitious, it enables the reader to go through in multiple sessions. The following few paragraphs give an outline of the next six sections. After the introduction and definition of the above stated research questions, section 2 attempts to review the existing literature on capital structure with a discussion of the main theories, after which a more detailed focus on the fields in respect of the research questions is provided. Section 3 discusses and justifies the methodology used to answer the research questions, which refers to data sampling and data collection, the treatment of missing values, the variables defined and applied hypothesis testing methods. Section 4 outlines the key findings in respect of the hypotheses initially stated, which are then analysed and discussed. Where appropriate, the results found are related to the most relevant findings discussed in the literature review. Section 5 recalls the research objectives and findings previously obtained. After that, it concludes with the underlying assumptions required for the implications drawn from those findings, which are part of the next section. Section 6 attempts to identify management implications and recommendations to solve the issues. Based on the results revealed from the sample, it aims to identify measures in reducing vulnerability and systematic risk in order to achieve sustainable economic growth without adverse effects for society. Section 7 points to the achievement of the objectives of this study, its strengths and weaknesses. Ultimately it gives insights to the personal development drawn from the execution of this research project with reference to difficulties faced.Inhaltsverzeichnis:Table of Contents: Abbreviations4 Acknowledgements5 Abstract6 1.Introduction7 1.1GENERAL DEFINITION AND JUSTIFICATION OF ISSUES AND OBJECTIVES7 1.2RESEARCH QUESTIONS AND METHODOLOGY9 1.3OVERVIEW AND ORGANISATION OF CHAPTERS10 2.Existing Theories and their Predictions12 2.1EXISTING THEORIES12 2.1.1The Trade-Off Theory14 2.1.2The Pecking Order Theory18 2.2PREDICTIONS OF EXISTING THEORIES21 2.2.1Capital Structure and Industry21 2.2.2Capital Structure and Profitability24 2.2.3Capital Structure and Liquidity27 2.2.4Capital Structure, RD and Tangible Assets28 2.2.5Capital Structure and Dividend Policy30 2.3A FINAL COMMENT32 3.Methodology34 3.1DATA SAMPLING34 3.2DATA COLLECTION35 3.2.1Missing Values and Adjustments36 3.3VARIABLES AND THEIR DEFINITIONS37 3.3.1Leverage and Gearing37 3.3.2Profits and Return39 3.4HYPOTHESES AND HYPOTHESES TESTING39 3.4.1H1: Capital Structure and Industry40 3.4.2H2: Capital Structure and Profitability41 3.4.3H3, H4 and H5: Capital Structure, Liquidity, RD and Dividend Policy42 4.Findings and Analysis44 4.1H1: THE IMPACT OF INDUSTRY ON CAPITAL STRUCTURE AND ASSOCIATED VARIABLES44 4.2H2: THE EXISTENCE OF A CORRELATION BETWEEN LEVERAGE AND ROCE54 4.3H3: THE EXISTENCE OF A CORRELATION BETWEEN LEVERAGE AND LIQUIDITY59 4.4H4: THE EXISTENCE OF A CORRELATION BETWEEN LEVERAGE AND RD62 4.5H5: THE EXISTENCE OF A CORRELATION BETWEEN LEVERAGE AND DIVIDENDS66 5.Conclusions71 5.1CAPITAL STRUCTURE71 5.2PROFITABILITY72 5.3LIQUIDITY72 5.4INVESTMENTS73 5.5DIVIDENDS74 6.Recommendations76 7.Reflections80 7.1OBJECTIVES80 7.2STRENGTHS81 7.3WEAKNESSES AND LIMITATIONS81 7.4PERSONAL DEVELOPMENT83 Bibliography84 Appendix ASP 500 industries, January 2004 and June 200991 Appendix BMissing values of dead firms, based on balance-sheet records92 Appendix CSignificant year-by-year correlations of core factors with Gearing 293 Appendix DIndependent t-test of delisted and non-delisted firms94 Appendix EIndependent t-test of the ten lowest and highest geared firms95 Appendix FIndependent t-test of the ten less and most profitable firms105 Appendix GMann-Whitney test of the ten lowest and highest geared firms115Textprobe:Text Sample: Chapter 2.2.5, Capital Structure and Dividend Policy: Shareholders expect a return on their investments, either in the form of an increase in share prices or through dividends for placing equity at the disposal of a business. Since some organisations, such as pension funds and charities, periodically require revenues, dividends might be preferred that also reduces transaction costs. This reality might be overseen in the simplified MM argument of 1961, according to which, dividend policy does not matter in perfect markets. Dividend announcements, due to information that they contain, influence stock prices and thus the market value of a firm which has an impact on equity issues, according to the pecking order. This concept was approved by Asquith and Mullins on a sample of 168 publicly listed US companies from 1964 to 1980, who began to pay dividends. Also Baskin argues that '[d]ividends provide signals both to current and future earnings' and found that higher dividend payments in 1965 resulted in considerably higher debt levels in 1972. He (ibid.:31) observed that the level of dividend payouts is rather stable, since '[s]erial correlation after twelve years is 0.714 and amounts to about 50% explained variance'. In contrast, Antoniou et al. find a negative correlation of gearing and dividend payments for US firms only, while Lintner argues that dividends depend on profits and successful investment strategies that allow a stable compensation for shareholders. Also Rozeff argues that more investment opportunities lead to lower dividend payout ratios that, however, do not reduce agency costs, which are offset by higher transaction costs for debt issuance. Thus, according to the pecking order theory, dividends contain information about the future that makes dividend policy a 'sticky' subject, 'while capital spending varies over the business cycle' that increases debt levels. According to Baskin, 'the need to adhere to stable dividend policy appears to be much stronger than those motivating adherence to some statically defined optimal capital structure." In a severe downturn, however, where profits and financial resources shrink, it is worth questioning whether a firm should stick with dividend policy or would be better selling undervalued assets to generate liquidity. An observation made by Graham is that 'dividend-paying firms issue debt more conservatively than do non-dividend-paying firms, even though they presumably have less severe informational problems.' This implies higher leverage for non-dividend-payers as is confirmed by Frank and Goyal. Thus, firms who pay dividends do not only have less interests to pay, but would also be able to reduce dividend payments in bad times and thus are able to avoid financial distress, while for them it is easier to continue investments. Another explanation is that non-dividend-payers have more growth opportunities, requiring new investments that are leveraged with external debt, while mature firms do not always have the possibility to invest in profitable projects. Baskin states that 'an increase in equity issues necessarily results in greater dividends, and greater dividends in turn give rise to a larger burden of personal taxation.' As a result, investors would prefer lower dividends in favour of faster growing share prices. While young firms with large growth potential do not have these problems with free cash flows, rational investors of mature firms expect dividends to avoid over-investment. Also large firms, who generally pay higher dividends, tend to expand more slowly than small ones, as observed by Baskin, which implies higher dividend payouts.

Sovereign credit ratings play an important part in determining countries' access to international capital markets and the terms of that access. In principle, there is no reason to expect that sovereign credit ratings should systematically predict currency crises. In practice, in emerging market economies there is a strong link between currency crises and default. Hence if credit ratings are forward-looking and currency crises in emerging market economies are linked to defaults, it follows that downgrades in credit ratings should systematically precede currency crises. This article presents results suggesting that sovereign credit ratings systematically fail to predict currency crises but do considerably better in predicting defaults. Downgrades in credit ratings usually follow currency crises, possibly suggesting that currency instability increases the risk of default.

This background note is intended to assist debt management offices (DMOs) in assessing whether a bond placement scheme combining auctions and syndications is an appropriate strategy in their markets and, if so, to assist them in designing the corresponding procedures.