“The new mercantilism”

Now it´s China´s turn to be badgered by the US. David Levey sends us three links (here, here and here) to related pieces. Barring his “fixed exchange rate/currency board” quirk, I agree with Steve Hank´s take:

The United States has a long history of waging currency wars in Asia. We all know the sad case of Japan. The U.S. claimed that unfair Japanese trading practices were behind the ballooning U.S. bilateral trade deficit.

To correct the so-called problem, the U.S. demanded that Japan adopt an ever-appreciating yen policy. The Japanese complied and the yen appreciated against the greenback, from 360 in 1971 to 80 in 1995 (and 77, today). But this didn’t close the U.S. trade deficit with Japan. Indeed, Japan’s contribution to the U.S. trade deficit reached almost 60 percent in 1991. And, if that wasn’t enough, the yen’s appreciation pushed Japan’s economy into a deflationary quagmire.

That´s quite true and almost unbelievable. The chart shows the exchange rate to the dollar of the German Mark and the Yen between 1980 and 1987, a period during which the dollar first appreciated against all currencies, except, you guessed, the yen and than depreciated against the same currencies. On the down leg it depreciated against the yen too!

In 1985/87, the people at the Japanese Ministry of Finance and the BoJ had to confront the problem of stimulating the economy. Faced with a dramatic appreciation of the yen that was directly responsible for the strong reduction in economic growth, interest rates were brought down to historically low levels and money growth increased sharply.

Asset prices (stocks and real estate) took off and the exchange rate at least stopped appreciating. As commented by an anonymous BoJ employee in 1988: “Our intention was first to give a push on real estate and stock prices. With those markets on the rise, the export industries would find ways to adapt to an expansion determined by the domestic market. The wealth effect from higher asset prices would foster consumption growth and then investment. In this way, an expansionary monetary policy would jumpstart economic growth”.

It did. Growth went up to 6% in 1988 and was around 5% in both 1989 and 1990. But inflation went up too, from -1% in 1987 to 3% in 1989-90.  The BoE “panicked” (even though at 3% inflation was not much different from what it had been in 1982-85). Interest rates were quickly brought up from 2.5% where they had stayed between 1987 and mid 1989 to 6% in late 1990. Asset prices tanked and Japan´s “lost decades” began.

Steve Hanks again:

Let’s hope China ignores U.S. demands for an ever-appreciating yuan. China’s compliance would do little more than attract massive hot money flows into the country and destabilize its economy. This would be bad news for the world economy’s main engine of growth.

Yes, let´s!

The “austerity” debate

The “fiscal austerity” debate rages on. I think it is very unproductive and detracts from the discussion that should be going on, and that pertains to monetary policy. Nevertheless I decided to “butt in”.

In the top part of the table below are the 6 OECD countries which registered the lowest increases in the G/Y ratio between 1960 and 2007 (brake point defined to avoid the “distortions” that followed the onset of the crisis). In the lower part the countries that registered the largest increases.

The last three columns show the average real economic growth rates in the first 13 years of the sample, in the last 13 years and the change in growth between the two periods.

Notice that the weight of government (G/Y) increased in all OECD countries between 1960 and 2007. However, the differences are substantial. In those countries where G/Y rose less the average increase was 10.6 percentage points while in those countries that the government share increased most, the average rise was 25 points.

As seen in the last three columns, growth was more strongly reduced among the countries that experienced the largest increase in G/Y: -2.8% which compares to -0.5% for the countries with the lowest increase in G/Y.

Note that three of today´s “crisis countries” – Greece, Portugal and Spain – are also countries that saw the largest increase in the share of government and the largest loss of dynamism, with economic growth rates falling significantly.

It would be interesting to see if the opposite case – a reduction in the weight of government – is associated with higher growth. For the time period under analysis – 1960 – 2007 – we observe four cases in which there was a substantial and persistent decrease in the G/Y ratio. These are:

  1. Ireland, where between 1986 and 2003 the ratio fell from 52.3% to 33.2%. While between 1977 and 1986, a period during which G/Y went from 43.7% to 52.3% average growth was 3.4%, between 1987 and 2003 growth was 6.2% on average.
  2. New Zealand, where between 1990 and 2003 the ratio fell from 53.6% to 35%. During this period average growth was 2.9%, compared to 1.8% in 1970 – 1990 during which G/Y went from 34.4% to 53.6%
  3. UK, where between 1981 and 1990 the ratio dropped from 48.5% to 39.7%. During this period growth averaged 3.4%, which compares favorably with the 1.8% growth observed during 1971 – 1981, when the G/Y ratio increased from 41.8% to 48.5%. This was an interesting outcome given that in 1981 a document signed by 364 economists, many of them famous, radically opposed the 1981 Thatcher budget, alleging that the “proposed policies will deepen the recession and threaten social and political stability…”
  4. The Netherlands, where between 1990 and 200 the ratio dropped a little more than 10 percentage points real growth averaged 3.3%, compared to 2.1% between 198o – 90, a period during which G/Y was relatively stable around 55%.

I find this quote from a little book called “Common Sense Economics” by James Gwartney, Richard Stroup and Dwight Lee (page 79) very pertinent:

Government is a little bit like food. Food is essential, but when consumed excessively, it leads to obesity, energy loss, and other health-related problems. Similarly, when constrained within proper boundaries, government is a powerful force for prosperity. But when it expands excessively and undertakes activities for which it is ill-suited, it undermines economic progress.

For convenience I´ll call “proper boundaries of government” the “core functions”. The chart below shows the share of “core functions” for a sample of countries.

The “Core Functions/GDP” estimate is for 2006. However, the changes over time in the share of core functions of government are not large. For example, in 1960, core functions in Canada were 13% of GDP compared to 17% in 2006. Another characteristic of the share of core functions is that, in addition to showing relatively low changes over time, the difference among countries at a moment in time is relatively low (especially when compared to the large variations between countries at a moment in time in the total share of government observed in the Table).

So yes, “too much government can be bad for the economy´s health”!

No Ryan, you didn´t “convince” me

Ryan Avent is right: I was disappointed to see him offer praise to Bernanke, but he agrees that so far the Fed has been “weak”:

IT SEEMS that a few people were surprised, and perhaps disappointed, to see me offer some praise to Ben Bernanke for changes announced in the most recent Federal Open Market Committee statement. Don’t get me wrong. I would like the Fed to do more, and I would have preferred it to have done more some time ago. I think we can chalk quite a lot of the weakness of the American recovery up to insufficiently stimulative monetary policy—a hugely costly policy error.

He then indicates that his “praise” was to be interpreted as an “incentive” – “let´s give Bernanke encouragement” – after all we recognize how difficult his job is and, who knows, maybe he´ll feel encouraged to become more “forceful”.

Every once in a while, however, it’s worth taking a break from haranguing policy officials when they show that they’re learning. And every once in a while, it’s important to remember the context in which Fed officials are making policy.

Mr Bernanke has a difficult job. He’s tasked with managing the world’s primary reserve currency and its largest economy through one of the modern world’s most treacherous economic periods. It’s a position within which one can’t afford to behave too incautiously.

I think Ryan is too “lenient” when he gives Bernanke “great credit” for undertaking “housekeeping chores”, even in the midst of the worse economic performance of the post war era. His predecessor may have been “obscure in his messaging”, but there´s no denying (although there are quite a few “revisionists”) that he was a success.

It is to Mr Bernanke’s great credit that, recognising the huge importance of the Fed in the world economy, he took the chairmanship with an eye toward shepherding its institutions toward greater transparency and accountability. His predecessor ran the Fed in near-dictatorial fashion, and sought to be as obscure in his messaging as possible. That’s a dangerous way to run one of the most powerful positions in the world, and Mr Bernanke was eager to change the way the Fed operated.

And I don´t see any “pivoting” by the Fed. It´s still set in avoiding deflation but is terrified of inflation, even when that´s a “non issue”. Bernanke has even satisfied his long standing “dream” and enshrined the 2% inflation target.

And while time may prove me wrong, it does seem that the Fed has pivoted in a very useful direction over the past year. As of early last year, it seemed that the Fed’s policy framework would only allow additional expansionary measures when deflation appeared to loom as a threat. It took several quarters of slowing growth to get the Fed to QE2, and it failed to continue purchases after its scheduled end in the absence of an ongoing disinflationary threat. 

Hooked-up on “communication”

In addition to his “creditism”, Bernanke is a “communications addict”. Only it´s much simpler than he makes it out to be. Instead of publishing “betting boards” he could come out and credibly commit to a TARGET – preferably an NGDP level target.

Tim Duy has a good take:

Maybe the next round of QE will do the trick, but I remain skeptical. Policy has consistently fallen short of that necessary to decisively propel the economy off the zero bound. Such policies have, in my opinion, fallen victim to fears of inflation. The Federal Reserve appears committed to a 2% target under any circumstances, with even a temporary increase considered unacceptable.

In short, I see the Fed’s policy as toxic not so much because interest rates are locked at the zero bound, but because the Fed sees no urgency in rectifying the situation. I think this will be proven to be a serious policy failure when the next recession arrives, and I wish the Fed would make a clear objective to lift the economy off the zero bound, rather than issue a forecast that, when coupled with lack of immediate policy action, represents acceptance of the zero bound. 


The problem is that the only “austerity” we read about (here, here, here and here, for a small sample) is Fiscal Austerity.

It takes a Market Monetarist like Scott Sumner to come out and speak against “Monetary Austerity”:

Keynesians are focusing on the fiscal part of the problem, but with Britain already having the third biggest budget deficit in the world, I think people need to start paying more attention to errors of omission by the BOE.  That’s the elephant in the room that almost everyone is ignoring.

“As time goes by”

Five months ago, following Bernanke´s speech at Jackson Hole, I quoted (my bolds):

…This economic healing will take a while, and there may be setbacks along the way. Moreover, we will need to remain alert to risks to the recovery, including financial risks. However, with one possible exception on which I will elaborate in a moment, the healing process should not leave major scars.

Normally, monetary or fiscal policies aimed primarily at promoting a faster pace of economic recovery in the near term would not be expected to significantly affect the longer-term performance of the economy. However, current circumstances may be an exception to that standard view–the exception to which I alluded earlier. Our economy is suffering today from an extraordinarily high level of long-term unemployment, with nearly half of the unemployed having been out of work for more than six months. Under these unusual circumstances, policies that promote a stronger recovery in the near term may serve longer-term objectives as well. In the short term, putting people back to work reduces the hardships inflicted by difficult economic times and helps ensure that our economy is producing at its full potential rather than leaving productive resources fallow. In the longer term, minimizing the duration of unemployment supports a healthy economy by avoiding some of the erosion of skills and loss of attachment to the labor force that is often associated with long-term unemployment.

That´s an important recognition. But to promote a stronger recovery in the near term, the Fed has somehow to lift the constraint imposed by:

Most importantly, monetary policy that ensures that inflation remains low and stable over time contributes to long-run macroeconomic and financial stability. Low and stable inflation improves the functioning of markets, making them more effective at allocating resources; and it allows households and businesses to plan for the future without having to be unduly concerned with unpredictable movements in the general level of prices.

The ideal is not to “temporarily” increase the inflation “target” as some have suggested, but to set a “target” for the LEVEL of spending you want to achieve to put the economy on the long run growth path that ensures the economy is producing at its full potential.

Has there been any advance towards “promoting a stronger recovery”? I don´t think so. But Bernanke has managed to make the 2% inflation target “official”!

Central Banks only do good!

Want to come out looking good? Shove the lady over the cliff and before she disappears into the abyss grab her hand and keep her dangling.

That´s what Bernanke is praised for:

Alan Blinder who was a governor and vice chairman of the Fed (1994-96) and like Bernanke is a Princeton University professor writes that while between mid 2007 and mid 2008 Fed actions fell short, following the Lehman blow-up “the Fed deserves extremely high marks for its work since then. It has hit the bull’s-eye regularly under very trying circumstances”.

And Mario Draghi in a fit of modesty says:

DAVOS, Switzerland—European Central Bank President Mario Draghi told the World Economic Forum Friday that the ECB’s actions in December had averted financial disaster and cited evidence of improvement in euro-zone markets in recent weeks.

“MM is on a roll”

This was posted today at “Pileus”, who describe themselves as:

“Pileus is a group of scholars who examine public policy and philosophy in light of our respective disciplines. We differ in many ways but share a commitment to liberty and personal responsibility.”

Sumner and the market monetarists are pushing a revolution in macro designed to put the Fed’s focus on nominal GDP.   His provocative claim is that the balancing act between employment and inflation that the Fed is charged with can be accomplished not by worrying about output and prices separately, but by worrying about their combination–which is NGDP.  If NGDP is too high, contract; if it is too low, expand.  In Sumner’s view the low expected inflation revealed by interest rates during the financial crisis of 2008 was not a silver lining (as media reports liked to claim).  Instead, the low inflation was the proximal cause of the recession.  When spending tanked in 2008, NGDP (and RGDP) took a nose-dive.  Sumner argues that even though the Fed did increase the monetary base, its policies were highly contractionary, just as they were in 1932.  What the Fed needed to do was credibly commit to higher inflation in the future by injecting more money into the economy.  Instead, interest rates and inflation stayed low and unemployment soared.

HT Bill Woolsey

One more member in the NGDP (level) Targeting group

This from John Quiggin:

in the post-crisis environment, achievement of inflation targets has no longer promoted stable economic growth. Rather, low  inflation has been a drag on growth. But with inflation clearly under control, central bankers like former European Central Bank President Jean-Claude Trichet have been able to describe their own performance as ‘impeccable’, even as the economies and currencies they manage appear headed for collapse.

This system is clearly unsustainable. But what is the alternative? The most popular idea begins with a change of target, from the rate of inflation, to the level of nominal GDP (the most commonly used measure of national output, valued at current prices).

The idea would be to combine a target rate of inflation (say 2-3 per cent) with an estimate of the medium-term rate of real economic growth required to maintain full employment (again 2-3 per cent is a plausible estimate). The aim would then be to keep the value of GDP, expressed in current dollars, on a growth path consistent with these targets (that is, at an average annual rate somewhere between 4 and 6 per cent).

This change would have several effects. First, it would restore the balance that used to prevail in monetary policy before the 1990s, when central banks were explicitly required to pursue full employment as well as price stability.

Second, because the target would apply to the level of nominal GDP, its adoption would require central banks to catch up the ground lost over the last few years of depressed growth and generally low inflation. That would permit a temporary increase in inflation, which is necessary if growth is to be restarted against a crushing burden of debt.

Third, the adoption of a nominal GDP target, by committing central banks to an expansionary policy would have self-fulfilling effects on expectations. By contrast, the effectiveness of past measures to expand credit has been undermined by the expectation (justified by events) that they would be wound back as soon as the immediate crisis was over.

Last but not least, a nominal GDP target would create room for fiscal policy as well as monetary policy. What is needed now is the abandonment of counterproductive austerity policies as a response to the slump in Europe and the US. Austerity should be replaced by a combination of short-term fiscal stimulus and long-run measures aimed at a sustainable budget balance. That can only be achieved if central banks co-operate with pro-growth fiscal policy, instead of seeking to counteract it in the name of inflation targets.

The abandonment of inflation targeting would, of course, be an admission of failure. But central banks have failed, disastrously, and admitting this would be the first step towards a sustainable recovery.

A system of nominal GDP targeting would maintain or enhance the transparency associated with a system based on stated targets, while restoring the balance missing from a monetary policy based solely on the goal of price stability.

Only quibble: he could have disregarded any need for “fiscal stimulus”.