Archive for the Category Eurozone


A bigger China shock?

I have a new piece at The Hill.  Here’s an excerpt:

The biggest puzzle is what the Trump administration is trying to achieve with its trade war. Is it a move to pressure the Chinese to open up their economy, thus reducing barriers to U.S. trade and investment? Maybe, but it was precisely the opening of the Chinese economy that first created the “China shock.”

Indeed, China was no threat at all to U.S. firms when its economy was closed under the leadership of Chairman Mao. An even more open China would create an even bigger shock, resulting in even more economic dislocation in the Rust Belt. Presumably, Ohio manufacturing workers who supported candidate Trump were not hoping China would buy more Hollywood films and computer software, so that America could buy more auto parts from China.

Read the whole thing.

PS.  A recent NBER paper by Zhi Wang, Shang-Jin Wei, Xinding Yu, and Kunfu Zhu reversed the finding of the famous Autor, Dorn and Hanson paper on the “China shock”.  Here is the abstract:

The United States imports intermediate inputs from China, helping downstream US firms to expand employment. Using a cross-regional reduced-form specification but differing from the existing literature, this paper (a) incorporates a supply chain perspective, (b) uses intermediate input imports rather than total imports in computing the downstream exposure, and (c) uses exporter-specific information to allocate imported inputs across US sectors. We find robust evidence that the total impact of trading with China is a positive boost to local employment and real wages. The most important factor is employment stimulation outside the manufacturing sector through the downstream channel. This overturns the received wisdom from the reduced-form literature and provides statistical support for a key mechanism hypothesized in general equilibrium spatial models.

I don’t “believe” either result.  The science of economics has not advanced to the point where it’s possible to have a high level of confidence in these sorts of empirical studies.

PPS.  Off topic, this made me smile:

Trump has moaned to donors that Powell didn’t turn out to be the cheap-money Fed guy he wanted. The president repeated the effort this week in an interview with Reuters, adding the ridiculous claim that the euro is manipulated and the more credible notion that China is massaging the yuan. (The European Central Bank rarely intervenes directly in currency markets; when the ECB does, it’s usually with the Fed.)

Where to begin:

1. Trump had a choice between Yellen and Powell.  I suggested Yellen, as she had done a very good job.  Trump’s advisors said he shouldn’t pick Yellen because she’s not a Republican.  So Trump picked Powell, even though he was slightly more hawkish than Yellen.  Trump is tribal and assumes everyone else in the world is just as corrupt as he is.  He thought Powell would be “better” because he’d want to help a Republican president.  And now Trump is shocked to find out that Powell is not his lapdog.  (Actually it’s too soon to know for sure, as Trump also wrongly assumes that higher interest rates mean tighter money.  But we can cut him some slack, as lots of other people make the same mistake.)

2. I also smiled at the notion that the ECB doesn’t intervene in the currency market.  Of course they have a 100% monopoly on the entire supply side of the euro currency market.  Yes, I understand the reporter meant “foreign exchange market” when he said “currency”.  But even that’s a bit misleading, as ECB policy does affect the forex value of the euro, and there have been ECB actions in recent years that were clearly aimed at depreciating the euro.  Ditto for the Fed and the Chinese central bank.  Still, the reporter is correct in claiming that Trump has no grounds to complain about ECB policy; I wish he had made the same point about China.

PPPS.  Another day, another two convictions of close Trump advisors.  In one case it was for for a crime that Trump ordered him to commit.  Trump’s now as deeply enmeshed in scandal as Nixon was back in 1974.  The good news for Trump is that none of this matters.  Trump’s support is in the low 40s and it will not decline at all.  There was no Nixon cult—his supporters abandoned him in droves.  But the Trump cult would support him if he murdered someone in the middle of Times Square, at least that’s what Trump himself claims.  As long as those 40% of voters stick with Trump, frightened GOP Congressmen will do the same.  Trump is safe.

Still, it will be fun watching the scandal play out—lots more to come!

Screen Shot 2018-08-21 at 6.53.56 PMPPPPS.  Focus on the blue line, as the yellow line partly reflected the worsening economy.

Reveal, depress, destroy: Three types of contagion

The term ‘contagion’ is used quite a bit in the financial press, but what does it actually mean?  There are at least three very different types of contagion, each with its own policy implications:

1.  An economic crisis in one country might reveal a weakness that was not previously apparent to the international investment community.  Thus in the late 1990s, the gradual rise of China and the strengthening US dollar was slowly weakening the position of export-oriented nations in Southeast Asia, which had fixed their currencies to the US dollar and also accumulated dollar-denominated debts.  When Thailand got into trouble in mid-1997, investors looked around and noticed similarities in places like Malaysia and Indonesia.  It wasn’t so much that Thailand directly caused problems in those countries (in the way a US recession might directly cause problems for Canada); rather it revealed weaknesses that were already there.

2.  A financial crisis in a big country might depress the global Wicksellian equilibrium real interest rate.  For example, the US housing bust and banking crisis of 2007-08 triggered a global recession.  By itself, this doesn’t necessarily cause problems in other countries.  But if the foreign country is already at the zero bound (Japan), or if the foreign central bank is too slow to cut interest rates (ECB), then a lower global equilibrium interest rate might lead to tighter money in other countries.  Here I would say that the US triggered the Great Recession, but the Fed, ECB and BOJ jointly caused the Great Recession.

Similarly, under an international gold standard, the hoarding of gold in one country can depress nominal spending in other countries.  Indeed gold hoarding by the US and France was a principal cause of the Great Depression.

3.  A financial crisis in one country can affect other nations if they are linked via a fixed exchange rate regime or a single currency.  Consider Greece, which comprises less than 2% of eurozone GDP.  Fears that Greece might have to leave the eurozone caused significant stress in other Mediterranean nations.  If one country were to exit, investors might expect this to lead to an eventual breakup of the entire eurozone.  That would trigger a banking crisis, and would also lead major debtor nations such as Italy to default on their huge public debts.  This is why a small country like Greece could have such a big impact on eurozone asset markets; investors feared that a Grexit would destroy the eurozone.

So far, Turkey looks like it fits the “reveal” template best.  The greater the extent to which Turkey is viewed as a special case reflecting local conditions, the smaller the contagion effect.  If Turkey becomes seen as emblematic of much of the developing world, then contagion is more likely.

How bad is the Italian debt situation?

Tyler Cowen recently linked to a John Cochrane post, discussing Larry Kotlikoff’s views on public debt sustainability.  Here’s Cochrane:

(By the way, if you’re feeling superior and taking comfort that Europe will go first off the cliff, Kotlikoff disagrees. Europe’s debts are larger, but their social programs are better funded, so their fiscal gaps are much lower than ours. The winner, it turns out, is Italy with a negative fiscal gap. Answering the obvious question, Kotlikoff offers

“What explains Italy’s negative fiscal gap? The answer is tight projected control of government- paid health expenditures plus two major pension reforms that have reduced future pension benefits by close to 40 percent.”Don’t get sick or old in Italy, but perhaps buying their bonds is not such a bad idea.)

I am a bit skeptical of that claim; so I decided to check with God, er . . . I mean I decided to check with the ultimate arbiter of truth, the asset markets:

Screen Shot 2017-04-24 at 4.13.10 PMAs you can see, Italian 10-year bonds offer considerably higher yields than German, French and Dutch bonds, and even higher yields than Spanish bonds. Italy has a massive public debt (third largest in the world), an economy that has shown almost no growth since 2000, and a very dysfunctional political system (which the voters recently decided not to reform.)

I greatly respect Kotlikoff, and even more so John Cochrane.  But I respect the markets far more than any mere mortal.   So unlike Kotlikoff and Cochrane, I remain relatively pessimistic about the Italian debt situation.

PS.  I am back from 5 days in Turks and Caicos (is there a law in the Caribbean mandating nothing but Bob Marley music at resorts?), and I am starting to get caught up.

I have a new post on Bretton Woods as an example of the guardrails approach to policy, and another post commenting on the French elections.

My guardrails post is intended to address tiresome criticism of NGDP targeting by people who have never bothered to actually read what I have written on the topic. No, neither the current lack of interest in NGDP futures trading nor the risk of market manipulation pose any kind of problem for the system I am actually advocating.  (Unless you believe, “Bretton Woods could not possibly have worked because speculators would have manipulated the market.”)

It was not “inability”

Over at Econlog, I have a post discussing Bernanke’s views on price level targeting.  Here I’d like to nitpick a couple passages from Bernanke’s post:

As price-level targeting and “make-up” policies are closely related, they could be combined in various ways. For example, by promising to return the price level to trend after a period at the zero lower bound, the Fed could use the language of price-level targeting to make precise its commitment to make up for its inability to respond adequately during the period when rates are at zero.

It was not inability to cut rates that prevented the Fed from acting after Lehman failed in September 2008.

It was not inability that caused the Fed to raise the interest rate on reserves in October 2008.

It was not inability that caused the Fed to refuse to cut rates to zero in November 2008.

It was not inability that caused the Fed to refuse to do negative IOR, when Sweden adopted the policy in 2009.

It was not inability that caused the Fed to prematurely end QE1 in late 2009.

It was not inability that caused the Fed to prematurely end QE2 in mid-2011

It was not inability that caused the Fed to prematurely talk about tapering in 2013.

It was not inability that caused the Fed to prematurely raise rates in 2015.

Now Fed policy is roughly appropriate.  But it was obviously too contractionary for many, many consecutive months and years, just as had been the case in Japan.  Just to refresh your memories, Bernanke’s paper that criticized the BOJ on almost precisely the same grounds as I criticized the Fed was entitled:

Japanese Monetary Policy:  A Case of Self-Induced Paralysis?

And the answer he gave was a resounding yes.  That’s not to say the Fed’s job is easy.  I might have done no better than Bernanke, if I were in his shoes.  There are all sorts of political pressures within the Fed and also from the outside.  It’s a very hard job.  But it’s never about inability; it’s about the Fed’s willingness to do whatever it takes.  It’s willingness to show what Bernanke once called “Rooseveltian resolve”.

One other quibble:

Support for a higher inflation target seems to be increasing along with worries about the ZLB. In a recent post entitled “The case for a higher inflation target gets stronger,” Stephen Cecchetti and Kermit Schoenholtz cite four arguments in favor:

  1. the persistent decline in normal interest rates;

  2. findings (like those of KR) that the frequency and severity of future ZLB episodes may be worse than previously thought, even given the low level of normal interest rates;

  3. some evidence, drawn from a study of the 1970s, that the costs of higher inflation might be less than previously believed; and

  4. calculations that suggest that standard inflation measures may overstate actual increases in the cost of living by more than had been understood.

I don’t have a big problem with this, but I don’t really like point four.  If higher inflation is a good idea, it has nothing to do with the fact that “standard inflation measures may overstate actual increases in the cost of living”.  There are several theories about the welfare cost of inflation, but none of them hinge in any way on the question of whether the BLS properly accounts for quality changes, or the substitution effect, or the new product effect.  The welfare costs of inflation have to do with things like menu costs for adjusting prices, or excess taxation of capital income when inflation is high.  Point four creates the misleading impression that economists want to control inflation so that consumers will benefit from a dollar that loses 2% of its purchasing power each year in terms of . . . what?  Utility?

I also disagree with this:

Second, although quantifying the economic costs of inflation has proved difficult and controversial, we know that inflation is very unpopular with the public. This may be due to reasons that economists find unpersuasive—e.g., people may believe that the wage increases they receive are fully earned (that is, not due in part to prevailing inflation), while simultaneously blaming inflation for eroding the purchasing power of those wages.

The thing that is unpopular with the public is called “inflation” by the man on the street, but it has nothing to do with inflation as defined by economists.  I talk a lot about how the American public in 1990 thought inflation was higher than in 1980.  But an even better example occurred in Europe, where polls showed that Europeans believed that inflation jumped dramatically after the euro was introduced.  I had European students tell me this with a straight face, back when I taught at Bentley.  I’m not sure what Europeans were annoyed about in 2002, but it was not “inflation” as the concept is understood by economists.  We need to stop trying to please a deeply confused public that doesn’t understand our terminology, and instead produce a macroeconomic environment with stable NGDP growth, stable growth in incomes, and stable employment growth.  They liked it in the 1990s, and they would like it now.

I vaguely recall reading that there were more complaints about inflation than deflation during the Great Depression.  (Can someone confirm?)

PS.  Here’s today’s headline from the FT:

Sign ‘Trumpflation’ sputtering as consumer prices fall

I’m still skeptical of the Trump reflation story.  Monetary offset is still in place, and supply side gains are likely to be a couple tenths of a percent at best, assuming he can get anything through Congress.

HT: rtd

About that eurozone “liquidity trap”

Just a year ago, Keynesians were telling us that the eurozone was stuck in a “liquidity trap” and that the ECB was “out of ammo”.  Instead, Europe needed fiscal stimulus.  Now markets are predicting that the ECB will raise rates within the next 12 months:

Screen Shot 2017-03-07 at 9.12.20 PMObviously if the eurozone actually were stuck in a “liquidity trap” then it would be absolutely insane to raise interest rates this year.

For years I’ve been arguing that the sluggish NGDP growth we see in many developed countries is due to contractionary monetary policies.  Central banks are perfectly capable of delivering faster NGDP growth, they simply don’t want to.

Prediction:  Even as the ECB raises rates, we’ll still hear from the usual suspects that “fiscal austerity” is the problem, even though the US has done just as much austerity over the past 5 years, if not more.

Suggestion:  Those who don’t think the supply side of the economy is important should take a look at Germany and Greece, both operating under the exact same monetary policy.