Archive for the Category Eurozone


Greg Ip on trade imbalances and demand

Ramesh Ponnuru sent me a WSJ article by Greg Ip:

If workers lose their jobs to imports and central banks can’t bolster domestic spending enough to re-employ them, a country may be worse off, and keeping those imports out can make it better off.

This occurs only in certain conditions, says a new paper by Harvard University’s Larry Summers and two co-authors, but those conditions may now be present.

Mr. Summers, a former Treasury secretary, is no protectionist and no fan of Mr. Trump, whose election, he warns, could lead to recession in the U.S. and financial crisis abroad. But he does worry that chronically weak demand could make protectionism both respectable and irresistible.

Others, such as New York Times columnist Paul Krugman and Michael Pettis at Peking University have already noted how in a world with too little demand, one country’s trade surplus inflicts unemployment on the country with a deficit.

Even if Summers, Krugman and Pettis are correct (and I think they are wrong) the argument does not apply to the world we live in today.  Thus Greg Ip is mistaken when he says “but those conditions may now be present.”  They are not.

Let’s start with the US.  The US is not at the zero bound, and the Fed is expected to raise rates in a few days because they think that failing to do so would result in excessive AD.  So if protectionism somehow miraculously boosted AD in the US, the Fed would simply raise rates even faster to prevent any stimulative effect on AD.

Now it’s true that the Eurozone and Japan are both at the zero bound.  But both economies have very large current account surpluses, so obviously trade deficits are not depressing output in those two regions.  Even very depressed areas such as Italy run surpluses.

In fact, unemployment has almost nothing to do with trade “imbalances” (a term I hate).

Update:  Dilip sent me the following, from Jared Bernstein and Dean Baker:

In this context, the trade deficit was subtracting from demand in the domestic economy. Spending that could have employed people who needed jobs in the U.S. was instead employing people in Germany, China, and other countries from which America imports goods and services. In principle, the U.S. government could have looked to spur other channels of demand to offset the trade deficit, but as a practical matter this is often not easy to do: The most straightforward way to generate demand is through additional government spending, but there are major political obstacles to running large budget deficits even at times when it would be beneficial to the economy.

No, the most straightforward way to boost demand is to adopt a more stimulative monetary policy.  But that won’t happen because the Fed currently thinks it’s better to slow the growth in demand by raising its target interest rate.  (And they may well be correct.  The consensus of private sector forecasters was that we were roughly on target for 2% inflation, even before the recent bump up in TIPS spreads):


Is Europe moving away from austerity? Will it matter?

Here’s a NYT headline:

Europe May Finally End Its Painful Embrace of Austerity

And here’s the claim:

As Europe has grappled with the trauma of a devastating financial and economic crisis, policy makers have consistently relied on one approach to managing the damage — budget austerity.

Shrink government spending by trimming pensions and cutting social programs, the logic runs, and the markets will gain confidence in the tough-minded people in charge. Confident markets make for happy markets. Money will pour in, and good times will roll.

Even as prosperity has remained painfully elusive across much of Europe, leaders have time and again renewed their faith in the virtues of this harsh medicine.

Until now.

Some policy makers are flashing tentative signs that they may be prepared to slacken their grip on public coffers to spur growth and improve the lot of ordinary people suffering joblessness and diminished wealth. In the clearest sign of this shift, the heavily indebted Italy is increasingly inclined to challenge Germany — the guardian of austerity — to loosen European purse strings.

Of course everything is relative, and European fiscal policy has not been particularly austere.  But even so, can we assume that a slackening of “austerity” will boost growth? Veronique de Rugy of the National Review reports:

The Congressional Budget Office recently released its Monthly Budget Review for September 2016. It includes a revised estimate of the deficit for 2016. It isn’t much different than the one projected in August. The document makes it hard to ignore that in 2016 the deficit grew by $149 billion, from $439 billion in 2015 to $588 billion at the end of FY2016. This explains why we haven’t heard president Obama brag about how the deficit is shrinking in a while.

Normally the deficit falls during expansions.  How did the economy respond to this loosening of “austerity”?  RGDP growth slowed to less than 1.3% during the past four quarters, as the Fed tightened policy.  As a result of our foolish fiscal policy, fiscal authorities will now have less room for “stimulus” during the next recession, as the deficit will be starting from a higher base.  Of course this will come as no surprise to readers of this blog.  The austerity of 2013 (when the deficit plunged from about $1,050 billion to about $550 billion between calendar year 2012 and 2013), coincided with an increase in GDP growth. But like Chicago Cubs fans, Keynesians never give up hope.

Now let’s look at the UK:

Before the June 23 vote for “Brexit,” the man in charge of the budget, the chancellor of the Exchequer, George Osborne, was publicly pursuing the aim of delivering a budget surplus by 2020. The target required cuts.

But as the political class absorbed the ballot result, interpreting it as a demand for redress from communities reeling from high unemployment and wage stagnation, Mr. Osborne acknowledged that his goal could no longer be achieved.

His successor, Philip Hammond, has raised the ante.

In a speech at an annual gathering of the governing Conservative Party on Monday, the new chancellor declared that the government would borrow more to finance new infrastructure projects — presumably creating construction and manufacturing jobs.

While reading this, I spied a link in the right column, to another NYT story, this one from May 25th:

‘Brexit’ Could Spell More Austerity for Britain, Study Warns

That’s pretty scary, but could the prediction be trusted?  The NYT says yes:

LONDON — Prime Minister David Cameron’s campaign to keep Britain in the European Union was bolstered on Wednesday by a report from one of the country’s most authoritative economic research bodies, which concluded that a withdrawal from the bloc would lead to up to two more years of public spending cuts or tax increases.

A frequent critic of government economic plans, the research body, theInstitute for Fiscal Studies, this time delivered some welcome news for Mr. Cameron.

Of course it could be trusted (the NYT signals), it came from “one of the country’s most authoritative economic research bodies”, which is also “A frequent critic of government economic plans”.  So we aren’t talking about one of those nutty right-wing outfits, like the Adam Smith Institute or the IEA.

NYT readers never need fear leaving their cosy intellectual cocoon, where fiscal stimulus produces growth miracles, and a continent where governments spend 50% of GDP is struggling because of “austerity.”  Yes, the Trumpistas are even worse (and also oppose austerity), but then I don’t expect much from the “stupid party”. I do expect more from the Times.

Our Trumpian Treasury

In Washington DC, all the best and the brightest in both parties are horrified by the prospects of a Trump Presidency.  But perhaps we owe Trump an apology, as in some respects he already controls our trade policy.  Here’s a report from 4 months ago:

The U.S. government is sending a message to countries it believes are manipulating their currencies: We’re watching you.

A Treasury report targets five countries in particular: China, Japan, Korea, Taiwan and Germany. Each meets at least two of the three criteria that “determine whether an economy may be pursuing foreign exchange policies that could give it an unfair competitive advantage against the United States.”

At a time when currency devaluation has become a major tool used by multiple countries to stimulate growth, the U.S. is looking to protect its own interests. The report is an outgrowth of the Trade Facilitation and Trade Enforcement Act of 2015, a bipartisan effort aimed at stemming the global race to the bottom.

The criteria to determine whether a country should be on the “Monitoring List” of countries using unfair currency practices are: a trade surplus of larger than $20 billion, or 0.1 percent of U.S. GDP; a trade surplus with the U.S. that is more than 3 percent of that country’s GDP; “persistent one-sided intervention,” defined as purchases of foreign currency amounting to more than 2 percent of the country’s GDP in a one-year period.

No country meets all three criteria, according to the report, though the five on the list meet at least two.

For those not familiar with open economy macroeconomics, those criteria reach almost Trumpian levels of ignorance.  Where to begin:

1.  If you worry about this sort of thing (and a few respectable economists do) then you would look at a completely different set of criteria.  For instance, the trade deficit is a meaningless data point, if anything, you’d look at current account deficits.

2.  Bilateral deficits with the US are stupidity squared, a data point of no conceivable relevance, even to the most mercantilist economist on Earth.  All that “matters” is overall surpluses or deficits, not bilateral.

3.  If you are looking for “villains”, you would certainly not look at overall surpluses; rather you’d focus on surpluses as a share of GDP, or some similar metric.  Otherwise you’d be biased against large countries.  The current account surplus for China is about $170 per capita, for Switzerland it’s over $8000 per capita.  Even as a share of GDP the Swiss surplus is far higher.

4.  “Intervention” should not be defined as purchases of foreign assets, but rather as high government saving rates.  All government saving tends to have the same effect on the CA balance, whether it is used to buy domestic or foreign assets.

5.  The Treasury singles out Asian countries in a Trumpian fashion, for no apparent reason.  Switzerland has a $71 billion CA surplus, and engages in massive purchases of foreign assets to hold down the value of the SF.  There’s two criteria right there.  Why did it not make the list?  I have no idea, its trade surplus is also well above $20 billion.  Lots of other northern European countries also have massive CA surpluses, and spend lots of money holding down the value of their currencies.  In contrast, China’s recently been trying to hold up the value of its currency.

6.  If you were an American mercantilist, I’d think that you’d be much more worried about Germany’s $300 billion CA surplus, than China’s $250 billion CA surplus.  Germany exports lots of capital goods that might otherwise be bought from America, whereas China tends to export less sophisticated goods, which might otherwise be produced in other Asian countries, or Mexico.  Norway, Sweden, the Netherlands and even Italy have CA surpluses far in excess of $20 billion.  Notice that the Treasury follows in the proud tradition Pat Buchanan and Donald Trump in pointing fingers mostly at Asian countries, even though the logic of their mercantilist argument would suggest we should target the northwest Europeans.  Perhaps Germany was put on the list to try to make the racism appear a bit less blatant.

PS.  I forgot to shed a few tears for the “victims” of all this evil currency manipulation.  There’s Australia, with its $62 billion deficit, and no recessions in 25 years.  The UK, with its $162 billion deficit and the US, with its $473 billion deficit.  Both countries have a 4.9% unemployment rate.  In contrast, those sneaky eurozone members with their $394 billion CA surplus keep stealing our jobs, which probably explains their 10.1% unemployment rate.

PPS.  I don’t put all this on the Treasury; it’s Congress that forces them to engage in this sort of nonsense.

PPPS.  Speaking of Trump, last May I had commenters earnestly informing me that I should support Trump because he favored low interest rates.  Now Trump is slamming Yellen for her low interest rate policy.  Trump reminds me of that anecdote about 100 monkeys typing away.  Yes, there’s a tiny chance they might randomly type out Hamlet, but I’d put my money on something far worse.  There are many more ways to screw up than there are ways to succeed.

And no, this is not “normal” in politics.  Normal politicians lie and change their views on occasion.  Hillary’s not much worse than average (although she is certainly worse.)  But Trump’s just completely off the charts in terms of policy ignorance and personal dishonesty.  I’ve never seen anything close to this in my life, and I’ve been following politics since the late 1960s.  Nixon might have been closest on the honesty criterion, but of course was far more knowledgeable.  And even Nixon tried to avoid statements that were obvious lies. He was a devious liar.  Trump just doesn’t care.  He’ll look you in the eye and tell you that he opposed the Iraq War.  And the reporter who asked the question will be too cowardly to call him a liar to his face.  I almost hope Trump wins.  We deserve him.

I said “almost”, I’m not quite there yet.  :)

There’s only one AD

Like any single currency area, the eurozone has only one AD.  That’s true despite the fact that it contains 19 countries.  In contrast, China has 4 ADs, for Mainland China, Hong Kong, Macao and Taiwan.  (The Taiwanese constitution says they are part of China, who am I to argue?)

Here is the eurozone unemployment rate:

screen-shot-2016-09-09-at-11-18-11-amThe disastrous policy tightening of 2011 pushed eurozone unemployment up from 10% to 12%.  Then policy eased slightly, and NGDP started growing again. Unemployment fell back to 10%, about the rate of 1999, when the euro was created.

Unemployment is still very high in Greece and Spain, but that fact does not and should not matter to the ECB.  There is only one AD for the eurozone, and it needs to be appropriate for the entire region, not any single country.  By analogy, the unemployment rate in Nevada should have and does have no bearing on Fed policy, which looks at the national unemployment rate.

That doesn’t mean ECB policy is not too tight—after all, they target inflation, not unemployment.  But here again I detect a weird pattern among pundits, to talk almost as if there are two ADs for the eurozone, one for inflation and one for unemployment.  Consider the ECB’s recent action, or should I say non-action:

US and European equities are under pressure as disappointment over the European Central Bank’s decision to stand pat on monetary policy and uncertainty over the Federal Reserve’s interest rate trajectory force up borrowing costs. . . .

Ian Williams, economist at Peel Hunt, said investors appear “rather underwhelmed by the ECB announcement, both the absence of further policy action and the lack of guidance offered by Mr Draghi at his press conference about what may come next”.

Fixed income analysts at Citi said the ECB had introduced volatility by failing to even discuss QE. “The decision not to extend the timetable of QE from Mar-17 weakens forward guidance and is bearish.”

So the ECB tightened monetary policy yesterday—why does that matter?  Here’s why it’s a big deal; roughly 90% of pundits, and even professional economists, don’t seem to have a clue as to what’s going on.  If asked to explain the recent ECB non-action, most would say the ECB is satisfied with the pace of recovery, including the fall in the unemployment rate, and that it expects inflation to rise in the future. They may not agree with that outlook (I don’t think inflation will rise as much as the ECB expects) but that’s why the ECB effectively tightened yesterday, disappointing markets.  So far, so good.

But when the discussion turns to inflation, these same pundits will insist that the ECB is trying and failing to hit its inflation target, and/or they are out of ammo.  In other words, the implicit assumption is that a single monetary policy can target two different ADs, one for inflation and one for employment.  On the employment front, the ECB still does normal monetary policy, tightening when they think the recovery needs no more juice.  But on the inflation front the pundit class insists the ECB is out of ammo.

Of course none of this makes any sense.  Obviously the ECB is not out of ammo, or markets would not have reacted negatively to their recent tightening of policy   So why do so many economists think they are out of ammo for inflation, but not employment?

Maybe they are dumb.

More plausibly, pundits and economists are smart, but excessively deferential to the wizards behind the curtain of our central banks.  People like Yellen, Bernanke, Draghi and Kuroda are deserving of our respect.  They are more qualified than most pundits and most economists, including me.  So if they are falling short on inflation, people assume that it must be because they do not have the tools to hit the inflation target.

What’s wrong with this view?  I think it’s a mistake to judge the competence of central banks by the competence of their leaders.  Central banks are complex and powerful institutions, embedded in even more complex and even more powerful political entities.  Assuming that the performance of the central bank represents the competence of their leaders is a big mistake, even if the leaders voted in favor of the recent policy action.  If the central bank heads had been assigned to the position of dictator of the world, we might be seeing an entirely different set of monetary policies.

PS. The ECB currently forecasts 1.6% inflation by 2018, which is close to its target of slightly below 2%.  I think they are too optimistic.  But excessive optimism and lack of ammo are two entirely different concepts, which most people don’t seem to be able to grasp.

Alternative for America

The German political party “Alternative for Germany” was founded in 2013 by a bunch of professors who thought the euro was a mistake, largely responsible for the depression in southern Europe.  Its other views tended to be fairly mainstream conservative.

Not any more.  In just three short years the AfD has morphed into a xenophobic, nationalist, pro-Russian party with nostalgia for the days when East Germany was run by the communists.  Many of its original supporters have abandoned the party:

It is not clear why the AfD is so popular in [low income, eastern] Mecklenburg. Its hallmark is anti-immigrant rhetoric. But Mecklenburg has just 23,000 refugees, or 1.5% of the population. Foreigners make up 3%, and most are Poles or ethnic Germans from Russia. Muslims are a rare sight. Yet even before the refugee crisis, about one in three locals told pollsters that “because of the many Muslims, I sometimes feel like an alien in my own country”.

Mecklenburg does have a longstanding core of far-right voters: it is the only state where the NPD, a party considered neo-Nazi, has seats in the assembly. But the AfD draws more support from former non-voters and The Left, a party descended from East Germany’s communists. In the West, that may seem illogical. But it matches the gut feelings of many locals. One of the AfD’s themes is Ostalgie, “nostalgia for East Germany”. It nurtures a sense of solidarity against all outsiders, including western Germans and cosmopolitan elites.  Since reunification people in the region have felt they were “overrun by the West”, says Mr Holm.

At campaign events Mr Holm evokes 1989, when Ossis marched in solidarity against the communist regime. Now the enemy is perceived political correctness imposed by Berlin. The tone is invariably pro-Russian and anti-American. Asked how they feel about Russia’s invasion of Crimea, supporters compare it with America’s war in Iraq. “If the Ami does it it’s okay, but if Russia does it, it’s wrong?” asks one.

Actually, yes.  We did not annex Iraq.

To give you an idea of just how bizarre this is, imagine an American analogy:

1.  Suppose that in just a few years, the formerly anti-big government Tea Party was taken over by a nationalist faction that favored a xenophobic, soft on Russia, big government, more spending, vastly bigger deficits, anti-trade, anti-free press candidate who railed against political correctness and elites in general.

2.  And suppose the core supporters of this candidate were not in affluent Republican areas, but rather in poor white areas like West Virginia.  And suppose those poor whites of West Virginia were freaking out about immigration, despite the fact that hardly any immigrants want to live in their poor, backward state.

I know, I know, it could never happen here.  But then 3 years ago I would have said there wasn’t one chance in a million that the AfD would suddenly change into a party with nostalgia for East Germany.

Lesson: As I keep saying, it’s not about who wins and loses elections, it’s about the nature of the parties, and how they change over time.  FDR and LBJ made the GOP more moderate (for a while).  Reagan and Thatcher made the Dems and Labour more moderate (for a while), and so on.  That’s what matters.

If you make a pact with the devil, and allow your favorite party to be taken over by evil people, and vote for them anyway as the “lesser of evils”, you’ll find out that in the long run you’ve only made the opposition stronger, and you’ve completely discredited your favored ideas, which won’t even be adopted by the usurper who stole your party.  No, your ideas will not be adopted.  But when he or she fails, as he surely will, your ideas will be blamed, and discredited.

The next president will be a failed president, and will be rejected by the voters in 2020.  The election you really want to win is the 2020 election, which will offer the possibility of dramatic policy reform.  What shape do you want your party to be in at that time?  Do you want it to be a discredited party, about to be steamrollered by the opposition?  Or the eager opposition party, about to take charge?

If I were a Republican (I’m not), I’d pray for Hillary to be defending her record in 2020