Archive for the Category Switzerland


At least the Treasury doesn’t focus on “intentions”

Here is the Treasury’s list of the three criteria it uses to identify “currency manipulators”:

Pursuant to Section 701 of the Trade Facilitation and Trade Enforcement Act of 2015, this section seeks to identify any major trading partner of the United States that has: (1) a significant bilateral trade surplus with the United States, (2) a material current account surplus, and (3) engaged in persistent one-sided intervention in the foreign exchange market. Section 701 requires data on each major trading partner’s bilateral trade balance with the United States, its current account balance as a percentage of GDP, the three-year change in the current account balance as a percentage of GDP, foreign exchange reserves as a percentage of short-term debt, and foreign exchange reserves as a percentage of GDP. Data for the most recent four-quarter period (January to December 2016, unless otherwise noted) are provided in Table 1 (on p. 13) and Table 2 (below).

This is obviously beyond stupid.  (Since when do bilateral trade deficits mean anything?)  But at least the Treasury doesn’t try to read minds, and interpret the intentions of other countries.

Matthew McOsker sent me an article from the Economist, which nicely illustrates the confusion surrounding the concept of currency manipulation:

Awkwardly for America, two of its friends in Asia have recently scored more highly than China: South Korea and, most clearly, Taiwan. But the highest score of all goes to Switzerland, by dint of its whopping current-account surplus and its hefty foreign-currency purchases. This illustrates one of the method’s flaws: in terms of the goods and services that it can actually buy, the Swiss franc is in fact among the world’s most overvalued currencies.

This is why it’s so important to have a clear definition of currency manipulation.  The Economist clearly thinks the concept is related to undervalued currencies, and most people probably agree.  But whether a currency is “undervalued” is completely unrelated to whether some of the other criteria are met, such as large purchases of foreign exchange and/or a current account surplus.  If you really believe that large purchases of foreign exchange and a big current account surplus constitute currency manipulation, then you should have the courage of your convictions and label Switzerland as one of the world’s worst villains.  After all, it is among the world’s leaders in both categories.

And this leads to another irony.  I frequently point out that the more conservative the central bank, the bigger the balance sheet as a share of GDP. Thus in the future we may end up seeing more and more countries like Switzerland, with huge purchases of foreign assets in a futile attempt to prevent their currency from appreciating.

To avoid being labeled a currency manipulator, they may instead choose to buy domestic assets (as in Japan).  This will also boost domestic saving, depreciate the currency and increase the current account.  But since they won’t be buying “foreign exchange”, they just might fool the US Treasury.  (It’s not hard, when the Treasury is hamstrung by the silly mandate given to it by Congress.)

Here’s another irony.  Some people seem to think that fixed exchange rate regimes are evidence of currency manipulation.  But in the 1990s the EU had a fixed exchange rate system with the express purpose of preventing currency manipulation.  In fact, fixed exchange rate regimes determine the path of the nominal exchange rate.  But if currency manipulation happens at all (I doubt it), then it surely relates to real exchange rates. Thus if currency manipulation happens, it is equally likely to occur with a fixed or floating exchange rate regime.  Indeed you don’t even need your own currency to “manipulate” your real exchange rate.  Germany depreciated its real exchange rate in the 2000s.  If Wisconsin wanted to depreciate its real exchange rate it could do so.

But why would they want to?

Language and unemployment

I like maps.  Randy Olsen recently linked to an interesting map of European unemployment:
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Before seeing this map I knew that Germany had higher lower unemployment than France.  And indeed you see a dramatic change in the unemployment rate right where the two countries meet—at the Rhine.

My assumption has been that the lower German unemployment reflects better labor market regulations. But this graph hints at another difference—language.  Let’s suppose that Germanic language areas have lower unemployment than Romance language areas.  How would we test whether language or government policies are more important?

One approach would be to note that some countries have multiple languages.  Thus southern Belgium and southwestern Switzerland speak Romance languages, and the rest of those countries mostly speak Germanic languages.

Now look at the map.  I see a sharp unemployment divide in Belgium, right on the line between French and Flemish.  And in Switzerland, I see much higher unemployment in French-speaking Geneva, Vaud, and Valais, as well as Italian-speaking Ticino.  Below is a map of Switzerland, so you can see the cantons more clearly.

Screen Shot 2017-05-01 at 9.41.05 PM

I also notice an area of very high unemployment from Greece to southern Italy to Sardinia to southern Spain. So maybe it’s not language, maybe it’s latitude.  Or maybe both language and latitude are proxies for culture.

Before we fall in love with this theory, however, there is just one problem.  As recently as 2005, Germany had about 11% unemployment and was regarded as the “sick man of Europe”.  We should be suspicious of cultural explanations that apply in one decade, but not the next. Surely culture doesn’t change very much in 12 years!

In the end, I’m included to think, “it’s complicated”.  There are probably lots of factors that are playing a role here.  Southern Belgium was once richer than northern Belgium, but today it’s more of a rust belt, as its old heavy industry is less competitive than the newer firms in the Flemish areas to the north.  Perhaps there are similar explanations for Switzerland. Perhaps culture and government policy interact—thus people in the far south of Europe have a culture that leads to political outcomes associated with excessive labor market rigidity.

So no easy answers, but the map is certainly food for thought.

PS.  Unemployment is related to wealth, and indeed probably more closely related than in earlier decades.  But the correlation is still far from perfect.  Northern Italy does better on wealth than employment (check out my “rich heart of Europe” post.)  For instance, Lombardy has more unemployment than northern England, despite being richer.  Or compare (rich) Paris with the Czech Republic.



Two targets, two tools

An important idea in macroeconomics is that you need at least as many tools as targets.  Over at Econlog, I have a long post discussing Roger Farmer’s views on monetary policy.  Here I’ll do a short post, giving you the Cliff’s Notes version.

In a better world, economists wouldn’t focus on interest rates.  But they do.  So how do we make sure that a change in interest rates has the desired effect?  After, all, higher rates could represent tight money (liquidity effect) or easier money (income and Fisher effects.)  How do we pin it down?

With two tools.  If you want interest rates to rise, you can raise the IOR.  If you want to make sure that this increase reflects the income/Fisher effects, you need to also use one of the following tools:

1.  A huge increase in the quantity of money (old monetarist)

2.  Target a higher commodity price index (1980s supply-side econ)

3.  Target a higher price of foreign exchange–i.e. depreciate your currency.  (Mundellian economics)

4.  Target higher stock prices.  (Roger Farmer)

5.  Target a higher NGDP futures price (market monetarist)

In each case, you use a “whatever it takes” approach to open market operations, to get your second policy tool moving in an unambiguously expansionary direction.

Recently, the Swiss did this in reverse.  In January 2015 they lowered interest rates and simultaneously appreciated the Swiss franc.  This assured that the lower interest rates were contractionary (income/Fisher effect.)  Singapore also uses exchange rates as a policy tool.  The BOJ has dabbled in Farmer’s approach, buying ETFs.  But not enough to make it effective.

PS.  Nick Rowe has a related post on Roger Farmer’s proposal.

Off topic:  In January 2014, I argued that “IndoAsia” would be the next big growth story.  This article says it’s beginning to happen.  And remember that 60 Minutes story about the ghost cities in China?  The ghost neighborhood in Zhengzhou that they highlighted seems to be doing fine:

Home prices in at least one district in Zhengzhou, which became a symbol of China’s property excesses because of rows of empty housing developments, have risen two-thirds this year to 25,000 yuan ($3,747.56) per square metre on average, a sales manager told Reuters on a recent visit to the city.

The average new home price in 70 major cities climbed an annual 9.2 percent in August, up from 7.9 percent in July, according to data from China’s National Bureau of Statistics.

After a period of modestly slower growth, the China boom is picking up speed again.  Looks like the naysayers will have to wait a few more years for the most widely predicted crash in history.

It’s hard not to be super optimistic about the world right now.  Asia is booming, and most people are Asians.

The Swiss dodge two bullets

Back in January 2015, the SNB foolishly allowed the SF to suddenly appreciate against the euro (by roughly 14%), after capping its value at 1.2 for about 3 years. Soon after, the SNB realized its mistake, and now the SF is up by only about 8% compared to the period just before the revaluation (the graph shows the inverse of the SF’s value):

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Another lucky break was that the euro weakened in 2015, and so the SF has actually been relatively weak against the dollar over the past year (again, graph shows the inverse of the SF’s value):

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Switzerland fell into mild deflation, although that may have partly reflected falling oil prices:

Screen Shot 2016-06-05 at 10.57.35 AMFortunately, unemployment rose only modestly, as the Swiss economy has always been more flexible than other European economies:

Screen Shot 2016-06-05 at 10.49.10 AM(Sorry, I could not find seasonally adjusted data, but you can see the mild upswing in unemployment.)

The other bullet dodged was a proposed Universal Basic Income, of roughly $30,000/year for each adult, and about $8000/year for each child. That is, about $76,000/year for a family of four.  There may come a time when a UBI is appropriate, but this proposal was way too soon, and way too generous.  It was rejected overwhelmingly:

Projections by the GFS polling outfit for Swiss broadcaster SRF showed nearly four out of five voters opposed the bold social experiment launched by Basel cafe owner Daniel Haeni and allies in a vote under the Swiss system of direct democracy.

Fed policy options

The Fed has three primary ways to impact NGDP:

1.  Change the supply of base money–primarily through open market purchases (OMPs), or sales.

2.  Change the demand for base money through adjustments in interest on reserves (IOR)

3.  Change the demand for base money through adjustments in the Fed’s target (inflation, NGDP, etc.), or making it more credible though actions such as level targeting, or currency depreciation in the forex market.

Most pundits think and talk in terms of binaries, and thus underestimate the policy options available to the Fed.  Thus a pundit might say we need to ban currency and break the zero bound, because OMPs are ineffective at the zero bound—forgetting the option of impacting base money demand by adjusting the policy target.

For each of the three options, it’s useful to treat one as a given, and think about the other options in a two dimensional space.  Thus if we have a given policy target, say a 4% NGDP target path, then the Fed has two tools to get there, OMPs and adjustments in IOR.  Then you can think about how much weight the Fed should put on each tool, by considering other objectives, such as size of the balance sheet.  For any given NGDP target, the higher the IOR the larger the balance sheet, and vice versa.  If the Fed wants banks to hold lots of liquidity, they might opt for a higher IOR.  If they are worried that they’ll need to do a lot of QE to hit their target, and that this QE will be politically unpopular, they’ll go for negative IOR.  (That’s where the ECB is right now.)

But we don’t have to think of the policy target as a given.  Japan recently raised their inflation target from 0% to 1%, and then later to 2%.

Or we could assume that for some reason IOR is fixed at zero, as it was during the Fed’s first 95 years. Then the trade-off would be between steepness of target path and size of balance sheet.  The faster the desired rate of NGDP growth, the smaller the ratio of base money to GDP, and hence the smaller the central bank balance sheet.  Australia chose a high target path, and got a very small RBA balance sheet as a result.

And finally, the balance sheet itself might be a key objective.  For instance, the Swiss National Bank recently became concerned about their ballooning balance sheet.  Suppose central banks are averse to a large balance sheet.  In that case the target path and IOR become the two policy options.  The Swiss could opt for a higher rate of inflation, or they could opt for a lower rate of IOR.  In fact, they’ve opted for negative 0.75% IOR, an especially low rate.  In my view they should have changed the (effective) inflation target, by not revaluing last year.

Even within a category such as OMPs, there are several possible options.  Thus the central bank could buy Treasury bonds, or they could buy a riskier asset.  Generally speaking, the riskier the asset the more “bang for the buck”, but not as much more as you might imagine (in my view.)  Monetary policy primarily works by impacting the liability side of the Fed’s balance sheet; the asset purchases are not very important.  However when we are at the zero bound, or when the market rate equals the interest rate on reserves, it’s quite possible that the asset side becomes relatively more important.  It’s hard to say how much more, because policy at the zero bound is especially sensitive to expectations of future policy.  But if we hold the NGDP target path constant, then the specific type of assets being purchased might make some difference.

Here’s a question from Eliezer Yudkowsky:

Should market monetarists be pushing heavily to have the Fed be buying higher-priced bonds, foreign assets, or non-volatile shortable equities, instead of US Treasuries?

It seems to me intuitively that buying Treasuries with money might itself be a wobbly steering wheel, because as the Treasuries have lower yields and especially as you foolishly start to pay interest on reserves, you’re substituting two very similar assets. As the two assets get *very* similar you might be approaching a division-by-zero scenario where it takes unreasonably large amounts of money creation to change anything. And yes, there’s still an amount of money that’s enough. But maybe you would literally have to run out of short-term Treasuries to buy. Maybe you’d need to print far less money if you were buying a basket of low-volatility stocks or something. So maybe this is one of the things that market monetarists should push for, for the same reason we push for not using interest rate targeting because the meaning of the asset keeps changing? Like, if we try to create money and exchange it for Treasuries, does the meaning of that act change and diminish even as the Treasury yields get closer to zero.

If printing more of the unit of account or unit of exchange is supposed to have a mode of action that doesn’t interact with the similarity of that currency to the Treasuries that it’s replacing, then I confess that this is something I still don’t understand myself and definitely couldn’t explain to anyone else. It might need to be explained to me with some kind of concrete metaphor involving apples being traded for oranges in a village that prices everything by apples, or something. Right now, the only part I understand is the notion that people have a price/demand function for things-like-currency, which implies that if a Treasury has become a thing-like-currency, creating currency and removing Treasuries will be a wash in terms of the demand function.

I think this question needs to be broken down into pieces.  First, are we happy with the policy target?  In my view the ECB and BOJ should not be happy with their policy target, as it leads to such low NGDP growth expectations that they are forced into unpleasant decisions on IOR and/or QE.  They’d be better off with another target, say level targeting of prices, which would lead to faster expected NGDP growth and less need to do negative IOR or QE.

But let’s say the target is carved in stone, then what are the options?

I prefer starting with buying Treasuries, even if it is less effective than other assets. Recall that seignorage is basically just a form of tax revenue, which ultimately goes to the Treasury.  Unless you specifically want to build sovereign wealth fund, it’s not clear why you’d want the Fed to buy stocks.  And if you do want to build a sovereign wealth fund, it seems like it should be the Treasury’s decision.  In other words, the Treasury could borrow a trillion dollars and use it to buy index stock funds. Then the Fed would have lots more T-debt to buy.  This combined operation has the same ultimate effect as Eliezer’s proposal, but the lines of authority are clearer.

The next question is how much T-debt should the central bank buy?  I don’t really know.  I’d probably ask the Treasury how much they’d like to leave in circulation to give liquidity to the markets (which might be $5 trillion), and then stop at that red line.  At that point I’d have the Fed buy other assets, such as Treasury-backed GSE debt (i.e. MBSs), foreign bonds, AAA corporate debt, etc.  I suppose at some point you might end up buying stock, but I can’t really envision that happening.  On the other hand, a decade ago I couldn’t envision where we are right now—-6 1/2 years of nearly 4% NGDP growth and interest rates at 0.5%.  So who knows?

To summarize, I have several objections to the Fed buying stocks right now:

1.  I doubt it provides much more bang for the buck, as it’s the liability side of the Fed’s balance sheet that really matters.

2.  Even if they do need to buy more Treasury debt (relative to stocks), buying that debt is not costly, indeed the Fed usually makes a profit.

3.  Any decision to build a sovereign wealth fund should be made democratically, i.e. by the Treasury.

I could add other objections, such as that it’s “socialism”.  However I’m actually not all that worried about the Fed meddling in the management of companies.  But lots of other people would be.

Eliezer’s right that base money and T-debt are much closer substitutes at the zero bound, but I don’t see that as a problem.  So do more!

I prefer to work back from the target.  What percentage of GDP does the public want to hold in the form of base money, if the central bank is expected to hit its target?  Right now people are confusing two issues, a desire to hold base money because rates are low, and a desire to hold base money because the central bank is not expected to hit its target (as in Japan and the eurozone).  If credibility is the problem, then you need a mechanism to restore credibility.  I like my “whatever it takes” approach and/or level targeting, but other options are available.  Thus small countries like Switzerland can simply devalue their currency.

Until we get clear thinking from the central banks about the three policy levers discussed above, it’s hard to give good policy advice.  For instance, if the ECB actually has big problems hitting its inflation target at the zero bound, then the asymmetry built into their target is obviously exactly backward.  In a world where the zero bound is a big problem, the target should be “close to but not below 2%”. Right now, they have a policy target that conflicts with their operating procedure. The target reflects the assumption that it is high inflation that is difficult to control. And yet exactly the opposite seems to be true.

Then central banks need to think clearly about the inflation rate/size of balance sheet trade-off (at each IOR).  They don’t seem to know whether they are more averse to higher inflation or to a very big balance sheet, and hence end up in the worst of both worlds—missing the inflation target and thus getting an even bigger balance sheet.  Of course the lack of clear thinking might actually reflect very clear thinking by each member of the ECB, but no agreement on which of those clear paths is best.  But I think it’s worse than that, you have central bankers saying we need to raise rates so that we can cut them in the future, an EC101-type error.  So I’m not willing to give them the benefit of the doubt.

I don’t think Eliezer will be happy with this post–it’s too long to be an “elevator pitch”