Archive for December 2011


The news that really matters

Like many other bloggers I am focused on the US, and to a lesser extent Europe.  But of course the most important economic and political issues lie elsewhere.  Here’s a few interesting stories from China:

1.  All hail Wukan villagers:

A Chinese village protest that tested the ruling Communist Party for over a week ended on Wednesday after officials offered concessions over seized farmland and the death of a village leader, in a rare spectacle of the government backing down to mobilised citizens.

Residents of Wukan, in southern Guangdong province, had fended off police with barricades and held protests over the death in police custody of activist Xue Jinbo, whose family rejects the government’s position that he died of natural causes, and against the seizure of farmland for development.

But after talks with officials, village representatives told residents to pull down protest banners and go back to their normal lives — provided the government keeps to its word.

“Because this matter has been achieved, we won’t persist in making noise,” village organiser, Yang Semao, told an assembly hall of village representatives and reporters, referring to the protests. He said protest banners would be taken down.

This actually seems like a big deal to me, I’m not sure why more people aren’t talking about it.  Here’s more:

Chinese officials sometimes make low-key concessions to local protests, especially after they are over, and also punish protest organisers. But Wukan turned negotiations into a rare public spectacle, watched by foreign reporters and discussed within China — despite domestic censorship of news.

.  .  .

Wang Yang, the Communist Party chief of Guangdong, obliquely acknowledged that the villagers had cause to complain, in comments published on Wednesday in the Southern Daily, the official province newspaper.

“This is the outcome of conflicts that accumulated over a long time in the course of economic and social development,” said Wang, seen by many analysts as nursing hopes of a spot in China’s next central leadership.

Guangdong is a prosperous part of China. But the upheavals of urbanisation and industrialisation have fanned discontent among increasingly assertive citizens, who often blame local officials for corruption and abuses.

Poverty and political repression are highly correlated.  And Guangdong province is getting richer and better educated at a rapid rate.  In about 20 years we’ll all wake up and find the old China is gone.

2.  But there are other problems on the horizon:

Rapid ageing, a lack of children and a sustained low birth rate herald changes in the structure of China’s population, and the real dangers will emerge further down the line. Guo Zhigang believes the existing population structure will mean a rapidly and severely ageing population in the first half of this century, and then a sharp drop in population in the second half.

Many demographers, both inside and outside of China, agree: getting the TFR wrong will result in misjudgements about ageing and labour supply and, ultimately, a family planning policy that is out of step with reality and storing up problems for the future. A report in British magazine The Economist asserts that China will face major population challenges in the future, while India and the Middle East will reap the benefits of their moderate birth rates.

Too few people in China!

3.  Everyone knows about the gender imbalance, but I was unaware of this angle:

The shortage of girls could lead to a warped reversal of the imbalance. Shang-Jin Wei, a Columbia University economist, says that China’s ballooning savings rate, unparalleled in the world, could be a result of families’ pressure to accumulate cash to attract wives for their sons. “If you’re a dirt-poor peasant somewhere,” Edlund says, “maybe your optimal choice would be a daughter, who can get married.” This trend could create a new marriage economy, she says, encouraging lower-class parents to sex-select for daughters while the wealthy continue to have sons. Relegated to the underclass, women’s growing financial value could prime them for exploitation by their impoverished parents who could sell them to wealthier families for ever-increasing bride prices. South Korea has been credited with eliminating its widespread gender imbalance in the 1990s, but it is actually an example of this exact scenario””the rich choosing sons and the poor choosing daughters, Edlund says. “They have not been able to eliminate sex selection.”

The entire article is interesting, particularly the part about the Vietnamese bride.

4.  Nicholas Kristof reports:

A child in Shanghai is expected to live 82 years. In the United States, the figure is not quite 79 years. (For all of China, including rural areas, life expectancy is lower, 73 years “” but rising steadily.)

Of course Shanghai’s air is extremely polluted.  I do understand that this data only covers residents, not migrant workers, but it still seems impressive.  It puts Shanghai in a tie with the countries that have the longest life expectancy on Earth; Japan, Singapore, Australia and Italy, all much richer than Shanghai.  But the pollution is what I really wonder about:

a.  Perhaps the data is wrong.

b.  Perhaps it’s correct but horrific pollution doesn’t affect life expectancy.

c.  Perhaps it’s correct and pollution does affect life expectancy.  But with cleaner air the Shanghaiese would live considerably longer than even the Japanese.  Maybe because they are richer and better educated than the average Chinese person.  Selection bias.

The first choice is the easy way out, but I suspect the third answer might be correct.

5.  Despite the current economic slowdown, long term I’m still bullish on China.  Here’s a golden bull placed in the lobby of the 1100 foot tall “Farmer’s Apartment” built by a wealthy rural village in Jiangsu province:

The link has more pictures of the building, which I briefly discussed when it was under construction.

Also check out this link of Tianjin, where an entire commercial district is under construction.  Note that in the bottom picture every single building is under construction.  And many more (even taller) are on the way.  And if that’s not enough, scroll the bottom bar to the right and see there’s even more across the river.  And this is all far for downtown Tianjin.  That’s one third of Manhattan’s entire office space–in a Tianjin suburb.  Ten years ago there was discussion of “overbuilding” in Chinese cities like Shanghai.  Those predictions weren’t just wrong, they were laughably wrong, as the construction was trivial compared to what’s going on now (and compared to the office space that’s been fully absorbed since 2001.)  But this time I think the critics will be right–I suspect Tianjin is overbuilding on a massive scale.

6.  The US payroll tax cut extended 2 months?  Read about the Vietnamese bride and then tell my why I should care.

Cochrane needs to review Hume, Fisher, and Friedman

John Cochrane has lots of sensible things to say about the euro-crisis, but his analysis is marred by a serious error:

A currency is simply a unit of value, as meters are units of length. If the Greeks had skimped on the olive oil in a liter bottle, that wouldn’t threaten the

metric system.

Bailouts are the real threat to the euro. The European Central Bank has been buying Greek, Italian, Portuguese and Spanish debt. It has been lending money to banks that, in turn, buy the debt. There is strong pressure for the ECB to buy or guarantee more. When the debt finally defaults, either the rest of Europe will have to raise trillions of euros in fresh taxes to replenish the central bank, or the euro will inflate away.

Leaving the euro would also be a disaster for Greece, Italy and the others. Reverting to national currencies in a debt crisis means expropriating savings, commerce-destroying capital controls, spiraling inflation and growth-killing isolation. And getting out won’t help these countries avoid default, because their debt promises euros, not drachmas or lira.

Perils of Devaluation

Defenders think that devaluing would fool workers into a bout of “competitiveness,” as if people wouldn’t realize they were being paid in Monopoly money. If devaluing the currency made countries competitive, Zimbabwe would be the richest country on Earth.

Hume, Fisher, and Friedman would have approved of the measuring stick analogy.  But they also understood that money is non-neutral in the short run.

In Zimbabwe the government destroyed the supply-side of the economy and then printed money to paper over the problem.  Of course their RGDP fell.  I could offer the following examples in reply:

1.  The big Argentine devaluation of 2002 turned a depression into 8% a year RGDP growth.

2.  The big US devaluation of 1933 turned a depression into 8% a year RGDP growth.

Cochrane could argue that there must have been “real” factors at work, but unfortunately in both Argentina and America all the real factors were government policies he (rightly) loathes.  Both countries grew rapidly in response to currency devaluation despite counterproductive statist policies.  And those two examples are at least as relevant (or irrelevant) as Zimbabwe.  Greece has both real and nominal problems, and thus is totally unlike Zimbabwe.

We know that when countries are severely depressed due to a fall in NGDP, a sharp currency devaluation most certainly will boost competitiveness.  That doesn’t mean that Greece doesn’t have all sorts of other problems, but Greek wages would not immediately double if they exchanged two drachmas for each euro.

I’m increasingly frustrated with the tendency of modern Chicago economists to treat Friedman as a hero, and then gloss over the fact that his greatest achievement was showing that recessions and depressions are caused by nominal shocks.

On all the microeconomic issues Cochrane is right, but on the euro he couldn’t be more wrong:

The euro, like the meter, is a great idea. Throwing it away would be a real and needless tragedy.

Fisher said the dollar was like a measuring stick with a length that was always changing.  He opposed fixed exchange rates (i.e. the gold standard) because he wanted the central bank to keep the “length” stable.  Greece can’t do that if it’s tied to Germany.  Friedman understood this problem as well, which is why he predicted the euro would end badly.  He was right.

Cochrane should have called for the ECB to make sure nominal growth doesn’t plunge next year.  If they want to make the euro work (and it seems they do) then the least the ECB can do is provide enough NGDP growth so that the structural problems in countries like Greece are not compounded by disequilibrium in the labor market.  [The original version omitted “not” before compounded.]

And I sure wish Chicago would go back to teaching its students the lessons of Hume, Fisher, and Friedman.

HT:  Tyler Cowen

Update: Ramesh Ponnuru has an excellent critique of a piece in The American Conservative that is critical of NGDP targeting.

Is there an upper bound on long term interest rates?

No, the central bank can raise inflation and interest rates as high as it likes.  But people who worry about central bank ineffectiveness seem to have something else in mind.  Here’s Izabella Kaminska:

And yet despite all that additional supply, longer-dated bond yields remained suppressed “” fueling Greenspan’s famous conundrum. Many theories have been proposed as to why that happened, though in our opinion Ben Bernanke’s “savings glut” explanation is one of the most compelling “” especially when tied to China’s rampant (currency-depreciation linked) Treasury purchases at the time.

Given what we’ve all come to know about outright bond purchases by central banks, one can safely conclude that these moves injected liquidity directly into the US system, suppressing yields. In fact, one might even say, it was a type of stealth QE operation by the Chinese (and the Japanese), focused on stimulating American demand for their own export-led economies. The side-effect “” the accumulation of all those Treasuries “” however, also presented these central banks with the ability to challenge the Fed’s monopoly power over the Treasury market and to quasi dictate rates themselves.

In one respect, the Fed was desperately trying to raise rates “” while Asian asset purchases were continually undermining those attempts. The Fed had control over the front end of the yield curve, but China (and other Treasury-consuming nations) were increasingly dictating the yields at the back of the curve.

Coupled with demand from western pension funds and asset managers, there was simply not enough safe US Treasury assets to go round. The more the Fed tried to raise rates, the more the yield curve inverted.

This is an interesting example of what happens when people confuse money and credit, more specifically easy money and easy credit.  The two concepts are actually unrelated, but are often confused.

The Fed can always raise short term rates.  It’s true that this doesn’t always result in higher long term rates.  But that’s not a sign that monetary policy is ineffective, rather exactly the reverse.  The Fed raises short term rates to keep inflation down close to 2%.  If long term rates don’t budge very much, that’s a sign that monetary policy is credible.  In the 1960s and 1970s both long and short rates tended to rise together, hence increases in short rates weren’t enough to get ahead of the curve.  Real rates didn’t rise, as the Fed wasn’t following the Taylor Principle.  Because the “tight money” policies weren’t credible, inflation expectations rose.  The final sentence of the quotation is quite revealing.  An inverted yield curve doesn’t indicate failure, rather it’s exactly what the Fed wants to occur when it tightens money, it wants to reduce expectations of NGDP growth, and an inverted yield curve indicates it did just that.

The comments on China and Japan are also peculiar.  Kaminska is claiming that increased government saving is expansionary for aggregate demand.  I actually find that a refreshing change from the ordinary Keynesian argument that more saving (from the public or government) is contractionary.  Both views are wrong, monetary policy determines the path of NGDP, not saving.  Yes, saving can reduce velocity, but that would only reduce AD if the Fed had a money supply rule.  Under any sort of modern inflation targeting or Taylor Rule the Fed offsets declines in V with more M.  So saving is not contractionary.  But it’s also not expansionary.  Kaminska should have said that government saving boosts exports, not that it boosts demand in export-led economies.  For every extra dollar of exports, there is one less dollar of domestic expenditure (mostly less consumption in the case of China.)

And there was no “stealth QE” for the US economy, as we weren’t at the zero rate bound back then.  Almost everyone agrees that the Fed drives NGDP in normal times, when interest rates are above zero.  Credit is one thing, money is another.  Yet for some reason lots of very smart people get them confused.  (Although Milton Friedman never did–recall he said that ultra-low interest rates are usually a sign that money has been tight.)

Part of the problem is terminology.  We throw around terms like “spending” in very vague and misleading ways.  Some people mean consumption, others mean a reduction in money demand.  Again, the two concepts are completely unrelated.  We need more spending in the sense of less money hoarding, and we (in America) need less spending in the sense that we need more saving.

HT:  Tyler Cowen

PS.   The saving conundrum did not cause any problems with Fed policy during the housing boom—they were able to produce roughly the sort of growth in NGDP that they wanted.  If they thought it was too high, they would have raised short term rates even higher.

PPS.  If you disagree with my comment about Asian government saving and AD, check out the growth in Japanese NGDP since 1993—it’s zero.

Next stop, Stockholm?

Back in August just about everyone was pessimistic about the economy, including me.  I’m still pessimistic, but markedly less so than a few months ago.  Recent numbers from both the asset markets and the real economy point to slightly faster than expected growth going forward.  For instance, weekly unemployment claims have recently fallen quite sharply, which suggests that the recent drop in the unemployment rate may not be a fluke.  Of course we need to keep in mind that this “recovery” has already gone through several phases that proved quite misleading.  But let’s say it’s true that growth is picking up; what could account for this?

My hunch is that I misjudged the Fed move back in August, when they promised low interest rates for the next two years.  That seemed pointless without making the promise condition on some sort of nominal growth target (GDP or inflation.)

Now there are indications that the Fed may do just that at the January meeting.  At that meeting the FOMC is likely to be considerably more “dovish” than the current FOMC (where three of the four floating seats are filled by hawks.)  Bernanke probably thinks it’s a good time to go on record with future policy intentions, and will be able to reassure markets that the Fed won’t make the same mistake as the BOJ and ECB made.  Recall that those two institutions twice tightened prematurely, and then soon after had to do humiliating about faces and cut rates again.  Central banks don’t like doing that, which shows just how bad the tightening errors were.  (The BOJ did this in 2000 and 2006, the ECB in 2008 and 2011.)

If the press chatter is correct, Bernanke will promise to avoid the mistakes of the BOJ and ECB, he’ll promise to keep rates low as long as it takes to get a decent recovery (by his criterion, not mine.)  This will be done by combining interest rate and economic forecasts, which will allow readers to discern implied policy feedback rules.  At least that’s what I think is going on.

If I’m right, and if it works, then Michael Woodford and Lars Svensson might come out of this as heroes, not we market monetarists.

But this policy will still be too little too late.  I still say they should promise to buy securities until they expect NGDP growth of 6% to 7% over the next few years, and something like 4.5% thereafter.  That won’t happen.  But if I’m not mistaken, even this policy will help somewhat.  More than I thought back in August, when the promise seemed too vague to have any impact. I misjudged the fact that there probably always was an implied conditionality in the interest rate promise.

Of course if the eurozone blows up . . .

[BTW, the title of this post refers to the Swedish Riksbank, which has been doing this sort of signaling for years.]

It’s interesting that it took me so many months to have second thoughts about my negative verdict on the policy last August.  Equity investors seemed to need only about 30 minutes to figure this out (after the 2:15 announcement.)

BTW, if they make the path of the fed funds rate conditional on demand, then there will no longer be any doubt about whether monetary policy is at least partly offsetting fiscal policy.

PS.  And kudos to Karl Smith, one of the few people that didn’t seem pessimistic a few months ago.  BTW, here’s a good Karl Smith post on this general topic.

We all know how it developed.

Matt Yglesias has a post describing how Hjalmar Schacht cleaned up after not one but two monetary policy disasters:

I was reading recently in Hjalmar Schacht’s biography Confessions of the Old Wizard (thanks to Brad DeLong for getting me a copy) and part of what’s so incredible about it are that Schacht’s two great achievements””the Weimar-era whipping of hyperinflation and the Nazi-era whipping of deflation””were both so easy. The both involved, in essence, simply deciding that the central bank actually wanted to solve the problem.

.   .   .

The institutional and psychological problem here turns out to be really severe. If the Federal Reserve Open Market Committee were to take strong action at its next meeting and put the United States on a path to rapid catch-up growth, all that would do is serve to vindicate the position of the Fed’s critics that it’s been screwing up for years now. Rather than looking like geniuses for solving the problem, they would look like idiots for having let it fester so long. By contrast, if you were to appoint an entirely new team then their reputational incentives would point in the direction of fixing the problem as soon as possible.

This reminded me 1936-37, when the Fed made the mistake of doubling reserve requirements.  Late in the year the economy slumped badly, and it was clear that the decision had been a mistake.  At the November FOMC meeting they discussed the possibility of reversing the decision:

“We all know how it developed. There was a feeling last spring that things were going pretty fast … we had about six months of incipient boom conditions with rapid rise of prices, price and wage spirals and forward buying and you will recall that last spring there were dangers of a run-away situation which would bring the recovery prematurely to a close. We all felt, as a result of that, that some recession was desirable … We have had continued ease of money all through the depression. We have never had a recovery like that. It follows from that that we can’t count upon a policy of monetary ease as a major corrective. …  In response to an inquiry by Mr. Davis as to how the increase in reserve requirements has been in the picture, Mr. Williams stated that it was not the cause but rather the occasion for the change. … It is a coincidence in time. … If action is taken now it will be rationalized that, in the event of recovery, the action was what was needed and the System was the cause of the downturn. It makes a bad record and confused thinking. I am convinced that the thing is primarily non-monetary and I would like to see it through on that ground. There is no good reason now for a major depression and that being the case there is a good chance of a non-monetary program working out and I would rather not muddy the record with action that might be misinterpreted. (FOMC Meeting, November 29, 1937. Transcript of notes taken on the statement by Mr. Williams.)”

This is one of the most chilling statements I have ever read.  The opening sentence is the sort of thing juvenile delinquents say to each other when their prank has gone horribly awry, and they are nervously working on a joint alibi.  An incredible effort at denial runs all through the piece.  First he admits that they raised reserve requirements because “some recession was desirable.”  Then he claims it was just a “coincidence in time” that the downturn followed the reserve requirement increase, even though the express purpose of the increase was to cause a “recession.”  Then he claims that if they reverse their decision it will look like the previous decision had caused the recession.  Then he said that a depression can’t be happening, because there is no good reason for a depression.  Well it was happening, unemployment rose to almost 20% in 1938.  In the end, they decided to stick with the high reserve requirements throughout the rest of 1937.  Reading that quotation one can almost see the perspiration on Mr. Williams’ forehead.

In a recent comment section a Fed employee named Claudia Sahm took me to task for some intemperate remarks I made about the Fed.  I think her criticism was valid.  I should not throw around terms like “criminally negligent.”  I don’t doubt that the vast majority of Fed employees are well-meaning.  Maybe all of them are.  But Matt’s piece reminds me that human psychology is very complex.  We often don’t know why we do things.  Why am I blogging?  Is it the valiant crusade I’d like to believe I’m engaged in, or am I just fooling myself?   (As Robin Hanson would presumably argue.)  Suppose Ben Bernanke had been at Princeton for the past 5 years.  Now suddenly the Fed chairman is “promoted” to Secretary of the Treasury, and replaced with Bernanke.  (As G. William Miller was replaced mid-term with Volcker.)  What would happen next?  My guess is that Bernanke would immediately set out implementing some of the bold policies that he recommended the Japanese adopt back in 2003.

In 2008 the Fed did what the consensus of economists thought they should be doing.  If we could go back in time to the meeting right after Lehman failed, most economists would now say the Fed should slash interest rates sharply (they actually left them unchanged.)  If John Taylor is appointed Fed chairman in 2014, and if aggregate demand is still quite depressed, I very much doubt he’d adopt the tightening of monetary policy that many on the right are now calling for.

Update: Speaking of Robin Hanson, his new post relates to his very issue.  And I also enjoyed this recent post:

For example, to impose punishments bigger than lifetime exile, beat them a bit first.

Some worry about variation in how much people dislike exile. But there is also variation in how much people dislike fines, prison, torture, and public humiliation. The best way to reduce punishment variation is probably to bundle together many kinds of punishment. Maybe fine them some, beat them a little, humiliate them a bit, and then exile them for a while.

In 2006 the US spent $69 billion on corrections, and 2.3 million adults were incarcerated at year-end 2009. A state prisoner cost an average of $24,000 per year in 2005 (source). Why waste all that money?!

Not so much the ideas, but the way they are expressed.  Only an economist can write like that!