Archive for February 2013


Apocalypse delayed, once again.

Time for my annual post pointing out that the China bears were wrong once again.  Chinese growth is picking up again, headed for about 8% to 8.5% this year.

The Chinese people tend to make relatively large down-payments on new houses.  As with all markets, mistakes will be made.  But there’s no reason to believe, ex ante, that people sitting in an armchair over in America are better judges of the value of Guangzhou or Wuhan real estate that the Chinese investors themselves. And that will remain true regardless of whether Chinese property prices rise or fall over the next 12 months.

Foreign Policy did a recent survey of opinion of the prospects for China’s growth:

I answered “neither” and “It already has.”  The first answer was the consensus, and the second put me in a distinct minority.  A minority of one to be precise.

What makes me such a China bull?  Why am I such a supporter of their government’s policies?   I’m not bullish, I think China is a pathetically poor country, poorer than Mexico.  I think the government is repressive and inefficient; I don’t support their policies.

Many people have trouble understanding the distinction between levels and rates of change.  China used to be far more repressive and far more inefficient. During its transition to the current policy regime, it grew extremely fast, yet remains poor.  That’s what you’d expect.

It is very difficult to make PPP comparisons, which are highly subjective.  When I travel around China it seems to me that their cost of living is roughly half of US levels.  More than half in the cities and less than half in the countryside.  The Economist magazine recently did PPP comparisons for most major countries, and estimated wealthy Taiwan’s cost of living to be less than one half US levels, but China’s to be much higher than 1/2 US levels.  I find that extremely implausible. But of course the bundle of goods consumed in each place is so vastly different that any comparison will be based on a set of arbitrary assumptions.   If you applied the Taiwan/US price ratio to China, its GDP for 2013 (including Hong Kong) would be nearly $20 trillion, far higher than the $16.3 trillion for the US.  So it’s anyone’s call.  But I believe China has the world’s biggest economy right now. It leads the US in food consumption, energy consumption, exports, construction, manufacturing, and a lot of other categories.

Some day China will have a recession.  And when it does the China bears will insist they were right all along.  And the press will believe them.  But of course they will have been wrong all along.  A prediction of something that is inevitable (eventually), without a date attached, is completely and utterly meaningless.  The China bears will be right if China gets stuck in the “middle-income trap”—which I think is very unlikely.  How many countries with the following characteristics have gotten stuck in the middle income trap?

1.  A relatively homogeneous population, with parts of the country already closing in on high income levels.

2.  Booming exports of IT goods.

3.  A manned space program.

4.  A history of being the most advanced country in many technologies during the Dark Ages.

5.  A relatively high average IQ, FWIW.

6.  A culture that has a reputation for being entrepreneurial and very hard-working, as far back as David Hume.

7.  Surrounded by culturally similar countries that did NOT get stuck in the middle income trap (although N. Korea has yet to leave the low income trap.)

8.  A government that has been driven by pragmatic reformist ideology for nearly 30 years.

9.  A culture with an intense desire to overcome earlier humiliations and become a world leader.

10.  A very high saving culture, even discounting the saving forced by government.

Yes, it MIGHT get stuck, but is that really the most likely long-run equilibrium?

PS. Some China bears question the GDP data.  Obviously that sort of data will be flawed in all sorts of ways.  But consider data on trade, which rose from roughly $500 billion trillion in 2001 to $3.87 trillion in 2012.  Does that seem consistent with a country averaging 10% RGDP growth?  It does to me.  I travel to China fairly often, and it sure looks like a fast growing East Asian economy, even in the interior of the country.  If not, it’s a helluva massive Potemkin village.

PPS.  I’m not saying that I endorse all the arguments on my list of ten Chinese characteristics.  I put them there to cover a wide variety of factors that I’ve seen others discuss.  I happen to think a country can reach developed country levels without a high IQ, for instance.

PPPS.  The answer to my “how many countries” question is none—with Russia coming closest.

In an alternative universe . . .

.  .  .  the GOP won the 2012 Presidential election.

In 2012, if all the 50 states had apportioned their electoral votes as Nebraska and Maine did, Mr Romney would have beaten Mr Obama by 276 to 262 despite having lost the popular vote by nearly four points.

And the Dems are really pissed.

Of course the GOP did win the House, despite getting fewer total votes in House elections.  (And for exactly the same reason; Nebraska and Maine apportion electoral votes by Congressional district.)  They were rejected by voters at all levels, but gerrymandered into a share of power.

NGDP targeting for Japan?

Here’s The Economist:

Mr Shirakawa’s decision [to resign], which caught even his BoJ colleagues by surprise, enables Mr Abe to appoint a new governor on the same day as two deputy governors. BoJ-watchers say there are three names prominently in the frame to replace him, all of whom share Mr Abe’s belief in bold monetary easing. They are Toshiro Mutoh and Kazumasa Iwata, both BoJ deputy governors from 2003 to 2008; and Haruhiko Kuroda, who currently heads the Asian Development Bank and, like Mr Mutoh, is a finance-ministry veteran.

Mr Iwata, 66, is widely considered the most dovish of the three. The head of the Japan Centre for Economic Research (which eschews interviews with journalists unaffiliated to the Nikkei, Japan’s main business paper), he supports big purchases of Japanese and foreign bonds to cheapen the yen and bolster the economy. Such ideas have been floated by Mr Abe.

Mr Kuroda, 68, fulfils different criteria set by the Abe administration: he is experienced at running an international financial institution, speaks good English and is used to globe-trotting. Masaaki Kanno of J.P. Morgan says he sits between Mr Iwata and Mr Mutoh in terms of dovishness.

According to a recent poll in the Nikkei, Mr Mutoh, 69, is the favourite among Japanese market participants (though an earlier nomination was blocked by a hostile upper house of parliament in 2008, when Mr Shirakawa got the job). In an interview with The Economist on February 5th, he called for “out-of-the-box” thinking at the top of an institution that he considers too cautious. He mentioned targeting nominal GDP growth, as well as inflation, in order to minimise the risk of stagflation. But he was dismissive of suggestions that the BoJ directly underwrite government bonds, and was opposed to the buying of foreign bonds to cheapen the yen artificially.

Naturally I favor the least dovish of the three.

Is it OK to lie for pedagogical reasons?

Most of us macro teachers work with some sort of new Keynesian model.  This is roughly the AS/AD model, with an upward sloping SRAS curve.

We teach the model by repeatedly lying to our students.  I’ll give a couple examples:

1.  We argue that the Keynesian model superseded a “classical model” that had a vertical AS curve, and assumed flexible wages and prices.  In fact, no such classical model existed prior to 1975.  Instead, the old Keynesian model replaced something closer to the modern new Keynesian model.  The model of Fisher/Hawtrey/Cassel and many other interwar economists featured sticky prices, short-run non-neutrality of money, and a self-correcting mechanism that brought us back to the natural rate on the long run.  In Fisher’s case there was even a Phillips Curve.

The textbook story is a good pedagogical device.  But it’s not true.  It’s not even close to being true.

2.  We explain that inflation can be produced by fiscal stimulus, supply shocks, and/or monetary stimulus.  Then we talk about the Great Inflation mostly by referring to two shocks.  The first was the huge fiscal stimulus of the 1960s, when LBJ ran up huge deficits to finance the Vietnam War and the Great Society without raising taxes.  Except that this never happened.  Then in the 1970s OPEC jacked up oil prices twice, and this caused the high inflation of the 1970s and early 1980s as the SRAS curve shifted to the left.  Another lie, as SRAS was shifting to the right during the 1970s.  The folly of the oil shock theory was illustrated in the 2000s when oil soared from $20 to $147, and core inflation barely budged.  People were actually surprised by that fact!

If oil shocks are going to raise inflation, they should lower RGDP.  Yet even during the worst of the oil shock period (mid-1973 to mid-1981) RGDP rose by 2.6% per annum.  So the inflation was almost all monetary, even if you generously assume RGDP growth would have been 3.6% in the absence of the oil shocks.  In fact, growth slowed sharply after 1973 for reasons mostly unrelated to oil; the rapid improvement in products like jet airliners and home appliances came to a screeching halt.  We shifted toward a slower growing service economy.  We couldn’t even average 3.6% growth in the 1990s, when oil got cheap and the computer revolution took off.

Are these lies justified?  It’s nice to give students some real world examples of fiscal shocks and supply shocks.  But what if the message they take from this exercise is that monetary explanations of inflation and NGDP determination are “just a theory,” just as evolution or global warming are “just a theory.”  What if the public doesn’t realize that the Fed drives the nominal economy?  Might that lead to less effective public policies?  Might that have contributed in some small way to the fiasco of 2008?

I think our students can handle the truth.  Why don’t we stop lying?”

PS.  If you are wondering why the LBJ story is a lie, recall that the huge budget deficits began under Reagan, and were associated with a big fall in inflation.

What the blogosphere does best

Think of the blogosphere as a sort of improv jazz band, where one blogger riffs off another.  Or a mind meld, where the collective brain is smarter than any individual brain.  Andy Harless started the ball rolling with his usual insightful metaphors:

Machismo is a type of commitment mechanism.

If you’re a perfectly rational nerd, people will always expect you to do the rational thing. You won’t be able to make credible threats unless it would be rational to carry out the threat. And it seldom will be. After all, how often is it really rational to whoop someone’s ass?

On the other hand, if you’re a tough, macho badass, people will always expect you to do the tough, macho badass thing. You’ll always be able to make credible threats, because carrying out threats is always the tough, macho badass thing to do. And since the threats are credible, you mostly won’t have occasion to carry them out.

This principle has a traditional application to monetary policy. If your central banker is a perfectly rational nerd, he’s going to let the inflation rate get too high, because he won’t be able to make a credible threat to cause a recession. Obviously you want a tough, macho badass. You want the kind of central banker that likes to pick up small animals in his talons so that he can crush them to death and serve them for dinner.

And then Cardiff Garcia takes it one step further:

To use the slightly altered terms of Harless, you can have rational nerdery and macho badassery, but you can’t have both.

Or maybe you can?

Yet an ideal monetary policy framework does include both. The rational nerdiness is there to correctly interpret economic conditions and diagnose the correct policy, while the macho badassery is needed to convince the markets and economic agents generally that the Fed will do what is necessary to carry out this solution, ie to influence expectations.

This is difficult so long as embracing the former means giving up the latter.

All of which has been a long windup to saying that the appeal of the Evans Rule, and if we ever get it, some variation of NGDP level targeting, is this: theyinstitutionalise the macho badassery, which in a dual-mandate framework can only be applied to one of the two mandates.

Not so with an Evans Rule or NGDP level targeting, where it can be applied symmetrically “” because in each it is well understood when the “recklessness” towards either unemployment or inflation kicks in, and when it will end. And therefore it ceases to be reckless.

I like that last line.  I’ve always been bothered by Paul Krugman’s “promise to be irresponsible” line.  Not that the comment wasn’t brilliant, in a counterintuitive sort of way.  But rather because it is an obvious turn-off to central bankers—who aren’t typically the Hunter S. Thompson type, if you know what I mean.  Even worse, it’s not even needed.  NGDPLT is the responsible thing to do, and it works.

PS.  Last year I had this to say on the topic:

This provides one more reason why inflation targeting should be abandoned and replaced with NGDPLT.  If inflation targeting can only work at the zero bound if austere conservative central banks promise to behave like drunken teenagers with the keys to their dad’s Porsche, then it can never work.

The post I took that quotation from has interesting quotes from Tim Duy, Matt Yglesias and Daniel Kuehn.

HT:  123