Archive for November 2014


America as #3

Ever since I started blogging in 2009, I’ve been predicting that China would become the world’s largest economy, and much faster than most people expected.  If you’ve been reading the news, you know that it has already happened.  But I also made a more outlandish claim, that India’s economy would soon be as large as Japan’s (a country with exactly 1/10th India’s population), and that in 100 years India would have the world’s largest economy.  Later I moved that auspicious date up to 2081.

Unfortunately India hit a wall right after I made those predictions, and its growth rate slowed.  The reform process stalled.  The Sumner jinx.  So am I scaling back my forecasts?  Not at all.  The Economist has come out with its GDP forecasts for 2o15, and it says India’s economy will be almost 60% larger than Japan’s economy, at nearly $8 trillion (PPP).  My new forecast is that India will surpass the US by the early 2030s, and become #2.  To give you a sense of just how outrageous that forecast is, consider that a few years ago Lester Thurow was forecasting that the US economy would remain larger than China’s for the next 100 years!  Many other forecasters expected China to surpass us eventually, but almost none as soon as I did.  India?  No one even talks about it.

Here are the Economist (PPP) forecasts for 2015:

China $19,584.0 billion (over $20 trillion if you include HK and Macao, and why the hell shouldn’t you?)

USA  $18,365.5 b.

India  $7,899.4 b.

Japan  $4,952.8 b.

Germany $3,844.7 b.

India is forecast to grow at 6.5% next year.  It seems reasonable that India will grow about 4% to 5% faster than the US for the next few decades.  By the early to mid-2030s America will be number three. And that’s something to give thanks for, as it is the only way that billions of Asians can move out of poverty.

BTW, I participated in a recent Cato symposium of economic growth.  And later this afternoon I’ll do a post on growth over at Econlog.

PS.  If any commenter wishes to complain that it’s per capita GDP that matters, then please move to Liechtenstein or Qatar and leave the rest of us alone.  If the US and India both spend 2% of GDP on the military in 2034, we’ll have roughly equal defense budgets.

PPS.  Some of this is due to the IMF and World Bank dramatically redoing their PPP adjustments. Back in 2009 I complained that the PPP adjustments for China were far to small, but there was no objective “truth” of the matter.  On the other hand, Rorty once claimed that when people say something like; “Although my peers believe X is true, I think Y is actually true” it’s an implied prediction that eventually people will come to believe that Y is true.  As far as PPP adjustments for China (and many other Asian nations), that day has arrived.

PPPS.  Unfortunately there still is no objective truth to the question of whether the US or China is the world’s 3rd largest country, geographically speaking.  That question remains shrouded in the Rortian mists of disputed borders.

PPPPS.  The Economist contains other interesting tidbits—next year Indonesia surpasses France and Great Britain in total GDP (PPP).  The distinction between middle and high income continues to blur—where do you put countries like Malaysia ($26,320 per capita) or Chile ($24,310 per capita?) Portugal and Greece are only around $27,000.

PPPPPS  Singapore at $83,340/person?  Even I don’t believe that.  What happened to common sense?  Who makes these estimates?

Neo-Fisherism in a world of multiple policy tools

Nick Rowe has another post criticizing the Neo-Fisherian claim that pegging nominal interest rates at a high level would raise inflation to a higher level.  Nick points out that in a model where interest rates are the central bank’s policy tool, the equilibrium is extremely unstable.

In my view the best way to see the problem with Neo-Fisherism is to first consider the situations where it is correct, and then ask what’s wrong with the actual claims being made.

In an earlier post I discussed the situation where Japan had a long-term trend rate of inflation of zero percent, and the US trend rate was 2%.  The BOJ wanted to raise their trend rate to 2%, at least in the long run.  How would a Neo-Fisherite do this?

One easy way is to simply peg the yen to the dollar.  Because PPP tends to hold in the ultra-long run (many decades), Japanese inflation would be expected to rise to 2% on average, although year-to-year changes might be rather erratic.  And because interest parity holds very well, even in the short run, Japanese interest rates would immediately rise to US levels.  BTW, to do this thought experiment right, you’d want to assume it was done in 2016, by which time US short-term rates will be higher than Japanese short-term rates.  You’d like Japanese interest rates to rise immediately.

Of course an immediate rise in short-term Japanese interest rates resulting from a change in monetary policy might be contractionary.  But the BOJ has multiple policy tools, and any contractionary impact can be offset by a suitable one-time depreciation in the yen, before it is permanently pegged to the dollar.  And BTW, if Japan wants 5% inflation they simply need to have a crawling peg, with the yen falling 3%/year against the dollar.

Can this work in a closed economy model, or is it simply a beggar-thy neighbor policy?  Yes, it can work in a closed economy model.  Instead of pegging the yen to the dollar, do a policy of pegging it to gold (or a basket of commodities), and then depreciating the currency by 2% per year against gold (or that basket.)  Now that would be a policy deserving of the name “Neo-Fisherian!”

Ironically, the basic problem with Neo-Fisherism is that it’s way too Keynesian.  The entire discussion is done using Keynesian assumptions—that control of interest rates is what we mean by “monetary policy.”  So when they talk about raising the interest rate peg to a higher level, people naturally assume that this is to be done in the way that Keynesians would raise interest rates, via tighter money.  But tighter money won’t raise the rate of inflation—hence the ridicule.  In fact, Neo-Fisherism is perfectly fine if they’d spell out that they plan to raise interest rates via easier money, as with an exchange rate peg, or a crawling commodity price peg.  Interest rates are only one of many possible policy tools, and in some ways the worst tool because the short-term effect of changes in M on interest rates is often the exact opposite of the long-term effect.  That’s what leads to the instability (or “fragility”) problem identified by Nick.

PS.  Switzerland adopted the policy discussed above just a few years back (depreciate the franc and then peg it to the euro at 1.2.)

That’s outrageous!

I’ve read both sides of the debate over the recent actions by Obama on illegal immigration.  And I can’t decide who’s right.  Was it a completely lawful decision by an executive exercising prosecutorial discretion, or an outrageous overreach by an executive who essentially re-wrote the law on immigration?

And that’s exactly the problem.  It ought to be possible to tell whether an outrageous abuse of power has occurred.  But our system of government in America is based on a hopelessly vague document called the Constitution, which does not clearly spell out who has the power to do what. If we had a parliamentary system like Britain, it would be immediately apparent whether an abuse of power had occurred.

On immigration it is the right complaining of an outrageous abuse of power.  But it is pundits on the left who worry that the Supreme Court may rule that the ACA does not allow for the federal government to provide insurance subsidies via federal insurance exchanges.  Paul Krugman is already warning that a ruling along those lines would be an outrageous abuse of power. There sure is a lot of abuse of power going around! And once again, this problem would not occur under a parliamentary government.  They would respond to any court ruling by simply fixing the language of the law.

As an aside, the immigration decision is a win from the utilitarian perspective.  What I don’t see discussed very much is that it is also a win for libertarianism.  It will create a small libertopia of about 5 million people right within the US.  These people will be terrified of stealing things, for fear of deportation.  But they will have little to fear if they don’t violate the property rights of others. They will no longer have to fear the INS—only the groups that all Americans fear (IRS, TSA, NSA, CIA, FBI, local police who need to seize more cash to finance their budgets, and all the other scary groups out there.)  And they will have to work to survive–no relying on welfare benefits.  That’s not a pure libertopia, but it’s pretty close.  In no other time or place did you have legal gay marriage, legal pot, and no welfare.  Not even Holland. And yet (formerly) illegal alien communities in many western states will now face that policy regime.  I wish them good luck.

PS.  Totally off topic, but in another big win for libertarianism, the world’s oldest government monopoly has just collapsed:

Starting in 2016, China will start liberalizing its nearly 2,600-year-old monopoly on table salt””opening up the world’s oldest monopoly to competition at last.

Tomorrow over at Econlog I’ll explain why China will eventually have smaller government than America

A time for nuance

Macroeconomics is really complicated.  I would consider myself a supply and demand-sider, a rational expectations and efficient markets guy, and a market monetarist.

So it’s not surprising that I am often misunderstood, just as more famous bloggers like Paul Krugman are often misunderstood.  When things are far out of whack, as in 2009, it’s much easier to be understood.  You simply need to pound the “monetary stimulus” theme with a sledgehammer.  No nuance required.  As the economy gets closer and closer to the natural rate of unemployment (and we are only about 6 months away), the issues get more and more complicated. Here are some things I find that I need to continually address in comment sections:

1.  Real shocks matter, even when demand is a problem.  If someone with cancer gets stabbed by a mugger on the way to the hospital, they have multiple problems.  Which problem is worse?  Well the stab wound is more acute, but the cancer is a bigger problem in the long run.  A demand shortfall may be more acute, but like a stab wound is more easily treated than structural problems. When an economy has severe structural flaws, a policy of monetary stimulus will not fix the country’s problems.  It will just fix one of them, leaving the more severe problems in place.

2.  Contrary to the recent claim of the New York Times, the definition of a recession is not 2 consecutive quarters of falling RGDP.  The US had a recession in 2001, but we did not have two consecutive quarters of falling RGDP, whereas Japan may have recently seen two consecutive quarters of falling RGDP, but is not in recession.  Economists look at many factors before determining whether a recession has occurred.  Recessions are periods where output falls well below trend.  It matters a lot whether the trend rate of RGDP growth is 7% (China) or zero percent (Japan.)

3.  Monetary offset works by adjusting the long run expected rate of growth in nominal aggregates (such as inflation or NGDP) to offset the effect of fiscal actions.  It is not capable of smoothing out high frequency fluctuations due to real shocks.  A sudden change in government spending, sales tax rates, or a natural disaster, will affect RGDP in the near term, even if monetary policy is offsetting any effects on NGDP 12 or 24 months out in the future.

4.  A failure to achieve RGDP growth and a failure to achieve NGDP growth are logically distinct events.  Don’t confuse them. Many economists use the wrong data when evaluating policy success. If you are making the Keynesian argument that monetary stimulus is incapable of boosting AD, you use NGDP data.  If you are making the Real Business Cycle (RBC) argument that monetary stimulus will not boost output you use RGDP data.  Many Keynesians seem to be oblivious to the distinction between a change in aggregate demand and a changed in the aggregate quantity demanded (caused by a supply shock.) For instance, the April 1 sales tax increase sharply depressed Japanese RGDP in Q2, leaving NGDP almost unchanged.  Keynesians don’t seem to realize that when they complain about slow RGDP growth in a country with high inflaiton (like Britain a few years back) they are making a RBC argument, which tends to discredit the Keynesian model.  There are lots of ways that policy can “fail.”  If you don’t know the right data to cite to make your point, no serious economist will pay attention to your arguments.

Furthermore, the EMH says the efficacy of policy is evaluated at the point it is announced (if a surprise) not after the fact.  There is no “wait and see to ascertain whether Abenomics worked.”  It was obvious from the get go that it would “work” in a limited sense, but fail to achieve the announced goals.  And it has.  If Japan wants to boost trend RGDP growth, then they need to adopt supply-side reforms.  Printing money doesn’t solve that problem, especially in a country with 3.6% unemployment.

5.  Rational expectations theory says that monetary policy cannot be evaluated in isolation, but rather must be considered in the context of a clearly spelled out policy regime.  Admittedly, when things are clearly far off course, (as in 2009) you can assume monetary policy is too tight under any plausible policy regime.  But not today.  For instance, I could easily construct plausible arguments for money being either too easy or too tight:

a.  Too tight:  Because we are likely to hit the zero bound in the next recession, policy should be more expansionary, to promote a trend rate of NGDP growth high enough to keep us away form the zero bound.

b.  Too easy.  NGDP growth is likely to average a bit over 3% over the next few decades, given the Fed’s inflation target.  In recent years it has run a bit over 4% per year.  If it keeps that up it will later have to be offset with sub-3% NGDP growth, perhaps leading to recession.  Inflation should be low during booms and high during recessions.  Yet Janet Yellen seems to be determined to raise inflation up to 2%, probably getting there near the peak of the business cycle.

Which do I believe?  Neither.  I don’t know what’s optimal until I’m told what sort of objective the Fed has in the long run.  Tell me their long run NGDP target, and I’ll tell you whether money is too easy or too tight today.

It’s much better to live in a place like Switzerland where the problems are complex and the solutions are unclear, rather than North Korea where the problems are simple and the solutions are straightforward.

Were market monetarists wrong about Japan?

If there has been any blogger more accurate than me in their claims about Japan in recent years, please send me all his/her relevant posts, so I can can give him/her some praise.

Just to review:

1.  I predicted the BOJ would be able to depreciate the yen, if it choose to do so.  I’ve been proved right again and again.  Paul Krugman had doubts.

2.  I predicted monetary stimulus would boost inflation, but that they’d fail to hit their 2% target (excluding taxes).  I was right.  Krugman’s been all over the map, hostile to fiscal stimulus in the late 1990s, then too pessimistic about the possibilities for monetary policy before Abe, then (perhaps) too optimistic.  And now?  I can’t tell.

3.  I predicted the monetary stimulus would boost growth, but that growth would remain low as the working age population is falling fast.  I was proved right. (Krugman agrees it boosted growth.)

4.  I predicted a growth surge before the April 1 tax increase and a growth slump afterwards.  I was right.  BTW, this has nothing to do with “monetary offset.”  And Japan is not in a “recession.”

I mention this in response to a recent post by Paul Krugman, who has totally forgotten about the outcome of his earlier 2013 “test” of market monetarism, and started claiming that monetary offset doesn’t hold:

The bad growth news shows, pretty clearly, that the consumption tax hike was a big mistake. It also shows, by the way, how weak the market monetarist argument “” which is that fiscal policy doesn’t matter, because central banks can always achieve the nominal GDP they want “” really is; do you seriously want to contend that Kuroda likes what he sees, that he isn’t trying as hard as he can to boost Japan out of deflation?”

This is Krugman being Krugman—making it seem like his opponents are making idiotic claims.

BTW, Kuroda is engaged in monetary offset (the yen has recently fallen from 109 to 118), just as market monetarists would expect, and no, he is not doing all he can.  For instance, he could do MORE, and in all likelihood will do MORE when he discovers that he needs to do MORE to hit his target.

Perhaps some day Krugman can explain to us how events that we predicted accurately somehow disprove the market monetarist view.  Does he believe that market monetarists claimed that Japanese consumers would be indifferent between buying a car on March 31 and April 1st, after the tax rise?   It sounds like an April Fools Day joke.

The real problem with the sales tax increase is that the money is being used to finance additional government spending.  A few years back the Keynesians told us that taxes didn’t matter very much, it was all about spending.  Well Japan is ramping up its government spending.  Now Keynesians seem to have suddenly discovered that it’s taxes that matter, not spending.

PS.  Just three weeks ago Krugman did a post showing that inflation expectations in Japan have risen to almost 2%.  I doubt that, but let’s say Krugman’s right.  If inflation expectations have risen to close to 2%, then how could the tax increase have had a major impact on the prospects for growth going forward?  Is Krugman making an Art Laffer-style supply-side argument that tax increases reduce growth without reducing inflation? Is he now an inflation optimist and a growth pessimist for Japan?  Where’s the model?  When conservatives used to make that argument he would ridicule it.  BTW, I’m a moderate on this question—call me a supply and demand-sider.

HT:  Michael Darda