Archive for August 2016


Four facts about monetary policy

Here are four facts about monetary policy:

1.  The Fed’s official goal is 2% headline PCE inflation.

2.  PCE headline inflation has averaged 1.12% over the past 8 years.

3.  Thirty year TIPS spreads are 1.66%, equivalent to 1.4% PCE inflation.

4.  Top Fed officials are discussing the need to tighten monetary policy in the near future.

Three more bonus facts:

1.  The longest expansion in US history lasted 10 years.

2.  We are more than 7 years into the current expansion.

3.  The Fed has no credible plan for dealing with the next zero bound event.

PS.  JP Koning directed me to Ricardo Reis’s new paper on monetary policy.  In section 5.2 he revives Robert Hall’s 1983 JME proposal to index the interest rate on reserves to the price level, which is a sort of “futures” approach to stabilizing prices, but using the demand side rather than the supply of money approach that I’ve focused on.  For decades I’ve been telling people that Hall’s paper was brilliant, and unfairly ignored.  Great to see it finally getting some well-deserved attention.

PPS.  Reis cites Hall (1997), but really needs to cite the 1983 paper.

The less lofty your goals, the harder you have to work

Central banking is not like other fields; the less ambitious your goals, the harder you have to work to achieve them.  Stephen Kirchner sent me an article suggesting that the Riksbank has not yet learned the lesson that the Swiss National Bank is now learning so painfully:

There’s growing speculation Sweden’s central bank will reintroduce an interval for its inflation target as well as change its price index, paving the way for it to start rolling back the record stimulus unleashed over the past two years as it battled deflation.

“Stefan Ingves began talking about this in spring,” said Torbjoern Isaksson, chief analyst at Nordea Bank. “That a central bank governor again and again talks about a reintroduced tolerance band is a clear signal that it could happen.”

Central bankers think low interest rates are easy money.  In fact, over any extended period of time, low rates are a sign that money has been tight. The same is true of big balance sheets.  Central bankers think a higher ratio of base money to GDP is easy money, whereas over any extended period of time it is usually a sign that money has been tight (although it might also reflect interest on reserves.)

The Riksbank is getting tired of buying all those assets, in an attempt to push inflation up to its 2% target.  But if they widen the band, it will be seen as a drop in the inflation target.  This will lower nominal interest rates in the long run, and increase the ratio of base money to GDP in Sweden.  It will have exactly the opposite effect that the Riksbank hopes for.

If they want a smaller balance sheet they’d be better off emulating the Reserve Bank of Australia, which has a 2% to 3% inflation band, higher than the Riksbank’s 2%.  Australia has a base/GDP ratio of only 4%, one of the lowest in the developed world.  As I keep saying, in the modern world it’s a choice between inflation and socialism.  Conservatives don’t want either and in trying to avoid both they end up as accidental socialists, with the central bank owning a massive quantity of assets. In Japan they are even buying stocks.  Where will it all end?

PS.  After months of moronic posts on Trump, I finally got some positive feedback on my previous post on the international fight for rents.  I need to stop talking about Trump.

So I’ll use pictures instead:

Screen Shot 2016-08-30 at 4.52.40 PM

Trade wars of the 21st century: The battle for rents

In the old days, international trade was mostly about the exchange of commodities, and the trade battles were over tariffs and quotas.  Today, tariff rates for most goods are fairly low, and a new battlefront has opened: Rents.

In our modern economy an increasing portion of value added is associated with intellectual property, which is hard to measure.  Here’s a recent example:

European authorities have clamped down on a special deal between Apple (AAPL) and Irish tax authorities, saying the arrangement uniquely favors Apple and is unavailable to other companies. Nixing the deal—which lowered taxes on much of Apple’s foreign income to virtually nothing—will force Apple to pay taxes in Ireland at the higher rate other companies pay. The bill: about $14.5 billion.

But Apple may get reimbursed for all of that by an unlikely benefactor: the US taxpayer. “It’s extremely possible the US taxpayer will have to pay this bill,” says Stuart Gibson, a former government tax official who’s now editor of Tax Notes International. “For every dollar in tax Apple has to repay in Ireland, they may get to reduce their US tax bill by $1.”

This is what happens when you try to tax income instead of consumption.  As I’ve argued before, “income” in the tax sense is a pretty meaningless concept.  (BTW, that doesn’t mean NGDP is meaningless, as NGDP is completely different from income as defined by tax authorities.)

I see three looming fronts in the war over rents:

1.  The allocation of multinational profits for purposes of taxation.

2.  Intellectual property rights.

3.  Anti-trust laws.

Because the US is the dominant producer of intellectual property, the US government (both liberal and conservative administrations) will argue for low overseas taxes on multinational earnings, weak anti-trust laws to preserve the profits of US companies with patents, copyrights and/or large network externalities, and strong intellectual property rights, to extract money from non-American consumers of stuff developed in California.

You might wonder why even liberal American politicians would defend the robber barons of California.  The answer is simple; these firms produce lots of tax revenue for the US, and for California.  They don’t want to kill the goose that lays the golden eggs.  Nor do they want to share eggs with Europe and Asia.  It doesn’t matter if our firms exploit consumers in Asia or taxpayers in Europe, as long as they share 30% of the loot with public employees in the US.

Take it easy ECB; don’t over exert yourself

In recent months there has been a rising chorus of calls for fiscal stimulus, from pundits all over the world.  If I didn’t know better I’d conclude that the world’s major central banks had run out of paper and ink, and that only fiscal policy remained effective.

And then I get jolted back into the real world:

Many international investors had feared a Brexit vote would undermine the EU and hurt business and market confidence across the euro zone. But surveys point to little impact so far.

As a result, many banks are revising forecasts for further European Central Bank stimulus. JPMorgan says it no longer expects the ECB to cut rates or announce an extension of its bond-buying programme in September after solid growth data.

Well that’s a relief.  For a moment there I had thought that there were other reasons why the ECB might prefer to adopt a policy of monetary stimulus:

Screen Shot 2016-08-28 at 10.01.06 PMSeriously, I don’t think I ever recall a time when so many economists were so out of touch with what’s actually going on in the real world.

As usual, Paul Krugman is able to express my frustration much better than I can. Here’s what he wrote in 1999, one year after his famous 1998 liquidity trap paper that he always likes to cite, and at a time when a bunch of pundits were insisting that Japan needed fiscal stimulus:

“What continues to amaze me is this: Japan’s current strategy of massive, unsustainable deficit spending in the hopes that this will somehow generate a self-sustained recovery is currently regarded as the orthodox, sensible thing to do – even though it can be justified only by exotic stories about multiple equilibria, the sort of thing you would imagine only a professor could believe. Meanwhile further steps on monetary policy – the sort of thing you would advocate if you believed in a more conventional, boring model, one in which the problem is simply a question of the savings-investment balance – are rejected as dangerously radical and unbecoming of a dignified economy.

Will somebody please explain this to me?”

PS.  For years I had wondered if I was the first to publish a paper discussing negative IOR as an option.  Not surprisingly, I was not.  Marvin Goodfriend of the Richmond Fed did so in 2000.


PPP demystified

It is clear from the comment section to the previous post that there is a lot of confusion about PPP.  Let me try to illustrate the basic ideas with an example, since my words don’t seem to be making an impact.

Assume that Saudi Arabia has a nominal GDP of $1000 billion, of which $600 billion is non-oil output and $400 billion is oil output.  Let’s assume that the domestic and international prices of oil are the same for Saudi Arabia, but that other goods are 3.5 times as expensive in the US as in Saudi Arabia.  In that case the Saudi GDP in PPP terms would be:

3.5 X $600b + $400b = $2500b

You might think about there being a “multiplier” of 3.5 for non-oil output, and a multiplier of 1.0 for oil.  The overall multiplier is 2.5 = $2500b/$1000b.

Now suppose you want to find the non-oil GDP in PPP terms (which I assumed was $2100b), how do you do that?

You started with the total output (from the IMF or World Bank) in PPP terms, which is assumed to be $2500b.  Then you subtract the output from the oil sector, using international prices.  In this case I assumed the domestic and international prices were identical.  Now suppose the domestic price of oil in Saudi Arabia were less than the international price.  In that case you’d want to subtract out oil at the international price, not the domestic price.  Do all PPP prices or all nominal prices; don’t mix the two.

Some commenters wanted to subtract the oil sector from nominal Saudi GDP.  But I’m not interested in nominal Saudi non-oil output; I want PPP non-oil output.  And if you apply the overall 2.5 multiplier to the non-oil sector, you get the wrong answer, as the actual multiplier is 3.5 for the non-oil sector (by assumption), and 2.5 for the total economy.

This is from a recent article in the Economist:

Cheap oil is forcing Gulf monarchs, who have hitherto bought their people’s acquiescence with cushy jobs and handouts, to trim the public payroll. And since Gulf monarchies cannot find enough jobs for their own people, the safety valve of emigration to work in the Gulf has closed to other Arabs. The largest Gulf state, Saudi Arabia, needs to create about 226,000 new jobs every year, according to Jadwa Investments, a Saudi research firm. But in 2015 employment rose only by 49,000.

Gulf states have set quotas for the employment of nationals, but many companies complain that local graduates lack the skills and work ethic required. “I know of firms that pay Saudis to satisfy the law, but tell them to stay at home,” says one businessman.

Now of course the foreign workers in Saudi Arabia are a different story.  But many of them are low skilled construction workers, maids, etc.  So I still find it kind of amazing that Saudi resident workers seem to be more productive than German workers, even if you exclude the entire oil production industry from the Saudi data. But that’s just me.

Or maybe (more likely) the IMF/World Bank/CIA PPP estimates are all inaccurate.

Also note that having lots of money doesn’t magically solve productivity problems. Countries in the “middle income trap” are often saving enough so that they ought to be catching up to the developed world.  The fact that they are not doing so suggests that productivity problems are much deeper than a lack of money.

If I had to argue against my anti-Saudi prejudice, here’s what I’d say:

Some places are unsentimental and very smart.  They realize that they can have living standards far above New York City through international labor arbitrage. They understand that NYC does not have “nice things” like good subways and good roads and good airports, because they insist on using union workers and local firms that are not skilled at building subways.  So the subways cost three times more than even in Europe.  These unsentimental smart places like Singapore and Dubai realize that they can bring in the best foreign firms and very cheap construction labor from Asia, and build great infrastructure for low prices.  If you then price the output of the infrastructure at America prices, it looks really impressive. So maybe the Saudi’s really are highly productive, because they do this sort of labor arbitrage.  They sell oil at American prices, and hire Bangladeshi construction workers at 5% of American wages.  Sounds good to me!

When I read Dems (and Trump) talk about the need to build infrastructure in order to create “jobs”, I’m reminded of Milton Friedman’s famous joke.  If you want jobs, use spoons.  If you want NYC to have nice infrastructure, use Bangladeshi workers.

PS.  I just saw this, from the WSJ:

The Wall Street Journal reached out to 45 economists who have served on the White House Council of Economic Advisers, under both Republican and Democratic presidents, to ask about this year’s presidential election. Most Democratic appointees said they supported Hillary Clinton, while no Republican appointees openly supported Donald Trump.

I know, the experts have “screwed things up” so why not give outsiders an opportunity?  Yes, instead of being screwed up as we are in America, we can have a policy-making apparatus run by non-experts, and get screwed up in the way that non-expert dominated places are screwed up, as in North Korea, or Venezuela, or Zimbabwe.

When you are a country that is already in the 97 to 99 percentile of the global economy, in terms of overall economic success, I’m not sure you want to just kick out all the experts and try something completely new.  Your upside if it works might be Singapore or Switzerland.  But your downside risk . . . ?

I wrote this back in 2011:

Now let’s start down through Dante’s seven circles of Hell:

1.  The US is much richer than Mexico.  So much so that millions of Mexicans will risk the horrors of human trafficking into the US to get crummy jobs picking tomatoes all day in the hot sun.

2.  China in 2011 is still considerably poorer than Mexico.  The Chinese take much greater risks to get here.

3.  China today is so much richer than China in 1997 that it’s like a different planet.  The changes (even in rural areas) are massive.

4.  The China of 1997 seemed like paradise compared to the China of the 1970s.  Throughout Hessler’s book, people keep talking about how horrible things were during that decade and how prosperous they are now (1997 in Sichuan!)

5.  The China of the 1970s was nowhere near as bad as during 1959-61, when 30 million starved to death.

It’s a loooooong way down to the lower percentiles.

PPS.  Yes, I know, there were nine circles.  I have a bad memory.