Archive for September 2023


The wrong lessons

The Economist has an article discussing how recent Japanese history provides some useful lessons for China. There are correct that Japan is a cautionary tale, but unfortunately they draw the wrong lessons:

And Mr Koo is himself keen to emphasize one “huge” difference between the two countries. When Japan was falling into a balance-sheet recession, nobody in the country had a name for the problem or an idea of how to fight it. Today, he says, many Chinese economists are studying his ideas.

His prescription is straightforward. If households and firms will not borrow and spend even at low interest rates, then the government will have to do so instead. Fiscal deficits must offset the financial surpluses of the private sector until their balance-sheets are fully repaired. If Xi Jinping, China’s ruler, gets the right advice, he can fix the problem in 20 minutes, Mr Koo has quipped.

Unfortunately, Chinese officials have so far been slow to react. The country’s budget deficit, broadly defined to include various kinds of local-government borrowing, has tightened this year, worsening the downturn. The central government has room to borrow more, but seems reluctant to do so, preferring to keep its powder dry. This is a mistake. If the government spends late, it will probably have to spend more. It is ironic that China risks slipping into a prolonged recession not because the private sector is intent on cleaning up its finances, but because the central government is unwilling to get its own balance-sheet dirty enough.

In other words, they are calling for China to make the same mistake the US has made in recent years, a reckless and irresponsible increase in fiscal deficits.

Japan ran huge budget deficits during the period from 1994 to 2012, partly under the influence of Western economists. The policy was a spectacular failure, with Japan seeing perhaps the weakest growth in aggregate demand ever seen over two decades, at least in a developed modern economy. By the end of 2012, Japan’s nominal GDP was actually lower than in early 1994:

When Prime Minister Abe took over at the beginning of 2013, he rejected this failed Keynesian advice, and switched to monetary stimulus. Over the following 21 11 years, Japan’s NGDP has risen by nearly 20%. Even that is too low—Abe should have switched to NGDP level targeting—but it’s a vast improvement over what came before. And fiscal policy actually became more contractionary, with several large increases in the national sales tax. Growth in the national debt slowed sharply.

Japan also has notable supply side problems. A country with such a high level of education and social cohesion should have a per capita GDP close to that of Germany or the Netherlands, not Spain or Italy. Thus monetary policy won’t solve all of Japan’s problems.

Similarly, China has some supply side problems, especially a high degree of investment in wasteful projects such as spectacular bridges in remote Guizhou province (which has 1/2 of the world’s tallest bridges). Those resources need to be redirected into more productive uses, such as high tech investments and consumption.

But if China does slip into a situation where there is a demand shortfall, the solution is not fiscal stimulus. Rather they need a “whatever it takes” approach to using monetary policy to sustain adequate growth in NGDP. Once the aggregate demand problem is fixed, it’s easier to address supply side issues.

PS. There is no such thing as balance-sheet recessions. Bad balance sheets are often the result of a bad monetary policy that sharply slows NGDP growth, leading to financial distress. When there are balance sheet problems, the natural interest rate often declines. If the central bank is targeting interest rates, this will cause an unintentional tightening of monetary policy. What looks like the cause of the recession (bad balance sheets) is more often the symptom. The underlying cause is bad monetary policy that leads to too little growth in NGDP.

Even when the balance sheet problems are unrelated to slowing NGDP growth (as is arguably the case in China), monetary policy still needs to adjust in order to prevent the decline in the natural interest rate from spilling over into a broader decline in aggregate demand.

PPS. In per capita terms, the post-2012 revival of NGDP growth was even more impressive.

Second worst

This National Review headline caught my eye:

Joe Biden Made the Worst Vice-Presidential Pick of the Last 50 Years

Obama’s pick was even worse.

According to data compiled by Bloomberg?

Unless I’m becoming senile (very possible), a recent Bloomberg article is total nonsense:

The Land of the Rising Sun experienced its largest decline in population last year, or more than 500,000 annually to 125.4 million, and residents are living longer than 84 years on average (fourth among 240 countries). And yet, the No. 3 economy had the most significant per capita increase in gross domestic product between 2013 and 2022 in local currency terms. That 62% appreciation to 4.72 million yen ($32,000) as the size of its society shrank 2% easily surpassed the US (16% with a 6% rise in population), Canada (45% and 12%), UK (48% and 5%) Germany (32% and 5%), France (33% and 3%) and Italy (30% and -1%), according to data compiled by Bloomberg.

What???? Those figures don’t seem even close to being accurate. US per capita nominal GDP growth has vastly exceeded growth in Japan. What am I missing here?

(Even if you used real GDP, the figures would be nonsense. But the article says “local currency terms”.)

PS. Is this the same Bloomberg unit that told us last October there was a 100% chance of a US recession within 12 months?

A US recession is effectively certain in the next 12 months in new Bloomberg Economics model projections . . . with the 12-month estimate of a downturn by October 2023 hitting 100%, up from 65% for the comparable period in the previous update.

The wisdom of Larry Summers

This is all good stuff:

I would suggest six misconceptions that purveyed a great deal of the current
economic debate.

First, it is supposed that the idea of economic policy is to maximize the
creation of jobs rather than to maximize the availability of goods at low
cost to consumers and firms. Both the officials responsible for competition
policy and those responsible for international trade have explicitly rejected
economic efficiency as a central guide for economic policy. This, I would
suggest, is a costly and consequential error. . . .

The second misconception is that these have not been good decades. For
the American economy in international perspective. I first got to know my
friend Ted Truman well when he was long into his career as the head of
the Federal Reserve’s International Economic Section. and I was a new
undersecretary of the Treasury for international Affairs. We were involved
in making various long term economic projections for the world.

None of them would have believed that US GDP as a share of global GDP
would have remained robust for the entirety of the next generation. And if
we had been told how spectacularly China was going to do over the next
30 years, we would have been that much more pessimistic. We could not
have imagined that the share of US wealth reflected heavily in the stock
market would have been far higher a generation later than it was at that
time. . . .

Third, the world has fared very well. Relative to the time when I was chief
economist of the World Bank at the beginning of the 1990s, child
mortality rates are less than half of what they were then. Literacy rates are
more than twice what they were then. Poverty rates, terms of extreme
poverty are less than 40% of what they were then.

And in some ways most fundamental and important, this month, we
celebrate the 78th anniversary of a situation where there has been no direct
war between major powers. You cannot find a period of 78 years since
Christ was born when that was the case. So, the idea that we’ve been doing
it all wrong is, I would suggest, a substantial misconception.

Fourth, the problems that we have are not due to trade liberalization. The
single most misleading idea that has moved from academic economic
research into the popular domain is the concept of the China shock
associated with China’s accession to the WTO. To start with, that
agreement did not change one iota of US policy permitting Chinese goods
to be sold in US markets.

The principle that China would be the beneficiary of most favored nation
treatment and get the same benefits that other countries did had been well
established years before. It was ritually reaffirmed annually by the
Congress. Yes, China’s tremendous economic progress did lead to far
more sale of goods in the United States. But it is hard to imagine a less
credible approach to the problem. The adding up all the losers from the
imports without taking any account of the jobs created and the economic
impacts of the goods we sold to China.

Of the lower cost inputs we received because of imports from China. Of
the enhanced real wages and associated with greater spending caused by
those lower prices. And the lower capital costs associated with the inflows
of capital that we received from China. When those calculations have been
done, as they’ve now been done by Rob Feenstra and several other teams
of economists, they show that, in fact, as with NAFTA, the net benefit to
the US economy has been substantial.

The fifth misconception is that domestic industrialization and some kind
of renaissance of manufacturing is somehow the central issue for US
prosperity going forward. This is simply not a realistic idea. In 1970,
about 20% of US workers were engaged in production work in
manufacturing. Today, that number is about 6%.

That number has trended downwards in countries like the United States
that have tended to run trade deficits. It has also trended downwards
rapidly in countries like Germany that have run manufacturing, export,
mercantilist oriented economic strategies and not at very different rates. It
is a consequence of the same set of phenomena that led to declining shares
of workers in agriculture over time.

Rapid productivity growth, relatively inelastic demand, rapidly declining
relative prices created abundance without substantial and with declining
levels of employment. And there is nothing in the coming robotic
revolution to suggest that these trends are likely to do anything other than
accelerate going forward. I would note that the president of Ford has
judged that it requires about 40% less labor input in a Ford factory to
make an electric car as to make a traditional car. . . .

Finally, I would suggest that substantial and accumulating deficits and
debts are a substantial threat to national security and national power
contrary to what is often believed in what sometimes seems like a post
budget constraint era of economic thinking. . . . [Our] budget prospects are vastly worse than they were at the time of the Clinton administration’s successful budget actions and substantially worse than they were at the time of the Simpson-Bowles efforts. The budget deficits a decade out comfortably in double digits now seems as a share of GDP now seem a reasonable projection with primary deficits quite likely in the 5% of GDP range.

This is without the assumption of the need for vast mobilization for
meeting contingencies, military or non-military. And I think it is
reasonable to ask the question. How long can or will the world’s greatest
debtor be able to maintain its position as the world’s greatest power.

The Q&A has more good stuff. Here he discusses recent anti-China hysteria:

I think we need to proceed with very considerable care. I’m also very alarmed anytime you have a dynamic where on any issue, it’s only safe to be on half the spectrum of views for an individual. You are at risk of the outcome, moving a very, very long distance. The reason why the grade point average at Harvard University is now above 3.7. Think about it. . . .

No one with ambition wants to be in the dovish half of those talking about policy directed towards China. And that creates a potentially very, very dangerous dynamic. So, I don’t think we can ignore the national security issues posed by China at all, but roughly speaking, whenever somebody talks about jobs in Ohio, at the same time they’re talking about the national security threat from China, and as an important benefit of the national security policy, I get pretty nervous.

I don’t mind being on the dovish half on China.

And this is also excellent:

I’m inclined to think that if climate change is a central problem, we should
want climate change technologies produced as inexpensively as possible.
My view, which I’ve been expressing for some years, that has become
more fashionable in the last few months, at least in some part of it, is that
people, historians will look back on American views of the Soviet Union
in 1960, American views of Japan in 1990 and American views of China
in 2020 in quite similar ways as maximum alarm just at the moment of
maximum mean reversion for the economy in question.

And I think we have to think very hard about, in the context of that
possibility, what the right strategies are and strategies that are about
maximum pressure can also be strategies that provoke maximally sharp
responses. Every time I hear somebody talk about Britain in the 1930 with
an emerging threat, I’m led to think about the antecedents to Pearl Harbor
in terms of Japanese perception.


HT: David Levey

How not to think about monetary policy

This Bloomberg piece caught my eye:

Faced with only limited signs of a slowdown in US demand despite more than five percentage points of interest-rate hikes, logic would say the Federal Reserve needs to do more.

But policymakers and Fed watchers are now giving more attention to a new line of argument, that central banks need to take account of what their actions mean for the supply side of the economy. The implication: Too-high rates could actually undermine the inflation fight, by squelching the benefits of increasing supply — which are just now coming on stream.

It’s true that bad monetary policy can affect the level of investment. But this is not a useful way of thinking about monetary policy. The primary cost of tight money is high unemployment. The fact that investment might also be impacted doesn’t really change the bigger picture.

The question is not whether tight money can be harmful; the question is what sort of regime makes overly tight money less likely to occur? What’s the appropriate policy rule?

Here’s Nick Rowe:

Take a look at the Bloomberg headline and two subheads:

Fed’s Policy Paradox: Too-Slow Growth Threatens Inflation Fight

  • Too-high rates can hurt supply, lift price pressures: paper
  • Theory in past focused on throttling demand to stem inflation

Yes, tight money can reduce supply. But the effect on demand is an order of magnitude larger.