Archive for the Category Switzerland


Natural experiments: Can we handle the truth?

Natural experiments are being conducted all the time.  And yet I often feel like people really don’t care about the outcome of these experiments.

Let’s consider 5 popular hypotheses:

1.  The mortgage interest deduction has a major impact on the housing market.

2.  The NASDAQ was obviously wildly overvalued in 2000.

3.  Switzerland was forced to revalue its currency in January 2015.

4.  The US housing market was obviously wildly overvalued in 2006.

5.  Brexit would cause a recession in the UK economy.

In my view, natural experiments have strongly suggested that all 5 of these hypotheses are false.  And these are not trivial unimportant hypotheses, they were widely held views about some really important issues.

1. The tax bill that passed last year sharply cut back on the mortgage interest deduction.  Before that happened I read about 1000 articles warning that if we took away this deduction it would severely hurt the housing market.  We didn’t completely eliminate the deduction, but it’s more than half gone.  And yet housing continues to boom.  I have yet to see a single news article discussing this important natural experiment.

2.  The Nasdaq is now far higher than in 2000.  Of course it could be wildly overvalued today.  Unlike in 2000, however, there is no widely held view that it is wildly overvalued today.  That’s a problem for the hypothesis that it was wildly overvalued in 2000.  If true, why don’t people feel that way about the current stock market?  And you can’t point to changing economic circumstances, such as lower nominal interest rates, as those factors are linked to other changing economic circumstances, such as an unexpected slowdown in trend NGDP growth.  I.e. where would Nasdaq be today if NGDP had grown during 2000-18 as rapidly as people expected back in 2000?  Maybe 10,000?

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3.  Tyler Cowen correctly noted that Denmark would provide a good test of whether Switzerland was forced to revalue in January 2015.  We now know that Denmark was not forced to revalue.  Even worse, evidence suggests that the Swiss revaluation did not have the intended impact on the SNB balance sheet, which kept growing. That was claimed as the reason the Swiss needed to revalue.  And yet despite this natural experiment, experts continue to claim that the Swiss were forced to devalue, as in this recent podcast. It seems obvious to me that the Swiss simply made a mistake—are there any good counterarguments?

4.  There are two powerful pieces of evidence against the claim that the US housing market was overvalued.  First, many who made that claim also said the same thing about housing markets in Canada, Australia, the UK, and other countries.  And yet many of those other countries did not crash.  Even worse, America’s housing market has mostly recovered, and yet I see almost no one currently saying “America’s in a huge housing bubble, and when it crashes we’ll have another Great Recession”.  So why continue to claim the 2008 recession was caused by a housing bubble that no longer even looks like a bubble at all?  (And don’t point to housing construction; that’s shifting the goalposts.  In 2008, everyone pointed to the historically high level of house prices in 2006; housing construction never reached unusual levels during the boom.)

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5.  This one hasn’t been entirely ignored, as the Brexit supporters pointed to a strong economy after the June 2016 vote.  The Financial Times claims that Brexit is now slowing British growth:

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In my view it’s too soon to claim that Brexit is slowing growth.  I expect it will, but the graph the FT presents does not look statistically significant to me.

Ditto on the recent corporate tax cut—it’s too soon.  Both supply-siders and Keynesians expected a short term boost to growth, for different reasons.  Only the supply-siders predicted a longer term boost.  My own view was somewhere in between.  I expect some sort of long run supply-side boost, but much less that the Larry Kudlows of the world expect.  I see perhaps an extra 2% in RGDP growth spread out many years, with most of the boost coming soon after the tax cut.  Supply-siders see the growth rate rising to a new trend of roughly 3%/year, which seems unlikely to me.  If growth is still running at 3% in late 2019, then I clearly will have underestimated its impact.  I hope I did.

I’ve done a number of previous posts on this general topic, discussing earlier experiments such as the 2013 fiscal austerity, and the 2014 elimination of extended unemployment benefits.  Those who suggested that these would be good natural experiments often ignored the results when they didn’t go as expected.  (GDP growth accelerated in 2013, and job growth accelerated in 2014.)

Many pundits can’t handle the truth, unless it confirms their prior beliefs.

At least the Treasury doesn’t focus on “intentions”

Here is the Treasury’s list of the three criteria it uses to identify “currency manipulators”:

Pursuant to Section 701 of the Trade Facilitation and Trade Enforcement Act of 2015, this section seeks to identify any major trading partner of the United States that has: (1) a significant bilateral trade surplus with the United States, (2) a material current account surplus, and (3) engaged in persistent one-sided intervention in the foreign exchange market. Section 701 requires data on each major trading partner’s bilateral trade balance with the United States, its current account balance as a percentage of GDP, the three-year change in the current account balance as a percentage of GDP, foreign exchange reserves as a percentage of short-term debt, and foreign exchange reserves as a percentage of GDP. Data for the most recent four-quarter period (January to December 2016, unless otherwise noted) are provided in Table 1 (on p. 13) and Table 2 (below).

This is obviously beyond stupid.  (Since when do bilateral trade deficits mean anything?)  But at least the Treasury doesn’t try to read minds, and interpret the intentions of other countries.

Matthew McOsker sent me an article from the Economist, which nicely illustrates the confusion surrounding the concept of currency manipulation:

Awkwardly for America, two of its friends in Asia have recently scored more highly than China: South Korea and, most clearly, Taiwan. But the highest score of all goes to Switzerland, by dint of its whopping current-account surplus and its hefty foreign-currency purchases. This illustrates one of the method’s flaws: in terms of the goods and services that it can actually buy, the Swiss franc is in fact among the world’s most overvalued currencies.

This is why it’s so important to have a clear definition of currency manipulation.  The Economist clearly thinks the concept is related to undervalued currencies, and most people probably agree.  But whether a currency is “undervalued” is completely unrelated to whether some of the other criteria are met, such as large purchases of foreign exchange and/or a current account surplus.  If you really believe that large purchases of foreign exchange and a big current account surplus constitute currency manipulation, then you should have the courage of your convictions and label Switzerland as one of the world’s worst villains.  After all, it is among the world’s leaders in both categories.

And this leads to another irony.  I frequently point out that the more conservative the central bank, the bigger the balance sheet as a share of GDP. Thus in the future we may end up seeing more and more countries like Switzerland, with huge purchases of foreign assets in a futile attempt to prevent their currency from appreciating.

To avoid being labeled a currency manipulator, they may instead choose to buy domestic assets (as in Japan).  This will also boost domestic saving, depreciate the currency and increase the current account.  But since they won’t be buying “foreign exchange”, they just might fool the US Treasury.  (It’s not hard, when the Treasury is hamstrung by the silly mandate given to it by Congress.)

Here’s another irony.  Some people seem to think that fixed exchange rate regimes are evidence of currency manipulation.  But in the 1990s the EU had a fixed exchange rate system with the express purpose of preventing currency manipulation.  In fact, fixed exchange rate regimes determine the path of the nominal exchange rate.  But if currency manipulation happens at all (I doubt it), then it surely relates to real exchange rates. Thus if currency manipulation happens, it is equally likely to occur with a fixed or floating exchange rate regime.  Indeed you don’t even need your own currency to “manipulate” your real exchange rate.  Germany depreciated its real exchange rate in the 2000s.  If Wisconsin wanted to depreciate its real exchange rate it could do so.

But why would they want to?

Language and unemployment

I like maps.  Randy Olsen recently linked to an interesting map of European unemployment:
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Before seeing this map I knew that Germany had higher lower unemployment than France.  And indeed you see a dramatic change in the unemployment rate right where the two countries meet—at the Rhine.

My assumption has been that the lower German unemployment reflects better labor market regulations. But this graph hints at another difference—language.  Let’s suppose that Germanic language areas have lower unemployment than Romance language areas.  How would we test whether language or government policies are more important?

One approach would be to note that some countries have multiple languages.  Thus southern Belgium and southwestern Switzerland speak Romance languages, and the rest of those countries mostly speak Germanic languages.

Now look at the map.  I see a sharp unemployment divide in Belgium, right on the line between French and Flemish.  And in Switzerland, I see much higher unemployment in French-speaking Geneva, Vaud, and Valais, as well as Italian-speaking Ticino.  Below is a map of Switzerland, so you can see the cantons more clearly.

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I also notice an area of very high unemployment from Greece to southern Italy to Sardinia to southern Spain. So maybe it’s not language, maybe it’s latitude.  Or maybe both language and latitude are proxies for culture.

Before we fall in love with this theory, however, there is just one problem.  As recently as 2005, Germany had about 11% unemployment and was regarded as the “sick man of Europe”.  We should be suspicious of cultural explanations that apply in one decade, but not the next. Surely culture doesn’t change very much in 12 years!

In the end, I’m included to think, “it’s complicated”.  There are probably lots of factors that are playing a role here.  Southern Belgium was once richer than northern Belgium, but today it’s more of a rust belt, as its old heavy industry is less competitive than the newer firms in the Flemish areas to the north.  Perhaps there are similar explanations for Switzerland. Perhaps culture and government policy interact—thus people in the far south of Europe have a culture that leads to political outcomes associated with excessive labor market rigidity.

So no easy answers, but the map is certainly food for thought.

PS.  Unemployment is related to wealth, and indeed probably more closely related than in earlier decades.  But the correlation is still far from perfect.  Northern Italy does better on wealth than employment (check out my “rich heart of Europe” post.)  For instance, Lombardy has more unemployment than northern England, despite being richer.  Or compare (rich) Paris with the Czech Republic.



Two targets, two tools

An important idea in macroeconomics is that you need at least as many tools as targets.  Over at Econlog, I have a long post discussing Roger Farmer’s views on monetary policy.  Here I’ll do a short post, giving you the Cliff’s Notes version.

In a better world, economists wouldn’t focus on interest rates.  But they do.  So how do we make sure that a change in interest rates has the desired effect?  After, all, higher rates could represent tight money (liquidity effect) or easier money (income and Fisher effects.)  How do we pin it down?

With two tools.  If you want interest rates to rise, you can raise the IOR.  If you want to make sure that this increase reflects the income/Fisher effects, you need to also use one of the following tools:

1.  A huge increase in the quantity of money (old monetarist)

2.  Target a higher commodity price index (1980s supply-side econ)

3.  Target a higher price of foreign exchange–i.e. depreciate your currency.  (Mundellian economics)

4.  Target higher stock prices.  (Roger Farmer)

5.  Target a higher NGDP futures price (market monetarist)

In each case, you use a “whatever it takes” approach to open market operations, to get your second policy tool moving in an unambiguously expansionary direction.

Recently, the Swiss did this in reverse.  In January 2015 they lowered interest rates and simultaneously appreciated the Swiss franc.  This assured that the lower interest rates were contractionary (income/Fisher effect.)  Singapore also uses exchange rates as a policy tool.  The BOJ has dabbled in Farmer’s approach, buying ETFs.  But not enough to make it effective.

PS.  Nick Rowe has a related post on Roger Farmer’s proposal.

Off topic:  In January 2014, I argued that “IndoAsia” would be the next big growth story.  This article says it’s beginning to happen.  And remember that 60 Minutes story about the ghost cities in China?  The ghost neighborhood in Zhengzhou that they highlighted seems to be doing fine:

Home prices in at least one district in Zhengzhou, which became a symbol of China’s property excesses because of rows of empty housing developments, have risen two-thirds this year to 25,000 yuan ($3,747.56) per square metre on average, a sales manager told Reuters on a recent visit to the city.

The average new home price in 70 major cities climbed an annual 9.2 percent in August, up from 7.9 percent in July, according to data from China’s National Bureau of Statistics.

After a period of modestly slower growth, the China boom is picking up speed again.  Looks like the naysayers will have to wait a few more years for the most widely predicted crash in history.

It’s hard not to be super optimistic about the world right now.  Asia is booming, and most people are Asians.

The Swiss dodge two bullets

Back in January 2015, the SNB foolishly allowed the SF to suddenly appreciate against the euro (by roughly 14%), after capping its value at 1.2 for about 3 years. Soon after, the SNB realized its mistake, and now the SF is up by only about 8% compared to the period just before the revaluation (the graph shows the inverse of the SF’s value):

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Another lucky break was that the euro weakened in 2015, and so the SF has actually been relatively weak against the dollar over the past year (again, graph shows the inverse of the SF’s value):

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Switzerland fell into mild deflation, although that may have partly reflected falling oil prices:

Screen Shot 2016-06-05 at 10.57.35 AMFortunately, unemployment rose only modestly, as the Swiss economy has always been more flexible than other European economies:

Screen Shot 2016-06-05 at 10.49.10 AM(Sorry, I could not find seasonally adjusted data, but you can see the mild upswing in unemployment.)

The other bullet dodged was a proposed Universal Basic Income, of roughly $30,000/year for each adult, and about $8000/year for each child. That is, about $76,000/year for a family of four.  There may come a time when a UBI is appropriate, but this proposal was way too soon, and way too generous.  It was rejected overwhelmingly:

Projections by the GFS polling outfit for Swiss broadcaster SRF showed nearly four out of five voters opposed the bold social experiment launched by Basel cafe owner Daniel Haeni and allies in a vote under the Swiss system of direct democracy.