Mass Suicide

Films like Downfall and Letters from Iwa Jima depict the cult of suicide, the tendency of people in cult-like groups to want to take others with them when they end their lives.  The most famous American example was Jim Jones’ religious cult.  What made me think of this issue was, of course, the recent G-20 meeting in London.  I was all set to do a clever piece on the G-20’s announced policy of strongly discouraging countries from engaging in competitive devaluations, when I saw that Barry Eichengreen beat me to it.  His piece is well worth reading, but was written before the G-20 meeting, so he was unaware of just how little sympathy they would show for his suggestion that competitive devaluations should be encouraged.  Not only did they not encourage them, they issued a communique which positively discouraged competitive devaluations.

Not all expansionary monetary policies will depreciate one’s currency.  Rather all effective expansionary policies will depreciate one’s currency.  The ECB has made it very clear that they have no interest in using an expansionary monetary policy to boost NGDP.  Now they are pressuring other countries to follow suit.  How did the world press treat this agreement, this promise of all G-20 members not to try highly expansionary monetary policies without the permission of the Eurozone?  I couldn’t find a single comment.  Not one.  This passivity reminds me of the Great Depression.  If the public in the early 1930s had understood that the Depression could have been quickly ended by expansionary monetary policy, they would have been outraged by the inaction.  But monetary policy is so complicated that the press paid little attention to what should have been viewed as an outrage.  And the same is happening today.   I didn’t expect the G-20 countries to agree on a coordinated stimulus package, but for them to issue a unanimous statement condemning monetary stimulus; that boggles the mind.  And where is the press reaction?

The only effective macro policy during the entire Great Depression (either Hoover or FDR) was the dollar depreciation program.  That would have been clearly in violation of this agreement (as Barry Eichengreen points out.)  BTW, Eichengreen is a Berkeley professor who wrote Golden Fetters, one of the most respected books on the role of the gold standard in the Great Depression.  So it’s comforting to know that at least one expert understands the absurdity of what’s going on.  BTW, the Europeans tried the same tactic in June 1933; it was called the World Monetary Conference.  FDR torpedoed the agreement at the last minute—a decision Keynes called “magnificently right.”

What if everyone tried to do a competitive devaluation at once?  You might think it wouldn’t work.  If the dollar falls against the euro, the euro cannot fall against the dollar.  And yet all currencies can depreciate at the same time—against goods and services.  And isn’t that what we are trying to do, boost AD?  If not, why did we just pass a nearly $800 billion dollar fiscal stimulus?

BTW, have you noticed the implicit assumption in the press and blogs that fiscal expansion has negative externalities from our perspective (we get the deficits, they get added export markets) whereas monetary stimulus has negative externalities from the perspective of other countries (competitive devaluations?)  I think this is somewhat misleading, especially for monetary policy.  Nevertheless, it is just one more argument for why we should have relied on monetary stimulus, not deficit spending.

Since this is my first shot at international monetary issues, I’d like to offer a few more comments on the euro.  In past posts I have argued that monetary policy is very counter-intuitive, that it is far too easy to assume that low interest rates mean easy money.  I am afraid that even I fall into that trap once and a while.  I don’t recall whether I specifically argued that the ECB’s policy was even further off course than the Fed, but if so I’d like to withdraw that accusation.

The ECB aims for about 1-2% inflation.  Given the Eurozone growth rate averages about 2%, I think we can assume 3.5% NGDP growth is a reasonable approximation of their long run strategy.  This year the Eurozone is expected to achieve roughly negative 1.8% NGDP growth, 5.3% below target.  If they only care about inflation, as I believe they claim, then the expected 0.6% rate is only about 0.9% below target.  In either case they are closer to their target than the Fed.

In the US, NGDP growth is expected to be about negative 2.8%, about 7.5% below the Fed’s likely implicit target.  Inflation is expected to be negative 0.6%, about 2.5% below target.  So the Fed is much further off course.  I think the reason I was even more negative about the ECB than the Fed in some earlier posts, is because with rates in Europe still well above zero (and indeed over 4% last fall) there was obviously no “liquidity trap” excuse that could be used for their inaction.  But since I don’t regard that excuse as having any validity for the Fed, there is no reason to apply it to the ECB.  When the key mistakes were made last year (July to November) the dollar soared against the euro.  Although it didn’t look that way, money in the U.S. was effectively much tighter than in Europe.  Appearances can be deceiving.

I am much better at closed economy macro than open economy macro, so I won’t have much to say about optimal policy responses in smaller countries.  I’d rather hear what you have to say.  In general, I think larger economies should forget about exchange rates, and simply focus on NGDP targets.  But what about smaller countries?  Some might be better off with fixed rates and/or currency boards, as a first step to joining a single currency such as the euro.  (Or because they want to be an international banking center, as with Hong Kong.)  On the other hand Argentina had a bad experience with its currency board, when compared with Chile’s inflation targeting.

Here’s my question.  What should a country like Taiwan do?  They have suffered a huge drop in manufacturing exports, through no fault of their own.  (I just checked their industrial production–it was down 43.3% from January 2008 to January 2009, but February was better.)  Should they keep their exchange rate stable vis-a-vis the dollar (or a basket of currencies?)  Should they target inflation?  How about NGDP, or would that result in high inflation during this severe recession?  (I assume that a small country cannot significantly impact world AD.)  Would NGDP targeting lead to an inefficient movement of labor from the traded goods sector to the non-traded goods sector?

Then there are countries like China, which would almost certainly be better off devaluing their currency.  Unfortunately, they would run into criticism from Western leaders who (wrongly) believe Asian currency manipulation explains our big trade deficits with China and Japan.




20 Responses to “Mass Suicide”

  1. Gravatar of Devin Finbarr Devin Finbarr
    9. April 2009 at 20:02

    Great post. After all of Bernanke’s past speeches and papers about avoiding deflation, it’s shocking that he’s been so reluctant to actually fire up the helicopter and drop out enough money to reflate.

    What should a country like Taiwan do? They have suffered a huge drop in manufacturing exports, through no fault of their own.

    Before the crisis companies in China, Taiwan, et al, would make products and export them for dollars. Then the government would print local money, exchange it for the manufacturer’s dollars, and hoard the dollars.

    Why don’t the Asian governments simply issue their citizens gift cards to buy local manufactured products? Then when the manufacturer sells the product in exchange for the gift card, the government prints money, gives the money to the manufacturer, and takes the gift card.

    This ends up being the same as the pre-crisis policy, except instead of ending up with a hoard of American dollars, the people of the country end up with HDTV’s and iPods. The government can call it the “Santa Claus” policy (an updated and happier version of Keynes’s ditch digging policy). It would be wildly popular, and completely solve the unemployment problem.

  2. Gravatar of septizoniom2 septizoniom2
    10. April 2009 at 01:45

    terrific post. i do hope someone at the fed and treasury is monitoring the blogs as diligently as i am and passing on these thoughts.
    i thing the main well of all the mistakes is a failure to have the benefit of a simple but intensely illuminating insight (which this blog clearly sees): asset prices crashes have been correlated around the world with a speed never before seen (as is the nature of our wired world now) which has driven money demand to extrodinary levels and thus devastated ngdp. thus depreciation is not so much relative to other currencies, but rather as you say, relative to non currency.

  3. Gravatar of Bill Woolsey Bill Woolsey
    10. April 2009 at 01:53

    The problem for a small open economy is their foreign demonanted debt. By assumption, nominal incomes remain steady, but debts denominated in foreign currencies increase in value when the currency depreciates.

  4. Gravatar of Alex Golubev Alex Golubev
    10. April 2009 at 06:19

    i always thought the primary PURPOSE of devaluations was to affect the demand for good and services and NOT to become more competitive vs other countries. It amazes me that anyone even tries to bring up the international environment first. If noone devalues, we’ll turn japanese, if everyone devalues, the last person to do it will suffer the most (when adjusted for all other variables). it’s the bandaid time/pain tradeoff decision. That however doesnt’ capture the self-reinforcing possiblities… i’m all for devaluations, but don’t even think about confiscating my gold.

  5. Gravatar of Thruth Thruth
    10. April 2009 at 07:30

    (These thoughts are a little on the hastily conceived side, but thought I’d throw them out there)

    The monetary policy objective in all countries, big or small, should be maintaining a stable inflation rate (realized and expected) using clear and credible rules/targets. The only constraints on such a policy appear to be political, motivated by pandering to interest groups.

    Policy ambiguity creates uncertainty and results in picking winners and losers by delivering random subsidies through time. Presumably, the ECB is representing the views of nations that are net long Treasuries: they clearly don’t want a USD devaluation. With the Fed’s history of commitment to some approximation of an inflation/NGDP target, the currency risks to USD debtholders should have been obvious, readily priced and hedged. aka It’s their own stupid fault for buying Treasury securities at near-zero yields.

    More broadly, I think the unwillingness of central bankers to devalue smells of: (a) an addiction to cheap credit; or (b) capture by bond holders.

  6. Gravatar of ssumner ssumner
    10. April 2009 at 11:18

    I am pleasantly surprised by these comments–I thought you might regard the post as a bit too off the wall.

    Devin, Your idea is probably not going to happen, but even though my instincts tell me it is not the best option, I don’t want to dismiss it either. In some ways this is a better version of “depression economics” than what is being promoted by Paul Krugman. Krugman’s insight is that when there are lots of underutilized resources, the opportunity cost of using them is less than the wage. The problem is that the actual government projects may have little value (bridges to nowhere.) Under your idea at least people would buy stuff they wanted. So while I don’t think it would end up being my first choice, it has every bit as much right as Krugman’s idea to be part of the conversation. BTW, I forget to mention Singapore’s interesting fiscal stimulus, which is directly aimed at unemployment. They usually run big fiscal surpluses. This gives them the ability to cut payroll taxes in a recession, to boost employment. It’s like a devaluation for a small nation, but without the inflation effect as long as they usually run surpluses.

    septizoniom2, Thanks.

    Bill, Yes, dollar debts could be a problem. Ironically I just taught that issue in class, then forgot to mention it. That may be another advantage to Singapore’s approach, discussed above.

    Alex, I agree. And I forgot to mention that our 1933 devaluation boosted growth so much that imports actually rose more than exports. The only reason to ever devalue is to avoid falling NGDP, not to fix a lack of competitiveness.

    Thruth, I mostly agree. I don’t know all the reasons why countries like China hold so many dollars (as compared to other currencies) but it is their choice.

  7. Gravatar of Mark Mark
    11. April 2009 at 06:53

    “And yet all currencies can depreciate at the same time””against goods and services. And isn’t that what we are trying to do, boost AD?”

    Isn’t there a problem focusing on AD in a country with such a wide wealth disparity as the US? It seems to me that we have a very large cohort that now struggles with non-discretionary expenses such as food & fuel. Even with a vicious recession we still have $50 oil and crop prices well above historical averages. Monetary policy can devalue currencies against goods and services but it cannot control which goods and services inflate. That will be driven (at least in part) by where money feels safest. With so many asset classes “tainted” and a large and growing buyer (China) of commodities I think we run a real risk of achieving 2% inflation via $150 oil. In that scenario, we may revive AD but wouldn’t we also push a large segment of the population below basic living standards and engender some sort of revolt?

  8. Gravatar of Mark Mark
    11. April 2009 at 07:41

    One more question: as someone who is a big believer in market-based signals what do you make of the fact that the TIPS implied CPI rises to over 2% in years 5+? The 5-year CPI expectation is about 0.6% I believe, and the 10-year is about 1.4%. Using simple arithmetic that means the 5-10y implied CPI is 2.2%. Hasn’t the Fed achieved its goals according to the market?

  9. Gravatar of ssumner ssumner
    11. April 2009 at 15:52

    Mark, Second question first. The market is saying that 5 years out they expect monetary policy to be back on track. I agree. It’s the next 5 years I am worried about. We need 2% inflation embedded in the five years TIPS, not 0.6%.

    If you told me that oil would be $150 next year I’d be thrilled, as it would mean a high real oil price, which indicates strong growth. I know you think that high prices hurt the lower classes, but ask yourself this question:

    Are the poor better or worse off than a year ago?

    If they are worse off (as I believe) then they would benefit from expansionary monetary policy boosting AD. If they are better off with $50 oil, as you seem to think, then we don’t have an economic problem at all, we have a solution. The solution to poverty is a depression, which will make things cheaper. You are probably thinking that it would be nice to have the best of both worlds, full employment and depression era prices. But that can’t be done. The poor have much more to gain from the jobs in a booming economy than they have to lose. The last few years of Clinton were very good for the poor.
    By all means let’s try to lower the cost of living for the poor, by eliminating occupational licensing laws, by deregulating health care (I think we could cut health care costs in half.) By reducing regulation, frivolous lawsuits. By introducing competition into public schools, etc. But you can’t solve poverty with easy money (has some have argued) nor can you help the poor with deflation induced by tight money.

  10. Gravatar of bob bob
    12. April 2009 at 08:17

    hmm… I understand -in theory – why you would not mind seeing inflation in oil and commodities, but in reality I think it is a horrible horrible situation that should be avoided at all cost. Remember in Spring ’08 when Bernanke was ‘successful’ in raising inflation/devaluation expectations. Did the resulting froth in the oil market help or hinder the economy? Jim Hamilton sees it as the gut-punch that drove the economy towards outright deflation and I tend to agree.

  11. Gravatar of ssumner ssumner
    13. April 2009 at 10:49

    bob, I differ with Hamilton on the early 2008 issue. NGDP grow was sow, indicating that monetary policy was not expansionary. I believe the dollar fell becasue of the subprime crisis–foreigners lost interest in our worthless mortgage bonds. Part of the oil story was developing country demand causing prices to rise even in euro terms. Another part was a weak dollar due to the subprime crisis, very little was easy money. With only about 3-4% NGDP growth, money was certainly not too easy.

  12. Gravatar of Mark Mark
    14. April 2009 at 09:43

    I still am not sold on the point that the specifics don’t matter as long as NGDP is growing.

    What if instead of buying $1 trillion of treasury securities the Fed performed QE by buying $1 trillion of oil futures. In theory this would restore the price level and therefore employment. Do you really believe that?

    What if instead of buying $1 trillion of oil futures, the Fed put out a purchase order for $1 trillion of teddy bears. We would build a massive teddy bear industry, everyone would be employed, and we’d all be OK?

    I’m guessing your argument will be that those are market distortions and by buying treasury securities the Fed avoids that. However, that seems to just send a different distorted market signal (i.e., go build too many homes or create too many financial products).

    As a practicioner I just can’t help but think the specifics of where credit flows and relative asset prices really matter.

  13. Gravatar of ssumner ssumner
    14. April 2009 at 17:52

    Mark, I agree it would matter for the specific goods market if you bought a specific good. But it wouldn’t matter much for the rate of NGDP growth, which is my concern. I was thinking of merely different kinds of bond purchases. But you point is basically valid.

    BTW, in my post today I emphasize that I don’t favor such massive purchases. For realistic size bond purchases there would be no significant effect on the allocation of capital. Many people wrongly believe the Fed shoveled lots on money into housing during the early 2000s. That’s totally wrong. Foreigners shoveled lots of money into housing.

  14. Gravatar of Mark Mark
    15. April 2009 at 03:50

    I would argue that is was the banks that shoveled lots of money into housing. Yes, it was largely foreign capital, but the banks could have sold them anything provided it was reasonably liquid and stamped with a credit rating. The Fed did help create a culture of yield-chasing via the implied put on asset prices (since so much credit now flows into financial assets we really cannot separate a “put” on economic growth from a “put” on asset values).

  15. Gravatar of ssumner ssumner
    15. April 2009 at 18:10

    Mark, I wish there was a put on economic growth!! (I’m just joking here, I do understand your point.) I don’t claim to have all the answers regarding our financial system. I understand the moral hazard, and I suppose the better the job the Fed does in stabilizing the economy, the more leverage banks will try to develop. But what’s the answer? We could create lots of depressions so that banks took less risk. But when we did that in earlier history the voters turned the country over to the statists. Or we could regulate the banks better. I suppose that would be better than depressions, but I don’t know whether regulation is likely to work either. We could try to use monetary policies to pop bubbles, but the last time we did that was 1929. I don’t think there are any easy answers. I hope that what just happened was something of a flute (despite what many believe, the villains did lose a lot of money.) I guess I am sort of hoping they learned a lesson. But only time will tell. In any case, with better monetary policy this financial fiasco would have been far less severe, a point I make often, but is easy to overlook

  16. Gravatar of Clayton Clayton
    21. April 2009 at 18:46

    I haven’t read a lot of the technical literature, but I think there are a couple easy and strait forward points when dealing with open (and particularly small export) economies.

    For thoroughness, PPP (purchasing power pairity) is complete crap. In anything remotely like objective (or perhaps globally indexed) terms, an economy that’s creating 10 houses in one year may be producing a lot less “real” value when they produce 10 houses in the next year. If you want to see a simple model, I’ll refer you to Knol I put together a while back:

    I had to start here because I must clarify that, when I speak of “real”, I mean something like an “objective” global index as a reference:

    The key is to start by thinking of the real economy. Take a simple two country model, with the US and a diamond exporter… but focus on construction workers in the economy when the US economy slows:
    – in the US, equilibrium construction wages fall somewhat and demand for diamonds falls faster/further
    – in the Exporter, without diamond exports to provide real income to the economy, the real value of construction and thus the real wage of a construction worker must fall even further

    A breif aside to clarify why the debt load, while mentioned, is actually irrelevant. When you think in strictly real terms, you realize that the real value of output (and thus the real tax base) in the exporter will crash no matter what monetary policy is instituted. If you devalue, the nominal value of debt (denominated in another currency) will rise. However, maintaining currency strength doesn’t fix the problem since real and thus NGDP will crash.

    With that in mind, the only REAL effect that you need to consider is a situation where the economy is running at less than 100% — which reduces the real tax base.

    So… if you accept that downward wage rigidity is a key problem that drives unemployment (or heck if you were NGDP indexing directly), then:
    – the value of the US dollar needs to fall slightly
    – the value of the exporter’s currency must fall even further

    This is not possible under a dollar-pegged scheme. Instead, massive underutilization of capital and labor would further reduce the real tax base of the exporter. You’re essentially locked into a huge fall in wages. Since this is really a deflationary policy, you’ll also contract the tax base by reversing the tax-distortions of inflation.

    Instead, it’s better to float your currency and manage it to your overall economic goals — requiring substantial devaluation. In fact, when you add in the tax distortions due to modest inflation (which benefit the government), debt service is actually doubly-strengthened by targetting low wage inflation and full employment – thus substantial devaluation.

    In reality, devaluation isn’t begger thy neighbor. In fact, I prefer to show the whole system as:

    Good A Currency A Currency B Good B

    If you assume that Good A&B and Currency A&B all have real values, then prices and exchange rates should adjust (in the long run) based on those real values. If money were truly an “illusion”, it literally wouldn’t matter. The only reason our choices matter are things like downward rigidity and distortions from tax policies.

    Of course, since PPP doesn’t hold, the relative value of Good A and Good B can shift even if they’re the same good. That’s one of the major reasons (the index definition is another) why, a change in exchange rates isn’t necessarily directly correlated to the differences in inflation rates.

  17. Gravatar of Clayton Clayton
    21. April 2009 at 18:49

    Unfortunatly, this system stripped out some characters in my model between various real units… it’s supposed to be (hopefully this works)

    Good A Currency A Currency B Good B

  18. Gravatar of Clayton Clayton
    21. April 2009 at 18:50

    I give up… there’s supposed to be:
    – a “price” between the good & currency
    – an “exchange rate” between the currencies

  19. Gravatar of ssumner ssumner
    22. April 2009 at 17:06

    Clayton, Obviously PPP has problems, but in your web site you give the example of a $100 transport cost creating a gap between a good that sells for $400 in one country and $500 in another country. But if the exporter sees the cost of production rise by $50 then the price in the home country rises to $450 and the price in the foreign country rises to $550. Now you might say that even that form of PPP (rates of change) doesn’t work very well in reality. And I would agree. But that suggests something beyond transport costs may be at work here, and I don’t claim to know what it is. All I know is that deviations from PPP are surprisingly large–even deviations from the rate of change version

  20. Gravatar of Clayton Clayton
    23. April 2009 at 06:40

    Well I use transport cost on a product just as a simple illustration because the Knol is designed for a non-technical audience and this is adequate to make the point. If you follow it further, the “transportation cost” of:
    – most services is exceptionally high (even tourism)
    – non-durable goods (like food) is relatively high

    So plenty of untraded products/services are unlinked except in their tenuous relationship to the exports.

    The relative value of goods is also influenced by trade/credit balances… which breaks a “rates of change” PPP. As the US increases its savings proportions, we would expect the value of its local goods to fall relative to the goods in exporting countries (i.e. we would anticipate dollar weakness, inflation being equal).

    In a multi-good world, import/export of marginal products would end once their relative prices fall below the shipping-cost threshold. Thus, the gap between some goods will fall. Other goods whose (closed economy) price disparity remain marginally above the transportation cost will continue to “anchor” the relative currency values. This would, all things being equal, cause an overall contraction in price disparities (i.e. opposite rates of change).

    The last big attack on PPP is illustrated by a simple thought experiment with “swimming” and “skiing” for two different parts of the country. Swimming in florida is cheap (basically the cost of transport to a shore). Swimming in the mountains of colorado is expensive, requiring construction of indoor facilities, heating, cleaning, etc. The opposite would be true for skiing (as Florida could build an indoor skiing slope like they have in Japan at great expense). There’s no reason to expect any of these costs to be interrelated — so a simple version of PPP doesn’t even work within a currency.

    Even worse from a econometrics standpoint, there’s no easy way to compare the utility from the two activities. The skiiers, despite a higher per-hour cost for their activity, may get more utility — any index that included both activities in some arbitrary proportion would be shear guesswork.

    Of course, the details of PPP weren’t critical to the subsequent argument about devaluation except to clarify that construction workers can continue to build the exact same number of houses in the diamond exporting country… but produce far less “real” value. This is counterinuitive to the usual definition of “real” which might imply that a house is a house is a house independant of money or exchange rates.

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