Tag: Macroeconomics

A Second Globalization Features The Great Convergence

In previous blog postings (here and here), I have addressed some of the key myths regarding international trade as well as the difficulties in determining whether U.S. exchange rates are over, under, or fairly valued.  This posting addresses how the forces that drive globalization have changed and so has the distribution of income (in both global and advanced country terms.)  Richard Baldwin’s new book The Great Convergence suggests that a major change in the forces of globalization took place around 1990.  He divides economic history into three broad periods: pre-globalization (until 1820), globalization I (1820 to 1990), and globalization II (from 1990 to the present.)

The graphic above (from a recent Baldwin’s presentation)  displays the three primary forces that affect the magnitude and character of globalization. For further analysis including Milanovic’s “elephant” chart on the global distribution of income, see the full posting here.



Are U.S. Exchange Rates Too High, Too Low, or Just Right?

Currency exchanges rates between any two countries are determined by a variety of factors including their balance of trade and payments, capital flows (both restricted and unrestricted), and monetary policies.  In a recent posting on Conversable Economics, Timothy Taylor argued that “all exchange rates are bad” (meaning that they generate some negative consequences.)  Although this posting does not take issue with Taylor’s arguments, I conclude that there is no one optimal set of exchange rates, since for any given set, there will be winners and losers, and trade-offs among policy objectives must be made. In short, there is no unique way to determine which exchange rate between countries is “just right.”

Exchange rate policy and monetary policy are intrinsically linked.  Countries face what has been called the “Impossible Trinity” or “Trilemma”; they can only choose two of the following: independent monetary policy (setting short term domestic interest rates), fixed exchange rates, and open capital markets.  Thus, a country’s desire to float, fix, manage, or abandon how the price of its currency relates to others depends critically on its views toward monetary policy and the flow of capital into and out of the country. Stated differently, to some extent, all countries (including the U.S.) manipulate their exchange rates by the judgments they make about the trade-offs among the three choices.

Tim Taylor argues that all exchange rates have some negative consequences:

  • If they are too low, they hurt net importers.
  • If they are too high, they discourage foreign direct investment and net exporters.
  • If the rates are too volatile, then the increased uncertainty will reduce economic activity.
  • If they are too stable, they can easily deviate sharply from what is needed to balance supply and demand for currencies.

As Taylor puts it, “the bottom line is clear as mud.  Exchange rates are bad if they move higher or lower, or moving, or stable.”

For more detail including attempts to empirically answer the question for the U.S. posed in the title go here.

Monetary Policy in an Age of Radical Uncertainty

Central bankers in all major developed economies have adopted NIRP, ZIRP, or near ZIRP policies.  The Bank of Japan and the European Central Bank now “offer” negative interest rates (NIRP) on reserves and project to do so for the foreseeable future.  The Bank of England and the Federal Reserve Bank of the United States remain committed to targeting interest rates slighted above zero (near ZIRP).  10 year government bonds offered by these countries range from -0.225% in Japan to -0.027% in Germany to 1.57% in the U.S. Such policies are not consistent with sustainable economic growth. See Professor Gerard’s previous posting on the pervasiveness of such interest rates.

In a recent book entitled The End of Alchemy, former Bank of England Governor Lord Mervyn King argues that the policies we have employed in the past (and present) to stabilize our economies – such as keeping interest rates low until economic growth returns to its long term rate or unemployment falls below some designated benchmark (full employment? natural rate of unemployment?) – are inconsistent with sustainable economic growth.  Furthermore, he suggests that central bank and regulatory policies adopted post Great Recession (December 2007 – June 2009 in the U.S.) fail to address the potential for a repeat of the financial failures witnessed during that period. Among other points, King observes the following (for more in depth comments on King’s insights go here.)

  1. In the contemporary world economy, many shocks to the economy are unpredictable; thus, one cannot use probability-based forecasting models to design policy to stabilize economies.  (King calls this radical uncertainty)
  2. Policies designed to stabilize economies in the short run, such as aggressive monetary and fiscal policies, leave a residue inconsistent with long run economic growth unless stagnation is viewed as the desired norm. For King, policymakers face the stark trade-off of short term stability for long term sustainable economic growth.  In contrast to Keynes, in the long run, we are NOT all dead.
  3. In contrast with central banks as “lenders of last resort,” King offers the innovative idea of “pawnbroker for all seasons” as a constructive substitute.  Banks would know in advance what their liquid assets will bring them in terms of central bank conversion to cash.

Each of the above points demonstrates how King views central banking and bank regulation in a world characterized by radical uncertainty.  In short, policy makers need to find viable coping strategies to reduce the downside cost of economic recessions in general and financial meltdowns in particular. With radical uncertainty, the “forward guidance” offered by central banks lacks credibility and fails to address such uncertainty.   In the words of Michael Lewis ( of Liar’s Poker, Moneyball and the Blind Side fame), “if his book gets the attention it deserves, it might just save the world.” (

GDP: Useful Construct or Weapon of Mass Misdirection

Estimates of GDP growth vary widely (often well over 1 percentage point) from the initial one (typically at the end of the first month after the quarter) to a final one (up to a year later).  This post addresses such variation and the debate about whether it arises from measurement error or definitions based on contemporary politics.  No matter which view you might hold, it’s pretty clear that macroeconomic policy should not be based on early estimates of quarterly GDP growth.

Last month, the Bureau of Economics Analysis (BEA) reported that 2nd Quarter 2015 GDP had increased by 3.7% (in annualized terms.)  Its first estimate (in July) was 2.3%.  For the first quarter of 2015, we now have three estimates: earliest +0.2%, 2nd -0.7%,  and most recent (August) +0.6%. In short, we can’t easily tell whether the economy grew or not.

Some of you may recall that GDP can be calculated in three ways:  1) the sum of what it would cost to purchase all goods produced in the US for final sale, 2) the income paid to all factors of production in the U.S. plus depreciation and indirect business taxes, and 3) the sum of all values added.

Typically no one calculates the third but recently, the BEA has begun to provide the income-based measure.  For the first quarter of 2015, the second estimate was 0.4% after an initial estimate of 0.1%.  For the second quarter of 2015, the only estimate of growth of gross domestic income was 0.6% (well short of the 3.7% GDP growth estimate cited above.)

GDP ResidualThe difference between income based and expenditure based methods, as reflected by the residual (in red) in the above chart, is far from trivial. The blue line reflects gaps in converting nominal GDP to real GDP.  These were substantial in the past, but appear not to be a problem today. See the St. Louis Federal Reserve’s discussion of this residual for details.

In a recent article entitled “Weapons of Economic Misdirection,” John Mauldin traces the history of GDP accounting and asks whether the changes reflect improved knowledge of the economy – such as updates to inventory, export, and import data – or political manipulation.  Keynes and Hayek disagreed about what to measure and how it should be used, and Simon Kuznets, who created the national income accounts and received one of the first Nobel prizes in economics for his work, disagreed with the Commerce Department regarding the same two concerns.

Mauldin refers to and quotes from Diane Coyle’s new book GDP: A Brief But Affectionate History to illuminate the controversy.  I encourage you to read Mauldin’s posting.

I’ll give Chinese Premier Li Keqiang the last word (especially with reference to the accuracy of Chinese GDP estimates – which seem to matter to many investors in the U.S.) “Chinese economic statistics are ‘man made’ and, apart from the numbers for electricity use, bank lending and rail freight, are for reference only.”  Gives you great confidence, doesn’t it?



The FOMC (Federal Reserve Open Market Committee) Meets at Lawrence

No, this is not April Fool’s Day.  Tomorrow’s Money and Monetary Policy class  will host Lawrence alum and Federal Reserve

Jim Lyon

Bank of Minneapolis’ First Vice President Jim Lyon (9 – 10:50, Briggs 217).  During the first hour, Lyon will discuss the Dodd-Frank Financial Reform Act passed in 2010.  He will detail how far along the implementation process is as well as what we can expect to happen.

During the second hour, Lyon will put on his “Ben Bernanke hat” and chair a shadow meeting of the FOMC. Students in the class will present the views of the other members of the Board of Governors of the Fed as well as those of the bank presidents of the 12 regional Federal Reserve banks.

You are welcome to attend these awesome proceedings.

What Will Happen if the Treasury Runs Out of Cash as a Result of Reaching Its Borrowing Limit? The President Will Have to Break the Law. The Only Question is Which Law.

In  yesterday’s Economix blog, former Reagan and GHW Bush administrator Bruce Bartlett addressed the possible options.  Below is a crisp summary of the details.  Read his full post for more.

1. The debt limit is public law.

2. Appropriations (passed by the Congress) are also public law.

3. Entitlement programs (such as Social Security and Medicare) are public law.

4. The Prompt Payment Act, which requires that obligations be paid when they come due, is public law.

Result:  something has to give.

5. Treasury can’t easily determine which bills to pay or not pay. It does not have sufficient information to determine priorities.  Various departments and agencies would need to set such priorities.  This, however, would be difficult since it would take time to do so and many staff members required to provide input have been furloughed.

6. To enable prompt payment, Treasury has established processes “to make payments when they are due, whether the cash is there or not.”

7. As a result of point 6, obligations are likely to be paid in order of due date as cash becomes available.

8. If 7 holds, some bondholders will experience a delay in receipt of payment, but this means the security would be classified as “non-performing.”  As Bartlett puts it.

Treasury would now be in default, and defaulted securities cannot be traded, accepted by the Federal Reserve as collateral, or held by money market funds.  In a note published on Oct. 5, Goldman Sachs said money managers are forced to dump Treasury securities before October 17 to avoid being stuck with securities that could not be traded.

9. Section 4 of the 14th Amendment to the Constitution provides a rationale for the president to override debt limit legislation.

10. President Obama has said, on numerous occasions that he will not use the authority granted by the Constitution to get around the debt limit set by Congress.

Result:  At best, uncertainty predominates.  At worst, Treasuries are not accepted as collateral by many financial managers and organizations.  I’m not sure which game theory structure applies –  Help, Professor Galambos.  Some have characterized the situation as a  game of chicken – who will give in first.  My conclusion is that  it is a negative sum game in which the magnitude of the losses in the resultant payoff matrix swamps the few available positive results.

Conclusion:  This is a game that should be avoided.  Will it be avoided?  I hope so.

Summers v. Hubbard

The Sunday New York Times has a contrast of Larry Summers and Glenn Hubbard on our collective economic future.

Summers is a past president of Harvard and economic-adviser extraordinaire to President Obama.   Hubbard is the dean of the NYU Business School, and star of this ‘stinging’ sendup of Ben Bernanke.

Neither lacks confidence, that’s for sure.

Will the US Economy Continue to Grow at 20th Century Rates? Robert Gordon and Eric Brynjolffson Square Off in a Lively Debate

This week Lawrence will be hosting a TEDx conference on re-imagining liberal education.  Thanks to Professors Galambos and Gerard, and a few other colleagues from other departments, this live discussion will be video streamed for all of us to watch.

Earlier this month, another TED conference took place.  This one featured economist Robert Gordon (Northwestern) and Eric Brynjolffson (MIT).  Some of you will be familiar with the arguments.  Those who took Capital and Growth last year read Gordon’s paper on the headwinds that will drive economic growth back to the level experienced prior to the first industrial revolution in the 18th century in England.   Gordon believes that our most productive innovations are behind us and innovation will be insufficient to enable us to sustain the 2% per capita real growth of the 20th century.

Some of you may recall the discussion we had in one of our reading groups of Brynjolffson and McAfee’s book, Race Against the Machine. In his TED talk, Brynjolffson explains why innovation is far from over and that we have the potential to continue the rate of growth of economic prosperity that we experienced in the 20th century.  Of course, the challenge, as he puts it is: “can we race with the machine?”

View both talks as well as a follow-up debate between these two economists here.

Inflation Is Your Friend!

This view point has been recently propounded by Japanese Prime Minister Shinzo Abe and his protege (puppet?) Haruhiko Kuroda,  selected to be in charge of the Bank of Japan.  Japan is tired of two decades of stagnation and falling or at least not rising prices.  Mr. Abe has pushed for a 2% inflation target and Mr. Kuroda will provide $77 billion worth of monthly bond purchases to achieve that goal.  If that’s not enough, will more be forthcoming?  Is a little good and more better?

Inflation as a cure for economic ills is not new.  In fact, check out this 1933 video on the how inflation is good for everything and everyone.  Clearly, proponents of Neo-classical macro beg to differ.  Those in Econ 320 will have a chance to sort out the winners and losers.  Indeed there will be losers, as we know that there is no free lunch.  Who will the winners be?

1. lenders or borrowers

2.  savers or consumers

3.  labor or management

4. bond holders or stock holders

5.  renters or buyers

6.  government officials or Wall Street tycoons

Place your bets now or maybe just guard (cover?) your assets.

Whatever else you do watch the video?  It’s a hoot.

The Fiscal Cliff Averted?

Yesterday, Congress passed legislation designed to avoid the strictures Congress enacted in the summer of 2011 to enable the United States government to borrow in excess of the existent debt ceiling.  These provisions would have allowed the income tax cuts enacted in the George W. Bush era to expire as well as imposed spending limits on defense and discretionary non-defense spending.

There are numerous provisions in yesterday’s bill, summarized by the White House here.  The Congressional Joint Committee on Taxation estimates the increased revenue from the bill to yield $62o over 10 years, far short of the 4 trillion dollars some estimate will be need to generate a sustainable level of debt.  Furthermore, the debt ceiling and expenditure components of the “cliff” will remain subjects of political debate for at least the next two months when further action will be required.  In short, we have  “kicked the can down the proverbial road” again.


Bruce Bartlett, in a New York Times Economix posting yesterday, offers little in the way of enthusiasm regarding the political feasibility of making serious headway in addressing prospective budget deficits now and in the near future.  His argument parallels the time inconsistency argument that  earned Edward Prescott and Finn Kydland the Nobel Prize in Economics in 2004.

The Congress that raises taxes and cuts benefits will suffer politically, while the benefits of lower deficits will accrue to future Congresses.

He goes on to argue that

Historically, what has moved Congress to enact big deficit-reduction packages was the prospect of quick improvement in terms of inflation, growth and interest rates. Given that deficit reduction today is very unlikely to improve any of these in the near term, deficit hawks lack any real payoff from a grand bargain.

Inflation has been low and stable as has expected inflation.

Even though expected inflation has been stable or declining for the past decade, real interest rates for treasuries (see chart below) – market rates minus expected inflation – has been negative for much of the past decade with the exception of the brief positive values in 2005 – 2007 and with expected deflation in late 2008.  If real interests are negative, the crowding effects of public sector borrowing are non-existent; thus, the cost of running deficits has not “spooked” the markets.  Of course, permanent negative real interest rates are not sustainable since few lenders will continue to offer their savings in exchange for reduced future consumption.

In the famous song from The Lion King, Hakuna Matata – there are no worries or no problem.  Of course, such attitudes last only as long as those who lend money to the US government continue to do so.  As Reinhart and Rogoff argue persuasively in This Time is Different: Eight Centuries of Financial Folly, this time is not different.  Financial excesses and repression eventually must be paid for.  We just don’t know when or how severe the price will be.

ZIRP: The New Free Lunch? Don’t Bet on It.

The Federal Reserve Bank of the US has followed a zero interest rate policy (ZIRP) since fall 2008.  It has employed a variety of mechanisms to lower not only overnight loans between banks (the Federal Funds rate – its usual target) but also to lower the entire yield curve. (See the details at the Federal Reserve Bank of St. Louis.) Previous postings here and here have addressed some of the costs of this approach.


Yesterday’s Financial Times contains some historical evidence consistent with the idea that ZIRPS are not free.  John Plender argues that experience in Japan over two decades indicates that very low interest rate monetary policy did significant structural damage to the Japanese economy.   In addition to creating a very low cost of capital, excessive monetary ease tends to lock-in the existing industrial structure or as he argues

“…from the Austrian perspective of Von Mises, Schumpeter, and Hayek, the Japanese bubble that burst in 1990 fostered economic distortions they dubbed ‘malinvestments’ – credit driven investments in real capital that prove loss making when a credit bubble implodes.”

As a consequence, Japan impeded  “creatively destructive” economic activity since “zombie” companies were kept alive by cheap credit that was not available to new entrants.  Capital allocation became very distorted; hence, many profitable opportunities were foregone and low return (perhaps even negative return) activities remained in existence.

Of course, that was Japan.  Not the U.S.  That couldn’t happen here, could it?


Economic Recovery: How Slow Has Our Recovery From the 2007-2009 Recession Been?

Much political debate – more appropriate described as hot or even toxic air – attempts to address how poorly the economy has recovered from what Reinhardt and Rogoff call The Great Contraction.  As noted in Professor Gerard’s recent post, R and R argue– as they have done many times before – that recoveries from balance sheet or financial crisis recessions are much slower than those related to “garden variety” declines in aggregate demand.  So what does the current recovery look like?  One way to answer this is to view the four major indicators that the National Bureau of Economic Research’s Business Cycle Dating Committee uses to identify the beginning and ending points for recessionary and expansionary periods.  Fortunately, our friends at the Federal Reserve Bank of St. Louis have done all the hard work.  As can readily be seen below (or more clearly here), industrial production and real retail sales have grown roughly in line with the average of past recessions.  Real income started to grow similar to past history, but for the past 18 months growth has slowed markedly.  The employment growth pattern, however, has shown the least responsiveness to the medicinal help provided by the Federal Reserve and other governmental policies.    This suggests that “financial crisis” related recessions require both more time and different policies than demand deficient recessions not induced by too much debt.  I will have more to say about why in future posts.

Regulating Wall Street: Did We Go Too Far?

Lawrence alum Elijah Brewer will address the above question in the next Economics Colloquium.  It will take place next Monday, October 8th, in Steitz Hall 102 at 4:30.  We encourage all to attend.

Brewer characterizes what he will argue as follows:

The causes of the financial crisis of 2007-09 are many and varied. Indeed, the crisis may be viewed as the product of a perfect storm. This address will discuss many of the popular causes of the U.S. crisis and enumerate their more important sins. It then presents the traditional way we like to think about commercial banks, and how that had changed leading up to the financial crisis. Indicators of stress in the financial system, and commercial banks in particular, are presented. What you will see is that many of these indicators were flashing red well before regulators got their hands around the problem. I will argue that it was not the lack of regulation, but a lack of will by regulators to enforce the rules that were already on the books.  Thus, the government’s and Congress’s desire to regulate Wall Street is mis-placed. The banking industry does not need more regulation for the regulators to ignore when it’s convenient for them to do so, but we need a greater will by regulators to enforce the regulations that they do have. I will conclude by offering an assessment of the Dodd-Frank Act.

Simplicity vs. Complexity : It’s Not That Simple

Everyone knows that the Dodd-Frank law passed in 2010 to regulate the financial industry is incredibly complex.  As those who took  Money and Monetary Policy last fall learned from alum Jim Lyon, it will take years just to write the implementation provisions.  Furthermore, these provisions will be influenced significantly by those (especially in the banking industry) whose behavior will be affected.

Andrew Haldane, in the most recent Kansas City Federal Reserve Bank symposium in an article entitled “The Dog and the Frisbee”, argues that such complexity is far from optimal in an economic environment in which uncertainty prevails.  He uses the concept of uncertainty in the same way that Frank Knight and John Maynard Keynes did almost a century ago; that is, situations in which assessing the probability of different outcomes is quite low and that risk cannot be easily measured and therefore, hedged against.  Haldane argues for simple rules, such as existed under the Glass-Steagall Act which forbids the mixing of commercial and investment banking.

In a recent blog entry on the EconoMonitor, Ed Dolan analyses this argument in terms of Goodhart’s Law, which suggests that as soon as a particular indicator becomes an explicit policy variable, it loses its predictive power because economic agents change their actions in response to expectations of the  authorities using this indicator for policy action.  Some of you might recall this as a variation of the Lucas critique of traditional monetary and fiscal policy actions.

All of the above is prologue for our next Economics Colloquium to be held next Monday.  Our visitor, 1971 Lawrence alum, Elijah Brewer, will address the topic “Regulating Wall Street:  Did We Go Too Far?”  Be sure to come to his talk at 4:30 PM, Monday, October 8th in Steitz Hall 102.


Great Stagnation or Leap Forward? Which will it be?

In a recent article in Forbes, contributor Nick Shulz asks what the “new normal” for economic growth in the U.S. will be. On one side, we find Tyler Cowen (The Great Stagnation) and Robert Gordon (“Is U.S. Economic Growth Over?…”) arguing that the technological low hanging fruit have been picked and that the future will feature economic growth similar to what existed before the industrial revolution (that is, well below 1% per year.)

On the other side of the debate, Race Against the Machine authors Bryjolfsson and McAfee and authors of the new volume The 4% Solution, published by the Bush Institute, suggest that the future will be brighter than the past.

Which do you believe?  On which future would you bet? Why?


Scary Stories (to Tell in the Dark)

In Monday’s Financial Times – of course, no US newspaper would publish it – Stephen Roach, former chair of Morgan Stanley Asia and present senior fellow at Yale University, describes a scenario that might take place if 1) Mitt Romney is elected and 2) he follows through on what he said would be his first order of business.  I encourage you to read this opinion piece in full.  Here are the pertinent details.

1. Romney declares China guilty of currency manipulation.

2. Romney proposes and Congress passes the Defend America Trade Act of 2013 (DATA2013 for short.)

3. Negotiations between the US and China fail so the US slaps a 20% tariff on all Chinese products entering the US.

4. Beijing interprets this action as economic warfare and files a complaint with the WTO.

5. Not willing to wait until the WTO dispute process plays out and given the large number of plants closed in China, China’s Ministry of Commerce introduces a 20% tariff on all U.S. exports (roughly $104B worth in 2011.)

6. Walmart announces average price increases of 5% and other retailers follow suit.

7. The Fed extends its commitment to zero interest rate policies to 2015 (ZIRP.)

8. Financial market swoon, and Romney and Congress up the tariffs on China by another 10%.

9. China publicly announces it will no longer buy US treasuries.

10. Both the US and Chinese economies tank.


Is this scenario just the ghosts of Smoot and Hawley (authors of the infamous Tariff Act of 1930) arising to exhort their contemporary counterparts in Congress or is this just a nightmare that will fade when Stephen Roach and I wake up?

This is clearly the “dark” side of public policy making.  But, where’s the “light” or enlightened side? I don’t see any.


Paul Krugman – The Economist Pushes Through

For most of his editorial postings, Paul Krugman’s opinions are political in character and offer limited if any economic analysis.  In today’s posting in The Conscience of a Liberal , Krugman demonstrates why his insights are worthy of a Nobel laureate in economics.  In particular, he discusses what the literature on optimal currency unions has to contribute to discussion of the Eurozone.  He draws insights from economists of various stripes regarding the necessary criteria for a successful currency union and how the Euro falls well short of what’s needed.

In summary, optimum currency area theory suggested two big things to look at – labor mobility and fiscal integration. And on both counts it was obvious that Europe fell far short of the U.S. example, with limited labor mobility and virtually no fiscal integration. This should have given European leaders pause – but they had their hearts set on the single currency.

He notes that most economists forecast that the Eurozone would have problems holding together given the above criteria.

So optimum currency area theory was right to assert that creating a single currency would bring significant costs, which in turn meant that Europe’s lack of mitigating factors in the form of high labor mobility and/or fiscal integration became a very significant issue. In this sense, the story of the euro is one of a crisis foretold.

Krugman does provide some options for Europeans to consider but isn’t optimistic that this political project will succeed.  In short political will or perhaps wishing thinking is not enough.  The economic fundamentals can’t be ignored.

The creation of the euro involved, in effect, a decision to ignore everything economists had said about optimum currency areas. Unfortunately, it turned out that optimum currency area theory was essentially right, erring only in understating the problems with a shared currency. And now that theory is taking its revenge.