global financial crash yay!

[vimothy]

Wait a sec, by double entry bookkeeping definition, Canada's BOP must sum to zero--right? (I.e., give or take central bank operations, a current account surplus equals a capital account deficit).

The MMT stuff doesn't seem inconsistent with your story, assuming I understand it. It's a question of getting the accounting right. So China's large trade surplus is offset by its net capital account deficit position, which is the savings glut you allude to, creating a capital account surplus in the US and an offsetting current account deficit. Ceteris paribus, if the Americans are buying net Chinese imports, the Chinese must be net acquiring US financial assets. If you close the model at the level of the state, sectoral balances must sum to zero. If you close the model at the international level, the logic remains the same (balances sum to zero), but the sectors have changed and expanded. It is possible in an open economy, then, to run net surpluses within a country and not experience deflationary or recessionary pressures, but only with offsetting positions in other countries such that AD is sufficient to keep the economy at capacity (e.g. Bernanke's China), or relying on the private sector spending above income, with its capital account implications (e.g. Godley's story about the Clinton era).

 

[rumble]

Wait a sec, by double entry bookkeeping definition, Canada's BOP must sum to zero--right? (I.e., give or take central bank operations, a current account surplus equals a capital account deficit).

Yes, quite right, I knew something was off there. I was thinking of the government portion of the capital account deficit as a reserve account activity, akin to CB operations that would be entered as a separate balancing item, as you note. In a balance of payments crisis some people will say that there is a "balance of payments deficit" that the CB needs to correct, with the CB's activities thought of as distinct from the capital account. I was basically substituting the government portion of the capital account deficit for CB operations, when it should just go under the general capital account. Now that I think about it though, reserve account CB operations probably should just be included in the capital account as well.

The MMT stuff doesn't seem inconsistent with your story, assuming I understand it. It's a question of getting the accounting right. So China's large trade surplus is offset by its net capital account deficit position, which is the savings glut you allude to, creating a capital account surplus in the US and an offsetting current account deficit. Ceteris paribus, if the Americans are buying net Chinese imports, the Chinese must be net acquiring US financial assets. If you close the model at the level of the state, sectoral balances must sum to zero. If you close the model at the international level, the logic remains the same (balances sum to zero), but the sectors have changed and expanded. It is possible in an open economy, then, to run net surpluses within a country and not experience deflationary or recessionary pressures, but only with offsetting positions in other countries such that AD is sufficient to keep the economy at capacity (e.g. Bernanke's China), or relying on the private sector spending above income, with its capital account implications (e.g. Godley's story about the Clinton era).

Yes that sounds about right to me. The problem that occurs is that the imbalances get too large, the US private sector can't sustain enough borrowing without getting completely reckless (subprime), and the U.S. government balks at running a sufficient deficit to support demand. Also, nobody wants to put the debt for keeping the world economy afloat on their own tab, so there's a coordination problem there. That's why there was the big emphasis on coordinated fiscal stimulus across many countries in order to solve the freerider problem. Even still, governments weren't willing to commit to enough deficit spending to get unemployment down, or to confront the underlying problem causing the imbalances.

In a perfect world, floating exchange rates and/or price level adjustment should bring each country's trade balance to a 0 net position over the long run. The Chinese peg when combined with capital account controls, prevents both the exchange rate and the price level in China from adjusting, and consequently prevents the same adjustment (in the opposite direction) from taking place in the United States. The US needs a lower dollar and inflation, but it can't really get either one so long as China continues its current policies. That's why Krugman is calling for tariffs - a good indication of how extreme the problem has become.

 

[vimothy]

So where is this heading? The US government won't step in, the consumer can't, but the Chinese don't seem likely to float the RMB any time soon, or to stop acquiring US paper. So that leaves output, but I don't understand how the distribution is likely to play out given the pegged exchange rate regime and capital account channel, and who then gets the worse terms of trade if that's the outcome. ( What if the US did pick up the tab, what would that look like? How dangerous is a big CAD for the States?)

Also, what about the EMU? Obviously the Eurozone has serious problems, given its unfortunate institutional set up. Individual states are fiscally constrained in ways that seem likely to by highly pro-cyclical in the downturn. E.g., no federal (EU) level debt instrument; its culture (the fact that the EU is already talking up the interest rate on Greece's debt and publicly attacking for its deficit), etc. If you add Japan to the picture, it probably looks like high unemployment and persistent shortfalls of AD in all major economies. Where is the growth going to come from? There is little private sector demand for credit and so monetary policy is moving the yield curve about but not stimulating much recovery. That leaves government spending, incorporating the surplus states, but that is not likely to happen.

Meanwhile, what government spending that exists over and above the norm is swallowed by the FIRE sector, which itself threatens a pro-cyclical reduction in government spending over the norm in order to stay within golden rule type fiscal policy constraints.

 

[vimothy]

Roubini covers some of this stuff here: http://blogs.reuters.com/felix-salmon/2010/01/29/talking-to-nouriel/

Salmon is a bit annoying though.

 

[rumble]

So where is this heading? The US government won't step in, the consumer can't, but the Chinese don't seem likely to float the RMB any time soon, or to stop acquiring US paper. So that leaves output,

bingo. The U.S. (and most of the developed world) is in for low output and high unemployment for the foreseeable future. They are narrowing the trade gap the hard way - by impoverishing American workers, so that they don't buy as much Chinese goods. It's basically the gold standard mode of adjusting for trade imbalances while maintaining a peg, aka barbarism. They don't want to do any more stimulus, because that will just blow out the trade deficit even more under current conditions "( What if the US did pick up the tab, what would that look like? How dangerous is a big CAD for the States?)", not giving them much bang for the stimulus buck, and giving rise to protectionism. They're doing just enough stimulus to keep everything afloat, keeping the US just above deflation, but no more than that. If you want to ascribe generous motives to Larry Summers & co., you could say that their strategy is to just maintain a holding pattern, while the Chinese economy rebalances, and the Chinese allow the renminbi to appreciate. If you want to ascribe more nefarious motives, which I think are more correct, the current policy is aimed at maintaining the value of Wall Street's assets and maintaining favorable conditions for trans-national corporations based in the US to continue to profit via the high dollar (Rubin's high dollar policy aka Roubini's carry trade) - workers be damned. They don't actually want the Chinese to revalue, not just yet anyhow, while there are still easy profits to be made. They are basically trying to buy time, because they actually LIKE the current setup, and would keep it if they could.

To use a stretched metaphor, the world economy with its structural problems is like plane with misconfigured wings. If they try to take off (reach full employment in the developed world), once it gets more than 10 feet off the ground and into the open air, it doesn't have sufficient thrust to stay up, and comes crashing back down to the ground. TPTB have decided to just keep the plane rolling along the ground for now.

Also, what about the EMU? Obviously the Eurozone has serious problems, given its unfortunate institutional set up. Individual states are fiscally constrained in ways that seem likely to by highly pro-cyclical in the downturn. E.g., no federal (EU) level debt instrument; its culture (the fact that the EU is already talking up the interest rate on Greece's debt and publicly attacking for its deficit), etc.

I don't really know a whole lot about the EU, but I'm not a fan of the ECB, and a lot of the policies seem highly questionable (skewed towards German interests, excessively hawkish). In their defense, it seems as though the crisis caught them at a particularly bad time, with Spain & co. in the union, but not yet having made the structural adjustments that would allow them to properly integrate. The other question is of optimal currency zones - whether or not certain countries should even be in the Union in the first place. I think that Roubini over-plays the benefits, and also over-plays the dangers of default & devaluation. I'm not sure what the internal labor mobility dynamics in the EU are like, but as it stands now, I assume that the standard solution would be for southerners (Portugal, Italy, Spain, Greece) to start moving north en masse. I don't know a whole lot about the situation, but my guess is that it would probably be better for Spain, Ireland etc. to exit the Union. If the EU became a full-fledged country, issuing debt, etc. it might be OK to stay in, but right now it seems like they are caught in an untenable middle-ground, and I would rather not sacrifice real output right now for some nebulous gains 20 years down the road.

If you add Japan to the picture, it probably looks like high unemployment and persistent shortfalls of AD in all major economies. Where is the growth going to come from? There is little private sector demand for credit and so monetary policy is moving the yield curve about but not stimulating much recovery. That leaves government spending, incorporating the surplus states, but that is not likely to happen.

They've basically come to terms with low growth and high unemployment in the developed world (of course none of the people making these decisions are actually going to suffer from it themselves). The growth will continue to be in the developing world, as it continues to syphon off demand from the developed, and slowly transitions to higher valued currencies, with adequate domestic demand to support balanced trade... that's best case scenario. Worst case.. no adjustments are made, Wall Street and WalMart continue looting via the carry trade & price level arbitrage, and we get a long drawn-out Japan-like recession. The likely course of events is somewhere in between those two. There are positive signs in China

 

[rumble]

Roubini covers some of this stuff here: http://blogs.reuters.com/felix-salmon/2010/01/29/talking-to-nouriel/

Salmon is a bit annoying though.

I'm a bit ambivalent about Roubini. He's overly free market, business school oriented. His prognostications are skewed towards what is good for business rather than what is good for the real economy. I imagine that he assumes that what is good for business assets is simply equivalent to what is good for output and the real economy. Case in point: Greece defaulting and devaluing. Also it seems as though he doesn't have a firm macro foundation for his views, that they come together in a piecemeal way that is sometimes incoherent, and leads him to make bad calls like the US dollar collapse, and also makes him overly hawkish about deficits.

In terms of popular writers that called the crisis, and more importantly, got all the reasons right, Dean Baker is probably the best:
http://www.cepr.net/index.php/dean-baker/

edit: check out this article in particular:
http://www.cepr.net/index.php/op-ed...olitical-constraints-obstructing-us-recovery/

 

[rumble]

this Krugman post also lays it out the case on the deficit, although he doesn't get into quantitative easing or exchange rate adjustments like Baker, although I'm pretty sure that he is of the same view

"while the freeze won’t be a big deal, it will depress demand during a period in which, according to the administration’s own projections, unemployment will stay very high.

What we’re witnessing is an awesome national failure."

http://krugman.blogs.nytimes.com/2010/02/01/a-depressing-budget/

and a couple more recent ones:

http://krugman.blogs.nytimes.com/2010/02/02/fiscalizing-failure/

http://krugman.blogs.nytimes.com/2010/02/02/a-couple-of-additional-budget-thoughts/

"2. There is a lot of near-term fiscal tightening built into the budget, mainly because of the fading out of the stimulus, but reinforced by the freeze and the expected wind-down of Iraq/Afghanistan and the planned expiration of Bush high-end tax cuts. All of this will take place in the face of high unemployment, with the Fed unable or unwilling to take offsetting action. 1937!"

 

[vimothy]

I'm a bit ambivalent about Roubini. He's overly free market, business school oriented. His prognostications are skewed towards what is good for business rather than what is good for the real economy. I imagine that he assumes that what is good for business assets is simply equivalent to what is good for output and the real economy. Case in point: Greece defaulting and devaluing. Also it seems as though he doesn't have a firm macro foundation for his views, that they come together in a piecemeal way that is sometimes incoherent, and leads him to make bad calls like the US dollar collapse, and also makes him overly hawkish about deficits.

Can kind of agree with that. While I don't know anything about what motivates the man, and wouldn't want to guess, Roubini seems like an aggregator (is that a word?) of bad news, piecemeal, and so deficits are another thing to chalk up on the ledger as a problem. He's also from an emerging market background (IIRC) and so probably has a view shaded by that, in a solvency fears / capital outflows / currency crisis sense. That said, you start to manage tail risk by laying out these scenarios, and I think Roubini does it well, but I don't understand his intellectual framework at all. I don't think I've ever read any overt mention of theory or even methodology on his site.

In terms of popular writers that called the crisis, and more importantly, got all the reasons right, Dean Baker is probably the best:
http://www.cepr.net/index.php/dean-baker/

Yeah, I've read a bit of his stuff. Don't read many blogs at the moment. But I don't find Baker to be that much more satisfying than Roubini, TBH. I am trying to get through lots of Godley's stuff, because there's some kind of method or framework that I can use.

edit: check out this article in particular:
http://www.cepr.net/index.php/op-ed...olitical-constraints-obstructing-us-recovery/

Help me to understand something:

If it is politically impossible to increase the deficit, then monetary policy provides a second potential tool for boosting demand. The Federal Reserve Board can go beyond its quantitative easing program to a policy of explicitly targeting a moderate rate of inflation (e.g. 3-4 percent) thereby making the real rate of interest negative. This would also have the benefit of reducing the huge burden of mortgage debt facing tens of millions of homeowners as a result of the collapse of the housing bubble.

I am no longer at all certain how this is supposed to work. Under QE's standard narrative, the CB buys long term assets and credits reserve accounts. This change in the asset mix--more reserves relative to higher yield assets--causes the banks to lend. The banks lend, the money gets spent, prices get bid up and nominal GDP recovers. CB high five! Assuming that this doesn't work (if there is no reserve constraint or demand for credit) and the interbank short term rates are already at zero, what can monetary policy do and how could the CB deliver 3% inflation with its existing policy tools? Also, if this policy succeeded, wouldn't a reduction in the real value of debt be offset by the extension of private sector debt--so the AD problem is solved by putting the clock back a few years before the private sector started saving, but at least the government deficit has come down?

 

[rumble]

I am trying to get through lots of Godley's stuff, because there's some kind of method or framework that I can use.

He does seem pretty good. I'm not sure why I've never heard of him before, but I just checked these two papers:

one from 2000: http://www.lrb.co.uk/v22/n13/wynne-godley/what-if-they-start-saving-again

and this one from 2008: http://www.levy.org/pubs/sa_dec_08.pdf

It sounds pretty good to me, and consistent with the Baker's views as well

Where are you finding his stuff from? anything recent available?

 

[vimothy]

Yeah, no doubt its consistent, but with the theory explained.

Published at the Levy Institute now: http://www.levy.org/vauthdoc.aspx?auth=104

Or up at his site: http://www.wynnegodley.com/

All the Strategic analysis stuff is invaluable (e.g. this really prescient paper from 1999). And there's loads of stuff explaining the SFC models they use for the projections. Dunno when exactly Godley last wrote something, but the rest of the same team have been publishing stuff more recently (Dec 09): http://www.levy.org/vtype.aspx?doctype=11

Older stuff is up here: http://www-cfap.jbs.cam.ac.uk/research.php?project=1

 

[rumble]

re: quantitative easing

QE does work. They only normally target short term rates, but if they hammer down the 30 year rate to the point where the 30 year mortgage rate is down to 1%, are you telling me that there will be no increase in demand for that credit? Demand for credit may not be perfectly elastic, but I don't get where Billy Mitchell gets the idea that it is perfectly inelastic. On top of that, bringing down the long term rates allows borrowers to refinance, freeing up more spending money, as Godley points out. It's not really a great long term solution, in the absence of structural adjustments, for the reasons you note, but it does work to a certain extent. Billy Mitchell is overly obsessed with fiscal deficits as the cure for everything. He's a bit of a Captain Ahab in that regard.

I'm with Godley, who just might be my new favorite economist:

"Fiscal policy alone cannot, therefore, resolve the current
crisis. A large enough stimulus will help counter the drop in
private expenditure, reducing unemployment, but it will bring
back a large and growing external imbalance, which will keep
world growth on an unsustainable path."

I sure wish I had have found his stuff earlier... it would have saved me having to put it all together myself

 

[rumble]

true

 

[vimothy]

re: quantitative easing

QE does work.

I think you're right that the demand for credit is not perfectly inelastic. So there will likely be an indirect effect on inflation, if no "quantity theory of money" effect, from a change in prices. I suppose what it comes down to is, to what extent is the price of credit suppressing AD, and to what extent will QE (the provision of reserves to the banking system) help. I am skeptical that QE can deliver a 3% inflation target. While we were engaging solely in QE here (plus limited fiscal response), the Fed was also engaging in direct credit easing (i.e. supplying credit directly to the private sector), and that seems to have resulted in more real output (or a greater relative reduction in the output gap). This is consistent with your story about the supply and demand for credit, but not necessarily with QE.

This seems good for policy comparisons: http://ner.sagepub.com./cgi/reprint/211/1/115

BTW, I believe that the BoE is ending QE tomorrow.

 

[vimothy]

Krugman:

Quantitative easing: There has been extensive discussion of "quantitative easing" , which usually means urging the central bank simply to impose high rates of increase in the monetary base. Some variants argue that the central bank should also set targets for broader aggregates such as M2. The Bank of Japan has repeatedly argued against such easing, arguing that it will be ineffective – that the excess liquidity will simply be held by banks or possibly individuals, with no effect on spending – and has often seemed to convey the impression that this is an argument against any kind of monetary solution.

It is, or should be, immediately obvious from our analysis that in a direct sense the BOJ argument is quite correct. No matter how much the monetary base increases, as long as expectations are not affected it will simply be a swap of one zero-interest asset for another, with no real effects. A side implication of this analysis (see Krugman 1998) is that the central bank may literally be unable to affect broader monetary aggregates: since the volume of credit is a real variable, and like everything else will be unaffected by a swap that does not change expectations, aggregates that consist mainly of inside money that is the counterpart of credit may be as immune to monetary expansion as everything else.

But this argument against the effectiveness of quantitative easing is simply irrelevant to arguments that focus on the expectational effects of monetary policy. And quantitative easing could play an important role in changing expectations; a central bank that tries to promise future inflation will be more credible if it puts its (freshly printed) money where its mouth is.

http://web.mit.edu/krugman/www/trioshrt.html

 

[rumble]

Yes there is the distinction to be made between pure quantitative easing (UK) and what people are calling "qualitative easing" (USA).

When there are deflation expectations, the banks basically are not going to want to increase lending. Even if you lower the rate the banks won't want to make the credit available. So there is the other side to demand for credit, the supply of credit, which gets held up at the banks, who may not reduce long rates for customers or start rationing credit. Quantitative easing doesn't really get around this, so I think you may be right. Qualitative easing on the other hand does lower the price of credit directly. If this results in increased demand, that should show up in increased lending & inflation (as it has in the USA). The only problem is that in deflation, borrowers might not want to take on debt, if they think that they will not be able to pay it off due to deflation. Qualitative easing goes further towards breaking the deflationary cycle than quantitative easing, by ensuring the supply of credit, but it doesn't address the issue of demand for credit directly.

The other thing to consider is the game theory that comes into play. If all of the players (borrowers and lenders) assume that none of the other players will take (or make) the loans at 1%, because of deflation, no credit gets extended. But if other players are thought to be irrational, or credit constrained, or in the case of lenders, trying to grab market share, loans will be made, triggering inflation and shifting the equilibrium so that it makes sense for everyone else to start taking out cheap loans as well. The supply of cheap credit creates an unsteady equilibrium, because if some people start choosing to take the credit you get inflation, and if you see inflation, it makes sense for you to start taking on ultra cheap loans.

I think that directly buying standard mortgage paper etc. (qualitative easing) probably does more to shift the equilibrium than true QE because it basically takes the banks out of the picture as a credit supply constraint, but they are both still fighting an uphill battle to change deflation expectations. Fiscal spending is where the main solution lies, which makes this shift much easier.

The point where I disagree with Billy Mitchell (if I understand him correctly) is that QE categorically does not work. In a normal situation characterized by inflation, I don't see how it wouldn't work, the same way that normal Fed policies of credit expansion work. If inflation expectations are for -2%, then OK, it probably doesn't work that well, but if inflation & inflation expectations are running at 2% I'm pretty sure that QE could bring inflation up to 4% pretty easily. It's just not good by itself during deflation.

 

[rumble]

Yeah, I pretty much agree with Krugman. Fiscal policy is going to be the main thing to shift expectations, but once that's done, QE probably will help to get actual inflation and output up faster

 

[vimothy]

Interesting article on the future of macro from former BIS economist and early caller of the bubble, Bill White: http://www.imf.org/external/pubs/ft/fandd/2009/12/pdf/white.pdf

 

[rumble]

interesting piece.. I agree with most of it, but his take on the Austrians is very very odd. I can't think of a single Austrian that was actually concerned about China, or did not mock the concept of a savings glut (we don't have too much savings, we have too much debt! bla bla bla). In fact it was Bernanke and the other New Keynesians that were most concerned about the imbalances (since when is the basic concept of an imbalance an Austrian thing?), while the Austrians were mainly just spewing the same old garbage, ADVOCATING A STRONG DOLLAR, TIGHT MONETARY POLICY AND A BALANCED BUDGET, which is completely at odds with having a concern over or even an understanding of the China imbalances. If anyone actually listened to the Austrians, we would be in a deep endless depression right now. New Keynesians may not be great, but Austrians are far far worse.

My take is that almost all useful economics is derived from Keynes, while the New Classicals were pretty much a bunch of sophists that successfully concern-trolled the whole profession in the 70s, and through Mankiw's New Keynesianism got their wrong ideas imbedded into the mainstream.

 

[vimothy]

There's a theory of the bust (credit extension and malinvestment are obviously central tenets of Austrian Capital Theory). But there's no Austrian solution. Although I believe that Hayek thought that stabilising nominal income was a good idea, this was never really developed into a coherent theory. Yes, there are plenty of goldbug loons. But there were some good calls made, e.g. White / BIS team, Doug Noland, Kurt Richebächer, etc. (Incidentally, the Richebächer letter is currently being edited by a PK researcher from the Levy Institute). So my take would be, don't look to them for the answers but there are some interesting questions there.

On the subject of the Eurozone, I read some calls today for Germany to leave the EMU (rather than Spain or Greece or whoever). Since German CBers are liquidationists, and since Germany plays the same role for the Mediterranean states that China plays for America—running large surpluses within the EMU that can’t be adjusted for because of the exchange rate peg—the Germans should step outside where they could engage in these practices without causing as much harm.

 

[vimothy]

One interesting / slightly weird aspect of NK is that it makes sticky prices and wages the cause of fluctuations in output and thus unemployment. This is pretty much the opposite of what Keynes wrote in the General Theory, IIRC.

Another QE related thought: I've heard Mosler saying that insofar as QE/CE brings down long rates, its effects on aggregate are uncertain, because although borrowers get lower rates, savers get reduced income (so the profit that the Fed makes on its investment portfolio is reducing AD because its interest income or capital gains lost to the private sector--effectively a stealth tax). The private sector's position WRT net lending or borrowing would also come into play, I guess, as well as distributional issues.

?