Wednesday, August 19, 2015

Opportunistic Flexibility

Last week, China moved to allow more flexibility in its exchange rate.  In this case, that meant a downward movement - headlines about a "devaluation" were rather overstated, though, as the depreciation from Monday to Thursday was about 3% (followed by a slight rise on Friday).  Last week's change is at the end of the graph:
Note, the graph is the yuan price of a dollar, so a downward movement is a yuan appreciation.

China has been criticized over the years for keeping its exchange rate undervalued to support its exports.  The graph shows that it has allowed the yuan to rise quite a bit since 2005, though it has done so in a controlled manner and took a pause for about two years starting in mid-2008.  Its appreciation has helped China make progress on one aspect of "rebalancing" - reducing its dependence on exports.  China's current account surplus is considerably smaller relative to GDP than it was in 2006-08:
So, does this move represent a return to China's old ways of undervaluing its currency to gain a competitive edge for its exports?

Well, yes and no...

As it has followed the dollar, and the dollar has risen, the yuan has appreciated in real terms.  This chart shows a trade-weighted average of the dollar:
During the last year the dollar has appreciated significantly and the yuan has been along for the ride.  Currency appreciation - which makes Chinese goods relatively more expensive on world markets - combined with a slowing economy led to political pressure for a change of course.  The Times' Keith Bradsher writes:
In a little-noted advisory to government agencies, the cabinet said it was essential to fix the export problem, and the currency had to be part of the solution.

With the government keeping a tight grip on the value of the renminbi, Chinese goods were more expensive than rivals’ products overseas. The currencies of other emerging markets had fallen, and China’s exporters could not easily compete.

Soon after, the Communist Party leaders issued a statement also urging action on exports.
However, China has also been moving in the direction of greater financial openness; this entails allowing freer exchange rate movements (as I discussed in this previous post), particularly if it wants the yuan to become an international reserve currency (a status Krugman rightly notes is highly overrated).  At Project Syndicate, Yu Yongding writes:
From now on, China’s government declared, the renminbi’s central parity rate will align more closely with the previous day’s closing spot rates. This suggests that the devaluation was aimed primarily at giving the markets a greater role in determining the renminbi exchange rate, with the goal of enabling deeper currency reform.
So, yes, China has other reasons for moving to a more flexible exchange rate, but it is convenient for them to take a step in that direction at a moment when doing so means a fall in the yuan that will boost demand for Chinese goods.

Tuesday, August 18, 2015

Stories from the Macro Wars

Ian Parker's recent New Yorker profile of Yanis Varoufakis included this nugget: "He has written of his hope, as a professor, to present economics as 'a contested terrain on which armies of ideas clash mercilessly.'"

That may be an apt description of macroeconomics in the 1970s and 1980s.  On his website, Paul Romer has offered an interesting take on the methodenstreit between the dynamic general equilibrium approach (so-called "freshwater" macro, championed by Robert Lucas) and Keynesian macro-econometric models (the "saltwater" camp).  Romer is particularly critical of Robert Solow, arguing that his dismissive attitude towards Lucas et al., contributed into a counterproductive hardening of differences. He writes:
Solow also seemed to be motivated to attack harshly because he was concerned that the type of model Lucas was developing might undermine political support for active countercyclical policy. To his credit, there was a legitimate basis for this concern. The new Chicago school of macro eventually did oppose an active response to the financial crisis and its aftermath. But the type of response that Solow exemplified may actually have contributed to the emergence of this new Chicago school. In retrospect, if the goal was to maintain support for active macro policy, the better course would have been to take seriously what the rebel group that was forming around Lucas was saying. This might have kept the rebels from cutting off contact with all outsiders, even those who were taking seriously the issues they were raising.
Brad DeLong and Paul Krugman responded in defense of Solow. DeLong writes:
And, at this point, Romer ought to say that Solow’s and Hahn’s criticisms were (a) no more biting in their rhetoric than the criticisms that Stigler, Friedman, and company had been inflicting on their victims at Chicago for a generation, and (b) correct and accurate.
Romer has more interesting detail in his response, including this summary of the main points:
In the summer of 1978, Lucas and Sargent were making three claims:
(a) Existing multi-equation macro simulation models were not identified. That is, these models summarized correlations in the data but did not yield reliable statements of the form “if the government does X, this will cause Y to happen.”
(b) It was time to use SAGE models to address such fundamental questions about economic fluctuations as why changes in the supply of money influence economic activity; and
(c) SAGE models will imply that an active monetary policy cannot stabilize economic fluctuations.
Solow thought that Lucas and Sargent were wrong about the policy ineffectiveness claim (c). DeLong, Krugman, and I all agree. In the 2013 introduction to his collected papers, Lucas uses some asides about the Great Depression and the Great Recession to admit that now even he agrees. Claim (c) is what DeLong and Krugman have in mind when they say that  Solow was right and Lucas was wrong.
Yet all macroeconomists now agree that Lucas and Sargent were correct about the fatal problems with the large simulation models. Much of Solow’s response amounted to an implausible denial that there was anything wrong with them. So on this point, the roles are reversed. Lucas and Sargent were right and Solow was wrong.
[Romer uses "SAGE" to refer to general equilibrium models].  See also: this from Krugman, and this from DeLongDavid Glasner has a thoughtful post putting things in a broader context.

In his post, Romer cites several papers, including Lucas and Sargent's "After Keynesian Macroeconomics," from the 1978 Boston Fed conference.  Perhaps it should be known as "the throwdown in Edgartown."

Fascinating stuff... but fortunately for contemporary macroeconomists - particularly those of us with conflict-averse midwestern temperaments - things aren't nearly so rancorous now.  There certainly are differences of inclination and opinion, and economists can be blunt in expressing their differences, but the "saltwater" vs. "freshwater" cleavage is largely a thing of the past, as this Steven Williamson post explains.  Since the wars of the 1970s and 80s, there has been some convergence: macroeconomists have developed a class of models - sometimes called "New Keynesian" - which respond to Lucas' methodological critique but also allow for a stabilizing role for macroeconomic policy.  That's not to suggest we've figured it all out, of course; this recent Mark Thoma column highlights some of the weak points of contemporary theory.

Thursday, August 6, 2015

NPR Visits Keynes' (Sister's) Grandchildren

One of the pleasures of teaching is the opportunity to re-read the articles I assign to my students; one particular favorite that I look forward to each semester is Keynes' essay "Economic Possibilities for Our Grandchildren."  NPR's Planet Money recently did an episode about it, focusing on Keynes' famously incorrect (thus far) prediction of a 15-hour workweek.  Although Keynes had no progeny, they did check in with his sister's grandchildren, as well as Harvard economist Richard Freeman - all of whom seem to be hard workers. I discussed some ideas about why we're not enjoying so much leisure in a post last year.  Tim Harford also has some thoughts on his blog.

The prediction about leisure was part of Keynes' more general forecast that economic growth would solve the "economic problem" of scarcity (and his guess about the rate of growth was pretty accurate), and speculation about the social change that would result.  In a similar spirit, in his Bloomberg column, Noah Smith suggested that a post-scarcity world might be like Star Trek: The Next Generation.  He concludes:
In other words, the rise of new technology means that all the economic questions will change. Instead of a world defined by scarcity, we will live in a world defined by self-expression. We will be able to decide the kind of people that we want to be, and the kind of lives we want to live, instead of having the world decide for us. The Star Trek utopia will free us from the fetters of the dismal science.
Or, as Keynes put it in 1930:
Thus for the first time since his creation man will be faced with his real, his permanent problem- how to use his freedom from pressing economic cares, how to occupy the leisure, which science and compound interest will have won for him, to live wisely and agreeably and well.

Thursday, July 30, 2015

Pushing on a String

One for the footnotes: Timothy Taylor has tracked down the origin of the "pushing on a string" metaphor for expansionary monetary policy in a depressed economy.  It looks like we owe it to Maryland congressman Thomas Alan Goldsborough, who used it in a 1935 hearing with Fed Chairman Marriner Eccles.


The BEA released the advance estimate of second quarter GDP growth today: the good news is that US output grew at a 2.3% annual rate in the period - a healthy, though unspectacular, pace.  The growth was largely driven by consumption (about 70% of GDP), which grew at a 2.9% rate.  Also, the BEA revised up its estimate of growth in first quarter to an 0.6% rate, from -0.2% in the previous release.

The more disappointing news came in the "annual revision" of estimates for 2012-2014 which were included in today's release.  The new estimates indicate that the agonizingly slow recovery has been a little more sluggish than we previously thought - GDP growth was revised downwards 0.1pt for 2012 and 0.7pt for 2013.
The red line shows the revised figures, the blue line is the previous estimate.  The lower estimates of output growth also imply that labor productivity - output per unit of labor - growth was a little slower than previously thought.  Since labor productivity is the main determinant of changes in living standards over time, further evidence that it has shifted to a lower trend is a discouraging indication about long-run prospects.

This release also had an interesting wrinkle: the BEA is also now releasing the average of the standard expenditure-based GDP figure and the income-based measure (which it calls Gross Domestic Income).  In principle, they should be the same, but, in practice, there is usually a "statistical discrepancy."  This issue brief from the Council of Economic Advisors explains why the average - which its calling "Gross Domestic Output" (we'll see if that sticks...) might be a better indicator.

Saturday, July 25, 2015

Professor Keynes is Optimistic

An archive of British Movietone newsreels has been added to YouTube, including one of John Maynard Keynes commenting on Britain's departure from the gold standard in 1931: Another newsreel discusses leaving the gold standard and includes footage of Sir Josiah Stamp explaining the decision: This Telegraph article describes some of the correspondence between the bank and the government about the crisis.  Britain's exit - after painfully resuming the gold standard at its prewar parity in 1925 - was one episode in a series of sterling crises in the 20th century. Last year, I posted some newsreels from the 1949 and 1967 devaluations.  

Note: An earlier post from 2011 had a fragment of the same Keynes newsreel, but now we are fortunate to have it in full.

Tuesday, July 14, 2015

Greek Tragedy, European Farce

It looks as though Greece is staying in the euro, after all (for now at least...).  The terms of the deal - pending approval by the Greek parliament - are not very favorable to Greece.  Essentially it means more of the same - additional financing from the EU in exchange for more austerity, "structural reforms" (in some cases absurdly detailed) and a EU supervised privatization of state-owned assets.  There is a vague promise to consider debt restructuring, but nothing concrete.

The reports from the negotiations over the weekend reinforced the impression that Germany, along with some of the other smaller countries, really wanted to push Greece out, but the French and Italians worked to prevent this outcome.

From the viewpoint of Germany, the issue is making sure that euro membership entails following associated rules and obligations: a more forgiving treatment of Greece would create a "moral hazard" problem, inviting more deviations in the future.  However, the rules they are enforcing do not make economic sense: they force procyclical fiscal policies and fail to confront an unsustainable debt burden.  (Some sympathy for the Germans, though: as this VoxEU piece by Kang and Mody illustrates, they were reluctant about the euro from the beginning).

The response to the deal has been highly critical: see Barry Eichengreen, Martin Sandbu, Wolfgang Munchau, Christian Odendahl and John Springford, Paul Krugman, Ambrose Evans-Pritchard, John Cassidy, Eric Beinhocker, Neil Irwin.  This interview with former finance minister Varoufakis is also interesting.  Simon Wren-Lewis has a nice post on "trust," a word which has been thrown around alot lately.

The FT's Gideon Rachman has a somewhat different take, emphasizing that Germany backed off its evident desire to force a "Grexit".

One condition of the deal was continued IMF involvement.  While Greece objected to this, it may ultimately prove to be in their favor - the IMF has the capacity to act as a voice of sanity, and they have said that Greece's debt is unsustainable (much of the criticism of the IMF is that they haven't pushed strongly enough for a debt writedown, as they ordinarily would).  IMF chief economist Olivier Blanchard discussed Greece in a blog post (and Ashoka Mody offered a critical response).

Although some of us think Greece might be better off outside the euro, their willingness to sign on to an agreement of the sort the Syriza govermnment came in to power promising to end (and essentially what they voted "no" on in the referendum a week ago) demonstrates how badly they want to stay in.  As long as Greece is saddled with an unsustainable debt, the prospect of a rerun of this drama will remain.  But the removal of the immediate threat of a euro exit hopefully will give a short-run boost (Daniel Davies gives some reasons for short-term optimism).

As for the euro, the last several years have laid bare the institutional shortcomings - some of which are discussed in this Simon Tilford column - underscoring the reasons many economists were skeptical of the project from the outset.  Although political solidarity and continued moves towards integration might have overcome these flaws, the last several weeks have demonstrated that, as a political matter, the sense of commonality needed to make the euro work does not exist.

Update: IMF to the rescue (?!):
The International Monetary Fund threatened to withdraw support for Greece’s bailout on Tuesday unless European leaders agree to substantial debt relief, an immediate challenge to the region’s plan to rescue the country.
On this, see also Ambrose Evans-Pritchard and Josh Barro.  A few hours ago I said they had the "capacity to act as the voice of sanity" but I didn't expect them to use it so soon...  This made me laugh:
Hmm... at this point, hard to say if this will lead to a better deal, or just blow it up, as Gideon Rachman suggests:

Thursday, July 9, 2015

Europe's Final Countdown to "Grexit"?

The "no" vote in its referendum last Sunday seems to have accelerated the momentum towards a Greek exit for the euro.  While there is plenty of room to second-guess the negotiating strategy, I think the Syriza government and Greek voters were right to reject continuing on the same policy path.  If they are forced out of the euro (which looks likely), it will be traumatic and disruptive, but the experience of Argentina in 2002 suggests a fairly quick rebound (from a very low starting point) is possible. 

Ultimately, this may be worse for the rest of Europe - not only does it open up the possibility of future crises by demonstrating the reversibility of the euro, it also demonstrates a fundamental lack of solidarity: the "ever closer union" isn't really that close (see Dani Rodrik and Peter Eavis).

Some of Europe's leaders seem recognize this; the main stumbling block in the last-ditch negotiations appears to be on whether some of Greece's debts will be written off (i.e., "restructuring" or "haircut").  The IMF has publicly said that Greece's debt are not sustainable (debt writedowns are part of standard IMF interventions), and the US is urging a writedown.

Politically, it is easy to see why this is a nonstarter in many of the creditor countries.  Some "leadership" is badly needed, particularly in Germany, and doesn't appear to be forthcoming: in the Times, Bruce Ackerman calls out Germany's "failure of vision.Clive Crook argues that the Greeks are being deliberately pushed outEduardo Porter notes that Germany seems to be forgetting that it has been a beneficiary of debt relief (see also Thomas Piketty).  The German stubbornness may be more than just politics - Simon Wren-Lewis argues part of the problem is that they (naturally) do not want to acknowledge the failure of their economic ideology.

Last minute negotiations are ongoing... when Syriza first came to power, the idea of GDP-linked debt was raised.  This seems to have fallen off the table, but it might provide a "face saving" way out: the IMF's knack for optimistic projections could be helpful in making the value to the creditors appear initially large.  Since they would have some equity-like characteristics, replacing the debt with GDP-linked bonds would have some passing similarity to what normally occurs in a corporate bankruptcy, where creditors receive equity stakes (and perhaps this would help make a "fairness" argument).  And it actually might work: if the chances of future austerity and/or a euro exit were substantially reduced, Greece should have a chance at some rapid "bounce back" growth.  I don't know anything about Greek politics, but I would think that, in the long-run, a government led by an "outsider" party like Syriza might have a better shot at implementing structural reforms like better tax collection.

See also: a good "tick-toc" on the negotiations from the Times' Landon Thomas on the breakdown of negotiations last week; Ambrose Evans-Pritchard; Ashoka Mody is very harsh on the creditors and the IMF, Daniel Gros is a bit more sympathetic.

Friday, June 26, 2015

More Greek Notes

perhaps Greece should be printing some notes this weekend...

Recently, Christian Odendahl had a sensible take on what should be done in Greece, but reasonable advice from economists is being overtaken by politics and events.  Catherine Rampell:
Greeks are hoarding cash and sending their savings abroad; by a conservative estimate, Greek bank deposits have fallen by about 45 percent since their peak in 2009. Recent talk of capital controls and bank closures has only accelerated this bank run (or, as some have dubbed it, a “bank jog”), making the banking sector weaker, and, by the day, even more in need of European assistance. Last week alone, Greeks withdrew an estimated 4 billion euros. For those keeping track, that’s two-and-a-half times what the country owes the IMF at the end of the month. 
Karl Whelan discusses the connection between a Greek government default, the ECB and a euro exit -- in theory, the ECB could help Greece stay in the euro even if the government defaults, but it doesn't appear inclined to.  Ultimately, if the euro is to avoid similar crises in the future, it needs to be robust to a sovereign default.

Reports over the deal terms being discussed are hardly encouraging.  Wonkblog's Matt O'Brien writes:
Europe is making life so difficult for Greece with such specific demands for austerity that it almost seems like Europe is trying to get Greece to leave the euro now. Before this latest showdown, Greece had actually cut so much that it had a budget surplus before interest payments...

But Europe isn't interested in that. It's interested in making Greece run bigger and bigger budget surpluses, without much regard for the economic consequences. Not only that, but Greece has to run surpluses the way Europe wants them to. Never mind that Greece has already cut its spending a lot, already cut its pensions a lot, and already reformed its labor markets a lot. There are always new cuts and new reforms that Europe says will make Greece grow at some point in the future.

If this is how it's going to be, why should Greece stay in the euro? It sure seems like Europe is trying to force Syriza to do what Syriza said it wouldn't just to prove a point: don't underestimate the power of the ECB. It's a not-so-subtle message to the anti-austerity parties in Spain and Portugal that they have nothing to gain and everything to lose from challenging the budget-cutting status quo.
Although its the EU that deserves most of the blame, the IMF's role has been controversial, too: see this Politico article and this Ambrose Evans-Pritchard column.  At the IMF's blog chief economist Olivier Blanchard explains what the IMF believes a "credible deal" requires.

See also: James Galbraith on "reform", and Branko Milanovic on what this means for Europe.

Update (6/29): The Greek government has called a referendum and imposed capital controls.  See Eichengreen, Krugman and Stiglitz (and Tony Yates for a take somewhat more critical of the Greek government) Charles Wyplosz on the ECBFrancisco Saraceno and Matt Yglesias on the politics, and Hugo Dixon on how the referendum may play out.

Thursday, May 21, 2015

A Theory of Production

Economists often use the word "technology" to mean the relationship between output and factors of production such as capital and labor.  The Cobb-Douglas production function, which is a ubiquitous description of technology has its origin in a 1928 AER article, "A Theory of Production," by Charles Cobb and Paul Douglas.

Using C to denote capital, L for labor and P for production, the production function makes its first appearance:
Although the description of technology is a theoretical contribution, much of the article is empirical in nature, as they construct indexes of capital and labor in order to test their model.  They compare the production implied by their function and estimates of capital and labor, P', with a measure of actual production.
To a contemporary macroeconomist reader, the striking thing about the article is the extent to which it anticipates how we analyze business cycles today.  Cobb and Douglas, separate out cyclical and trend components (using 3 year moving averages) and show that the deviations of actual production and the production implied by changes in capital and labor are procyclical.
The article includes a chronology of business cycles which aligns with the NBER chronology; the NBER recessions during this period are
  • June 1899 - Dec. 1900
  • Sept. 1902 - Aug. 1904
  • May 1907 - June 1908
  • Jan. 1910 - Jan. 1912
  • Jan. 1913 - Dec. 1914
  • Aug. 1918 - Mar. 1919
  • Jan. 1920 - July 1921
Cobb and Douglas' estimates are annual, but several of these do line up with points where P' (implied production) exceeds actual production, P.

Today these deviations of actual output from the amount implied by changes in factors of production are known as "Solow residuals" after work by Robert Solow in the 1950s and interpreted as measures of technological progress (i.e., our ability to wring more output out of given amounts of capital and labor).  Although Solow was mainly concerned with long-run growth trends, in the 1980's, Real Business Cycle theorists interpreted short-run fluctuations as "technology shocks".  In Real Business Cycle models these shocks drive economic fluctuations, and the same pattern identified by Cobb and Douglas - using postwar data and newer detrending techniques - was cited in support of this theory.  One weakness of this argument is that short run movements in the Solow residual are at least partly due to utilization - "factor hoarding" - rather than changes in technology.  This, too, was anticipated by Cobb and Douglas:
The index does not of course measure the short-time fluctuations in the amount of capital used.  Thus, no allowance is made for the capital which is allowed to be idle during periods of business depression nor for the greater than normal intensity of use int he form of second shifts etc., which characterizes the periods of prospertity.
Overall, this article would fit very well into a syllabus for a current course on business cycle theory.  Hmm...