What Happens to a Global Rebalancing Deferred?

Tim Duy notes that the shifts in relative global demand that would lead to a 'rebalancing' of current account deficits and surpluses seem to be on hold. With the crisis in Europe leading to a decline in the euro, which, in turn appears to have given China cold feet about letting the yuan rise, it looks like we may be back to the status quo ante where the US is the world's "consumer of last resort". He concludes:

Where does this all leave us? The rest of the world is intent on pursuing a begger thy neighbor strategy, with the US being the neighbor. I suspect US policymakers will eventually relent; it will be the only choice left. All we can do now is sit back and wait for the inevitable explosion in the US trade deficit, waiting idly by for the next crisis and the "chance" to bring some sanity to the global financial architecture.

Michael Pettis believes that the European crisis makes the yuan revaluation more urgent, but he is not optimistic that the powers-that-be see it that way. He worries the end result will be trade tension and protectionism:

Most policymakers around the world – while publicly excoriating the US for its spendthrift habits – are intentionally or unintentionally putting into place polices that require even greater US trade deficits.

This cannot be expected to happen without a great deal of anger and resistance in the US. The idea that suffering countries should regain growth by exporting more to the world, and that rapidly growing surplus countries should not absorb much of this burden, will only force the US into even greater deficits as US unemployment rises to reduce unemployment pressure in Europe, China, Japan and elsewhere.

I would be surprised if the US accepted this with equanimity. On the contrary, I expect it will only exacerbate trade tensions and ensure that next year the dispute will become nastier than ever.

Of course, real exchange rates can adjust due to price changes as well as exchange rate movements. Some of the recent wage gains by Chinese workers give some reason for optimism. In a story about rising prices of Chinese exports, the Times' David Barboza writes:

Last week the Japanese automaker Honda said it had agreed to give about 1,900 workers at one of its plants in southern China raises of 24 to 32 percent, in hopes of ending a two-week strike, according to people briefed on the agreement. The new monthly average would be about $300, not counting overtime.

And last Thursday, Beijing announced that it would raise the city’s minimum monthly wage by 20 percent, to 960 renminbi, or about $140. Many other cities are expected to follow suit.

Analysts say the changes result from the growing clout of workers in China’s economy, and are also a response to the soaring food and housing prices that have eroded the spending power of workers from rural provinces. These workers, without factoring in the recent wage increases by some employers, typically earn $200 a month, working six or seven days a week.

But there are other reasons. Analysts say Beijing is supporting wage increases as a way to stimulate domestic consumption and make the country less dependent on low-priced exports. The government hopes the move will force some export-oriented companies to invest in more innovative or higher-value goods.

Also, other emerging market countries are providing another engine of demand. At project syndicate, Mohammed El-Arian and Michael Spence write:

Over the past two years, industrial countries have experienced bouts of severe financial instability. Currently, they are wrestling with widening sovereign-debt problems and high unemployment. Yet emerging economies, once considered much more vulnerable, have been remarkably resilient. With growth returning to pre-2008 breakout levels, the performance of China, India, and Brazil is an important engine of expansion for today’s global economy.

High growth and financial stability in emerging economies are helping to facilitate the massive adjustment facing industrial countries. But that growth has significant longer-term implications. If the current pattern is sustained, the global economy will be permanently transformed. Specifically, not much more than a decade is needed for the share of global GDP generated by developing economies to pass the 50% mark when measured in market prices.

(see also Mark Thoma's comments).

DeLong Answers Kocherlakota

Brad DeLong responds to the claim made in Minneapolis Fed President Narayana Kocherlakota's essay on the state of macro (see earlier post) that:

I believe that during the last financial crisis, macroeconomists (and I include myself among them) failed the country, and indeed the world. In September 2008, central bankers were in desperate need of a playbook that offered a systematic plan of attack to deal with fast-evolving circumstances. Macroeconomics should have been able to provide that playbook. It could not.

DeLong argues that a better understanding of how to respond to economic crises exists, even if it is outside of Kocherlakota's realm of "modern macroeconomics." He goes back to John Stuart Mill:

Let me briefly set out what the macro playbook is, and how it has been developed by economists and policymakers over the past 185 years. Start with Say's or Walras's Law: the circular flow principle that everybody's expenditure is someone else's income--ands everyone's income is somebody else's expenditure. It has to be that way: for every buyer there is a seller: and for every seller who is disappointed because they sell for less than their cost plus normal profit because of excess supply there must be another who is exuberant from selling at more than cost plus normal profit.

How, then, can you have a depression--a "general glut," a situation in which there is excess supply of not one or a few but all commodity goods and services? How can you have a situation in which workers laid off from shrinking industries where demand is less than was expected and thus less than supply are not rapidly hired into industries where demand is more than was expected and hence more than supply?

Moral philosopher, libertarian, colonial bureaucrat, feminist, public intellectual, and economist John Stuart Mill put his finger on the answer in a piece he published in 1844:

[T]hose who have... affirmed that there was an excess of all commodities, never pretended that money was one of these commodities.... [P]ersons in general, at that particular time, from a general expectation of being called upon to meet sudden demands, liked better to possess money than any other commodity. Money, consequently, was in request, and all other commodities were in comparative disrepute. In extreme cases, money is collected in masses, and hoarded; in the milder cases, people merely defer parting with their money, or coming under any new engagements to part with it. But the result is, that all commodities fall in price, or become unsaleable...

DeLong puts the problem in terms of a shortage of "safe" assets. The policy response of creating more of them - issuing more government bonds - is the flip side of the traditional Keynesian remedy of deficit spending (or deficit financed tax cuts), as well as of an aggressive "lender of last resort" central bank policy. See also DeLong's related project syndicate column, and this Vox piece by Ricardo Caballero.

So, is this further evidence that we are living in what Krugman called the "dark age of macroeconomics"? Yes and no. As DeLong notes, policymakers have largely been following his playbook (though there are ominous signs they are pulling back too soon). However, academic models employing the reigning methodology of "dynamic stochastic general equilibrium" (DSGE) have generally not been very helpful. That paradigm is still relatively young - it remains to be seen if it will develop in a direction that makes it more useful for policy, or whether it will be supplanted in a more fundamental shift.

Feldstein on the Euro

At Project Syndicate, Martin Feldstein says the Euro was doomed from the start:

The attempt to establish a single currency for 16 separate and quite different countries was bound to fail. The shift to a single currency meant that the individual member countries lost the ability to control monetary policy and interest rates in order to respond to national economic conditions. It also meant that each country’s exchange rate could no longer respond to the cumulative effects of differences in productivity and global demand trends.

In addition, the single currency weakens the market signals that would otherwise warn a country that its fiscal deficits were becoming excessive. And when a country with excessive fiscal deficits needs to raise taxes and cut government spending, as Greece clearly does now, the resulting contraction of GDP and employment cannot be reduced by a devaluation that increases exports and reduces imports.

So Its Not Too Late

to change my major, after all...

according the e-mail newsletter of the Western Economic Association:link here.

Rodrik on Greece

At Project Syndicate, Dani Rodrik writes:

Deep down, the crisis is yet another manifestation of what I call “the political trilemma of the world economy”: economic globalization, political democracy, and the nation-state are mutually irreconcilable. We can have at most two at one time. Democracy is compatible with national sovereignty only if we restrict globalization. If we push for globalization while retaining the nation-state, we must jettison democracy. And if we want democracy along with globalization, we must shove the nation-state aside and strive for greater international governance.

So we must learn to accept that, in the immortal words of Meat Loaf, "two out of three ain't bad."

The State of Macro

Greg Mankiw points out a nice essay on modern macro by Minneapolis Fed President Narayana Kocherlakota. A week too late for this semester, but definitely on the reading list for the next equilibrium macroeconomics course.

Kocherlakota argues that macro has largely gotten beyond the "saltwater" - "freshwater" schism that has, I think, been overplayed in much of the conversation about macroeconomics and the recession (including Krugman's widely noted NYT magazine article, that I responded to in this post). His picture is of a field that is more pragmatic than ideological. For example, he suggests the use of "social planner" solutions in dynamic stochastic general equilibrium models has been more a matter of convenience than of a rigid belief that perfectly competitive market conditions hold at all times. He writes:

My own idiosyncratic view is that the division was a consequence of the limited computing technologies and techniques that were available in the 1980s. To solve a generic macro model, a vast array of time- and state-dependent quantities and prices must be computed. These quantities and prices interact in potentially complex ways, and so the problem can be quite daunting.

However, this complicated interaction simplifies greatly if the model is such that its implied quantities maximize a measure of social welfare. Given the primitive state of computational tools, most researchers could only solve models of this kind. But—almost coincidentally—in these models, all government interventions (including all forms of stabilization policy) are undesirable.

With the advent of better computers, better theory, and better programming, it is possible to solve a much wider class of modern macro models. As a result, the freshwater-saltwater divide has disappeared. Both camps have won (and I guess lost). On the one hand, the freshwater camp won in terms of its modeling methodology. Substantively, too, there is a general recognition that some nontrivial fraction of aggregate fluctuations is actually efficient in nature.

On the other hand, the saltwater camp has also won, because it is generally agreed that some forms of stabilization policy are useful. As I will show, though, these stabilization policies take a different form from that implied by the older models (from the 1960s and 1970s).

PHD PTSD

I made the mistake of taking a glance at the web page of my graduate alma mater:
In sympathy, I'll hide under the covers.

About That Mediterranean Work Ethic

According to many accounts of the financial crisis in Europe, one reason intervention has been slow is that it is hard to convince Germans, widely seen by themselves and others as hard-working, thrifty and virtuous, to "bail out" those lazy, spendthrift Greeks.

This bit of OECD data on hours worked per worker (via Economix) runs contrary to the stereotypes:
That is, according to the OECD, the average Greek worker logs 2120 hours per year - 690 more than a German worker.

Holding Out for a Euro

In Friday's Paul Krugman column, gloom about Greece:

Greece’s problems are deeper than Europe’s leaders are willing to acknowledge, even now — and they’re shared, to a lesser degree, by other European countries. Many observers now expect the Greek tragedy to end in default; I’m increasingly convinced that they’re too optimistic, that default will be accompanied or followed by departure from the euro.

Barry Eichengreen is a relative optimist, but even his roadmap out of the crisis begins with a debt restructuring:

European leaders and the IMF have badly bungled their efforts to stabilise Europe’s financial markets. They have one last chance, but success will require a radical change in mindset.

First the easy part: Greece will restructure its debt. This point is no longer controversial; the only controversy is why a restructuring was not part of the initial IMF-EU rescue package.

Only the delusional can believe that, when everyone else is taking swingeing cuts, Greece's creditors can continue receiving 100 cents on the euro. It beggars belief that Greek government debt can top out at 150% of GDP, as the IMF envisages. At this point the government will be transferring well more than 10% of national income to the creditors. In a time of severe austerity, this outcome is unsustainable both economically and politically.

The lack of a restructuring seems the most obvious weakness of the current rescue plan; on this The Economist makes an astute point:

EU governments and the IMF refuse to discuss the possibility of an eventual rescheduling of Greek debt for fear that it would spark uncontrolled contagion. In fact, the logic may increasingly be the opposite. By refusing to admit that Greece faces an obvious solvency problem, whereas Spain, Portugal and Ireland do not, Europe’s policymakers have made it harder to draw a clear distinction between Greece and the rest. As a result contagion has intensified.

Why is the Greek government so hesitant to make a move that seems so obviously necessary? In a Vox column, Edwardo Borzenstein and Ugo Panizza offer a political economy insight from their research:

[D]efault episodes seem to have high political costs. We find that, on average, ruling governments in countries that defaulted observed a 16 percentage point decrease in electoral support. We also look at changes in top economic officials and show that in any given tranquil year there is a 19% probability of observing a change in the finance minister, but after a default episode the probability jumps to 26%. The presence of such political costs has two implications. On the positive side, a high political cost would increase the country’s willingness to pay and hence its level of sustainable debt. On the negative side, politically costly defaults might lead to ‘‘gambles for redemption’’ and possibly amplify the eventual economic costs of default if the gamble does not pay off and results in larger economic costs.

Krugman's column also prompted an interesting exchange on optimum currency areas - the crisis shows that Europe isn't one, but how sure are we that the US is? - among Greg Mankiw, David Beckworth, and Krugman.

On Greece, see also Ezra Klein's conversation with Desmond Lachman and this Vox column with advice from Domingo Cavallo (!!*), which includes an interesting idea about how Greece (and Portugal and Spain) could improve competitiveness without devaluation by shifting taxes from labor to consumption.

*Argentina's Finance Minister during its 2001 crisis.

Bad Headline, Better News

It was not pleasant to wake up to the news that the unemployment rate rose to 9.9% in April (from 9.7% in March), but, behind that discouraging headline number, the other figures in the BLS employment situation report are more positive.

The key thing to remember unemployment rate is calculated as the number of people unemployed as a fraction of the labor force, which includes both employed people and those who are looking for work. In April, the labor force surged by 805,000 which suggests that some people who had given up on looking for work were drawn back into the labor market. This is reflected in an increase in the labor force participation rate, to 65.2%.

Labor Force Participation Rate

According to the household survey (from which the unemployment and labor force participation rates are calculated), the number of people employed rose by 550,000, and the employment-population ratio increased to 58.8%.

Employment-Population Ratio

The establishment survey yielded an increase in employment of 290,000. Some of that is government hiring for the census, but private payrolls were up 231,000.

Overall, the April numbers suggest things are moving in the right direction. Because so many people had left the labor force during the downturn, the unemployment rate has been understating how bad things are. The increase serves to remind us - and our policymakers - how deep the hole is.

Also, it may be worth noting seasonal adjustment contributed to the change - the unadjusted unemployment rate was 10.2% in March and 9.5% in April (that is, the BLS tries to remove the 'normal' month-to-month changes that occur within every year, including a significant improvement that occurs every April).