Stiglitz on Singapore

Joseph Stiglitz writes:

Singapore has had the distinction of having prioritized social and economic equity while achieving very high rates of growth over the past 30 years — an example par excellence that inequality is not just a matter of social justice but of economic performance.

Finally, an example of a country that can walk and chew gum at the same time!  Oh, wait...

I'm not really that familiar with Singapore (aside from knowing you can't chew gum there), so I won't comment on the particulars, but its worth noting that the comparison Stiglitz makes of Singapore's growth record to that of the US is a little unfair because Singapore was once - not that long ago - a much poorer country than the US.  Standard growth theory predicts that low-income countries should "converge" (i.e., catch up) to higher income ones.  That means that they'll have higher growth rates.

(Data: World Bank)

That said, many low income countries haven't managed to converge, so Singapore does stand out as a successful example which may provide some useful lessons.

Is Euro-geddon Nigh?

 Brad DeLong writes on the value of studying economic history:

Ten years ago I thought that my curiosity about and interest in the Great Depression was an antiquarian diversion from my day job of understanding the interaction of economic institutions, economic policies, and economic outcomes. The fact that we had gone through the Great Depression, had learned lessons from it, and had incorporated those lessons into our institutions and policy processes meant that there was little practical use to going over it once again. Boy, was I wrong. History may not repeat itself, but it certainly does rhyme—and nothing made an economist better-prepared and better-positioned to understand what happened to the world economy between 2007 and 2013 than a deep and comprehensive knowledge of the history of the Great Depression.

One of the most basic lessons from the 1930's, as well as the semi-regular banking panics of the 19th century, is the importance of preventing bank runs.  This can be accomplished by providing a mechanism, such as deposit insurance, that makes depositors confident that they will always be able to get their money out - therefore they won't feel an urgent need to take it out at the first sign of trouble.

Even though its been evident for a while that Europe, or at least its "leaders", seem determined to forget (or ignore) the lessons of economic history, what they're doing with Cyprus is rather stunning.  Neil Irwin writes:

It is a bad day to have your money deposited in a bank in the Mediterranean island nation of Cyprus. And it may just mean some bad days ahead for the rest of us.

Early Saturday, the nation reached an agreement with international lenders for bailout help. Part of the agreement: Bank depositors with more than 100,000 euros ($131,000) in their accounts will take a 9.9 percent haircut. Even those with less in savings will see their accounts reduced by 6.75 percent. That’s right: Anyone with money in a Cypriot bank will have significantly less money when the banks open for business Tuesday than they did on Friday. Cypriots have reacted with this perfectly rational reaction: lining up at ATM machines to try to get as much money out in the form of cash before the money they have in their accounts is reduced.

The Economist's "Schumpeter" blog further explains some of the ways in which this move is problematic:

The bail-out appears to move Europe further away from the institutional reforms that are needed to resolve the crisis once and for all. Rather than using the European Stability Mechanism to recapitalise banks, and thereby weaken the link between banks and their governments, the euro zone continues to equate bank bail-outs with sovereign bail-outs. As for debt mutualisation, after imposing losses on local depositors, the price of support from the rest of Europe is arguably costlier now than it ever has been.

It is also hard to square this outcome with the ongoing overhaul of finance. The direction of efforts to improve banks’ liquidity position is to encourage them to hold more deposits; the aim of bail-in legislation planned to come into force by 2018 is to make senior debt absorb losses in the event of a bank failure. The logic behind both of these reform initiatives is that bank deposits have two, contradictory properties. They are both sticky, because they are insured; and they are flighty, because they can be pulled instantly. So deposits are a good source of funding provided they never run. The Cyprus bail-out makes this confidence trick harder to pull off.

Prophecies of impending Euro-doom over the past several years have repeatedly been wrong (or premature, at least), but this doesn't look good.  How many hours until banks open in Spain?

Update: According to the FT, it was the IMF that had been pushing the idea of "depositor haircuts" - I'd thought they were a little more enlightened, but apparently not...

See also: Karl Whelan,  Felix Salmon, David Beckworth, Paul Krugman.

The 'Woodford Period': A Bourbon for Bernanke?

The news release summarizing  St. Louis Fed President's James Bullard's recent speech on the "current stance of monetary policy" includes the following:

He stated that “the current St. Louis Fed forecast for the unemployment rate implies that the 6.5 percent threshold will be crossed in June 2014.” However, he noted, the policy rate implied jointly by the Taylor (1999) rule and the St. Louis Fed forecasts should increase in August 2013.  Thus, “The Committee’s thresholds imply a ‘Woodford period’ since the policy rate would be held at zero past the point where ordinary FOMC behavior would indicate an increase,” Bullard said.   

William McChesney Martin, who chaired the Fed in the 1950's and 60's once said it was the Fed's job "to take the punch bowl away just as the party gets going."  It sounds like the Fed's new corollary to Martin's rule involves leisurely sipping bourbon for a while when the economic slump is ending.  If the slump is the hangover from a financial crisis, maybe its kind of a "hair of the (monetary) dog" thing.

The release continues:

The period from August 2013 to June 2014 would be the “Woodford period,” which refers to Michael Woodford of Columbia University.  “According to received theory, this is a more stimulative monetary policy and possibly even an optimal monetary policy when the zero lower bound is constraining,” Bullard added.  

Oh, "Woodford" is the author of Interest and Prices, not Woodford Reserve bourbon whiskey.

Perhaps that's for the best... if distilleries expected the Fed to print money to buy bourbon we might expect to see them them start diluting it in anticipation.  Hmmm...

Stanley Fischer

At Wonkblog, an interesting profile of Stanley Fischer by Dylan Matthews, which mixes in a little recent history of economic thought, recounted with the help of one of Fischer's advisees at MIT:

“He was not fundamentally a rat-exian,” Bernanke said, invoking the derogatory slang that Keynesians used to describe Lucas and his theory of “rational expectations.” “He was basically a Keynesian in his instincts, so he got along just fine with Samuelson and [fellow MIT professor Robert] Solow.”

The fruit of Fischer’s effort to integrate the two approaches is known today as “New Keynesian” economics. It is the dominant approach in most leading economics departments, with Mankiw, Bernanke, IMF chief economist Olivier Blanchard and many others contributing to the movement.

But Fischer was arguably first out of the gate. He helped originate the argument that “sticky prices”— that is, practical impediments to changing prices for goods, such as the expense of printing a new restauarant menu — mean that even rational, self-interested businesses and consumers can make choices that add up to an economy much like the one Keynesians describe.

Fischer, Bernanke said, wrote “one of the very first papers that had both sticky prices and rational expectations in it.” By doing this, Fischer had in effect united the two sides of economics. “I still think Keynesian economics is extremely important, and if anybody didn’t think so, this crisis should have made them rethink,” Fischer said in an interview.

The profile includes some speculation that Fischer might succeed his student as Federal Reserve chair (Bernanke's term ends in Jan. 2014).  If he were nominated, it would be interesting to see whether the fact that he is from outside the US - he was born in Zambia (when it was Northern Rhodesia) and came to the US for grad school at Chicago - and served as head of another country's (Israel's) central bank would cause trouble during the Senate confirmation process.  It seems likely that some in the Senate would make trouble for whoever President Obama might nominate (which may be an argument for trying to keep Bernanke on), but I would guess opponents would be more likely to latch on to the fact that Fischer also held a high-ranking job at Citigroup for several years.

Update (2/17): David Warsh's Economic Principals also discussed Fischer as a potential Fed candidate a couple of weeks ago.

From 'The Economic Consequences of Mr. Churchill'

J.M. Keynes, "The Economic Consequences of Mr. Churchill" (1925):

The truth is that we stand mid-way between two theories of economic society.  The one theory maintains that wages should be fixed by reference to what is "fair" and "reasonable" as between classes.  The other theory - the theory of the economic Juggernaut - is that wages should be settled by economic pressure, otherwise called "hard facts," and that our vast machine should crash along, with regard only to its equilibrium as a whole, and without attention to the chance consequences of the journey to individual groups.

The gold standard, with its dependence on pure chance, its faith in "automatic adjustments," and its general regardlessness of social detail, is an essential emblem and idol of those who sit in the top tier of the machine.  I think that they are immensely rash in their regardlessness, in their vague optimism and comfortable belief that nothing really serious ever happens.  Nine times out of ten, nothing really serious does happen - merely a little distress to individuals or to groups.  But we run a risk of the tenth time (and are stupid into the bargain) if we continue to apply the principles of an Economics which was worked out on the hypotheses of laissez-faire and free competition to a society which is rapidly abandoning these hypotheses.

Basic economic theory typically ignores the role of social norms in labor markets.  To some degree, that's ok - we can't have everything in every model, and the basic models (i.e., intermediate micro) give some useful insights.  The danger comes when economists - and the consumers of economics - forget that the models are (over) simplifications.

The context for Keynes's essay was Britain's return to the gold standard at an overvalued level - Winston Churchill was the Chancellor of the Exchequer at the time - but much of it holds up well 88 years later as an essay on the danger of "internal devaluation" such as we're seeing now in Spain.

The End of Mystique

Until fairly recently, central banks tended to be secretive and cultivate a "mystique" (hence "Secrets of the Temple" as the title for the 1987 William Greider book about the Fed, which helped inspire my interest in economics). In the early 1980's Karl Brunner explained (via Marvin Goodfriend):

Central Banking [has been] traditionally surrounded by a  peculiar and protective political mystique. Criticism of Central Banks, if it occurred at all in the political arena, [has been] muted and infrequent. The Federal Reserve operated in the USA over decades with little criticism from the public or its political representatives. The same phenomenon can be found in many other countries. The political mystique of Central Banking was, and still is to some extent, widely expressed by an essentially metaphysical approach to monetary affairs and monetary policy-making. The possession of wisdom, perception and relevant knowledge is naturally attributed to the management of Central Banks. The possession of such knowledge and perception bearing on matters of concern to Central Banking is a function of the political position. The relevant knowledge seems automatically obtained with the appointment and could only be manifested to holders of the appropriate position. The mystique thrives on a pervasive impression that Central Banking is an esoteric art. Access to this art and its proper execution is confined to the initiated elite. The esoteric nature of the art is moreover revealed by an inherent impossibility to articulate its insights in explicit and intelligible words and sentences. Communication with the uninitiated breaks down. The proper attitude to be cultivated by the latter is trust and confidence in the initiated group's comprehension of the esoteric knowledge.

Things have changed a great deal since then, and the pace of change has accelerated.  In a recent speech, Fed Vice Chair Janet Yellen traced this "revolution" in central bank communication, which academic economists generally regard as an improvement.  It was only in 1994 that the Fed began announcing changes in the federal funds rate target, and I was pretty surprised last year when Bernanke began holding press conferences.

Given all the recent changes, I shouldn't have been surprised to see a further step towards greater central bank openness - Federal Reserve banks are now sending jokey tweets:

So much for that mystique.

New From the Fed: TBG

That is, "Threshold Based Guidance." 

The Federal Open Market Committee's statement today included the following:

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

Since the federal funds rate hit the zero lower bound - four years ago - other monetary policy tools have taken on a more prominent role.  One of them is the Fed's ability to influence expectations, which it tries to do by making promises about future policy ("forward guidance").  Because long-term interest rates depend on expected future short term rates, convincing people that short-term rates will be low for longer can bring down long-term rates, and thereby reduce the cost of investment and credit purchases.  One of the difficulties that the Fed has to get around, though, is that people believe it places a high priority on keeping inflation low and would tighten policy at any hint of the economy heating up.  As Mark Thoma explains:

The Fed believes that policy will be most effective if it can convince people policy will remain loose even after there are signs of a strong recovery.

However, one of the problems the Fed has had in its communications strategy is convincing people it will carry through with this commitment even if inflation drifts above the 2 percent target. In some sense, the Fed has too much credibility on inflation.

The adoption of numerical thresholds -- in particular an inflation threshold that is a half a percent above target and the commitment to maintain present policy "at least" until the thresholds have been met -- is an attempt to overcome this communication problem though a commitment to a clear, well-defined policy rule.

This month's announcement was a shift from its previous statements, which had provided forward guidance in terms of the timing of expected rate increases - e.g., in October, the FOMC said "exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015."

Of course, quite a lot can happen between now and mid-2015 and the economy may do considerably better or worse than anticipated. Nobody really believes the Fed would keep the federal funds rate target at zero through mid-2015 if the economy suddenly boomed in 2013 (and, though some seemed to interpret it that way, its wasn't trying to claim that it would).  Alternatively, if things aren't much better in 2015, the fed funds rate could stay at zero considerably longer.

Shifting to thresholds spares the Fed the embarrassment of repeatedly re-adjusting the date in its forward guidance.  Announcing that it will allow forecast inflation to go up to 2.5%, which is 0.5% above the long run goal it formalized in January, seems to be an attempt to convince everyone that the Fed doesn't treat its 2% goal as a "below, but close to" target like the ECB does, and that it is willing to give a little on the "stable prices" side of its "dual mandate" in service of its other objective, "maximum employment."  But it won't let inflation get out of hand (or even close) - its a "dovish" statement only  by the standards of monetary policy discourse long-dominated by inflation "hawks".  Stating the goal in terms of the Fed's forecast of inflation means that it won't feel obliged to tighten in response to a burst of inflation it sees as transitory (e.g., due to an energy price shock).  However, putting it in terms of forecast inflation also makes it a little squishier (which is part of Stephen Williamson's critique).

In his press conference, Ben Bernanke also suggested that the threshold based guidance had an "automatic stabilizer" characteristic (and it appeared he was making this argument off the cuff): in the event of a negative shock to the economy, the threshold would cause markets to lengthen the period of expected zero short-term rates, which would bring long-term rates down.  A positive shock would cause the market to expect the threshold for potentially raising rates to come sooner, which would lead to higher long-term rates.

The other part of the Fed's announcement was that it planned to purchase $45 billion of Treasuries per month, which is intended to continue the expansionary effect of its effort to shift the composition of its balance sheet towards longer maturities ("operation twist").  It will also continue to buy $40 billion of mortgage backed securities per month.  This follows through on its October statement that it would be purchasing assets and expanding its balance sheet with no definite limit or end date until a substantial improvement in the labor market "is achieved in a context of price stability."

Overall, the Fed really seems to be stepping up to the plate and seriously trying to address the crisis of persistent high unemployment as best it knows how.  Bernanke's genuine concern about unemployment was evident in the press conference.

Of course, it remains to be seen how much effect the Fed's policies will really have (the Economist's Greg Ip struck a cautionary note) and fiscal policy appears likely to be either somewhat, or highly, contractionary in the coming year depending on the outcome of the "fiscal cliff" bargaining.

As an academic economist, I was particularly amused by Bernanke's response to a question in the press conference about how the FOMC chose the thresholds.  He said that they were based on staff assessments "under so-called optimal policy, or in the best policy that we can come up with, what would the interest rate path look like and how would it be connected or correlated with changes in unemployment and inflation."  That embodies the tension between academic and policy-making economics.  Bernanke comes from the academic world, where we write and discuss papers about "optimal" policies - usually specified in terms of the utility functions of "agents" in the economy - but he now works in the world of "the best policy that we can come up with".

We academics will be debating how sub-optimal the Fed's policy is for years, but at least they're trying to come up with the best policies they can.

See also: Binyamin Applebaum's NYT story, Neil Irwin, Michael Woodford and David Beckworth.

A Review of Roger Farmer's Books

My review of Roger E.A. Farmer's Expectations, Employment and Prices and How the Economy Works: Confidence, Crashes and Self-Fulfilling Prophecies has finally appeared in the Eastern Economic Journal.

Farmer's ideas are spiritually Keynesian, but he accepts the belief which developed out of the work of Friedman, Lucas and others, that macroeconomic theory should be consistent with microeconomic optimization.  His point of departure from standard DSGE models (both of the Real Business Cycle and New Keynesian varieties) is that he allows for the lack of a unique equilibrium in the labor market.  This opens up a key role for asset values and confidence in determining output, with the policy implication that monetary policy should be directed at stabilizing asset prices.

Expectations is addressed to a professional audience economics book, while How the Economy Works second is written for a general audience.  How the Economy Works also provides a nice overview of how macroeconomics has evolved which would be a good background for laypersons and students about some of the debates within the field.

A subscription is necessary to read the review, which concludes:

The financial crisis and recession have led to considerable hand-wringing and soul-searching by macroeconomists. Caballero [2010, p. 85] argues that “macroeconomic research has been in ‘fine-tuning’ mode within the local-maximum of the dynamic stochastic general equilibrium world, when we should be in ‘broad-exploration’ mode.” Farmer's work answers that call nicely. It is a synthesis in the best sense of the word, blending Keynesian insight with key subsequent developments such as rational expectations, the permanent income hypothesis and the search model of the labor market. It deserves the attention of macroeconomists, who will find it a healthy challenge to their thinking.

Dark Matter: A Quick Revisit

Back in the days before the 2007-8 financial crisis, one of the big sources of anxiety among (some of us) macroeconomists was the US current account deficit, a measure of how much the US was borrowing from the rest of the world each year.

After running deficits for most of the 1980s, an export boom helped bring the current account back into a small surplus in 1991 (aided, that year, by the financial assistance the US received from other countries to pay for the Gulf War).  The deficit began to grow again in 1992, and in the mid-2000's seemed to be on an ever-increasing path.

US Current Account (% of GDP), 1980-2006

The flow of borrowing naturally generated an increasing net stock of debt - the United States' foreign liabilities exceeded its assets in 1986, and the net international investment position (assets minus liabilities) became increasingly negative during the 2000's.

Note that the change in the net international investment position doesn't exactly track the current account deficit because of changes in the values of assets.

And yet, while this data seemed to indicate that the US was on an unsustainable borrowing path - and perhaps facing the risk that the willingness of the rest of the world to lend to it could quickly evaporate in a "sudden stop" crisis, like a number of emerging market countries had experienced - the US continued to receive more in income from its foreign assets than it made in payments to foreign holders of US assets.  That is, the income balance part of the current account remained positive.

US Net Income from Abroad, 1980-2006

How could the US consistently generate positive net income from its assets even as it became an increasingly large net debtor?  Ricardo Hausmann and Federico Sturzenegger turned this question on its head - they argued that if the US was earning net income, it should not be considered a net debtor.  In their account US foreign assets were under-estimated, with the official numbers leaving out what they dubbed "dark matter".  In a December, 2005 op-ed, they explained:

We propose a different way of describing the facts. We measure the assets according to how much they earn and the current account by how much these assets change over time. This is just like valuing a company by calculating its earnings and multiplying by a price-earnings ratio. Of course this opens up methodological questions, but the discrepancies with official numbers are so big that the details do not matter. To keep things simple in what follows we just take an arbitrary 5 per cent rate of return, which implies a price-earnings ratio of 20.

Let's get to work. We know that the US net income on its financial portfolio is $30bn. This is a 5 per cent return on an asset of $600bn. So the US is a $600bn net creditor, not a $4,100bn net debtor. Since the assets have remained stable then on average the US has not had a current account deficit at all over the past 25 years. That is why it is still a net creditor.

We call the $4,700bn difference between our measure of US net assets and the standard numbers "dark matter", because it corresponds to assets that generate revenue but cannot be seen. 

This hypothesis generated a considerable amount of discussion, nicely summarized in this Economist article from January 2006.  Many economists were skeptical of such a blithe interpretation of the situation.  One of the people quoted by the Economist was William Cline:

Mr Cline agrees with the dark materialists when they say there is “something misleading about calling a country that makes money on its financial position the world's largest debtor”. But sadly he does not think Americans can stop worrying. After making $36.2 billion in 2004, America made just $4 billion on its net foreign assets in the first three quarters of 2005. If it continues on its present trajectory, it will shell out about $190 billion in 2010, Mr Cline calculates. Using Messrs Hausmann and Sturzenegger's methodology, America's net foreign assets would then amount to minus $3.8 trillion. A dark matter indeed.

Seven years later, the US current account remains in deficit, though much less so:

US Current Account (% of GDP), 2001-2011 

That is, the US is still borrowing from the rest of the world, but at a reduced pace.  The value of the US' net foreign assets has been volatile as markets and currencies have gyrated over the past several years, but the official data says the US is even more in debt to the rest of the world now:

 And yet, the balance of income on foreign assets is more in favor of the US now than ever before:

US Net Income from Abroad, 2001-2011

Repeating Hausmann and Sturzenegger's calculation today says that (as of the end of 2011) the US was a net creditor by $4540 billion.  Relative to the official net international investment position of $4030 billion, that implies a stock of "dark matter" of $8570 billion!

Although the main source of "Dark Matter" in Hausmann and Sturzzenegger's original reckoning was the "know how" that helped US firms earn higher returns on Foreign Direct Investment (i.e., this was the main missing export), the most relevant for understanding what's happened since is probably the idea that the US exports "liquidity" and "insurance" services by selling assets that are considered safe and liquid by the rest of the world (e.g. US Treasury and "agency" - Fannie Mae and Freddie Mac bonds), while buying riskier assets.

The worry, circa 2005, was that buyers of US debt would run for the exit, leading to a spike in US interest rates and a collapse in the dollar.  The crisis we actually got had the opposite effect, as everyone rushed into US debt, which has helped drive yields down.  The US' net income is boosted by the fact that its paying very low returns on all those Treasuries being held abroad these days.  In Hausmann and Sturzenegger's framework, the financial crisis has been a huge boon to US exports of (unmeasured) liquidity and insurance services.

Macro Update

The BLS released a moderately good jobs report this morning: payrolls rose by 171,000 in October.  The unemployment rate ticked up by 0.1 to 7.9%, but this was due to a large increase in the labor force. In the household survey (separate from the survey of firms where the headline jobs number comes from), the labor force grew by 578,000.  The number of people employed rose by 410,000, while the number unemployed rose by 170,000, hence the increase in the unemployment rate.  The increase in labor force participation may be a sign that some previously "discouraged" workers may now feel like it is at least worth looking for work (to be counted as "unemployed" one must be looking for work).

The payroll figures for the past two months were also revised upward, by 50,000 for August and 34,000 for September.  While this represents a pick up in the pace of job growth, unemployment remains very high - and some have been out of work for a long time - and the recovery is excruciatingly slow.  As Catherine Rampell notes:

Getting the economy to 5 percent unemployment within two years — a return to the rate that prevailed when the recession began — would require job growth of closer to 280,000 per month.

Calculated Risk provides a useful graph of the employment-population ratio for persons aged 25-54 (as a way of taking out the effect of demographic changes), which illustrates how far the labor market has to go:

Last week's GDP release was also consistent with the picture of a slightly improving but still way-too-slowly growing economy.  The BEA's advance estimate put third-quarter real GDP growth at a 2% annual rate, which is mediocre, but better than the 1.3% in the second quarter.

That is, the economy is growing, and so is employment, but still not fast enough to make up lost ground in the 2008-09 recession.  James Hamilton commented on the report at Econbrowser.

However, historically speaking, downturns caused by financial crises are larger and more persistent than typical recessions.  Moritz Schularick and Alan Taylor and Carmen Reinhardt and Kenneth Rogoff both argue that the US is actually doing a little better than might be expected based on evidence from the aftermaths of past financial crises. That is a useful perspective, particularly for evaluating economic policy (as one might right before an election..).  Arguably, US economic policy has been moderately successful if you grade on a curve compare to an appropriate counterfactual.  However, that is little comfort to the over 12 million who remain unemployed.