Tag: International Finance

Must-Read: Martin Wolf: David Cameron, the Ex-Prime Minister, Took a Huge Gamble and Lost

Posted on by Brad DeLong

Must-Read: The very sharp Martin Wolf sees structural recession in Britain’s near future.

People minimizing risk are going to leave Britain. People who would otherwise locate in Britain and are risk-shy are going to pause and wait and see. The Bank of England needs to drop the value of the pound by enough to try to maintain full employment in Britain–but not by so much as to make investors feel that investments in Britain are unsafe and so lose the pound its exorbitant privilege.

As Keynes wrote at the beginning of his Tract on Monetary Reform back in 1923:

I dedicate this book, humbly and without permission, to the Governors and Court of the Bank of England, who now and for the future has a much more difficult and anxious task entrusted to them than in former days…

Martin Wolf: Brexit: David Cameron, the Ex-Prime Minister, Took a Huge Gamble and Lost: “The fearmongering of Boris Johnson, Michael Gove, Nigel Farage, The Sun and the Daily Mail has won…

…The UK, Europe, the west and the world are, this morning, damaged. The UK is diminished and will, quite possibly, end up divided. Europe has lost its second-biggest and most outward-looking power. The hinge between the EU and the English-speaking powers has been snapped…. It is, above all, a victory of the disappointed and fearful…. The geography of the outcome reveals that this has also been a revolt of the provinces against a prosperous and globalised London. It is also a revolt against the establishment…. The UK might not be the last country to suffer such an earthquake….

The UK is now at the beginning of an extended period of uncertainty that, in overwhelming probability, foreshadows a diminished future. The Conservatives… will have to do what the Brexiters failed so egregiously to do during their mendacious campaign, namely, map out a strategy and tactics for unravelling the UK’s connections with the EU. This will probably consume the energies of that government and its successors over many years. It will also involve making some huge decisions… [abandon] membership of the single market. At best, the UK might participate in a free trade area in goods. Meanwhile, the rest of the EU, already burdened with so many difficulties, will have to work out its own negotiating positions. I expect them to be tough ones….

The UK economy is going to be reconfigured. Those businesses that have set up in the UK to serve the entire EU market from within must reconsider their position…. Manufacturers… will have to consider how to readjust…. Many will ultimately wish to relocate. Businesses who depend on their ability to employ European nationals must also reshape their operations…. In the short term, however, it will be difficult for businesses to make such decisions sensibly…. This uncertainty has always been the most obvious result of a vote to leave….

The UK’s decision to join the EU was taken for sound reasons. Its decision to leave was not. It is likely to be welcomed by Ms Le Pen, Mr Trump and Vladimir Putin. It is a decision by the UK to turn its back on the great European effort to heal its divisions. It is, for me, among the saddest of hours.

Must-Read: Gauti B. Eggertsson, Neil R. Mehrotra, Sanjay R. Singh, and Lawrence H. Summers: A Contagious Malady? Open Economy Dimensions of Secular Stagnation

Posted on by Brad DeLong

Must-Read: Gauti B. Eggertsson, Neil R. Mehrotra, Sanjay R. Singh, and Lawrence H. Summers: A Contagious Malady? Open Economy Dimensions of Secular Stagnation: “We consider an overlapping generations, open economy model of secular stagnation…

…and examine the effect of capital flows on the transmission of stagnation. In a world with a low natural rate of interest, greater capital integration transmits recessions across countries…. In a global secular stagnation, expansionary fiscal policy carries positive spillovers implying gains from coordination, and fiscal policy is self-financing. Expansionary monetary policy, by contrast, is beggar-thy-neighbor…. Competitiveness policies, including structural labor market reforms or neomercantilist trade policies, are also beggar-thy-neighbor in a global secular stagnation…

Must-Read: Steve Cecchetti and Kermit Schoenholtz: Spillovers, Spillbacks and Policy Coordination

Posted on by Brad DeLong

Must-Read: The very sharp indeed Steve Cecchetti and Kermit Schoenholtz on how, contrary to the models of the early 1980s–and, I fear, the view of the world still held by the FOMC–U.S. monetary tightening is not expansionary for the rest of the world:

Stephen G. Cecchetti Kermit L. Schoenholtz: Spillovers, Spillbacks and Policy Coordination: “Reserve Bank of India Governor Raghuram Rajan’s recent plea for increased coordination is merely the latest protest by emerging-market economy (EME) policymakers about the spillovers from advanced-economy (AE) monetary policy…

…We are still at the early stages of understanding all of this…. Perhaps the real question is whether AE policymakers have underestimated not only the spillovers, but the potential for spillbacks… are insufficiently attentive to the financial stability risks that their policies may cause—not just domestically, but globally…..

The leverage of some intermediaries rises markedly when the accommodation is sustained…. After two years of policy easing… the leverage of the median bank rises from 10.2 to 12.5. For insurance companies, leverage rises from 6.5 to 7.4…. The impact on leverage abroad from an easing of U.S. monetary policy is a multiple of the impact of easing by the home-country central bank! For example, non-U.S. bank leverage jumps from a baseline of 15.8 to 23.6….

Spillovers spillbacks and policy coordination Money Banking and Financial Markets

The dollar’s position in the global economy is special…. This Global Dollar system… magnifies the impact of changes in Federal Reserve policy on the behavior of intermediaries around the world…. [Global] inancial stability depends on the stability of dollar funding. This, in turn, means that the Federal Reserve has an obligation that other central banks do not have: namely, to prevent a collapse of dollar intermediation globally. In the end, this is very clearly in the U.S. interest because the spillbacks from global financial instability will almost surely be large.

I Continue to Fail to Understand Why the Federal Reserve’s Read of Optimal Monetary Policy Is so Different from Mine…

Posted on by Brad DeLong

Does you think this looks like an economy where inflation is on an upward trend and interest rates are too low for macroeconomic balance?

Personal Consumption Expenditures Chain type Price Index FRED St Louis Fed Graph Personal Consumption Expenditures Excluding Food and Energy Chain Type Price Index FRED St Louis Fed

Mohamed El-Erian says, accurately, that the Federal Reserve is much more likely than not to increase interest rates in June or July: Mohamed El-Erian: Federal Reserve Is Torn: “”Moves in financial conditions as a whole are making [the Fed]…

…more confident about going forward [with interest-rate hikes,] and they were worried that the markets were underestimating the possibility of a rate hike this year and they wanted to do something about it…. In the end, what’s clear is a hike will definitely happen this year…. If the Fed unambiguously signals that it will move, you will see a stronger dollar and that… will have consequences on other markets…

Olivier Blanchard (2016), [Blanchard, Cerutti, and Summers (2015)2, Kiley (2015), IMF (2013), and Ball and Mazumder (2011) all tell us this about the Phillips Curve:

  • The best estimates of the Phillips Curve as it stood in the 1970s is that, back in the day, an unemployment rate 1%-point less than the NAIRU maintained for 1.5 years would raise the inflation rate by 1%-point, and that a 1%-point increase in inflation would raise future expected inflation by 0.8%-points.
  • The best estimates of the Phillips as it stands today is that, here and now, an unemployment rate 1%-point less than the NAIRU maintained for 5 years would raise the inflation rate by 1%-point, and that a 1%-point increase in inflation would raise future expected inflation by 0.15%-points.
Www bradford delong com 2016 01 must read olivier blanchard says that he and paul krugman differ not at all on the analytics but rather substantially html

In only 6 of the last 36 months has the PCE core inflation rate exceeded 2.0%/year. I keep calling for someone to present me with any sort of optimal-control exercise that leads to the conclusion that it is appropriate for the Federal Reserve to be raising interest rights right now.

Civilian Employment Population Ratio FRED St Louis Fed

I keep hearing nothing but crickets…

My worries are compounded by the fact that the Federal Reserve appears to be working with an outmoded and probably wrong model of how monetary policy affects the rest of the world under floating exchange rates. The standard open-economy flexible-exchange rate models I was taught at the start of the 1980s said that contractionary monetary policy at home had an expansionary impact abroad: the dominant effect was to raise the value of the home currency and thus boost foreign countries’ levels of aggregate demand through the exports channel. But [Blanchard, Ostry, Ghosh, and Chamon (2015)][6] argue, convincingly, that that is more likely than not to be wrong: when the Fed or any other sovereign reserve currency-issuer with exorbitant privilege raises dollar interest rates, that drains risk-bearing capacity out of the rest of the world economy, and the resulting increase in interest-rate spreads puts more downward pressure on investment than there is upward pressure on exports.

It looks to me as though the Fed is thinking that its desire to appease those in the banking sector and elsewhere who think, for some reason, that more “normal” and higher interest rates now are desirable is not in conflict with its duty as global monetary hegemon in a world afflicted with slack demand. But it looks more likely than not that they are in fact in conflict.

[6]: Blanchard, Jonathan D. Ostry, Atish R. Ghosh, and Marcos Chamon

Must-read: Oscar Jorda, Moritz Schularick, and Alan M. Taylor: “Macrofinancial History and the New Business Cycle Facts”

Posted on by Brad DeLong

Must-Read: Oscar Jorda, Moritz Schularick, and Alan M. Taylor: Macrofinancial History and the New Business Cycle Facts: “In the era of modern finance…

…a century-long near-stable ratio of credit to GDP gave way to increasing financialization and surging leverage in advanced economies in the last forty years. This “financial hockey stick” coincides with shifts in foundational macroeconomic relationships beyond the widely-noted return of macroeconomic fragility and crisis risk. Leverage is correlated with central business cycle moments. We document an extensive set of such moments based on a decade-long international and historical data collection effort. More financialized economies exhibit somewhat less real volatility but lower growth, more tail risk, and tighter real-real and real- financial correlations. International real and financial cycles also cohere more strongly. The new stylized facts we document should prove fertile ground for the development of a newer generation of macroeconomic models with a prominent role for financial factors.

Must-read: Ed Balls: “Echoes of the 1930s must focus finance ministers’ minds”

Posted on by Brad DeLong

Must-Read: Ed Balls: Echoes of the 1930s must focus finance ministers’ minds: “The lesson of the global financial crisis of 2009 is that…

…when the G20 gets going, it can act in a decisive and co-ordinated way. However, we should not have to wait for the crisis to hit before our financial leaders take the action needed to deal with it…. One problem is focus. Back in 2009, the whole world was alive to the risk of global depression. Not so today. Europe is focused on Brexit and the refugee crisis; America is in pre-election paralysis; meanwhile Asian countries are trying to convince everyone there is no need for panic…. Stagnating growth, fragile investor confidence, fears of competitive devaluation spreading mistrust, isolationist politicians flourishing in the polls–the echoes of the 1930s should be enough to focus minds on making the case for co-operation, open markets and finding new policies to deliver more inclusive economic growth…. Listen to the OECD and IMF on fiscal activism. Countries with room for manoeuvre should boost growth through infrastructure spending. That includes the US, Germany and, yes, Britain too. Medium-term fiscal consolidation is vital. But a slide in growth will make things worse. And the cost of funding these investments is very low.

Must-read: Ben Bernanke: “China’s Trilemma—and a Possible Solution”

Posted on by Brad DeLong

Must-Read: The extremely-sharp Ben Bernanke continues to make the argument that the Washington-Consensus Great-Moderation division of labor between technocratic central banks and directly-elected governments–central banks tasked with macroeconomic stabilization, and directly-elected governments focused on rightsizing a public sector funded by an appropriately-prudent debt management system–is simply wrong and inadequate, as we have learned to our great cost. Here he addresses the problem of macroeconomic balancing in China, and says smart things:

Ben Bernanke: China’s Trilemma—and a Possible Solution: “Is the no-devaluation strategy a good one for China?…

…If it is, what does China need to do to make its exchange-rate commitments credible?… China’s ability to avoid a significant devaluation in the medium term will depend on a number of factors, including the country’s other policy choices. China… cannot simultaneously have more than two of the following three: (1) a fixed exchange rate; (2) independent monetary policy; and (3) free international capital flows….

Start with four premises…. 1. China is undergoing a difficult but necessary transition… to [a growth model] that focuses on… services and… consumer demand… accompanied by a slowdown in Chinese GDP growth…. 2. China’s growth appears to have slowed recently by more than the leadership expected or wanted…. 3. To support economic growth… China has eased monetary policy…. 4. At the same time, China has continued a process of reforming and opening up its capital markets. Notably, private Chinese citizens are allowed to invest some of their savings abroad, to a limit of $50,000 per person. Points #3 and #4 are the sources of China’s trilemma…. Chinese households and firms who are able to do so are spurning yuan-denominated investments and looking abroad for higher returns. However, increased private capital outflows also constitute a flight from the yuan toward the dollar and other currencies; that, in turn, puts downward pressure on China’s exchange rate.

In the short run, the PBOC can offset this pressure by selling some of its enormous stocks of dollar-denominated securities and buying yuan…. [But] here is the trilemma in action: If China wants to use monetary policy to manage domestic demand and to simultaneously free up international capital flows, it may not be able to fix the exchange rate at current levels…. One approach would be to devalue now and get it over with. (A series of small devaluations wouldn’t work, as expectations of future devaluations would just accelerate capital outflows.)… [But] a big yuan devaluation would likely be deflationary for the rest of the world… [and] would work against the goal of promoting services over exports. A second possibility… would be to stop or reverse the process of liberalizing capital flows…. This strategy… would sacrifice some of the progress that China has made in opening up its financial system…. Moreover, the horse may be out of the proverbial barn, in that the effectiveness of new capital controls in China would be uncertain…. A third option is to wait and hope…. However, hope is not a plan.

So what to do? An alternative worth exploring is targeted fiscal policy, by which I mean government spending and tax measures aimed specifically at aiding the transition…. Fiscal policies aimed at increasing income security, such as strengthening the pension system, would help to promote consumer confidence and consumer spending. Likewise, tax cuts or credits could be used to enhance households’ disposable income, and government-financed training and relocation programs could help workers transition from slowing to expanding sectors…. Targeted fiscal action has a lot to recommend it, given China’s trilemma. Unlike monetary easing, which works by lowering domestic interest rates, fiscal policy can support aggregate demand and near-term growth without creating an incentive for capital to flow out…

Must-read: David Glasner: “Competitive Devaluation Plus Monetary Expansion Does Create a Free Lunch”

Posted on by Brad DeLong

Must-Read: The very sharp David Glasner says–correctly–that currency war is different from war-war. War war is a negative sum game. Currency war is a positive-sum game:

David Glasner: Competitive Devaluation Plus Monetary Expansion Does Create a Free Lunch: “Hawtrey explained why competitive devaluation in the 1930s was–and in my view still is–not a problem…

…Because the value of gold was not stable after Britain left the gold standard and depreciated its currency, the deflationary effect in other countries was mistakenly attributed to the British depreciation. But Hawtrey points out that this reasoning was backwards. The fall in prices in the rest of the world was caused by deflationary measures that were increasing the demand for gold and causing prices in terms of gold to continue to fall, as they had been since 1929. It was the fall in prices in terms of gold that was causing the pound to depreciate, not the other way around….

Depreciating your currency cushions the fall in nominal income and aggregate demand. If aggregate demand is kept stable, then the increased output, income, and employment associated with a falling exchange rate will spill over into a demand for the exports of other countries and an increase in the home demand for exportable home products. So it’s a win-win situation.

However, the Fed has permitted passive monetary tightening over the last eighteen months, and in December 2015 embarked on active monetary tightening…. Passive tightening has reduced US demand for imports and for US exportable products, so passive tightening has negative indirect effects on aggregate demand in the rest of the world…

Must-read: Barry Eichengreen and Charles Wyplosz: “How the Euro Crisis Was Successfully Resolved”

Posted on by Brad DeLong

Must-Read: When people ask me if Barry Eichengreen is in, I sometimes say: No, he is in the 1920s. But he will be coming back via time machine and in his office this afternoon.

Now I learn that I was wrong: that he has been visiting Charles Wyplosz, whose home base is a parallel universe in which the Euro crisis was successfully resolved in 2010:

Barry Eichengreen and Charles Wyplosz: How the Euro Crisis Was Successfully Resolved: “When the newly elected Greek government of George Papandreou…

…revealed that its predecessor had doctored the books, financial markets reacted violently. This column discusses the steps implemented by policymakers following this episode, which were essential in resolving the Crisis. What is remarkable, in hindsight, is the combination of pragmatism and reasoning based on sound economic principles displayed by European leaders. Instead of finger pointing, they acknowledged that they were collectively responsible for the Crisis….

A miracle [was] made possible by a combination of steely resolve and economic common sense. In their historic 11 February 2010 statement, European heads of state and government acknowledged that the Greek government’s debt was unsustainable. Rather than ‘extend and pretend’, they faced reality…. Greece, European leaders insisted, had to restructure its debt as a condition of external assistance…. Trichet, rather than opposing debt restructuring, opposed the Emergency Liquidity Assistance, noting that the ECB’s mandate limited it to lending against good collateral. German Chancellor Angela Merkel and French President Nicolas Sarkozy, not happy that their banks had recklessly taken positions in Greek bonds, agreed that those banks should now bear the consequences. If banks failed, then the German and French governments would resolve them, bailing in stakeholders while preserving small depositors. Chancellor Merkel was adamant: asking Greek taxpayers to effectively bail out foreign banks was not only unjust but would aggravate moral hazard….

[The] IMF staff’s debt-sustainability analysis showed that Greece’s debt was already too high for [any] large loan to be paid back…. The managing director quickly concluded that the expedient path was to ally with European leaders and embrace the priority they attached to debt restructuring. At the landmark meeting of the IMF Executive Board on Sunday 10 May, European directors overrode the objections of the US Executive Director. The Board agreed on a programme assuming a 50% haircut on Greek public debt…. Fiscal consolidation was still required but for the moment would be limited to 5% of GDP, which was just possible for Greece’s new national union government to swallow. 

In return for this help, Greece was asked to prepare a programme of structural reforms, starting with product market reform… [which] lowered prices and increased households’ spending power, thereby not worsening the recession…. Programme documents gave the Greek authorities considerable leeway in the design of these measures and acknowledged the reality that they would take time to implement. The Greek government having been reassured of IMF support commenced negotiations with its creditors. A market-based debt exchange, in which investors were offered a menu of bonds with a present value of 50 cents on the euro, was completed by the end of the year…

Must-read: Ken Rogoff: “The Great Escape from China”

Posted on by Brad DeLong

Must-Read: Just how large is the Chinese elite’s potential demand for political risk insurance in the form of dollar assets underneath the U.S.’s legal umbrella anyway? The extremely-sharp Ken Rogoff

Ken Rogoff: The Great Escape from China: “The prospect of a major devaluation of China’s renminbi…

…has been hanging over global markets like the Sword of Damocles. No other source of policy uncertainty has been as destabilizing…. It might seem odd that a country running a $600 billion trade surplus in 2015 should be worried about currency weakness. But… slowing economic growth and a gradual relaxation of restrictions on investing abroad, has unleashed a torrent of capital outflows…. Private citizens are now allowed to take up to $50,000 per year out of the country. If just one of every 20 Chinese citizens exercised this option, China’s foreign-exchange reserves would be wiped out. At the same time, China’s cash-rich companies have been employing all sorts of devices to get money out…. Now that Chinese firms have bought up so many US and European companies, money laundering can even be done in-house…