An RMB appreciation?

There's a small piece over at voxeu on the appreciation of the renminbi (rmb). I think all the banter that went to and fro on the valuation of the rmb seems to have cooled down after the election cycle but also because the rmb has appreciated significantly over the last few years especially in real terms:

You have to be careful when you discuss issues of manipulation, fairness and the like. Far from it being a mathematical issue, there are opinions everywhere on conceptually disputing this. Some of the thinking is that when looked at from a savings-investment dynamic point of view, the accumulation of foreign reserves that China is so famous for - essentially is a reflection of distortions and imperfections in the domestic financial market. The authors in this case, try and link an expected gradual decline in savings with an appreciating currency as opposed to the Balassa-Samuelson approach of productivity differentials.

In fact, if one considers a semi-open economy (China's has a restricted capital account), then theoretically I could see inconsistencies with being able to keep an exchange rate undervalued over the long term. If higher savings is linked to the CA surplus (CA = S - I after all), then an undervalued nominal rate would persistently boost exports and feed back into the economy in the form of higher domestic price levels and wage pressure as well. Eventually, the real effective rate would have to normalize.

Without the free flow of capital, the balance of foreign reserves becomes a reflection of what's happening in the current account. So the central bank can accumulate international reserves and finance them by issuing domestic saving instruments that boost private saving further. The key here, as should be noticed by now is where the adjustment lies. Without a completely open capital account, domestic interest rates will factor into the necessary adjustment.

Monetary Mapping

Some interesting reads in the FT. Here's one of them:

Gillian Tett has an article on the McCulley-Pozsar paper that delves into a sort of formal mapping of the interaction of monetary and fiscal policy in certain situations or cycles of deleveraging etc. This plays on the approach a few years ago to map the shadow system in a detailed manner and what they essentially propose this time is a quadrant-based approach to central banking reactions that argue against the whole idea of independence in unusual times. The charts are really interesting, I'll try and post them up as well. 

Perhaps it simplifies things once you take the diametrically opposite approach, i.e: either the private sector is leveraging or deleveraging and the fiscal stance is that of consolidation or stimulative. If both are stimulative, there could be rapid credit growth (which the central bank needs to keep under control). When one is and the other isn't, a mixed pattern is likely and when both sectors are deleveraging, there is likely to be a deflationary environment - when monetary policy hits the ZLB and loses traction, a boost to the monetary base does nothing to stimulate spending and the economy experiences a liquidity trap. 

This is the main point that Tett takes away and it's primarily the reason for the paper - that in this special circumstance of a dual lack of stimulus, could central bank independence (price stability) be counter-productive? Because loose money won't work, perhaps an MoF needs to work in tandem to ensure fiscal support as well. 

Tett ends with this:

" We are not in the same place today: the US, say, faces modest inflation, not deflation. But it would be a bold investor who would assume history could never be replayed, if the economic crises grind on.

If there is one thing we learnt in the 2008 financial crisis, it is that events which once appeared unimaginable do sometimes occur. In retrospect, the only reason we were surprised by events was that we had a bad (or limited) mental map of how the world worked. Shadow banking was one case in point. It is unlikely to be the last."

The Power of Monetary Policy

I spent a fair bit of time poring over the money multiplier, the base and the money supply among others so maybe I'll have something on that later. Naturally there arose some relationships (historically) that seemed a bit confusing to me so I'm being forced to hold that though. You know the story though - exploding base post-recession, tame price levels and a consistent money stock - and of course, the almost-90 degree spike in excess reserves; it's not hard to put the narrative together...

...in the meantime, however, I came across a Romer(s) draft that I think was presented at the AEA (I can't remember). It's a really interesting read and strongly recommended. What they basically do (in a lot more detail than it seems at first!), is analyze the perceptions of the power of monetary policy based on how the Fed has acted and reacted historically. 

Now this would lead to two approaches - either you have an 

1) "Overinflated belief" that contributes to an error. For example, banking too much in the power of monetary policy and getting it wrong, as in the mid 60's when a highly expansionary policy led to the inflation nightmare of the 70's.

2) A more relevant and recent idea that involves a sense of pessimism as to what monetary policy can accomplish - for example, believing that monetary policy would be ineffective and perhaps too costly  in stimulating the recovery this time around. 

The paper focuses on the latter and is aptly titled, "The Most Dangerous Idea in Federal Reserve History: Monetary Policy Doesn't Matter". And naturally, the greatest error (if you could call it that), was the Great Depression when the money stock, price level and output all plummeted by about 25%! In such a case, the Romers argue that while there is no known evidence of an over-reaching belief, there is general consensus that an "overly pessimistic assessment of the Federal Reserve's ability to combat the downturn was critical in this period", i.e: that policymakers believed that expansionary action would involve high costs and lack effectiveness. 

Essentially, the sense one gets from historical accounts of statements made is that the two vastly different eras weren't all that different when it came to policy fear. The typical response to doing more bordered around the fear of failure and a damage to credibility - that if a decision/move/action had little impact, the Fed's credibility would take a beating. Also, expansionary monetary policy approach can never seem to shake off the inflationary bogieman - the fear that easy credit encourages overborrowing and that an expansion "might well add unwise stimulus to the inflation of prices" or that "a further increase in excess reserves of member banks might give added impetus to existing inflationary tendencies"  - all these are fears that have been voiced recently too. 

Take the 70's - put into fresh perspective for me post the Volcker book. Once inflation gathered steam, a lack of faith or perhaps a fear of the cost of monetary policy played a role, the paper states, to NOT do anything about it. Tightening would bring up fears of output costs and after the mild recession of '69-'70 the Fed under Arthur Burns started to believe that the natural rate wasn't so low after all - and that more importantly, inflation was being unaffected by a drop in economic activity. 

In any case, the more important issue is the relevance of this over the past few years which obviously leads us to believe that the Fed story has not and cannot be written just yet. It takes a much longer period of time to rightfully assess the impact of policies. It is in this section that the authors draw the parallel in beliefs across these three eras mentioned above. In each case, policy makers to an extend, believed that the tools at their disposal were perhaps not effective enough and simultaneously potentially costly. 

There have been all kinds of new fears and questions raised. Why should there be a need for additional liquidity when "so much is presently lying fallow"? Another stresses the danger of a ZRP in increasing the misallocation risk of real resources and perhaps aid a rise in new bubbles. And of course, there is the old inflation demon, the fear that inflationary expectations will quickly spiral out of control. 

Perhaps policy makers at times, try to ensure that the belief that monetary policy can accomplish everything does not gain traction as this diverts attention from other areas, as Bernanke stated most recently. 

All this discussion however, leads the authors to ask what is desirable and key to a central banker's success. Hubris can have disastrous effects - as the belief that monetary policy could cheat the trade-off between low inflation and below-normal unemployment led to a pursuit of seemingly reckless policies. But hubris, in human nature always has these effects. What is more intriguing, and perhaps is the gist of this entire draft, is that humility can have equally disastrous consequences because it can translate into a pessimism and lack of belief that can further lead to inaction. 

This leads to their conclusion, that a central banker needs to have a balanced appreciation of both the limitations as well as the capabilities of the power of monetary policy and a comprehensive understanding of what a particular policy can accomplish and when it can accomplish it. 

Moar Multiplier Musings

I wanted to discuss the detailed Blanchard-Leigh WP at the AEA that brought up multiplier-mania again but still haven't read it in enough detail, so I thought I'd postpone before I came across a Noahpost that he deems incendiary. Why? Because it's conveniently titled (more web hits!) - "Why the multiplier doesn't matter". 

That aside, there are some valid points here. Namely that the first thing he does is add these caveats:
The multiplier doesn't matter:
1) The 'Theoretical" multiplier
2) in the United States
3) At this time in history

And the basis for his argument is that it doesn't matter what the multiplier is period. The bottom line is that the US should be investing in infrastructure. That's why the multiplier doesn't matter. Theoretically, discussing the multiplier in a strictly Keynesian model makes sense if you assume that the Fed is deaf to what's going on fiscally and furthermore has been banned to react in any way. That much, is obvious.

As Noah points out further though, what about public goods? What if there's something the private sector can't provide or won't provide or maybe even shouldn't provide? If these goods are complements (in a good way!) to the private sector then a low multiplier shouldn't matter. Smith then cites the Baxter and King paper from 1993 (I haven't read it and am not likely to soon!) on "government capital" which describes a situation where 'government spending on "government capital" is efficient even without any aggregate demand deficiencies at all. Efficient, that is, as long as the current amount of "government capital" is below the optimal amount - in other words, as long as the country has recently been underinvesting in things like infrastructure.'

That's the point. If you're looking at investment in infrastructure as some sort of a counter-cyclical measure etc. then you're missing it totally. The benefits of infrastructure investment don't differ whether you're in the biggest boom or the biggest bust but the cost of borrowing does - and the cost of capital is so low! 

The Keynesian multiplier doesn't have to be x or y or z to justify repairing a severely underinvested infrastructure. 

If you can't see that, your vision is poor. 

If you choose not to see that, you're a modern-day Republican.

What Am I Reading?

Umair Haque on some certain ways America is excelling at...mediocrity. Noah Smith has a sort of rebuttal on this but it's partially fair. The truth is that while there are several things still good and great, it's becoming increasingly difficult to deny the erosion of the bedrock that made America a global hegemon - infrastructure.

In the broader sense of the word, schools/education, institutions, transportation etc which cost money to build, maintain, revamp, upgrade. It's true, the pace of convergence (and divergence now for some!) vis-a-vis other developed nations is startling. Sooner or later, this is going to start telling a lot more.

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Feldstein has an interesting piece on India Shining: Part (I've lost count - insert number here). I could save you the read and encapsulate bits into a paragraph:

"The Indian economy is coming back. After several years of disappointing performance, the authorities are shifting to policies aimed at boosting the annual growth rate closer to the roughly 9% level that India achieved from 2004 to 2008...All of this is an enormous undertaking – one that 

confronts innumerable potential impediments, both economic and political. But I am betting that India is rising again: millions more will be lifted out of poverty in the coming years, while the increasingly prosperous Indian middle class will expand further." 

Nope, that's not really fair is it? Time to quit being a skeptic and put in the other bits:

"Although India has outstanding universities and technological institutes, the primary-education system is disastrously poor...India’s infrastructure is inadequate for a modern economy. With too little electricity, blackouts are common. Ports are inefficient, roads are congested, and traffic is astonishingly chaotic...Likewise, India’s recent decision to allow large foreign retailers like Wal-Mart to enter the market reflects an encouraging change of attitude that is important beyond the specifics of the particular firms that will now come to India. And legislation will soon create the opportunity for expanded foreign ownership in the financial sector...On the fiscal front, the shift from a complex system of state-level indirect taxes to a national goods and services tax (a type of value-added tax) will improve efficiency and raise revenue. Lowering the subsidy for diesel fuel was politically difficult, but will reduce both the fiscal deficit and excessive use of diesel products...Government investment in infrastructure, both alone and in partnership with private firms, will also directly benefit growth and attract larger inflows of foreign investment."

Easy enough to be optimistic when you're not living the pessimism or in other words, easy enough to see the glass half-full when you're not the one drinking the water.

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And Stephen Roach comes down pretty hard on Abe's latest and greatest from the Land of the Rising Sun. In general, he comes down hard on easing measures taken globally and compares Japan's zombie corporations of the lost decade to America's zombie consumers, both products of ineffecient central banking I presume. 

What Roach does make clear though, is this: we're mired in a classic liquidity trap and the last thing Japan needs is to follow suit and backtrack on serious structural reform. Roach worries about the excess liquidity that is due to be 'sloshing around' in global asset markets without having boosted balance-sheet repair or led to structural change. 

In that sense, he's not wrong.

On the edge of a cliff

I made a mistake in running out of time to jot down some slope/cliff/crevasse/precipice notes and now there's just too much reaction for my liking. This seems quite undeserving because I don't see much to cheer about. Somehow one side of the spectrum has made it out to be a deal-that-saved-mankind when the reality is completely different. That said, the House Republicans really do play nasty and have now wrought the wrath of the scary Chris Christie! I'd be scared, Christie could snap Cantor and Boehner with his left hand - yes, picture that for a second will you.

Anyways...this is what was going around before the deal passed, note the consistency at least! DeLong makes the point of the actual difference the deal made from the status-quo negative impulse the economy would have suffered - not that great you see:

" The big reason to make a deal before January 1, 2013 was that detonating the "austerity bomb" would impose 3.5% of fiscal contraction on the U.S. economy in 2013, and send the U.S. into renewed recession. It was worth making a good-enough deal--sensible long-run revenue increases and tax cuts to close the long-run fiscal gap plus enough short-term fiscal stimulus to make the net fiscal impetus +1.0% of GDP--in order to avoid renewed recession. But by my back-of-the-envelope count, the deal the Obama administration has agreed to still leaves a net fiscal impetus of -1.75% of GDP to hit the U.S. economy in 2013. That is only 40% of the way back from the "austerity bomb" to where we want to be."

Krugman is more severe on Obama, claiming that although it seems like a 'progressive' victory - no benefits cut and tax increases for the first time - you can't help feeling cheated. To him, the POTUS has been drawing lines in the sand and repeatedly proceeded to erase them and draw another...and another.

And Jeffrey Sachs is on the next level of critical. From the HuffPo:

"Even Mitt Romney could never have accomplished for the Republicans what Obama has just done for them...Allowing the Bush tax cuts to expire today would have raised tax collections by around 2.5 percent of GDP, to around 21 percent of GDP by the end of the decade, thereby allowing the government to pay its bills assuming that the useless wars are ended and the bloated Pentagon budget is brought under control...With a revenue baseline of around 18 percent of GDP, there will be years of harsh spending cuts ahead. What will they be? Medicaid? Food Stamps? Roads? Water? Renewable energy? Education? Pre-School? Environment? It will probably be "All of the above." ..."

And lastly, Mankiw came down hard as well - from another angle - stating that everything the BS (yes that's what it is!) commission had espoused has largely been ignored - a perfect example of poor fiscal reform. 

You see, the problem is in everyone pretending to be two saviors at once - for the country's 'bankruptcy' (let's face it, some people are still hell bent on comparing the economy to a household!) and for social insurances. And it's hard to be both at once. 

Once the deal had been passed, naturally there was a varied response across the board. Tellingly, Andrew Semwick, the CEA's Chief Economist a decade ago, had this to say on the winner of the fiscal cliff, 

"Obviously, former President George W. Bush. Despite how much he has been vilified in the years since his departure from office, the Congress and the President yesterday decided to ratify almost all of his tax policy agenda...that even if top marginal tax rates are not lower than in the Clinton years, taxpayers with the highest incomes are still paying lower taxes because all the tax rates below the top are lower...In over eight years of blogging, you won't find a single word of praise for the Bush-Obama tax cuts. As a matter of revenue, we now permanently have a tax system that will not raise enough revenue to cover our expenditures..."

The End of Growth?

This is just a really good read. Professor Gordon from Northwestern makes his case that the rapid rise in per capita (in the advanced economies), might well have been a two-century blip in the really really long term. 

He lays out the three revolutions (steam engines/rail roads - electicity/water - computers/internet) and then argues against further increases at such historical rates. The abridged/intro version is available on voxeu.