Wednesday, February 13, 2008

Running on Empty

. Wednesday, February 13, 2008
1 comments

Macroeconomic stability, reserve accumulation, and debt relief in emerging market economies is creating budget problems for the IMF. As The Economist reports, "Its $1 billion budget is traditionally funded by the small profit it makes on lending money to cash-strapped countries. But IMF lending has collapsed in recent years as developing countries have improved their economic management. As a result, the fund looks set to run a deficit of some $400m a year for the foreseeable future."

One might think, "Right then, job well done. Last one out please turn off the lights." After all, the current placid environment reflects in many respects the end of an era that began 35 years ago with the first oil shock. Developing countries developed balance of payments problems in part (though not solely) as a consequence of the negative shocks directly and indirectly generated by the first oil shock. Governments turned to the IMF for assistance and reform. In a very broad sense, one might conclude that although it did take a long time for these problems to work their way through the system, they have finally done so.

This final working out has had two consequences. On the one hand, governments in developing societies have reflected (if that is possible) on the lessons and concluded "never again." Their response has been to recognize the importance of a stable macroeconomic environment and to accumulate foreign exchange reserves as insurance against external shocks. This is especially the case in East Asia, but ever more so in other parts of the world too. Hence, less demand for IMF resources and macroeconomic stabilization. On the other hand, because of these changes, the IMF has a vastly reduced role to play in the global economy.

If ever there were a time at which one could restructure the IMF, this is it. Yet, organizations persist. So, rather than liquidating the fund, or finding ways to fundamentally reduce its scale to bring it in line with current demand for its services, the Fund and the G7 governments are searching for alternative sources of revenue. The most popular source is the sale of some of the IMF's gold holdings (of which it holds 103.4 million ounces, currently valued at around $92 billion). The proceeds would then form a fund that would generate an annual revenue capable of contributing to the budget.

It will be interesting to watch this unfold over the next couple of months. Gold sales require Board approvals, and last time the issue arose (1999) the US Congress was not so keen to see this development. Let's see if they are any more keen this time around.

We're Not So Special

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Kenneth Rogoff: "As the United States’ epic financial crisis continues to unfold; one can only wish that US policymakers were half as good at listening to advice from developing countries as they are at giving it. Americans don’t seem to realize that their “sub-prime” mortgage meltdown has all too much in common with many previous post-1945 banking crises throughout the world.

Professor Carmen Reinhart of the University of Maryland and I systematically compared the run-up to the US sub-prime crisis with the run-up to the 19 worst financial crises in the industrialized world over the past 60 years. These include epic crises in the Scandinavian countries, Spain, and Japan, along with lesser events such as the US savings and loan crises of the 1980’s.

Across virtually all the major indicators – including equity and housing price runs-ups, trade balance deficits, surges in government and household indebtedness, and pre-crisis growth trajectories – red lights are blinking for the US. Simply put, surging capital flows into the US artificially held down interest rates and inflated asset prices, leading to laxity in banking and regulatory standards and, ultimately, to a meltdown.

The US economy is in trouble, and the problems it spins off are unlikely to stop at the US border. Experts from emerging markets and elsewhere have much to say about dealing with financial crises. America should start to listen before it is too late."

You can access the academic paper this op-ed draws upon here.

Sunday, February 10, 2008

How Unequal Are We?

. Sunday, February 10, 2008
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"The bottom fifth [of Americans} earned just $9,974 [in 2006], but spent nearly twice that — an average of $18,153 a year." How is that possible? " So begins a fascinating Op-Ed in today's New York Times written by two Federal Reserve Bank of Dallas economists. The editorial's broader purpose is to offer an alternative measure of economic inequality in contemporary America.

The punch line is simple: measuring household income yields a 15:1 ratio between the highest and lowest fifths of the income distribution. This gap income lies at the base of most hand-wringing over globalization. Yet, if one measures household consumption expenditures instead of income, the ratio between the richest and poorest fifths falls to 4 to 1. Measured at the individual (rather than the household) level, the ratio falls further to only 2.1 to 1 (wealthier households have more people than poorer households). Thus, the extent of inequality we observe is sensitive to how we measure it.

I don't know if they are right when they assert that consumption expenditures provide a better measure of inequality than income. What I do know, however, is that different measures of the same concept can generate very different conclusions. As we often base policy on what we believe is happening, it might prove useful to examine multiple measures before deciding on a change in policy.

Update: Krugman posts on this article. He thinks it's inaccurate: "So my basic reaction to the piece was, there they go again. There’s some truth in what they say, but no news."

Friday, February 8, 2008

While the House Burns

. Friday, February 8, 2008
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Legend has it that shortly after FDR's inauguration in 1932, Congress engaged in a long floor debate on one of the components of the first New Deal. As the debate carried on into the night, a group of legislators began heckling, "the house is burning! the house is burning!" In that spirit, I give you the following.

The Group of Seven meet tomorrow in Tokyo to confirm their unwillingness to work collectively to stabilize the world economy. The list of items on which the world's advanced industrialized countries cannot agree is short but includes practically every policy that matters.
Exchange rates: EU governments are not particularly happy about the dollar's weakness, but the US is unwilling to discuss exchange rates.
Fiscal policy: Governments disagree about the need for a coordinated fiscal response. While the UK is contemplating fiscal expansion, the Japanese and Germans resist. The German attitude is particularly troubling: "Germany’s deputy finance minister has said the blame, and thus the responsibility, lies squarely with the US."
Monetary Policy: The Fed has slashed rates. The ECB remains committed to its current emphasis on holding the line against incipient inflation and shows no indication that it believes that it should shift away from that target (H/T Mankiw). (Brings the old adage to mind: "Generals always prepare to fight the previous war."

I'm not saying that 2007-08 is the same as 1929-1932, but in the face of a pretty serious financial crisis that has raged, with varying degrees of ferocity, since mid-2007, one can't help but be a little concerned (and puzzled) by the systematic unwillingness to consider any kind of cooperative response. Also, isn't it about time we started to invite China to these affairs?

Thursday, February 7, 2008

True or False?

. Thursday, February 7, 2008
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I find this video funny. Mario Cuomo asks to be asked a series of True-False questions about the economy and US policy. One might suspect that the answers to True-False questions would be, well, short. True or False. Watch and learn what it takes to be a politician.

Also, notice the importance he attaches to finding who is to blame...

H/T The Big Picture

Wednesday, February 6, 2008

Who is to Blame?

. Wednesday, February 6, 2008
0 comments

Who should we blame for our current economic difficulties? I have been thinking about this question for the past week. Not because I wonder who we should blame, but because I am puzzled by the quest to find the person or persons who are responsible. The consensus places primary responsibility on Alan Greenspan. A few, such as Fred Bergsten, blame the IMF as well (for what, exactly, remains unclear). There appears also to be a consensus that Bernanke is to blame for failing to respond correctly to financial weakness (whatever that means) in order to make things better.

I find the search for a culprit puzzling for two reasons. First, the blame game rests on faulty reasoning. Those who assign blame implicitly compare what did happen with a utopian counter-factual of what would have happened had a different policy been followed. Greenspan is to blame because he cut rates too much and fueled the housing bubble. Asserting that these rate cuts were mistaken (and thus G is to blame) requires one to believe that not cutting rates would have produced a much better outcome. Yet, what would have happened had G not cut rates? We might have had a severe rather than a mild recession in the early 2000s. Then we would blame him for not cutting rates (fully unaware, of course, that cutting rates would have produced a housing bubble). So, when we assign blame we assume that the path not taken was a better path without having any good reason to believe this.

Second, when we assign blame we assume that individuals can control highly complex systems. Yet, our understanding of the relationship between monetary policy instruments and economic activity has not yet reached the status of Newtonian mechanics. There is considerable uncertainty about how financial markets work, and how they respond to changes in monetary policy. Whatever imperfect understanding does exist is constantly in flux as financial markets innovate. Is it reasonable to expect the Fed to anticipate the emergence of the new and highly complex financial instruments that drove the sub-prime lending boom? How reasonable is it then to argue that the housing bubble was foreseeable (and foreseen) by Greenspan? This is, of course, the inverse of the first flaw in reasoning; we assume that the future consequences of our current decisions are knowable and we can therefore avoid bad futures.

So why do we insist on assigning blame? I don't know, maybe it reflects our discomfort with the uncertainty that pervades all of the decisions we make and our inability to accept how little direct control we have over the broader forces that shape our lives. Or, perhaps it reflects the exigencies of democratic politics. In a world in which we expect so much from our government, we have lost the capacity to distinguish between those things that a government can be reasonably expected to do and those things we think it should be able to do. As a consequence, we expect unreasonable things from our government, and these expectations create opportunities that those seeking office can exploit to their electoral advantage.

International Political Economy at the University of North Carolina: February 2008
 

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