Running on Empty

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

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.

How Unequal Are We?

"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."

While the House Burns

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?

True or False?

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

Who is to Blame?

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.

Rational Ignorance?

I puzzled a few days ago about why the media focuses so much attention on how our Presidents in Waiting would respond to the current economic situation. Today, the folks over at Marginal Revolution have a nice post summarizing and then discussing a Matt Yglesias post on PIW John McCain's apparent ignorance of economics. (Davide Leonhardt has a good article here) Yglesias' bottom line is: "John McCain would not govern very well on economic policy issues, and would fare poorly in a campaign that focused heavily on economic problems."

How much economics McCain knows, and what that implies for his qualification to be President raises a broader question: might it be fully rational for president to know zero economics? Consider the following two propositions:

• The president has no institutional authority to affect any macroeconomic policy instrument directly. The constitution (Article I) assigns to Congress (to the House, actually) authority over fiscal policy. The Federal Reserve Act assigns to the Federal Reserve Board the authority to set monetary policy. Thus, the president cannot directly make any decision that affects either of the two major macroeconomic policy instruments. It is not obvious, therefore, why a person who wishes to be president would invest lots of time learning the intricate details about economic policy. Because time is scarce, wouldn't it be more rational to invest in learning about those issues that one would be able to affect directly? In the US political system, the president has greatest authority over foreign and security policy. (This is probably why most presidents ultimately wind up focusing on foreign policy and wind up being remembered more for foreign policy than domestic policy successes and failures (with some obvious exceptions, such as FDR).
• In selecting a president, we are really selecting a presidency, an organization with a highly-refined division of labor staffed by people with specialized knowledge. Perhaps we have a mental image of our president sitting in the oval office for hour after hour pouring over the details of one policy after another. Being president is much like being in school--one hour on macroeconomics, one hour on international politics, etc. This is not what the president does. The president sets a broad agenda; the president (and staff) select people. These people, with expertise in their field, make policy. The president then persuades and cajoles, brides and threatens legislators to vote for these policies.
  

The president's job, therefore, is to set the agenda, pick smart people with expertise who share this broad agenda, create an organizational structure that enables these people to work effectively, and try to get Congress to enact the policy proposals that emerge. It thus seems quite rational for McCain (and all other candidates) to have little knowledge about economics.

This makes me wonder whether we don't focus on the wrong things when we select presidents. Because the president is a leader, a politician, and not a policy maker, perhaps we should focus more attention on our PIWs' leadership capabilities: their broad agendas ("where do you see the country in five years?"), their ability to work effectively with Congress ("do you think that you work well with others?"), and the degree to which we believe they will exercise good judgment in those domains where they have greatest authority (foreign affairs). This would allow us to worry less about what they as individuals would do when confronted with some hypothetical situation about which they have no expertise and over which they have little direct authority.

Economists and fiscal Stimulus

The New York Times disputes my assertion that the serious economists do not think that fiscal stimulus is warranted at this point. Apparently, mainstream economists such as Jared Bernstein (Economic Policy Institute), Alan Tonelson (?) and Larry Summers (Clinton Administration) think that stimulus is warranted. Only non-mainstream economists such as David Henderson, (who the Times labels as a "libertarian economist") question its merits. As an aside, I don't know why Bernstein doesn't warrant a "liberal economist" label if Henderson warrants the "libertarian" one. And Alan Tonelson is not an economist. His bio says he has a BA in History.

The story draws conclusions that are not warranted by the evidence provided: "Most economists praised the deal as a necessary effort that by increasing the public debt to put cash swiftly into the hands of ordinary consumers, could limit the severity and duration of a recession and very likely spare some jobs." Did they survey all economists? If not, how do they know that this is what most economists did?

Stimulus Package

Congress and the administration reached agreement on fiscal stimulus. Paulson's comments in the announcement of the agreement indicates partly why this may offer much in the way of quick relief. "If all works well," he expects the rebates to begin flowing in May. He said the aim is to start sending the checks within 60 days of enactment of the stimulus package, with most recipients receiving their checks in less than 10 weeks.

There has been considerable chatter about whether a fiscal stimulus is a) necessary and b) likely to work. The balance of commentary by macroeconomists seems to be a double no. See, for example,
Mankiw, and Brad DeLong. Of quite different ideological stripes, from conservative (Mankiw) to to DeLong a moderate liberal, and yet, similar conclusions: not time yet--let monetary policy do its job and then use fiscal policy. DeLong's video is worth watching, if only for its somewhat fascinating dorky-intellectual-oddness.

Krugman (the columnist, not the economist) demurs.

It is hard to argue with DeLong's conclusion (which I think I anticipated): "John Edwards and Hillary Rodham Clinton might respond that these stimulus packages are political rather than policy documents--acts of campaigning rather than acts of governance--and they are right, up to a point."

Schadenfreude

EU Finance Ministers seem almost happy about current financial market turmoil.

"Mr Almunia (the EU's Monetary Affairs Commissioner) contrasted imbalances in the US economy with what he described as Europe’s “solid, sound fundamentals”.

“We have a positive current account position. We have a level of savings that is the level required to finance our investments. We have improved our fiscal positions a lot. Moreover, we haven’t got subprime mortgages in our financial systems,” Mr Almunia said.

He denied, however, that he was gloating over the US economy’s troubles. “I’m not engaged in any criticism. I’ve simply described the situation,” he told reporters.