Sometimes economics can be helpful even if it does not allow you to make point predictions with any degree of confidence. This is the case, for instance, when it can rule out certain combinations of outcomes for different economic variables as unlikely or even nigh-on impossible. An example of such an unlikely configuration of outcomes is (a) a strong and sustainable recovery of the US economy and (b) a strong (let alone a strengthening) US dollar. A very similar statement can be made about the prospects for a speedy recovery of the UK economy.  Continue reading "A stronger US economy requires a weaker dollar"

(VI) Will a fiscal stimulus work as effectively when the economy has been hit by a credit crunch?

The credit crunch is now hitting the non-financial enterprise sector hard.  How does a fiscal boost affect demand when the enterprise sector is credit-constrained?  If the constraints are tight enough, they will weaken and may even completely neutralise the effect of a fiscal stimulus on output and employment not (just) because of financial crowding out of consumer and business demand, but because of credit constraints on supply, what Alan Blinder (1987) has called effective supply failure.  This is most easily seen if production is subject to a lag (inputs go in before saleable output comes out).  This means that firms need working capital to get production going.  Increased demand can be met from inventories, and that may provide some working capital, but once inventories have been worked off, the credit constraint on production and employment becomes binding.

The notion that a credit crunch could lead to effective supply constraints being binding in the market for goods and services, even if demand is depressed, was first developed by the South-American structuralist school of Raul Prebisch and Celso Furtado, and its neo-Structuralist successors (e.g. Lance Taylor and Domingo Cavallo (1977)), although its antecedents go back much further to the Austrian school of Hayek, Mises and to Marx. Continue reading "Is there a case for a further co-ordinated global fiscal stimulus? Part 4 & ultima"

(IV). When does a fiscal stimulus boost aggregate demand?

A fiscal stimulus is a key weapon in the policy arsenal used to address an undesirable weakening of aggregate demand.  For the policy to make sense, either an increase in public spending on goods and services (public consumption or investment) or a tax cut (an increase in transfer payments) must raise aggregate demand at a given price level, wage, interest rates, exchange rates and other asset prices.  In the textbook IS-LM model this means that the fiscal measure shifts the IS curve to the right in output - interest rate space - there is no full direct crowding out, Ricardian equivalence or Minsky equivalence.

We may still not get any effect on output and employment, even if the IS curve shifts to the right, either because there could be ‘financial crowding out’ through higher interest rates, lower asset prices or a stronger exchange rate or because there is ‘real crowding out’ through scare real resources on the supply side; real crowding out or ‘factor market crowding out’ occurs through rising real wages and other real factor costs, and through rising inflationary pressures.

But unless the fiscal stimulus shifts the IS curve to the right, it achieves nothing at all - we don’t even have to investigate whether there is financial or real crowding out. Continue reading "Is there a case for a further co-ordinated global fiscal stimulus? Part 3"

On September 16 and 17, the Earth Institute at Columbia University (well, at least it’s not called the Universe Institute) and the Asian Development Bank organised a conference at Columbia University on The Future of the Global Reserve System.  Papers were presented by the members of the Asian Development Bank’s International Monetary Advisory Group (IMAG), of which I am one (the other members are Prof. Jeffrey Sachs, Dr. Nirupam Bajpai, Dr. Maria Socorro G. Bautista, Prof. Barry Eichengreen, Dr. Masahiro Kawai, Prof. Felipe Larrain, Prof. Joseph Stiglitz, Prof. Charles Wyplosz, Dr. Yu Yongding).

The paper “Is there a case for a further co-ordinated global fiscal stimulus” is my take on the subject assigned to me for the New York conference: “Are the coordinated stimulus plans working and are they effective? Should we continue with fiscal stimulus? Are there other approaches to aggregate demand management?”

I will publish the paper in this blog in two or three installments, as I revise the initial draft.  Installment one follows below.

Introduction

For further internationally co-ordinated expansionary fiscal policy measures to be desirable today, a number of conditions must be satisfied.

First, there must be idle resources - involuntary unemployment of labour and unwanted excess capacity.  Output and employment must be demand-constrained.

Second, there must be no more effective way of stimulating demand, say through expansionary monetary policy.

Third, expansionary fiscal policy must not drive up interest rates, either by raising the risk-free real interest rate or by raising the sovereign default risk premium, to such an extent that the fiscal stimulus is emasculated through financial crowding out.

Fourth, at given interest rates, the expansionary fiscal policy measures are not neutralised by direct crowding out (the displacement of private spending by public spending or of public dissaving by private saving at given present and future interest rates, prices and activity levels).  Such direct crowding out can occur in the case of tax cuts (strictly speaking, cuts in lump-sum taxes matched by future increases in lump-sum taxes of equal present discounted value) because of Ricardian equivalence/debt neutrality.  In economies with very highly indebted households, debt neutrality can occur when taxes on households are cut, because of what I shall call “Minsky equivalence” (see Minsky (2008)).  Increases in public spending on real goods and services (”exhaustive” public spending) can fail to boost aggregate demand because of a high degree of substitutability (in the utility functions or the production technology) between private consumption and investment on the one hand and public consumption and investment on the other.

Fifth, there must be cross-border externalities from expansionary fiscal policies that cause decentralised, uncoordinated national fiscal expansions to be suboptimal.

This paper will consider these issues in turn.  After reaching some fairly discouraging conclusions on the scope for further conventional expansionary fiscal policy now, unless there are significant political realignments in fiscally challenged nations that support coalitions in favour of significant future fiscal tightening through tax increases or public spending cuts, I briefly outline some unconventional fiscal/financial policies that may be effective in their own right and may help to enhance the effectiveness of conventional expansionary fiscal policy.  Collectively, they can be characterised as the equitization of debt - household mortgage debt, bank debt and public debt. Continue reading "Is there a case for a further co-ordinated global fiscal stimulus? Part 1"

Until yesterday’s defeat of Roger Federer in the final of the US Open at Flushing Meadows, the most disappointing development this year was the performance of president Barack Obama and his administration - and my expectations were modest to begin with. Continue reading "Expect little and you may yet be disappointed"

Science with very few (if any) data

Doing statistical analysis on a sample of size 1 is either a very frustrating or a very liberating exercise.  The academic discipline known as history falls into that category.  Most applied social science, including applied economics, does too.  Applied economists use means fair and foul to try to escape from the reality that economics is not a discipline where controlled experiments are possible.  The situation that an economically relevant problem can be studied by means of a control group and a treatment group that are identical as regards all but one external or exogenous driver, whose influence can as a result be isolated, identified and measured, does not arise in practice. Continue reading "I know I know nothing; but at least I know that"

In the current worldwide debate about greenhouse gas emissions, the political leaders of the new big polluters (NBPs, especially China and India) attempt to shift the burden of reducing the global flow of new carbon-dioxide-equivalent (CO2E) emissions to the old big polluters (OBPs, mainly Europe, North America and Japan) by claiming the moral high ground, based on two arguments: (1) we are poor, you are rich, and (2) it’s our turn now to pollute.

I will, in what follows, take as given the proposition that (1) global warming is a reality; (2) global warming is a bad thing and (3) that human-made CO2E emissions are a significant contributor to global warming.  The science underlying these propositions is inevitably shaky - as has to be the case for any non-experimental science.  Still I believe that, even if I don’t really know whether my grandchildren are more likely to swim down Oxford Street or to ice-skate down Oxford street, the cost of not doing something about man-made CO2E emissions if they are indeed as harmful as the Greenhouse Lobby argues is vastly greater than the cost of unnecessarily restricting CO2E emissions - an application of the precautionary principle, if you want. Continue reading "Does poverty give a country the right to pollute the atmosphere?"

Like most authors, I tend to cringe when I read something I wrote more than a few years ago.  But while engaging in some authorial auto-archeology recently when preparing the index for a new paper (after all, if I don’t cite myself, who will?), I was pleasantly surprised with a few bits from a paper I wrote in 1999 and published in 2000 in the Bank of England’s Quarterly Bulletin, titled “The new economy and the old monetary economics”.

The paper takes aim at the assertion, rampant in 1999, that the behaviour in recent years of the world economy, led by the United States, could only be understood by abandoning the old conventional wisdom and adopting a ‘New Paradigm’. Prominent among the structural transformations associated with the New Paradigm were the the following: increasing openness; financial innovation; lower global inflation; stronger competitive pressures; buoyant stock markets defying conventional valuation methods; a lower natural rate of unemployment; and a higher trend rate of growth of productivity.

I argue, first, that the New Paradigm has been over-hyped. “…Unfortunately, the ‘New Paradigm’ label has been much abused by professional hype merchants and peddlers of economic snake oil.”

Second, I argue that, to the extent that we can see a New Paradigm in action, its implications for monetary policy have often been misunderstood.

I was particularly pleased that I had written following about financial innovation: Continue reading "Harmful financial innovation"