Friday, 22 October 2010

Antipodean Reflections

I am in Santiago de Chile for a few days, attending the 14th Annual Conference of the Central Bank of Chile. There were plenty of papers that gave food for thought (perhaps even one by yours sincerely on fiscal adjustments and unrest). The one that particularly caught my eye was by Jeff Frankel of the Kennedy School at Harvard, who looked at the work of the Chilean commission that helps to decide which share of revenue the government should save (some related musings by Jeff are here). To put things in perspective, we know that a) output volatility in the developing world is much higher than in richer countries b) that fiscal policy in LDCs is typically procyclical. If tax revenues depend a lot on resource extraction (copper in the case of Chile), there is a big temptation to just go out and spend when the big times roll. Jeff argues that Chile has much to teach to the rest to the world. As part of a commitment to running a structural surplus over the cycle, it delegated forecasts of copper prices and tax revenue to an independent commission. This might be a good idea not just in countries suffering the wild swings of the resource cycle. He neatly shows that budget forecasts are almost always too optimistic, especially in the European Union. This is largely driven by people overestimating GDP growth. I like the idea of putting more of fiscal policy into the hands of non-politicians (part of "post democratic politics", I guess). The thing I am not so sure about is if the biases Jeff documents (in a place like Ireland, say) aren't partly to do with a general tendency to overestimate improvements in good times... which might affect technical experts too. It's one thing to be in a country with commodity booms, and to realize that these tend to last only so long; it's quite another to look at Ireland in 2006 (or Singapore in 1995, or the US in 2000) and to say - this can't last.

Monday, 18 October 2010

Bad news is good news ... again

Why do I have this sense of deja vu? No, it's not because I am heading to the airport tomorrow for another conference in far-flung lands (the Central Bank of Chile is having what promises to be a good one). It's that strange sensation I get from seeing stock markets rallying hard because Bernanke and friends are promising us more quantitative easing. So let's get this right. QE 2 is being discussed because a) output growth is slowing b) unemployment is high c) the US housing market is in the doldrums d) which means that the banks will have even more problems in the future e) which all sums up to a good chance of deflation. One can debate whether more money printing by the Fed is the right answer. As for the wisdom of bidding up stocks... either it works, which means that we will have anaemic growth plus rising prices, and then we have to worry about inflation (which has traditionally been bad for stocks). Or it doesn't, and we are getting something between the Great Depression and the Japanese lost decades. Neither prospect seems much of a cause for cheer. Now, when was it when I saw this last? That's right, in the fall of 2007, when increasingly bad news led markets to expect interest rate cuts from the Fed. For a few months, the bad news was accumulating, and the markets continued to move higher. Back then, people had complete confidence in the Fed's powers to make any recession disappear in... and when people realized it wasn't quite true, things really collapsed hard. It made for a good show back then. Given how untested QE is compared to good old interest rate tools, I wouldn't be surprised if we get a rerun in a stockmarket near you before long...