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.

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...

Stupid Germans and the surpluses

Talk to any German these days about economic policy, and they will soon share with you a sense of outrage that the world is conspiring against their hyper-competitive exports. The German press never talks economics - it talks business. And what's good for business is good for a country as a whole, right? So if Germany has big surpluses, it reflects highly competitive firms. The other - like Mrs. Lagarde of France - are just envious. One COULD actually make some arguments that make sense of the German pleasure in trade surpluses. An ageing country should accumulate assets; some of these should be held abroad. The strongest argument AGAINST piling up trade surpluses is that all those shiny Audis and machine tools sold to the rest of the world buy very few things that will make Germans richer, either today or tomorrow. Michael Lewis has a brilliant book called "Short" about the financial crisis. One of the recurrent themes is how the bubble in subprime really got inflated because of the superabundance of stupid German money. His latest piece on Bloomberg gives you a flavor:

The proprietary trading business turns in part on one’s ability to find the fool -- to find people willing to take the stupid side of the smart bets you are placing. One of the side effects of our seemingly endless financial crisis is to wash a lot of fools, many of them German, out of the game.

If you export lots and import little, you have to export capital, by definition - you are lending to the rest of the world. For whatever reason, German banks - many of them state-owned - have a singular ability to populate financial markets with klutzes who cannot tell garbage from fine food. The trade surpluses which should translate into a huge foreign capital stock, ready to pay the pensions of ageing Germans, instead have a habit of going up in smoke every time a Nasdaq/subprime/bond bubble bursts. The welfare implications of that are not very hard to figure out... and you won't read in the German press about it. So either the country fixes its financial system (beloved 3 pillars and all), or it should use some of those shiny cars at home.

Is history "fate"? The strike in Barcelona

Just this Tuesday, I was teaching the Comin, Easterly and Gong paper on whether today's riches were determined by technological development in the year 1,000 BC in the "Rise of the Global Economy" class in the ITFD. Today is the day of the general strike in Spain. By some strange accident, I was reading Orwell's "Homage to Catalonia" in the last few weeks, and - just as I was arguing in class - history really doesn't have to be spell "fate". Barcelona, the hothouse of Anarchist sentiment in the early days of the civil war, was remarkably genteel and tranquil today. Traffic flowed easily, taxis were available - with a bit of an effort - and a few posters apart, the university was quiet. Only a plume of dark smoke hanging over the Placa Universidad indicated some trouble (a police car had been torched, it turned out). In general, people seem to accept the changes to labor laws with a sense of frustrated resignation. Bizarrely, the people most likely to benefit - i.e. the young, university students, etc. - are more violently opposed than the rest. So the deeply ingrained instinct to start building barricades that Orwell describes somehow got mislaid... so big shocks - decades of Franco rule - really can change the cultural outlook and social fabric. Which reminds me of a paper I should have on the syllabus, one in the sequence of beautiful Acemoglu et al papers on institutions and economic growth. This one is on the impact of the French Revolution, and it's co-authored by our new UPF colleague Davide Cantoni...

congratulations

It's a tough job market out there. That's why it is very nice to see that our students are doing well, despite the headwinds. Clara Sofía Gómez Botero (ITFD 09-10) just got appointed as advisor to the Colombian Deputy Minister for Housing. I am particularly pleased since Clara and her team showed a lot of feel for the policy process in developing countries like Colombia as part of their policy memorandum exercise (which focused on social insurance and indirect labor costs). Good luck to you!

Euro redivivus...

or dead cat bounce? The Euro has surged since touching a recent low of below 1.20 to the dollar. After relentless news headlines hammering the common currency, and all the pundits claiming that parity was next, the market decided to turn a corner. Apparently, the upcoming double-dip in the US is even worse than all the "EU can't compete" sneers of our Anglo-Saxon friends. But make no mistake - purchasing power parity is still a long way off, and probably closer to 1.10 or so. That's true if you look at the Big Mac Index or more sophisticated measures, which the Economist just updated today. OANDA updates the Big Mac Index every day [and cites the exchange rate the other way around, i.e. you get 0.78€ per $]. Introduced by the Economist, it simply uses the ratio of Big Mac prices in different countries as an exchange rate forecast. It actually does pretty well, over relatively long time horizons. Elsewhere, Orley Ashenfelter and co-authors have used Big Mac prices to calculate ppp-adjusted wages. So, what does this mean for the exchange rate? In the short term, there is no way to tell. It's darn easy to tell really pessimistic stories about the US economic outlook (making monetary easing more likely than tightening), or do the same for Euro (another failed bond auction, anyone?). Over the medium term, I expect those Big Macs to do well at forecasting.

Damn good writing...

for the five-minute-creative-reboot; but who will fix my umlauts?

http://www.newyorker.com/humor/2010/07/05/100705sh_shouts_ephron