Friday, October 31, 2014

...and what Japan is doing...

...and BOJ Governor Haruhiko Kuroda expanding its massive stimulus spending in a stark admission that economic growth and inflation have not picked up as much as expected after a sales tax hike in April.  Why?
...Kuroda said that while the economy continues to recover, plunging oil prices, slowing global growth and weak household spending after the tax hike were weighing on price growth.
and this quote from the Wall Street Journal is very interesting:
 Is it a coincidence the BOJ moved so soon after the U.S. Fed ended its own asset purchase program? The U.S. economy might be in good enough shape to be slowly weaned off central bank life support, but the rest of the world is flagging. The IMF recently shaved its global growth forecasts, China is slowing and the eurozone is edging towards recession. So while the measures are geared towards domestic factors, the BOJ is also battling global headwinds.
How will Mario Draghi react?
The European Central Bank chief can only fantasise about pushing through policy decisions with a one-vote majority, as Bank of Japan Governor Haruhiko Kuroda did on Friday...(from Reuters blogs)
And the same article continues:
Part of the problem is that the ECB's actions are still viewed through the optic of nationalism, and some nations count more than others. It is huge news if a German central banker is overruled. It would barely register if a Cypriot were left to sulk.
True, Germany is Europe's biggest economy and it might seem understandable that the views of its central bankers matter more in practice than they do in the central bank's charter.
However, ECB policymakers are supposed to be politically independent, to rise above national considerations and to focus only on what is good for the euro zone as a whole.
 Sure. Mario Draghi may have to...
 ...wait until the economic situation is so dire that he can win over a healthy majority.
In the meantime,  how much more pain and misery for so many families will be inflicted?

On deflation, Japan, the West and ideology (by P. Krugman)

Deflation features prominently in the IB Economics syllabus (Discuss the possible consequences of deflation, including high levels of cyclical unemployment and bankruptcies) and given what has been going on lately, especially in Europe, it makes sense for IB economics candidates to be very aware of the topic.

Today in tn the New York Times there is another interesting Krugman op-ed titled Apologizing to Japan worth reading and taking down a few notes. Quoting

The point, however, is that the West has, in fact, fallen into a slump similar to Japan’s — but worse. And that wasn't supposed to happen. In the 1990s, we assumed that if the United States or Western Europe found themselves facing anything like Japan’s problems, we would respond much more effectively than the Japanese had. But we didn’t, even though we had Japan’s experience to guide us. On the contrary, Western policies since 2008 have been so inadequate if not actively counterproductive that Japan’s failings seem minor in comparison. And Western workers have experienced a level of suffering that Japan has managed to avoid.
 What policies is PK referring to?
...responding effectively to depression conditions requires abandoning conventional respectability. Policies that would ordinarily be prudent and virtuous, like balancing the budget or taking a firm stand against inflation, become recipes for a deeper slump.
And why according to the author has the policy response been so inadequate or even deleterious?
...why the West has done even worse than Japan, I suspect that it’s about the deep divisions within our societies. In America, conservatives have blocked efforts to fight unemployment out of a general hostility to government, especially a government that does anything to help Those People. In Europe, Germany has insisted on hard money and austerity largely because the German public is intensely hostile to anything that could be called a bailout of southern Europe.
Let's wait for the next chapter of this story.  Let's see how long it takes for those in charge to realize that perhaps, over the longer term, these choices are even against their own interests.

Tuesday, October 21, 2014

On rising income inequality: Janet Yellen, Mohamed El-Erian and Dani Rodrik

Piketty and Saez have definitely managed to let the 'gini out of the bottle' (the Economist and others used this expression: see here and here

Now, Janet Yellen warns against rising income inequality in the US in her speech at the Conference on Economic Opportunity and Inequality organized by the Federal Reserve Bank of Boston (her speech can be found here),  In a New York Times article we read that
...she painted a bleak picture of the increasingly unequal distribution of wealth  and income, warning that Americans already have relatively little chance to advance economically, and that the problem may be worsening...
On the 17th of October Mohamed El-Erian wrote an article published in Project Syndicate with he title The Inequality Trifecta.  It is crisp and to the point and should be a must reading for IB Economics students:
most countries face a trio of inequalities – of income, wealth, and opportunity – which, left unchecked, reinforce one another, with far-reaching consequences. Indeed, beyond this trio’s moral, social, and political implications lies a serious economic concern: instead of creating incentives for hard work and innovation, inequality begins to undermine economic dynamism, investment, employment, and prosperity.
and
Given that affluent households spend a smaller share of their incomes and wealth, greater inequality translates into lower overall consumption, thereby hindering the recovery of economies already burdened by inadequate aggregate demand. Today’s high levels of inequality also impede the structural reforms needed to boost productivity, while undermining efforts to address residual pockets of excessive indebtedness
This is particularly true in the case of Greece where most Greeks are unwilling to accept much needed structural reforms because they are suspicious of the short term and long term effects these will have.  It increases political polarization and may result in greater instability which could prove disastrous for the country.  As El Erian writes, rising inequality '...erodes social cohesion, political effectiveness, current GDP growth, and future economic potential'.

El-Erian also points to the article How the rich rule by Dani Rodrik where we read about the
...strategies to which political leaders resort in order to get elected. A politician who represents the interests primarily of economic elites has to find other means of appealing to the masses. Such an alternative is provided by the politics of nationalism, sectarianism, and identity – a politics based on cultural values and symbolism rather than bread-and-butter interests. When politics is waged on these grounds, elections are won by those who are most successful at “priming” our latent cultural and psychological markers, not those who best represent our interests.
with Rodrik concluding that...
 ...widening inequality in the world’s advanced and developing countries thus inflicts two blows against democratic politics. Not only does it lead to greater disenfranchisement of the middle and lower classes; it also fosters among the elite a poisonous politics of sectarianism.
 (Read about who Mohamed El-Erian, here and here)

Saturday, October 11, 2014

What policymakers in the world are NOT doing....

A great overview of what policymakers are not doing and what they could do can be found in this NYT article: A Global Economic Malaise.

Quoting from the article:
...officials from Germany continue to insist that countries that use the euro meet restrictive fiscal rules, and they are trying to prevent the European Central Bank from buying government bonds.  
German officials need to play a more constructive role by encouraging the European Central Bank to buy government bonds to pump money into the economy and lower interest rates. Such policies are certainly in Germany’s self-interest, because its economy, which previously bucked the downtrend in the rest of the eurozone, contracted in the second quarter and remains weak
or,
...There is a lot governments and central banks could do to avoid another recession. For example, a recent I.M.F. report showed that increasing government spending on public investments like roads, ports and railways can help stimulate the economy immediately and for several more years.

or,
Other European countries, like Italy and Spain, need to do more to encourage companies to invest and create jobs, in part by reforming laws that make it hard for entrepreneurs to set up new businesses

How close to its NRU is the US economy?


The latest unemployment figure for the US is out:  Unemployment dipped below 6% to 5.9% in September, the lowest recorded since July 2008.

This article from the BBC seems good for IB Economics purposes: US unemployment rate hit a six-year low in September.  It may help illustrate:

  • the connection between monetary policy stance and the size of the deflationary gap
  • the connection between interest rates and the exchange rate
  • the new -unorthodox- toolbox of Central Banks (i.e. quantitative easing)
  • the concept of the NRU
  • what may happen if unemployment decreases below the NRU or real output increases above its potential level
  • the SR and LR Phillips Curve material
  • etc etc

Quoting from this article:
The jobs figures are seen as a significant gauge of the health of the economy and there has been much debate over when US interest rates will rise.
The question is, why has this figure sparked debate over when US interest rates will rise?

An analyst is quoted in the article saying:
"The most important item in this report is the drop in the unemployment rate below 6%. (Fed Chair Janet) Yellen has said there is only so much slack if the unemployment rate falls below 6%," said Christopher Low, chief economist at FTN Financial in New York.
This is a reference to the size of the deflationary gap in the US right now or how much below potential output is equilibrium real output.  Stated symmetrically, it is also a reference on how close is the current 5.9% unemployment rate to the natural (normal) rate of unemployment of the country.

Interest rates may increase to slow down the increase in US AD (by discouraging borrowing by households and firms as well as by decreasing US NX since the higher (expected) interest rates will make US bonds more attractive to financial investors who will want to buy them, thus first buying US dollars and leading to an appreciation of the USD (which renders Abercrombie and Fitch shirts as well as Jeep Cherokees pricier abroad and BMWs more attractive inside the US market)

Quoting from the BBC article:
The US dollar was pushed higher as expectations rose that interest rates would go up sooner than previously predicted.
and:
The Federal Reserve has indicated it will raise short term interest rates if the economy continues to grow.
It seems that analysts/markets/policymakers consider the 5.9% an indication that the US is reaching its potential level of real output/ its NRU and so any further increase in AD wil create inflationary pressure which policymakers would like to avoid.

The article though also notes that:
It also said nearly 100 000 job-seekers stopped looking for work in September.
This is a clear reference to so-called 'discouraged workers'.  Two issues arise: first of all, the 5.9% is probably an underestimation of 'true' US unemployment (as many of these 100 000 job-seekers would probably gladly accept a job offer if it became available.  Second, the US NRU may thus be somewhat lower these days than the five point seven, eight or nine percent as a result of the changes in the structure of the US labor market.

Unfortunately, we know only after the fact that we were at the NRU as only if unemployment decreases below it will there be an acceleration of inflation.  And, each tenth of a percentage point of unemployment policymakers manage to shave - off, implies thousands of poor US households escaping poverty and misery.

Economics is indeed quite inexact.

In any case, this article (and many others on the same unemployment statistic) is useful for IB Economics candidates to draw real world examples and use in their paper 1 essays.

On rising income inequality

The second article from the October 4, 2014 issue of the Economist which I believe can be very useful for IB Economics students in their effort to understand the concepts & theories of the syllabus but especially to equip themselves with real world examples which they can effectively employ in their paper 1 essays is titled: The history of inequality Breaking the camel’s back What an impressive work of economic history tells you about inequality

It is a brief report on a new work by the OECD and the University of Utrecht 'How Was Life?
Global Well -being since 1820' which can be found here.

Quoting from the Economist article:
There is an exception to this generalisation, though: inequality. You would expect that the world of the Qing dynasty, Tsar Nicholas I and the British East India Company would be more unequal than today’s. Yet in China, Thailand, Germany and Egypt, income inequality was about the same in 2000 as it had been in 1820. Brazil and Mexico are even more unequal than they were at the time of Simón Bolívar. Only in a few rich nations—such as France and Japan—do you find the expected long-term decline in income inequality

And what about between nations?
What is true for individual countries is also true if you treat the world as a single nation.  The global Gini rose from 49 in 1820 to 66 in 2000. But this was not caused by widening disparities between rich and poor within countries. Inequality of that sort fluctuated for 130 years to 1950, before falling sharply in 1950-1980, in what the report calls an egalitarian revolution. Since 1980 it has risen again (as Thomas Piketty, a French economist, has shown), back to the level of 1820.
Also, the gap between rich and poor nations ('between-country inequality') has widened sharply:
 In 1820 the world’s richest country—Britain—was about five times richer than the average poor nation. Now America is about 25 times wealthier than the average poor country. The Gini coefficient for between-country  inequality stood at only 16 in 1820 (ie, very low). It soared to 55 in 1950, and has been stable since.

The concluding paragraph is also telling as it wraps up findings on the effect of globalization on income distribution:
As globalisation ebbed, it argues, rich countries had more freedom to steer domestic policies and used it to narrow differences between rich and poor. As globalisation spread again after 1980, the opposite happened: “globalisation contributed to higher income inequality within countries,” the report concludes, “while at the same time leading to a decline of income inequality between countries.”

The above may come in handy when discussing several sections of the IB Economics syllabus.  For example:

  • Analyse data on relative income shares of given percentages of the population, including deciles and quintiles 
  • Explain how the Gini coefficient is derived and interpreted. 
  • Explain that due to unequal ownership of factors of production, the market system may not result in an equitable distribution of income. (but also role of institutions and, globalization...)


Friday, October 10, 2014

A great article on the role of infrastructure spending in an economy...

Long flights are great to read cover to cover the Economist!  Flying back home from Singapore provided me with such an opportunity.  I spotted at least 2 articles that may prove useful for IB Economics (HL and SL) candidates.

The first one is titled Concrete benefits: Public investments in infrastructure do the most good at times like the present' and is in the October 4th issue of the magazine/newspaper.

It is a primer on the role of infrastructure spending, complete with explanation and discussion/ evaluation and is it based on a new study by the International Monetary Fund, released as part of its half-yearly “World Economic Outlook”.  The whole chapter can be found here (and is worth skimming through at least) and the press release here (which is only one page).

Remember that a definition of infrastructure is 'physical capital, typically financed by Governments that lowers the overall production and transaction costs of firms and households as it is responsible for sizable positive externalities' (see my OUP Study Guide glossary on page 183 or any IB Economics textbook)

Quoting now from this excellent Economist article:

Public infrastructure is one of the few forms of government spending that both liberals and conservatives support. Ports, power lines and schools are essential to the smooth running of the economy. (But)... public investment is at the mercy of the fiscal weather. Cash-strapped governments are loth to pile on debt or raise taxes even for something as popular as a new road. After a burst of stimulus spending in the immediate wake of the recession, public investment has fallen back in the rich world. 
This is profoundly short-sighted. That is the message of a new study by the IMF. It found that in rich countries at least, infrastructure spending can significantly boost growth through higher demand in the short run and through higher supply in the long run.

This is the first important point made:  the government expenditure will increase aggregate demand in the short term (as G is a component of AD) but will also shift to the right the LRAS curve as it increases the productive capacity of the economy, decreases overall costs of doing business and (as will be explained later) can lead to 'crowding-in' of increased private investment.

It continues stating that
...the results depend on how the investment is financed, how efficiently it is carried out and what the prevailing economic conditions are'
You realize that financing an increase in government spending can be through borrowing, through raising new taxes or by cutting some other public spending.  How it is financed is also of importance. It also matters whether the project is efficiently undertaken (if a 3-lane highway was financed but because of corruption and waste a 2-lane highway was delivered -as it has happened in Greece- or if the final cost of the project is double the initially budgeted/ planned cost, obviously the net effect on growth will be less).  Lastly, when the author writes that it also depends on the 'prevailing economic conditions' he/she implies how large or small the prevailing deflationary gap is i.e. how far/close from potential output the economy is operating.

The article also reminds us why such infrastructure projects are an example of a natural monopoly (thus there are microeconomic links from the syllabus):
Upfront fixed costs for infrastructure projects are typically high and operating costs relatively low. For these reasons, public infrastructure is often a natural monopoly: a city needs only one local telephone network, electricity grid or sewer system, so they are frequently publicly owned or regulated.
How about any multiplier related effects from the increased government expenditure?  Real world estimates are provided and the question of debt accumulation is also discussed:
On average, an unexpected increase in public investment equal to 1% of GDP boosted GDP by an underwhelming but still beneficial 0.4% in the same year and by a more impressive 1.5% four years later. The extra spending did not result in unsustainable debts; quite the opposite. Thanks to higher GDP, the debt-to-GDP ratio fell by 0.9 percentage points in the first year and four percentage points after four years
What if the 'new road' is financed through taxes?  Read on!
When investment is financed without borrowing—that is, with higher taxes or cuts to other spending—it has a small but still positive impact, which grows over time. The authors interpret this as evidence that even when public investment does not directly lift demand, it does so indirectly by “crowding in” private investment, for example by stimulating the  construction of houses and factories when new roads and water mains are installed. Private investment, the authors note, rises in line with the new, elevated level of GDP after a burst of public investment
And, if it is financed through borrowing (issuing new bonds)?
The stimulus is heightened when the investment is financed by borrowing: an increase in public investment equivalent to 1% of GDP boosts GDP by 0.9 points in the first year and 2.9 points in the fourth. This would not be so if debt-financed spending inevitably drove up interest rates and thereby diminished private investment. But the effect is bigger in a slow-growing economy, when rates are low and competition for loans subdued. Under those circumstances, a boost in public investment equal to a percentage point of GDP boosts GDP by an impressive 1.5 points in the first year and three points in the fourth. By contrast, in a fast-growing economy, the impact is actually negative in the first year, and only marginally positive in the fourth, suggesting that “crowding out” can indeed be a problem.
The above paragraph would be excellent to mention in an essay question asking candidates to explain the 'crowding out' effect or to evaluate expansionary fiscal policy!

This excellent article wraps it up by explaining why the time is right for most countries to go ahead and increase now infrastructure investment spending:
...the time is now optimal for more public investment. The added demand would be welcome since unemployment is still too high in most rich countries and interest rates near zero. The supply-side effects may also be considerable; declining public investment has led to a shrinking stock of infrastructure relative to GDP...
and, concludes with meaningful caveats:
Still, identifying a general shortfall in infrastructure investment is easier than working out what projects to spend extra money on. Of the seven biggest rich economies, only Germany and America have suffered a clear deterioration in infrastructure investment since 2006. And public investment is easily wasted on vanity projects such as football stadiums or inflated contracts with politically connected suppliers. Even in relatively transparent, democratic places such as America, with lots of bureaucrats to conduct cost-benefit analyses, identifying the most beneficial investments is hard.

Once again I'd like to stress the need for IB Economics candidates to include examples in their paper 1 essays.  The descriptors for attaining Level 4 marks (9 or 10 in part a and 13-15 in part b) explicitly require that 'examples are used effectively' by candidates.

Some 2013 IB Economics syllabus learning outcomes for which this article may prove handy include:

  • With reference to economies of scale, and using examples, explain the meaning of the term “natural monopoly”.
  • Explain, with reference to the concepts of leakages (withdrawals) and injections, the nature and importance of the Keynesian multiplier.
  • Evaluate the view that increased investment is essential to achieve economic growth.
  • Explain the mechanism through which expansionary fiscal policy can help an economy close a deflationary (recessionary) gap.
  • Fiscal policy and its impact on potential output 
  • Evaluate the effectiveness of fiscal policy through consideration of factors including ...the direct impact on aggregate demand, the effectiveness of promoting economic activity in a recession,...crowding out... 
  • Explain how increased and improved infrastructure will have a short-term impact on aggregate demand, but more importantly will increase LRAS.
  • etc etc


(BTW, it is amazing to me that nowhere in this Economist article is the name 'Keynes' to be found...)