Monday, August 15, 2022

The End of Magic Money


In the July 2022 issue of Foreign Affairs there is an interesting article titled "The End of Magic Money: Inflation And The Future Of Economic Stimulus". In it the author explains how, "under the right conditions, magic money can undoubtedly be deployed successfully" and how US policymakers were successful in dealing with the 2008 financial crisis and how the first response to Covid-19 was also impressive. 

"The pandemic caused U.S. GDP to collapse in the second quarter of 2020: output shrank at an annualized rate of 32 percent. This fall was four times deeper than the hit from the financial crisis in the fourth quarter of 2008; indeed, it was the sharpest ever contraction in the post–World War II period. The Fed responded aggressively, creating twice as much money as it had from 2008 to 2009. Likewise, the president and Congress delivered a budget stimulus that was twice as big as the 2009 version."

This 'mega-stimulus' worked perfectly as the economy 'bounced back' to pre-pandemic levels 'with no sign of inflation' writing that "If the authorities had been able to stop there, they would have pulled off a textbook example of macroeconomic stabilization".

 According to the author, Sebastian Mallaby, "Starting in the spring and summer of 2021, the Fed committed three mistakes, opening the door to today’s price surge".  As a result of the March 2021 $1.9 trillion fiscal stimulus, Brookings forecast that by the end of 2021 the US economy 'would be operating above its maximum sustainable level'. All IB economics students should precisely understand what exactly this implies.  That was the first error according to Mallaby. The Fed did not tighten at that point, preferring to take a 'wait-and-see approach (which is understandable, given the uncertainty faced at that point).  For many it should have 'hiked interest rates, snuffing out the inflation before it became serious'.  Back then many academics claimed (most notably Krugman) that the rise in inflation was 'transitory' (see my earlier post on the debate between 'team transitory' and 'time persistent'; the Summers-Krugman debate, where Laurence Summers proved right: A primer on inflation).  

Then Mallaby goes on to explain the second error the Fed made.  in March 2022 it increased interest rates by only 25 basis points (0.25%), the smallest possible increase. Why? According to Mallaby it was because the Fed is "attached to 'forward-guidance', the practice of signaling interest-rate moves well ahead of implementing them". He calls this the 'speak-wait-act triple jump approach' which may be useful is inflation is too low (the ZLB problem monetary policy faces; you can check if you wish the Oxford IB Economics Study Guide volume on this: pages 98, 118, 122-123, 131, 140-142) but is not useful when the central bank faces the 'opposite challenge of high inflation'. Sometimes 'speed is the priority' when dealing with inflationary pressures arising.  

The third error relates to the fear that a sizable increase in interest rates would spook financial markets.  'Calling market tops is hard, and the Fed's caution is understandable'. But 'asset prices were screaming that the economy was running hot'.  According to Mallaby again, the Fed should have 'factored financial signals into its decisions' and tightened earlier.

The circumstances are such that 'magic money...for the foreseeable future is off the table'. Achieving price stability (the 2% average that Neel Kashkari of the Minneapolis Fed  reiterated in the Roundtable - see my post) is of paramount importance and this will perhaps be more difficult now because 'globalization has stalled' and many many economies are 'stockpiling strategic commodities and "friend-shoring" supplies which is inflationary.

The article IMO is excellent for IB Economics students as it provides them with examples of macroeconomic policies that helps their understanding and can be used in Paper 1 essays.

This is the link: The End of Magic Money Worth your time.

(if not a Foreign Affairs subscriber you can enter your email and they'll send a paywall-free link directly to your inbox).

The logic of carbon pricing

The new IB Economics syllabus expects a lot from students on
  • Negative externalities of production
  • Common pool resources
  • Government intervention in response to externalities and common pool resources including carbon pricing
This piece (see link below) by Max Roser published in June 2021 on carbon pricing in Our World in Data is exactly what an IB Economics candidate (HL and SL) should read to understand the logic behind it.

Quoting from the article:
Consequences include the negative economic impacts of climate change through its effects on people’s livelihoods, and the damage to infrastructure through rising sea levels, thawing permafrost, and extreme weather events. They pose a large threat to the life of animals and ecosystems on our planet and include the destruction of coral reefs, forest fires, the loss of ice shields, and the expansion of deserts. They include an increase in extreme weather events, like heat waves, droughts, floods, and storms. And especially for the world’s poorest people they pose a threat to their lives, as they increase the risk of hunger and food insecurity.

Climate change isn’t the only negative consequence of burning fossil fuels. The air pollution that is caused by burning fossil fuels kills an estimated 3.6 million people in countries around the world every year. 

This is the price we are already paying for burning fossil fuels.
 The author goes on to explain that
There are two ways in which a carbon price can be implemented: a carbon tax or a ‘cap and trade’ system:

In a ‘cap and trade’ system the carbon price changes over time. A maximum level of pollution (a ‘cap’) is defined and manufacturers need licenses to emit carbon. How expensive these licenses are is determined by a trading system. The price of a license increases as emissions approach the cap. 
A carbon tax is simply a levy that is applied to all goods and services which lead to carbon emissions in their production. 
In both systems the price of any product increases with the amount of carbon emitted in the production of it. The result is that products with a low carbon footprint (like taking the train or solar energy) do not get more expensive, while goods that do create a lot of emissions (like a flight or coal energy) do get more expensive.

This helps us reduce emissions and pollution in two ways: it makes carbon-intensive goods much more expensive, meaning consumers will opt for cheaper low-carbon alternatives when they are available; and in markets where they’re not available yet producers will be incentivised to develop low-carbon alternatives.
The link for this excellent Max Rosen article is here: The Argument for a Carbon Price

Carbon pricing can take the form of either a carbon tax or a 'cap and trade' system.  An excellent (brief and simple) article comparing the two is by Charles Frank of Brookings:
A carbon tax is one way to put a price on emissions. Cap-and-trade is another. A carbon tax and cap-and-trade are opposite sides of the same coin. A carbon tax sets the price of carbon dioxide emissions and allows the market to determine the quantity of emission reductions. Cap-and-trade sets the quantity of emissions reductions and lets the market determine the price. Which of the two is better?
Frank breaks down his simple analysis into four sections:
  • which has greater uncertainty and imposes more risks?
  • which is easier and less costly to administer?
  • which is more likely to be politically palatable?
  • what mix of policies combines the best of cap-and-trade and a carbon tax?
There are of course real world examples for students to use.
The link to this Brookings article is here: Pricing Carbon: A Carbon Tax or Cap-and-Trade

Finally, Ian Parry,  the Principal Environmental Fiscal Policy Expert at International Monetary Fund, has these has this list of Five Things to Know about Carbon Pricing for IB Economics students.  Brief and easy.

PS: Complementary to the above is of course ending fossil fuel subsidies.  Students can check out this one: greenhouse gas emissions we should not pay people to burn fossil-fuels, again by Max Roser at Our World in Data.

Hope these help IB Economics students thinking about this issue and tackling effectively related exam questions.

Nota Bene!👇

I just read an Opinion in the New York Times by Paul Krugman written on 16/8/22 and titled 'Why We Don’t Have a Carbon Tax'.  I decided to add his opinion here to help students have a (slightly) different view in related Paper 1 essay questions.  

Bottom line is that he does not  consider carbon pricing a panacea to the climate change challenge we face.  He writes about the Inflation Reduction Act that Biden in the US just signed (according to Krugman 'despite its name, [it] is mainly a climate bill') which 'relies almost entirely on subsidies intended to promote clean energy, offering tax credits for renewable energy, aid to keep nuclear plants operating, incentives to buy electric vehicles and make homes more energy efficient and more'. He continues arguing that 'an exclusive focus on carbon taxes was “dubious economics and bad political economy.'  A carbon tax would be bad political economy because 'people aren’t just consumers and taxpayers, they’re also workers. And any policy that reduces greenhouse gas emissions will displace jobs in fossil fuel industries.'  It would be interesting to point here to the objection that Larry Summers voiced in the roundtable concerning this displacement (go to 34:53) where at 35:17 he ask the rest to put this displacement issue in perspective saying that 'there are only 50000 coalminers in the United States of America right now.  That is one sixth of the number of manicurists...'! Following Krugman's arguments he concludes the piece by writing 'Does this mean that we should never impose a carbon tax? No, not at all. [But,]There’s still a good case for giving people a direct financial incentive to limit emissions, and such a thing may become politically possible as the economy decarbonizes and green energy becomes a more powerful interest group.'
This excellent (short and sweet) complementary article to the above can be reached by clicking here: 
Why we don't have a carbon tax (of course, he is referring to the US). Enjoy!

PS1: The 2019 Twitter thread Krugman refers to in the article is here 

PS2: Olivier Blanchard, the senior fellow at PIIE (also ex-chief economist at the Fund and MIT professor) another heavyweight also weighs in on the carbon tax vs green subsidies debate sparkled by IRA 'climate bill'; Blanchard argues that carbon pricing (carbon taxes) are necessary as (a) a subsidies only approach may prove way too costly for the Government (b) the effectiveness of such subsidies varies significantly and (c) carbon taxes are needed to finance such subsidies
This debate is great for IB Economics students.  The debate is now on Twitter:

Friday, August 12, 2022

A Roundtable on the US Economy to watch (easy and useful)

A most interesting roundtable organized the other day at the Aspen Institute on whether the US economy is headed towards stagflation.  

Excellent for IB HL Economics candidates.  

Exposure to what is going on in a major economy by Lawrence Summers of Harvard, Neel Kashkari of the Minneapolis Fed, Melissa Kearney Professor at the U. of Maryland and of the Aspen Economic Strategy Group and Lawrence Fink, the CEO of BlackRock that manages $10 trillion in assets.  The discussion was moderated by Greg Ip, of the WSJ and author of the great book The Little Book of Economics. Many connections with the current Economics syllabus.  

The video link is here: Is the US Headed for Stagflation

How do we measure living standards

Very often in HL and SL IB Economics exams, candidates are asked questions that relate to living standards and how can we compare across countries or through time.  The new syllabus pays even more attention to this topic so it is recommended that student research it more.

One thing to keep in mind is that even Simon Kuznets, the economist who developed national income and product accounts, warned against using per capita income as a way to make such comparisons.  

A December 2021 article by Benjamin, Cooper and Kimball, titled Measuring the Essence of the Good Life is, in my opinion at least, a must read for any serious student of IB Economics walking into May or November final exams. It was published in Finance & Development, an IMF free publication.  This publication has numerous (short!) articles that perfectly align with the requirements of our syllabus. And students (or an instructor) can request free hard copies.  Many of my students have and they thoroughly enjoy it!

The link to this interesting and useful  article is here: Measuring the Essence of the Good Life (8 minutes read)