The State of the US and World EconomiesThis program's central focus is the use of Levy Institute macroeconomic models in generating strategic analyses of the US and world economies. The outcomes of alternative scenarios are projected and analyzed, with the results—published as Strategic Analysis reports—serving to help policymakers understand the implications of various policy options.
The Levy Institute macroeconomic models, created by Distinguished Scholar Wynne Godley, are accounting based. The US model employs a complete and consistent system (in that all sectors “sum up,” with no unaccounted leakages) of stocks and flows (such as income, production, and wealth). The world model is a “closed” system, in which 11 trading blocs—of which the United States, China, Japan, and Western Europe are four—are represented. This model is based on a matrix in which each bloc’s imports are described in terms of exports from the other 10 blocs. From this information, and using alternative assumptions (e.g., growth rates, trade shares, and energy demands and supplies), trends are identified and patterns of trade and production analyzed.
The projections derived from the models are not presented as short-term forecasts. The aim is to display, based on analysis of the recent past, what it seems reasonable to expect if current trends, policies, and relationships continue. To inform policy, it is not necessary to establish that a particular projection will come to pass, but only that it is something that must be given serious consideration as a possibility. The usefulness of such analyses is strategic: they can serve to warn policymakers of potential dangers and serve as a guide to policy instruments that are available, or should be made available, to deal with those dangers, should they arise.
By Gareth HutchensThe Age (Melbourne), April 21, 2013. All Rights Reserved.
If we needed more evidence that economics is not a science, we have it now.
A shock wave hit the economics world this week when two of its most famous practitioners—Kenneth Rogoff and Carmen Reinhart—were found to have produced some very dodgy data to support their claims about the consequences of high government debt.
It comes back to a research paper of theirs, Growth in a Time of Debt widely quoted since it was published in 2010. The paper shows that if government debt becomes too high—say, around 90 per cent of gross domestic product—then economic growth will almost always suffer. Global policymakers have taken it to mean that if countries with too-high debt levels want to kick-start flagging economies then they ought to begin the resuscitation process by reducing debt levels first.
It has been repackaged into a simple message: Reduce your debt and economic growth will begin to pick up. But the corollary is that highly indebted governments should not try to spend their way out of economic stagnation because spending more will only make things worse. It has helped to provide the intellectual justification that the proponents of austerity wanted; thus the wave of austerity policies washing around the world since 2010. Millions of people have suffered because of it.
But the intellectual edifice for the global austerity movement was severely weakened this week after it emerged that professors Reinhart and Rogoff had made some basic errors in their interpretation of data that supported their research. The errors were discovered by Thomas Herndon, a student at the University of Massachusetts Amherst's doctoral program in economics. He published a paper this week explaining what he found, with help from two of his teachers, Michael Ash and Robert Pollin.
The paper shows Reinhart and Rogoff had omitted data, made a mistake in their Excel spreadsheet, and used a bizarre statistical methodology, all of which skewed results. It set the academic world ablaze.
As Nobel laureate Paul Krugman wrote: "In this age of information, maths errors can lead to disaster. NASA's Mars Orbiter crashed because engineers forgot to convert to metric measurements; JPMorgan Chase's "London Whale" venture went bad because modellers divided a sum instead of an average. So, did an Excel coding error destroy the economies of the Western world?"
Reinhart and Rogoff have acknowledged they made a spreadsheet error, but they also say it didn't affect their result much.
"It is sobering that such an error slipped into one of our papers despite our best efforts to be consistently careful," they said. "We do not, however, believe this regrettable slip affects in any significant way the central message of the paper or that in our subsequent work."
But in the brouhaha that followed, a few people have been asking why it took so long for Reinhart and Rogoff's research to be tested.
Imagine you've handed your assignment in at school. You make some wonderful claims in it about the way the world works. Your research—based on an analysis of data of 44 countries spanning 200 years—has led you to discover that high government debt to GDP ratios above a "90 per cent threshold" almost always lead to a slowdown in economic growth. It's a law that seems to hold no matter what you throw at it. You can compare different countries in disparate regions, and once you try to take account of the fact that a country's political and financial systems evolve over time you can mix and match these things across centuries of data and the law stays the same.
It's a striking thesis. And luckily for you, you're not expected to hand your data in with your assignment so your work can be checked. Your teacher takes your word for it. That's not how the scientific method is supposed to work. Some economists, such as L. Randall Wray of the Levy institute, say they have written to Reinhart and Rogoff in the past to ask for data, but have been rebuffed. "They ignored our request. I have heard from several other researchers that Reinhart and Rogoff also ignored their repeated requests for the data," Professor Wray wrote this week.
It is sobering to be reminded that economic analyses, produced in this way, can have such influence in the real world. It's worth remembering next time we hear some politician referring to "economic modelling" that supports his or her claim.Associated Program:Region(s):United States
By Robert LenznerForbes, April 20, 2013. All Rights Reserved.
The President of the Federal Reserve Bank of Boston, Erick Rosengren, suggested this week that there could still be runs on money market mutual funds, as took place at the peak of the 2008 financial crisis, since these funds have “no capital” and invest in uninsured short term securities of banks and other financial service firms. While debate over potential regulatory solutions for money market funds continues on, the Boston Fed chief, emphasized that the safety of the money market mutual funds are a “significant unresolved issue.”
As of April 13 there was $903.56 billion in retail money market funds sponsored by Fidelity, T. Rowe Price, Dreyfus, Invesco and others, The total amount of all kinds of money market funds, some owned by institutional investors, was $2.6 trillion. The average weekly yield was a record low of only 0.02%.
He also singled out the issue of capital for the broker-dealer fraternity, where he raised the problem of “virtually no change for broker-dealers since the collapse of Lehman Brothers in September, 2008 and the shotgun marriage of Merrill Lynch into BankAmerica. The solution Rosengren recommended was that the “larger(these investment firms) get the higher the capital ratio”: should be imposed on them. The Boston Fed chief executive, speaking at Bard College’s Levy Institute conference on the economy and financial markets, seemed to be suggesting that the cause for this vacuum in policy is that “Regulatory bodies haven’t evolved as much as the financial markets.” In other words, 5 years after the 2008 meltdown we still have a major challenge in trying to make the global financial system secure against runs and speculative bubbles. There is still further to go in the structural reorganization of the danger from derivatives, but he believes clearing derivatives contracts on exchanges and the decline in bilateral transactions has reduced an element of risk.
Nevertheless, Rosengren made crystal clear in conversation after his talk that he “sees no bubbles anywhere, not even in real estate where prices are still below their 2006 peak.” He believes prices of residential real estate in Boston and New York are still 15-20% under their peak—and prices in Miami, Phoenix, Las Vegas, California– are still priced at a steeper discount to the peak in 2006.
As for the economy in general, Rosengren sees “traction” picking up momentum, in which case he would support the “prudent” position of gradually reducing the QE stimulus program. However, he is troubled by the fact that monetary policy(quantitative easing and record low interest rates) are in conflict with fiscal policy, the restraint of sequester and reduction of federal, state and local government spending, ie “the Obama cuts.”
By Robert LenznerForbes, April 19, 2013. All Rights Reserved.
The growing disparity in wealth made the great recession worse and the recovery weaker than ever before. This nation’s wealth disparity widened more than ever before over the last five years because of the steep decline in the value of residential homes and stagnant wages for the lower and middle income groups in the U.S., explained a member of the Federal Reserve Board, Sarah Bloom Raskin, in a speech that explored for the first time a fresh explanation about the obstacles holding back economic growth.
This “financial vulnerability and marginal ability” to recover from the decline in the wealth of lower income and middle income Americans is “undermining our country’s strength,” Governor Raskin emphasized in New York yesterday at an economic conference sponsored by the Levy Institute at Bard College and the Ford Foundation. Raskin admitted to a feeling of frustration at the central bank about the inability of the Fed’s low interest rate policy together with the expansion in the money supply to alleviate this growing disparity between the wealthy and the rest of American families. She admitted there was current exploration at the Board level of the central bank that “our macro models should be adjusted,” because four years into the recovery a confluence of factors have contributed to a weak recovery.
“Inequality contributed to the severity of the recession,” Raskin said flatly, and blamed this inequality- for the “differential expectations” in the future between well-off families– with those families not so well off, who were battered by a plunge in the value of their homes, a high level of debt and a continuance of lower wages. I had never heard that theme so sharply expressed as the blame for the mediocre rate of growth we are experiencing.
Here are the Fed’s latest breakdown on the disparity in wealth. The top 20% of the population own 72% of the nation’s wealth in large part due to their vast holdings in the common shares of publicly held companies. By comparison, the poorest 20% of the U.S. population only own 3% of the wealth, and so were unable to shelter themselves when their homes declined in value, often below the face value of their mortgage and their take-home pay was not growing– or they lost their jobs.
The distribution of wealth inequality is far worse than the disparity in incomes. Nonetheless, the Fed Governor suggested it does explain the lower levels of consumer spending. As to income disparity between 1979 and 2007, the Federal Reserve figures shows the highest income cohort doubled their annual compensation when adjusted for inflation. The top 1% of earners in the nation saw their share of the national income rise from 10% to 20%. Meanwhile the bottom 40% of the nation’s workers saw their share of the national income decline slightly from 13% to 10%.
The middle class average income rose in those 30 years to 2007 by only 20% or less than 1% a year, underscoring just how much middle income Americans have fallen behind their wealthier brethren. Fed Governor Raskin called this performance “sluggishness.”
One hopeful sign is the gradual increase in prices for residential homes throughout the United States. This trend has restored some semblance of household wealth for homeowners from low income and middle income sectors of the population. Another 10% increase in home values, Gov. Raskin suggested, would allow many more low income families to stay in their homes.
More worrisome, however, is the trend for more and more jobs to be only part-time with less pay and less benefits. “We have lost 9 million jobs,” she said and the growing trend for new jobs to be part-time employment or involving contingent work is “no way to upward mobility” in America.Policy Note 2013/3 | April 2013
This policy note discusses the prospects for job creation in the US based on the most recent Levy Economics Institute Strategic Analysis report, Is the Link between Jobs and Output Broken? The results of our analysis confirm the continued weakness of the US economy in terms of job creation—a phenomenon that has come to be known as a “jobless recovery.” We argue that to understand the problem we must look beyond the unemployment rate, which can conceal changes in the labor force. A prolonged recession can discourage workers, causing them to drop out of the labor market, thus lowering the unemployment rate without increasing employment. Therefore, the total number of people employed should be considered in tandem with the unemployment rate.Download:Associated Program:Author(s):Region(s):United States
Leading Economists and Policymakers to Discuss Poverty, Deficits, and Financial Reform at the Levy Economics Institute's 22nd Annual Hyman P. Minsky Conference, in New York City, April 17–19Press Releases | April 2013
Download:Associated Program:Author(s):Mark PrimoffRegion(s):United States
By Dimitri B. PapadimitriouLos Angeles Times, April 5, 2013. All Rights Reserved.
The government can and should increase the deficit to return us to prosperity. Without such outlays we can’t get enough GDP growth to seriously attack unemployment.
Just before the congressional spring break, a Senate budget proposal to decrease, but not eliminate, the deficit over 10 years was denounced as “pro debt” by an Alabama senator. It was the kind of proud and loud anti-deficit rhetoric that, no matter how nonsensical, plays nicely into Washington group-think on the subject.
The deficit has arguably gained the distinction of being the single most widely misunderstood public policy issue in America. Just 6% (6!) of respondents in a recent poll correctly stated that it had been shrinking, which has in fact been the case for several years, while 10 times more, 62%, wrongly believed that it’s been getting bigger.
Despite prevailing notions in the capital and throughout the nation, those of us at the Levy Economics Institute—along with many other analysts and economists—have concluded that the deficit should be increased.
Why add to the deficit right now? Jobs. Our economic models clearly show that without increased government outlays we’ll be unable to generate enough GDP growth to seriously attack unemployment. If we tried to balance the budget through tax hikes, our still-recovering economy would be hurt. That leaves a temporarily bigger deficit as an important option.
A mutation in the link between growth and jobs makes the issue urgent. While we are seeing some economic growth, the unemployment rate is not responding as strongly to the gains as it did in the past.
This slow job growth—today’s “jobless recovery”—isn’t an outlier. It’s a phenomenon that has been increasing over the last three decades, with jobs coming back more and more slowly after a downturn, even when GDP is increasing. The weak employment response has been an almost straight-line trend for more than 30 years.
Our institute’s newest econometric models show that each 1% boost in the GDP today will create, roughly, only a third as much improvement to the unemployment rate as the same 1% rise did in the late 1970s.
Traditionally, we’ve assumed that GDP growth would be followed by an employment surge. The break in that link is now very clear. It’s especially worrisome this year, with only a small GDP rise universally anticipated.
The Federal Reserve, for one, just reduced its growth outlook to 2.8% at most for 2013. The shallow recovery we’re seeing may indeed continue through 2014 and beyond. Since employment now consistently lags well behind GDP, we’ll have a long slog before we reach pre-crisis unemployment levels (below 4.6%). Some Federal Reserve officials believe it might take three years just to get from today’s 7.7% down to 6.5%. Full employment would still be nowhere in sight.
The quantitative data are telling us that without a stimulus, we can’t expect a strong employment lift. But instead of stimulus, we’re devising federal budgets that cut spending and lay off workers. The sequester is expected to depress GDP growth by perhaps half a percentage point—when we know that more growth than ever will be needed to raise employment—and cost anywhere from 700,000 to more than 1 million jobs.
Slower government spending is one reason that post-recession growth has been below par compared with other recoveries, Fed Vice Chair Janet Yellen has argued. As government outlays and employment have shrunk, the contribution of public funds to national growth has also fallen. By our estimates, that contribution now stands at about zero. That’s another data point indicating that federal deficits need to be increased.
To better understand the changing relationship between growth and jobs, the Levy Institute recently looked at three scenarios through 2016: what the results might be of a small, medium or large stimulus. A strong stimulus was clearly the most effective option, since it had a powerful, positive influence on employment growth and, in the long term, on deficit reduction. Of course, that route is completely unfeasible in the current political climate. But we saw that even a small amount of deficit spending could help put the recovery on track if it were combined with a mix of private investment, increased exports and good policy alternatives.
That points toward a way forward. Increasing the deficit while our economy is fragile is not “pro deficit,” any more than a family with a 30-year home mortgage is “pro debt.” To reclaim a phrase that deficit hawks have tried to make their own, it is “sensible and serious.” The federal government can run a deficit, as it almost always has, to help the nation return to prosperity.
With our new understanding of the fraying tie between GDP growth and jobs, we know that millions of Americans are on course for an agonizingly slow march out of joblessness unless we make a move. The nature of slumps and recoveries has changed, and the policies to manage them need to change too.
Dimitri B. Papadimitriou is president of the Levy Economics Institute of Bard College and executive vice president of Bard.
Austerity Budget Cuts Threaten to Undermine Economic Recovery and Keep Unemployment High, New Levy Study SaysPress Releases | March 2013
Download:Associated Program:Author(s):Mark PrimoffRegion(s):United StatesStrategic Analysis | March 2013
As this report goes to press, the official unemployment rate remains tragically elevated, compared even to rates at similar points in previous recoveries. The US economy seems once again to be in a “jobless recovery,” though the unemployment rate has been steadily declining for years. At the same time, fiscal austerity has arrived, with the implementation of the sequester cuts, following tax increases and the ending of emergency extended unemployment benefits just two months ago.
Our new report provides medium-term projections of employment and economic growth under four different scenarios. The baseline scenario starts by assuming the same growth rates and government deficits as the Congressional Budget Office’s (CBO) baseline projection from earlier this year. The result is a new surge of the unemployment rate to nearly 8 percent in the third quarter of this year, followed by a very gradual new recovery. Scenarios 1 and 2 seek to reach unemployment-rate goals of 6.5 percent and 5.5 percent, respectively, by the end of next year, using new fiscal stimulus.
We find in these simulations that reaching the goals requires large amounts of fiscal stimulus, compared to the CBO baseline. For example, in order to reach 5.5 percent unemployment in 2014, scenario 2 assumes 11 percent growth in inflation-adjusted government spending and transfers, along with lower taxes.
As an alternative, scenario 3 adds an extra increase to growth abroad and to private borrowing, along with the same amount of fiscal stimulus as in scenario 1. In this last scenario of the report, the unemployment rate finally pierces the 5.5 percent threshold from the previous scenario in the third quarter of 2015. We conclude with some thoughts about how such an increase in demand from all three sectors—government, private, and external—might be realistically obtained.Download:Associated Program:Author(s):Related Topic(s):Aggregate demand Congressional Budget Office Fiscal austerity Fiscal policy Jobless recovery Unemployment United StatesRegion(s):United States
Conference on “Debt, Deficits, and Unstable Markets” at the Deutsche Bank Headquarter in Berlin’s Unter der Linden, GermanyIn the Media | December 2012
By Mitja StefancicThe University of Ljubljana Faculty of Economics provides an overview of the Institute's Minsky Conference on Financial Instability here.Associated Program:Region(s):United States, Europe
Policy Note 2013/5 | May 2013
The EU and the Pillage of the Indebted CountriesThe European Union (EU) is a treaty-based organization that was set up after World War II as a means of putting an end to a favorite practice of the Europeans: sorting out their national differences by engaging in bloody warfare. The European experiment—the formation of a Common Market, which led eventually to economic and monetary union—has been linked to some remarkable outcomes: Europe has experienced its longest period of peace since the end of World War II, and war among European member-states now seems highly unlikely. Naturally, senior EU officials never miss an opportunity to remind the public of this achievement whenever the policies of the “new Rome” are questioned by a European citizenship fed up with authoritarian decision-making processes by the EU core, bank bailouts masquerading as national bailouts, austerity policies—and what amounts to the pillaging of the debtor countries by the center.Download:Associated Program:Author(s):Related Topic(s):Economic and Monetary Union (EMU) European economic policy Eurozone debt crisis Maastricht Treaty Neoliberalism Single European Act (SEA)Region(s):EuropePolicy Note 2013/4 | April 2013In March of this year, the government of Cyprus, in response to a banking crisis and as part of a negotiation to secure emergency financial support for its financial system from the European Union (EU) and International Monetary Fund (IMF), proposed the assessment of a tax on bank deposits, including a levy (later dropped from the final plan) on insured demand deposits below the 100,000 euro insurance threshold. An understanding of banks’ dual operations and of the relationship between two types of deposits—deposits of customers’ currency and coin, and deposit accounts created by bank loans—helps clarify some of the problems with the Cypriot deposit tax, while illuminating both the purposes and limitations of deposit insurance.Download:Associated Program(s):Author(s):Related Topic(s):Region(s):EuropeWorking Paper No. 762 | April 2013
Highlighting that France and Germany held largely contradicting hopes and aspirations for Europe’s common currency, this paper analyzes how the resulting euro contradiction conditioned the ongoing euro crisis as well as current strategies to resolve it. While Germany generally prevailed in hammering out the design of the euro policy regime, the German authorities have failed to see the inconsistency in their policy endeavors: the creation of a model whose workability presupposes that others behave differently cannot be made to work by forcing everyone to behave like Germany. This fundamental misunderstanding has made Germany the main culprit in the euro crisis, but it has yet to face the full consequences of its actions. Germany had sought every protection against the much-dreaded euro “transfer union,” but its own conduct has made that very outcome inevitable. Conversely, having been disappointed in its own hopes for the euro, France is now facing the prospect of a lost generation—a prospect, shared with other debtor nations in the union, that has undermined the Franco-German alliance and may soon turn it into the ultimate euro battleground.Download:Associated Program:Author(s):Related Topic(s):Competitiveness Currency union Economic and Monetary Union (EMU) Euro European Central Bank (ECB) Eurozone debt crisis France GermanyRegion(s):Europe
March 27, 2013“Rethinking the State” is a video project funded by the Ford Foundation and the Institute for New Economic Thinking (INET) with the aim of using the recent economic crisis to question assumptions behind economic theory and to rethink the role of the state, finance, and austerity in promoting growth and innovation. In the first of a series of interviews with leading economists, Senior Scholar Jan Kregel discusses the causes and consequences of the Greek crisis, and the ineffectiveness and side effects of austerity. Click here for the complete interview. More information on “Rethinking the State” is available from INET.
By Tom KrisherThe Associated Press, March 25, 2013. All Rights Reserved.
The last-ditch effort to save the banking system in Cyprus should bring a rally when U.S. stock markets open today, according to several investment managers.
Cyprus and its international creditors agreed early today on key elements of a deal for a 10-billion-euro ($13-billion) bailout. Cyprus’ second-biggest bank, Laiki, will be restructured, and holders of deposits exceeding 100,000 euros will have to take losses, a European Union diplomat said. The diplomat spoke on condition of anonymity pending the official announcement.
It was unclear just how big of a hit big depositors will have to take, but the tax on deposits was expected to net several billion euros, reducing the amount of rescue loans the country needs.
U.S. investors won’t care too much about who takes losses in Cyprus, as long as there’s a bailout that stops the run on banks in the Mediterranean island nation and keeps the eurozone stable, said Karyn Cavanaugh, market strategist at ING Investment Management in New York.
“If this works out, regardless of the terms, this is going to be good for the market,” she said Sunday night.
The tax on large deposits likely will be 10 to 20 per cent, in order to raise about $7.5 billion, said Jack Ablin, chief investment officer for BMO Private Bank in Chicago.
The move should be well received by U.S. investors because it’s the third bailout deal in the eurozone, including Greece and Spain, and in each case the countries have agreed to austerity plans.
“I suspect investors will take that news pretty well,” he said.
The Dow Jones industrial average dropped more than 90 points Thursday in part on fears that the crisis in Cyprus will intensify. But it rebounded and erased the loss on Friday.
Late Sunday, Dow Jones industrial futures were up 42 points to 14,501. The broader S&P futures added six points to 1,558.00 and Nasdaq futures rose fractionally as well. Japan’s benchmark Nikkei 225 gained 1.35 per cent to 12,505.51 in early trading.
The European Central Bank had threatened to stop providing emergency funding to Cyprus’ banks after today if there is no agreement on a way to raise 5.8billion euros needed to get a 10-billion-euro rescue loan package from the International Monetary Fund and the other countries that use the euro currency.
If Cyprus fails to get a bailout, some of its banks could collapse within days, rapidly dragging down the government and possibly forcing the country of around one million people out of the eurozone.
Analysts say that could threaten the stability of the currency used by more than 300 million people in 17 EU nations.
A plan agreed to in marathon negotiations earlier this month called for a one-time levy on all bank depositors in Cypriot banks. But the proposal ignited fierce anger among Cypriots and failed to garner a single vote in the Cypriot Parliament.
The idea of some sort of deposit grab has returned to the fore after Cyprus’ attempt to gain Russian financial aid failed this past week, with deposits above 100,000 euros at the country’s troubled largest lender, Bank of Cyprus, possibly facing a levy of up to 25 per cent.
Monday’s deal between Cyprus, the International Monetary Fund and the European Commission still needs approval by the 17-nation eurozone’s finance ministers. The deal could still be scuttled if Parliament rejects the tax on depositors, said Dimitri Papadimitriou, president of the Levy Economics Institute of Bard College.
And Cavanaugh said any glitch that thwarts the deal could still cause U.S. markets to plunge later. She’s still concerned that the U.S. economy, with recent weak corporate earnings, may be hurt by economic troubles in Europe. She’s advising investors to be defensive, staying in the market but moving some of their portfolios into bonds.
However, Ablin said tiny Cyprus shouldn’t have much of an impact on U.S. markets short of a total default.
“We’ve been through a lot, and the euro has not yet fallen off the table,” he said. “I guess the conventional wisdom is the euro can sustain a big setback in Cyprus and still continue to move forward.”Associated Program:Region(s):Europe
Economic Catastrophe in Greece Highlights Failure of EU and IMF Neoliberal Economic Policies and Corruption and Ineptitute of Greece's Domestic Political Elite, New Levy Study SaysPress Releases | March 2013Download:Associated Program:Author(s):Mark PrimoffRegion(s):Europe
Background Briefing: Ian Masters Interviews Dimitri B. PapadimitriouMarch 18, 2013. Copyright © 2013 KPFK. All Rights Reserved.
Pacifica Radio host Ian Masters interviews Levy Institute President Dimitri B. Papadimitriou about the banking meltdown in Cyprus that has revived concerns about the viability of the eurozone. They also look into the exposure that Russian companies and individuals have in troubled banks in Cyprus, where banking assets are eight times the size of the country’s economy.
Full audio is available here.
Working Paper No. 761 | March 2013
The Case of China
The recent declines in China’s financial account balance ended the “twin surplus” era and led to a modest decline in the stock of official reserves, which reflects a reversal in expectations for the Chinese currency. Negative balances, which have been visible in China’s financial balances since the last quarter of 2011, have heightened fears/anxiety in markets. These deficits stand in sharp contrast to the typical financial account surplus that existed until 2010. The announcement in September 2011 by Chinese monetary authorities of a “two-way floating” RMB in the foreign exchange market has unsettled market expectations and has led to a sharp fall in the financial balance. The latter brought a change in the expectations regarding the RMB-USD exchange rate. This change was reflected in the drop in foreign exchange assets, which was caused by a jump in short-term trade credits to prepay (for imports) in dollars, a rise in dollar advances from banks, and a withdrawal of dollar deposits. These changes have, of late, been a cause of concern relating to the future of China’s economic relations vis-à-vis trading and financial partners, which include the United States.
The experience of China, in a changing world beset with deregulation and with speculation affecting her external balance in recent years, provides further confirmation of John Maynard Keynes’s observation, in 1937, regarding uncertainty in markets: “About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know.”Download:Associated Program:Author(s):Related Topic(s):Region(s):AsiaWorking Paper No. 714 | April 2012
China and India
The narrative as well as the analysis of global imbalances in the existing literature are incomplete without the part of the story that relates to the surge in capital flows experienced by the emerging economies. Such analysis disregards the implications of capital flows on their domestic economies, especially in terms of the “impossibility” of following a monetary policy that benefits domestic growth. It also fails to recognize the significance of uncertainty and changes in expectation as factors in the (precautionary) buildup of large official reserves. The consequences are many, and affect the fabric of growth and distribution in these economies. The recent experiences of China and India, with their deregulated financial sectors, bear this out.
Financial integration and free capital mobility, which are supposed to generate growth with stability (according to the “efficient markets” hypothesis), have not only failed to achieve their promises (especially in the advanced economies) but also forced the high-growth developing economies like India and China into a state of compliance, where domestic goals of stability and development are sacrificed in order to attain the globally sanctioned norm of free capital flows.
With the global financial crisis and the specter of recession haunting most advanced economies, the high-growth economies in Asia have drawn much less attention than they deserve. This oversight leaves the analysis incomplete, not only by missing an important link in the prevailing network of global trade and finance, but also by ignoring the structural changes in these developing economies—many of which are related to the pattern of financialization and turbulence in the advanced economies.Download:Associated Program(s):Author(s):Related Topic(s):Capital mobility Current account imbalances Efficient markets Impossible trinity Monetary policy National autonomy Official reservesRegion(s):AsiaWorking Paper No. 675 | July 2011
This paper traces the rise of export-led growth as a development paradigm and argues that it is exhausted owing to changed conditions in emerging market (EM) and developed economies. The global economy needs a recalibration that facilitates a new paradigm of domestic demand-led growth. Globalization has so diversified global economic activity that no country or region can act as the lone locomotive of global growth. Political reasoning suggests that EM countries are not likely to abandon export-led growth, nor will the international community implement the international arrangements needed for successful domestic demand-led growth. Consequently, the global economy likely faces asymmetric stagnation.Download:Associated Program:Author(s):Thomas I. PalleyRelated Topic(s):Region(s):United States, Latin America, AsiaWorking Paper No. 642 | December 2010
China occupies a unique position among developing countries. Its success in achieving relative stability in the financial sector since the institution of reforms in 1979 has given way to relative instability since the beginning of the current global financial crisis. Over the last few years, China has been on a path of capital account opening that has drawn larger inflows of capital from abroad, both foreign-direct and portfolio investment. Of late, a surge in these inflows has introduced problems for the monetary authorities in continuing with an autonomous monetary policy in China, especially with large additions to official reserves, the latter in a bid to avoid further appreciation of the country’s domestic currency. Like other developing countries, China today faces the “impossible trilemma” of managing the exchange rate with near-complete capital mobility and an autonomous monetary policy. Facing problems in devising and sustaining this policy, China has been using expansionary fiscal policy to tackle the impact of shrinking export demand. The recent drive on the part of Chinese authorities to boost real demand in the countryside and to revamp the domestic market shows a promise far different from that of the financial rescue packages in many advanced nations.
The close integration of China with the world economy over the last two decades has raised concerns from different quarters that relate both to (1) the possible effects of the recent global downturn on China and (2) the second-round effects of a downturn in China for the rest of world.Download:Associated Program:Author(s):Related Topic(s):Capital account opening Financial crisis Impossible trinity Integration Official reserves State-owned enterprises Stock markets Trade surplus VolatilityRegion(s):AsiaWorking Paper No. 619 | September 2010
Recovery Prospects and the Future
The global crisis of 2007–09 affected developing Asia largely through a decline in exports to the developed countries and a slowdown in remittances. This happened very quickly, and by 2009 there were already signs of recovery (except on the employment front). This recovery was led by China’s impressive performance, aided by a large stimulus package and easy credit. But China needs to make efforts toward rebalancing its economy. Although private consumption has increased at a fast pace during the last decades, investment has done so at an even faster pace, with the consequence that the share of consumption in total output is very low. The risk is that the country may fall into an underconsumption crisis.
Looking at the medium and long term, developing Asia’s future is mixed. There is one group of countries with a highly diversified export basket. These countries have an excellent opportunity to thrive if the right policies are implemented. However, there is another group of countries that relies heavily on natural resources. These countries face a serious challenge, since they must diversify.Download:Associated Program:Author(s):Related Topic(s):Region(s):AsiaWorking Paper No. 617 | September 2010
The Risk of Unraveling the Global Rebalancing
This paper investigates China’s role in creating global imbalances, and the related call for a massive renminbi revaluation as a (supposed) panacea to forestall their reemergence as the world economy recovers from severe crisis. We reject the prominence widely attributed to China as a cause of global imbalances and the exclusive focus on the renminbi-dollar exchange rate as misguided. And we emphasize that China's response to the global crisis has been exemplary. Apart from acting as a growth leader in the global recovery by boosting domestic demand to offset the slump in exports, China has in the process successfully completed the first stage in rebalancing its economy, which is in stark contrast to other leading trading nations that have simply resumed previous policy patterns. The second stage in China’s rebalancing will consist of further strengthening private consumption. We argue that this will be best supported by continued reliance on renminbi stability and capital account management, so as to assure that macroeconomic policies can be framed in line with domestic development requirements.Download:Associated Program:Author(s):Related Topic(s):China Currency revaluation Export-led growth Global imbalances Rebalancing Renminbi Stimulus packageRegion(s):AsiaWorking Paper No. 611 | August 2010The key factor underlying China’s fast development during the last 50 years is its ability to master and accumulate new and more complex capabilities, reflected in the increase in diversification and sophistication of its export basket. This accumulation was policy induced and not the result of the market, and began before 1979. Despite its many policy mistakes, if China had not proceeded this way, in all likelihood it would be a much poorer country today. During the last 50 years, China has acquired revealed comparative advantage in the export of both labor-intensive products (following its factor abundance) and sophisticated products, although the latter does not indicate that there was leapfrogging. Analysis of China’s current export opportunity set indicates that it is exceptionally well positioned (especially taking into account its income per capita) to continue learning and gaining revealed comparative advantage in the export of more sophisticated products. Given adequate policies, carefully thought-out and implemented reforms, and skillful management of constraints and risks, China has the potential to continue thriving. This does not mean, however, that high growth will continue indefinitely.Download:Associated Program:Author(s):Jesus Felipe Utsav Kumar Norio Usui Arnelyn AbdonRelated Topic(s):Capabilities approach China Diversification Export-led growth Open forest Product sophistication Product spaceRegion(s):AsiaIn the Media | October 2008
By Martin Wolf
October 8, 2008. Copyright 2008 The Financial Times Limited. “FT” and “Financial Times” are trademarks of the Financial Times.
“Things that can’t go on forever, don’t.” —Herbert Stein, former chairman of the US presidential Council of Economic Advisers
What confronts the world can be seen as the latest in a succession of financial crises that have struck periodically over the last 30 years. The current financial turmoil in the US and Europe affects economies that account for at least half of world output, making this upheaval more significant than all the others. Yet it is also depressingly similar, both in its origins and its results, to earlier shocks.
To trace the parallels—and help in understanding how the present pressing problems can be addressed—one needs to look back to the late 1970s. Petrodollars, the foreign exchange earned by oil exporting countries amid sharp jumps in the crude price, were recycled via western banks to less wealthy emerging economies, principally in Latin America.
This resulted in the first of the big crises of modern times, when Mexico’s 1982 announcement of its inability to service its debt brought the money-centre banks of New York and London to their knees.
Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard University identify the similarities in a paper published earlier this year.* They focus on previous crises in high-income countries. But they also note characteristics that are shared with financial crises that have occurred in emerging economies.
This time, most emerging economies have been running huge current account surpluses. So a “large chunk of money has effectively been recycled to a developing economy that exists within the United States’ own borders,” they point out. “Over a trillion dollars was channelled into the subprime mortgage market, which is comprised of the poorest and least creditworthy borrowers within the US. The final claimaint is different, but in many ways the mechanism is the same.”
The links between the financial fragility in the US and previous emerging market crises mean that the current banking and economic traumas should not be seen as just the product of risky monetary policy, lax regulation and irresponsible finance, important though these were. They have roots in the way the global economy has worked in the era of financial deregulation. Any country that receives a huge and sustained inflow of foreign lending runs the risk of a subsequent financial crisis, because external and domestic financial fragility will grow. Precisely such a crisis is now happening to the US and a number of other high-income countries including the UK.
These latest crises are also related to those that preceded them—particularly the Asian crisis of 1997–98. Only after this shock did emerging economies become massive capital exporters. This pattern was reinforced by China’s choice of an export-oriented development path, partly influenced by fear of what had happened to its neighbours during the Asian crisis. It was further entrenched by the recent jumps in the oil price and the consequent explosion in the current account surpluses of oil exporting countries.
The big global macroeconomic story of this decade was, then, the offsetting emergence of the US and a number of other high-income countries as spenders and borrowers of last resort. Debt-fuelled US households went on an unparalleled spending binge by dipping into their housing “piggy banks.”
In explaining what had happened, Ben Bernanke, when still a governor of the Federal Reserve rather than chairman, referred to the emergence of a “savings glut.” The description was accurate. After the turn of the millennium, one of the striking features became the low level of long-term nominal and real interest rates at a time of rapid global economic growth. Cheap money encouraged an orgy of financial innovation, borrowing and spending.
That was also one of the initial causes of the surge in house prices across a large part of the high-income world, particularly in the US, the UK and Spain.
What lay behind the savings glut? The first development was the shift of emerging economies into a large surplus of savings over investment. Within the emerging economies, the big shifts were in Asia and in the oil exporting countries (see chart). By 2007, according to the International Monetary Fund, the aggregate savings surpluses of these two groups of countries had reached around 2 per cent of world output.
Despite being a huge oil importer, China emerged as the world’s biggest surplus country: its current account surplus was $372bn (£215bn, €272bn) in 2007, which was not only more than 11 per cent of its gross domestic product, but almost as big as the combined surpluses of Japan ($213bn) and Germany ($185bn), the two largest high-income capital exporters.
Last year, the aggregate surpluses of the world’s surplus countries reached $1,680bn, according to the IMF. The top 10 (China, Japan, Germany, Saudi Arabia, Russia, Switzerland, Norway, Kuwait, the Netherlands and the United Arab Emirates) generated more than 70 per cent of this total. The surpluses of the top 10 countries represented at least 8 per cent of their aggregate GDP and about one-quarter of their aggregate gross savings.
Meanwhile, the huge US deficit absorbed 44 per cent of this total. The US, UK, Spain and Australia—four countries with housing bubbles—absorbed 63 per cent of the world’s current account surpluses.
That represented a vast shift of capital—but unlike in the 1970s and early 1980s, it went to some of the world’s richest countries. Moreover, the emergence of the surpluses was the result of deliberate policies—shown in the accumulation of official foreign currency reserves and the expansion of the sovereign wealth funds over this period.
Quite reasonably, the energy exporters were transforming one asset—oil—into another—claims on foreigners. Others were recycling current account surpluses and private capital inflows into official capital outflows, keeping exchange rates down and competitiveness up. Some described this new system, of which China was the most important proponent, as “Bretton Woods II,” after the pegged adjustable exchange rates set-up that collapsed in the early 1970s. Others called it “export-led growth” or depicted it as a system of self-insurance.
Yet the justification is less important than the consequences. Between January 2000 and April 2007, the stock of global foreign currency reserves rose by $5,200bn. Thus three-quarters of all the foreign currency reserves accumulated since the beginning of time have been piled up in this decade. Inevitably, a high proportion—probably close to two-thirds—of these sums were placed in dollars, thereby supporting the US currency and financing US external deficits.
The savings glut had another dimension, related to a second financial shock—the bursting of the dot-com bubble in 2000. One consequence was the move of the corporate sectors of most high-income countries into financial surplus. In other words, their retained earnings came to exceed their investments. Instead of borrowing from banks and other suppliers of capital, non-financial corporations became providers of finance.
In this world of massive savings surpluses in a range of important countries and weak demand for capital from non-financial corporations, central banks ran easy monetary policies. They did so because they feared the possibility of a shift into deflation. The Fed, in particular, found itself having to offset the contractionary effects of the vast flow of private and, above all, public capital into the US.
A simple way of thinking about what has happened to the global economy in the 2000s is that high-income countries with elastic credit systems and households willing to take on rising debt levels offset the massive surplus savings in the rest of the world. The lax monetary policies facilitated this excess spending, while the housing bubble was the vehicle through which it worked.
The charts show what happened, as a result, to “financial balances”—the difference between expenditure and income inside the US economy. If one looks at three sectors—foreign, government and private—it is evident that the first has had a huge surplus this decade—offset, as it has to be, by deficits in the other two.
In the early 2000s, the US fiscal deficit was the main offset. In the middle years of the decade, the private sector ran a large deficit while the government’s shrank. Now that the recession-hit private sector is moving back into balance at enormous speed, the government deficit is exploding once again.
Looking at what happened inside the private sector, a striking contrast can be seen between the corporate and household realms. Households moved into a huge financial deficit, which peaked at just under 4 per cent of GDP in the second quarter of 2005. Then, as the housing bubble burst, housebuilding collapsed and households started saving more. With remarkable speed, the household financial deficit disappeared. Today’s explosion in the fiscal deficit is the offset.
Inevitably, huge household financial deficits also mean huge accumulations of household debt. This was strikingly true in the US and UK. In the process, the financial sector accumulated an ever greater stock of claims not just on other sectors but on itself. This frightening complexity, which lies at the root of many of the current difficulties, was facilitated by the environment of easy borrowing and search for high returns in an environment of low real rates of interest. These linked dangers between external and internal imbalances, domestic debt accumulations and financial fragility were foretold by a number of analysts. Foremost among them was Wynne Godley of Cambridge University in his prescient work for the Levy Economics Institute of Bard College, which has laid particular stress on the work of the late Hyman Minsky.**
So what might—and should—happen now? The big danger, evidently, is of a financial collapse. The principal offset, in the short run, to the inevitable cuts in spending in the private sector of the crisis-afflicted economies will also be vastly bigger fiscal deficits.
Fortunately, the US and the other afflicted high-income countries have one advantage over the emerging economies: they borrow in their own currencies and have creditworthy governments. Unlike emerging economies, they can therefore slash interest rates and increase fiscal deficits.
Yet the huge fiscal boosts and associated government recapitalisation of shattered financial systems are only a temporary solution. There can be no return to business as usual. It is, above all, neither desirable nor sustainable for global macroeconomic balance to be achieved by recycling huge savings surpluses into the excess consumption of the world’s richest consumers. The former point is self-evident, while the latter has been demonstrated by the recent financial collapse.
So among the most important tasks ahead is to create a system of global finance that allows a more balanced world economy, with excess savings being turned into either high-return investment or consumption by the world’s poor, including in capital-exporting countries such as China. A part of the answer will be the development of local-currency finance in emerging economies, which would make it easier for them to run current account deficits than proved to be the case in the past three decades.
It is essential in any case for countries in a position to do so to expand domestic demand vigorously. Only in this way can the recessionary impulse coming from the corrections in the debt-laden countries be offset.
Yet there is a still bigger challenge ahead. The crisis demonstrates that the world has been unable to combine liberalised capital markets with a reasonable degree of financial stability. A particular problem has been the tendency for large net capital flows and associated current account and domestic financial balances to generate huge crises. This is the biggest of them all.
Lessons must be learnt. But those should not just be about the regulation of the financial sector. Nor should they be only about monetary policy. They must be about how liberalised finance can be made to support the global economy rather than destabilise it.
This is no little local difficulty. It raises the deepest questions about the way forward for our integrated world economy. The learning must start now.
*“Is the 2007 US subprime financial crisis so different? An international historical comparison.” Working paper 13761, www.nber.org
The writer is the FT’s chief economics commentator and author of Fixing Global Finance, published in the US this month by Johns Hopkins University Press and forthcoming in the UK through Yale University Press.Associated Program:Region(s):Asia
Working Paper No. 760 | March 2013
As domestic exports usually require imported inputs, the value of exports differs from the domestic value added contained in exports. The higher the domestic value added contained in exports, the higher the domestic national income created by exports will be. In this case, exports will expand the domestic market. Therefore, exports will push economic growth in two ways: through their direct effect on aggregate demand, and through their effect on the domestic market. For these reasons, the estimate of the magnitude of the domestic value added contained in exports helps explain the capacity of exports to lead economic growth.
Domestic exports may be classified as direct and indirect exports. Direct exports are the goods sold to other countries; indirect exports are the domestically produced inputs incorporated in direct exports. The distinction between direct and indirect exports leads to a distinction between direct and indirect domestic value added contained in exports. The income of the factors directly involved in the production of exports constitutes direct domestic value added; the income contained in domestically produced inputs incorporated into exports constitutes the indirect domestic value added. Therefore, the magnitude of indirect value added depends on the density of the domestic intersectorial linkages.
The aim of this paper is to present an estimation of the domestic indirect value added contained in Mexico’s manufacturing exports in two ways. The first derives from the fact that a direct exporting sector may be the vehicle through which other sectors export in an indirect way; this leads us to estimate the indirect value added contained in exports by sector of origin. The second refers to the destination of this indirect value added—that is, to the direct exporting sectors in which the value added contained in indirect exports of each sector appears.
Based on the input-output table for Mexico (National Institute of Statistics and Geography–INEGI 2008), we estimate the domestic value added contained in inputs used to produce Mexican manufacturing exports. We show separately the domestic value added from maquiladoraexports and from exports produced by the rest of the manufacturing sector. In order to distinguish the indirect value added in exports by sector of origin and destination of the intermediate inputs, we work with square matrices of indirect domestic value–added multipliers.Download:Associated Program:Author(s):Gerardo Fujii-Gambero Rosario Cervantes-MartínezRelated Topic(s):Region(s):Latin AmericaWorking Paper No. 728 | July 2012
A Post-Keynesian Approach
Conventional wisdom about the business cycle in Latin America assumes that monetary shocks cause deviations from the optimal path, and that the triggering factor in the cycle is excess credit and liquidity. Further, in this view the origin of the contraction is ultimately related to the excesses during the expansion. For that reason, it follows that avoiding the worst conditions during the bust entails applying restrictive economic policies during the expansion, including restrictive fiscal and monetary policies. In this paper we develop an alternative approach that suggests that fiscal restraint may not have a significant impact in reducing the risks of a crisis, and that excessive fiscal conservatism might actually exacerbate problems. In the case of Central America, the efforts to reduce fiscal imbalances, in conjunction with the persistent current account deficits, implied that financial inflows, with remittances being particularly important in some cases, allowed for an expansion of a private spending boom that proved unsustainable once the Great Recession led to a sharp fall in external funds. In the case of South America, the commodity boom created conditions for growth without hitting the external constraint. Fiscal restraint in the South American context has resulted, in some cases, in lower rates of growth than what otherwise would have been possible as a result of the absence of an external constraint. Yet the lower reliance on external funds made South American countries less vulnerable to the external shock waves of the Great Recession than Central American economies.Download:Associated Program:Author(s):Esteban Pérez Caldentey Matías VernengoRelated Topic(s):Region(s):Latin AmericaWorking Paper No. 675 | July 2011
This paper traces the rise of export-led growth as a development paradigm and argues that it is exhausted owing to changed conditions in emerging market (EM) and developed economies. The global economy needs a recalibration that facilitates a new paradigm of domestic demand-led growth. Globalization has so diversified global economic activity that no country or region can act as the lone locomotive of global growth. Political reasoning suggests that EM countries are not likely to abandon export-led growth, nor will the international community implement the international arrangements needed for successful domestic demand-led growth. Consequently, the global economy likely faces asymmetric stagnation.Download:Associated Program:Author(s):Thomas I. PalleyRelated Topic(s):Region(s):United States, Latin America, Asia