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October 14, 2016
Cumulative U.S. Trade Deficits Resulting in Net Profits for the U.S. (and Net Losses for China)
The United States has run trade deficits for decades (1976 is the last year with a recorded surplus). To illustrate this, chart 1 depicts the cumulative U.S. trade deficit since 1980, which now surpasses $10 trillion. As a result, a drastic deterioration in the U.S. net foreign asset position—the difference between the amount of foreign assets owned by U.S. residents and the amount of U.S. assets owned by foreigners—has occurred. That is, as Americans borrow from the rest of the world to finance the recurring trade deficits, the national net worth goes deeply into the red. Not long ago, many commentators predicted that as a result of this increasing U.S. foreign debt, the U.S. dollar was set to collapse, which would trigger a stampede away from U.S. assets. Of course, this has not happened.
Much of the rising U.S. deficit is the by-product of deficits with one country in particular: China. Chart 2 shows that U.S. bilateral trade deficits with China have been growing steadily during these years. In 2015, the total U.S. goods trade deficit was about $762 billion, and the goods deficit with China alone made up nearly half of that total ($367 billion). This situation is not unique to the United States, as many countries find themselves in similar trade positions with China. During the last few decades, China has been running protracted trade surpluses with the rest of world and has accumulated a positive and sizeable net foreign asset position.
Yet, despite accumulating a positive and sizeable net foreign asset position, China is facing increasing losses in net income on its foreign assets. Put differently, China has been accumulating negative returns on its increasingly large portfolio of foreign assets. Chart 3 shows this observation, made in a paper by Eswar Prasad of Cornell University at a recent conference cosponsored by the Atlanta Fed and the International Monetary Fund.
The net income on foreign assets measures the return a nation receives from the foreign assets it owns minus the return paid on domestic assets held by foreigners. In sharp contrast to China, however, the U.S. international net financial income has remained positive and has even increased. This increase comes despite the fact that the United States has consistently run trade deficits, and its net foreign asset position has deteriorated. Chart 4 shows the U.S. income from foreign assets and foreigners' income on U.S. assets, which is reported as a negative number for this series because it is regarded as a liability for the United States. The difference between these amounts is depicted by the middle line, which shows the net foreign income of the United States.
How is this possible? Ricardo Hausmann (Harvard University) and Federico Sturzenegger (currently, the chairman of Central Bank of Argentina) came up with an explanation more than ten years ago: the United States gets a far higher return on its foreign assets than the other way around. Indeed, U.S. foreign direct investments (FDI) often generate a relatively high rate of return. In part, U.S. FDI are benefiting from business expertise, brand recognition, and research and development in new product and service lines. Comparatively, foreigners tend to earn substantially less return on the American assets they own. Foreigners often desire to hold their dollar assets in the form of safe, liquid assets, which—following the "low-risk, low-return" principle—have relatively low returns.
To see this, chart 5 shows the sources of the net financial income of the United States. The U.S. government net income is negative—mostly the by-product of interest payments in government debt held by foreigners. The U.S. gets most of its financial return from FDI. Although much has happened in the world economy during the last decade, the implications of Hausmann and Sturzenegger's analysis remain intact. In sum, the differential return from these foreign assets and liabilities appear to largely compensate for the trade deficits.
Eswar Prasad also showed that China is in a starkly different situation. Most of its foreign liabilities are in the form of FDI, while the vast majority of the foreign assets are reserve assets and foreign exchange reserves—not surprisingly, largely U.S. dollars and U.S. Treasury securities. The rate of return foreigners make on Chinese assets is around twice the rate of return China gets on its foreign assets.
This analysis suggests that focusing on a country's net foreign asset position conveys an incomplete picture of the profitability of foreign assets because it fails to account for the differences in rates of returns that countries earn on their foreign assets. Overall, the United States makes a sufficiently high return on foreign assets that it maintains positive net income on foreign assets. The situation is similar to role leverage in investing; debt can be profitable if you can devote it to purposes that earn a higher rate of return than your cost of borrowing it. Therefore, when viewed in terms of the net income earned on foreign assets the United States holds, the sizable U.S. trade deficits may not be as much of a concern as commonly thought.
May 19, 2011
The long and short (runs) of tax reform
In an earlier part of my career, I spent a fair amount of time thinking about fiscal policy issues. The evolution of my responsibilities eventually moved my attentions in a somewhat different direction, but you never really forget your first research love. With questions of debt, government spending, and taxes at the top of the news, it isn't hard for my old fondness for the topic to reemerge.
So, in that context, I had a somewhat nostalgic response to an item at Angry Bear, written by contributor Dan Crawford. In essence, the Crawford post formally (through statistical analysis) asks the question "How is GDP growth related to marginal tax rates (that is, the tax rate applied to your last dollar of income)?" More specifically, Crawford analyzes how gross domestic product (GDP) growth next year is related to the marginal tax rate faced by the average individual and the marginal tax rate faced by the highest-income taxpayers.
I don't intend to quibble with the specifics of that experiment per se but rather highlight an aspect of taxation and tax reform that I think should not be forgotten. That is, the short run is no place for a decent discussion of tax policy to be hanging out. To say that more formally, the largest effects of tax policy accrue over time, and it is probably not a good idea to be too focused on the immediate—say, next year's—effects of any given policy or change in policy.
The following chart is based on tax reform experiments in a paper I co-authored over a decade ago with Alan Auerbach, Larry Kotlikoff, Kent Smetters, and Jan Walliser. (Note that the chart does not appear in the paper, but I created it using data from the paper—a publicly available version of the paper can be found here.) The chart depicts the cumulative percentage increases in national income that would be realized (in our model) in the years following three different tax reforms.
The three experiments depicted in this chart were as follows:
"[The clean income tax] replaces the progressive taxation of wage income with a single rate that is also applied to capital income. In addition, the clean income tax eliminates the major federal tax-base reductions including the standard deduction, personal and dependent exemptions, itemized deductions, the deductibility of state income taxes at the federal level, and preferential tax treatment of fringe benefits...
"Our flat tax experiment modifies the clean consumption tax by including a standard deduction of $9500. In addition, housing wealth, which equals about half of the capital stock, is entirely exempt from taxation."
Parenthetically, the "clean consumption tax"
"...differs from the clean income tax by including full expensing of investment expenditures. This produces a consumption-tax structure. Formally, we specify the system as a combination of a labor-income tax and a business cash-flow tax."
"Our [flat tax with transition relief] experiment adds transition relief to the flat tax by extending pre-reform depreciation rules for capital in place at the time of the tax reform."
Here's what I want to emphasize in all of this. If the change in policy you might be considering involves a reduction in effective marginal tax rates (implemented via a combination of changes in statutory rates and adjustments in deductions and exemptions), the approach taken by Crawford in his Angry Bear piece is probably acceptable. The clean income tax reform is in the spirit of Crawford's calculations, and in our results the long-run impact on output is realized almost immediately. If, however, the tax reform involves changing the tax base in a fundamental way (in both versions of our flat tax experiments the base shifts from income to consumption), then the ultimate effects are felt only gradually. In our flat tax experiments, the longer-run effects on income are in the neighborhood of three times as large as the near-term effects.
All of the experiments described were done under the assumption of revenue neutrality, so questions of the right policy for budget balancing exercises weren't explicitly addressed. (Nor is it the nature of the experiment contemplated in the Angry Bear post.) Nonetheless, they do suggest that deficit reduction exercises that involve changes in tax rates and the tax base will have differential effects over time, and realizing the full benefits of tax reform may require a modicum of patience.
Note: A user-friendly description of the paper that the chart above is based on appeared in an Economic Commentary article published by the Cleveland Fed.
Update: Though the item at Angry Bear was posted by Dan Crawford, Mike Kimel actually wrote it. I apologize for the mistake and draw your attention to Kimel's follow-up post.
By Dave Altig
senior vice president and research director at the Atlanta Fed
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April 18, 2011
Can Keynesians be anti-Keynesian?
Follow any policy debate, and you are sure to find a list of economists who support or inspire those on both sides of the issue. In The Economist, we find some of those on the roster for the new Republican leadership in the House of Representatives, and why:
"When Republicans proposed slashing billions of dollars from federal spending this year, Democrats circulated predictions by economists that jobs and growth would be hit. John Boehner, the Republican speaker in the House of Representatives, countered with an economic expert of his own: John Taylor of Stanford University. 'Nothing could be more contrary to basic economics, experience and facts,' Mr. Taylor asserted on his blog, which Mr. Boehner cited. By cutting government spending, he said, the Republicans would 'crowd in' private investment and create jobs.
"… if there is one ideology that unites today's Republicans, it is Keynesianism, whose nefarious influence they are determined to stamp out. 'Young Guns,' the book-sized manifesto of Eric Cantor, Kevin McCarthy and Paul Ryan, leading Republican House members, devotes several pages to the evils of Keynesian activism and its exponents in the administration."
One of the interesting things about the article is that among the economists cited as being among the critics of "Keynesianism," you find the names John Taylor, Robert Mundell, and Kenneth Rogoff. I find that list interesting because if you follow the links I attached to those names you will find work with models that are decidedly Keynesian in structure. Works by Taylor and Rogoff are, in fact, seminal contributions to the "New Keynesian" paradigm that dominates macroeconomics today.
As far as I know, none of these men have repudiated the basic worldview that motivates the referenced work. In fact, as recently as last year John Taylor approvingly described, as he has many times, a key characteristic of the paradigm for monetary policy that was in place the decades before the financial crisis:
"… the central bank has a strategy, or rule, to adjust the interest rate depending on economic conditions: In general, the interest rate rises by a certain amount when inflation increases above its target and the interest rate falls when by a certain amount when the economy goes into a recession."
I added the emphasis to the last part of that passage as it is a feature of the so-called Taylor rule that is entirely built on the foundation of the New Keynesian model.
How, then, to explain the Keynesian predilections of the economists mentioned as presumed carriers of the anti-Keynesian mantle? The source of the confusion, I think, goes back to the historical, but somewhat obsolete, distinction between so-called Keynesianism and monetarism. The latter was, of course, personified in Milton Friedman and his dispute with what was the orthodoxy in the three decades following the Great Depression. Lost in the early-days labeling, however, was the fact that the disputes were more about the empirical details of theory rather than the theory itself.
In particular, Friedman did not deny the effectiveness of policy in principle but rather its wisdom or impact in practice. This sentiment is exactly the one he expressed in his prescient and transformative 1968 presidential address to the American Economics Association:
"In the United States the revival of belief in the potency of monetary policy was strengthened also by the increasing disillusionment with fiscal policy, not so much by its potential to increase aggregate demand as with the practical and political feasibility of so using it."
In a recent essay on Friedman's views about the ineffectiveness of fiscal policy, Tim Congdon notes Friedman's views on the issue:
"Friedman offered two informal theoretical arguments for the virtual irrelevance of fiscal policy, as he saw it. The second was that fiscal policy is much harder to adjust in a sensitive short-term way than monetary policy. But the first was the more telling and deserves detailed discussion.… In Friedman's words, 'I believe it to be true… that the Keynesian view that a government deficit is stimulating is simply wrong.' The explanation was the wider effects of the way the budget deficit is financed. To quote again, 'A deficit is not stimulating because it has to be financed, and the negative effects of financing it counterbalance the positive effects, if there are any, on spending.' "
Though Congdon emphasizes different channels (associated with the mix of monetary and fiscal policy associated with deficit spending), those who follow such things may recognize in Friedman's remarks the notion of Ricardian equivalence:
"This is the idea that increased government borrowing may have no impact on consumer spending because consumers predict tax cuts or higher spending will lead to future tax increases to pay back the debt.
"If this theory is true, it would mean a tax cut financed by higher borrowing would have no impact on increasing aggregate demand because consumers would save the tax cut to pay the future tax increases."
My point is not to dispute or defend the truth of the Ricardian proposition. My point is that it has absolutely nothing to do with whether one believes (or does not believe) that the New Keynesian framework is the right way to view the world. The essential policy implications of the New Keynesian idea (like the old Keynesian idea) is that changes in gross domestic product can be driven by changes in desired spending by households, businesses, foreigners, and the government in sum. You can believe that and still believe in fiscal policy ineffectiveness, as long as you believe that total spending is unaltered by a particular policy intervention.
There are, of course, plenty of arguments against fiscal policy activism that do not require adherence to Ricardian equivalence, in total or in part. The most obvious would be the position that any short-term rush from stimulative policies is more than reversed in the long run by the negative consequences of higher tax rates on productive activity, or the redirection of private investment to lower return public spending. Again, the point is that a self-professed adherent to a Keynesian reality need suffer no doubts about the coherence of his or her intellectual framework if he or she objects to fiscal policies aimed at juicing the economy through greater government spending.
This whole discussion may seem like a bit of inside baseball, and perhaps it is. But the stakes in this debate are high, as clearly illustrated by today's announcement from rating agency Standard & Poor's that it reduced its outlook to negative on the triple-A credit rating of the United States. In my view, productive discussions about the truly pressing issues of our day are unlikely unless we understand where the disagreements lie—and where they do not.
By Dave Altig
senior vice president and research director at the Atlanta Fed
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January 11, 2011
The pluses and minuses of reluctant consumers
If you've been keeping up with news from last weekend's convergence of economists at the annual meeting of the Allied Social Science Associations, you will probably have heard of this optimistic-sounding conclusion by Harvard economist Martin Feldstein:
"It is not hard to imagine that a few years from now the current account imbalances of the US and China will be very much smaller than they are today or even totally gone."
An advance copy of the article was provided a few weeks ago at Real Time Economics, and considerable commentary has followed since (here, here, here, and here, for example). Not surprisingly, the progress Professor Feldstein envisions has two components:
"The persistence of large current account imbalances reflects government policies that alter the savings-investment balances in both the United States and China.
"The large current account deficit of the United States reflects the combination of large budget deficits (negative government saving) and very low household saving rates. ...
"In contrast, China's large current account surplus reflects the world’s highest saving rate at some 45 percent of GDP [gross domestic product]."
The source of Feldstein's belief that progress will come?
"Consider first the situation in the United States. Current conditions suggest that national saving as a percentage of GDP will rise as private saving increases and government dissaving declines. Private saving has been on a rising path from less than two percent of disposable income in 2007 to nearly six percent of disposable income in 2010. The forces that caused the rise in the U.S. saving rate since 2007 could cause the saving rate to continue to rise. Those forces include reduced real wealth, increased debt ratios, and a reduced availability of credit. ...
"The reduction of the U.S. current account deficit implies that the current account surplus of the rest of the world must also decrease. While this need not mean a lower current account surplus in China, I believe that the policies that the Chinese have outlined for their new five year plan are likely to have that effect. These include raising the share of household income in GDP, requiring state owned enterprises to increase their dividends, and increasing government spending on consumption services like health care, education and housing."
Some skepticism about the probability of a substantial decline in Chinese saving rates was noted in a recent post at The Curious Capitalist, which focuses on some interesting new research that relates high Chinese saving rates to an increase in income volatility. To the extent that the increased income volatility is inherent in China's ongoing transition to a more market-based economy, substantial changes in consumer behavior might be difficult to engineer. That said, only about half of the increase in Chinese saving rates appears explainable based on natural economic forces, and the Chinese government can certainly reduce national saving of its own accord (via deficit spending). Furthermore, according to Feldstein's calculations, a relatively small decline in the Chinese saving rate could eliminate their side of the current account imbalance.
As to the first part of the equation—an increase in saving by U.S. consumers—Atlanta Fed President Dennis Lockhart offered this yesterday in remarks prepared for the Atlanta Rotary Club:
"Households have been actively deleveraging—that is, working down debt levels and saving more of their income. The savings rate has increased from a little over 1 percent in 2005 to more than 5 percent currently.
"Consumer debt as a percent of disposable income has declined markedly over the past three years after rising steadily since the 1980s. Most nonmortgage consumer debt reduction has been in credit card balances. As consumers have reduced their debt, the share of income used to service financial obligations has fallen sharply to the lowest level in a decade.
"Consumer action to reduce debt is not the whole deleveraging story. In the numbers, the decline in overall household indebtedness has been highly affected by bank write-offs. Also, banks' stricter underwriting requirements for new consumer debt have contributed to runoff.
"I expect the phenomenon of household deleveraging to continue."
Restrained consumer spending was one item on a list of three "headwinds" that President Lockhart believes will serve to restrain growth in 2011 (the other two being policy uncertainties and ongoing credit market repair). Not that this is all bad:
"First, today's headwinds to a significant degree reflect structural adjustments that will, in the longer term, place the U.S. economy on a stronger footing. The preconditions for strong future growth are reduced uncertainty, improved consumer and household finances, and healthy credit markets.
"Second, I believe the headwinds I have emphasized will restrain growth but not stop it. I fully expect growth in gross domestic product, in personal incomes, and in jobs to be better in 2011 than in 2010.
"Finally, I acknowledge the potential that economic performance this year could surprise me on the upside. Businesses, for example, are sitting on lots of cash. Cash accumulation is not something that can continue forever, particularly in the case of public companies. It may not take much weakening of headwinds to unleash some of the economic forces that thus far have been bottled up."
Though faster progress would be welcome—particularly with respect to job creation—the Lockhart and Feldstein commentary makes it clear there is a delicate balance between resolving the short-run pain and setting up the longer-term gain.
By Dave Altig
Senior vice president and research director at the Atlanta Fed
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November 04, 2010
Some in Europe lag behind
Since around June, news of European fiscal deficits, financial markets stresses, potential sovereign debt defaults, or even a breakup of the euro zone has faded. The focal points of global economic policy have shifted to the sluggish recovery in developed countries and potential for further unconventional monetary stimulus.
A cursory look at a few key data reflects an improved European economic outlook from this summer. The simple dollar/euro exchange rate (see chart 1) shows that since June 1 the euro has appreciated nearly 15 percent against the dollar. While many different factors affect exchange rates—and increasing expectation of further monetary stimulus in the United States has helped the euro appreciate against the dollar—some of the appreciation seems to reasonably reflect the relative improvement of market sentiment about the fiscal situation in several European countries. Similarly, looking at the major stock indexes (mostly in Western European nations) shows a steady improvement from the lows of this summer, with the Euro Stoxx 50 index rising nearly 11 percent since June 1 (see chart 2). Thus, looking at most aggregate European data paints a picture of relative improvement, though most forecasters expect sluggish growth going forward. It's when one examines individual countries that it becomes clear some are lagging behind.
While the early stages of the European sovereign debt crisis centered on the fiscal scenario in Greece, market stress eventually spread to all the so-called PIIGS (Portugal, Ireland, Italy, Greece, and Spain) and even appeared to threaten the wider euro zone. Following an assortment of unprecedented interventions—highlighted by the 750 billion euro (approximately $1.05 trillion) rescue package from the European Union (through the European Financial Stability Facility) and support from the International Monetary Fund—market confidence slowly grew, and since this summer, various measures of financial market functioning have stabilized.
But while the threat of wider European contagion appears contained, fragilities remain. As has been documented in a variety of media reports, the recent improvement masks the individual euro zone peripheral countries' struggles with implementing fiscal consolidation, improving labor competiveness, resolving fragile banking systems, and staving off a crisis of confidence in sovereign debt markets.
Both bond spreads of individual European sovereign debt (over German sovereign debt) and credit default swap spreads show some stabilization for a few of the euro zone countries, but spreads in three countries—Greece, Ireland, and Portugal—are distinctly more elevated than the others (see charts 3 and 4).
The reasons for rising financing costs in these countries vary. In Ireland, for example, concerns about the Irish banking system (and the resolution of Anglo Irish Bank, in particular) were initially the driving cause. In Portugal, it was doubt over the implementation of necessary economic reforms that drove investor reluctance to provide financing; the recent adoption of austerity measures into the 2011 budget should alleviate some worry. But now much of the market action in both Irish and Portuguese bonds is focused on tough new bailout rules being implemented by the European Union.
On one hand, the renewed financing pressure brought upon these countries is less worrisome because of the backstop of the European Financial Stabilization Facility (EFSF). In fact, Moody's thinks it is unlikely there will be a euro zone default. Should market financing become too expensive for Greece, Ireland, or Portugal, the special purpose vehicle (SPV) imbedded within the EFSF could help by providing financing up to 440 billion euros ($616 billion).
But on the other hand, as part of the wider crisis prevention following the introduction of the EFSF, most European governments are implementing some level of fiscal austerity measures. From a political perspective, the implementation of these austerity measures varies widely, as demonstrated recently by the strikes in France over legislation trying to raise the retirement age. In addition to the uncertainty of implementing fiscal consolidation, there is pressure from the administrators of the EFSF to enforce burden-sharing on private bondholders in the event of any future bailout. This pressure is the primary impetus causing investors to shun the weaker peripheral countries.
One important player in this saga is the European Central Bank, which began buying European bonds for Greece, Ireland, and Portugal (among others) in conjunction with the EFSF announcement. Yet in recent weeks this bond buying has abated, and with money market pressures remaining in Europe, "something clearly has to give way," as Free Exchange wrote recently.
While aggregate market measures (exchange rates, stock indices, etc.) from Europe appear to be improving, a few specific countries face some hard challenges ahead.
By Andrew Flowers, senior economic research analyst in the Atlanta Fed's research department
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December 08, 2009
Another rescue plan comes in below the original price tag
Though the tab to taxpayers could still be substantial when all is said and done, it now appears the taxpayer cost of the Troubled Asset Relief Program (TARP) will be substantially lower than was thought not too long ago:
"The Obama administration expects the cost of the Troubled Asset Relief Program to be $200 billion less than projected, helping to reduce the size of the budget deficit, a Treasury Department official said yesterday.
"The administration forecast in August that the TARP would ultimately cost $341 billion, once banks had repaid the government for capital injections and other investments. Congress authorized $700 billion for the program in October 2008."
There is precedent for such good news. Travel back for a moment to the formation and operation of the Resolution Trust Corporation (RTC), the agency formed to purchase and sell the "toxic assets" of failed financial institutions following the savings and loan crisis of the 1980s. As noted in a postmortem by Timothy Curry and Lynn Shibut of the Federal Deposit Insurance Corporation (FDIC), the cost projections for the RTC ballooned in the early days of its operations:
"Reflecting the increased number of failures and costs per failure, the official Treasury and RTC projections of the cost of the RTC resolutions rose from $50 billion in August 1989 to a range of $100 billion to $160 billion at the height of the crisis peak in June 1991..."
In the end, however, the outcome, though higher than the very first projections, came in well below the figures suggested by the worst case scenario:
"As of December 31, 1999, the RTC losses for resolving the 747 failed thrifts taken over between January 1, 1989, and June 30, 1995, amounted to an estimated $82.7 billion, of which the public sector accounted for $75.6 billion, or 91 percent, and the private sector accounted for $7.1 billion, or 9 percent."
While people may debate the approaches taken, it is heartening to see evidence that TARP, like the RTC before it, is ultimately costing considerably less than estimated.
By David Altig, senior vice president and research director of the Atlanta Fed
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July 26, 2007
Why Central Bankers Worry About Fiscal Policy
Today I again hand the keys to Mike Bryan -- now a fellow adjunct faculty member in the University of Chicago's Graduate School of Business -- who provides us with a contemporary example of why it behooves central bankers to speak out when a nation's fiscal situtation gets out of whack:
The reports from Zimbabweover the past year and a half are the stuff that makes for good Money and Banking lectures. It seems that inflation in that country, as officially reported, topped 1,300 percent last year and may now exceed 3,700 percent, with some unofficial reports putting the country’s inflation rate even higher. Let’s put this inflation in perspective. If the last reported inflation number can be believed (the country’s Central Statistical Office recently stopped reporting the inflation numbers as it reviews its methodology), prices in Zimbabwe are doubling every month. Inflation of this magnitude renders the government-issued money virtually worthless, wrecking trade and financial institutions in the process.
While the rate of inflation in the African nation isn’t known for certain, there is little doubt it is extraordinarily high. Also not in doubt is its cause. All inflations originate from the same phenomenon—too much money chasing too few goods. In this case the Reserve Bank of Zimbabwe is rapidly printing Zimbabwe dollars in order to “pay” for a large fiscal shortfall.
In a recent IMF paper on the Zimbabwe situation the author argues that the Reserve Bank of Zimbabwe’s (RBZ) inflation problems stem not from the usual monetary or fiscal laxness that has triggered other “hyperinflations,” but rather “quasi-fiscal” losses incurred by the central bank itself. Still, the report concludes that these losses, which stem from some combination of credit subsidies, realized and unrealized exchange losses, and losses from open market operations, were nevertheless incurred to support government policies, and the failure to address these losses has interfered with the monetary management, independence, and credibility of the RBZ.
The immediate “solution” to the Zimbabwe inflation has been the imposition of price controls, an approach that has been attempted by governments ancient and modern, including our own. I can think of no better source on this topic than economist Hugh Rockoff of Rutgers. Zimbabwe’s controls are actually retroactive, in the sense that merchants have been asked to reduce prices to earlier levels. Predictably, the problem seems to have gotten worse—now there are even fewer goods for the Zimbabwe dollar to chase. When and where will the Zimbabweinflation end? I certainly don’t know. But I’ve got a pretty good idea how it will end, by a sharp curtailment of their currency expansion. And that’s the Money and Banking lesson. If a central bank wants to end inflation, either they better start producing goods, or stop producing money.
And that, I would add, will be a hard row to hoe unless the fiscal house is put in order.
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June 21, 2006
What Is The Right Road To Budget Discipline?
Senator Judd Gregg is leading a move to force cuts in the spiraling growth of federal benefit programs.By twelve to ten vote yesterday, the Senate Budget committee approved a bill written by Gregg, the committee's chairman. It would force mandatory cuts to the deficit, enforced by across-the-board cuts to programs like Medicare, Medicaid and unemployment insurance if Congress can't meet deficit targets on its own.
The bill also revives the idea of the line-item veto which would allow the president to single out wasteful items contained in bills he signs into law, and it would require Congress to vote on those items again.
The problem with Judd Gregg's proposal is that Gramm-Rudman didn't work when we tried it in the 1980s. It, I think, made matters worse--members of congress became more eager to vote for budget-busting measures when they could claim that Gramm-Rudman placed a cap on the total deficit, and then the congress was unwilling to apply the cap medicine when the dose turned out to be unexpectedly high, and so the process died.
The Budget Enforcement Act framework seemed to work much better in the 1990s than Gramm-Rudman worked in the 1980s.
To be fair to the proponents of Senator Gregg's proposal (who may not be legion), the new variant of GRH seems to address some of the perceived weaknesses of GRH itself -- specifically the inclusion of a presidential line-item veto and the removal of shelter for entitlement expenditures. And at least in implicit in the Gregg plan is a pay-as-you go feature that was central to the Budget Enforcement Act (as enacted under G.H.W. Bush and extended during the Clinton administration).
Democrats in Congress unveiled their 2006 campaign agenda last week, laying claim to the mantle of "fiscal responsibility." The GOP's spendthrifts have handed them this political opening, which makes it all the more disappointing that Democrats are falling back on an old confidence trick.
Their ruse goes by the name of "pay-as-you-go" budgeting, which has the political virtue of sounding as if spending won't be able to exceed revenue...
That's because paygo rules apply only to new or expanded entitlement programs, not to those that already exist and grow automatically with user demand. Thus spending for Medicare, growing this year at an astounding 15% annual rate, would continue to run on autopilot. Ditto for Medicaid. So-called "discretionary" programs (education, Defense) that Congress approves each year are also exempt. Democrats somehow forget to disclose that those notorious "earmarks" stuffed into spending bills are also exempt from paygo.
Well, OK, but I'm with Brad, on the paygo issue and his broader support for the mechanisms of the Budget Enforcement Act. In my opinion, the fundamental problem with the GRH approach to budget arose from its focus on the deficit per se. To me, fiscal policy boils down to answering a few simple questions. How much do we want to spend, and what do we want to spend it on? Having answered that question, it is beyond obvious that revenues have to pay for that spending in the long run. The only remaining question, then, is how those revenues should be raised (that is, who and what do we want to tax).
I am not presuming to answer these questions. In particular, I am not suggesting that correct answer is to raise revenues to match projected spending, anymore than I am suggesting the correct answer is to lower projected spending to match revenues. What I am suggesting is that an institutional process that puts the focus squarely on the trade-off between a dollar spent on one type of government spending versus another, a dollar spent in the public sector versus one spent in the private sector, and one type of taxation versus another, is the right way to go. The Budget Enforcement Act had the great virtue of requiring explicit decisions about new spending (for the discretionary part of the budget and new entitlement programs) and forcing explicit consideration of the inevitable trade-offs when anyone wanted to deviate from the program.
I'll close with an appeal to higher authority:
... For about a decade, the rules laid out in the Budget Enforcement Act of 1990 and in the later modifications and extensions of the act helped the Congress establish a better fiscal balance...
Reinstating a structure like the one formerly provided by the Budget Enforcement Act of 1990 would signal a renewed commitment to fiscal restraint and help restore discipline to the annual budgeting process. Such a step would be even more meaningful if it were coupled with the adoption of provisions for dealing with unanticipated budget outcomes. As you are well aware, budget outcomes have often deviated from projections--in some cases, significantly--and they will continue to do so. Accordingly, well-designed mechanisms that facilitate midcourse corrections would ease the task of bringing the budget back into line when it goes awry. In particular, the Congress might want to require that existing programs be assessed regularly to verify that they continue to meet their stated purposes and cost projections. Measures that automatically take effect when a particular spending program or tax provision exceeds a specified threshold may prove useful as well. The original design of the Budget Enforcement Act could also be enhanced by addressing how the strictures might evolve if and when reasonable fiscal balance came into view.
I do not mean to suggest that the nation's budget problems will be solved simply by adopting a new set of budgeting rules. The fundamental fiscal issue is the need to make difficult choices among budget priorities, and this need is becoming ever more pressing in light of the unprecedented number of individuals approaching retirement age.
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April 12, 2006
The Deficits Move in Opposite Directions -- For Now
The dollar touched a more than one week high against the euro and strengthened versus the yen after the U.S. trade deficit narrowed more than forecast in February. The trade gap, the amount by which imports exceed exports, fell 4.1 percent $65.7 billion from a record $68.6 billion in January, led by a decline in Chinese imports...
A separate report showed the U.S. budget deficit gap widened last month to $85.5 billion in March, from $71.2 billion in the same month last year.
So, one deficit rises and the other falls? Maybe not. Both Brad Setser and The Nattering Naybob point out that China's trade surplus grew in March, on a strong expansion in exports. And Menzie Chinn notes that the March (and April) surge in oil prices does not bode well for sustaining the February decline in U.S. imports. The guessing is that when the March trade numbers are revealed, the two deficits may look like twins again.
UPDATE: The Skeptical Speculator also makes reference to the March surplus in China, among many other things.
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March 26, 2006
Odds And Ends
Another quarter begins at the University of Chicago Graduate School of Business, and I have once again cleverly fallen behind on my reading, giving me the excuse to introduce some of my favorite weblogs to new students, via this review of things I should have talked about last week.
First things first, the week ended with economic news that was mixed, at best. Kash at Angry Bear reads the durable goods reports and concludes (fairly, I think) that business investment spending is still short of spectacular. On the other hand, at The Nattering Naybob Chronicles, Mr. Naybob is able to look on the bright side: "Both [the durable goods and house sales] reports eased inflation fears and bond yield dropped."
With respect to the real estate news, Calculated Risk, a consistently fine go-to source on the housing market, has the latest on home mortgage applications (down slightly), existing home sales (up, but perhaps not the best indicator), and new home sales (a better indicator, and coming in "very weak".) CR also has a handy chart, mapping the pattern of home sales in recessions. At the Big Picture, Barry Ritholtz opines: "The [Real Estate] market has dropped from white hot to red hot to mid-plateau." Calculated Risk says "The sky may not be falling, but... housing sales are clearly trending down." Captain Capitalism, however, is not cheered by that prognosis, and Michael Shedlock pores over the Calculated Risk pictures, to find that his disposition is soured as well. ElectEcon finds a prediction that things are going to get ugly fast.
For those who simply must have more housing indicators to watch, Daniel Gross bears good news, from Standard & Poor's. For those who just can't get enough detail on economic data period, Mark Thoma has more at Economist's View.
Speaking of data, a nice summary of U.S. wealth as reported in the Federal Reserve's Flow of Funds can be found at Angry Bear. (Although I don't necessarily endorse the conclusions, you might also enjoy the pictures provided at Economic Dreams - Economic Nightmares.)
Last week I (sort of) came to the rescue of the Consumer Price Index. Barry Ritholtz (again) counter punches, with a Wall Street Journal survey of readers indicating the vast majority don't think very highly of the Consumer Price Index, but Russell Roberts effectively (in my view) defends the beleaguered index, at Cafe Hayek.
Mark also relays the crux of Federal Reserve Chairman Ben Bernanke's speech on the yield curve. Meanwhile, the inverted yield curve watch continues, at The Capital Spectator.
Shifting to the fiscal side of the government house, Kash breaks down the sources of federal spending growth in the United States over the past five years. The guys at Angry Bear have had several useful, even if a bit partisan, posts on the subject in the recent past -- here, here, here, here, and here. Gary Becker and Richard Posner provide some much needed perspective on how to think about the build-up in defense spending.
In other legislative news, Andrew Chamberlain at Tax Policy Blog indicates that tax reform may not be dead just yet (good), and at Vox Baby, Andrew Samwick reports on the progress of pension reform (decidedly not good).
David Weman at A Few Euros More gives us the heads up on an item (from the Guardian Unlimited (U.K.) blog) bemoaning the rising tide of protectionism (among countries, including the U.S., that really ought to know better). The Skeptical Speculator concurs that "protectionism looms." Asia Pundit reminds us that, in the United States, the impulse is bipartisan (and Sun Bin channels Stephen Roach's comments on the subject). William Polley deems it "Nothing if not predictable." Mark Thoma provides an extended commentary from the Financial Times on the dangers of "Dobbism" (as in Lou). Daniel Drezner, however, has better news. Brad DeLong takes notice of a Alan Blinder's sometimes less charitable view of trade and globalization, to which Arnold Kling replies -- here and here.
Steve Antler (of EconoPundit) makes the connection from trade protectionism to immigration reform. Russell Roberts is even less tolerant of the anti-immigration argument. So is Arnold Kling (at EconLog). EurActiv reports on how the EU is attempting to deal with its own immigration questions. The New Economist provides a glimpse of research suggesting that outsourcing explains about 28 percent of the growth in the wage gap between high- and low-skilled labor between 1980 and 1999.
Continuing with the international theme, Brad Setser thinks both sides are at fault in the ongoing tensions over Chinese exchange rate policies. He also has terrific coverage of Larry Summers' must-read views on the current state of global financial markets and capital flows. Mark Thoma notes an article on the relationship between exchange rate policies and trade gaps and a summary of research on foreign direct investment. Steve Antler suggests an explanation for "why the dollar still reigns". Barry Ritholtz is pretty sure the answer is not Dark Matter. Menzie Chinn, writing at Econbrowser, is even less convinced. (He follows up that post with a very nice discussion of "purchasing power parity." Don't worry if you don't know what that means -- Menzie will fill you in.)
Speaking of China, Daniel Gross carries a story from the New York Times on the development race between China and India, the latter a country that I think gets far less attention than it deserves. (Lest there is any confusion, I mean positive attention.) Interestingly, Toni Straka at The Prudent Investor -- who unfailingly does not ignore India -- reports that India is about to float its currency and remove foreign exchange controls.
About Economics has a macro-relevant post on the, increasingly quaint, problem of the so-called zero nominal interest rate bound. Digging even further into the history of monetary theory, Jane Galt ruminates on "free money." In the some-think-it-matters-I-don't category, The Capital Spectator comments on the retirement of M3. So does Tim Iacono. That makes the graphs at Economist's View on M3 velocity -- explained here -- somewhat obsolete, but don't worry -- there is still M1 and M2 to absorb your attention.
UPDATE: Oh yeah -- Tyler Cowen has a new gig at the New York Times.
SPECIAL BRAIN-LOCK UPDATE: Above I hat-tipped A Fistful of Euro's David Weman for a Guardian article "bemoaning the rising tide of protectionism" (my words). Unfortunately, the Guardian article that does the bemoaning is not the one David cites. I had in mind an earlier article by James Surowiecki. David was pointing to another article, by Daniel Davies, arguing that capital controls do not count as protectionism. Double hat-tip to David for keeping me on the straight and narrow. (Oh, and by the way -- I'm with Surowiecki.)
March 26, 2006 in Asia, Data Releases, Deficits, Europe, Exchange Rates and the Dollar, Federal Debt and Deficits, Housing, Inflation, Interest Rates, Labor Markets, Saving, Capital, and Investment, Taxes, This, That, and the Other, Trade , Trade Deficit | Permalink
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» Round-up of Recent Economics Blog Postings from EclectEcon
Dave Altig at Macroblog has a very comprehensive round-up of recent blog postings from all over creation, all grouped by various economics topics. It is very thorough and ... [Read More]
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» Carnival of the Economists from The Big Picture
Over at Macroblog, Dave Altig collects lots of Odds And Ends from the week's economic writings. He's a one man Carnival of the Economists. Looks like it took hours to put together. If you are looking for additional sources of economic writing and discu... [Read More]
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