Download China`s currency policy

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Economics
Free exchange
China's currency policy
It's complicated
Oct 4th 2011, 17:22 by R.A. | SOMEWHERE IN EUROPE*
ONCE again, America's Congress is considering punitive action against China over its currency
policy, and once again a debate is raging over whether this is a good idea. Paul Krugman
is leading the charge yet again, and he's preemptively responding to a number of arguments
against action on China—but not mine.
The issue is not whether a floating yuan would be, on balance, good for America. It would; the
dollar would probably weaken against the yuan, which would probably result in a reduction in
America's multilateral trade balance. This isn't guaranteed, of course. The dollar has been rising
against the euro and many emerging-market currencies of late, mostly thanks to broader financial
fear. The resulting shifts could offset depreciation against the yuan, and that's assuming that a
China with fewer restriction on capital movements wouldn't be subject to the same capital
outflows as other emerging markets. It does seem likely, however, that the American economy
would adjust somewhat more easily given a floating yuan.
The policy is also harmful to China. Export-led growth is a useful way to facilitate catch-up
development, but China's dollar peg has fueled inflation and led to imbalances that may hasten
its entry into a middle-income trap and a growth slowdown. China also bears a significant
financial costin accumulating huge dollar reserves. Joe Gagnon pegs the expense at something
like $240 billion a year; in an email to me he argues that the cost may be substantially higher.
So what's the problem? This last data point is telling. Obviously, China's currency peg entails
large costs, and it's extremely unpopular with much of the rest of the world. It's difficult to
understand why China wouldn't abandon it—unless it believed it were getting some benefit out
of the thing. It seems likely to me that China understands the costs of its policy and has therefore
been willing to accept a managed appreciation, but it may fear the impact of a quick shift in its
exchange rate on domestic political and financial stability. If that's right, then there are two
potential costs to forcing China's hand on its currency. One is that America may succeed in
winning a rapid appreciation, but at the cost of turmoil in China. That could have all kinds of
negative effects, from a panic-driven rush to greenbacks that worsens the trade deficit to a
negative shock to the global economic outlook. The other potential costs is that America is not
successful, China retaliates, and the global economy suddenly becomes a much uglier place to
live and do business.
The question I'd ask myself if I were Mr Krugman is this: is American pressure likely to lead to
appreciation over and above the current pace with acceptable costs to the global economy and
important international relationships? Now, maybe Mr Krugman would argue that the answer is
yes. For now, he simply ignores the possibility that anything truly bad could happen as a result of
a "get tough" approach in America. That's just not good enough; typically we're somewhat
careful about trying to force major economies to do something they clearly are reluctant to do,
particularly when the benefits are likely to be relatively small. I'm not sure that what the global
economy needs right now is a round of sabre-rattling between the two largest economies. (Mr
Krugman would argue that China was the initial agressor, but ongoing—slow, but meaningful—
yuan appreciation means that China is effectively disarming.)
Mr Krugman, by contrast, thinks that all options should be on the table:
Ben Bernanke, the chairman of the Federal Reserve, said it clearly last week: unemployment is a
“national crisis,” with so many workers now among the long-term unemployed that the economy
is at risk of suffering long-run as well as short-run damage.
And we can’t afford to neglect any important means of alleviating that national crisis. Holding
China accountable won’t solve our economic problems on its own, but it can contribute to a
solution — and it’s an action that’s long overdue.
I'm uncomfortable with that logic, and you should be too. Unemployment is a national crisis, but
that doesn't mean that America should throw cost-benefit analyses out of the window. And in
fact, Mr Krugman spends the first half of his column laying out the benefits of a policy that
strictly dominates a dust-up with China: monetary expansion. Based on my reading of the 1930s,
the worst thing a country can do is to try and achieve internal adjustments by forcing
deflationary policy on others. America should ignore China's peg—and its warnings against
taking further steps to loosen monetary policy—and adequately reflate. That will place pressure
on China to revalue, but without putting the country in a position that weakens international
institutions and a key diplomatic relationship. And it will have a much, much more salutary
effect on the American economy than a stronger yuan—as I suspect even Mr Krugman would
agree.
http://krugman.blogs.nytimes.com/
October 17, 2011, 6:04 PM
Vector Autoregressions And Keynesian Macro
Some readers wanted to know about how the Sims/Sargent methodologyplays into Keynesian or ISLM-type models. Does it support them? Well, yes, but the case needs a bit of explaining.
At this point the big freshwater-saltwater divide in economics is between real business cycle types,
who believe that neither monetary nor fiscal policy “works”, and New Keynesians who believe that
both work or at least can work. But there’s a sort of lesser divide between full IS-LM extended types
and what to my mind is a somewhat confused position in which monetary policy is effective but
somehow fiscal policy isn’t under any circumstances.
So, what’s the role of statistical techniques here? A good place to see current stuff is the lecture notes
for Christy and David Romer’s course on macroeconomic history. If you look at the slides for lecture
three (pdf) you’ll see how various vector autoregressions seem to show that yes, monetary policy
works.
The Romers don’t make as much consistent use of VARs in Lecture 4 (pdf), on government spending,
relying a lot more on natural experiments like the differential impact across states of swings in
defense spending. But there are other studies, like Ilzetzki, Mendoza, and Vegh, that use VARs on
international data to estimate the effects of government spending; here too, if you look at the
relevant cases, the evidence seems to support the notion that fiscal policy has the effects IS-LM
would predict.
So the point is that this sort of technique — and technique is what the Nobel was for — is consistent
with and in fact broadly supportive of the kind of model the Romers, Brad DeLong, and yours truly
among others think is the right way to think about the mess we’re in.
O
October 17, 2011, 5:44 PM
Legends Of The Rentiers
I feel Dean Baker’s pain. Dean is exercised over an NPR report which says that Argentina is suffering
from its 2001 default — a claim that is totally at odds with the evidence. Argentina actually did very
well by thumbing its nose at creditors.
This isn’t the only case where news organizations consistently report as truth something that didn’t
happen, while failing to report what did. Another one that comes to mind is the California electricity
crisis of 2001-2002. As some readers may recall, that crisis was caused by market manipulation —
and that’s not a hypothesis, Enron traders were caught on tape telling plants to shut down to create
artificial shortages. Yet “news analyses” published after the whole thing was revealed would often tell
readers that excessive environmental regulation and Nimbyism caused the crisis, with nary a
mention of the deliberate creation of shortages.
And as you’ll notice, in both cases the imaginary history just happened to be one more comfortable to
status quo interests.
I don’t want to go all Chomsky here, but this sort of thing really can radicalize you.
O
October 17, 2011, 8:38 AM
Nobel Lies
The right was quick to claim this year’s economics Nobel as an anti-Keynesian prize. Chris Sims sets
the record straight:
Professor Sims doesn’t want to be pigeonholed. “I’m not ‘non-Keynesian,’ ” he said, adding that he
has been an active “promoter of new Keynesian macroeconomic models,” because they “are the place
in our profession where theory and data and policy decision-making are coming together.”
“It doesn’t really make much sense to stand on the sidelines and take potshots at them,” he said. “If
you don’t like the way they’re working, you should try to do better.”
He and Professor Sargent have been “trying to do empirical macroeconomics using formal tools of
statistics,” he said. “Those tools aren’t in themselves ideological.”
Professor Sims spoke favorably of the Obama administration’s fiscal stimulus programs, which are
Keynesian in their countercyclical spending. “An expansionary fiscal policy is probably what we need
right now,” he said.
Let me also add a bit of meta here. What does an economics Nobel mean? What does it do? Not what
some people seem to think.
Anyone who imagines that the Nobel can tip the balance between rival schools of thought in
macroeconomics or anything else is just being silly. The committee that chooses each year’s Nobel is
just a committee — smart, well-informed, and scrupulous, but not gifted with godlike powers of
discernment not granted to mortal men.
So why does the prize matter? Mainly, I’d say, because it gives visibility. And the main way the Nobel
can alter the debate is by highlighting work that wasn’t getting as much attention it arguably should.
Something like, say, Herbert Simon’s Nobel can raise the profile of a line of work in ways that affect
both public debate and actual research.
In my own case — hey, we can’t avoid that subject — I think there were two things. One was that the
trade and geography under increasing returns project that a number of us had advanced over the
previous several decades was not as widely known even within economics as you might have
expected; the field can be surprisingly fragmented. The other was that a lot of people who knew me
only as a Times columnist were informed for the first time that I had this other side. The point,
however, is that the verdict wasn’t what mattered; it was the increased visibility.
So the Sims/Sargent prize isn’t a vindication of anyone or any particular point of view; it’s basically a
signal saying, hey, if you haven’t been aware of this important line of work, now is a good time to
read up on it.
Oh, and in case I haven’t made this clear, hearty congratulations again to both men.
O
October 17, 2011, 8:20 AM
Mortified
Digby points us to Mort Zuckerman continuing to complain that Obama is being a big meanie.
The thing is, right from the start, he was making stuff up — taking umbrage at Obama remarks that
he had taken radically out of context, so as to make the very mild-mannered president sound like a
rabble-rouser. In a sane world, Zuckerman’s rants would be discounted entirely as coming from
someone obviously looking for ways to feel aggrieved.
But the rich are different from you and me: they get taken seriously even when they’re whining, “Ma!
He’s looking at me funny!”
O
October 17, 2011, 8:14 AM
European Spillovers
Wolfgang Munchau suggests a reason for European misjudgements — he argues that European
leaders have failed to take account of the fact that Europe, collectively, is a fairly closed economy,
selling primarily to itself:
The many failures of the eurozone’s crisis response policy have a common cause: the eurozone is a
large closed economy. Each of its 17 members is small and open. The political leaders who run the
eurozone have a small open economy mindset – every one of them, without exception. The
economists they employ mostly use small, open economy models.
It’s an interesting thesis, and I agree that the within-Europe spillovers from fiscal austerity are
significant. Early on in the crisis I did some back-of-the-envelope calculations for fiscal expansion
and guesstimated that a coordinated expansion had twice the bang per euro of a unilateral expansion
by just one euro area economy. By the same logic, austerity would look much more attractive to each
individual country if they don’t take the cross-border effects into account.
That said, I think Munchau is being too kind here. European leaders and institutions by and large
didn’t even get to the point of devising policies that might have worked in a small open economy.
Instead, they went in for fantasy economics, believing that the confidence fairy would make fiscal
contraction expansionary. The ECB, which Munchau credits as the institution most aware of the
linkages, was also the institution most dedicated to the doctrine of expansionary austerity.
In general, economists love models in which smart people make individually smart choices that end
up being collectively dumb; and they especially love it when such models make a case for
international policy coordination. Me too! But in the real world, bad policy more often arises from
failure even to get the principles right at the individual country level. Bad economics, not adding-up
constraints, is at the core of recent European foolishness.
O
October 16, 2011, 5:50 PM
Gross Miscalculation
Somehow I missed this: Joe Weisenthal informs us that Bill Gross has publicly apologized for getting
the bond market so wrong, predicting a spike in interest rates when QE2 ended. As Weisenthal
points out, however, Gross’s exaggerated fear of deficits was very widespread; it was, indeed, what all
the Very Serious People were obsessing about, even as the real economy was falling apart.
Weisenthal also points out that I called this in real time. If you want to have some fun, read the
vituperative comments on that post.
The thing is, all it took to get this right was understanding IS-LM, and taking it seriously.
O
October 16, 2011, 1:53 PM
Sunday OWS Notes
A couple of scattered notes on what’s going on.
First, Suze Orman endorses the protests:
I want to publicly say thank you to the Occupy Wall Street movement. Thank you for not accepting
the status quo. Thank you for not assuming there is nothing to be done. Thank you for rattling the
cages. Much coverage of Occupy Wall Street has cast this as the beginning of something new. That’s
only partly true. What I find so encouraging is that Occupy Wall Street’s more important message is
that this marks an end point. An end to just shrugging and putting up with the inequity. An end to
patiently waiting for government to get its act together and take steps to reduce the pain felt by
millions of Americans who are unemployed, the millions more who are underemployed, and the
millions more again who worry that if we indeed slip into a double dip recession they will soon
become unemployed. An end to letting Washington just continue further down its dysfunctional dark
hole without being called out.
I think we can definitely say that the effort to dismiss the whole thing as a bunch of smelly ignorant
hippies has failed.
Second, I’m a bit behind on this, but the Times had an excellent piece yesterday on what the lords of
finance are saying in private. Whiners take all!
I especially liked the guy who said that we must treat finance nicely because it’s the only thing
America is still good at. Aside from the fact that this is an insult to American workers, who are
actually quite productive in a lot of areas given a chance, how, exactly, did we become a society in
which so many of our elite students end up going into finance? Was that, you know, sort of a choice
— and a bad one?
It’s also useful, for a bit of perspective, to go back to another good Times article from the summer of
2007, The Richest of the Rich, Proud of a New Gilded Age :
These days, Mr. Weill and many of the nation’s very wealthy chief executives, entrepreneurs and
financiers echo an earlier era — the Gilded Age before World War I — when powerful enterprises,
dominated by men who grew immensely rich, ushered in the industrialization of the United States.
The new titans often see themselves as pillars of a similarly prosperous and expansive age, one in
which their successes and their philanthropy have made government less important than it once was.
The prosperity, such as it was — it never did trickle down much — is gone. But these guys still think
they earned it all, and the rest of us should be grateful to have them.