Samuelson on Mankiw, dollar, and bubbles

Part II of an interview with Samuelson:

In one of Greg Mankiw's articles, he said that maybe when the interest rate gets down to zero and it's threatening to be negative, you should give a subsidy with it. Well, that's what fiscal policy is!

I think it's almost inevitable that, with a billion people in China wide awake for the first time, and a billion people in India, there's going to be some kind of a terrible run against the dollar. And I doubt it can stay orderly, because all of our own hedge funds will be right in the vanguard of the operation. And it will be hard to imagine that that wouldn't create different kind of meltdown.

But there never has been a true macro efficient market. You just have to look at the record of economic history the ups and downs. Bubbles are self-generating. And I'm not sure most of the people that get caught up in the middle of a bubble can be described as irrational. It seems pretty rational to buy a house and flip it in the next few weeks at a profit when that's been happening for along time. It works both ways.

I think it would be surprising if, down the road -- not in the long long run but in the somewhat short run -- we don't have some return of inflation. On the other hand, I'm of the view that if we come out of this with some kind of temporary stabilization at least, and the price level is let's say 10-12% above what it was before we got into the meltdown, I think that's a price I would be willing to pay!

I'm against inflation, but what I worry about is continuing, galloping, self-reinforcing inflation. I would not try to roll things back to some sacred earlier price level.

Links of Interest (06/16/2009)

Interview with Paul Samuelson (Part I)

I am a cafeteria Keynesian. […] Well, reasonable men are not reasonable when you're in the bubbles which have characterized capitalism since the beginning of time.

Milton Friedman. Friedman had a solid MV = PQ doctrine from which he deviated very little all his life. By the way, he's about as smart a guy as you'll meet. He's as persuasive as you hope not to meet. And to be candid, I should tell you that I stayed on good terms with Milton for more than 60 years. But I didn't do it by telling him exactly everything I thought about him. He was a libertarian to the point of nuttiness. People thought he was joking, but he was against licensing surgeons and so forth. And when I went quarterly to the Federal Reserve meetings, and he was there, we agreed only twice in the course of the business cycle.

Krugman on new financial regulations

Good review of Dead Aid

A short (incomplete) review of (free) market system in Nepal

Remittances expected to fall by 5 to 8 percent in 2009

Health and growth

The hungry people are watching!

Javier Blas reviews Enough: Why the World’s Poorest Starve in an Age of Plenty. This paragraph shows the irony of ‘invisible hand’ belief.

“Much of the chronic, everyday hunger in the world is now a man-made catastrophe, caused one anonymous decision at a time, one day at a time, by people, institutions and governments doing what they thought was best for themselves or sometimes even what they thought at the time was best for Africa,” they write.

The global food industry typifies a market dominated by few players, vested interest groups, and predatory pricing in the form of food aid, which is not only lowering food prices (crucial for meeting household needs of a farmer in the developing world) but also discouraging farmers from engaging in agriculture business (because the rate of return is very low). The aid industry is tied up with food industry and basically supply their surpluses to developing countries leading to two fiscal effects: (i) increase in debt, and (ii) decrease in revenue as farmers get displaced by the inflow of cheap food from the West. The poor always remain poor and the masters always prevail!

Nothing could illustrate the shortcomings of US food aid policy, in which Washington sells American farmers’ output in Africa rather than sending money to buy local food, better than a dialogue between an Ethiopian farmer and a US executive at a food aid meeting in Addis Ababa. The farmer asks the executive enthusiastically: “Can you help our farmers sell their beans in America?” He receives an unexpected answer: “Actually, we represent American bean growers.”

Advice from the western world has not helped, however. It is telling that one of the best agricultural programmes in Africa – a subsidy system for fertiliser and high-yielding seeds in Malawi that has transformed the country into a net exporter of corn – was objected to, even to the point of threats to withhold some aid, by the Washington-based World Bank and the Department for International Development in Britain.

Collier on ‘investing in investing’ for the bottom billion

Paul Collier on investing in investing for the bottom billion:

… in Africa the average investment rate to GDP is less than 20 percent, whereas to catch up, to converge with other economies, it needs to be over 30 percent. So they must move from under 20 to over 30. … It means an agenda of raising the capacity to invest productively. I call that a phase of investing in investing. It is something that has partly a macroeconomic agenda, but also a microeconomic agenda. If we just say it’s hopeless, the country doesn’t have a capacity to invest, it drives them into what I call the economics of Polonius: “Neither a borrower nor a lender be.” … That is the strategy for investing in investing, building the capacity to make good investments.

[…] the typical low-income country should be investing something like 30 percent of GDP. And for low-income countries that are depleting natural assets, it should be higher than that. […] We need a phase of investing in investing, and this goes back to my earlier point. An investing-in-investing phase is even more important in the resource-rich low-income countries.

[…] Typically, there is somewhat of a bypass of the domestic construction sector by bringing in foreign construction firms, and that’s throwing the baby out with the bathwater because potentially the construction sector can generate a lot of employment in these economies; in postconflict situations, that’s enormously valuable. In technical terms, the shadow wage of young men in postconflict environments is negative. It’s worth spending money employing them even if they were to do nothing. But actually you can get them productively employed in the construction sector.

And on the role of IMF:

I think that there are three different roles for the IMF. First, for governments of low-income countries, the Fund is a source of money. Second, the Fund provides a commitment framework for donors through its programs. And the third role, which I think is the most important, is one of providing a conceptual and coordination framework to assist the many different players in the low-income development field, including various agencies and the different governments. But my larger point is that the right macro answers depend on resolving the micro and institutional issues. The right macro answers, taking the micro and institutional as given—which is what the IMF has been doing—are the wrong macro answers for development.

Fiscal policy defined

Horton and El-Ganainy explain the basics of fiscal policy, a topic of much discussion in recent days especially relating to fiscal stimulus in almost all countries in the world. A very basic explanation that gives a taste of intro to macro econ, chapter one!

Fiscal policy is the use of government spending and taxation to influence the economy. Governments typically use fiscal policy to promote strong and sustainable growth and reduce poverty. The role and objectives of fiscal policy have gained prominence in the current crisis as governments have stepped in to support financial systems, jump-start growth, and mitigate the impact of the crisis on vulnerable groups. […] Fiscal policy that increases aggregate demand directly through an increase in government spending is typically called expansionary or “loose.” By contrast, fiscal policy is often considered contractionary or “tight” if it reduces demand via lower spending.

Besides providing goods and services, fiscal policy objectives vary. In the short term, governments may focus on macroeconomic stabilization—for example, stimulating an ailing economy, combating rising inflation, or helping reduce external vulnerabilities. In the longer term, the aim may be to foster sustainable growth or reduce poverty with actions on the supply side to improve infrastructure or education. Although these objectives are broadly shared across countries, their relative importance differs depending on country circumstances. In the short term, priorities may reflect the business cycle or response to a natural disaster—in the longer term, the drivers can be development levels, demographics, or resource endowments. The desire to reduce poverty might lead a low-income country to tilt spending toward primary health care, whereas in an advanced economy, pension reforms might target looming long-term costs related to an aging population. In an oil-producing country, fiscal policy might aim to moderate procyclical spending—moderating both bursts when oil prices rise and painful cuts when they drop.

Many countries can afford to run moderate fiscal deficits for extended periods, with domestic and international financial markets and international and bilateral partners convinced of their ability to meet present and future obligations. Deficits that grow too large and linger too long may, however, undermine that confidence. Aware of these risks in the present crisis, the IMF is calling on governments to establish a four-pronged fiscal policy strategy to help ensure solvency: stimulus should not have permanent effects on deficits; medium-term frameworks should include commitment to fiscal correction once conditions improve; structural reforms should be identified and implemented to enhance growth; and countries facing medium- and long-term demographic pressures should firmly commit to clear strategies for health care and pension reform.

Does South Asia need a counter-cyclical fiscal policy?

Yes, yes, says that World Bank as the fear of inflation is now replaced (Nepal has over 12% inflation rate right now???) by declining growth and the impact of global slump on poverty.

South Asian countries do not have automatic stabilizers or social safety nets to counter the negative effects of economic slump. So, the only option left is Keynesian fiscal policies (as expected). However, the WB argues that the extent to which this can be used is constrained by the bloc’s high public debt. This should be least of the worries because right now all that matters for countries like Nepal (which has over 12% inflation rate) is how to balance a rise in general price level and ensure economic growth. As is popular right now, the WB recommends investment in public infrastructure such as roads, schools, and hospitals.

South Asian countries may have missed the opportunity to strengthen their fiscal position during good times, which would have enhanced their capacity to counter downturns. Timing is of the essence. Any counter-cyclical policy needs to be tailored to conditions in individual countries. The capacity of a country to undertake counter-cyclical fiscal policy depends on its ability to finance the resulting fiscal deficit, which is easier when public debt is low and external balances are in good shape.

It is essential to protect core public spending in social and physical infrastructure in the face of declining revenues. Spending targeted at vulnerable groups may need to increase. This would require reallocation of expenditures from other areas, as well as greater reliance on borrowing or grants. However, it will always be a risky proposition especially for countries with a weak track record of controlling spending and where there are fears of inflation. Once introduced such spending may be hard to reverse.

According to a number of Economists, a fiscal stimulus program for countering an economic downturn needs to fulfill the 3-Ts; it needs to be timely, targeted, and temporary in order to be effective.

When will people read Keynes correctly?

Robert Skidelsky writes a very interesting article about the cycle of ideological debates and what Keynes actually meant (I wonder why people are still not (trying) understanding the simple, common sense concept put forth by Keynes in the 1930s). The beauty of classical economics and its different variations is that their models can be proved mathematically in a very slick and convincing fashion (ceteris paribus). This does not mean that they represent reality cent percent. Economics is a social science and not all things can be simplified without missing some stuff. What matters is good judgment arising from some sort of economic model (may or may not be comprehensive). This is what Keynesians do!

And remember, when resources are idle, economy is not in full employment, and market forces hesitate to function as they should (due to, say, crisis of confidence arising from self-fulfilling and reinforcing prophesy of some speculators/investors), government can turn the tide around by managing demand/using fiscal policies to put idle resources to work. Things could go awfully wrong even in a stable market economy, when then needs an escort to safety. Isn’t this a common sense?

For 30 years or so Keynesianism ruled the roost of economics – and economic policy. Harvard was queen, Chicago was nowhere. But Chicago was merely licking its wounds. In the 1960s it counter-attacked. The new assault was led by Milton Friedman and followed up by a galaxy of clever young disciples. What they did was to reinstate classical theory. Their “proofs” that markets are instantaneously, or nearly instantaneously, self-adjusting to full employment were all the more impressive because now expressed in mathematics. Adaptive Expectations, Rational Expectations, Real Business Cycle Theory, Efficient Financial Market Theory – they all poured off the Chicago assembly line, their inventors awarded Nobel Prizes.

No policymaker understood the maths, but they got the message: markets were good, governments bad. The Keynesians were in retreat. Following Ronald Reagan and Margaret Thatcher, Keynesian full employment policies were abandoned and markets deregulated. Then along came the almost Great Depression of today and the battle is once more joined.

Keynes had proved that such crowding-out could occur only at full employment: if there were unemployed resources, fiscal deficits would not drive up interest rates without also expanding the economy. Prof Ferguson’s ignorant remarks only confirmed that “we’re living in a Dark Age of macroeconomics, in which hard-won know-ledge has simply been forgotten”.

This is to take economics to be like a natural science, which Keynes never believed it was, because he thought its subject matter was much too variable over time.

Markets could behave in ways described by the classical and New Classical theories, but they need not. So it was important to take precautions against bad behaviour. Ultimately, the Keynesian revolution was a triumph not of good science over bad science, but of good judgment over bad judgment.