Wednesday, February 9, 2011
Thinking about exchange rates through the Venezuela case
Via Rosanna an interesting article on Venezuela´s January devaluation. Why was the country forced to devalue? And what are the potential consequences of a devaluation on prices? Things to think about as we see the application of macro-discussions to real life.
The NYT and inflation in Argentina
The New York Times echoed a worry in various places about Argentina´s growing inflation. There is little doubt that inflation is higher than the government recognizes and that a combination of a weak nominal exchange rate and growing public deficits may have contributed to it. However, it is just surprising that the NYT implicitly mentions a risk of hyper-inflation and, moreover, places Brazil in a similar vote:
"Inflation has reared its head elsewhere in Latin America as well. Brazil, which was ravaged by hyperinflation of more than 2,000 percent as recently as 1994, has become increasingly concerned that inflation will exceed 5.5 percent this year."
Is a 5.5 percent really such a problem, particularly in times of soaring commodity prices and growing capital inflows?
"Inflation has reared its head elsewhere in Latin America as well. Brazil, which was ravaged by hyperinflation of more than 2,000 percent as recently as 1994, has become increasingly concerned that inflation will exceed 5.5 percent this year."
Is a 5.5 percent really such a problem, particularly in times of soaring commodity prices and growing capital inflows?
Thursday, February 3, 2011
New policy brief
Juliana Martínez and I have just published a brief on the Comparative Research Program on Poverty (www.crop.org). You can find it here. Based on our research on Costa Rica, we argue that building complementarities between the welfare regime and the economic regime in developing countries is very complicated. Structural heterogeneity (sharp differences between low productivity and high productivity sectors) means that it is hard to generate enough revenues to support social policy and, at the same time, a high demand for education spending. It is a first attempt to understand these complementarities, which are probably at the heart of our future research and policy agenda in Latin America.
Comments most welcome!
Comments most welcome!
The liquidity trap
The concept of the liquidity trap goes back to Keynes and to Hicks' interpretation of the argument. For a long time, it was more part of a theoretical debate than a real possibility, but Japan's crisis in the 1990s changed this slightly.
To understand the "liquidity trap" is important to remember that it takes place in moments of highly recessionary environments. In these instances, nobody is really interested in investing much and the price level may be going down. The key insight is that monetary policy may end up being irrelevant in this situation. Why? Because there is a downward limit in the reduction of interest rates: when nominal interest rates are zero or almost zero, how can you reduced them more?
With interest rate equal to almost zero (with bonds at very high levels), the is no real reason to hold bonds. This mean that any expansion of money will result in an expansion of liquidity in the hands of people... and at the same time there are a lot of idle resources in the economy. You can find useful explanations of this process here and here.
Since the late 1990s, the concept entered into the debate on the Japanese crisis: in Japan, low interest rates were very low and monetary policy ineffective. Paul Krugman elaborated a dynamic model in which he showed that the liquidity trap can be a real possibility if people think that the price level will not increase steadily. You can find his explanation here (just read the introduction as the rest is somewhat complicated).
We represent the idea that monetary policy by a horizontal LM curve. Again, expansions of money supply do not affect the interest rate and will only result in more liquidity in the hands of people.
What about fiscal policy? In this environment, fiscal policy will be very effective both in the simple IS-LM model but also in the more complicated, Krugman version.
How can we see the intuition in our graph? Here is a possibility: there is a lot of liquidity (and a lot of idle resources) in the hands of households and firms. In this case, government spending will simply put some of this money "to work" but there will not be further increases in the demand for money (people are already holding a lot of money).
Is this an ideal world because you have fiscal policy with crowding out? Not really because we are in a deep recession and you may need to expand fiscal policy more than you are capable of (in terms of your borrowing constraint). Moreover, it could be that fiscal policy does not help to re-start the economy.
To follow all this discussion and the IS-LM model a little better, you can also check these slides from a professor at the University of Hawai.
Finally, how likely is the liquidity trap in practice? There is a lot of debate about it, but many people believe that we were very close to one in the recent global crisis, particularly in the US. Interest rates were very low, but this did not promote investment. People (and banks) simply kept more money in their pockets. At the same time, however, there has not been a process of deflation and the economy is slowly recuperated (although nobody knows for how long).
How likely are liquidity traps in developing countries (our main interest)? The answer is probably that not very likely because inflation is higher than in developed countries and interest rates can go down significantly. Moreover, as our Stiglitz et al book argues, the expansion of liquidity can have a positive effect on firms that are constraint by a lack of credit.
To understand the "liquidity trap" is important to remember that it takes place in moments of highly recessionary environments. In these instances, nobody is really interested in investing much and the price level may be going down. The key insight is that monetary policy may end up being irrelevant in this situation. Why? Because there is a downward limit in the reduction of interest rates: when nominal interest rates are zero or almost zero, how can you reduced them more?
With interest rate equal to almost zero (with bonds at very high levels), the is no real reason to hold bonds. This mean that any expansion of money will result in an expansion of liquidity in the hands of people... and at the same time there are a lot of idle resources in the economy. You can find useful explanations of this process here and here.
Since the late 1990s, the concept entered into the debate on the Japanese crisis: in Japan, low interest rates were very low and monetary policy ineffective. Paul Krugman elaborated a dynamic model in which he showed that the liquidity trap can be a real possibility if people think that the price level will not increase steadily. You can find his explanation here (just read the introduction as the rest is somewhat complicated).
We represent the idea that monetary policy by a horizontal LM curve. Again, expansions of money supply do not affect the interest rate and will only result in more liquidity in the hands of people.
What about fiscal policy? In this environment, fiscal policy will be very effective both in the simple IS-LM model but also in the more complicated, Krugman version.
How can we see the intuition in our graph? Here is a possibility: there is a lot of liquidity (and a lot of idle resources) in the hands of households and firms. In this case, government spending will simply put some of this money "to work" but there will not be further increases in the demand for money (people are already holding a lot of money).
Is this an ideal world because you have fiscal policy with crowding out? Not really because we are in a deep recession and you may need to expand fiscal policy more than you are capable of (in terms of your borrowing constraint). Moreover, it could be that fiscal policy does not help to re-start the economy.
To follow all this discussion and the IS-LM model a little better, you can also check these slides from a professor at the University of Hawai.
Finally, how likely is the liquidity trap in practice? There is a lot of debate about it, but many people believe that we were very close to one in the recent global crisis, particularly in the US. Interest rates were very low, but this did not promote investment. People (and banks) simply kept more money in their pockets. At the same time, however, there has not been a process of deflation and the economy is slowly recuperated (although nobody knows for how long).
How likely are liquidity traps in developing countries (our main interest)? The answer is probably that not very likely because inflation is higher than in developed countries and interest rates can go down significantly. Moreover, as our Stiglitz et al book argues, the expansion of liquidity can have a positive effect on firms that are constraint by a lack of credit.
Wednesday, February 2, 2011
Macroeconomic webpage and lectures
Nouriel Roubini has a very useful webpage of his two courses on Macroeconomics and Macroeconomic policy. The notes and book on the bailouts are particularly interesting.
Monday, January 31, 2011
Income inequality and financial crises
Thanks to Jack Reynolds, I noticed the following interesting post by Duncan Green based on this paper by the IMF. The paper basically argues that income inequality may have contributed to the recent crisis. The idea is that workers compensated their low wage growth through loans, which generated assets held by the rich. Excessive leverage triggered the crisis. This is an important argument and one that links the obvious process of financialization with the expansion of wealth at the top.
Yet we need more research on the evolution of the asset pricing as a generator of inequality. Who has benefited from growing asset prices in both the stock market and the real state market? Who was investing there? And how was it connected to lending by the poor?
A striking difference with developing countries also emerged: there inequality is high but there is little access to credit and thus little compensation for the poor and middle class. This is a difference between developed and developing countries worth analysing.
Update: An interesting documentary in the subject has just been produced. I have not watched it but are trying to find out how to show it in St Antony´s. It would be a great opportunity to discuss some of these issues.
Yet we need more research on the evolution of the asset pricing as a generator of inequality. Who has benefited from growing asset prices in both the stock market and the real state market? Who was investing there? And how was it connected to lending by the poor?
A striking difference with developing countries also emerged: there inequality is high but there is little access to credit and thus little compensation for the poor and middle class. This is a difference between developed and developing countries worth analysing.
Update: An interesting documentary in the subject has just been produced. I have not watched it but are trying to find out how to show it in St Antony´s. It would be a great opportunity to discuss some of these issues.
Wednesday, January 19, 2011
The value of GDP
I am committed to re-launch this blog again, mainly because I am now teaching a new course on Economic Foundations (Macroeconomics) for the MPhil in Development Studies at Oxford and there are many issues that we cannot cover in the class but are worth discussing.
Today one issue was the extent to which GDP is a good measure of welfare and whether economic growth per se is good or it all depends on what things are being produced. My view is that expanding the amount of goods and services in developing countries is extremely important to: (a) Expand livelihood opportunities for people. (b) Create the resources that can contribute to produce social services and meet social demands for the whole population.
Does that mean that it does not matter what we produce? Absolutely not. We need to be aware that different activities generate different spillovers, contribute to meeting different demands and generate different levels of wages and profits. We should promote sectors that can lead to improvements in welfare for a majority of the population in the long run... but we should also recognize that trade can be useful to exchange goods and services that are not useful to meet social demands for others that may be useful.
For two different positions about the usefulness of GDP, it may be useful to go here (a positive view from OECD here) and here (a critical view, although not from anthropology).
Much to discuss!
Today one issue was the extent to which GDP is a good measure of welfare and whether economic growth per se is good or it all depends on what things are being produced. My view is that expanding the amount of goods and services in developing countries is extremely important to: (a) Expand livelihood opportunities for people. (b) Create the resources that can contribute to produce social services and meet social demands for the whole population.
Does that mean that it does not matter what we produce? Absolutely not. We need to be aware that different activities generate different spillovers, contribute to meeting different demands and generate different levels of wages and profits. We should promote sectors that can lead to improvements in welfare for a majority of the population in the long run... but we should also recognize that trade can be useful to exchange goods and services that are not useful to meet social demands for others that may be useful.
For two different positions about the usefulness of GDP, it may be useful to go here (a positive view from OECD here) and here (a critical view, although not from anthropology).
Much to discuss!
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