Hartar Blog

It is refreshing to see top academics questioning some of the assumptions that economists have been using in their models. Krugman , Brad DeLong  and many others are opening a methodological debate about what constitute an acceptable economic model and how to validate its predictions. The role of micro foundations, the existence of a natural state towards the economy gravitates,... are all very interesting debates that tend to be ignored (or assumed away) in academic research. I would like to go further and add a few items to their list that I wished could become part of the mainstream modeling in economics. In random order: 1. The business cycle is not symmetric. Most macroeconomic models start with the idea that fluctuations are caused by a succession of events that are both positive and negative (on average they are equal to zero). Not only this is a wrong representation of economic shocks but is also leads to the perception that stabilization policy cannot do much. Interestingl...

In a recent post Paul Krugman refers to the potential link between rising levels of debt prior to the 2008 crisis and the current discussion on secular stagnation. The argument can be illustrated by the chart below (borrowed from Krugman's post). Quoting from Krugman's post:  "Debt was rising by around 2 percent of GDP annually; that's not going to happen in the future, which a naive calculation suggests a reduction in demand, other things equal, of around 2 percent of GDP" In summary, increasing debt ratios area unsustainable and the adjustment can have a negative effect on growth. The argument is probably right but when it comes to assessing the real impact on growth I think we need to do a more careful analysis before reaching that conclusion.  Here is where I think the reading of the previous chart becomes more complicated: Why was debt going up? For some this is simply a reflection of excessive spending that directly feeds into demand. The fact that it is ex...

It has been surprising to see how over the last five years some have been holding to their economic theories even if the facts kept proving them wrong (Yyperinflation? Confidence and austerity?). At the end, it seems that ideology dominates much of the macroeconomic analysis we see these days. But what is more surprising is how broad this phenomenon is and how the general economic commentary that one reads in the press cannot move away from those theories either. One statement that will not go away is the constant reference to "printing money" which is not only incorrect from a factual point of view (most of the increase in the monetary base corresponds to reserves not to bank notes being printed) but also misleading when it comes to the understanding of the role of central banks. Even those who support central bank actions during the crisis have to add a sentence at the end to warn us about the danger of so much liquidity. And austerity, as much as the data has disproven the...

I have written before about the investment dearth that took place in advanced economies at the same time that we witnessed a global saving glut as illustrated in the chart below. In particular, the 2002-2007 expansion saw lower investment rates than any of the previous two expansions. If one thinks about a simple demand/supply framework using the saving (supply) and investment (demand) curves, this means that the investment curve for these countries must have shifted inwards at the same time that world interest rates were coming down. But what about emerging markets? Emerging markets' investment did not fall during the last 10 years, to the contrary it accelerated very fast after 2000. This is more what one would expect as a reaction to the global saving glut. The additional saving must be going somewhere (saving must equal investment in the world). As interest rates are coming down, emerging markets engage in more investment (whether this is simply a move along a downward-sloppin...

In his last press conference Mario Draghi said that the ECB was ready for negative deposit rates if necessary. His comments led to several European bankers rejecting this as a possibility ( here and here ). The comments of the Deutsche Bank and Commerzbank CEOs reflect on either their ignorance of how monetary policy works or their fighting against an ECB action that could make their lives harder (and their profits lower). Martin Blessing from Commerzbank argues that "too much cheap credit could lead to future crises" and he concludes that he does not know "how too much cheap liquidity can solve a problem that was created by too much cheap liquidity." This argument has now been wrongly used for 5 years, I thought that by now we would have learned that this is the wrong analogy. Fischen from Deutsche Bank complains that setting negative interest rates on deposits at the ECB would be like "penalizing banks". And this "will later be felt in a painful man...

Martin Wolf at the Financial Times argues that the future of the world economy, in particular that of advanced economies, looks sluggish because investment rates have displayed a downward trend over recent years, even before the financial crisis started. I made similar points in my blog post yesterday , let me add some evidence to that story. It is a fact that since the mid 1990s interest rates in the world started a downward trend. This trend was explained by Ben Bernanke in his March 2005 speech “To be more specific, I will argue that over the past decade a combination of diverse forces has created a significant increase in the global supply of saving--a global saving glut--which helps to explain the relatively low level of long-term real interest rates in the world today”  This can easily be represented in a standard demand and supply chart for the global market for funds where the saving glut is simply a shift of the saving (supply) curve to the right. What was interesting abo...

The presentation of Larry Summers at a recent IMF conference  has generated a good amount of comments. While some of what he said was not completely new, the way he put together some of these ideas to present a fairly pessimistic view of the state of the US economy has led to a debate around the possibility of secular stagnation (see Krugman ). Secular stagnation refers to the fact that some of the output losses during the crisis become permanent, the economy does not ever return to the previous trend. But there was something else that Larry Summers discussed that I also find interesting: he referred to the fact that in previous expansions the US economy barely managed to reach full employment despite the existence of strong bubbles and excesses. This also leads to a pessimistic view of the recent years and not so much because of what happened after 2008 but what happened before 2008. Here is some data and a story to make you share that pessimism: it is a fact that global real inte...

In a recent Vox article , Lorenzo Bini Smaghi raises some questions about the argument that austerity is the main reason why European countries' growth rates have been so low since 2008. To be fair, he is open to the idea that austerity has done some damage but he suggests that structural issues are also responsible for what we have seen in Southern European countries. His main argument can be summarized by a set of charts where growth during the 2008-2012 period is shown to be negatively correlated to measures of competitiveness. For example, comparing growth during the crisis with the competitiveness index produced by the World Economic Forum, one gets the following correlation: So the argument is that the low growth performance of Southern Europe (and Ireland) during the crisis is related to their structural problems. I will not disagrees with the statement that some of those countries have structural weaknesses that can constraint their growth rates. But I find that the chart a...

When I teach these days about the negative performance of the Euro economies over the last six years I always get asked about how policy makers could get it so wrong. The answer can be found in the article that Hans-Werner Sinn published today in the Financial Times ( Why Draghi was wrong to cut interest rates ). It is hard to know where to start commenting on the article. It is not only inconsistent but also full of arguments that go against any economic logic and misleading use of partial data. Interestingly, the article starts with the argument that given that inflation in the Euro area is below its target and falling (down to 0.7% in October), it seems that "last week's interest rate cut is understandable". Correct. That's the only reasonable paragraph of the article as the next one opens with the sentence: "However, deflation in parts of a currency union is not the same as deflation of a union as a whole, because its internal effects on competitiveness canno...

For some it is clear that the all-time record levels in the stock market are supported by loose monetary and the day policy starts changing, stock markets will suffer a sharp drop. While I also worry about the tendency of stock markets and investors to be overoptimistic, I am less concerned by the fact that we are hitting all-time record levels. First, we keep forgetting that we are talking about nominal variables and they will keep setting record levels as long as inflation remains positive. But I am also less worried because tightening of monetary policy normally happens when growth is picking up so the stock market will have to decide if they like more faster growth than higher interest rates. And the reaction might surprise some. A historical example that I have mentioned earlier and that I find interesting is the period 1993-1996. In 1993 the recovery from the previous recession was slowly taking shape and the stock market was going up and, yes, setting all-time records. What did ...

I did not realize that some of my earlier posts on sudden stops and the Euro area would be so controversial, I thought I was making a simple point. And this time those who disagree with me are the ones that I always agree with so it makes you think even harder about whether the argument that I was making are right! Brad DeLong wrote a post yesterday to show that sudden (capital) stops should not be a concern for countries that have their own currencies. Let me start with all the arguments where I do not have any disagreement: - Taking about the possibility of a sudden stop in the UK or the US makes no sense. I agree. The comparison that some establish to argue that the "US is the next Greece" is idiotic. - Countries with fixed exchange rates that have accumulated a large amount of debt denominated in foreign currency are more likely to be exposed to crisis caused by sudden stops. Correct. Where we disagree is on whether sudden stops are relevant to other countries with flexi...

My post yesterday on how the US economy would have performed if it was going through the crisis as a member of the Euro area was an attempt to explain that the perspective of a small Euro country with limited credibility can be very different from that of the US. Robert Waldmann  at Angry Bear is surprised by the macroeconomic logic I use so let me clarify what I had in mind -- given that what I am saying is quite standard. A country with a current account deficit must have a matching capital inflow to finance the excess of spending above its income (this is an accounting identity). During the financial crisis many European countries faced a sudden stop -- which is defined as a situation where international financial markets are not willing anymore to fund the current account deficit of a country. This is something that any textbook discusses although normally in the context of emerging markets [by the way, it is not easy to use the IS-LM model to deal with sudden stops given that...

Paul Krugman responds to my earlier post about how exchange rate regimes do not matter much (I was referring the work of  Andrew Rose ). Krugman has a different view on the issue and argues that countries in the Euro area have suffered from not having their own currency and this is visible by the higher interest rates that they faced relative to other countries. He makes a good point and the data speaks in favor of his hypothesis. I also think that Euro countries have suffered from being part of the Euro area because of many other reasons (e.g. they ended up adopting the wrong policy mix). Where I am less sure is about how much the ability to control the exchange rate mattered relative to other factors. The only way to understand these effects would be to build a counterfactual: what would life without the Euro have looked like for these countries? I have tried to answer this question before and it less clear than what some might think. As an example, for those who see the cur...

Via Barry Ritholtz I read the analysis of Lacy Hunt about how recent Federal Reserve policies have been a failure to lift growth. I am somehow sympathetic to the argument that Quantitative Easing has had a limited effect on GDP growth -- although one has to be careful when analyzing the effectiveness of QE by comparing it to the alternative scenario (no QE at all) rather than simply measuring the observed GDP growth. But I find that the analysis of the article is not accurate when it come to the working of central bank reserves (and I have made a similar point before ). Maybe it is a matter of semantics but the way the author analyzes the relationship between reserves and the money multiplier is not consistent with the conclusions reached about the lack of effectiveness of monetary policy actions. Let me highlight two pieces of the analysis that I have difficulty understanding. First, there is the argument that increasing the amount of Reserves (deposits of commercial banks at the ce...

The benefits and costs of different exchange rate regimes is one of the most debated topics in international macroeconomics and it is crucial for a very important decisions that policy makers regularly face on how to manage exchange rates. The launch of the Euro gave great impetus to this debate as some countries had to decide whether they wanted to be in or out and the rest of the world was looking at this experiment as a way to think about similar arrangement in other regions of the world. The 2008-09 crisis and the dismal performance of some Euro countries have reopened the debate about what life would have looked like for some of these countries if they had stayed out of the Euro. I have written before my views that run contrary to the conventional wisdom. Many believe that while the Euro might make sense as part of a political process of European integration, it has had clear negative consequences on economic performance, consequences that are obvious when one looks at t...

Marco Buti and Pier Carlo Padoan reply to the criticism that I had raised in an earlier blog post to their previous article on how to strengthen the European economy recovery. I can see that their argument is now more balanced where fiscal policy consolidation is mentioned as a potential factor to explain the dismal recovery. We still probably disagree on how much of a factor it was and whether there were alternatives to the policies that Euro countries implemented but at a minimum it is good to see that it is not included as a possible factor. On the issue of reforms it is hard to disagree with them on the need for further reforms in Europe, the real debate is whether these reforms will pay off fast enough and if they do not, what is the role for traditional demand policies (monetary and fiscal). But there is something else in their article where my reading is quite different from theirs: the role of policy uncertainty. Before I express my views let me state that one of my most cited...

The narrative about the 2008 financial crisis is about the notion that several economies were following an unsustainable path before the crisis started. We talk about excessive spending, exploding debt levels, bubbles in asset prices and the imbalances they create. These imbalances are the seed of the crisis. While the story sounds simple, it is not well understood by standard macroeconomic models and this has led in my view to excessive pessimism about growth and the recovery. In macroeconomics, the notion of "growing too fast" or "producing too much" is normally captured by measures of potential output or the output gap. When GDP is above its potential (or the output gap is positive) we label that situation as unsustainable. But in reality, most times we only see this after the crisis. It is only when we are in the middle of the crisis or even out of it that we recalculate all the measures of potential output to argue that the pre-crisis level were unsustainable. ...