Escaping the Liquidity Trap
Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others, Lars E.O. Svensson
Abstract
Existing proposals to escape from a liquidity trap and deflation, including my “Foolproof Way,” are discussed in the light of the optimal way to escape. The optimal way involves three elements: (1) an explicit central-bank commitment to a higher future price level; (2) a concrete action that demonstrates the central bank’s commitment, induces expectations of a higher future price level and jump-starts the economy; and (3) an exit strategy that specifies when and how to get back to normal. A currency depreciation is a direct consequence of expectations of a higher future price level and hence an excellent indicator of those expectations. Furthermore, an intentional currency depreciation and a crawling peg, as in the Foolproof Way, can implement the optimal way and, in particular, induce the desired expectations of a higher future price level. I conclude that the Foolproof Way is likely to work well for Japan, which is in a liquidity trap now, as well as for the euro area and the United States, in case either would fall into a liquidity trap in the future.
In which we learn about the relationship between profits and bonuses on Wall Street…
Hat-tip: Nancy Folbre, Economix
Reasons to be cheerful: the continuing decline of world poverty
Parametric Estimations of the World Distribution of Income, by Maxim Pinkovskiy and Xavier Sala-i-Martin
Abstract
We use a parametric method to estimate the income distribution for 191 countries between 1970 and 2006. We estimate the World Distribution of Income and estimate poverty rates, poverty counts and various measures of income inequality and welfare. Using the official $1/day line, we estimate that world poverty rates have fallen by 80% from 0.268 in 1970 to 0.054 in 2006. The corresponding total number of poor has fallen from 403 million in 1970 to 152 million in 2006. Our estimates of the global poverty count in 2006 are much smaller than found by other researchers. We also find similar reductions in poverty if we use other poverty lines. We find that various measures of global inequality have declined substantially and measures of global welfare increased by somewhere between 128% and 145%. We analyze poverty in various regions. Finally, we show that our results are robust to a battery of sensitivity tests involving functional forms, data sources for the largest countries, methods of interpolating and extrapolating missing data, and dealing with survey misreporting.
“What ended the Great Depression?”
This paper examines the role of aggregate-demand stimulus in ending the Great Depression. Plausible estimates of the effects of fiscal and monetary changes indicate that nearly all the observed recovery of the U.S. economy prior to 1942 was due to monetary expansion. A huge gold inflow in the mid- and late 1930s swelled the money stock and stimulated the economy by lowering real interest rates and encouraging investment spending and purchases of durable goods. That monetary developments were crucial to the recovery implies that self-correction played little role in the growth of real output between 1933 and 1942.
Christie Romer, What ended the Great Depression?
New paper by Obstfeld & Rogoff
Global Imbalances and the Financial Crisis: Products of Common Causes, by Maurice Obstfeld and Kenneth Rogoff
Introduction
Until the outbreak of financial crisis in August 2007, the mid-2000s was a period of strong economic performance throughout the world. Economic growth was generally robust; inflation generally low; international trade and especially financial flows expanded; and the emerging and developing world experienced widespread progress and a notable absence of crises.
This apparently favorable equilibrium was underpinned, however, by three trends that appeared increasingly unsustainable as time went by. First, real estate values were rising at a high rate in many countries, including the world’s largest economy, the United States. Second, a number of countries were simultaneously running high and rising current account deficits, including the world’s largest economy, the United States.
Third, leverage had built up to extraordinary levels in many sectors across the globe, notably among consumers in the United States and Europe and financial entities in many countries. Indeed, we ourselves began pointing to the potential risks of the “global imbalances” in a series of papers beginning in 2001. As we will argue, the global imbalances did not cause the leverage and housing bubbles, but they were a critically important codeterminant.
In addition to being the world’s largest economy, the United States had the world’s highest rate of private homeownership and the world’s deepest, most dynamic financial markets. And those markets, having been progressively deregulated since the 1970s, were confronted by a particularly fragmented and ineffective system of government prudential oversight. This mix of ingredients, as we now know, was deadly….
Update: See also this useful discussion of the paper at David Beckworth’s blog.
“No economy without economics”
Callon and 
alı
kan introduce the notion of “economization” in the first paper in a two part series in Economy and Society.
Economization, part 1: shifting attention from the economy towards processes of economization
This article proposes a research programme devoted to examining ‘processes of economization’. In the current instalment we introduce the notion of ‘economization’, which refers to the assembly and qualification of actions, devices and analytical/practical descriptions as ‘economic’ by social scientists and market actors. Through an analysis of selected works in anthropology, economics and sociology, we begin by discussing the importance, meaning and framing of economization, as we unravel its trace within a variety of disciplinary backgrounds. We show how in combination, these works have laid the foundations for the study of economization. The second instalment of the article, to appear in the next volume of Economy and Society, presents a preliminary picture of what it might mean to take processes of economization as a topic of empirical investigation. Given the vast terrain of relationships that produce its numerous trajectories, we will illustrate economization by focusing on only one of its modalities – the one that leads to the establishment of economic markets. With emphasis on the increasingly dominant role of materialities and economic knowledges in processes of market-making, we will analyse the extant work in social studies of ‘marketization’. Marketization is but one case study of economization.
The Paradox of the “Great Moderation”
In the Financial Development Index and Report, recently published by the World Economic Forum, Nouriel Roubini notes that,
Financial crises are pervasive phenomena both among advanced and emerging market economies. Moreover, in spite of the “great moderation” (a sustained period of high growth and low inflation) of the last two decades, financial crises have become more frequent and more virulent rather than less frequent and less severe. Paradoxically, such great moderation may have triggered asset and credit bubbles. Indeed, with low inflation, sustained growth, and lower nominal and real interest rates, given the loose monetary and credit conditions and the ability of borrowers to lever up again, the possibility of asset bubbles and credit booms has increased.
Stormcrow Economics
With so much to blog about at the moment, I don’t know where to begin. However, I couldn’t let this one slip past without a link. The New York Times has just profiled (the indispensible) RGE Monitor’s Nouriel Roubini. Roubini, a notorious pessimist, is now, much like The Black Swan author and career contrarian Nassim Nicholas Taleb, lauded where he was once obscure for predicting to a large degree the current financial crisis. The NYT calls him “Dr Doom”, but Roubini is more like Hyman Minsky or Keynes, an economist trying to understand what happens when the past doesn’t resemble the future. His diagnosis of the current crisis draws on his work with emerging market financial crises in the ’90s. The common denominator Roubini identified was large current account deficits, financed by “borrowing from abroad in ways that exposed them to the national equivalent of bank runs”. Roubini has watched with trepidation the same dynamic at work in the US for the last few years — a position that he ironically describes as more realist than pessimist, because “things are turning out even worse than I initially predicted.”
For the US though, the future Roubini sees is undeniably bleak,
“Reckless people have deluded themselves that this was a subprime crisis,” he told me. “But we have problems with credit-card debt, student-loan debt, auto loans, commercial real estate loans, home-equity loans, corporate debt and loans that financed leveraged buyouts.” All of these forms of debt, he argues, suffer from some or all of the same traits that first surfaced in the housing market: shoddy underwriting, securitization, negligence on the part of the credit-rating agencies and lax government oversight. “We have a subprime financial system,” he said, “not a subprime mortgage market.”
Roubini argues that most of the losses from this bad debt have yet to be written off, and the toll from bad commercial real estate loans alone may help send hundreds of local banks into the arms of the Federal Deposit Insurance Corporation. “A good third of the regional banks won’t make it,” he predicted. In turn, these bailouts will add hundreds of billions of dollars to an already gargantuan federal debt, and someone, somewhere, is going to have to finance that debt, along with all the other debt accumulated by consumers and corporations. “Our biggest financiers are China, Russia and the gulf states,” Roubini noted. “These are rivals, not allies.”
The United States, Roubini went on, will likely muddle through the crisis but will emerge from it a different nation, with a different place in the world. “Once you run current-account deficits, you depend on the kindness of strangers,” he said, pausing to let out a resigned sigh. “This might be the beginning of the end of the American empire.”
Occupation is good for you: US troop presence & economic growth
Given that the US is in the midst of a deeply unpopular occupation in the Middle East, in a new paper on SSRN, economists Garett Jones and Tim Kane ask a question conspicuous by its absence in the contemporary debate: “Is the presence of American forces in a foreign nation a help or hindrance to that occupied country’s development?”
The authors consider development, economic history and institutional economics literature, which suggest that security — as in the monopolisation of the use of force — is a precondition of growth. For instance, in Douglass North et al’s model (already covered in an earlier post) of social order development, the organisation of the state moves in linear fashion from a primitive, small band type order, through a limited access order or “natural state”, wherein an elite monopolises the use of force and limits access to power through patronage networks, to an open access order, where access to power is democratic and theoretically evenly distributed across society. According to this model, solving the question of violence is the first and possibly most important problem facing a society. Without monopolisation and the resulting high barriers to entry, activity in the markets for violence is likely to be extensive, and as a consequence actual economic activity is likely to be limited.
There are, then, theoretical reasons for believing that “troop presence”, broadly defined as a functioning security force, be it foreign or local, will be positively correlated with economic growth. Certainly, it is unlikely that chaotic and violent hollowed-out states will produce successful and dynamic economies.
Garett and Kane suggest that US troop presence might positively impact growth along three dimensions: improved security, the diffusion of improved technologies and institutions, and the increased aggregate demand effect of large numbers of relatively wealthy US soldiers. In fact they find that “countries hosting large numbers of U.S. troops experience large and persistent increases in their long-run growth rate.” In addition, they also show that “when a country hosts U.S. military troops, the quality of economic policy and economic institutions in that country generally improves.” The results indicate that “on average, an increase in troop levels of an order of magnitude is associated with a 0.3% higher long-term growth rate of per capita gross domestic product (GDP).”
Furthermore, these results are not simply driven by the experiences of Germany, Japan and South Korea. The authors note that
countries that ranked 11th through 20th in troop deployments (a group that includes Turkey, Iceland, and Morocco) grew twice as quickly as the fifty countries with the lowest troop deployment levels. Thus the positive unconditional correlation between troop levels and growth is not driven by a few observations.
