Friday, May 6, 2016

Global Imbalances

I gave some comments on “Global Imbalances and Currency Wars at the ZLB,” by Ricardo J. Caballero, Emmanuel Farhi, and Pierre-Olivier Gourinchas at the conference, “International Monetary Stability: Past, Present and Future”, Hoover Institution, May 5 2016. My comments are here, the paper is here 

The paper is a very clever and detailed model of "Global Imbalances," "Safe asset shortages" and the zero bound. A country's inability to "produce safe assets" spills, at the zero bound, across to output fluctuations around the world. I disagree with just about everything, and outline an alternative world view.

A quick overview:

Why are interest rates so low? Pierre-Olivier & Co.: countries can't  “produce safe stores of value”
This is entirely a financial friction. Real investment opportunities are unchanged. Economies can’t “produce” enough pieces of paper. Me: Productivity is low, so marginal product of capital is low.

Why is growth so low? Pierre-Olivier: The Zero Lower Bound is a "tipping point." Above the ZLB, things are fine. Below ZLB, the extra saving from above drives output gaps. It's all gaps, demand. Me: Productivity is low, interest rates are low, so output and output growth are low.

Data: I Don't see a big change in dynamics at and before the ZLB. If anything, things are more stable now that central banks are stuck at zero. Too slow, but stable.  Gaps and unemployment are down. It's not "demand" anymore.


Exchange rates. Pierre-Olivier  "indeterminacy when at the ZLB” induces extra volatility. Central banks can try to "coordinate expectations." Me: FTPL gives determinacy, but volatility in exchange rates. There is no big difference at the ZLB.

Safe asset Shortages. Pierre-Olivier: driven by a large mass of infinitely risk averse agents. Risk premia are therefore just as high as in the crisis. Me: Risk premia seem low. And doesn't everyone complain about "reach for yield" and low risk premia?

Observation. These ingredients are plausible about fall 2008. But that's nearly 8 years ago! At some point we have to get past financial crisis theory to not-enough-growth theory.

But, finally, praise. This is a great paper. It clearly articulates a world view, and you can look at the assumptions and mechanisms and decide if you think they make sense. I am in awe that Pierre-Olivier & Co. were able to make a coherent model of these buzzwords.

But great theory is great theory. To a critic, the assumptions are necessary as well as sufficient. I  read it as a brilliant negative paper, almost a parody: Here are the extreme assumptions that it takes to justify all the policy blather about "savings gluts" "global imbalances" "safe asset shortages" and so on. To me, it shows just how empty the idea is, that our policy-makers understand any of this stuff at a scientific, empirically-tested level, and should take strong actions to offset the supposed problems these buzzwords allude to.

I hope this taste gets you to read  my comments and the paper. 



5 comments:

  1. That is a really good observation about low risk premia. Many of the people commenting on global imbalances are not really asset pricing guys. I wonder however if asset pricing theories (like FTPL) can really address questions of determinacy when they don't consider the quantity of money. What makes rupees different than dollars?

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  2. There is growth - it is just that a lot of it is happening in the third world resulting in contraction of some existing businesses in the developed world.

    The lack of safe assets explanation is nonsense. The problem is two fold: first problem is that many industries, particularly in the West, need declining amounts of capital; the second problem is that global savers want to accumulate more capital than the economy actually needs, pushing the risk free real rate to zero and below, and creating a shortfall in demand. If the surplus capital went into building roads or buying machines it would be fine but that capital is trying to go into financial assets which are a very indirect way of creating additional demand (it creates some additional demand through the wealth effect).

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  3. Seems that periods of sustained strong demand generate productivity improvements. This makes sense as not only does the demand validate capital outlays but overhead per unit costs drop.
    The 1990s saw this pattern and federal surpluses.
    The trends in productivity are long-term, sinking and rising.
    Curiously, at the AEI claims are made that federal R&D spending has driven productivity improvements (DoD).
    In conclusion, who knows?

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  4. Seems that periods of sustained strong demand generate productivity improvements. This makes sense as not only does the demand validate capital outlays but overhead per unit costs drop.
    The 1990s saw this pattern and federal surpluses.
    The trends in productivity are long-term, sinking and rising.
    Curiously, at the AEI claims are made that federal R&D spending has driven productivity improvements (DoD).
    In conclusion, who knows?

    ReplyDelete
  5. I disagree about your comment that risk premia are low during the recovery from the crisis. As a practitioner, my view is that this era has been characterized by valuations where anything that is readily investible trades "rich", but new and/or different assets and asset classes have unusually large risk-premia attached to them.

    There's a whole industry of modern day asset managers that would rather simply chase valuations to ridiculous levels rather than spend the intellectual energy to research new assets and invest in them. A lot has to do with the rent-seeking element that comes from managers acting as AUM gatherers for fat fees rather than actually seeking out the best returns for their clients.

    In closing, my comment on your comment would be that you are also guilty of the sin of pinning everything on "low marginal productivity", which is not a settled argument once measurement considerations are taken into account.

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