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November 14, 2009

Economist's View - 3 new articles

"The Ghost in the Recovery Machine"

Robert Shiller:

The ghost in the recovery machine, by Robert J Shiller, Commentary, Project Syndicate: The International Monetary Fund's October World Economic Outlook proclaimed that, "Strong public policies have fostered a rebound of industrial production, world trade, and retail sales". The IMF, along with many national leaders, seem ready to give full credit to these policies for engineering what might be the end of the global economic recession.
National leaders and international organisations do deserve substantial credit... But one also suspects that world leaders have been too quick to claim so much credit for their policies. After all, recessions generally tend to come to an end on their own, even before there were government stabilisation policies. ...
Economic theorists long ago developed models that describe how recessions end on their own. ... Some of these factors, rather than just the actions taken by governments and multilateral organisations, plausibly played a role in the current economic improvement. Unpredictable human psychology also plays a role. Such factors, indeed, matter very much for the economic outlook, and for judging the success of the recovery programme.
One can start with the stock-market turnaround since March of this year, which has been stunning. ... Moreover, this same sharp turnaround occurred in many countries – and for many assets, including oil prices, gold, and, in some countries, residential real estate.
Any solid understanding of the causes of this turnaround is likely to prove elusive. ... A market boom, once started, can continue for a while as a sort of social epidemic, and can foster inspiring "new era" stories that are spread by news media and word of mouth. The stories themselves help magnify the boom, becoming part of the feedback that sustains it.
The agreements reached at recent G-20 meetings stand as one of these stories, for they suggest a new era of international co-operation and economic professionalism – a narrative that has probably been exaggerated in the psychology of recovery.
The G-20 story is particularly salient in the developing world, for the international recognition that the G-20's expanded role has given to developing countries is highly resonant psychologically.
Beyond that, stories of highly profitable banks paying huge bonuses to their executives have also inspired people to think that things are not so bad in the business world. Anger at these profits and bonuses only tends to increase the contagion of the story.
But any such speculative boom is inherently unstable... It was, in fact, an excessive speculative boom in the stock market and the housing market that got us into this financial mess in the first place.
To be sure, governments and multilateral institutions made some reasonable attempts to restore confidence. But they did not "engineer" a recovery. They got lucky, and the G-20, as well as the governments that instituted stimulus packages, are currently in a honeymoon period of apparent success.
Where our still-ailing world economy goes from here is as uncertain as the speculative markets that played such an important role in both the financial crisis and the recovery. We can only wish that formulating economic policy were as clear-cut as, say, mechanical engineering. It is not: a host of poorly understood natural cyclical factors play a role, and so do the vagaries of human psychology.

He may not want to give much credit to policy, but I would not have wanted to go through this crisis without the aggressive monetary and fiscal policy measures that policymakers put into place (and given the state of the labor market, even more was and is needed).

"The Illusion of Improving Global Imbalances"

Richard Baldwin and Daria Taglioni warn that the recent improvement in trade balances brought about by the recession is likely to be temporary since the underlying forces generating global imbalances are still present, and " the recovery of trade flows – a recovery that seems to have started this summer – will almost surely return the US, Germany, China and others to their old paths."

Remember all the talk before the crisis about whether we'll have a hard landing or a soft landing when global imbalances unwind? That's still an important question, and the fact that we cannot rule out a hard landing (with the accompanying rise in interest rates, rise in inflation, fall of the dollar, and a recession) means we will need find a way to reduce these pressures without triggering another crisis A key factor will be how the US manages the budget deficit in the future (which is definitely not a call to begin balancing the budget now, that's a task for better times). If the recent increase in US savings rates persists, that will help as well:

The illusion of improving global imbalances, by Richard Baldwin and Daria Taglioni, Vox EU: They are blamed for the global crisis directly (Paulson 2008) or indirectly (Calvo 2009), G20 leaders are committed to ending them, and commentators have generated an ocean of html painting them as one of the world's greatest banes. "They" are global imbalances – large trade surpluses and large trade deficits.
Good news then – global imbalances have been shrinking at a fabulous rate (Figure 1). The figure – which includes China, Germany, the US and all the other usual suspects in the global-imbalances saga – shows that trade gaps have closed remarkably quickly since late 2008. ...
This rapid improvement seems odd given how little reform has occurred. The renminbi has not appreciated against the dollar and Chinese consumption has not boomed; the dollar has depreciated modestly against European currencies and the US savings rate has risen gently, but neither seems large enough to account for the massive shifts already observed, to say nothing of the World Bank predictions for future improvements.
We argue here that these global imbalance improvements are mostly illusory – the transitory side effect of the greatest trade collapse the world has ever seen. Before making the argument, we lay out the basic facts.
The trade collapse
Since late 2008, global trade flows collapsed in a historically unprecedented manner (Figure 2...). As the figure shows, global trade has suffered large blows on three previous occasions in the post-war period but this one is substantially larger.
The old "Quad" (EU, US, Japan, and Canada) plus China account for over 60% of world trade. They all saw their exports and imports plummet dramatically, as did the other nations listed in Figure 3. (These 11 nations account for three-quarters of world trade.) Each of these trade flows dropped by more than 20% from 2008Q2 to 2009Q2.
With the recession at hand, a trade drop is unsurprising; what shocks is its magnitude. Freund (2009) averaged the world GDP and trade drops for four large recessions (1975, 1982, 1991, and 2001) and found that the trade drop was 4.8 times larger than the GDP drop. This time, global quarter-on-quarter GDP growth was negative in the fourth quarter of 2008 and first quarter of 2009, but over the period of the great trade collapse (2008Q2 to 2009 Q2) IMF data shows world GDP actually rising by 1.5% while global trade dropped about 15%.
Economists around the world have been working hard to understand the causes of this unusually large trade shut down. The findings of over 20 studies will be summarised by the researchers in a e-book The Great Trade Collapse: Causes, consequences and prospects to be released 27 November 2009 (in time for the WTO Ministerial). The emerging consensus is that this is mostly a demand-side phenomenon with two distinct but mutually reinforcing channels of transmission:
  • Commodity prices collapsed with world demand sending the value and volume of commodities trade diving by double digits (food, fuels and raw materials make up a quarter of global trade).
The basic facts are clear from Figure 4; 2007 and 2008 saw a rapid rise in food and fuel prices that collapsed in the summer of 2008 – well before the Lehman's debacle.
  • Supply-chain manufacturing collapsed as the Lehman's-induced shock-and-awe caused consumers and firms to wait and see; private demand for all manner of 'postpone-able' consumption crashed.
The manufactures trade drop was amplified many times over by "compositional" and "synchronicity" effects. ...
Looking forward
Taking as read that the great trade collapse was primarily driven by a sudden, synchronised and severe drop in demand, it is clear that trade will recover as demand recovers. Indeed, trade is already bouncing back at a fairly spectacular rate. While the bounce is impressive, it is not unexpected. Indeed all the post-war trade collapses have been followed by very rapid recoveries in trade flows, as Figure 5 shows. The chart plots the three major trade collapses highlighted above. In the 1982 and 2001 episodes, trade returned to its pre-crisis level in two or three quarters after the nadir; the 1975 crisis took four quarters.
Using the mean of these historical adjustment paths, we can guess the future evolution of world trade in the next few quarters. If 2009Q2 turns out to be the nadir – as the monthly data suggests – world trade should be back to its 2008Q2 level by 2010Q1 or Q2. ...
Concluding remarks
Do global imbalances matter? Is their continued existence driving the world economy towards another global crisis? These are questions on which macroeconomists have not yet formed a consensus. The IMF and World Bank have calmed the waters by projecting reductions in the imbalances of the world's largest trading nations – especially China and the US.
This column points out that these projections of improving imbalances are almost surely wrong. The rapid collapse of trade between the third quarter of 2008 and the first quarter of 2009 improved most balances of trade. It could not have done otherwise; if both imports and exports drop rapidly, the gap between them drops equally rapidly. In the same mechanistic manner, the recovery of trade flows – a recovery that seems to have started this summer – will almost surely return the US, Germany, China and others to their old paths. ...

links for 2009-11-13

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