Here the link:
"The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist."
The General theory of employment, interest and money (1935)
Well, this time it's the Dutch who are criticizing ECB policy. More specifically, Knot who is head of the Dutch Central Bank calls for a more or less immediate end of the ECB's program of Quantitative Easing, never mind that the Eurozone has experienced over the last decade the largest economic downturn since the Great Depression. More recently, however, Eurozone growth has finally picked up again, not thanks to fiscal policy makers who more or less idly stood by while millions of people became unemployed, but rather because the ECB provided some desperately needed stimulus in the aftermath of the crisis. The ECB switched its gear under the brace leadership of Mario Draghi without whom the Eurozone might very well have blown up a couple of years ago when countries in Southern Europe suddenly faced a combination of a sudden stop (short run capital outflows) as well as an attack by bond market vigilantes. While real GDP growth has been quite spectacular with more than 2% on an annual basis, economies in Southern Europe are still relatively depressed with unemployment rates still at extremely elevated levels. Moreover, the ECB's mandate of price stability is defined as an inflation rate of close to 2%. Well, even though the ECB has undershot its own official inflation target for many years in a row now, some people still seem to be desperate to end its program of monetary easing, very often alluding to some risks of asset price inflation and an overheating economy. After years of stagnation, would a hot labor market and rising wages be a such a bad thing? Obviously not! How about the risk that continuously undershooting the inflation target will unanchor inflation expectations to the downside. Moreover, low inflation rates will automatically produce low nominal interest rates, meaning that the ECB had very little room to manoeuver if the Eurozone is hit by another adverse shock. Doing more now would bring about a normalization of interest rates at a quicker pace than a premature tightening of monetary conditions. Given record high unemployment in Southern Europe, low inflation across the Eurozone, and extremely timid wage increases I see absolutely now reason why the ECB should step on the brakes now.
Here the link:
Q4 2017 U.S. GDP growth came in at about 2.6%, thus significantly lower than what the Nowcast estimates of the regional Federal Reserves suggested (with the Atlanta model suggesting 3.4% growth, NY Fed model suggesting 3.9% growth), thus showing again how volatile and difficult it is to estimate quarterly GDP figures.
This somewhat disappointing growth figure, disappointing in the sense that it came in lower than consensus estimates, implies that annual GDP growth for the U.S. in 2017 was about 2.6%, which makes the last year one of the strongest performances since the Gobal Financial Crisis of 2008/2009.
In terms of my "model", the new numbers now suggest the following forecast:
quarterly GDP growth = 0.18 * NY model + 0.7 * Atlanta model
The model of the New York Fed has been less successful in predicting quarterly GDP growth, thus giving it a much smaller weight than the Atlanta mode. The regression coefficient for NY is actually not statistically significant at the 10% level. This however, is more likely the result of insufficient data. Since the model was only introduced in spring 2017, we only have 9 observations of data (nine quarters) for which we can evaluate the models' accuracy.
U.S. GDP growth has accelerated last year amidst a global economic recovery that is also taken place in Europe and in emerging market. Consequently, global economic growth has been reaching 4% again for the first time ever since the financial crisis. U.S. GDP growth figures for the 4th quarter of 2017 will be released by the BEA tomorrow. I have written before how several branches of the U.S. Federal Reserve, most notable the Atlanta Fed and the New York Fed, are now using so-called Nowcast model to estimate actual GDP growth figures with current economic data as the quarter goes along. The Atlanta Fed is predicting growth of 3.4% for Q4 2017 while the New York Fed is predicting even stronger growth of about 3.94%.
Based on previous forecasts, I did a quick and dirty regression and estimated that the "best forecast" is a weighted average of the two models with weights of 66% and 25%, respectively. This would lead to the following estimate:
0.78 * 3.4% + 0.2 * 3.94% = 3.45%
So my regression predicts a slightly higher growth rate than the Atlanta model, which has proven to be a relatively accurate forecast methodology for quarterly GDP figures, which are historically quite volatile. U.S. GDP growth has been extremely robust so far last year with the following quarterly growth rates:
Q4: 3.5% ?
Note that this would lead to an annual real growth rate of about 2.8%. This would be the second strongest years since the financial crisis:
By the way, I am on record saying that the chance of above 2.5% growth for the U.S. for the 2017 is below 5% (with the chance of growth coming in at 2 to 2.5% at about 20%). Not a great prediction! However, I was not alone there as many other institutions, including the IMF and quite a few Central Banks recently had to raise their forecasts for last year as well.
I was counting on growth being roughly similar to the previous years, with average growth rates in the decade after the financial crisis barely reaching 2%. The "secular stagnation outcome" that was revived as an idea by Lawrence Summers a few years ago.
This only shows how macroeconomic forecasts are notoriously difficult. Past performance is does not always seem to be a good predictor of the future.
Here are two factors I have not been counting on. First, there is currently a global economy on its way. Even the severely depressed Eurozone has been experiencing very high growth rates over the last 2 to 3 years. A rising tide lifts all boats!
Second, while the Trump tax cut is mainly a gift to the rich and super rich, it will boost the economy's growth rate in the very short run. However, this will by far not be enough to make the tax cut self-financing as many conservatives have claimed. Self-financing supply side tax cuts are a zombie idea that should have died a long time... But you know how it is with zombies, they'll always come back from the dead.
Just something that went through my mind while listening to Justin Yifu Lin yesterday, former chief economist of the World Bank, who gave a talk here at Lund University about the Chinese economy. Over the last few decades the world has seen unprecedented progress with hundreds of millions of people being lifted out of poverty, especially in South-East Asia (unfortunately Africa has not been a success story for the most part). Here China's growth rates of above 10% since the early 1990s have been totally unprecedented. Of course China started as an extremely poor country. However, thanks to its extremely high growth rates China can now be classified as a middle-income country as it has been catching up with the West in recent decades. Globalization has been a huge benefit for a large part of the global population, especially many low-income countries have made much progress.
Thanks to rapid growth rates, especially in China, global inequality has actually decreased over the last few years. At the same time, however, within-county inequality has also increased a lot. This phenomenon is especially pronounced in the Anglo-Saxon economies where the top income shares are taking on an increasing share of the pie. We see a similar trend across all advanced economies as well as developing countries like China (see the world wealth and income database for the fantastic data, link below).
While from a global welfare point of view we should care much more about the decline in global inequality, it is simply a matter of fact that humans tend to care much more about their relative status compared to their neighbors, what is commonly called "keeping up with the Joneses". There is even a popular movie with Charles Duchovny about this phenomenon. While advanced economies have also benefited from globalization, the gains have been very unevenly distributed with workers at the very bottom of the income distribution losing out. This surely contributed to the recent rise in populism across advanced economies, including Brexit and the election of Trump. While the backlash against globalization is very real, the reality of the matter is that protectionist and inward-looking policies are not going to solve any of the important issues at hand. To the contrary, beggar-thy-neighbor policies were tried in the 1930s and only worsened the global economic downturn. Similarly, Trump's protectionist policies will not benefit American workers and will only come at the expanse of the American economy.
Raising tariffs will only hurt American consumers and are unlikely to give American firms an edge.
Here the link:
Income share of the top 10%
Note the U-shaped pattern, which is pretty much global phenomenon, with top income shares falling in the years after World War II and rising steeply in recent decades to approach levels we have not seen since the beginning of the 20th century.
Some thoughts on the Chinese economy, inspired by a lecture that former chief economist of the World Bank Justin Yifu Lin gave today at Lund University. The topic of the talk was the Chinese economy.
We know that economists cannot forecast recessions, which in itself is not very astonishing. Similarly, engineers cannot predict the collapse of a bridge and doctors cannot predict sickness. Economists are much better at conditional forecasts. During the financial crisis of 2008/2009, many economists warned that much greater fiscal stimulus and monetary policy accommodation was needed to prevent a severe downturn from happening. Unfortunately, those warnings were shrugged off and policy makers repeated to a some extent the mistakes that were made during the Great Depression, thus leading to a prolonged period of economic stagnation and a rise of populism across advanced economies, a repeat of the 1930s if you will (It probably didn’t help either that within the economics profession a small but quite influential group proclaimed that fiscal stimulus cannot increase aggregate demand or that prolonged monetary stimulus would lead to hyperinflation, two fallacies that should have died a long time ago with Keynes’ General Theory).
More recently, economic historians have found that the best predictor of a coming financial crisis and economic recession is a large run-up in debt combined with elevated asset prices, either stocks or real estate. More specifically, private sector debt seems to matter more than public debt. The financial crisis in the U.S. and in the Eurozone, for example, was preceded by large increases in mortgage to GDP ratios and rapidly rising house prices, see below (the run-up in private debt was actually much more impressive in the UK than in the U.S.).
Real house prices and private sector loans to GDP ratio in the U.S. and the UK
Source: Òscar Jordà, Moritz Schularick, and Alan M. Taylor. 2017. “Macrofinancial History and the New Business Cycle Facts.
In the case of China, the country has experienced a large sunup in private sector debt over the last year with the debt to GDP ratio exceeding 250% (see graph below). Moreover, house prices have rapidly inflated at the same time.
While growth rates in the early 2000s have averaged above 10%, the country has slowed down in recent years with growth now averaging 6-7% after the Global Financial Crisis. However, this slowdown was to be expected as China’s GDP per capita rises. The country’s capacity for catch-up growth reduces as the country becomes more wealthy, thus leading to an eventual slowdown. Moreover, China’s demographics are quite unfavourable, partly a result of the one-child policy. With population growth slowing down and eventually reaching a negative, potential GDP growth is also reduced. Finally, the country has had extremely high investment rates in recent years, up to a point that many economists have started to worry about malinvestment. While high investment rates can lead to transitory growth, eventually diminishing returns will kick in. This is true both for private investment as well as for public investment (infrastructure, housing, etc.).
The big question is whether China will be able to manage a smooth transition from an unsustainable growth model with too high investment rates to a growth model that focuses to a bigger extent on domestic consumption. More recently, many economists as well as a number of financial market participants have turned extremely bearish on China, by which I mean that they were betting on an eventual economic crisis and financial collapse. During the years 2015-2017, those bets looked increasingly appealing as GDP growth slowed. Moreover, private debt increased at a higher rate. Meanwhile, the country lost about a fourth of its 4 trillion reserves over a time period of little more than a year as the Chinese were trying to defend their currency peg against the dollar, thus preventing the currency from rapidly depreciating amidst the economic slowdown. However, over the last year pressures against the currency have eased, the level of foreign reserves and private debt levels have stabilized. Moreover, many hedge funds have lost a considerable amount of money by betting against China’s macroeconomy. Being a China bear has not paid off in recent years!
While the transition from 10% growth in the early 2000s to about 6-7% growth nowadays has occurred more smoothly than anticipated, there is a question on how well the country will manage the transition to a slower growth regime. Modernisation theory, a theory that relates economic development with democratisation, has not panned out so far in the case of China. Justin Yifu Lin thinks that the country has still a lot of room for catch-up growth, given that its income per capita is barely a fifth of that of the U.S. However, the country will soon enough experience negative population growth, which should translate into a lower GDP growth rates. I’m a little bit sceptical on China’s ability to grow at above 6% over the next two decades and think that a growth rate in between 4-5% might be more realistic (given that the country does not experience a financial collapse). However, regardless on how strong the ultimate decline in potential growth will be, what matters much more is whether the country will be able to manage the transition in a smooth way. This is indeed the trillion dollar question (given the size of the Chinese economy). Furthermore, it will be of enormous importance whether the country will eventually move towards a democratic system. With the exception of the resource rich gulf states and Singapore, every rich country in the world is a Western- style democracy. This begs the question whether the China can continue to make progress being an authoritarian regime.
For now though, being bearish on China is a losing bet. Furthermore, with about 3 trillion in foreign reserves as well as a relatively low public debt to GDP ratio, the country has definitely the resources and the firepower to prevent any financial crisis from becoming a full-blown economic meltdown. In that sense, being an authoritarian regime might actually be of help, at least in the short-run, because any emergency measures can be quickly directed from above without going through lengthy parliamentary procedures.
My name is Julius Probst.