Tapering And What To Do About It

As always in such matters, the answer is: it depends (excerpt; emphasis added):

Should Policy Makers in Emerging Markets be Concerned about “Tapering”?

The US and European economies are showing some signs of recovery from the global financial crisis that began in 2008. As a result, the US Federal Reserve Bank is considering phasing out, or “tapering”, the extraordinary monetary policy measures through which it responded to the crisis…The World Bank's East Asia and Pacific regional update estimated that in East Asia alone $24 billion was withdrawn from equities and $35.2 billion from bonds...Financial markets largely recovered once the Fed decided to postpone tapering in September, but there is still nervousness….

Dynamics and Economic Analysis

Hands up everyone who thought that the S&P downgrade of the US would raise the Federal government’s borrowing costs. A funny thing happened on the way from theory to reality – the markets aren’t cooperating (excerpt):

Treasury yields plunge as stock markets swoon

WASHINGTON: Fears about the weakness in the U.S. economy and Europe's financial crisis caused Treasury prices to rally on Tuesday, sending long-term interest rates lower. Traders dumped stocks in search of lower-risk investments.

The yield on the 10-year Treasury note traded below 2 percent, near the lowest point on record, as strong demand for U.S. government debt boosted Treasury prices...

...Treasurys were plenty attractive on Tuesday as global stock markets fell. The Dow Jones industrial average lost as many as 307 points in morning trading, but recouped much of those losses and closed down 100 points. European markets had plunged on Monday, sending the Stoxx 600 index 4.1 percent lower. U.S. markets were closed Monday for the Labor Day holiday...

...The yield on the 10-year note was 1.97 percent at 4:30 p.m. EST, compared with 2 percent late Friday. Its price rose 12.5 cents for every $100 invested.

The yield fell as low as 1.91 percent late Monday, the lowest yield on record since the Federal Reserve Bank of St. Louis began keeping daily records in 1962.

New World Bank Publication Discusses The Future Of Economic Policy

From the World Bank blog (excerpts):

The Day After Tomorrow: Macro-Financial Policy Catches Up With Reality

The 2008–09 crisis opened the door to a different kind of thinking in international macroeconomics—and closed it on some of the previous orthodoxy. Let’s take a look at some of the most obvious cases.

First, some now see a bit of inflation (perhaps as high as 5 percent per year) as desirable for countries that pursue inflation targets, because it would allow more space to reduce nominal interest rates when an economy falls in recession. In fact, what to target (e.g., consumer, producer, asset, housing, or other prices) is the question.

Second, regulatory parameters and practices in the financial sector have proved to be more critical for real growth than we previously thought, whether through systemic risk, over-lending, costly bailouts, or other channels. Floating exchange rate regimes are falling out of favor, since “managed” ones proved to be better at controlling inflation and reducing sudden, unnecessary fluctuations. Controls on the movement of capital across boundaries have become an acceptable tool (they used to be heretical), almost the price to pay for policy success.

Third, multilateral surveillance is in the cards, initially through the G-20, since the actions of hard-hit, over indebted rich countries cause volatility in many emerging markets. But fiscal policy advice is bifurcated—between a short-term need for sustained stimulus and a medium-term need for consolidation, and between massive deficits in the developed world and the accumulation of surpluses in sovereign funds in the developing one.

From all this, a new paradigm is likely to rise…

…The bottom line is that the search for financial stability, through regulatory or macroeconomic policy, is just beginning. This is putting developing countries in a bind. Should they wait for new global standards to emerge, or should they tailor their own regulatory strategies? Stay tuned.

The Future of Economic Models

One of the key issues that has bedeviled the economics profession in the last three years has been the almost complete failure to predict the financial crisis and its contributing factors. Apart from a prescient few like White, Roubini, Shiller and Roach (among others), regulators, policymakers and pundits were caught off guard by the near collapse of an over leveraged financial sector in the Western nations, and the speed and depth of the downturn.

Part of that failure has been the poor performance of standard econometric models of both New Classical and New Keynesian varieties to adequately explain what’s going on. There’s a great critique of the current state of macro-models at the Macro Advisors Blog – well worth an investment of time, if you have some basic econometric knowledge.

An article in last week’s Economist magazine points a potential way out of this mess (quoted in full):

Lovely, Lovely Post On The State Of Macro-modelling

I stumbled on this post this morning, via The Economist magazine’s Free Exchange blog:

The Emperor has no Clothes: MA on the state of "modern" macro

Much has been made of the failure of modern macroeconomics to predict or understand the Great Recession of 2007–2009. In this MACRO FOCUS, our resident time-series econometrician, James Morley, explains what is currently meant by “modern” macroeconomics, what is behind its failure, and what can be done to rehabilitate its reputation.

This should be required reading for undergraduate and graduate economics students interested in applied work. It’s highly wonkish for everybody else (lots of jargon and math), but if you’re interested in the mechanics of macro-modelling, it’s well worth a read.

Links of the Day

Esther Duflo says we can't trust bankers:

"There is another argument, implicit or explicit, for the nationalisation of banks; we can not trust bankers not to leave with the cash, let alone spend any assistance whatsoever in the general interest. Two recent studies that analyse the experience of recent years show that they will not hesitate to enrich themselves at the expense of the public good if they have the opportunity."

Willem Buiter offers a stinging critique of modern macroeconomics:

"In both the New Classical and New Keynesian approaches to monetary theory (and to aggregative macroeconomics in general), the strongest version of the efficient markets hypothesis (EMH) was maintained. This is the hypothesis that asset prices aggregate and fully reflect all relevant fundamental information, and thus provide the proper signals for resource allocation. Even during the seventies, eighties, nineties and noughties before 2007, the manifest failure of the EMH in many key asset markets was obvious to virtually all those whose cognitive abilities had not been warped by a modern Anglo-American Ph.D. education."