Archive for April 1st, 2015

The coming emerging-market debt squeeze

April 1, 2015

Andres Velasco warns about upcoming  debt squeeze in EMEs.

Consider the following scenario, one that has played out time and again in emerging-market countries. Local banks and firms go on a borrowing binge and pile up dollar-denominated debt – debt that pundits consider perfectly sustainable, as long as the local currency is strong. Suddenly, something (an increase in United States interest rates, a drop in commodity prices, a domestic political conflict) causes the local currency to drop in value against the dollar. The debt burden, measured in domestic currency, is now much higher. Some borrowers miss interest payments; others are unable to roll over principal. Financial mayhem ensues.

This is how the Latin American debt crisis of the 1980s, the Mexican Tequila crisis of 1994, the Asian debt crisis of 1997, and the Russian crisis of 1998 unfolded. It was also how the financial crisis of 2008-2009 transmitted itself to emerging markets. Every time, borrowers and lenders claimed to have learned their lesson.

Not only could it happen again today; it could happen on a much larger scale than in the past. Taking advantage of ultra-low interest rates in advanced countries, emerging-market banks and firms have been borrowing like never before. A recent paper by the Bank of International Settlements shows that since the global financial crisis, outstanding dollar credit to non-bank borrowers outside the US has risen by half, from $6 trillion to $9 trillion.

The bulk of that debt is in Asia, with China alone accounting for approximately $1 trillion. Other big dollar borrowers include Brazil (over $300 billion) and India ($125 billion). Countries such as Malaysia, South Africa, and Turkey, plus Latin America’s more financially open economies, also have rising foreign-currency debts.

This time is never different really ..


Dangers of not understanding economic concepts..

April 1, 2015

Jean Pisani Ferry writes about dangers of using potential output into economic policymaking.


Are we still paying for giving too much policy attention to monetarists?

April 1, 2015

Brad De Long takes on Friedman and his venerated monetarist ideas.

Ideas matter. That is the lesson of Hall of Mirrors, the American economist Barry Eichengreen’s chronicle of the two biggest economic crises of the past 100 years: the twentieth century’s Great Depression and the ongoing Great Recession, from which we are still struggling ineffectually to recover.

Eichengreen is my friend, teacher, and patron, and his book is to my mind the best explanation to date of why policymakers in Europe and the United States have reacted to the most dramatic economic collapse in almost four generations with half-hearted measures and half-finished interventions.

According to Eichengreen, the Great Depression and the Great Recession are related. The inadequate response to our current troubles can be traced to the triumph of the monetarist disciples of Milton Friedman over their Keynesian and Minskyite peers in describing the history of the Great Depression.

In A Monetary History of the United States, published in 1963, Friedman and Anna Jacobson Schwartz famously argued that the Great Depression was due solely and completely to the failure of the US Federal Reserve to expand the country’s monetary base and thereby keep the economy on a path of stable growth. Had there been no decline in the money stock, their argument goes, there would have been no Great Depression.

This interpretation makes a certain kind of sense, but it relies on a critical assumption. Friedman and Schwartz’s prescription would have worked only if interest rates and what economists call the “velocity of money” – the rate at which money changes hands – were largely independent of one another.

What is more likely, however, is that the drop in interest rates resulting from the interventions needed to expand the country’s supply of money would have put a brake on the velocity of money, undermining the proposed cure. In that case, ending the Great Depression would have also required the fiscal expansion called for by John Maynard Keynes and the supportive credit-market policies prescribed by Hyman Minsky.

The debate over which interventions would be needed to put a halt to something like the Great Depression should have been a simple matter of analyzing the evidence. In economic hard times, did interest rates have little impact on the velocity of money, as Friedman suggested? Was Keynes correct when he described the concept of a liquidity trap, a situation in which easing monetary policy further proves ineffective? Is the stock of money in an economy an adequate predictor of total spending, as Friedman claimed, or is the smooth functioning of credit channels a more important factor, as Minsky argued?

This has always been the problem of economics. We hype certain individuals/ideas a bit too much. There is a lot of context, situation, local knowledge and above all luck for any policy to work. And here we do not even know whether monetarism would have worked in Great Depression. But we still bought the ideas as if they have delivered.

The dominance of Friedman’s ideas at the beginning of the Great Recession has less to do with the evidence supporting them than with the fact that the science of economics is all too often tainted by politics. In this case, the contamination was so bad that policymakers were unwilling to go beyond Friedman and apply Keynesian and Minskyite policies on a large enough scale to address the problems that the Great Recession presented.

Admitting that the monetarist cure was inadequate would have required mainstream economists to swim against the neoliberal currents of our age. It would have required acknowledging that the causes of the Great Depression ran much deeper than a technocratic failure to manage the money supply properly. And doing that would have been tantamount to admitting the merits of social democracy and recognizing that the failure of markets can sometimes be a greater danger than the inefficiency of governments.

The result was a host of policies based not on evidence, but on inadequately examined ideas. And we are still paying the price for that intellectual failure today.

The price is not just paid in US but across the world. All these ideas transmit quickly to rest of the world. What did not even work in the place where it was supposed to  work is expected to work in places where it is completely ill-suited.

David Glasner says it was not even Friedman but likes of Hawtrey and Cassel which had started the monetarism ideas. Even they did not look narrowly at interest rates alone but gave a more broader perspective saying going back to gold standard in 1920s was a really bad move. Points well taken. I mean how many of us really know the works of Cassel and Hawtrey.

All these ideas keep saying one thing – know your history…

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