Wednesday, September 25, 2013

Quartz: Emerging markets need to stop focusing on their exchange rates

Here's a link to my 3rd Quartz article on how much of the emerging market sell-off was about monetary policy failures in the emerging markets themselves. In particular, by trying to maintain exchange rate policies, central banks in these countries overexpose themselves to foreign economic conditions. The highly positive response to the recent delay of taper serves as further evidence that many of these emerging economies need better ways of insulating themselves from foreign monetary shocks. Much of the work, draws on blog posts from Lars Christensen. His examples comparing monetary policy in Australia and South Africa versus policy in Brazil and Indonesia were particularly helpful. A few excerpts:

The sell-off in emerging markets is not an omen of a prolonged economic contraction. Although capital flows were also turbulent after the 2008 financial crisis, growth in emerging markets continued. Nor is this a sign of financial crisis. “One thing most people seem to agree on is that this is not a replay of the late 1990s,” writes Ryan Avent in the Economist. A combination of exchange rate flexibility and low external debt means that emerging markets are unlikely to experience the same level of carnage as was seen in the 1997. Rather, the sell-off is a statement about how monetary policy has been unable to stabilize output in emerging markets and the importance of monetary reform. 
...Since all capital controls eventually leak, emerging markets can commit to stabilizing either the exchange rate or domestic output—not both. Economists Joshua Aizenman, Menzie Chinn, and Hiro Ito (pdf) have shown that this tradeoff is real. In the 1972 to 2006 time period, “Greater monetary independence [was] associated with lower output volatility while greater exchange rate stability [implied] greater output volatility.” 
Between these two options, the answer should be clear. Central banks in emerging markets need to focus on domestic output, and not the exchange rate.

Tuesday, September 10, 2013

Some Noahpinion Posts: Gold, Macro, and Bubbles

I just wanted to remind my readers that I am spending this fall guest blogging at Noahpinion, and so far I have three posts up. 

First, I have one on the determinants of the value of gold. A key excerpt:
Gold glitters, but from an investment perspective it does little else. It is backed by neither cash flows (like stocks are) nor a value at maturity (like bonds are). It's just a metal that, historically, has always been highly valued: a value that exists beyond its role in jewelry or in industry. 
So what gives? Broadly speaking, when people make a bull case for gold, they tend to talk about two catalysts. First, they argue that because central banks are engaging in expansionary monetary policy, this will lead to massive levels of inflation that will drive gold prices higher. Second, they argue that gold is valuable because it acts like a panic button and serves as insurance against crisis. These in fact, were the primary motivators behind Paulson's famous bet on gold. In this post, I hope to show that the theory underlying (1) is flat out wrong, and that the logic behind (2) does not correspond to the actual challenging facing the world right now.
Second, I had a post on an elementary outline of general equilibrium theory as it applies to macro. I particularly enjoyed writing the post because I had the chance to play around with drawings to illustrate the theory. In the post, I argue:
Any macroeconomy can be broken down into two main markets: a real market for current goods and services, and a financial market for claims on future goods and services. For brevity, I will reduce the model for financial assets to the market for money, which, because of money's role as a store of value and medium of exchange, captures the notion of "claims on goods". To simplify further, I take all the markets for goods and reduce them down to one composite market, say, for apples. From this caricature, we can start thinking about how markets fit together.
Third, I had a post arguing that there is little evidence for a current bubble in stock prices. I think this was the weakest of the three posts, but I took a look at both forward and backwards PE ratios and concluded that the evidence did not smell of a crisis.
Without a doubt, QE has been an incredible boon for financial markets. Backed by QE3, the SP500 stock index has risen by more than 12% year to date. Yet in spite of this increase in the stock market, overall real economic conditions remain relatively stagnant. Year over year inflation as measured by the core PCE price index ticks in at only 1.2% YoY, and last quarter's real GDP grew by only 1.4% YoY. This disconnect is a bit unsettling, because it suggests that bullishness in the stock market has failed to translate into broader growth. On this basis, some commentators, such as Frances Coppola, have argued that quantitative easing does nothing for the broader economy and worsens economic inequalities. But this concern can be reduced to an even simpler question: Has recent stock market growth just been a bubble?