Kenneth #Rogoff: The 4% non-solution @BSIndia

"it is hard to find any deep rationale for a four per cent target. At least the existing two per cent inflation target stands for something, because central bankers can portray it as the moral
equivalent of zero. "

The 4% non-solution

Kenneth Rogoff

Business Standard Opinion

For some time now, there has been concern that central bankers have "run out of bullets". Having lowered their policy rates to near zero, they have engaged in increasingly extravagant measures such as "quantitative easing" and "forward guidance".
Given the fog cast over real economic activity by the financial crisis,
it is difficult to offer a definitive assessment of just how well or
badly those measures have worked. But it is clear that there must be a
better way to do things.

There is no longer any reason to let the zero bound
on nominal interest rates continue to hamper monetary policy. A simple
and elegant solution is to phase in a switchover to a fully electronic
currency, where paying interest, positive or negative, requires only the
push of a button. And with paper money - particularly
large-denomination notes - arguably doing more harm than good, currency
modernisation is long overdue. Using an electronic currency, central banks could continue to stabilise inflation exactly as they do now. (Citigroup's chief economist, Willem Buiter, has suggested numerous ways to address the constraint of paper currency, but eliminating it is the easiest.)


A second, less elegant idea is to have central banks simply raise their
target inflation rates from today's norm of two per cent to a higher
but still moderate level of four per cent. The idea of permanently
raising inflation targets to four per cent was first proposed in an
interesting and insightful paper led by the International Monetary
Fund's chief economist, Olivier Blanchard, and has been endorsed by a number of other academics, including, most recently, Paul Krugman. Unfortunately, the problem of making a smooth and convincing transition to the new target is perhaps insurmountable.


When Mr Blanchard first proposed his idea, I was intrigued but
sceptical. Mind you, two years previously, at the outset of the
financial crisis, I suggested raising inflation to four per cent or more
for a period of a few years to deflate the debt overhang and accelerate
wage adjustment. But there is a world of difference between temporarily
raising inflation to address a crisis and unhinging long-term
expectations.

After two decades of telling the public that two
per cent inflation is nirvana, central bankers would baffle people were
they to announce that they had changed their minds - and not in some
minor way, but completely. Just recall the market's "taper tantrums" in
May 2013, when then-Fed Chairman Ben Bernanke
suggested a far more modest turn in monetary policy. People might well
ask why, if central bankers can change their long-term target from two
to four per cent, they could not later decide that it should be five or
six per cent?

Given the likelihood of a confused, mistrustful
public, it is hard to find any deep rationale for a four per cent
target. At least the existing two per cent inflation target stands for
something, because central bankers can portray it as the moral
equivalent of zero. (Most experts believe that a true welfare-based
price index would show significantly lower inflation than government
inflation statistics indicate, because official data fail to capture the
benefits of the constant flow of new goods into the economy.)

There is an analogy to the problems countries faced when they tried to re-establish the gold standard after World War I. Until the war, money was backed by gold and could be redeemed at a fixed rate. Though the system was highly vulnerable to bank runs and there was little scope for a monetary stabilisation policy, people's confidence in the system enabled it to anchor expectations.


Unfortunately, the system completely collapsed after the war broke out
in August 1914. Revenue-desperate combatants were forced to turn to
inflation finance. They could not simultaneously debase the currency and
back it with gold at a fixed rate.

After the war, as things
settled down, governments tried to return to gold, partly as a symbol of
a return to normalcy. But the revived inter-war gold standard
ultimately fell apart, in no small part because it was impossible to
rebuild public trust. A move by central banks to a long-term four per
cent inflation target risks triggering the same dynamic.


Fortunately, there is a much better way. Moving to an electronic
government currency would not require a destabilising change in the
inflation target. Minor technical issues could easily be ironed out. For
example, ordinary citizens could be allowed zero-interest-transactions
balances (up to a limit). Presumably, nominal interest rates would move
into negative territory only in response to a deep deflationary crisis.


But when such a crisis does occur, central banks could power out of it
far more quickly than is possible today. And, as I have argued
elsewhere, governments have long been penny-wise and pound-foolish to
provide large-denomination notes, given that a large share is used in
the underground economy and to finance illegal activities. Moving to a
21st-century currency system would make it far simpler to move to a
21st-century central banking regime as well.



Read the article online here:  Kenneth Rogoff: The 4% non-solution | Business Standard Opinion

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China’s Cities Digging Up Mountains of Debt - NYTimes.com

Building Boom in China Stirs Fears of Debt OverloadJuly 6, 2011

By DAVID BARBOZA

WUHAN, China — In the seven years it will take New York City to build a two-mile leg of its long-awaited Second Avenue subway line, this city of nine million people in central China plans to complete an entirely new subway system, with nearly 140 miles of track.

And the Wuhan Metro is only one piece of a $120 billion municipal master plan that includes two new airport terminals, a new financial district, a cultural district and a riverfront promenade with an office tower half again as high as the Empire State Building.

The construction frenzy cloaks Wuhan, China’s ninth-largest city, in a continual dust cloud, despite fleets of water trucks constantly spraying the streets. No wonder the local Communist party secretary, recently promoted from mayor, is known as “Mr. Digging Around the City.”

The plans for Wuhan, a provincial capital about 425 miles west of Shanghai, might seem extravagant. But they are not unusual. Dozens of other Chinese cities are racing to complete infrastructure projects just as expensive and ambitious, or more so, as they play their roles in this nation’s celebrated economic miracle.

In the last few years, cities’ efforts have helped government infrastructure and real estate spending surpass foreign trade as the biggest contributor to China’s growth. Subways and skyscrapers, in other words, are replacing exports of furniture and iPhones as the symbols of this nation’s prowess.

But there are growing signs that China’s long-running economic boom could be undermined by these building binges, which are financed through heavy borrowing by local governments and clever accounting that masks the true size of the debt.

The danger, experts say, is that China’s municipal governments could already be sitting on huge mountains of hidden debt — a lurking liability that threatens to stunt the nation’s economic growth for years or even decades to come. Just last week China’s national auditor, who reports to the cabinet, warned of the perils of local government borrowing. And on Tuesday the Beijing office of Moody’s Investors Service issued a report saying the national auditor might have understated Chinese banks’ actual risks from loans to local governments.

Because Chinese growth has been one of the few steady engines in the global economy in recent years, any significant slowdown in this country would have international repercussions.

As municipal projects play out across China, spending on so-called fixed-asset investment — a crucial measure of building that is heavily weighted toward government and real estate projects — is now equal to nearly 70 percent of the nation’s gross domestic product. It is a ratio that no other large nation has approached in modern times.

Even Japan, at the peak of its building boom in the 1980s, reached only about 35 percent, and the figure has hovered around 20 percent for decades in the United States.

China’s high number helps explain its meteoric material rise. But it could also signal a dangerous dependence on government infrastructure spending.

Venezuelan Inflation: Structural or Self-Generated?

Seems pretty clear, but for some reason they just can't get their heads around the fact the inflation is simply a monetary phenomenon, as uncle Milton used to say….

an excellent piece from The Devil's Excrement

Venezuelan Inflation: Structural or Self-Generated?

The Devil's Excrement

March 24, 2011

We were told by Minister of Planning and Finance Giordani, who has been in this Government over ten of the last twelve years, that Venezuela's inflation problem was "structural" and in the never changing strategy of blaming the "previous" Government for everything, he accused the IVth. Republic of this problem. I guess twelve years is not enough in his mind to solve this problem, ignoring the fact that in those twelve years, the most insidious influence on inflation, that of the world, almost magically vanished, with most countries not only having single digit CPI's, but many in the low single digits.
As a famous true and real economist said, inflation is simply a monetary phenomenon. Such a simple concept that is so poorly understood in inflationary and populism-ruled countries like ours. You see, if this were not true, Governments could just spend and make everyone rich. Life would be as simple as Chavez and Giordani want it to be.
But money does not imply wealth. Money is how we exchange things. We went from barter to money, to create a neutral way of transacting. In the beginning of commerce, you had one good and exchanged it for another or for a service. Too many mangoes on the trees and nobody wanted to give you anything for a mango, too much supply. By the end of mango season, you could probably get a lot for it, not enough supply and probably some demand.
But I digress…
If the Government "creates" too much money, without the underlying productivity or supply of goods and services increasing, the money will lose value, there will be inflation and it will be worth less. So, that is what Central bBank's are supposed to do, try to fine tune the amount of money to balance it out with the supply of goods and services.
Thus, if you want to see why there is inflation, you have to look first at monetary liquidity, the so called M2, which measures all of the money available out in an economy. This number is supposed to be made public weekly by the Venezuelan Central Bank under "Agregados Monetarios" here. Lately, there is some delay to have this number published, but more ominously we no longer see its components, it has been over a year since we can see what is increasing faster in all the parts of M2. I will not bore you with the technicalities.
When you look at M2 since Hugo Chavez became President, the picture is quite scary at first and at second sight, as seen in the plot below:

As you can see, since Chavez became President and Giordani Minister of Planning (He has been in the Board of the Central Bank ever since he was named the first time in 2001 or 2002) M2 has gone from Bs. 8.9 billion to Bs. 302 billion. That is an increase of a factor of 33! Or there is 3,200% more money floating around in the Venezuelan economy, than there was when Chavez became President. (This is all Bolivares Fuertes BTW)
Clearly, someone has not been doing their fine tuning job and to call it a "structural" problem is cynical at best and as we will see, simply an outright lie.
Because in the graph above you can see that for at least the first three or four years of the Chavez Government, the growth in M2 was slower than it became at around 2003-2004.
But when a number changes so much in time and at such different rates, it is better to change the scale of M2 to a logarithmic scale. Why? Because with a log scale, all changes of say a factor of ten are the same. If a variable goes up from 1 to 10, it will look the same as when it goes from ten to one hundred, a ten fold increase. The changes look the same, not like in the above curve, where the change from Bs. 10 billion to Bs. 100 billion can barely be discerned and it is the largest and fastest in the plot.
In a logarithmic scale, M2 looks like this:

You can see in the above graph that there are three very different periods in this plot. First, there is one slope from 1998 to 2002, then from 2002 to about 2007, M2 grows much faster and then it slows down to something that looks more like the first stage, even if with a higher slope.
Basically, in the first stage M2 increased by about 66% in four years, in the second one, it increased by about 666% in five years and in the latest one, it has increased by 162% in four years.
These are really bad, awful numbers, simply because the Venezuelan economy has not grown at a comparable rate during any of this periods. In fact, the increase in M2 during the first four years is larger than the growth of the economy in all of the twelve years of Hugo Chavez. Certainly this means that inflation is induced by this mismanagement of monetary liquidity, there is simply too much money chasing basically the same goods.
There is nothing structural about this, it is structurally unstable to allow M2 to grow this way, except there are elections, of course.
Even worse, all of this money has almost the same backing in foreign currency than it did in 1998. In 1998, when Chavez came to power, there were almost US$ 18 billion in international reserves, today there are US$ 26 billion, barely a 44% increase when the number of Bolivars has changed by a factor of 3200%. This says that when Chavez got to power, there was a half a Bolivar per US$ in reserves (roughly), while today there are eleven Bs. for each dollar in international reserves. Oh yeah! Modern economists believe in "fiat currencies" . But that concept stops working in the face of such irresponsible economic policies. People stop believing in the "fiat" part, they tell their Governments: "Show me the money!" In Venezuela, there has been little "fiat" since 1982.

And the reason reserves are so low, is that some Chavista economists created the concept of "excess reserves", allowing Chavez to withdraw every year some billions of dollars so that he can spend this as petty cash and without control. We are talking about US$ 64 billion so far removed from reserves. If they were at the Central Bank, inflation would be lower as that bank would have a cushion to control M2, imports, capital flight, etc. as needed. To date, it has so little room for maneuver, so much that it even carries those US$64 billion in its balance sheet (most of them have been spent!), to avoid showing that it is bankrupt. But that is another story.
Finally, if you look at month to month inflation, you can see why the "structural" argument holds no water:

Between when Chavez took over and Dec. 2001, twelve month inflation was actually going down! This happened for two reasons: M2 was being controlled and extra income from oil was being saved in the Economic Stabilization Fund (FIEM). But then, oil went down, and none other than Jorge Giordani decided it was time to use the FIEM, which was drawn down very fast. So fast, that in February 2002, Chavez had to allow the "devaluation" of the currency, which up to that point was only allowed to trade within some bands set by the Government. It was a "light" form of exchange controls, and as expected, it failed to work.
After that, the one to one correspondence between inflation in time and M2 breaks down because of exchange and price controls. Initially, M2 was allowed to increase like crazy, all those bolivars were chasing dollars and inflation jumped up as the currency and devaluation expectations devalued sharply the currency in a country with so many imports. Then in January 2003, the Government began to totally control the exchange rate, introduced price controls, all of which drove inflation down for a while.
Why?
Because at the beginning the Government became very stingy with its dollars, refused to allow price increases and like exchange and price controls everywhere, there is an initial positive effect, but it always breaks down. Markets are like that!
Holding the currency constant delays inflation adjustments. That is why inflation first went down and even as the Government reduced the increase in M2 in 2007, inflation has not gone down, because prices and the exchange rate were held back by artificial controls.
But in 2006, the increase in M2 was so large that all the positive effects of controls disappeared and inflation began to grow. And the Government decided to not allow M2 to increase as fast, but inflation did not go down.
Why?
Because it did not allow for devaluations, holding back the currency, subsidizing everything and eventually, even that became unsustainable. Thus, even though M2 has not increased as fast, inflation is at the same levels because the Government has to adjust prices and the currency periodically when things get really tough.
Now, that is really structural!
It is built into the absurd system of controls that Giordani, who is not an economist, has built around this Government. And as long as the controls are in place, inflation will not go down for the simple reason that there will be periodic devaluations, periodic price adjustments (This week it was wheat and bread) and the risk of higher inflation is probably higher than that of lower inflation.
Thus, it is all self-generated and is becoming structural, but by structures that were not in place twelve years ago. This is not a chicken and an egg problem. Giordani laid the egg and Chavez allowed him to do it and out of it came this weird chicken who nobody can control.
And if nothing is done, which will be the case as long as Giordani is where he is, inflation, the worst tax on the poor, as the cartoon shows, will remain as high as it is today, if not worse.

       
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Venezuela Inflation reading Island Canuck inflation Index closes at 59.7% in 2010

Venezuela Inflation reading via The Devils Excrement:

Island Canuck inflation Index closes at 59.7% in 2010The MasterBlog

Island Canuck inflation Index closes at 59.7% in 2010 moctavio | January 23, 2011 at 9:26 am | Categories: Uncategorized | URL: http://wp.me/ppwPU-35e

Our friend and reader Island Canuck sent me a while back his final numbers for inflation in 2010. Recall that at the end of June the expat sent us his numbers and inflation was running at a 30% clip for the first half of the year. Well, despite the fact that there was no devaluation in the second half of 2010, his food and beverage index essentially doubled in 2010 as you can see in the table below. Note that most vegetables had triple digit increases in the year (They are mostly produced locally). Note also that things that are not available had small increases. Any insights by readers are welcome.

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