National leaders are meeting at the United Nations in New York today, to discuss the climate change negotiations. Talks will continue at the G-20 meeting in Pittsburgh later in the week. But hopes look very bleak for progress sufficient to produce at Copenhagen in December a successor treaty to the Kyoto Protocol. The biggest roadblock is the familiar game of “After you, Alphonse.” The United States will not accept quantitative emission targets unless China, India and other developing countries do the same, at the same time. But the developing countries will not cut their emissions below the Business as Usual path (BAU) unless the rich countries go first.
In the past I have developed my own proposal for how to break the deadlock, a politically realistic plan to assign emission targets in ways that leaves no country feeling it is being asked to incur an economic cost that is unfair or too large. The targets are derived from a family of formulas The specific detailed example of the plan that I have given in the past attained an environmental target by the year 2100 of CO2 concentrations equal to 500 ppm. It did so without violating the political constraints, which included that no country is asked to accept an ex ante target that costs it more than 1% of income in present value, or more than 5% of income in any single budget period.
The G-7 leaders, meeting in Italy in June 2009, set a more aggressive collective goal, corresponding approximately to concentrations of 380 PPM. I have been trying to hit that goal, working with Valentina Bosetti, within the same political constraints and framework of formulas. To achieve the more aggressive environmental goal, we advance the dates at which some countries are asked to begin cutting below BAU. We also tinker with the values for the parameters in the formulas (parameters that govern the extent of progressivity and equity, and the speed with which latecomers must eventually catch up). The resulting target paths for emissions are run through the WITCH model to find their economic and environmental effects. We found that it is not possible to attain the 380 ppm goal, subject strictly to our political constraints. We were however, able to attain a concentration goal of 460 ppm with somewhat looser political constraints than 500.
Some may conclude from these results that the more aggressive environmental goals are not attainable in practice, and that our earlier proposal for how to attain 500ppm is the better plan. We take no position on which environmental goal is best overall. Rather, we submit that, whatever the goal, our approach will give targets that are more practical economically and politically than approaches that have been proposed by others.
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The field of International Monetary Economics is not without its own cycles and fads.
In a speech at the European Central Bank over the summer, “On Global Currencies,” I identified eight concepts that I saw as having recently “peaked” and eight more that I saw as newly rising in relevance. Those that I viewed as losing traction were: the G-7, global savings glut, corners hypothesis, proliferating currency unions, inflation targeting (narrowly defined), exorbitant privilege, Bretton Woods II, and currency manipulation. Those that I saw as receiving increased emphasis now and in the future were: the G-20, the IMF, SDR, credit cycle, reserves, intermediate exchange rate regimes, commodity currencies, and multiple international currency system.
A condensed version appears this month in Finance and Development, from the IMF, titled “What’s ‘In’ and What’s ‘Out’ in Global Money.” I boil the list down to five concepts that I pronounce “on the way out” and five more that I see as replacing them:
- The G-7 has been rendered largely obsolete by its lack of representation of developing countries, and thus in the course of 2009 has been overtaken by the G-20.
- The corners hypothesis had become conventional wisdom by the end of the 1990s. This was the idea that all countries were or should be abandoning intermediate exchange rate regimes (bands, baskets, crawling pegs, adjustable pegs, and heavily managed floats) in favor of either the floating corner or the institutionally fixed corner (currency boards, dollarization, or monetary union). Since 2001 the tide has turned against the corners hypothesis, and far fewer economists would now assert it as a sweeping generalization. Certainly a huge fraction of the members of the IMF continue to follow intermediate regimes.
- The language of “unfair currency manipulation,” has been in US law since 1988 and the IMF Articles of Agreement for longer. China during the years 2004-2008 was pretty much the first large country to face charges of unfairly manipulating its currency to keep it undervalued. But US Congressmen who have for years urged China to abandon its link to the dollar could well live to regret it, if they were to get their way and the People’s Bank of China did in fact stop buying US treasury bills. It is finally beginning to sink in among Americans that having China as its largest creditor carries with it some new constraints. What concept is “on its way in,” to replace the idea that intervening to prevent one’s currency from appreciating is anathema? Reserves. Two short years ago, Western economists were lecturing surplus countries that they were acquiring too many reserves. Today we see that the developing countries that have weathered the 2007-09 crisis the best are countries that had previously piled up the most reserves, other things equal.
- Most controversially, I assert that Inflation Targeting — narrowly defined, I hasten to add — has seen its best days. The definition of IT I have in mind is the proposition that the monetary authorities should set a target range for the increase in the CPI each year, and then should focus all their efforts on hitting it. This orthodoxy says that the central bankers should pay no attention to asset prices, the exchange rate, or commodity prices, except to the extent that they carry implications for the CPI. For large rich countries, it has become clear since 2007 that Alan Greenspan was wrong when he (plausibly) abjured all attempts to identify or discourage bubbles in real estate and stock markets. As a result, the credit cycle view of monetary policy has been resurrected , after a long period when only inflation was thought to matter. For smaller and developing countries, I would also argue that volatility in commodity prices has made it clear that monetary policy should let currencies depreciate, at least somewhat, when the terms of trade worsen, rather than the opposite as is implied by a strict interpretation of CPI targeting. For them, I would propose replacing the CPI target with a more production-oriented price index, such as a target for the PPI or even an export price index.
- The United States has benefited throughout the post-war period by an unlimited ability to borrow in dollars. A popular view two years ago, supported by some of the best scholars, was that the US had earned the dollar privilege by establishing a unique comparative advantage in supplying a saving-glut world with high-quality assets. Then the sub-prime mortgage crisis in 2007 revealed that US assets were not so high-quality after all. The dollar did retain the benefit of being the safe haven currency in 2008, as an exorbitant privilege — contrary to the predictions of those of us who had predicted that the unsustainable current account deficit would lead to a large depreciation. Nevertheless, some developments in the course of 2009 have suggested a global movement away from the unipolar dollar standard, and toward a new multiple international reserve system. These events include the gradual rise of the euro as an international currency to rival the dollar, the sudden and unexpected resurrection of the SDR from near-death, new interest in the yen and gold as safe haven assets (including among central banks), and the very first glimmerings of an international role for the RMB.
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The Queen of England during the summer asked economists why no one had predicted the credit crunch and recession. Paul Krugman points out that, inasmuch as economists can almost never predict the timing of recessions (and don’t claim to be able to), the real questions are worse. The real questions are, rather how macroeconomists (most of us) could have gotten it so wrong as to believe that:
- a severe recession like this was not even looming ahead as a danger, and
- a breakdown of many of the world’s most liquid financial markets, in New York and London, was not possible.
To anyone wondering about these questions, I recommend Krugman’s essay in the New York Times Sunday magazine, September 6: “How Did Economists Get it So Wrong?”.
I would only add that he is modest in skipping over one point: during Japan’s lost decade of growth in the 1990s Paul forcefully drew from the Japanese experience the implication that a severe economic breakdown was, after all, possible in a modern industrialized economy — a breakdown that both was reminiscent of the Great Depression and was outside the ken of modern macroeconomic theory. But macroeconomics went on as before. (Likewise with the stock market correction of 1987, the LTCM crisis of 1998, and the dotcom bust of 2000-01. I do think, however, that our field did a better job with the emerging market crises of 1994-2001, in part because it was considered permissible to argue that financial markets in this case were highly imperfect.)
Even the cartoons in the NYT article are good… except that I have never seen Olivier Blanchard in a double-breasted suit. But Robert Lucas definitely merits a place there: when given one page to defend orthodox economists regarding the crisis in a recent Economist essay, he actually thought it was a useful rebuttal to point out that critics are repeating arguments they have made before. And he also thought it was useful to explain: “The term ‘efficient’ as used here means that individuals use information in their own private interest. It has nothing to do with socially desirable pricing; people often confuse the two.” — as if it is not the latter question that the public is wondering about.
(For other economists’ reactions to the Krugman piece, see the National Journal site.)