Wednesday, December 24, 2008

Balancing unbalances: is expanding public expenditure the answer to the slowdown and the financial crisis?

It is a major consensus among economists -along all the political spectrum- that bubbles are caused by an excess in supply of available funds for lending. Maybe it is time to look closer into those causes of the latter. One natural place to look at is China's current account surplus. Let's not forget that this implies that China must allocate great amounts of savings. Let us assume that Chinese savings are use to buy US Treasuries, the latter makes US bond's prices go up and the benchmark interest rate go down.

Thus, we have a recipe for a bubble. Going deeper, it is a pervasive cycle, though a plausible one, to conclude that increases of the US' borrowings caused evermore borrowing. It is now clear to everyone that the latter is unsustainable.

Let us look now into the proposed solutions to the current economic slowdown and financial crisis. They're founded in either tax rebates or debt increases... both policies imply a further increase of US' borrowings. It is troublesome to argue that in the long run, expanding public spending is a key element to go back to a sustained growth path.

However, there is a great difficulty to find an alternative to the latter. It is clear that the existing unbalance of US' borrowings will only grow further and that there still exists a great amount of resources available for lending, particularly in the BRIC's economies. US citicens will have to honor their debt, although the Treasury department can go along with the FED printing money, they should start thinking how to balance the capital account deficit.

Are we all Keynesians now?

As the financial crisis has developed, economic indicators weaken consistently. A recession has been declared by the NBER, surprisingly since December of 2007. But it is even more important to look at the the trend in every major indicator: it is downward. There are indeed some signs of deflation at the US, which combined with relatively high unemployment and the grim attitude toward risk in the financial sector resemble some features of the Great Depression.

Since the cure for slow growth in those nasty years is closely related to high levels of public spending, is natural to start looking in these policies for a cure to the current crisis.
It is remarkable how all policy makers and some scholars had change their attitude toward temporal public deficits, ending an "era" of fiscal discipline as the key for sustainable economic growth. Moreover, spending money is the best way to get the financial system into tough regulation, since it forces bailed out firms to follow the guidelines that the government dictates. But how exactly will this increase in public spending change the outlook of the economy? How will expectations and the attitude toward risk be affected? It seems complicated to link throwing-money-at-like solutions to a feasible stable growth path.

A higher level of public spending, as old-school keynesians ask, does not necessarily stimulates the level of employment of the economy, as professor Mankiw's post says, there is hard evidence proving that lowering the tax burden would constitute a more powerful way to make the economy grow. Furthermore, Lawrence Summers published recently an article with more details of the Obama administration spending targets. Those aim at schooling, alternative energies and infraestructure. Even though it is not detailed in how it will be financed, it is clear that no limits on debt are bounding.

So even though government's balance sheet is almost unchanged in either policy -tax cuts and debt growth- the odds that a tax cut policy work seem more effective that
throwing-money-at a problem. It allows every economic agent to make the best decisions in allocating resources. There still one problem, how can government create incentives for people to spend their "new" income?

Clearly, tax rebates should not be allocated to the unemployed, since this would create a negative incentive for them to work. This is a question to be answered soon: which tax structure poses a premium in looking for a job? Furthermore, would this tax structure lead to an increase in consumption of the employed? There is a recent paper recommended by Mankiw from the IMF on this. This is a loose end that the incoming administration will have to address to provide sustainability and reinforce credibility in the stimulus plan.

Sunday, November 2, 2008

Energy Reform in Mexico

Since March of 2008 the energy reform has been in the public agenda. Government proposed to allow private investment in refinery and transportation of oil. It pretended also to allow risk-sharing contracts in offshore exploration and oil extraction. Political opposition forced to a two-month debate in the Senate. As a result, two more proposals were sent to Congress.

As the financial crisis deepened last September, Government decided to give PEMEX independence in its investment and budget planning. This constituted the first step towards three more reforms. All those changes in the opposite direction of the official proposal. The approved reform will indeed provide PEMEX with more independence, however, it will not allow for more oil extraction, thus limiting the original purpose. It is a reform in the right direction, but it is considerably short.

Two substantial changes will privilege Mexican suppliers, although there are not many firms that can provide the machinery necessary to find oil in deep water in Mexico’s Gulf.

Yet another important figure compels to incentives for contractors to increase efficiency in their assignments, this scheme is just in the borderline of risk-sharing contracts. However, according to industry ‘s legal experts, big oil firms would not have enough incentives to participate in contract allocations for exploring.

After long debates that exposed different views over the legal boundaries of the official proposal in the risk-sharing contracts it is for certain that economic rent from oil extraction must be well defined, and that this particularly complicated task will make the difference every time the sector face a possible reform. Strictly speaking, there is economic rent only when oil is extracted, and not when oil is refined or sold as gasoline, for example. Opposition thinks different: defining economic rent as all the money oil can generate at any stage in industry.

The latter approach cannot answer a simple question: why is public sector forced to absorb every single penny oil generates, even in advanced stages?

There is no incentive for public firms to do it efficiently, clearly, there is wealth lost in the process.

Furthermore, important limits that recent reforms did not correct are that incentives for contractors to reveal information remain low. This is, since there will not be any reward for extracting oil, then PEMEX supports all the risk instead of sharing it.

This reform can be labeled as one that prevented private investment from Mexican oil, but the cost is, necessarily to have less oil available for exportations. Since oil revenues account for almost 40 percent of public expenditure, this will only make a new fiscal reform a clear urgency.

Sunday, October 26, 2008

Keynesian policies: The Mexican way

While most countries around the world are preoccupied with their financial institutions -as a strange new way of nationalism-, Mexico took, for the first time in many years, a decision of policy that resemble Keynes' prescriptions.

But in what extent are this measures really a burden on fiscal balance? How will this new expenditure can help Mexican economy to stem economic growth? Or to tam economic slowdown?

The answer to the first question is really just an accounting update. Before the latest reform of the budgetary law, debt in the form of long term commitments for infrastructure, known as PIDIREGAS, were outside fiscal balance artificially, along with a program for reestablish highway quality known as FARAC, both in the form of debt, the latter considerably smaller in GDP terms than the former, constitute the financing mechanism PEMEX and CFE -electricity public firm- had to increase the volume of their infrastructure projects.

Another account change that took place was: Public Sector Balance is composed by the sum of the government balance and the public enterprises balance, so Mexico had indeed a balance budget for the last ten years, but in the former sense. Government issued debt -among this debt PIDIREGAS- and exhibit a deficit, while public enterprises were forced to have a balance sheet with surplus thus adding up to zero.

This scheme worked while fiscal balance had to be sustained close to zero, but this year, the budgetary process lacked an exogenous source of revenue, and so, a fiscal stimulus was needed to increase government budget with respect to last year's.

The fiscal stimulus born with the reform of budget law, PEMEX was not forced to have a surplus to compensate government deficit, in exchange for its independence PEMEX should pay PIDIREGAS debt associated with oil projects. Thus 78k million pesos will be at government disposal for 2009's budget.

The second question is considerably more difficult to answer. So far 53k millions of pesos would be allocated to expand infrastructure, a plausible demand stimulus policy of short run. However, global slowdown is pulling down growth expectations everywhere. Mexico is not the exception, but, for sure, if there is a year that mexican government should push growth through short run policies, such as public spending, it is 2009.

Exceptional policy times

This are indeed exceptional times in financial history. U.S. Government put through Congress its proposal, which leaves 700 billion U.S. dollars, has not changed markets' perception of distrust.

Even though several countries in Europe have followed the U.S. with similar measures with considerable few resources, are, apparently much more focused on reestablish people's trust on financial institutions and the financial markets. This complicated environment claims for the necessity of address base scenarios, the first question to answer is: how to avoid the financial meltdown? Thus avoiding any risk of depression. Reestablish trust. As Europe attempted, although it's still the complicated task to achieve. A coordinated action could be used.

But then again, how can trust be reestablished? Sadly, putting public resources there for buying financial institutions' deposits, temporarily. Buying toxic assets is the worst investment a government can make. There wont be any market for toxic assets as their value converge to zero. Banks should continue the writing down of bad assets they bought. Sound institutions should continue to buy hurt ones. A normal market mechanism in the way to stability.

What role does monetary policy can play amid the financial crisis? A lesser every time. Efficiency of monetary policy was always sustained on the financial market's ability to quickly spread actions through future markets, swaps, warrants and an endless list of assets. However current conditions claim for outside push of institutions,regulations on market formation can make the difference.

Monetary policy eases won't help economic growth since its channels of transmission are all broken. A public spending stimulus presents as the policy action to go with. So this means that keynesian policies should be implemented to restore economic growth, with the corresponding commitment of future fiscal surpluses to restore balance.

Regulation and public spending are the policy actions in current environment. Neither means, in any way, that market mechanisms are doomed.

Sunday, September 28, 2008

Should Government bail-out the financial sector

About the $700 bn proposed by the Treasury Secretary Paulson, Mexico had its own financial bail-out in late 90's, it was called FOBAPROA -now IPAB-. In essence, the plan for the U.S. lack considerable differences with mexican's. If Congress concedes the special power to Secretary Paulson, the government would back (probably buying) the "toxic" assets from bank's balance sheet.

So, what are the lessons to be learned from IPAB? First, whether using taxpayer's money to save rich's banks is right or wrong is not worth to discuss. Consider the following argument: if the government bails-out the rich's banks it should do it in order to protect the lower income population from inflation, unemployment and financial unstability. What would happen to low income families' savings if the financial crisis spreads to regional institutions? They would probably be at risk.

Second, as long as the government provides confidence to financial sector's agents a plan could be developed to profit from current dismal. Summers' approach puts it simply in macro words: the plan is not necesarly a downfall for a number of reasons, specially, because the intertemporal sum of income for the government in the medium term can be greater or equal to zero.

Third, financial institutions, just as the FED did with AIG's bail-out, should be charged with a penalty rate for the loans they get.

Fourth, the financial sector must be restablished quickly, with tougher rules, in order to start making profits for the government and pay the loans.

Certainly, even though the sum of revenue for government in a period of time could be positive, an asymetric treatment of taxpayers needs to be addressed. Lets not forget that as interest rates increase, current consumption is more expensive relative to future consumption, thus, current taxpayers are very likely to have a budget much more constrained than future ones -this is probably the exact same effect that eplains why there was a lessening on the government's deficit in the 90's.

Fortunately, governments often can make profits from those companies that bail-out, take for example airlines. Consistently, governments must save either airlines or financial institutions. The latter has some clear characterisctics of being an industry a natural monopoly, Summers mentions Mexico's bail-out in 1995. The financial sector is clearly a very particular one. Calculation of the long term profits made -in a positive scenario- for financial assets bought are, inherently, far more complicated.

It is indeed a weak spot of the $700 bn proposal that, in case of buying toxic assets, is far from clear the value at which they should be bought. Now the government could be pushing up the value of those toxic assets, increasing in the process future taxpayer's burden. Some market mechanism could be, as recently suggested, a reverse auction.

There are, indeed, a lot of voices that prevent from using taxpayers' money for buying private assets, specially toxic ones. Zingale's approach is just as comprehensive as Summers', it privileges the use of current mechanism for bankcrupcies such as Chpater 11. However costless for taxpayers this approach, it takes far more time as stress by Chicago's professor. A positive shock in confidence is a particularly strong policy in current situation, in order to restor confidence.

Now that Congress voted against the bail-out, is hard to tell whether it was an electoral decision or a unbiased one. For certain, the delay in the bail-out package would just make it more important.

Saturday, September 6, 2008

There are no such bubbles: An extension

At the end of Salvador’s post there is a policy transmission channel that left some ends untied. Maybe central banks’ around the world are leading the way answering them.

Assuming that the link between future markets and agricultural commodities is, at most, weak, assume also that the link between future oil prices and agricultural prices is strong. A downward trend of almost every commodity since last month surprised investors dragging down yields in commodities future markets’. Gold is down by 21 percent from January’s price, corn is down 29 percent, oil 26 percent, wheat, and soy are down too.

What has happened? There is an ever growing probability that U.S. GDP will stop growing at some point this year (maybe it already has as the economic growth is to be publish for the 3rd semester) Department of Commerce calculated a 3 percent rate of growth for the second quarter just last august 28th. This among other reasons helped to finish the very slow transition of the FED’s monetary policy stand from loose to neutral (adding more weight on inflation concerns).

The European Central Bank has not languished in its rough stand against inflation over any other threat. A growing number of central banks around the world are more focused on fighting increasing inflation expectations. Banco de Mexico shifted its primary rate three times this year, from 7.5 percent to 7.75 percent on June, then to 8 percent on July and finally to the current 8.25 percent.

There is a great number of voices claiming that restrictive monetary policy will not help to stimulate aggregate demand around the world. Moreover, they preach that economies will sink since there are fundamental factors that cause high prices of agriculture commodities.

Maybe its time to start considering that central banks are, indeed, fighting inflation with restrictive monetary policies. The thing is that they are not doing so through traditional channels. Consider the following argument: as central banks are increasing interest rates and in most cases pushing up sovereign bond yields, this un-coordinated action (think of it as it were coordinated without lost of generality) is bursting the bubble component of high commodity prices.

How is this possible? Just a coordinated action among central banks could burst a global bubble, thus shifting investors' money to sovereign bonds from future markets. So, unwillingly, restrictive world monetary policy is contributing to commodity prices’ slump.

Taking Salvador’s argument. High prices in commodities do not cause grain supply increases because of the nature of technology-lacking agricultural sector in many countries, then, again, how is it possible that corn lost around 29 percent in just 6 weeks? Or that oil had lost almost 26 percent in the same period? A plausible answer is that the “coordinated” monetary policy is bursting global bubbles.

Furthermore, if “coordinated” policy remains, its possible that the next bubble to be born after commodity’s will be stopped. The only loose end thus would be that a stronger dollar, pushed by low growth expectations in Europe and Asian economies, will not temper U.S.’ trade deficit, nor will help to the biggest economy in the world to grow. There are no such bubbles, thanks to restrictive monetary policy.

Friday, September 5, 2008

Gasoline Prices

The welfare assessment that Mexican government implicitly did when it choose not to apply a more aggressive price adjustment on gasoline prices, helping the inflation forecast not to explode is luckily paying back soon. As commodity prices slump, oil has lost around 25% in just six weeks, gasoline prices in Mexico are to converge faster with those in the south border of the U.S.

A closer look to price settings in the last eight months show that Magna Gasoline, the fuel with a greater demand, increased by 4.85%. This rate is considerably lower than the inflation figure for basic goods, which the central bank reported at 6.55% in the same period.

Strictly speaking, there still exists a distortion in relative prices. What should we expect? It is possible to construct a strong case against diminishing distortions effects on prices. It is hard to deny that changes in gasoline prices cause, in a greater proportion, changes in overall prices.

This is equivalent to argue that further increases in gasoline prices will only lead to increases in basic goods’ prices. Why? Taking the recent evidence provided by the fiscal reform of September 07, where the tax burden on gasoline prices was increased, however changes were planned for start in January 08, prices in Mexico jumped in 07’s last quarter.

So, are Mexicans frightened of inflation? Is hard to prove. Yet, it is easier to contrast the slow responses in prices of average businessmen to the introduction of a new tax, the fixed rate entrepreneurial tax, IETU, with the prompt response to a future increase in gasoline prices.

Despite its name, IETU has real and monetary consequences in Mexican’s wealth, even if they are not businessmen. For starters, as any tax in the economy it reduces disposable income whether of firms or individuals. It certainly creates distortions in some prices. This particular tax, for instance, increases the price of future capital relative to current capital boosting physical investment.

A Ricardian equivalence assessment is needed to insure that this distortion exist, however in its short life it has collected revenue under the forecast figure, letting the hypothesis of a bigger investment rate unanswered.

In any case, IETU has not induced firms to raise prices, whereas future gasoline prices did. Government could include in future welfare assessments the long run compared to short run effects of taxes, whether negative or positive. IETU price distortions thus boost Mexican economy, while gasoline negative taxes were unnecessary given the one time response to future gasoline price increases.

Wednesday, August 27, 2008

Economic Distortions

A definition of economic distortion goes: an action (of the government) or situation which leads to non-optimal decisions, or that provides biased information to agents that allocate resources.

Taxes (whether negative or positive) are common economic distortions. Negative taxes are levied in Mexico on fuel. However gasoline prices around the world are rising, as a direct result of high oil prices, gasoline in Mexico is considerably cheaper than in the U.S., almost half as cheap.

Several distortions arise as a result, the worst is that the relative price for emissions of CO2 decrease, a growing environmental concern. People drive more since the relative price of driving decreases, thus, the demand for motor vehicles remains constant at best, instead of the expected decrease. There are no incentives for people to buy smaller cars, or for industries to look for alternative energies. Yet another distortion is that the government fails in one of its chief purposes: poverty and inequality of income distribution reduction.

The ministry of finance informed in an official study that 42.9 percent of the gasoline is consumed by the upper income decil. This means that a negative tax in gasoline is recieved by the wealthiest subset of population. Moreover, official projections point that by the end of 2008 this negative tax will add up to 200 thousand millions of pesos (some USD 20 billion), this is more than four fold the yearly federal budget of regional public Universities.

So, where is the rationale of this negative tax? The central bank remains quiet, clearly, because the negative tax contains not only government prices, but also overall inflation, gasoline taxes affect an important number of prices in the economy, this is, relative prices move with gasoline prices. A faster pace of gasoline price increases is to be implemented. But this is not enough to correct all relative prices that are distorted as a result of low gas prices. Take for example the relative price of exports to foreign imports, commonly know as the terms of trade. Since mexican government supplies all gasoline demanded, more than 45 percent is imported implying that any appreciation of mexican peso will be offset by the increasing demand of fuel. 

A welfare asessment such as Kehoe and Serra Puche (1991), concludes that wealth from rural population is transferred to urban population. How can the government asses whether the gains on welfare provided by a stronger peso are not enough to compensate the loss of wealth (even the implicit one of the regressive nature of the negative tax) from high energy prices?

Sunday, August 24, 2008


Como es una práctica común ya entre los economistas, aceptando que desconozco otras profesiones, este blog servirá para compartir mis puntos de vista sobre algunos temas, en su mayoría económicos, así como las ideas que surgen a partir de conversaciones con colegas y del análisis de la literatura económica.