Transcript Risks in the Global Economy

Risks in the Global Economy
Finn E. Kydland
University of California
Santa Barbara
ASSAL 2012
San Jose, Costa Rica
• Outline of Theme
Predictability of economies varies
considerably across nations or regions
of the world. Major reasons:
1. Growth-promoting decisions, such as
capital formation, innovation, including
development of new products and
production processes, are forwardlooking and require a view of the
future policy environment
2. Finding from economic theory: optimal
government policy is inconsistent over time.
Examples of bad implications in practice:
a) Consistently poor policy is being
pursued in that nation
b) Apparent good policy is being pursued,
but there is considerable uncertainty as
to whether this policy will change in the
future, with adverse implications for the
investment environment, currently and in
the future
A deep understanding of the interaction
of points 1 and 2 above will aid one in
forming expectations about the future,
depending upon the region or nation
within that region.
Talk about Latin America, the United
States, Canada, the EU and Euro Zone
(also touching upon Norway, not a
member), China, Kazakhstan, Azerbaijan,
and Sub-Saharan Africa
Real
GDP
per
capita
Real GDP per capita
• Elementary background
Aggregate production function
GDPt = ZtF(Kt,Lt)
Technology for converting inputs of capital
and labour into output of goods and services
• Main driving force for economic growth:
Innovation and technological change
(Z in the production function).
They lead to future productivity growth.
• But, to take advantage of technological change:
Need investment in new capital, physical
(structures and equipment) and human
Government policy may be a crucial
factor, positive or negative, for growth
Examples:
Argentina in 1990s and early 2000s (negative)
Ireland in 1990s and early 2000s (positive)
• Examples of policy
(theme: significant stimulus for the economy?)
Fiscal policy: Stimulus through
temporary tax rebates – little effect on
consumer spending (and investment)
Stimulus spending? Infrastructure,
education, research, if future productivity
improves significantly, can justify the
additional debt to pay for it. Otherwise, may
be a bad idea, especially for a nation with
budget problems.
• Perspective from theory of a benevolent
government:
Suppose the government has an unchanging
objective, say, to maximize some measure of
the present value of citizens’ welfare over time
Theoretical implication:
The resulting optimal government policy is
inconsistent over time; it requires a
commitment mechanism in order to be
implemented. Otherwise, there’s a strong
temptation to change policy in the future.
Rules rather than Discretion.
• Where is that temptation theoretically the greatest?
Increase tax on physical and human capital
(especially relevant in the current situation
with large and growing debt/GDP ratios)
Partially renege (default) on government
debt, say, through surprise inflation
Examples of mechanisms used in
practice by governments to tie their
own hands (not always successfully!)
(i) Gold Standard
(ii) Currency Board
(iii) Independent Central Banks
• Commitment mechanisms (cont’d)
These examples apply to monetary
policy. Not obvious how to commit to
good fiscal policy.
• Probable main explanation
Time-inconsistency “disease” due to
past hyperinflations, devaluations,
deposit freezes and defaults on
government obligations, resulting in
lack of credibility among investors
Real
GDP
per
capita
Real GDP per capita
Real
GDP
per
capita
Real GDP per capita
So far, no evidence that the “new trend” is moving
any closer the old
If anything, it’s diverging, with recent growth rates
lower than the average for the 1947-2007
trend
Growth rate of real GDP so far in 2012 under 2%.
Last reported, for July-Sept., 2%.
• But, as the example of China demonstrates:
Consistent policy not sufficient
• Summary Remarks
Significant risks exist for the continuation
of low growth in many important nations
Major cause: Uncertainty about future
government policy
We need ways to avoid the “timeinconsistency disease”
Designing policy for the Longer Run
much more important than short run
Enough uncertainty in the world as is;
extra government uncertainty is bad
Opportunity for nations with credibility
to narrow gap to the high-income-percapita countries
• Copenhagen Consensus Center’s
Consulta de San Jose
Question: If Latin America were willing to spend,
say, $10 billion more over the next five years on
improving welfare, which projects would have
the greatest benefits (benefit/cost ratios)?
Areas: democracy; education; employment/
social security; environment; fiscal problems;
health, infrastructure; poverty/inequality;
public administration and institutions;
crime and violence
Copenhagen Consensus Priorities
for Latin America
1) Early childhood development programs
2) Fiscal rules
3) Increased investment in infrastructure,
including maintenance
4) Policy and program evaluation agencies
5) Conditional cash transfer programs
• Interesting proposed solution
Increase the level of political party
and party system institutionalization