Also known as the continuing case for agnosticism, especially when it comes to small countries. There is actually a paper on this topic (Cowen’s Second Law!), let’s look at the end part:
Currency depreciation is said to stimulate aggregate demand by increasing its net export component. On the other hand, it is said to discourage aggregate supply by increasing cost of imported inputs. The ultimate impact is ambiguous on theoretical grounds. A recent review article reveals that in developing countries, devaluation or real depreciation is indeed contractionary in the short run. In the long run, however, devaluation is neutral in most countries. Emerging economies have received no attention and we try to fill this gap in this paper.
In this paper we consider the experience of nine emerging countries of Belarus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Russia, and Slovak Republic with currency depreciation. Using the bounds testing approach to cointegration and error-correction modeling that distinguishes the short-run effects from the long-run effects, the results turn out to be country specific. In the short run we find that real depreciation is expansionary in Belarus, Latvia, Poland, and Slovak Republic; contractionary in Czech Republic, Estonia, Hungary, and Russia; and has no effect in Lithuania. In almost none of the countries, the short-run effects lasted into the long run.
A few remarks on this:
1. I have read dozens or maybe hundreds of blog discussions about the wage effects of depreciation/devaluation. I can’t recall very many on the input and portfolio effects. I can’t recall any serious assessment of which effects are more import (sorry if I have forgotten your post or didn’t read it). I also don’t see many discussions of whether observed short-run effects persist in the longer run.
2. I am not trying to push the particular conclusion of this paper on you (“Ah, now I understand where Belarus falls!”), rather I wish to indicate that the matter is not so simple as to always favor floating rates. I am myself usually in the floating rate camp, but with far more agnosticism than I usually see when this topic is tossed around these days. Furthermore the growth literature does not in general indicate that simply sticking with a fixed rate offers inferior long-run performance.
3. It is fine to argue that this 2008 paper may not apply to the conditions of 2012. That would again leave us will very little sound basis to go on for assessing 2012, as we would be asserting that the previous evidence no longer is relevant. Such an attitude should not then push us into a dogmatic point of view, one way or the other.
4. In general I worry that the literature on contractionary devaluation does not have clearly defined exogenous events, or good independent measures of how bad the economic situation is in the first place.
5. The people who actually study this topic, if I dare introduce them into this discussion, very often end up believing that country-specific factors are extremely important. This makes “Econ 101″ (or is that 306?) discussions of the topic misleading.
6. It is not the fault of any single individual, but overall I find it disconcerting, and not reflecting so favorably on the econ blogosphere, how disconnected this discussion has been from the actual literature.
7. As a good rule of thumb, any time you hear a dogmatic macroeconomic pronouncement in the econ blogosphere, or the assertion that someone else doesn’t know what he or she is talking about, the actual reality is usually far less certain than the view which is being pushed on you.
Either later today or tomorrow I will address some remarks to the latest dust-up over Iceland, but you can take this post as useful background.
I believe this is the review article that was mentioned:
http://www.economicissues.org.uk/Files/2003/203aAre%20Devalutations%20Exspansionary%20or%20Contractionary%20-%20A%20survey%20article.pdf
Titled “Are Devaluations Expansionary or Contractionary? A Survey Article”.
What? Macro is complicated, belying simple models and their “obvious” policy implications? Say it ain’t so! I’ve been reading Paul Krugman in the NYT for the past year or so, and I was under the impression that the final word on this issue had been made, but that it was being supressed by The Man.
Isn’t the entire point of monetary stimulus to change the relative prices of different goods (allowing the sticky prices to fall relative to the flexible ones)? In that case, isn’t a rise in non-labor inputs exactly what you want? Feature, not bug.
IMHO 4 and 5 are critical points generally in these discussions, Econ 101 is a good general guide but re specifics the Anna Karenina principle applies — every unhappy country is unhappy in its own particular way, and it’s well-nigh impossible to control for every confounding factor, esp. the exogenous ones. Too often it’s look like, say, looking at U.S. defense budgets, where we spent more in 1989 than in 2000 (in nominal terms, even!) without taking into account the collapse of the Soviet Union.
Macro waves a broad brush over everything, and therefore says almost nothing.
Surely, the balance of factors during devaluation — more competitive prices for exports, higher prices for imports discouraging aggregate supply — depends crucially on what is being exported. “Exporting” hotel rooms in Greece depends very little on imported goods, and the same is true for aluminum ore in Iceland.
Whenever anyone discusses this sort of economic tinkering, I try to remember that these policies are conceived by politicians with specific stakeholders in mind. Net of all the rent seeking and external costs of a political choice, I don’t believe that any of this produces unambiguous net gains for a society. These policies bring benefits mostly to the politicians themselves who perpetuate the myth that central planning is superior to market outcomes. This contributes to the malaise of spirit where most people feel that their fortunes do not belong to themselves, and that the only way to improve one’s situation is to elect the right kind of politician – one that favors them. It goes far beyond the native efficiency of any particular policy option, right to the heart of the living, breathing souls of the inhabitants.
We are discussing macro policy, not “central planning.” If you have a severe recession and revenues suddenly collapse, do you cut spending (including on the military) or borrow? Do you establish a central bank or not? Gold standard, silver standard, both or neither? When a major bank like Baring Brothers or Lehman fails, do you try to rescue its creditors?
These are questions that every industrial society over the past 200 years has had to confront and there is no avoiding them or waiving them away with catch phrases like “central planning.”
Solecism: TC: “I can’t recall any serious assessment of which effects are more import” should read: ‘I can’t recall any serious assessment of which effects have [are] more import” or “are more importANT”. Please make a note of it.
As for devaluation, it’s very difficult to control for all the variables. Look at the excellent Barron’s Guide to Economics chapter on devaluation and the myriad of parameters mentioned. So naturally it’s hard to say whether the Plaza Accord of the 80s was good or bad or neutral for the US or Japan.
Happy 4th of July!
Confucious say, devaluation is of great import.
I tend to think avoiding devaluation is the more politically difficult which then needs more cheerleading and so to more aggressive claims about how well it is working, but overall this is more about political consideration rather than economic.
“7. As a good rule of thumb, any time you hear a dogmatic macroeconomic pronouncement in the econ blogosphere, or the assertion that someone else doesn’t know what he or she is talking about, the actual reality is usually far less certain than the view which is being pushed on you.”
I can say that in three words: “macro is hand-waving”
Eschew obfuscation…
“7. As a good rule of thumb, any time you hear a dogmatic macroeconomic pronouncement in the econ blogosphere, or the assertion that someone else doesn’t know what he or she is talking about, the actual reality is usually far less certain than the view which is being pushed on you.”
too long for a bumper-sticker, but…
Was it not the situation in some of those countries that much private debt was denominated in Euro or Swiss franc, so all devaluation did was increase debt costs?
Another issue is volatility of exchange rates. It forces manufacturers to become strictly marginal value added producers; importing components from the destination market, doing some value added, then selling it back. This reduces the risk of being caught with inventory now worth 3/4 of what it was yesterday.
As for new investment, the only thing that is cheap is the labor. The equipment, anything from the buildings to the specialized manufacturing hardware, is expensive, especially high productivity equipment. It is usually imported. So you end up with easy to setup, high labor input processes requiring little in anything except space, management and inputs from the destination market country. A slight change in ratios, labor policy changes, whatever makes these operations vulnerable for the same reason that they exist. They can be moved and set up somewhere cheaper.
So if you want to compete on the world stage as a low productivity, low labor cost environment, go ahead. It better be part of a structural reform of government, labor laws, financial sector, etc., essentially giving you a few years to make the tough adjustments. Low productivity stagnation is an addictive substance for a country.
I agree with #5. You have to, at the very least, glance at the specifics of each country before drawing significant conclusions. The Graphs/Charts often begin the Analysis. I’m also wary of Chart/Graph Shopping.
Devaluation is good , Devaluation works and with a bit luck Devaluation might just save this Bankrupt ole state of ………… Yes I think overall most countries will solve their problems with Devaluation better than fixed currency wage cuts to improve productivity . Of course it will work better for some countries than others depending on the Economic strengths and weaknesses of an individual country . Why does Devaluation work better ?
Years ago I was a cox on The A team Varsity 8 man rowing boat . We were doing a head of river lengthy time trial event and our B team were also competing the same day. The rule was the faster boats would go off first so
they would not be held up trying to overtake weaker boats that had started
ahead of them . So our A boat started with the stronger boat off first competing on a beautiful stretch of water out from EnnisKillen against other similar strong A Boats . It was a hard fought river head with our A boat being just slightly behind the whole 4.5 miles the other A boats .My Oarsmen couldn’t see how well they were doing because they couldn’t see to the front the other close A boats . However they could see the B Boat doing well behind, overtaking a lot
Of other weaker boats and seeming to gain all the time . Our A boat came in wrecked and disappointed and silent . Our time was still healthily ahead of the B team and only narrowly behind the other A boats who had set off ahead of us , but we had overtaken nobody . The B team cheered when they crossed the line – the were in the inferior boat mind, meaning older and worn – they had overtaken all their similar ranked B boats and felt they had motored at top speed the whole way . They had rowed above themselves and were pleased with their time even though it didn’t beat the A team and were looking forward to the next training session and races . The A team went home in silence on the bus and spent the next few months criticising and chopping and changing . Some of the B team ultimately became mainstays on the A team as the racing season wore on . How does this explain why devaluation is better ?
The Essence of the story is this . The B team, the devalued team did way better at a Pschological level because they passed out weaker opponents but got constant feedback that they were achieving and moving in the right direction but in real terms were only slightly better off and still not better than A . Because they generated forward momentum their improvements began to increase even more until in the end they passed out many in the A boat and took their places . Devaluation works the same for most countries , like Iceland after the initial pain they got the accelerating forward momentum going again to start dramatically improving . Ireland by contrast is like the A team doing great despite the huge debt dumped on the backs of tax Payers and the high and rising unemployment only spared by the negative cycle for society and future generations of Mass Imigration . No one suffering in Austerity Ireland feels like the place is doing well or really going to recover . There doesn’t appear to be light at the end of the tunnel no matter what the politicians say . Just like A in the boat story there is too much negativity and pain around to recover . It’s taking too long and people are losing belief in a better future likely to materialise during the course of their lives . That is why it is better to go with the con trick of Devaluation it improves the confidence and background sentiment just like it did for the B Rowing team . That’s my argument for Devaluation as the better option for Recovery . Yours Sincerely , Peter Pipesmoker from Ireland .
Too often people talk about macro in general terms when you need to know country-specific issues in order to understand how interventions (such as currency devaluations) work their way through an economy. Some countries choose to devalue their currency in order to build up investment and gradually work up their way up the value-chain as part of a process that is designed to improve productivity and capital per labourer over the long run.
Others are forced into devaluation because structural factors in their economy are not conducive to growth, they choose devaluation because this way they can easily affect a huge part of business without having to go down the policy-route and get entangled in all sorts of trouble with various constituencies such as labour etc.
Devaluation can work as part of a long-term process in moving up the value-chain where countries make sure the forex-earning go towards productive imports but it can also serve as a stop-gap to prevent further bloodshed in the export/industrial sector – without leading to more real growth as it is used as a band-aid. Precisely because of devaluation some countries choose not to implement hard reforms. Periphery countries had the implicit pact within their socities that some inflation and a weak currency were exchanged for soft policy.
THis is from PK’s blog post the other day, responding to the criticism from the CFR…his usual “dogmatic pronouncements” always followed with a remark on how dumb or evil the opposing idea or person is — Tyler’s point number 7 above.
“But I was alerted to a remarkably stupid attack on me over the subject of Iceland from the Council on Foreign Relations — and I use that term advisedly.”
“In almost none of the countries, the short-run effects lasted into the long run.”
Somebody needs to engage a better editor (or possibly any editor at all). What a horrible sentence.
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