Month: November 2010

The “Dalai Lama” effect on international trade

Andreas Fuchs and Nils-Hendrik Klann report:

The Chinese government frequently threatens that meetings between its trading partners’ officials and the Dalai Lama will be met with animosity and ultimately harm trade ties with China. We run a gravity model of exports to China from 159 partner countries between 1991 and 2008 to test to which extent bilateral tensions affect trade with autocratic China. In order to account for the potential endogeneity of meetings with the Dalai Lama, the number of Tibet Support Groups and the travel pattern of the Tibetan leader are used as instruments. Our empirical results support the idea that countries officially receiving the Dalai Lama at the highest political level are punished through a reduction of their exports to China. However, this ‘Dalai Lama Effect’ is only observed for the Hu Jintao era and not for earlier periods. Furthermore, we find that this effect is mainly driven by reduced exports of machinery and transport equipment and that it disappears two years after a meeting took place.

For the pointer I thank The Browser.

*State of Emergency*

Could it be the best non-fiction book so far this year?  The author is Dominic Sandbrook and the subtitle is The Way We Were: Britain, 1970-1974, here is an excerpt:

As a spender, Joseph had only one Cabinet rival: the Education Secretary, Margaret Thatcher.  Derided as the "Milk Snatcher" in 1971 because she had to carry out Macleod's plan to scrap free school milk for children aged between 8 and 11.  Mrs Thatcher was actually a big-spending education chief who secured the funds to raise the leaving age to 16 and to invest £48 million in new buildings.  In December 1972, she even published a White Paper envisaging a massive £1 billion a year for education by 1981, with teaching staff almost doubling and vast amounts of extra cash for polytechnics and nursery schools.  She wanted "expansion, not contraction", she said.  It never happened; if it had, her reputation in the education sector might be very different.

Every page of this book has excellent analysis and information, attractively presented.  It masterfully covers a wide range of topics, ranging from how the British started drinking wine, to how the power cuts affected public morale, to the strategies of British labor unions, to the insightfulness of Fawlty Towers.  It's a key book for understanding how the Thatcher Revolution ever came to pass.

It is simply a first-rate book.  It is out only in the UK, but I was happy to pay the extra shipping charge from UK Amazon, which you too can pay here.  Or maybe try these used sellers.  Some reviews are here.

Why I assign less weight to the liquidity trap argument

A few people have been asking me about this, so here is a summary statement of some points:

1. The liquidity trap argument implies that the money-short bonds margin doesn't, at current magnitudes, matter.  I am more closely wedded to marginalism than that.  The argument also sees all the action (or should I say, non-action) in one margin, the money-bonds margin.  The money-goods margin matters too.  In the liquidity trap argument, everything is decided by one irrelevance result at a single margin in a highly complex multi-trillion dollar economy.

2. Short-term interest rates being zero, and short-term interest rates being almost zero, are very different cases, especially for understanding nominal shocks and whether they can stimulate aggregate demand.  Unless short-term rates are literally the same as the rate on cash, asset swaps still can succeed.  And QEII isn't be the same as simply switching the term maturity of the debt, as Krugman has suggested.  There will be nominal effects also.

3. Even Keynes didn't believe he had ever seen a liquidity trap, including in the Great Depression.

4. Most of the good predictions of the liquidity trap models are covered by recognizing there are lots of unemployed resources and weak business confidence.  

5. Consumer spending just rose 2.6 percent and business profits are high, yet we are in a liquidity trap?  What exactly is the story here?  "We can get spending up by 2.6 percent but not a smidgen higher"? 

6. The stock market responded positively to the announcement of QEII and the TIPS spread went negative; both are the opposite of what a liquidity trap model would predict.  Markets don't seem to think the liquidity trap idea is a very useful one and that alone creates real positive effects from monetary policy.  If markets don't believe in a liquidity trap, that's enough for the trap not to bind.

7. Monetary policy worked quite well in the Great Depression, when it was tried.  And on Japan I am persuaded by Scott Sumner.

These points are a less fundamental, but they are still relevant to the debate, if not always to the substantive issue itself:

7. There are different liquidity trap models.  For instance I often see the "short nominal rates are zero" model being confused with the more stringent "money demand is a bottomless sink" model.  It's only the latter case — clearly not true today — which generates the extreme results of liquidity trap models.  Otherwise the money-goods margin remains operative and monetary policy can succeed.

8. Some of the LT models imply upward-sloping AD curves and downward-sloping AS curves, yet I don't see anyone applying those assumptions consistently to other decisions, such as tax policy for instance.

9. If a liquidity trap is to persist beyond the short run, something must be preventing the marginal product of capital from adjusting upwards and solving the problem.  In other words, a non-short-run version of the liquidity trap has to be combined with an account of problems on the real side.

10. I see liquidity trap proponents spending a lot of time criticizing naive versions of real business cycle theory, bond market vigilante arguments, and so on.  They spend less time engaging the most serious criticisms of the liquidity trap argument.  A study of the liquidity trap literature does not raise one's confidence in the idea, though it might sound OK if the relevant alternative seems sufficiently bad.

11. Whether or not we should use fiscal policy depends on how well our government can target and mobilize unemployed resources; you don't need a liquidity trap to address that argument.

12. Ultimately I view the liquidity trap idea as a kind of shaggy dog that's been pulled out of the closet.  If it's going to be made convincing, it needs a lot more work than simply repeating that some short-term interest rates are near zero.