Economics

Financial Markets

  • Monetary Policy
    Global Monetary Policy Tracker
    CFR’s Global Monetary Policy Tracker compiles data from 54 countries around the world to highlight significant global trends in monetary policy. Who is tightening policy? Who is loosening policy? And what is the policy stance of the world as a whole?
    Report by Benn Steil March 13, 2017 Greenberg Center for Geoeconomic Studies
  • Monetary Policy
    Does Korea Operate A De Facto Target Zone?
    Fred Bergsten of the Peterson Institute has long argued for target zones around the major exchange rates. In the past twenty years, no G-3 economy has followed Bergsten’s policy advice.* The world’s biggest advanced economies have wanted to maintain monetary policy independence, and—Japan perhaps excepted, at least during certain periods—they haven’t viewed foreign exchange intervention as an independent policy tool. China formally has a band around its daily fix, but its exchange rate is still more of a peg (now a basket peg, without any obvious directional crawl over the last 7 months) than anything else. I though increasingly think that Korea’s exchange rate management could be described as a target zone of sorts. It buys dollars and sells won when it thinks the won is too strong (recently, too strong has been less than 1100 won per dollar). And it sells dollars and buys won when it thinks the won is too weak (recently too weak has been above 1200 won per dollar). As a result, Korea intervened heavily to cap won strength in q3 2016. Counting the change in its forward position, government deposits, and government purchases of foreign debt securities, its total foreign exchange purchases in q3 were roughly $12 billion (about 3.5 percent of GDP).** It then turned around and sold dollars to limit won weakness in q4 2016. Using the same metric, total sales reached $8 billion, or around 2.5 percent of GDP (counting the change in the forward book is important here). And it presumably stayed mostly on the sidelines in January, as the won moved within Korea’s zone of intervention (the Koreans also have been hinting that they may need to intervene a bit less to stay off Trump’s radar. See Christine Kim of Reuters. Worth watching.) Korea’s target zone isn’t declared. It has to be inferred from watching the levels where Korea intervenes. And the level where the Koreans intervene has shifted over time. For most of the post-crisis period, they intervened at 1050 against the dollar—and briefly they allowed the won to appreciate all the way to 1000 before intervening. But over the past couple of years Korea’s intervention to limit won appreciation has typically come at around the 1100 mark.*** And this raises an important question for both the IMF and the U.S. Treasury in their exchange rate surveillance. Does the exchange rate where intervention occurs matter, or just the amount? Korea’s total intervention over the last 12 months—even with my adjustments for forwards and the debt purchases by the government—hasn’t been significant. After q4, the government on net looks to have sold about $5 billion over the course of the year. It on net bought in the second half of 2016. But its net buying in the second hold of the year certainly doesn’t cross the 2 percent of GDP thresh-hold the U.S. Treasury set out a year ago. But looking only at total intervention over the course of a turbulent year, in my view, also misses a lot of the story. Korea bought and sold, buying a bit more than 3 percent of GDP (annualized) in q3. But its buying and selling in my view raises the question of whether it is buying and selling at the right levels. And given Korea’s ongoing trade and current account surpluses, I would argue the answer to that question is still "no." * Edited after posting. Fred Bergsten has indicated the post-Louvre reference rates were a target zone of sorts. I confess that I wasn’t thinking back to the 1980s when I wrote this. ** I have left out the National Pension Service’s ongoing purchases of foreign equities, which totals—based on the balance of payments data—around $12 billion (roughly 1 percent of GDP). That ongoing flow certainly raises Korea’s current account surplus (it is financed out of tax withholdings, as the social security system takes in far more in contributions than it pays out) and structurally weakens the won. But it isn’t classically considered intervention. *** Before the summer of 2014, Korea typically intervened at the 1050 mark. It briefly allowed the won to rise toward 1000 in the summer of 2014. But after the dollar strengthened in late 2014, Korea has not allowed the won to rise above 1075 on a sustained basis.
    Blog Post by Brad W. Setser February 8, 2017 Follow the Money
  • Financial Markets
    The Price of U.S. Imports From China Keeps Falling
    The way trade is to be taxed at the border may—or may not—be about to change radically. But rather than speculate on the nature of the new world, I wanted to highlight one feature of the old. I sometimes hear that China is loosing trade competitiveness because of rising domestic costs. And thus Chinese manufacturing firms need to move out of their ancestral homeland, either to low cost manufacturers like Vietnam or even to advanced economies like the U.S., in order to remain competitive. I do not see it in the data. At least not in aggregate -- the stories of individual sectors of course could differ. . If the price of imports from China (as reported by the U.S. Department of Labor) is compared to the price of U.S. made finished goods and the price of domestic manufactures, Chinese goods not only look very competitive, but broadly speaking have been gaining in price competitiveness against U.S. made goods ever since the yuan stopped appreciating—and with the yuan depreciation of the past year, are poised to become even more competitive. China maybe has lost a little of its previous edge over Canada and Europe thanks to the depreciation of the Canadian dollar and the euro over the past couple of years. But broadly speaking, the price of goods imported from China is back to where it was in 2004 (when the data series starts) while price of manufactured goods from the United States wealthier trading partners has gone up since then. There is one potentially significant problem with the U.S. data here. About a quarter of U.S. imports from China are computers and cell phones. And getting the right "price" for goods marked by rapid technological change over time is hard. I suspect that the gap over time between the evolution of Chinese prices and U.S. finished goods prices would be smaller if computers and consumer electronics were removed. In fact, I would be thrilled if the BLS put out such a series. The area of real overlap between the U.S. and China increasingly is in the production of machined parts and capital goods (suggestions for how best to capture this most welcome, the right measure of U.S. prices might not be final goods excluding food and energy). Setting that caveat aside though, I do not doubt that the basic story in the U.S. import price data is true: Over the past couple of years, the combination of U.S. workers and U.S. industrial robots has been loosing price competitiveness to the combination of Chinese workers and Chinese industrial robots. And—building on points made by both Eichengreen and Krugman—it isn’t hard to see that the U.S. has gained in price competitiveness during periods of dollar weakness, and lost price competitiveness during periods of dollar strength. The data here is for import prices, but it reflects prices for all manufactures. 2007 was a very good year for U.S. exports for example. 2015 and 2016, by contrast, were not.
    Blog Post by Brad W. Setser January 27, 2017 Follow the Money
  • Financial Markets
    Mini Mac Trumps the Big Mac
    The “law of one price” holds that identical goods should trade for the same price in an efficient market.  But how well does it actually hold internationally? The Economist magazine’s famous Big Mac Index uses the price of McDonald’s Big Macs around the world, expressed in a common currency (U.S. dollars), to measure the extent to which various currencies are over- or under-valued. The Big Mac is a global product, identical across borders, which makes it an interesting one for this purpose. var divElement = document.getElementById('viz1494265926379'); var vizElement = divElement.getElementsByTagName('object')[0]; vizElement.style.width='604px';vizElement.style.height='539px'; var scriptElement = document.createElement('script'); scriptElement.src = 'https://public.tableau.com/javascripts/api/viz_v1.js'; vizElement.parentNode.insertBefore(scriptElement, vizElement);     Big Macs travel badly, however.  Flows of burgers across borders won’t align their prices. So in 2013 we created our own Mini Mac Index that compares the price of iPad minis across countries. Minis are a global product that, unlike Big Macs, can move quickly and cheaply around the world.  As explained in the video below, this helps equalize prices.   As shown in the graphic at the top, the Mini Mac Index suggests that the law of one price holds far better than does the Big Mac Index. Both indexes currently show the dollar overvalued against most currencies.  But the Big Mac Index puts the average overvaluation at 27 percent—a Whopper. Our Mini Mac Index puts it at only 3 percent—Small Fries. The Mini Mac Index also suggests that the dollar has become less overvalued (down from 7 percent) since July. This is despite a 4½ percent rise in the trade-weighted value of the dollar since Trump’s election.  An increase in the local price of iPad minis in over three-quarters of the countries in our sample offset the impact of a more expensive dollar.  This is what we would expect when the law of one price is at work. The Mexican peso has taken a pounding since the election.  This is not surprising, given Trump’s pledges to impose import tariffs, re-open NAFTA, and build a wall.  The peso is now 16 percent undervalued according to the Mini Mac Index, up from 9 percent in July.  But the Russian ruble, which has benefited from Trump’s suggestions that sanctions would be cut and relations improved, is now 18 percent overvalued—double what it was in July.  Both currencies should be volatile in the coming months as Trump’s actual policies take form.
    Blog Post by Benn Steil and Emma Smith January 19, 2017 Geo-Graphics
  • China
    China’s Exorbitant Detriment, Mirror Image of America’s Exorbitant Privilege, Is Costing It Dearly
       
    Blog Post by Benn Steil and Emma Smith January 10, 2017 Geo-Graphics
  • Financial Markets
    Appreciate the Disaggregated Dollar
    The broad dollar is now up well over 20 percent since the end of 2012. The vast bulk of the move occurred in the last two and a half years. The dollar has essentially reversed its 2006 to 2013 period of sustained dollar weakness (tied to the weakness of the U.S. economy, the size of the U.S. trade deficit, and the Fed’s willingness to act to ease U.S. monetary conditions at a time when the ECB was stubbornly resistant to monetary easing). And in some sense we have already seen some of the results play out. U.S. export growth has slowed (though U.S. import growth has remained fairly subdued, particularly in 2016—moderating the impact of net trade on output) China decided that it couldn’t continue to manage its currency primarily against the dollar, but only after (essentially) following the dollar up in 2014. The transition though to a basket peg—if that is what managing with reference to a basket means—hasn’t been clean. After the 2014 appreciation, it seems China wanted to use the transition to a new regime to bring the yuan down a bit against the basket. One big question is whether China thinks the 10 percent depreciation against the basket that it carried out over the past year and a half is enough. Many, but not all, oil exporters that maintained heavily managed currencies against the dollar let their currencies depreciate. Saudi Arabia is of course the most important exception. And—illustrating the impact of the reserves that were accumulated by most emerging economies over the last decade plus—the big dollar appreciation has yet to trigger a major emerging market default. Brazil and Russia have both weathered large depreciations and recessions without default. One particularity of the United States is that two of its closest trading partners—Canada and Mexico—are both major oil producers and large exporters of manufactures. The value of both the Mexican peso and the Canadian dollar both really matter for U.S. trade, and both are to a degree influenced by the price of oil. The following graph, prepared by Cole Frank of the Council on Foreign Relations, disaggregates the contribution of different currencies to the move in the trade-weighted (nominal) dollar. The G3 currencies (dollar, euro, and yen) naturally tend to attract a lot of attention. Especially with the euro approaching parity against the dollar. But, I at least, find it useful to remind myself how much Mexico, Canada, and China matter for the broad dollar index (and thus U.S. trade). Given that China and emerging Asian currencies that tend to ultimately move in a somewhat correlated way with China are about 30 percent of the trade-weighted dollar index, it seems obvious that the U.S. would face a significant real shock if the move in China’s currency ends up matching the moves in some other key currencies over the last four years. China has a bigger weight in the index than either Mexico or Canada, and China and the other emerging Asian economies combined have a somewhat larger weight than Mexico and Canada combined. Yet so far China’s contribution to the overall dollar move has been modest.
    Blog Post by Brad W. Setser December 20, 2016 Follow the Money
  • United States
    Is the Emerging Market Currency Plunge Really About Trade?
       
    Blog Post by Benn Steil and Emma Smith December 12, 2016 Geo-Graphics
  • Sub-Saharan Africa
    S&P Leaves South Africa’s Bond Rating Unchanged
    Standard & Poor (S&P), the international credit rating agency, left its assessment of South Africa’s foreign-currency debt unchanged. It remains at the same level as Italy’s and India’s. However, it did lower South Africa’s local-currency rating, which remains above “junk.” On the S&P news, the South African currency, the Rand, rose 1.6 percent against the U.S. dollar, and yields of rand-denominated government bonds fell nine basis points to 9.02 percent. S&P warned that Zuma government interference in economic reform could damage investor confidence, affect exchange rates, and lead to a future downgrade: “Political events have distracted from, growth-enhancing reforms, while low GDP growth continues to affect South Africa’s economic and fiscal performance and overall debt stock.” Within the governing African National Congress (ANC), there is a struggle over the successor to Jacob Zuma, who must step down as party leader by December 2017, and the future direction the party will take. The party has been roiled by credible charges of corruption involving the Gupta brothers, confidants of the president. An S&P downgrade of South African debt to “junk” status had been widely anticipated, and such a move could have provided the occasion and excuse for President Jacob Zuma to reshuffle his cabinet and remove the highly regarded Finance Minister Pravin Gordhan. Gordhan is usually numbered with those ministers that are seeking Zuma’s ouster by the party, the most recent failed effort being within the ANC National Executive Committee on December 3 and 4. The S&P move is probably contrary to Zuma’s goal of restoring his power within the party and strengthens the hand of the “reformers” within the cabinet. Nevertheless, Zuma as president retains the power to remove Gordhan, though should he do so the markets would react badly.
    Blog Post by John Campbell December 6, 2016 Africa in Transition
  • Development
    Five Questions on Innovative Finance With Georgia Levenson Keohane
    This post features a conversation with Georgia Levenson Keohane, executive director of the Pershing Square Foundation, adjunct professor of social enterprise at Columbia Business School, and author of Capital and the Common Good: How Innovative Finance is Tackling the World’s Most Urgent Problems. She talks about what innovative finance means and how it works, addressing its successes and limitations in putting private and public capital to work for the common good.   1) Can you explain what innovative finance is (and what it is not) and how you came to work on it? Innovative finance is about creative ways to finance and pay for unmet needs and public goods—about integrating government, financial, and philanthropic resources to invest in solutions to global challenges and promote inclusive, shared prosperity. It is not the same as “financial innovation”—feats of engingeering designed to improve market efficiency, but not always a valuable end in themselves (as we saw in the 2008 financal crisis). Instead innovative finance, by design, is intended to solve problems, overcome market and political failures, and meet the needs of the poor and underserved. The innovation often comes in a new application, pressing time-tested tools like lending, insurance, and credit enhancements into the service of global health, financial inclusion, disaster relief, and battling climate change. Which is to say, virtual currencies, speed trading, subprime mortgages, or even payday lending might be considered financial innovation. Micro agriculture insurance for poor farmers, low income loans or equity for higher education, pay-as-you-go financing for solar electricity in Kenya, or discounted Metro Cards in New York City are innovative finance. In the fall of 2012, I had just finished a book on social entrepreneurship and public-private partnerships, when Hurricane Sandy hit—and I started to consider innovation in a different light. Sandy’s surging waves caused more than $5 billion in damage to New York City’s mass transit systems and the Metropolitan Transit Authority (MTA) emerged from the wreckage uninsurable. This was a huge challenge: no insurance, no subway, and the city shuts down. In a municipal finance first, the MTA went to the catastrophe (cat) bond market for coverage against future Sandys. (With cat bonds, insurers transfer risk to capital market investors who bet against catastrophe: that a hurricane will not hit in a particular place, time, or intensity.  If that proves true, investors are repaid principal plus a high rate of interest). I thought this was an entrepreneurial use of finance, and went on to explore others: vaccine bonds, green bonds, social impact bonds, new kinds of financing facilities and emerging insurance entities large and small. The work took on greater urgency last year when the United Nations adopted the global Sustainable Development Goals—and with them a multi-trillion funding gap to meet the goals. Many see innovative finance as a way to harness more and particularly private capital to fill this gap. But, in fact, innovative finance is also about smarter capital: finance as an instrument that encourages behavior change, motivating governments to respond faster to disasters like drought or pandemic, or to invest in cost-effective preventions like vaccines or maternal health. 2) What are some successful examples of innovative finance? Many involve technology. For example, Kenya’s M-Pesa, a mobile payments platform that allows people to send and receive money from their phones, has been an extraordinary success. Ten years ago, for all practical purposes, mobile phones did not exist in Kenya, and most of the country was unbanked. Today 80 percent of Kenyans own a mobile phone, and 70 percent have mobile money accounts. By some estimates nearly 40 percent of Kenya’s GDP flows through the M-Pesa platform. Yet as interesting as what people pay for (just about everything—remittances, taxes, school fees, etc.) is how they pay for it. The mobile money platform has created new kinds of consumer finance, as it allows people to save, insure, and to pay for things over time. Consider the case of solar. Eighty perecent of the country may now use mobile money, but they still live far from the electric grid, reliant for light on things like kerosene—an expensive and noxious source of energy that poisons, burns, and contributes to global warming. For Kenyan families who pay over $200 a year for kerosene, a one-time investment in a $199 solar panel would make sense, but they lack the upfront cash to make this purchase. That is where companies such as M-Kopa or Angaza come in; they use the M-Pesa platform to allow households to pay for solar panels in small installments. By some estimates, pay-as-you-go finance has accelerated the rate of solar adoption fourfold. A company called Alice Financial is using the same approach to public transportation in New York City, where a one-way subway or bus ride costs $2.75. This is no small expense for a daily commuter, who makes 500 of those trips a year. For many New Yorkers, the substantial discount of a thirty-day metrocard is out of reach, since it costs $116 upfront each month. (New Yorkers overpay $500,000 a day because they can’t afford the discount). Alice offers instead a pay-as-you go weekly installment plan, made possible via its socially-motivated, innovative finance arbitrage. 3) What are the limits of innovative finance? Unfortunately, technological innovation alone is not going to solve all of our financial inclusion needs and aspirations. Technology might make more financial services and products available or affordable, but that does not necessarily mean people use them. Just as innovative financial service organizations across the globe have recognized that they need to offer more than just credit to move people out of poverty, so too do they realize that simply having a broader set of product offerings—savings, pensions, insurance—may not be enough. Adoption often requires an important relationship, a human interaction. For example, IFMR Trust in India now employs local wealth managers who are trusted members of the community to work with poor, rural families by collecting their basic financial information on a tablet, and then walking them through the product or service recommendations generated by the company’s algorithms. The combination of technology and a trusted agent translates into greater use of beneficial financial service products.  Neighborhood Trust Financial Partners (NTFP) in Upper Manhattan illustrates the same principle. In recent years, NTFP has developed a range of new products for their their low-income customers: a socially-responsible credit card to pay down debt, an app to encourage savings, and payroll innovations for lending or retirement needs. Yet their success depends on the work of local financial advisors who educate, translate, and earn the trust of their clients. 4) What are some areas that market-based solutions cannot, or perhaps should not, address? Innovative finance is not a panacea. It is particularly well suited to challenges that can be measured, and benefits or savings that can be achieved—and monetized—in a relatively short time frame. Cap and trade, for example, allows us to put a price on carbon, which is not as simple for problems such as government corruption or racial injustice. In many cases, there will never be a viable market solution. Serving the very poorest, working in particularly challenging geographies or conditions—or areas where a constellation of problems is particularly complex (and solutions hard to isolate)—might never be profitable, and will always require substantial philanthropic or government support or subsidy. However, even on issues that don’t lend themselves to these kinds of tools or instruments, the innovative finance lens helps us think differently about the costs of delay and inaction, and the benefits of prevention. Vaccines are cheaper than treating full-blown disease (and cheaper still than pandemic); early childhood education and job training costs a whole lot less than mass incarceration. Innovative finance reminds us that an ounce of prevention is worth a pound of cure. 5) How can government policy help innovative finance succeed? There are a number of ways policy can encourage greater use of innovative finance. For example, last fall the U.S. Department of Labor repealed restrictive rules that had previously prevented U.S. pension funds from considering social, environmental, and good governance factors when making in investment decisions. This “ERISA” (Employee Retirement Income Security Act) reform has the potential to catalyze greater investment in innovative financial products by pension funds that must follow the guidelines. While there is more work to do on norms and guidance related to fiduciary responsibility, this is an important first step. Under the Obama administration, the Treasury Department, USAID, the White House Office of Social Innovation, and even Congress promoted various forms of innovative finance activity. The hope is that the next U.S. administration has the same openness to this approach. Perhaps more important, many of the most successful innovative finance examples are those that involve cost-effective investments in prevention, made possible through new kinds of public-private partnerships. The International Finance Facility for Immunization (IFFIm), for example, has raised over $5 billion since 2006 in “vaccine bonds” to fund large-scale immunizations. Bondholders are repaid out of future government aid pledges, front loading that future aid for investment in vaccines today. Closer to home, social impact bonds (SIBs) are a new breed of pay-for-success contracts between local governments, social service providers, and private investors that finance preventive social services like early childhood education, maternal health support to families to keep children out of foster care, or programs to keep former prisoners from re-offending. Investors, who loan working capital to service providers, are only repaid by the government if interventions work—with payments coming out of the social savings. Today there are more than sixty SIBs in action across the globe, and much of the innovation occurs at the local level. This willingness to partner across sectors is critical for innovative finance in the years ahead.    
    Blog Post by Guest Blogger for Shannon K. O'Neil December 6, 2016 Development Channel
  • Financial Markets
    Global Economics Monthly: December 2016
    Bottom Line: Financial markets rallied following the U.S. election, on hopes that President-Elect Donald J. Trump’s fiscal stimulus and deregulation initiatives would spur corporate profits and growth. Perhaps so, but a strong case could be made for the opposite: that Trump’s economic agenda will prove disruptive to trade and growth, face growing headwinds in Congress, and exert a contractionary impact on the U.S. economy. In the days after the election, financial markets exhibited optimism that would have been inconceivable prior to the vote. Within a week, U.S. equity markets had risen around 3 percent, the dollar had strengthened, and bond yields had climbed on expectations of higher inflation. Banks in particular benefited, with the Standard and Poor’s 500 Financials Index up by more than 10 percent. Market commentary attributed the rise to expectations that the president-elect, backed by Republican majorities in both houses, would rush ahead with a substantial fiscal stimulus, wide-ranging deregulatory measures, and other market-positive reforms—including in health care. The rotation of confidence from securities to equities markets reflects the hope that Trump’s proposed fiscal stimulus packages will promote investment and stronger U.S. economic growth. At the center of the Trump economic program is an ambitious promise of tax cuts and expanded infrastructure investment. The Trump plan would update individual and corporate tax codes, reducing the number of individual income tax brackets to three. It would also cut tax rates across the board, including a reduction of the nominal corporate income tax rate from 35 percent to 15 percent. Trump also pledges to invest at least $550 billion to improve the nation’s infrastructure, and at other times has talked about a $1 trillion package of spending and tax measures to boost infrastructure spending. Details remain scarce. One early proposal relied entirely on private financing (essentially tax breaks in exchange for investment in projects), but most economists argue that reaching these ambitious targets would require a broader approach that included additional government spending and innovative measures to boost private spending (for example, through the creation of an infrastructure bank). The financial markets are likely getting ahead of themselves, though, in rallying in anticipation of a major fiscal stimulus. These proposed measures would almost certainly trigger congressional opposition, with the tax cut plan potentially facing hostility from Democrats and the infrastructure spending opposed by Republicans unless offset by other spending cuts. Even if Congress approves these policies without much modification, their impact on the U.S. economy will  be mixed or even contractionary after an initial boost, as a sharp increase in the government deficit and debt puts upward pressure on interest rates. Finally, though there is broad consensus that fiscal policy needs to take a stronger role in stimulating demand, it cannot do the job by itself. Potentially contractionary monetary policy, coupled with protectionist trade and restrictive immigration policies, could neutralize or even overpower the effects of fiscal expansion on demand and growth. Division Persists Tax cuts and infrastructure spending are, on the surface, popular, and the president-elect can make a compelling case that he was elected in part on promises that he made in these areas. The challenge is how to pay for them, if at all. On this issue the incoming Congress remains sharply divided. On taxes, Trump’s plan contrasts sharply with Republican proposals in terms of its net impact on the economy. The cost of Trump’s tax plan is high: researchers at the Tax Policy Center estimate that it could increase the federal debt by $7.2 trillion in the first decade. Contrast this with Paul Ryan’s A Better Way proposal supported by Republicans. The Ryan plan, also known as the House Republican plan, seeks to cut rates and simplify tax codes by, for instance, collapsing today’s numerous tax brackets into just three. In contrast to the Trump plan, however, A Better Way proposes more modest rate cuts: for example, it proposes reducing the corporate tax to 20 percent rather than 15 percent. In Ryan’s blueprint, the tax cuts would be accompanied by equivalent spending cuts, and would therefore have a neutral effect on the fiscal deficit. Kevin Brady (R-TX), chairman of House Ways and Means Committee, has stated that his committee is preparing legislation based on the Ryan plan to vote on in early 2017. Trump and congressional Republicans will struggle to reconcile the discrepancies between their proposed plans. While Republicans in Congress have historically been willing to tolerate rising deficits under Republican presidents, today’s high debt and divided, distrustful public make such a shift harder to imagine. Assuming a budget-neutral bill in order to hold the Republican coalition together, tough decisions will have to be made that will strain any coalition in favor the bill. Budget politics plays a role here. Republican congressional leaders have committed to retaining the “Hastert rule,” an informal understanding enforced fairly consistently since the mid-1990s, maintaining that a bill will not be allowed a floor vote unless it commands a majority of the majority party. Some shortfall is likely to be covered by other tax reforms, including a forced repatriation of offshore income to pay for a portion of the deficit (this could provide $150 billion in revenue over ten years). Some portion of the deficit increase—perhaps between 0.25 percent and 0.5 percent of gross domestic product (GDP)—can reasonably be covered by the assumption in the budget calculations that stronger economic growth will boost future revenues—the so-called dynamic scoring approach. To go beyond that would be a transparent attempt to explode deficits and would be likely to trigger an adverse market response. Consequently, Republicans will press for spending cuts, including to entitlements, though the president-elect opposed entitlement cuts in the campaign. Whatever form the tax plan takes, it will face hostility from Democrats. One important source of contention: neither the Trump plan nor the Ryan plan addresses the equity of income redistribution. One recent study estimates that the highest-income households would benefit the most from Trump’s tax proposal. Such households would experience a tax cut equivalent to 14 percent of their after-tax incomes, compared to the 4 percent average for all income groups. Similarly, it can be argued that the white working class that voted for Trump will not necessarily benefit as a result of this tax reform. Infrastructure investment could be a divisive issue as well. While Trump may be able to gather more Democratic support on this issue, it is questionable whether he can obtain sufficient Republican backing so that he does not damage his coalition going forward. Major disagreements would arise when it comes to how the investment would be paid for. Trump’s current plan relies almost entirely on private funding, an approach that limits the scope of possible projects and could reduce its economic impact. Larry Summers points out that projects such as fixing bridges and modernizing schools are among the most pressing infrastructure issues, yet they do not bring immediate commercial benefits and thus cannot attract sufficient private investment. That means that the infrastructure investment will fall short of the president-elect’s targets under the current plan. Public funding will be requisite to fill the gap. But it is highly likely that Republicans will oppose significant direct government spending on infrastructure, in the same way they blocked President Barack Obama’s $447 billion plan that included infrastructure spending in 2011. Nor are they likely to support Obama’s proposal for a government-funded infrastructure bank. On both the tax and infrastructure fronts, Trump’s plans will not go unchallenged in a divided Congress. While it is possible that an infrastructure package could be passed on a bipartisan basis, it is equally likely that differences over how to pay for it will force a combined, scaled-down package of infrastructure, tax breaks, and repatriation to be passed primarily with Republican votes. In order for the tax legislation to pass in 2017, Republicans may resort to the “reconciliation” process, which allows for enacting tax and budget measures not subject to filibuster or amendment. Most important, this process permits legislation to pass with simple majority (rather than a three-fifths majority) in the Senate. However, this can only be done through a budget bill, which means only two bills can be passed in the upcoming year. (One bill, associated with the FY17 budget that has been held over from the last congress, is expected to be used for health care reform; this means that only one reconciliation bill, likely in the second half of 2017 and linked to the FY18 budget, can be passed through these accelerated procedures.) In sum, a modest tax cut and infrastructure program, passed through reconciliation with mainly republican votes, will see its fiscal stimulus largely offset.   Fiscal Policy Takes the Baton, But Cannot Do It Alone Even under the most optimistic scenario, in which both tax reform and infrastructure spending are approved in forms resembling Trump’s plans, their direct linkages to and immediate impact on economic growth are limited. Academic and policy studies generally call into question the effects of tax changes on economic growth. As for infrastructure, most major projects take years to complete, and their impact will be backloaded. The tax and infrastructure measures are central to Trump’s economic plan, but even combined with other measures, they will not generate the 4 percent growth rate he promised. Absent a dramatic expansion in the supply side of the economy, any fiscal stimulus will likely force the Federal Reserve to tighten monetary policy more quickly than currently expected to counter inflationary pressures in an economy that appears near full employment. Concerns about rising federal deficits are also likely to put upward pressure on interest rates. This continued tightening of monetary policy will neutralize the stimulus effects of Trump’s proposed policies. The president-elect has repeatedly expressed his disapproval of low-interest rate policies, and a future Federal Board of Governors nominated by him could be hawkish (though it would not be surprising if, once president, Trump sees the virtue of low interest rates to fund rising federal deficits). Further, as mentioned earlier, the tax cuts and infrastructure spending will contribute to rising deficits that can push up interest rates and curtail public investment. Other policies that the Trump administration will implement, especially in international trade and immigration, also could overwhelm a fiscal stimulus and ultimately exert contractionary effects. My colleague Ted Alden has written in depth about the incoming president’s trade and immigration policies. If U.S. trade policy becomes inward-looking and confrontational with important trade partners—especially China—the results could be disruptive and contractionary. We will witness more cases against China brought to the World Trade Organization, along with more trade barriers such as high tariffs being implemented. In economic literature, the positive link between international trade and economic growth is strong, as is the negative correlation between protectionism and growth. A trade war would significantly dampen investment and consumption, both important components of growth.  Similar to the new trade agenda, Trump’s immigration policy will be extremely restrictive, surpassing the severity of the post-9/11 immigration reform. Any effort to expand deportations and limit access of undocumented peoples to the labor market is likely to prove highly distortive. Just one element of the president-elect’s agenda, his promise to repeal the Deferred Action for Childhood Arrivals (DACA) policy put in place by the Obama administration, has the potential for substantial dislocations and economic losses, as over one million people have been exempt from deportation and received work permits through this policy. Layoffs by firms concerned about future sanctions, and undocumented workers leaving the formal labor market, would create broad-based shortages in the service, agricultural, and small-scale manufacturing sectors. Further, during his campaign, Trump called for “extreme vetting” of immigrants and even a visa ban on Muslims. In my study with colleagues Heidi Crebo-Rediker and Ted Alden to examine the economic impact of a potential Muslim ban, results that would apply equally to the enhanced vetting procedures currently being discussed, we found that Trump’s proposed ban would be immediately damaging to the U.S. economy. Those effects would linger for many years, even if the restrictions proved to be temporary. During the “lost decade” following the 9/11 attacks, the U.S. share of total overseas travel fell by nearly one-third, a loss of some 68 million visitors, which the travel industry estimates cost the U.S. economy more than $500 billion over that period. Our research suggests that the direct and indirect cost to the U.S. economy of the proposed travel ban would be substantial. We present two scenarios: one in which the cost to the U.S. economy is at least $36 billion annually (including travel, tourism, and education) and another potentially as high as $71 billion per year. Depending on the response by other countries and by foreign travelers not directly targeted by the ban, the losses could approach or exceed those in the post-9/11 period. Conclusion Donald Trump faces a tough choice—he can attempt to pass expansionary policies with bipartisan support and risk fracturing the Republican majorities in the House and Senate that support him, with possibly adverse effects on inflation and government debt; or he can pass more narrow bills with primarily Republican support that may involve little net stimulus. Either path will be challenging, and any boost to spending and investment is likely to be backloaded to 2018 and beyond. Meanwhile, the negative effects from a disruptive immigration and visa policy could be felt right away, and financial conditions could tighten as growing concerns about the possibility of a more hawkish Federal Reserve intensify over the course of 2017. At this point we do not know which way the new administration will choose to go, and it is possible that President-Elect Trump is able to mobilize a bipartisan consensus in support of truly growth-supporting policies while backing away from some of his most disruptive social policies. However, taken together, it is easy to have doubts about the prospect of material economic stimulus. Indeed, a contraction may well be in the cards. Looking Ahead: Kahn's take on the news on the horizon The Federal Reserve The Federal Reserve has paved the way for a rate hike in December, with a message that future hikes will be gradual. Capital Flows Emerging markets continue to see significant outward capital flows, which raises the vulnerability of highly indebted countries. Venezuela China has agreed to fund additional energy production in Venezuela, but the government will not receive additional cash. Venezuela remains on an unsustainable path.
    Report by Robert Kahn December 2, 2016
  • China
    China’s Bond Market Can’t Handle a Global RMB
      
    Blog Post by Benn Steil and Emma Smith December 1, 2016 Geo-Graphics
  • Global
    A Conversation With Robert Greifeld
    Play
    Robert Greifeld discusses how the recent and upcoming elections in France, Germany, and the United States might affect trade, markets, and the future of globalization.
    Event with Robert Greifeld and John Micklethwait November 29, 2016 Bernard L. Schwartz Lecture
  • Emerging Markets
    Korea’s September Intervention Numbers
    Korea’s balance of payments data—and the central bank’s forward book—are now out for September. They confirm that the central bank intervened modestly in September, buying about $2 billion.* That is substantially less than in August. Based on the balance of payments data, intervention in q3 was likely over $10 billion (counting forwards). Korea is widely thought to have intervened when the won got a bit stronger than 1100 at various points in the third quarter (a numerical fall is a stronger won). I suspect that had an impact when the market wanted to drive the won higher. And, well, market conditions have changed since then. The dollar appreciated against many currencies in October, and Korea’s own politics have weighed on the won. Korea’s headline reserves fell in October, but that was likely a function of valuation changes that reduced the dollar value of Korea’s existing holdings of euro, yen, and the like, not a shift toward outright sales. There though is a bit of positive news out of Korea. The new finance minister, at least rhetorically, seems keen on new fiscal stimulus. The Korea Times reports the nominee for Finance Minister supports additional stimulus: "I [Yim Jong-yong] believe there is a need (for a further fiscal stimulus) as the economy has been in a slump for a long time amid growing external uncertainties." Korea has the fiscal space; it should use it! * The balance of payments shows reserve purchases of $1.9 billion; the forward book increased by just under $0.2 billion. And if you look at broader measures that try to capture changes in the offshore accounts of the fiscal authorities, the intervention in September might be a bit smaller, a rise in offshore fiscal deposits in August was partially reversed.
    Blog Post by Brad W. Setser November 4, 2016 Follow the Money
  • Sub-Saharan Africa
    Exit of South Africa’s Finance Minister? Not So Fast
    Pravin Gordhan faces charges of fraud and has been summoned to the Pretoria Regional Court on November 2. The charges appear to be spurious. They concern Gordhan’s approval of the early retirement of a government employee and his subsequent re-employment under contract. The claim is that the amount of money involved is just over ZAR 1.1 million (approximately $76,000). Early retirement followed by re-engagement on contract is commonplace in many governments, including that of South Africa. The seemingly trumped up charges should be seen in the context of an ongoing struggle within the governing African National Congress in the aftermath of the August 2016 local government elections and the reverses and scandals that plague the Zuma administration. Gordhan and the Treasury are associated with “reformers” who want to repair the party, restore its eroded grass roots support, and manage the economy to generate badly needed economic growth. Zuma, parts of the security services, various patronage/clientage networks, and (broadly speaking) the traditional party machinery seek to restore the political power of the president and break the intra-party opposition that is associated with Gordhan and many other senior party figures, including Deputy President Cyril Ramaphosa. Zuma’s allies are likely to call on Gordhan to step down, pending his trial. But, Gordhan is unlikely to do so, not least because of his considerable support within the party. Gordhan also enjoys the respect and support of the domestic and international financial community. In attacking Gordhan, Zuma and his allies are playing with international financial fire: in the day since the fraud charge was levied on Gordhan, the rand has fallen nearly four percent to 14.28  to the U.S. dollar. Efforts to remove Gordhan also raise the specter that the international financial rating agencies will down grade South African bond to ‘junk’ status. Hence, it is by no means certain that Gordhan will actually be brought to trial, and if he is, that he will be convicted.
    Blog Post by John Campbell October 12, 2016 Africa in Transition
  • United Kingdom
    Understanding the Libor Scandal
    The manipulation of interbank lending rates by a host of global financial institutions could have significant repercussions for financial markets, consumer loans, and regulatory policy.
    Backgrounder by James McBride October 12, 2016