Monday, December 17, 2018

How low is low for Chinese GDP growth?

The deceleration in the Chinese economy over the last decade has raised concerns about the sustainability of the Chinese economic "miracle". But is that deceleration unusual when compared to other countries? What is to be expected in the coming years?

Economists like to look at emerging markets through the lens of the convergence model (based on the work of Robert Solow). Successful emerging economies are supposed to grow faster than advanced economies and catch up. But as the process of catching up materializes, growth will slow down and over time will approach that of the most advanced economies. How does China compares to other successful emerging economies? It is not easy to find a perfect historical example for China but South Korea comes the closest. It is a successful converging economy in Asia and it is a fairly large economy (unlike Singapore or Hong Kong, two other successful converging economies).

We start by focusing on the period 1980-2018 and use GDP per hour as an indicator of productivity. For each year we compare the initial level of GDP per hour with the growth of GDP per hour over the 5 years that followed. The initial level of GDP per hour is measured relative to the US (as an example of a country close to the technology frontier).



In the context of this period, the deceleration of China makes its growth rate land right at the sample place as the growth rates that Korea had at similar levels of development. The last observation corresponds to the period 2013-2018. Today (2018), China is abut 20% of the US level and if it were to follow the Korean benchmark it would be growing at rates around 6%, very close to current Chinese growth rates. China reached this position after a volatile early decades. Possibly underperforming in the 1980s and over performing in the decade of 2000s when growth passed 10%. 

If we add early decades the comparison becomes much noisier as both South Korea and China had much more volatile, and lower overall, growth rates.



In summary, the deceleration of GDP growth rates in China can be seen as a natural evolution of the economy as it follows its convergence path, in particular if we use recent decades in South Korea as a benchmark. Let's not forget that South Korea is one of the best performer for countries in the range below 50% of the US GDP per capita. So using South Korea as a benchmark we might be providing an optimistic benchmark for Chinese growth.

Antonio Fatás

[Data Source: Total Economy Database, The Conference Board]
on December 17, 2018 |   Edit

Tuesday, November 27, 2018

Global Rebalancing

Prior to the Global Financial Crisis the world economy experienced a period of increasing global imbalances where a group of countries saw their surpluses increase rapidly while, on the other side, a group of countries increased their deficits. These patterns were partly related to the "saving glut" hypothesis put forward by Ben Bernanke to explain the decline in global long-term real interest rates. It was also the case that some of the deficit countries (in particular in the Euro periphery) found themselves in a large crisis after 2008.

This post is an update of the last ten years. Today the world displays smaller imbalances than at the peak of 2008 but what it was more interesting is the extent to which rebalancing had happened between different country groups.

Let's start with the global view. The Figure below shows current account balances as % of world GDP for some regions or groups of countries. Data goes all the way back to 1980 although data is missing for some countries before 1995 (see footnote on data sources).

In the period 1998-2008 (Global Imbalances period) we see the increasing surpluses of oil producer countries, China, advanced Asia (this includes Japan, South Korea, Singapore and Taiwan) and the rest of the world (ROW, many of these countries are emerging markets). The Euro area remained quite balanced (more on this below) and the only deficit country in this figure is the US, absorbing all the surpluses generated by the other countries [of course, the US was not the only deficit country. Some of the Euro area countries had a deficit as well as some of the countries in the rest of the world].

Since 2008 we have witnessed:

  • China is moving fast towards a balanced current account (IMF forecasts suggest that China's current account will be balanced within the next 2 years). 
  • Oil producers have moved towards a balanced CA with small deficits in 2015-2016 as a result of the decline in the price of oil.
  • The Euro area has massively shifted towards a large surplus (the largest among the surplus regions)
  • Advanced Asia has maintained or increased its surplus relative to previous years.
  • The US continues to be the country that absorbs most of the surpluses. The US deficit is smaller than in 2008 but remember this is measured as a ratio of World GDP not US GDP (relative to US GDP the decline would be less pronounced).
  • While in 2008 many emerging markets were savers, in 2018 all the surplus countries are advanced economies (Euro and Asia). Some emerging countries appear under rest of the world as absorbing some of these capital flows.



Some details on the two largest sources of surpluses today. What happened among advanced countries in Asia? The figure below shows that Japan was dominant in this group in the early years. But in recent years the increase in surpluses in Korea, Taiwan and Singapore means the three of them together have a larger surplus than Japan. Overall size is similar to before when measured against world GDP. If we were to measure it against their own GDP we would see an increase in surpluses.

And finally the Euro area. I divide the Euro area into three groups: Germany and Euro Deficit and Euro Surplus. The last two groups are decided by looking at the pattern of the current account of Euro members (excluding Germany) during the 2000-2008 period. Countries that showed consistent deficits are in the first group while the others are in the second one. We can see the large increase in surpluses in Germany in the decade of the 2000s while the group of deficit countries massively increased their deficits. After 2008 we see a fast rebalancing from the deficit countries towards a surplus while Germany maintains (measured as % of world GDP) or increases (relative to its own GDP) the current account surplus.

Antonio Fatás

Data source: Current Account balances (in USD) and World GDP (in USD) from IMF World Economic Outlook database. Data from 1980-1995 is missing for some countries (in particular emerging Asia, including China). During those years they appear as rest of the world.
on November 27, 2018 |   Edit

Wednesday, November 14, 2018

Digital money and payments

New technologies in the financial sector are opening the door for potential disruptions: cryptocurrencies, M-Pesa, WeChat,... Many of them are seen as alternatives to either traditional currencies issued by central banks or to the intermediation role played by commercial banks.

In this discussions, there is often the assumption that "money" and "payments" are features that always come together, they cannot be separated. The confusion originates in the standard definition of money: It is the asset that allows us to purchase goods and services, the "medium of exchange". The ultimate example is physical currency where a piece of paper that says €50 or $100 is both the asset (where the value is being held) and the medium of exchange (the payment vehicle of the payment technology). Transfer of the asset cannot be separated from the "technology" used to make the payment. By giving the note to a seller, you get in return goods and services for exactly that value.

But the moment we think about electronic forms of money, there is a clear separation between the asset and the payment technology. The asset is a balance typically held in a bank (but it can also be in a mobile operator as in the case of M-Pesa). The payment technology is the way I can transfer the value of that asset to someone else. This technology can be a debit card or an NFC chip inside a watch combined with a terminal at a store or it can be a messaging application via an app in your mobile device that connects your balance with the balance of the seller via a network where all institutions operate.

In theory the two features can be treated as separate. A commercial bank can move from a cumbersome and costly payment technology of cheques and inefficient wire transfers that take days to a modern technology where payments and interbank transfers are immediate through a real-time gross transfer system. The nature of money has not changed (the balance in your bank account) but the way money is being used as a medium of exchange (the payment technology) has become much more efficient.

In the real world the two features might come some times together. For example, the case of M-Pesa in Kenya where a mobile phone provider offers a form of money that combines a balance within their systems and a technology to make the payments (via the mobile phone). This is of course more likely to happen in a country where bank accounts are rare so the only way to offer an efficient payment technology was to combine it with a provision of the asset through these balances.

Here is another example where money and payments are being mixed: Christine Lagarde, IMF managing director, speaking at the Singapore Fintech Festival, discussed the benefits of digital currencies issued by central banks (i.e. allowing individuals to hold accounts at the central bank). One of these benefits is "Privacy". Quoting from her speech:

"Consider a simple example. Imagine that people purchasing beer and frozen pizza have higher mortgage defaults than citizens purchasing organic broccoli and spring water. What can you do if you have a craving for beer and pizza but do not want your credit score to drop? Today, you pull out cash. And tomorrow? Would a privately-owned payment system push you to the broccoli aisle? Would central banks jump to the rescue and offer a fully anonymous digital currency? Certainly not. Doing so would be a bonanza for criminals."

In this debate, in order to discuss the benefits and costs of different solutions we also need to separate money from payment technologies. Governments might want to have all the relevant information about the identity of individuals holding money accounts. But they might not care about whether you buy pizza or broccoli; the information about the actual payment. One could imagine a system where the institutions that are holding the assets (money) are highly regulated and compliant with KYC (know your customer) regulations. But the companies that have access to that balance to execute payments do not need to share any information with governments. In fact, we might want them to be required to maintain strong privacy rules regarding the information they collect or sell. No need to create central bank digital currency for all.

Antonio Fatás
on November 14, 2018 |   Edit

Monday, September 10, 2018

Is the Great Moderation back?

The "Great Moderation" was a term used to describe the reduction in business cycle volatility observed in several advanced economies. It started in the mid-1980s and it coincided with the period of time where inflation had successfully brought down to a low level (and remained low and stable since then).

There was a debate about the causes of the Great Moderation. Some put central banks at the center of the phenomenon while others thought good luck was a significant part of the explanation for these benign years. The crisis that started at the end of 2007 represented for some the end of this period and a validation of theories that had seen good luck as the main reason for it. The deep and protracted recession that followed 2007 questioned the idea that business cycles had become less volatile.

But looking at the volatility from today's perspective, 2018, the "Great Moderation" might still be relevant, at least for the US economy. I calculate below a (previous) 5 year standard deviation of real US GDP growth (using quarterly data, growth rates calculated relative to one year earlier).


The data speaks for itself. There is a marked reduction in volatility in the mid-80s that persisted all the way to 2007. Then the increase in volatility is evident, due to the crisis. But in recent years we have seen volatility fall to its lowest levels. This is the result of a a very stable GDP growth and the fact that we are in the second-longest expansion phase the US economy has even seen (10 more months to become the longest one). 

What is interesting is that looking at the whole period 1985 until today, even including the sharp increase in volatility resulting from the global financial crisis, GDP remains much less volatile than in the earlier decades. The Great Moderation seems to be alive in US data.

And here is the same analysis using French data. Similar pattern although because the data start later when volatility was low, it looks more like the exception is the 70s when volatility was much higher than any other period for the French economy. And the surge in volatility after 2007 is stronger partly because the Euro area went through a second recession around 2012.



Antonio Fatás

on September 10, 2018 |   Edit

Wednesday, June 6, 2018

Lost decades: Italy 3 - Japan 0.

The last decade has not been good for many advanced economies. The Global Financial Crisis, a second recession in the Euro area and central banks hitting the zero lower bound have led to disappointing GDP growth rates. But GDP growth rates can be a  misleading indicator about the true performance of different economies. For example, as Matt O'Brien summarizes well, Japan has done much better than what most people believe.

The confusion comes from the fact that there are two forces driving GDP growth. One is the number of hours we work and the other one is how productive those hours are. The absolute number of hours we work is a function of the population of a country. Because of that reason we usually measure GDP per capita growth instead of GDP growth. But this is not enough. Hours per capita can change in response to two forces. First, age matters. Typically engagement in the labor market declines with age, an aging country is likely to have fewer hours per capita. Second, the labor market. Even for groups of the population where labor market engagement should be the highest (prime-age workers) we see interesting variation over time and across countries that reflect on the performance of the labor market.

In this post I judge the performance of countries separating two factors:

  1. Productivity, measured as GDP per hour worked.
  2. The labor market: measured as employment to population for the group of 25-54 years old.

I am just leaving one factor out, which is aging (over which policy makers have little influence except for immigration policies or incentives to increase fertility rates).

Using data from the Conference Board (for productivity) and OECD (for labor market), I have compared the performance of a sample of advanced economies for two periods. 1999-99, which happens to be a pre-Euro period, and 2000-17.

All the numbers are expressed as the value achieved by the variable in the last year as compared to the initial year which is made equal to 100. So an index of 110 means that in the whole period, that variable grew by 10%.

Two caveats: I am measuring performance ignoring initial levels. A country with a very high employment rate is unlikely to increase that rate over time so its performance would seem disappointing. Second, this is about relative performance. Compared to the other advanced economies, how did a particular country perform?

We start with productivity (click for a larger image). Japan does well on both periods. The 4th best performer in the 90s and the 6th one since then. The US climbs up in the post-2000 period ranking. Among the Euro members, Germany loses a few positions with the Euro, same as France, although the change in ranking is smaller. Among the Southern European members, different fortunes. Spain seems to benefit from the Euro membership while Italy and Greece drop to the lowest positions, from already a very low level. For these two countries, performance has been low since 1990 and it got worse since the introduction of the Euro.


There are some countries like the Netherlands that are towards the bottom in both tables. But the Netherlands has one of the highest GDP per hour levels among these countries so it is natural that its growth rate is low. That's not true for Greece or Italy that remain as two of the countries with the lowest GDP per hour level.

What about the labor market? I focus on prime-age workers so that we cannot ignore issues related to aging and effective retirement age. Here Japan is a low performer in the 1990s but then it becomes the best performer in terms of improvements in labor market outcomes for this group. Some of this is related to Abe's policies in particular the increase the female labor force participation. Some Euro members are strong on both periods (Germany and Spain). Italy manages to improve its relative performance in this period although remains in the lower part of the table. Greece, on the other hand, and as a reflection of the large effects of the crisis, becomes the worst performer since the Euro was launched. 

And, interestingly,the US falls to the bottom of the table in the post-2000 period. While productivity-wise the US has done well since the year 2000, the labor market has underperformed relative to the other advanced economies. The UK labor market does well in the post-2000 period and partially compensates for its average productivity performance.

This is still a partial analysis of the data because we are looking at relative performance without considering initial levels (more to come in future posts). But the data so far points to some interesting conclusions:
  • Once the effect of an aging population is removed, Japan has done very well since 1990. It has sustained a good productivity growth while becoming a leader in terms of labor market outcomes in the post 2000 years. No lost decades despite a deflationary environment.
  • Southern Europe has not followed a unique trajectory after the introduction of the Euro. Spain has improved its productivity while maintaining significant improvements in the labor market. Italy was a low performer in the 1990s and since the launch of the Euro its productivity performance declined while its small improvement in the labor market could not do enough to compensate. Italy stands out among the largest advanced economies because performance on all dimensions is low across all decades and this is more remarkable if we consider that both in terms of productivity and in terms of labor markets, its initial level was already relatively low.
  • The US has seen a relative improvement in productivity while the labor market has deteriorated at a rate that only Greece can match.
Antonio Fatas



on June 06, 2018 |   Edit

Thursday, May 10, 2018

It's a (low inflation) trap!

Mark Carney did his best yesterday to justify the decision of keeping interest rates at 0.5% at the same time that it was promising that the economic momentum will be regained and that interest rates will have to rise soon.

Unfortunately, this is not new. Since March 5th, 2009 (more than nine years ago), when interest rates were lowered to 0.5% in the UK, we have not seen much action despite all the talk and promises of higher interest rates. And inaction of interest rates has mostly come as a surprise as projections on interest rates were always much higher than what was later delivered by the central bank (see image below).


What we are seeing in the UK is not different from what we have seen in the US after the Federal Reserve stopped quantitative easing and engaged in a slow path of increasing interest rates. So far there have only been surprises on one direction: the Federal Reserve ended up postponing an interest rate increase that was anticipated by the market. And the ECB or the Bank of Japan are still far to get to the point of talking about higher interest rates but when they do, they are likely to face the same issues.

Either central banks are setting the wrong market expectations or they are being themselves as surprised as everyone else by the slow pace of economic growth and wage and price inflation. Regardless of the reason, this is a reminder that the last 9 years have not been normal for monetary policy. That we have learned that getting out of a low inflation environment is much harder than what we thought. And let's not forget (if history is an indication) that one of these days we will have another global crisis and interest rates will have to come down (from 0.5%?) and we will start all over again, hoping to get out within the next 10 years. Will interest rates be clearly above zero in these markets 10 years from now? Chances are that they will not be. 

And given all these lessons and persistence of low interest rates you would think that we would have spent some time thinking about how to avoid falling into similar situations in the future. Unfortunately we have not. The most obvious solution is to raise the inflation target so that we all move away from 0%, but that is clearly not an option in any of these countries. I do not like the expression "the new normal" because it is applied too often even when nothing has really changed but in this case there is no doubt that 10 years ago monetary policy entered the new normal and we are not sure when we will get out of it.

Antonio Fatás
on May 10, 2018 |   Edit

Friday, January 19, 2018

The shrinking (US) Risk Premium

As the US stock market continues to climb and reaches "record-high" levels, questions on overvaluation and bubbles become more common. Robert Shiller CAPE measure of the US stock market shows now a market that is at a higher level than during the Great Depression. The market has only been more expensive in the years 1998-2000 in the run up to the burst of the internet bubble.

While high CAPE values signal potential overvaluation, one has to compare those numbers to levels of interest rates to assess whether stock prices are truly overvalued relative to other asset prices. One simple way to compare the two is to calculate the stock market risk premium implied by current levels of stock prices, earnings, nominal interest rates, expected inflation as well as expectations of future earnings growth. In previous posts I have explained in detail the data and methodology to calculate the risk premium. Below is the most updated analysis including the value of 10-year interest rates that just hit 2.642% today.


A combination of higher stock prices and increasing interest rates has led to a sharp decrease in the risk premium which is quickly approaching 4%. Not far from the values in 2007. But, of course, still really far from the 1990s bubble. 

So the market is becoming more expensive and either investors are expecting an improvement in long-term growth expectations relative to the potential growth estimates from CBO or they are willing to accept a lower risk premium. A lower risk premium seems like a surprise to some given that there are good reasons not to ignore downside risks in 2018.  

While none of these valuation measures are perfect predictors of future returns, stock market bubbles are always preceded by rising prices and decreasing risk premium - signals that the market is underestimating risk. Today, these ingredients are becoming more obvious in US stock markets. Maybe these indicators are not that useful to understand stock prices and it is all about "narratives" (as Robert Shiller argues), but all narratives come to an end when some of the risks are materialized and markets have to face reality.

Antonio Fatás
on January 19, 2018 |   Edit