"Kee" Points with Jim Kee, Ph.D.

US economic data continues to tell a fairly consistent story of moderate expansion, low inflation and inflation expectations, and a continued divide between the industrial/manufacturing sector, which remains weak (along with business investment spending), and the service/consumer sector (along with consumer spending), which continues to be stronger. Housing data (new and existing home sales) continue their gradual uptrend (Federal Reserve Bank of New York). First quarter GDP growth estimates have been revised upwards from .5% to .8%, and current “Nowcasting” models expect GDP growth in the second quarter to be above 2%. PollyVote indicates a slight gain in favor of Hillary Clinton last week, with the odds of Democrats retaining the White House (estimated from multiple modeling and survey methodologies) at 52.5%, versus  47.5% for the Republicans.


As of today (Monday), markets are experiencing a big upward surge based upon new polling data over the weekend that showed an increase in those intending to vote to “remain” in the European Union in this Thursday’s British referendum. But that wasn’t the most important international news last week. That was the fact that Indian Central Bank Governor Raghuram Rajan will not seek a second three-year term in September, when his current term expires (he will be returning to the University of Chicago). Rajan began serving as the Governor of the Reserve Bank of India (RBI) in September 2013, and since that time India stocks (e.g. iShares MSCI India) have outperformed the broader emerging market indices. From 2003 to 2006 Rajan was Chief Economist at the International Monetary Fund, where he wrote brilliant papers that I often re-read. Most of these insights are summarized in his book Fault Lines, which was published in 2010. Rajan has always been a strong advocate of central bank independence (freedom from government influence), which gave the RBI a huge boost in international credibility. Although a successor has not yet been identified, I view Raghuram Rajan’s departure in September as a huge loss for India.


Infrastructure spending and exchange rate stability: Last week I talked a little bit about the growth rate of the global economy, although the notion of “the global economy” is quite an abstraction! Monetary policy has likely run its course, and fiscal policy changes (i.e. spending, tax, regulatory reforms) are very hard to implement politically. The move towards more consumption spending and less savings by the emerging economies was cited as one catalyst for global growth.


As for potential growth policies, the easier to implement politically, the higher the probability of being adopted. For example, there seems to be a lot of enthusiasm around the world for “infrastructure spending,” a term which is growing to include everything from actual bridges, roads, electrical grids, waters systems, green energy, ports to education. Financing it is another story, and it is reasonable to ask why the private sector wouldn’t already be doing these things if they were economically feasible (i.e. profitable, or generating benefits greater than their costs). One answer – the one that separates trained economists from laymen – has to do with the notion of “non-exclusion.” If I want to build a missile defense system as a business, for example, I have to be able to charge people enough to cover its costs. But that’s hard to do if I can’t exclude non-payers, who think: “if my neighbor is protected, than I probably am too, so why should I pay anything?” Unfortunately, everybody has the same incentive to think this way, so you don’t see the private sector supplying goods and services like missile defense systems that are non-exclusionary. Many infrastructure projects are considered to have some non-exclusionary properties (though many do not). In economics, that leads to what is known as “market failure,” meaning that goods and services that society values more than their costs will not be produced by private firms. What does get produced by the private sector are goods and services that are valued by more than their costs, and that do not have non-exclusion characteristics. [Aside: a political exception would of course be the fact that the poor, by definition, can be excluded from a lot of things they need just to live. That’s one reason many economists have preferred cash grants to the poor, so that the efficiency of the market can be utilized while also allowing the poor access to its output].


Another policy that I think is gaining in political expediency and that could generate some growth would be a movement by the world’s central banks, particularly the US Federal Reserve and the European Central Bank, towards exchange rate stability. Economist Robert Mundell notes, “Today we are again in a position where we don’t have an international monetary system.” He’s referring to the previous Bretton Woods system of a gold linked dollar and fixed exchange rates that lasted from 1944 to the early 1970s, and various metal standards before it (e.g. gold/silver). We currently have a situation where the world’s major economies are relatively stable, but where exchange rates are extremely volatile, with the dollar and the euro making big 20%-30% moves up or down fairly regularly. That uncertainty over exchange rates makes it difficult for the global pricing system to operate efficiently, i.e., to accurately convey the ever-changing realities of supply and demand across millions of products, services, and individuals. Older economists would call this a “dimming” of the signals of the price system, which reduces the gains from trade and lowers global wealth creation. Exchange rate instability also invites speculative capital movements, which can be destabilizing when they are large and swift. Because these deficiencies, I see a move towards some exchange rate coordination among the world’s central banks increasing in probability over the next 12-24 months, and I would welcome it.