Friday, June 20, 2008

A Question For Martin Wolf, Brad Sester, and Other Advocates of the 'Saving Glut' View

There has been a lot of talk about how current U.S. monetary policy, which has been highly accommodative for domestic reasons, is pushing up demand and thus inflationary pressures in those Asian and Gulf region countries whose currencies are pegged to the dollar. A big concern is that since these countries in the 'dollar block' make up a significant portion of the world economy, loose U.S. monetary policy is effectively creating a global monetary stimulus that may create undesired outcomes for the world economy. Nouriel Roubini describes it this way:
Easy US monetary policy, followed by monetary easing in countries that formally pegged their exchange rates to the US dollar (as in the Gulf) or that maintain undervalued currencies to achieve export-led growth (China and other informal members of the so-called Bretton Woods 2 dollar zone) has fueled a new asset bubble in commodities and overheating of their economies... [this and other] factors are akin to positive global aggregate demand shocks, which should lead to economic overheating and a rise in global inflation.
Ken Rogoff similarly notes:
[M]any countries, from the Middle East to Asia, effectively tie their currencies to the dollar. Others, such as Russia and Argentina, do not literally peg to the dollar but nevertheless try to smooth movements. As a result, whenever the Fed cuts interest rates, it puts pressure on the whole ''dollar bloc" to follow suit, lest their currencies appreciate...

Looser U.S. monetary policy has thus set the tempo for inflation in a significant chunk ― perhaps as much as 60 percent ― of the global economy.

But, with most economies in the Middle East and Asia in much stronger shape than the U.S. and inflation already climbing sharply..., aggressive monetary stimulus is the last thing they need right now...
Finally, Martin Wolf's says it most succinctly with the following:
To simplify, Ben Bernanke is running the monetary policy of the People’s Bank of China. But the policy appropriate to the US is wildly inappropriate for China and indeed almost all the other countries tied together in the informal dollar zone or, as some economists call it, “Bretton Woods II”.

Thus, not only have the imbalances proved hugely destabilising in the past, but they are going to prove even more destabilising now that the US bubble has burst. When most emerging economies need much tighter monetary policy, they are forced to loosen still further.
So the Federal Reserve is now being called to task for not being more careful with its monetary hegemon status and thus its ability to create real economic distortions in the global economy. Note, though, that the countries on the receiving end of the Fed's global monetary stimulus are the same ones that a few years ago were being blamed for creating global economic distortions via a 'saving glut'. This 'saving glut', it was argued, was so economically powerful that even the Fed's monetary policy was held hostage to it. Martin Wolf, for example, argued the following:
Prof Taylor dismisses the “savings-glut” explanation for the low US interest rates, with the observation that global savings rates are lower than three decades ago. But the world, without the US, had a rapidly rising excess of savings over investment in the early 2000s, much of it directed to the US. Given the huge capital inflow, the Fed’s monetary policy had to generate a level of demand well above potential output.
So Martin Wolf is telling us the poor Fed had no choice, it was victimized by the global saving glut and forced to lower interest rates to historically low levels. But wait, this is the same Martin Wolf we just saw above who stated that the Fed is determining monetary policy for these regions and has done it in a destabilizing fashion. Martin Wolf is not alone in this change of heart. Most observers who sang the 'saving glut' tune over the past few years are now singing--sometimes unknowingly--a global liquidity glut tune. These observers have somehow gone from a world where the Fed is a slave to the dollar block to world where the dollar block is a slave to the Fed. For these folks, then, I pose the following questions:

(1) If the Fed is a monetary hegemon and has the ability to create a global monetary stimulus with real economic effects today, is it not possible that had a similar ability to do so back in the early 2000s?

(2) If the answer is yes to (1), then is it not possible that some of global economic imbalances developed during that time were the result of the Fed's monetary policy?

Here and here are my answers to the questions.


  1. The answer to 1) is clearly yes. If a cut in US interest rates put pressure on the dollar which translates into a rise in reserve growth in the countries that peg to the dollar, then there is a channel that transmits loose US monetary policy to the world economy. The practical impact of this depends on the extent of sterilization, so the link isn't one to one, but there should be a connection.

    There are though important differences between the 2002-04 period and the current period. Back in 2002 the world was working through the aftershocks of two big investment booms that went bust -- the investment boom in asia in the mid 90s and the us tech boom. both created a bit of surplus capacity that needed to be worked through. there also seems to have been a bit more slack in the energy market. and I think you can make a plausible arguement that US monetary policy in 2000 was too tight for much of the $ zone.

    It is also important to remember that there have been large changes in the world economy since say 200o or 2001. in 2000 China exported $250b; in 2008 that number will be closer to $1500b. Chinese energy use has increased dramatically -- as has Chinese demand for a host of commodities.

    that said, there were signs of overheating from excessively loose monetary policy in parts of the $ zone in 2003 and 2004. Chinese inflation moved up significantly amid concerns about very rapid loan growth. China responded by a very significant administrative tightening -- one that brought down lending growth and inflation. The limits on lending likely limited investment growth and thus contributed to the emergence of China's current account surplus.

    as I have noted in the past, from 2004 on savings and investment are both up substantially in the big current account surplus regions of the global economy -- namely china and the oil exporters, so in that sense the "glut" component of the argument is stronger now than when Dr. Bernanke first made the argument.

    On 2)Low US policy rates could lower long-term rates and thus stimulate investment, and by raising home value and facilitating borrowing against home equity, consumption. so they could induce a rise in investment. low US policy rates also should induce a fall in the dollar and thus encourage net exports and reduce the current account deficit. THe overall effect consequently seems ambiguous to me -- one channel suggests a rise in investment/ fall in savings that would push the external deficit up; another suggests a fall in the dollar that would make us exports more attractive and push the trade deficit down.

    Here I would note that the difficulties attracting foreign savings to a savings short economy with low policy rates should eventually produce pressures that would push rates up. Deficits have be financed; someone had to build up claims on the US despite low US short and long-term rates. A normal check on too loose monetary and fiscal policy in a country with big external deficits never quite seemed to kick in.

    and here i would point to the rise in central bank reserve growth/ buildup of central bank claims on the US -- and also note that China preferred a policy of domestic restraint in 04 to a policy of allowing the rmb to appreciate, which meant that China's government took policy steps to restrict domestic investment and thus free up Chinese savings to lend abroad. these policies tended to augment the impact of low rates on investment in the non-tradables sector and reduce the impact of low rates on the dollar/ the stimulus to current production in the tradables sector.

    So what might have happened in a counter factual where the fed raised rates faster and sooner -- and kept on raising rates during the period when the US curve was inverted (due to strong CB demand for treasuries/ agencies). Well, higher short-term rates would have acted as a brake on some kinds of investment (tho if long-rates stayed low, the impact would have been muted). higher rates would have tended to support the dollar - and make us debt more attractive to private investors. so there would have potentially been less central bank reserve growth/ more private financing of the US deficit. All in all, I think the result would likely have been lower activity in the US and a smaller deficit -- tho this can be debated (due to the impact on the $). there also would have been a bit less activity globally -- and less us demand for Chinese goods would mean less chinese growth (barring a policy shift in China).

    all this said, I really don't see why this issue generates as much controversy. Menzie highlights a small upward move in real rates when the fed started hiking, but real rates remained (and have remained) quite low in the US. and long-rates didn't move much even as the fed raised rates. Part of that the modest improvement in the fiscal deficit at the time. but part of it is a reflection of the huge rise in savings v GDP in China and the oil exporters and corresponding rise in their government asset accumulation. the data here is unambiguous: savings rates are way way up in much of the emerging world. that implies a fall in savings or a rise in investment outside of the savings surplus countries to produce global equilibrium.


  2. Brad:

    Thanks for your reply. I want to be clear--I am only questioning whether some, not all, of the global economic imbalances can be traced to the Fed. With that said, here are two more comments:

    (1) Regarding the differences between then and now, what I see is that then--between 2003 and 2005 to be precise--there was a positive global aggregate supply (AS) shock coming from the opening up of Asia, ongoing technological gains,and financial innovations. This development, rather than the aftershocks in the early 2000s you mention, is what made the Fed's low interest rate policy at that time so distortionary. Given its monetary hegemon status, the Fed was adding a monetary stimulus to the global economy at the same the global economy was receiving a series of positive global AS shocks. Such shocks resulted in record global growth rates and in turn, should have been manifested in a higher global neutral interest rate. Instead the Fed, given its monetary hegemon status, pushed global short-term rates below their neutral rate level. Some kind of asset boom-bust cycle was inevitable.

    (2)Regarding your counterfactual, I would note that a tighter monetary policy by Fed would have meant less need for dollar block CBs to intervene and prop up the dollar, and thus less need to buy up Treasuries/agencies in the first place. In turn, this would have affected the yield curve and the availability of liquidity in the U.S. mortgage market. In short, some (not all) of the saving glut was simply dollar block CBs recycling the loose U.S. monetary policy back to the United States.

  3. Thank you for exposing the "savings glut" hoax. It was just another of Helicopter Ben's salvos from his well-oiled spin machine. He's been good at deflecting blame, though his luck seems about to run out.