Some impressions from BoL conference 19

What I really don't like about the BoL stance on this devaluation question (yes, here I go again) is how extreme Governor Rimsevics is in denying its positive effects. I mean, I'd find BoL position to be a lot more credible if they said something like "yes, devaluation has some positive effects, but these are outweighed by the negative effects". What the Governor said, in effect, boiled down to devaluation not having any positive effect, and anyone who talks about it is dispensing "pseudo-advice". I suspect the BoL projections of the effect of devaluation simply assume away all of its positive effects. How can the resulting numbers be credible?

Iesaki citiem:

I am talking about two fallacies here: (i) denial of devaluations' positive effect on exports; and (ii) denial of domestic demand substitution effects. Regarding exports, BoL says that devaluation would have little or no effect because demand in world markets is falling. However, this confuses shifts in demand curve for exports (falling incomes in the world) with movements along the demand curve (shifts in supply as a result of devaluation). Re substitution effects, all BoL is saying is that devaluation would result in inflation. They don't like to mention that prices of imported goods would rise by more than prices of (largely) domestically produced goods. Thus, whatever is produced by domestic producers would, in effect, become cheaper compared to imports. As a result, we would see substitution, i.e. increase in demand for whatever is produced locally. This would lessen, if not stop, the rate of job loss and have a positive effect non tax revenues. Yet the BoL says that their estimate of price elasticity of demand for imports to be close to zero, i.e. a demand curve for imports being near vertical! Both (i) and (ii) are equivalent to saying that people (consumers and producers) don't respond to changes in prices. Well, if that's what you believe, don't bother reading this blog and don't bother listening to any economists. Moreover, if price mechanism doesn't work, there is no point in having competitive markets - lets just go back to central planning.

Another highlight of the conference was a presentation by Anders Aslund. It's worth mentioning that, of course, Professor Aslund was invited precisely because he opposes devaluation. However, it's important to understand why he opposes it. In contrast to Governor Rimsevics, he does not deny devaluation's positive effects. In fact, Prof. Aslund opposes devaluation precisely because it works. His point is that going the way of 'internal devaluation' forces the policy-makers to implement painful 'structural reforms', i.e. to fix the supply side of the economy. Aslund sees sort of a 'governance failure' in peace time, when a country is not able to push through the necessary reforms because of all sorts of political opposition. He sees a crisis as a God-send opportunity for a reform; the more crises you have - the better, the harder the crisis is - the better. Devaluation is bad because it ends the crisis quickly, and does not provide sufficient pressure for implementation of structural reforms. Now that's a respectable intellectual argument against devaluation. If that's your position - fine. I hope you understand all the implications, though. Crises are good and should happen more often. We should prolong this crisis and strive to make it harder. High unemployment is good. Suffering is good. Bring it on! Still excited? - you would make a good zealot.

There is also something I really did not like in Anders Aslund's talk. I am talking about him invoking analogy with this 'two islands paper'. In short, there are two extremely similar islands - Barbados and Jamaica. They started from very similar initial positions in 1960s but widely diverged in their economic performance. According to Anders Aslund at the conference, "the big difference is that they [Barbados] did not devalue." But such a conclusion just does not follow from this paper! Check a short digest, or the paper itself. Especially, check Figure 1 in the paper. Jamaica's sharp decline in GDP per capita took place in 1973, a year after People's National Party came to power with a promise of "democratic socialism" and implemented "self-reliance" and "social justice" economic policies, i.e. heavy state intervention (p.7). Fans of industrial policy and "priority industries" - pay attention!

The 'internal devaluation' episode, that Prof. Aslund must be referring to, took place in the early 1990s when Barbados had a recession, turned to IMF for help, but refused to devalue. Barbados succeeded in reducing the wages, "achieving the same result as a devaluation", and "the economy recovered quickly" (p.10). However, note the following from Figure 1 in that paper. First, the gap with Jamaica was already there by that time and was reduced by this 'internal devaluation' episode, rather than widened. Second, note what happened after recession started in 1990. A sharp fall in GDP per capita until 1993, and then a period of very low growth until about 1997. Not exactly an L-shape, but not exactly a U-shape either, and certainly not a V. What a great example!

To summarize, this paper just doesn't prove Aslund's point that Barbados did so much better [than Jamaica] because "they [Barbados] did not devalue"! Ok, Riga is not an intellectual center of any kind, but that's not an excuse for Prof. Aslund to be so sloppy in his argument.

Iesaki citiem:
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Komentāri (19) secība: augoša / dilstoša

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Jah 10.10.2009 21:00
LB ir gana detalizēti dati, lai varētu sarēķināt, kā devalvācija ietekmēs LV ekonomiku. Vēl trakāk LB ļaudis to ir sarēķinājuši, tāpēc Rimševics tā izrunājas. Es tikai nesaprotu, kāpēc šie aprēķini netiek likti galdā publiski.

Autors diemžēl izvairās meklēt devalvācijas iedarbības apstiprinājumu salīdzinot LV ar tiem, kas devalvēja. Jācer, ka ne speciāli, jo izrādītos, ka valstis, kas devalvēja, neko būtisku nav panākušas.

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G.D. 09.10.2009 17:23
About exports I pretty much agree with the BoL. Latvian exports are usually produced in markets where the demand curve is actually extremely elastic,i.e. they are 100% price takers and their market share depends largely on geographic proximity. That means that devaluation really would not influence the price but would definitely positively impact profit margins (but it should be remembered that to achieve similar effect, devaluation should be larger than deflation because deflation of the wage bill shoud also compensate increase in the costs of imported goods). And, in this case, it really does not matter whether you devalue or you have unemplyment. It is the same effect: both have positive effects on profit margins. Of course, situation is a bit more complicated if we assume that wages bill is sticky, But it is not! Look at the statistics: it is falling drastically! And that is basically what wee see from anecdotical evidence: it is not exporters who are desperate. Different story is local consumption but I guess we have discussed it already somewhere.

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G.D. 09.10.2009 16:49
"High unemployment is good. Suffering is good. Bring it on! Still excited? - you would make a good zealot."

So... What is the opposite argument? "Everyone should retain their job? All the teachers, civil servants and the real estate guys should not suffer and stay in their jobs". Ok, nice...

As to the Jamaica - Barbados argument I cannot comment because I was not there. But as far as I see, merits of devaluation very much depend on structure of economy. If you are a leading economy in a number of fields and no substantial shifts in economic structure had occurred due to overheating, then yes, devaluation can improve situation: you devalue and everyone is better off producing the same volvos or legos but with larger margin. But as far as I see, that is not the case of Latvia with its enormous employment in real estate, retail and similar sectors. If devalued, Latvia would most certainly grow faster in the short term but what would be the medium term effect? We would preserve all those nice industries in building and we would have a nice employment in the public sector (which undoubtedly would grow fast!). But the result of this will be unsustainable debt. Therefore, yes, we should suffer! :)

Merits of devaluation are usually overstated exactly because of this fact: the scale of the figures is limited and comprise period of usually 5-10 years and they exclude debt. Devaluation or any nominal measures is actually a way sweeping the problems under the carpet. That is what we see currently in the West: yeah, sure, stimulus and unorthodox monetary policy works, but does it? The story is not over yet, whether the story will turn out to be a success or a failure depends on the last act in the play: planned "exit strategy" which supposedly imply unprecedented fiscal consolidation everywhere... Latvia, due to its love for fixed exchange rate is actually doing something which the whole world is supposed to be doing in 2012-2014 (Germany has a law postponing consolidation to 2020 :DDD). And I am not quite sure that we will see a happy ending there... But until now, gold prices have reached a new record (apparently there are quite a lot of people who have doubts).

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V Dombrovsky --> ME 08.10.2009 11:30
Maybe. The problem is we don't know anything about how many have migrated and how many of the unemployed are still here...

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ME 08.10.2009 00:35
Of course, in Latvia we have unemployment but if we consider massive immigration out of the country due to the low wages, I believe that employers might have very sufficient lack of qualified labour force here in the future

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V Dombrovsky --> Me 07.10.2009 08:38
Re wages, it all depends on the state of the labor market, doesn't it? Formation of wages depends on the unemployment. It's hard to ask for a higher wage if there are so many unemployed who could potentially replace you.

For example, if you were to devalue some time in 2006, the effect would be zero because it would all be offset by rising wages. Devaluation works when there are idle resources, e.g. unemployment.

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V Dombrovsky ---> nc 07.10.2009 08:33
Thank you for the kind words and also for asking pretty good questions.

As a matter of fact, we're preparing to write a more thorough article on this - maybe seomwhere to the end of this year. I'll mark your questions and make sure they're addressed.
Off the top of my head:

1. I don't, but I didn't look into this
2. Re businesses - not large (I have some data on this). The main thing here is that real effects are the same for devaluation and 'non-devaluation', but the latter works through reducing nominal incomes - we're seeing this, right?
3. Very good question. Noone knows by HOW MUCH you need to devalue. So the only way to be relatively sure you've done it is to make a large devaluation (50%?). Or, devalue and join the euro (unilaterally?) to rule out any future speculation/uncertainty.
4. I don't see a problem here. If you convince the markets that you've done your adjustment of relative prices, business as usual would resume. Or, maybe I just didn't understand your question here

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V Dombrovsky --> Trauts 07.10.2009 08:26
Hmmm.... I wonder where bold statements like (1) come from? Is it based on some empirical studies, your introspection, hearsay?

Why don't you start here? http://economics.about.com/od/priceelasticityofdemand/a/gaso...

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Me 07.10.2009 01:54
I also a bit disagree with Slava about this devaluation question. Let's say that devaluation is good, because it increases our exports and is God's gift for Latvia at the moment ( so to say - match made in heaven ) but there are some underlying assumptions which I would like to question. First of all, it is really interesting to know whether Marshall Lerner condition holds in Latvia at the moment( perhaps it is time to write a paper investigating this phenomenon ). If it holds then fine, but perhaps you could elaborate a bit more on the data side, declarative statements sounds good but are not valid for making inferential conclusions. Second of all, would it be possible to make this devaluation credible ( in other words is it possible that after one devaluation we experience many subsequent devaluations )? Very minor one - what about wage effect. We both know that people in Latvia do not really believe to government, so after devaluation basically higher wasges would be demanded thus it would just worsen the crisis and I believe that perhaps it is a bit too late for D...

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nc 06.10.2009 20:31
Slava, although I oppose your views, it is always a great pleasure to read your blog as a rare sample of quality in journalism/blogosphere in and about Latvia.

However, I would like to join Trauts and ask you or fellow commentators to write or maybe link the really missing piece of the puzzle in pro-devaluation camp:
(1) have any coutries with successful devaluation had huge private setor debt, denominated in foreign currency
(2) how big would be the number of household and business insolvencies caused solely by the devaluation (direct and indirect) of lat?
(3) Can this devaluation and bankruptcy spiral be controlled at all and how?
(4) What will happen to domestic lending after devaluation? Will there be foreign money to lend out / will local money be enough?

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xi 06.10.2009 19:27
Cheers, Slava!

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Andris_2 05.10.2009 21:23
Žēl ka es nesaprotu ko anglis raksta,varētu kādu žultainu komentāru uzrakstīt.

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Trauts 05.10.2009 12:52
I would prefer suffering because:
1.Price elasticity of demand for imports like oil, gas, electricity etc. ARE close to zero.
2.Most of our daily use products are import. Why? Because we don't manufacture wide variety of goods.
3.Think about all the debtors.
Yet you could mention these factors in your next analysis because they exist and are important to Latvia.

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x 05.10.2009 12:15
my compliments!

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to Slava 05.10.2009 01:07
I guess it's a pity that you don't publish your blogs on web pages of some recognized media, like the Diena. Your ideas and analyzes are quite of a fresh air in the overall "stink" of stupidity in different statements in regard to economics. My bet is that your blogs could make at least a bunch of people think a bit beyond the conventional, and it's already something.

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Jeffrey Sommers 03.10.2009 19:45
Bravo, Slava! I must admit to having had doubts regarding Aslund's Caribbean comparison previously. Your analysis certainly now makes me wish to dig into this further...

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a > JO 03.10.2009 12:03
Precīzi!

Šeit ir citāts:
"From this fact, many observers draw the specious conclusion that the difference in exchange rate
policy accounts for Barbados’ superior economic performance (e.g., Seaga, 2006). But
Barbados’ fixed exchange rate did not cause its economy to outperform Jamaica’s."

Tā kā Anders Aslunds acīmredzami iekļaujas starp tekstā minētajiem "many observers", kuru viedokli pētījuma autori kritizē.

Par augsmes atšķirību iemesliem autori min, lūk, ko:
"Rather, the proximate source of Barbados’ superior performance was a set of growth-facilitating policies— monetary restraint, fiscal discipline, openness to trade, and ultimately wage cuts to restore competitive unit labor costs—that had the side effect of enabling the monetary authority to maintain the exchange-rate parity without losing external competitiveness. In contrast, Jamaica’s policies were never consistent with maintaining commitment to any parity the government might have wanted to adopt."

Tā kā viss slēpjas valdību vēlmē veikt nepieciešamas reformas nevis pašā monetārajā politikā.

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JO 02.10.2009 23:05
starp citu, tajā Barbadosas vs Jamaikas pētījumā, uz kuru atsaucas Aslunds ir melns uz balta rakstīts, ka nedrīkst secināt, ka barbadosa attīstījās labāk, jo nedevalvēja. Tā arī rakstīts. Aslunds nevis ir sloppy, bet vnk melo.

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