Financing the Budget Deficit and the Wealth Effect

People are already thinking about the bill of COVID-19, and how would it be paid. Just look up the Google mail and see the flood of articles. The New Zealand Minister said that the government will borrow to finance the deficit, but it is not as simple as this. At some point in time, a government, which may not be this government would have to raise taxes. The borrowing matters whether the public holds an interest-bearing government bonds or non-interest bearing bonds. The latter type is like the US Treasury Bills. They are non-interest bearing bonds or zero-coupons, which are bought at a discount price of their face value i.e., they pay no interest, but eventually sell at the par value, therefore, they bring about a positive yield to holders.  

What's the difference between these bonds and what is the effect on the economy?

On this issue, I remember a paper that I read when I was a graduate student preparing for my PhD exams, Robert Barro (1974) wrote in the Journal of Political Economy "Are Government Bonds Net Wealth?" This issue is pertinent to the situation we and others are facing.

Barro argued that government debt, which is held by the public could increase or decrease in real terms when the price level changes. So if the price level falls for whatever reason (the situation now with a near zero interest rate means that people are indifferent between holding money or bonds), the real value of government debt increases, and economy's level of wealth increases too. However, if the government finances the budget deficit with interest-bearing bonds, and people anticipate an increase in future taxes to finance the deficit, an increase in the real value of government debt outstanding will also imply an increase in the present value of future tax liabilities. Therefore, government debt cannot be considered a net wealth increase for New Zealanders.This bond buying business may not stimulate the economy as much as the government thinks. 

The NZ government bonds are low interest bearing bonds as shown in the this statement, but not a zero-coupon. Therefore, holding these bonds cannot be net wealth.

Financing the budget deficit with a non-interest bearing bonds (zero coupon bonds), on the other hand, could be a net wealth to New Zealanders. The reason is that the increase in the real value of the debt outstanding is not associated with an expected increase in tax liabilities. 

I seems like a great idea to buy government bonds while working and cash them to finance retirement, if they were zero-coupon type of bonds. In this case government debt is net wealth to Kiwis, and the government can finance its deficit and lower income tax on people's labor income. One can see how such fiscal policy can increase labor productivity. 

   

   

حول انخفاض سعر النفط والسياسة النقدية للعراق

تعاني الدول المصدرة للنفط كثيراً عندما ينخفض سعر النفط من "صدمات التجارة الخارجية السلبية (Terms of Trade Shocks)." وسبب المعاناة هو انها تعتمد على تصدير سلعة واحدة تكاد تكون، أو انها في الغالب، المصدر الوحيد للدخل كما في حالة العراق. وبما ان قائمة الاجور والمعاشات كبيرة جداً لان اغلب العاملين هم موظفون في الدولة وان سعر الصرف مقابل الدولار ثابت، فان هبوط اسعار النفط بشكل كبير ومفاجيء يؤدي الى انخفاض الدخل (الناتج المحلي). فعلى سبيل المثال انخفض سعر النفط الى حوالي 33 دولار امريكي الشهر الماضي. وبما ان سعر الصرف الثابت هو دولار واحد يساوي 1,192.54دينارعراقي تقريباً، اذاً سعر البرميل بالدينار العراقي حوالي 39,353.82 دينار. أنخفضت عائدات النفط في العراق الى حوالي النصف مؤخراً!

 

ما هو الحل لمجابهة التغيرات المفاجئة في سعر النفط؟ هناك سياستين معروفتين لكلٍ منهما فوائد ومضار. الحل الاولى هي خفض الاجور وشد الاحزمة على البطون – سياسة تقشفية. هذه سياسة يمكن ان يكون لها مردود سيء على الحالة المعيشية للناس وربما تؤدي الى تذمر شامل وعصيان مدني...الخ بالاضافة التى التدهور الاقتصادي الكلي. والحل الاخر هو الامثل والاصعب، ربما لذلك تتهرب اغلب الحكومات منه، هذا الحل يكمن في سياستين تتعلقان بنظام سعر الصرف.

 

 ألاولى، هي استهداف / تثبيت السعر المناسب للنفط ولكن بالعملة المحلية (الدينار). لنفترض ان الحكومة العراقية تريد ان تحقق سعر ثابت لبرميل النفط 100,000.00 دينار على سبيل المثال بدلاً من  39,353.82

ولا تريد أن تأبه لتغير سعر النفط بالدولارأبداً. كيف تحقق هذا؟ في هذه الحالة تعلن الحكومة للملأ انها تريد ان يكون سعر البرميل ثابت = 100,000.00 دينار مهما كان سعره العالمي بالدولار. اذا سعر الصرف الذي يحقق 100,000.00هو 100,000/33= 3,030.3 دينارً لكل دولار امريكي. أي على قيمة العملة أن تنخفض لكي يتحقق سعر النفط المطلوب بالدينارالعراقي. في هذه الحالة تحافظ الحكومة على الدخل بالدينار وبدون تأثير على ميزانية الدولة.

 

ان هذه السياسة لها فوائد عديدة. أولاً استقرار في الدخل والميزانية. ثانياً ان تغيرات سعر النفط لا تؤثر على الميزانية  والمواطنين. ثالثاً تقلل الطلب المحلي على الدولار. رابعاً يعمل سعر الصرف المتغير على امتصاص الصدمات بحيث يتأثر ولا يؤثرعلى الاقتصاد. ولكن هذه السياسة قد تؤدي الى زيادة الاسعار المحلية (اسعار السلع والخدمات) وربما تؤدي الى تضخم نقدي وذلك لان الاسعار والاجور بالدينار العراقي يجب أن ترتفع أيضا بما يناسب انخفاض قيمة العملةً بحيث تبقى القيمة الحقيقية ثابتة. ولكن في نفس الوقت يعطي تعويم العملة بهذا الشكل البنك المركزي القدرة على اتباع سياسات لمعالجة التضخم.

 

يعتبر مقدار تغير الاجور والاسعار والسرعة التي تتم فيها تعديل الاجور وتغير الاسعارالمسألة الاساسية والاهم في هذه التجربة. يفترض ان تكون هناك دراسة لقياس سرعة وحجم التغير في الاسعار والاجور نتيجةً لتغير سعر الصرف (The Pass-Through Effect).على سبيل المثال، اذا كان سعر الصرف قد تغير بمقدار 150% مثلاً (أي انخفضت قيمة الدينار 150نسبةً للدولار 150%) وان العلاقة بين الاسعار والاجور من جهة وبين سعر الصرف من جهة اخرى هي 1:1 ، فالاجور والاسعار يجب ان ترتفع 150% أيضاً.

 

أما السياسة الثانية فتدعوا الى تثبيت سعر الصرف الى سلة تحتوي على الدولار الامريكي واليورو وسعر النفط أيضاً. أي اضافة سعر النفط الى سلة العملات.فبدلاً من تثبيت سعر الصرف نسبةً للدولار، تُثبت العملة نسبةً للدولار واليورو وسعر النفط بالدولار.

 

 جيفري فرانكل (جامعة هارفارد) هو مؤلف هاتين السياستين.[1] وقد حاولَ الترويج لها بدون نتيجة فقد صمت دول الخليج اذانها لها. وقامت جمعية الاقتصاديين الكويتية باستضافته في الكويت قبل عدة سنوات لعرض هذه المقترحات الا انه لم يفلح بجذب انتباه السياسيين وبقي الدينار الكويتي مروبطاً بسلة من العملات ( ربما يشكل الدولار النسبة الكبرى فيها). ولكن دول الخليج تعتقد ان لديها خزين احتياطي تستخدمه عند الحاجة ولحين انتهاء أزمات  انخفاض اسعار النفط وهذا يغنيها عن الدخول في سياسات سعر الصرف العائم وما يترتب عليها من تبعات هي في غنى عنها.

 

أما العراق فيختلف عن دول الخليج من هذه الناحية. فالعراق ليس لديه صندوق احتياطي. انه يعتمد كلياً على النفط.

 

أتباع السياسة الثانية – أي سياسة تثبيت سعر الصرف الى سلة من العملات من ضمنها سعر النفط – لا يحتاج الى سياسة خاصة لمعالجة التضخم النقدي لان سعر الصرف لا يزال ثابت. أما أذا ما اتبعت السياسة الاولى، فهناك سياسيات عديدة للتصدي للتضخم ولكنها في الحقيقية تحتاج الى كفاءة عالية للبنك المركزي لذلك تخشى كل الدول الخليجية من تعويم العملة لانها تفتح الباب لهذه السياسات. مصر على سبيل المثال مضت في هذا الطريق وكذلك المغرب. فقد قاموا بتعويم العملة ولكنهما ليسا دولتين نفطيتين.

 

 من السياسات التي تستهدف السيطرة على التضخم النقدي مثلاً واكثرها سهولة هو تثبيت معدل نمو النقد المطروح للتداول. أو اخرى أكثر تعقيداً وهي قيام البنك المركزي بتحديد سعر الفائدة كما يجري في معظم دول العالم اليوم والذي يحدد سعر فائدة عند اقتراض البنوك التجارية من بعضها من اجل اتمام التسويات المصرفية (Overnight Interbank Interest Rate). أو استهداف معدل نمو الناتج المحلي الاسمي. هذه السياسات لا تختلف كلياً من حيث النتائج اذا ما كان معدل دوران النقد (Velocity of Money) دالة مستقرة مع تغير سعر الفائدة. بالامكان أيضاً اتباع سياسة لاستهداف الاسعار بدلاً من التضخم النقدي والتي تعمل على الحفاظ على استقرارالاسعار ذاتها وليس التغير في الاسعار.

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[1]على سبيل المثال أنظر  https://scholar.harvard.edu/files/frankel/files/ccb_erf_2017_oup_01.pdf ، و https://ideas.repec.org/p/cid/wpfacu/335.html

What Have I Learned from COVID-19 Data So Far...

Everyone knows that there is an argument about the data of the number of confirmed cases. Many papers were written about understating the number of infections. The typical story is that, with the absence of reliable and timely tests, we may have understated the infections by a factor of 10. Because the US government pays hospitals for treating infected patients, and also pay them more if the patients need to be on ventilators, some hospitals were overstating the number of COVID-19 deaths related cases. Minnesota was one state circulating in the news. So, if the numbers of confirmed cases, which we are using from Oxford University, the Johns Hopkins, or else in our research, are understated, researchers must deal with these measurement errors. Ordinary Least Squared regressions estimates are biased and inconsistent. IV estimators should be used. Testing for COVID 19 matters for reducing the number of deaths even though millions remained untested. See my paper

The second thing I learned from COVID-19 data is that the modelling of the infection using the Gompertz (1825) function overestimates the peak infection. Usually, we try to model the data as they arrive. The data have a steep upward slope. The Gompertz function is a very suitable model for this kind of events. However, it is a statistical function, which has a couple of fixed parameters. It does not account for policy. So if we have data from time t to t+k and we fit the function up to time t+k+1 without having accounted for policy, we will overestimate the peak infection. Policy (stringent) reduces the number of infections, but the Gompertz function does not take this into account.

Figure (1) plots my estimates of the New Zealand curve, see my paper ...The data that I used in this paper were from Feb 28 to Mar 27. Figure (2) use the same graph but add the actual data up to Apr 23. As you can see in figure (1), I predicted the peak infection to be 2630 cases on April 3. Then we learned when the actual data arrived that the number of infections on April 3 was 772, see figure (2). The peak, probably did not occur until April 22...and much lower than my estimate.

Figure (1)

Figure (2)

I also learned that policy responds to the number of infections positively, and the latter responds to the former negatively. Policy response, however, is endogenous and country-specific. New Zealand and Australia responded quite differently to the infection, but the outcomes of the two countries are pretty much similar. I also learned that if country A adopts country B policy response, country A cannot achieve the same outcomes of country B. I tested whether, or not, the New Zealand policy response, which achieved zero infections, could reduce infection to zero if it is adopted by Denmark, Sweden, and the USA.I found that it is effective in reducing the infections significantly, but not to zero as it did in New Zealand. There are omitted factors that need to be taken into account in such analysis. Culture might be an important missing variable. Although the Swedes and the Danes are seemingly Scandinavians, they followed different polices and the people have been reacting differently. The outcomes are very different. See my paper.     

I am sure that we will learn more from doing more research.

Future Prices and inflation

What happens to the future prices and inflation as a result of the expansionary polices in response to the pandemic? 

As a result of the increases in the money supply and government spending in response to the pandemic, future prices of goods, services, and assets will increase for sure...not necessarily the inflation rate. 

Under a system of inflation targeting, bygones are treated as bygones. It means that the increase in prices is not a concern, but the rate of growth of prices, i.e., inflation, is kept constant. 

The plot shows that currency per unit of real output and the CPI are positively correlated, thus in the short run the increase in the money supply increases prices under inflation targeting (it increases real output sooner, in the short run).

The second plot shows that there is no correlation between the growth rate of money per unit of real output and the expected inflation rate in the long run (6 quarter moving average) under inflation targeting. 

These are New Zealand data, but it is true in all inflation targeting countries.

That said, the pandemic might be an adverse supply shock. It knocks output production and increases the price.

Socialism, Government Expenditures, and Income Per capita

The former communist countries in the last century had very limited or no private enterprises at all. The share of government expenditures to GDP was almost 100 percent. The higher the share of government in GDP the more socialized the policies are. 

The share of government in the Western economies is quite high. They have public education, public health, public services, banks, government monopolies, public services, etc, i.e., socialized policies. 

Here is a plot of the average government expenditures to GDP ratio over the period 1990-2019 (source: here). The Asian countries, Singapore, Hong Kong, and Taiwan have smaller shares of government in output. 

The more important question is whether the increase in government share in output has any relative benefit? Are people better off? Here I plot the average growth rate of real GDP per capita at constant prices (in purchasing power parity; 2011 international dollar) over the period 1990-2019. 

The Asian countries are on top. The have relatively more private free market and higher growth rate of real GDP per capita in than all Western countries.


Finally, I put the two data together to show the negative correlation between the share of government in the economy and the richness of people. The Asian countries are in the upper left corner of the graph, where there is high income growth and less government. The Western countries are mostly in the middle and the lower right corner with less income growth and more government. 

More government means more socialism, bigger public sector, and relatively poorer people. 


The new generations of Americans and Western Europeans, including New Zealand, do not remember the communist countries of the last century. Today, many people, seem to favor socialized policies. They want more government even though they know that more government means more inefficiency, more regulations, more corruption, more interventions, and less freedom, etc. 

They want free education, free healthcare, etc. even though they know that people have to pay more taxes for them and they would get lesser quality services. 

The argument is that they care more about fairness and equality. 

Thomas Piketty, a famous French economist, proposes a tax on wealth to narrow the gap between the poor and the rich, i.e., reduce inequality. But why propose a policy to take money from a few wealthy people to give to the poor instead of a policy to enable the poor to be rich? Why not Italy, for example, which is in the lower right corner of the plot above be like Taiwan at the upper left corner? 

People should read more about the communist countries. It is true that 90 percent of the people were living at the same level, but there were elites who lived significantly lavish life. In fact there were only two distinct classes: the people and the elite.

There is a lot of corruption in the West. There is no free market. Big private businesses do not like free market. They are crony capitalists. They benefit from the government in many different ways, e.g., subsidies, grants, tax exemptions, quotas, tariffs on foreign imports, bailouts, etc. 

There is a wide revolving door, where these guys go in and out of government. For example, a big company CEO becomes a minister who bails out his friends, go back to the private sector, then come back to the government again a few years later. If people are concerned about corruption, they should know that the main cause of it is more government. Communist and socialist countries had corruption too. 

Young people who look up for a better future must think hard about a new form of a political system. They are surely capable of charting new future. Fundamentally, they should ask if more government reduces economic freedom (free market and perfect competition...), if it reduces civic freedom (free speech and free movement...), and if it reduces political freedom. The data show that more government reduces freedom.


    

New Zealand's Coronavirus Policies

The government's Coronavirus policy is driven by many factors, but R0 number (the reproduction rate) seems to be the PM (Jacinda Ardern) preferred indicator. The reproduction rate depends on total infections. There are more papers posted now arguing that total infections are understated especially when "testing" is lacking. So R0 is understated too. The official R0 is less than 0.5, maybe it is more than 1 or even higher. 

Conversely, the good news is that the death rate would be smaller than what we have, which is already relatively small. (death rate is number of deaths / infections). Should death rate be the guide for successful policy? I think so.

But what about those asymptomatic people who are infected? If indeed we have more infected people than we can tell, and we relax the lockdown to level 3 or 2, we could have a spike of infections and deaths next month.  I think that effective testing can resolve the problem. Those who test positive get quarantined and treated and those who test negative go back to work. The question is about testing every person, and quickly. Testing, however, requires money and resources.

It was reported that the government is looking into the proposal of the Chief Economist of the Kiwibank Mr. Kerr to give people cash, maybe 6 billion dollars. Cash gift is an ineffective stimulus. The theory of consumption predicts that people do not spend windfalls. A few desperate people might, but there will be no significant increase in consumption. Deposits in Kiwibank might go up a little :) A better way to spend the money, in my view, is that the PM Jacinda Ardern spends it on testing. Test every person, and do it before the end of the year. Hopefully a vaccine will be available early next year.

Does Testing for Coronaviris Reduce Death?

The Nobel Laureate Paul Romer explained his plan to restart the U.S. economy. He argues that conducting 30 million tests a day and allowing those who test negative to resume working would restart the economy sooner. Certainly, this is a smart idea that I have not heard anyone in this entirely infected world think about. Although they have been thinking about it for sure, so far, no government has provided any plan on how to restart the economy. Trump in fact said that he might stop testing altogether! 

Germans, on the other hand, have been testing people more efficiently. Say that there are five people in your bubble. They do a combined test for all five at once. If the result is negative then all five people are safe. If positive, they redo the test to each one in the bubble. So Germany could easily follow Romer's plan to restart the economy.

The population is very small in NZ so we have a very good chance that we can restart the economy in a week if the government follows these strategies. 

Ten days ago I began working on examining the effect of testing for Coronavirus on death. Ten days ago I found two data sets. The first one is published by the  EU (here) and the other is by Oxford University (here). The EU data set is large and reports data for deaths and infections by more than 200 countries and territories. Oxford University data set is smaller and reports data on testing for Coronavirus. The data are daily. Some countries report fewer data than other, different dates, and many have missing data. I combined both data sets to arrive at a balanced panel of 8 countries only that have continuous data from March 1 to March 31 for all three variables, tests, death, and infections.

I found that, on average, a one percent increase in daily testing for the Coronavirus reduces death by about 4 a day. When I allowed the coefficients to vary across countries, I found that the U.S. and Italy could reduce death by about 13 and 68 respectively. At a lower significance level, the Belgium and the U.K. could reduce death by about 2 and 32 respectively. Japan could reduce death by 25. So there is reasonable evidence in this small panel that testing for the virus reduces death. You can read the paper on Massey University Website in a couple of days (here).