I am Mostly Fuzzy

This week is the week when the International Monetary Fund releases its World Economic Outlook for April 2015. Newspapers are filling space with IMF analyses. Martin Sadnbu at FT (‘Free lunch’) cited a blog post by Francesco Saraceno (FS) as to how the IMF now appears willing to correct its own previously held views. The blog post is interesting. We need to read it to keep ourselves updated that there is no Washington Consensus, at least in Washington, as FS writes. May be, it is just the US Treasury consensus only, now. Intellectual openness at the Fund is to be welcomed.

That said, the extensive simulations done by the Fund economists based, presumably, on their DSGE models make eyes glaze over. An example is this. There is no way in hell of knowing how much would a Euro weakness help or hurt growth anywhere in the world, including in the Eurozone, especially now, when the band of uncertainty about what is happening to economic growth, global trade and energy demand, etc. is far wider than before. At worse, such analyses may help trigger ‘beggar thy neighbour’ reactions at the most inopportune time.

Look at another WSJ blog post on the rise in Eurozone household savings rate. At the same time the ECB is printing money, European households are saving more. Makes sense, from their point of view. After all, when returns to savings are lower, the targeted savings levels take longer to reach and hence households increase the quantum of savings. So much for policies such as low interest rates that boost spending. In other words, polilcymakers have to keep in mind the impact of policies on expectations. The latter are changed by the very policies that seek to achieve economic impact premised on unchanged expectations. This is the essence of Lucas’ critique and Lucas Critique, in plain English, is that Ceteris is not paribus. Other things simply do not remain the same. That is why economic theories are only useful starting points at best. The most egregious rejection of Lucas’ Critique is to be found in the QE policies of major central banks.

Most of the models are not equipped to deal with structural shifts and changes that economists and policymakers neither anticipated nor know how to handle. Consider this statement in the FT article on global trade growth slowing down:

With Tuesday’s forecasts the WTO seems to be joining a camp of economists who argue that the slowdown in trade growth is not only cyclical but has also been due to structural factors. [Link]

In the middle of the prominence given to the WEF released by the IMF, the WTO report on global trade outlook has been somewhat sidelined.

The opening lines of this story in FT on the world energy outlook confirm the same issue confronting all of us – we are flying blind:

The rebalancing of the global oil market may still be in its early stage with the outlook “only getting murkier”, according to the International Energy Agency, as uncertainties remain about demand and supply responses to the steep drop in prices. [Link]

There is no visibility for any one and, in such a situation, to make precise forecasts of how Euro weakness (or strength) would affect growth in the US and in China up to 2018 is a largely meaningless exercise.


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