Economist's View

Fed Watch: ZIRP and Interest Income

Tim Duy:

ZIRP and Interest Income, by Tim Duy: Edward Harrison at Credit Writedowns describes the Fed's zero interest rate policy as "toxic," noting that it is a transfer from savers and fixed-income investors to borrowers. On net, this is stimulative if the spending propensities of the latter exceeds that of the former, but the willingness of the borrowers to spend is constrained by weak household balance sheets. The Fed is thus pushing on a string, and possibly even making matters worse by reducing the income flow to households. Harrison points to the following chart to illustrate the severity of the problem:

If the Obama Administration takes advantage of low interest rates and is able to push forward with refinancing efforts for underwater borrowers, then we can expect an at least temporary economic boost of potentially substantial magnitude. See Joe Gagnon for estimates. I would expect more modest outcomes, as the Administration has proved itself capable of half-hearted efforts in the past. Anything, however, would be helpful at this point.

My question is how much of the zero interest rate environment is attributable to Fed policy directly? Or, in other words, is the Fed really just following the economy down? It seems that the banking system is awash with cash - note the trend of total checkable deposits:

Considering the lack of take-up on the other side of the savings/borrowing equation, I have trouble seeing that interest rates would go to anywhere but down to rock bottom levels. And I certainly have trouble seeing that the Fed would improve conditions by raising interest rates.

That said, I fully agree with Harrison when he predicts:

But remember, households are still over-levered and interest rates cannot be stimulative since they are zero percent. When the next recession hits and the yield curve is still flat as a pancake, bad things are going to happen. That’s why I have to remind you how toxic this policy is.

We have witnessed lower interest rates with each recession since the mid-1980's, which begs the question of what happens when the next recession hits and the economy is still locked on the zero bound. Bad things, I think. From this I conclude that the Federal Reserve is clearly not taking the zero bound seriously enough. This is even more evident when one recognizes the central tendency for the Fed Funds rate forecast over the longer term is 4.0 to 4.5%, while six FOMC participants see the rate unchanged through 2014! Seems like a serious disconnect between where the economy is and where it should be. It is simply tough to disagree with Brad DeLong, who, upon reading Jim Hamilton, concludes the Federal Reserve is just plain wrong in its implementation of policy.

Maybe the next round of QE will do the trick, but I remain skeptical. Policy has consistently fallen short of that necessary to decisively propel the economy off the zero bound. Such policies have, in my opinion, fallen victim to fears of inflation. The Federal Reserve appears committed to a 2% target under any circumstances, with even a temporary increase considered unacceptable.

In short, I see the Fed's policy as toxic not so much because interest rates are locked at the zero bound, but because the Fed sees no urgency in rectifying the situation. I think this will be proven to be a serious policy failure when the next recession arrives, and I wish the Fed would make a clear objective to lift the economy off the zero bound, rather than issue a forecast that, when coupled with lack of immediate policy action, represents acceptance of the zero bound. As far as what the Fed can do to accomplish such an objective, in addition to loosening the inflation target, I tend to think they need to shift their policy framework to regular, permament additions to the balance sheet until the economy is well beyond the zero bound rather than emphasize the temporary nature of the entire monetary policy agenda.

Harmful Austerity

I noted the damage that austerity has done to the recovery here, and as Paul Krugman notes today, Jared Bernstein has been pushing the same point. As I wrote:

Austerity is Holding Back the Recovery: ...premature austerity -- cutting spending before the economy is ready for it -- is taking a toll on the recovery. The fall in government spending reduced fourth-quarter growth by 0.93 percent...

This is the opposite of what the government should be doing to support the recovery. We need a temporary increase in government spending to increase demand and employment through, for example, building infrastructure. That would help to get us out of the deep hole we are in. Instead, the government seems to be trying to make it harder to escape.

We do need to address our long-run budget problems once the economy is healthy enough to withstand the tax increases and program cuts that will be required. But the idea of "expansionary" austerity has failed. Austerity in the short-term simply makes it harder for the economy to recover and delays the day when you can finally address budget issues without harming the economy. The lesson is that government needs to support the recovery, not oppose it through a false promise that contraction of one sector in the economy will be expansionary. And given how far we still have to go before the economy is healthy again, it's not too late to put that lesson into practice.

As Jared Bernstein emphasizes, the main driving force behind the cuts in government spending has been declines at the state and local level. Here's a story from the local paper illustrating the harm this is doing not just to our present, but also to our future:

Eugene's Halls of Not Learning, by Susan Palmer, The Register-Guard: It’s a little after 1 p.m. at North Eugene High School and the lounge areas are filled with clusters of students. At one table, a group of junior and senior boys plays Magic, a complicated card game.

When asked, they say they’d rather be in class. “Don’t depict us as being lazy,” said Walker Squires, a junior. “We’re not doing it out of idleness. If I could, I would be in class.”

But this is the new normal at Eugene School District high schools. Students arrive late, leave early, or find something to do in the middle of the day because they can’t get all the classes they need or want.

Cuts that have reduced the district’s general fund budget by more than $20 million over the past three years mean fewer teachers and fewer course offerings in the high schools.

Michael Anderson, a junior at North, would be taking Advanced Placement physics and chemistry this term if he could, but there is no room in those classes for him.

“It’s frustrating when you actually want to be in school,” Anderson said. He had hoped that high school would allow him to go more deeply into the sciences that captivated him when he was younger, but there just aren’t enough classes, he said. The problem is widespread across all Eugene district high schools. ...

Links for 2012-01-29

• Assessing John Cochrane - Brad DeLong
• Fannie and Freddie not to blame for bubble - Washington Post
• Social democracy and equal opportunity - John Quiggin
• Science on the Internet - Paul Romer
• The Worse-than Club - Paul Krugman
• What a Drag - Jared Bernstein
• Does the renminbi matter? - Vox EU
• Perverse Fiscal Policy - EconoSpeak
• The siren call of austerity - David Cay Johnston
• Higher Taxes Help the Richest, Too - Robert Frank
• Why Jobs in Manufacturing are Better - Robert Waldmann

Is Romney Double Taxed?

Rajiv Sethi:

Double Taxation, by Rajiv Sethi: The release of Mitt Romney's tax returns has drawn attention yet again to the disparity between the rates paid on ordinary income and those paid on capital gains. It is being argued in some quarters that the 15% rate on capital gains vastly underestimates the effective tax rate paid by those whose income comes largely from financial investments, on the grounds that corporations pay a rate of 35% on profits. Were it not for this tax, it is argued, dividends and capital gains would be higher, and so would the after-tax receipts of those (such as Romney and Warren Buffett) who derive the bulk of their income from such sources.

Romney himself has made this argument recently, claiming that his effective tax rate is closer to 50%:

One of the reasons why we have a lower tax rate on capital gains is because capital gains are also being taxed at the corporate level. So as businesses earn profits, that's taxed at 35 percent. Then as they distribute those profits in dividends, that's taxed at 15 percent more. So all total, the tax rate is really closer to 45 or 50 percent.

The absurdity of this claim is clearly revealed if one considers capital gains that accrue to short sellers, who pay rather than receive dividends while their positions are open. Following the logic of the argument, one would be forced to conclude that short sellers are taxed at an effective rate of negative 20%, thereby receiving a significant subsidy due to the existence of the corporate tax. The flaw in this reasoning is apparent when one recognizes that asset prices are lower (relative to the zero corporate tax benchmark) not only when a short position is covered, but also when it is entered. ...[continue reading]...

The Purpose of Macroeconomic Policy?

Chris Dillow is trying to figure out why the UK won't admit it's error in pursuing austerity. Perhaps the answer is that for some it wasn't an error:

Macro amateurs, micro geniuses?, by Chris Dillow: Simon Wren-Lewis says the coalition’s austerity is a “major macroeconomic policy error.”

It’s difficult to imagine the government ever acknowledging this. On Wednesday, Cameron resorted to immunizing strategies such as blaming the euro crisis (without noting that exports to the euro area have risen by 11.3% in the last 12 months), or celebrating the “lowest interest rates for a hundred years“, oblivious to the fact that these are a sign of economic weakness. I suspect that even if the GDP numbers had been much worse, he’d have used similar arguments.

Macroeconomic policy, then, is not only made by rank amateurs - not one of the five Treasury ministers in the Commons has a postgraduate qualification in economics and only one has significant experience in financial work. It is made by amateurs who seem immune to feedback. Errors are only to be expected.

Which raises a paradox. The job of running the economy is entrusted to anyone.  But the job of running companies requires people of such rare and delicate talent that only multi-million salaries will attract and motivate them.

Why the inconsistency? I suppose you could argue - Robert Lucas style (pdf) - that the benefits of good macroeconomic stabilization policy are small, as are the costs of bad policy, so it doesn‘t matter much who runs macro policy. But ... the benefits of “good management” are also small. Even if Stephen Hester could raise RBS’s value by 50%, the annuity value of this to tax-payers would be only 0.03% of GDP.

An alternative argument is that fiscal policy is not meant to be competent, but is instead meant to reflect the preferences of voters, and democracy is an intrinsic good, not an instrumental one.

There is, though, a third possibility. The purpose of macroeconomic policy is not to stabilize the economy or to raise growth, but is instead merely an ideological cover for shrinking the state. And that justification for multi-million salaries is merely ideological cover for kleptocracy. It’s just class war.

There clearly is a class of people willing to sacrifice the livelihood and well-being of others in pursuit of their ideological goal of a smaller government (so long as their own future remains secure). The notion of "expansionary austerity" was the cover, but so long as government shrinks as a result of the policy, the expansionary part is secondary. If reducing the size of government slows the recovery, that's a small price to pay for such a worthy goal -- for them anyway, the power behind this is in no danger of becoming unemployed. The main thing is to impose the small government ideology whenever there is a chance, and to use whatever argument is needed to serve that purpose, austerity is expansionary, tax cuts pay for themselves -- whatever works -- the ideologues will even embrace Keynesian economics if it allows them to argue for tax cuts that might further "starve the beast" (e.g. see Bush's argument for the first round of his tax cuts). But in the end the goal is a simple one, reduce the size and influence of government, and everything else is just a means of getting there.

Links for 2012-01-28

• Postmodern Business Cycles - Paul Krugman
• The Return of Schools of Thought Macro - mainly macro
• What does "Keynesian" mean? - Not the Treasury view
• More On Principal Reduction - Jared Bernstein
• Expanding our efforts to help more homeowners - Treasury Notes
• The Innovation Nation vs. the Warfare-Welfare State - Alex Tabarrok
• Alex Tabarrok: Public Goods Public Goods...!!! - Noahpinion
• The ECB is Plugging Holes - Rebecca Wilder
• Is opacity an excuse? - interfluidity
• What Is Private Equity? - James Kwak
• The politics of NGDPLP targeting, redux - Nick Rowe
• The Brain-Drain Panic Returns - Jagdish Bhagwati
• Francis Fukuyama on the Financial Crisis - The Browser
• Richmond Fed President Lacker on FOMC Dissent - FRB Richmond
• International Capital Flows, House Prices, and the Euro - The Street Light
• Do Big-Time Sports Mean Big-Time Support for Universities? - NYT.com
• Faster GDP Growth will be Welcomed by the White House - Ed Dolan
• 'Hire and fire' has destroyed Britain's jobs economy - Comment is Free

"Elite Wall Street Donations Jumped 700% in the Last 20 Years"

Via Derek Thompson:

Elite Wall Street Donations Jumped 700% in the Last 20 Years, by Derek Thompson: Banks "frankly own the place," Sen. Dick Durbin famously said of Washington during the debate over financial regulation in 2010. And when it comes to total contributions for big donors, you can see what he's talking about (FIRE = the Finance, Insurance and Real Estate sector):

Most of that growth is coming from the securities and investment sector, followed by real estate, Lee Drutman writes at the Sunlight Foundation, elaborating:

In 1990, 412 of the 1,091 elite donors from the finance industry came from the securities and investment industry, followed by 328 from real estate; by 2010, it was 2,178 from securities and investments, followed by 1,468 from real estate. In 1990, elite donors from securities and investments contributed $6.1 million and elite donors from real estate contributed $4.6 million. In 2010 elite donors from securities and investments contributed $84.0 million, while real estate donors contributed $44.5 million."

So, in a span when the financial sector's share of the economy expanded by a third, from 6% to 8.4% of GDP, donations from this particular group increased by 700%. ...

Greenspan's Faith in Markets

Antonio Fatás:

A matter of faith (in markets), by Antonio Fatás: Alan Greenspan contributed yesterday to the Financial Times debate about Capitalism in Crisis. The title of his article was "Meddle with the market at your peril". Not surprisignly Greenspan presents a strong defense of capitalism and market economies by comparing its success to the failures of other systems (such as planned economies).

I do not think that many disagree with that conclusion. But where the article surprised me is when he talks about the potential failure of markets:

Anti-capitalist virulence appears strongest from those who confuse “crony capitalism” with free markets. Crony capitalism abounds when government leaders, usually in exchange for political support, routinely bestow favours on private-sector individuals or businesses. That is not capitalism. It is called corruption.

This is the only sentence in the article where Greenspan admits that there could be some failure in a market economy. But that failure is driven by bad government behavior! Other than that, markets work fine. I hope his views are not really that extreme and that he is willing to accept some of the market failures that economists have identified in the past and that are taken care of by different forms of regulation. This is to me the interesting debate, the one that identifies market failures and then tries to address them via intervention or regulation. In that debate we might find that government intervention is not always possible or efficient. And I am sure we will find disagreement on the domains where government intervention is necessary or optimal. The other debate, the one that compares "capitalism" with the economic system of the former Soviet Union does not sound too interesting or useful at this stage. And it only leads to statements like the one above that seem to be driven by faith in one of the two systems.

For awhile, Greenspan seemed to recognize that his excessive faith in markets blinded him to the dangers of the housing bubble -- his famous mea culpa. But lately he seems to be backing away from that recognition in an effort to defend his reputation and his record as Fed Chair.

GDP Report: Austerity is Holding Back the Recovery

A few comments on the GDP report:

GDP Report: Austerity is Holding Back the Recovery

The government should be supporting the recovery, but it's not.

Paul Krugman: Jobs, Jobs, and Cars

Industrial clusters are more important than "heroic entrepreneurs":

Jobs, Jobs and Cars, by Paul Krugman, Commentary, NY Times: Mitch Daniels,... Indiana’s governor, made the Republicans’ reply to President Obama’s State of the Union address. ... Mr. Daniels first berated the president for his “constant disparagement of people in business,” which happens to be a complete fabrication. ... He went on: “The late Steve Jobs — what a fitting name he had — created more of them than all those stimulus dollars the president borrowed and blew.” ...

But ... Apple employs very few people in this country..., only 43,000..., and ... it’s not just about low wages. China also derives big advantages from the fact that so much of the supply chain is already there. A former Apple executive explained: “You need a thousand rubber gaskets? That’s the factory next door. You need a million screws? That factory is a block away.”

This is familiar territory to students of economic geography..., companies that make a large contribution to a nation’s economy ... don’t exist in isolation. Prosperity depends on the synergy between companies, on the cluster, not the individual entrepreneur.

But... From the G.O.P.’s perspective, it’s all about the heroic entrepreneur, the John Galt, I mean Steve Jobs-type “job creator” who showers benefits on the rest of us and who must, of course, be rewarded with tax rates lower than those paid by many middle-class workers.

And this vision helps explain why Republicans were so furiously opposed to the single most successful policy initiative of recent years: the auto industry bailout.

The case for this bailout ... rested crucially on the notion that the survival of any one firm ... depended on the survival of the broader ... cluster of producers and suppliers in America’s industrial heartland. If G.M. and Chrysler had been allowed to go under, they would probably have taken much of the supply chain with them — and Ford would have gone the same way.

Fortunately, the Obama administration didn’t let that happen... And the details aside, much of Mr. Obama’s State of the Union address can be read as an attempt to apply the lessons of that success more broadly.

So ... Mr. Daniels ... got his facts wrong, but he did, unintentionally, manage to highlight an important philosophical difference between the parties. One side believes that economies succeed solely thanks to heroic entrepreneurs; the other has nothing against entrepreneurs, but believes that entrepreneurs need a supportive environment, and that sometimes government has to help create or sustain that supportive environment.

And the view that it takes more than business heroes is the one that fits the facts.

Links for 2012-01-27

• The BEPress Journals Have Sold Out - Cheap Talk
• Berkeley Electronic Press Closes up Journals - Digitopoly
• A less opaque Fed will become boring - FT.com
• The Debate on Private Equity in 1989 - Rortybomb
• Elsevier’s economic case is lacking - Digitopoly
• Two Percent Is Not Enough - Paul Krugman
• Inflation target tyranny - John Quiggin
• Bergsten and Kierkegaard Need to Read Schelling - Monkey Cage
• The coming resolution of the Eurozone crisis - Bergsten and Kirkegaard
• The Greater Depression - Paul Krugman
• UK: Worse than the Depression? - Twenty-Cent Paradigms
• One-Sentence Tax Reform - Arnold Kling
• Weekly Initial Unemployment Claims increase - Calculated Risk

Is President Obama a Mercantilist?

I think this is right. As I've said, I have doubts about relying upon increasing exports as our growth policy for the future, but what the president proposed in his State of the Union address is not what I think of as Mercantilism:

The mercantilist impulse, The Economist: Matthew Ygesias, writing at Slate, is perplexed by Barack Obama's plan to "boost the economy by hindering trade". He argues that in his state-of-the-union address, the president evinced "a strikingly retrograde, self-contradictory, and confused agenda of reviving American prosperity through mercantilism". ...

Others also perceived a mercantilist undertone in the president's speech, and not for no reason. The president called for the creation of a new Trade Enforcement Unit, extolled the virtues of a tariff on Chinese tires, and said the country was on track to fulfill his promise, made in 2010, to double export growth by 2015.

But mercantilism is about more than promoting exports. It also carries an implication of protectionism.... And on this count, setting the trade complaints aside for a moment, the evidence doesn't fully support the charge. Over the past three years Mr Obama has made a number of moves that effectively facilitate trade, smoothing the way for imports as well as exports. Last year, for example, he ended a ban on Mexican trucks entering the United States—a NAFTA provision that had not been previously implemented. He also signed free-trade agreements with Colombia, Panama and South Korea, which he cited in last night's speech.

My colleague at Free Exchange is also critical of the president's rhetoric on trade. He argues that it will bring us to a thankless zero-sum game, at best. The president said that "if the playing field is level, I promise you–America will always win." ... It's a sympathetic intuition on his part, but I interpreted the president's comment as a narrower critique of China's business practices. And that critique is widely shared; you hear it from Republicans, from Democrats, from business, from environmental and human-rights organisations, and so on. Mr Obama has arguably been on the dovish end of the spectrum when it comes to China. Just last month, his adminstration declined to accuse the country of manipulating its currency; Mitt Romney, by contrast, has repeatedly said that it is, and urged the president to take action.

On balance, then, I would say that Mr Obama's mercantilism is overstated, even if he has rhetorical impulses in that direction. ...

Here are what I think of as the "tenets of Mercantilism." I'll let you decide the extent to which they accord with the president's policies:

Mercantilists believed gold and silver are the most desirable forms of wealth. They also believed that the wealth of a nation depended upon the quantity of gold and silver in its possession. To maximize their holding of gold and silver, countries should maintain a positive balance of trade (with every country in the early years, but in later years they thought that an overall positive balance of payments was the goal, not a positive balance with every country you trade with).

They did not see lowering costs of production, or production in general, as creating wealth. This was a time when guilds produced most goods, and they were very inefficient. Thus, there was no notion of say, using division of labor and innovation to reduce costs and gain a competitive advantage over other producers (producers were not thought to add any value to production -- this was a big part of their beleif that economics was a zero-sum game -- when they looked at their society and history, they didn't see much in terms of productivity led growth, or much growth at all, the key was to maximize your share of the wealth that existed rather than try to gain wealth through productive innovations). The key to wealth was arbitrage and astute trading, not production. So trade -- and merchants who could win the trade battle -- were the focus of attention. Nations became strong by winning the zero-sum trade game.

They promoted nationalism. Since everyone cannot have a positive trade balance - they saw trade as a zero-sum game - a country needs to be powerful in order to compete effectively. This led to a desire for a strong military, a strong navy in particular (many advocated war on land and war at sea as ways to increase wealth).

They promoted protectionism in all its guises to maximize exports and minimize imports.

They supported colonization. This was a source of cheap raw materials, and a captive market to sell the finished goods. This essentially creates monopoly power since they did not let other countries trade with their colonies.

They believed in free trade within a country, but monopolies on external trade so as to be as powerful as possible in trade negotiations.

They favored a strong central government to enforce regulation of business (regulation was widespread and used to try to maintain the quality of goods so they would be in high demand on international markets --some regulations, e.g. for textiles, required stacks of books -- they controlled just about every aspect of production in their attempt to ensure quality and protect their reputations).

They believed a strong central government would also help with another goal, that of maintaining a large, hard-working, poorly paid labor force (e.g., they had maximum wage laws) . The point of focus was the nation, not the individual, and a productive, cheap labor force helped to keep goods cheap, made producers competitive, and hence helped with the accumulation of gold and silver. They did not tolerate idleness, and forced children into the workforce as soon as they were able (e.g. by age six or the family paid a penalty). If children (or anyone else, e.g. the unemployed) could produce something for export, then put them to work so they can help the country grow strong.

Fed Watch: Notes on the Fed Meeting

Tim Duy:

Notes on the Fed Meeting, by Tim Duy: Just a quick note today – I am swamped with classes and travel this week, and sadly cannot really do justice to the wealth of information provided today by the Fed.

The basics are well known at this point. The Fed extended its expectation for low rate out through the end of 2014, with the new hawk on the FOMC, Richmond Fed President Jeffrey Lacker, dissenting. The growth and inflation forecasts for 2012 were downgraded, while the unemployment forecast was upgraded slightly. Individual forecasts of the path of the Federal Funds rate were revealed, with six participants anticipating interest rate hikes in 2012 or 2013, in contrast to the broader expectation for low rates through 2014. The Fed now has an explicit inflation target of 2%. No new QE at this time.

Some initial thoughts:

First, the forecast for unemployment and inflation, combined with the restatement of the dual mandate with an explicit inflation target, scream for additional QE at this time. This is especially so when you realize the range of 2014 inflation forecasts remains centered on something south of the 2% target. Simply put, the Fed is clearly falling short of both mandates at this point. We need to be patient for the minutes where we can expect to learn more about QE options, and I agree with Calculated Risk that the Chairman paved the way for additional QE, assuming of course that the economy does not show immediate signs of improvement. Still, the delay is frustrating given the forecasts. That said, I think in the last minutes it was clear the Fed was moving in stages, and the communication stage is now complete. Now we can focus on the next round of QE. In addition, most participants would not see a need for immediate action given the improvement in the data flow combined with still stable inflation expectations.

Second, the unemployment forecast appears vulnerable given how quickly the rate decreased in recent months. If the rate of job growth necessary to keep with labor force growth is significantly less than the 125k-150k estimates often used, then I would expect even tepid growth would send the unemployment rate lower than the Fed’s forecast. The Fed is likely expecting a rebound in the labor force participation rates, but is that likely given the tepid growth forecasts? And how much of a decline of unemployment over the next month or two would prompt Bernanke to put a hold on QE3?

Third, I don’t read too much into the divide between the hawks and the doves regarding the timing of a rate increase. That timing is based on each participant’s individual forecasts, with the hawks likely having somewhat more optimistic forecasts for growth and employment compared to the doves. If forecasts disappoint, then the hawks will not be in a position to push for a more aggressive path of tightening. Likewise, the doves will modify their position relative to how their forecasts evolve. Which is why I am looking at that unemployment rate forecast – it seems the most vulnerable.

Bottom Line: The Fed is poised for additional easing, but the next round of QE is not quite a certainty yet. But I think we would need to see some significant upside surprises in the data in the near term to put plans for additional easing on hold. Watch the unemployment rate. We are already at 8.5%, the upper end of the Fed’s forecast. The lower end is just 8.2% - not far away, and something that is plausible at early as next week. The Fed’s forecast just doesn’t feel right given the 0.6 percentage point decline over the past four months.

Promise in American Manufacturing?

In the State of the Union address, president Obama featured a revival of US manufacturing as one of the keys to a secure economic future. I am skeptical, but a group at MIT sees promise in this idea (and there does seem to be evidence pointing in this direction):

MIT faculty see promise in American manufacturing, by Peter Dizikes, MIT News Office: Not long ago, MIT political scientist Suzanne Berger was visiting a factory in western Massachusetts, a place that produces the plastic jugs you find in grocery stores. As she saw on the factory floor, the company has developed an innovative automation system that has increased its business: Between 2004 and 2008, its revenues doubled, and its workforce did, too. Moreover, the firm has found a logical niche: Since plastic jugs are both bulky and inexpensive, it’s not economical to produce them overseas and ship them to the United States, simply to fill them with, say, milk or syrup.

“Is this just an odd little story?” Berger asks. “Actually, no.” While the decline of American manufacturing has been widely trumpeted — manufacturing jobs in the United States have dropped from 20 million in 1979 to about 12 million today — conglomerates such as Procter & Gamble and high-tech firms such as Dow Corning have kept significant amounts of manufacturing in the country. Moreover, 3,500 manufacturing companies across the United States — not just the jug-making firm in Massachusetts — doubled their revenues between 2004 and 2008. With that in mind, Berger asks, “How can we imagine enabling these firms to branch out into more innovative activities as well?”

That is the kind of problem Berger and 19 of her faculty colleagues at MIT are now studying as part of a two-year Institute-wide research project called Production in the Innovation Economy (PIE), which is focused on renewing American manufacturing. The guiding premise of PIE is that the United States still produces a great deal of promising basic research and technological innovation; what is needed is a better sense of how to translate those advances into economic growth and new jobs.

As Berger puts it, “The single most important question in the study is: What kind of manufacturing do we need in order to get full value out of our innovation strengths?” ...

Like IT or not?

In so doing, PIE is also broadly scrutinizing a common assumption of the last quarter-century: that the information technology industry is the basic paradigm for innovation-based manufacturing in the United States. “Some people think we can just do the innovation, and then license and sell and outsource it,” Berger notes. By contrast, she says, “those of us in the PIE study think it’s an open question whether a similar model works elsewhere, particularly in the new emerging-technology areas.” ...

"A World with Healthy Middle-Class Societies"

Justin Fox:

Is the Next Karl Marx a Management Consultant?, by Justin Fox: Wouldn't it be nice, Francis Fukuyama writes in an article called "The Future of History" in the current issue of Foreign Affairs, if some "obscure scribbler ... in a garret somewhere" would "outline an ideology of the future that could provide a realistic path toward a world with healthy middle-class societies and robust democracies."

This ideology, Fukuyama goes on:

could not begin with a denunciation of capitalism as such, as if old-fashioned socialism were still a viable alternative. It is more the variety of capitalism that is at stake and the degree to which governments should help societies adjust to change. Globalization need be seen not as an inexorable fact of life but rather as a challenge and an opportunity that must be carefully controlled politically. The new ideology would not see markets as an end in themselves; instead, it would value global trade and investment to the extent that they contributed to a flourishing middle class, not just to greater aggregate national wealth.

It is not possible to get to that point, however, without providing a serious and sustained critique of much of the edifice of modern neoclassical economics, beginning with fundamental assumptions such as the sovereignty of individual preferences and that aggregate income is an accurate measure of national well-being.

There are other, more political, aspects of this ideology that Fukuyama goes into (and for those who have already clicked through to the article and found most of it to be behind a foreignaffairs.com wall, you can get through the wall just by registering; you don't have to pay). But reading his description of the economic side of it, I couldn't help but think to myself: This ideology already exists. Its scribblers aren't in "a garret somewhere." They're in well-appointed offices at business schools and management consulting firms.

I know this because these people are constantly submitting articles to HBR. A brief sampling: Michael Porter and Mark Kramer's "Creating Shared Value;" Christoper Meyer and Julia Kirby's "Runaway Capitalism;" Dominic Barton's "Capitalism for the Long Term;" the collected works of Umair Haque. And it's not just us: I got a press release last night from the World Economic Forum (presumably written in a Davos garret) headlined, "To Serve Society Better, Capitalism Needs a Redesign."

You could say this is just rhetoric and PR meant to stave off those truly radical scribblers in garrets — and that may be partly right. But something more fundamental is going on. ...

I hate to be Mr. Negative today, but I'm less than fully convinced that we are anywhere near embarking on a path that places the welfare of the middle class at the forefront of economic decisions.

"How the Big Three Forgot Accounting 101"

The accountant's view:

How the Big Three forgot Accounting 101, EurekAlert: The Big Three were so driven by short-term profits that they forgot – or ignored – basic accounting practices that could have helped guard against production decisions with long-term damage, according to an award-winning study by Michigan State University and Maastricht University in the Netherlands.

Essentially, the domestic automakers built far more vehicles than they needed while failing to appropriately account for the costs of excess capacity or the damage the overproduction would have on their reputations. ...

Karen Sedatole, MSU associate professor of accounting ... co-authored the study with Ranjani Krishnan, MSU professor of accounting, and Alexander Bruggen, associate professor at Maastricht.

From 2005 to 2006 – several years before the auto bailouts – the researchers did field interviews with managers from one of the domestic automakers and collected a wealth of production data on the entire North American auto industry.

What they found was a culture of emphasizing short-term gain over long-term brand stability at General Motors Co., Ford Motor Co. and Chrysler Group LLC.

By building more cars than the market demanded, domestic automakers could better compete with their foreign counterparts on the hours-per-vehicle metric used in the influential Harbour Report and widely considered an indicator of automotive efficiency. Increasing production also allowed them to keep significant and rising costs of excess capacity off the Income Statement and on the Balance Sheet in the form of inventory. This practice, although acceptable for financial reporting purposes, is contrary to good accounting practices from a management decision-making perspective.

By doing this, the automakers made it appear as though their costs-per-vehicle were lower and their profits higher. Such behaviors are not uncommon for firms facing pressure from stockholders to boost operating profit and pressure from the public to justify large bonuses to executives. Sedatole characterized all these factors coming together as the "perfect storm."

Krishnan said the problem was worsened by high turnover in the management ranks. "The fact is, five years from now a certain manager may not be working here, so he needs to make his production numbers today so his analysts are happy, his investors are happy, his customers are happy and he makes his bonus," Krishnan said.

In the field interviews, many managers indicated they knew the short-term strategy would hurt their company's brand image, or reputation, in the long-term, but could not alter the culture. ...

As a result, the automakers were left with an excess supply of vehicles they had to sell by offering huge incentives to consumers, a costly endeavor that also exacerbated the decline in brand image.

Since the industry crisis of 2008-2010, which led to the bailouts, the automakers have reduced some excess capacity, the researchers said. But as long as the automakers still can exceed market demand for short-term gain, Krishnan believes they will continue to do so. ...

Links for 2012-01-26

• Tax Distortions - Jared Bernstein
• The Specter of Rapid Austerity - The Denouement
• Finding the Truth - Paul Krugman
• What drives surges in capital flows? - Vox EU
• IMF Urges ECB to Expand Its Balance Sheet to Tame Crisis - WSJ
• How Hayek helped us to find capitalism’s flaws - FT.com
• State of the Union—Health Care Cannot Be Ignored - Aaron Carroll
• UK Growth reveals a major macroeconomic policy error - mainly macro
• The Impact of UI Insurance: As High as Barro Suggested? - Econ J. Watch
• Demographics and stock prices - John Cochrane
• Is there an austerity curve? - Stumbling and Mumbling
• Behind Closed Doors at the Fed - NYTimes.com
• The Sons Also Rise - Paul Krugman
• “Built to Last” - Jeff Frankel
• Musing on Economics - Modeled Behavior
• What we do with the debt matters - Antonio Fatas

The Fed will Keep Rates at "Exceptionally Low Levels" Through Late 2014

The Press Release describing the decisions of the Fed's monetary policy committee decisions was released this morning, and it is very similar to the press release from its last meeting in mid December with one notable exception. The Fed announced a commitment to "maintain a highly accommodative stance for monetary policy" by keeping the federal funds rate at "exceptionally low levels" at least through late 2014. The previous policy was to keep rates low through "at least through mid-201," so this extends the commitment by a year and a half and represents an easing of policy (I would have preferred more aggressive easing, it's not clear how much effect extending the commitment will have -- I don't expect it to be large -- but this is certainly a step in the right direction).

As for the tone of this statement relative to the statement in December, there is not much of a difference. There are a few minor changes, for example the statement about business investment is slightly more negative this time, and the committee dropped a statement about continuing to monitor inflation and inflation expectations closely (the "subdued outlook for inflation over the medium run" is one of the reasons the Fed decided to ease policy further), but beyond the change described above the two statements are very similar.

Here's the latest release:

SOTU: The President's Economic Proposals

My response to the economic policies discussed by president Obama in the State of the Union address (no link yet):

SOTU: The president's economic proposals, Commentary, CBS News: Prior to president Obama's State of the Union address I said he should do two things, defend the administration's economic policies to date, and talk about what will be done from this point forward to solve the nation's economic problems.

However, except for the bailout of the auto industry and a brief mention of a few other successful initiatives such as financial reform, the president didn't say much about his administration's past economic policies. In retrospect, that was probably wise. Trying to convince people that the stimulus and bailout policies were more effective than they realize simply brings these issues into the limelight. The policies were very unpopular, and arguing with the public about their success is a losing proposition. It's better to look ahead. As Obama said in the speech:

I want to speak about how we move forward, and lay out a blueprint for an economy that's built to last -- an economy built on American manufacturing, American energy, skills for American workers, and a renewal of American values.

The president began the discussion of his economic initiatives by outlining a proposal to revive manufacturing in the US. The plan is to use tax breaks to encourage companies to locate in the US, to keep jobs at home by eliminating tax advantages for companies that move offshore, to lower corporate taxes in the US, and to appeal to the goodwill of US companies (who should do what they can do to bring jobs back to this country).

He also wants to boost exports. To this end, he proposed more trade agreements (and lauded those the administration has already put into place), and he highlighted the creation of a "Trade Enforcement Unit that will be charged with investigating unfair trade practices in countries like China."

Finally, the plan to revive economic growth and employment also involves more support of small businesses, e.g. tax cuts and a reduced regulatory burden, support for research and development (particularly in energy related areas), mortgage refinancing for "responsible" homeowners," an extension of the payroll tax cut, and a plan to repair crumbling infrastructure.

The plan the president outlined is fine as far as it goes, but I wanted a jobs plan that was big and bold. I wanted a plan that puts immediate job creation at the forefront. However, this plan is largely tax cuts, it's piecemeal, and it's mostly directed at our long-run problems. Bringing business home doesn't happen overnight, R&D takes time, so does infrastructure, and so on. Millions of people need jobs now, not later. They don't have time to wait, for example, for manufacturing to move from China back to the US, and there's no certainty that will happen in any case. What was missing from the speech is a strong, coherent plan to create jobs immediately. Don't get me wrong, we need to address our long-run problems. But we also need to get people back to work as soon as possible.

Obama's education initiatives also deal with long-run rather than short-run issues. His call to improve education at all levels, and to make sure higher education is available to everyone is certainly welcome and it would help us in the long-run, but it won't create many jobs over the next few months. He does call for improved job retraining programs, and "a national commitment to train two million Americans with skills that will lead directly to a job," but even those programs will take time to put into place.

He also mentioned other issues in the speech such as the budget deficit and the need to regulate markets, financial markets in particular. The most notable proposals are his plan to impose a minimum 30 percent tax rate for incomes over a million dollars per year, and the surprisingly strong commitment to pursue financial fraud. The administration will create "a Financial Crimes Unit of highly trained investigators to crack down on large-scale fraud and protect people's investments." Obama will also ask the Attorney General "to create a special unit of federal prosecutors and leading state attorneys general to expand our investigations into the abusive lending and packaging of risky mortgages that led to the housing crisis." This is very much needed, and should have been done long ago.

Finally, in my list of recommendations I also mentioned the need to hammer Republicans over obstructionism, and on this topic the president said "I intend to fight obstruction with action." I'm not exactly sure how that works, but at least he mentioned the issue.

Right now, there are millions of people unemployed. That's a poor state of the union -- we have an employment crisis -- and putting people back to work ought to be treated as a national emergency. Though I am less enthusiastic than the administration about an export led strategy for economic growth, the speech hit many of the right notes where our structural problems are concerned. And there were certainly nods toward our short-run problems as well. But a strong sense of urgency about our immediate employment problem was missing from the speech. It's probably wise politically not to promise to create jobs between now and November. That could backfire if unemployment falls sluggishly or not at all (and if unemployment falls at a relatively fast pace, the administration can still claim credit). Nevertheless, I would have preferred a more concerted and detailed effort to deal with our immediate employment problems.

Links for 2012-01-25

• What to Expect From the Fed - WSJ
• The world’s hunger for public goods - Martin Wolf
• Buffett vs. Mankiw on Taxes - NYTimes.com
• A Tale Of Two Bubbles - Paul Krugman
• Did Summers Fear the Invisible Bond Market Vigilantes? - Brad DeLong
• How Summers' memo hobbled Obama's stimulus plan - Dean Baker
• The Concentration of Capital Gains and Dividend Income - Rortybomb
• Using Beveridge curves to ID cyclical and structural shocks - MacroMania
• Real Economists of the Ivory Tower - Blog of the Century
• Keynes on Austerity and Extremism - NYTimes.com
• The IMF's latest forecast: Perverse austerity - Greg Ip
• A modest proposal for tax reform - Richard Green
• Romney's Taxes - Paul Krugman

"How to Save Economics"

Robert Johnson on how to save economics:

...first, economists should resist overstating what they actually know. The quest for certainty, as philosopher John Dewey called it in 1929, is a dangerous temptress. In anxious times like the present, experts can gain great favor in society by offering a false resolution of uncertainty. Of course when the falseness is later unmasked as snake oil, the heroic reputation of the expert is shattered. ...

Second, economists have to recognize the shortcomings of high-powered mathematical models, which are not substitutes for vigilant observation. Nobel laureate Kenneth Arrow saw this danger years ago when he exclaimed, “The math takes on a life of its own because the mathematics pushed toward a tendency to prove theories of mathematical, rather than scientific, interest.” ...

The third remedy for repairing economics is to reintroduce context. More research on economic history and evidence-based studies are needed to understand the economy and overcome ... mechanistic bare-bones models...

Fourth, we must acknowledge the intimate, inseparable relationship between politics and economics. Modern debates about who caused the financial crisis—­government or the private financial sector—are almost ­nonsensical. We are living in an era of money politics and large powerful interests that influence the laws and regulations and their enforcement. In order to catalyze the evolution of economics, research teams would benefit from multidisciplinary interaction with politics, psychology, anthropology, sociology and history.

Such interdisciplinary communication would also benefit another neglected area of economics: the study of macroeconomic systems. Psychologists mock what economists call the micro­foundations of consumer behavior.... That this framework is suitable for aggregate systems in a globalized economy simply because the tribe called economics has agreed to adhere to these ad hoc assumptions makes no sense. Increased interactions with disciplines that economists have often mocked as unscientific would greatly improve economists’ understanding of the real world and would be more truly scientific. ...

Curious to hear your thoughts on this, the last point in particular.

Cochrane and Stimulus

Noah Smith is surprised:

Cochrane: Just don't call it "stimulus"!, Noahpinion: John Cochrane has a long blog post up, the first half of which is a general discussion of the idea of fiscal stimulus, and the second half of which is a rant about how mean Paul Krugman and Brad DeLong are. I'm going to talk about the first half.

Cochrane writes:

Let's be clear what the "fiscal stimulus" argument is and is not about. 

It is not about the proposition that governments should run deficits in recessions. They should, for simple tax-smoothing, consumption-smoothing, and social-insurance reasons, just as governments should finance wars with debt. That doesn't justify all deficits -- one can still argue that our government used the recession to radically increase permanent spending. But disliking "stimulus" is not the same thing as calling for an annually balanced budget. 

Nor is it about debt financing of "infrastructure" or other genuine investments. If the project is valuable, do it. And recessions, with low interest rates and available workers, are good times to do it. That doesn't justify all "infrastructure" roads and rails to nowhere, of course... 

The "stimulus" proposition is that additional spending -- whether needed or not -- raises output and general welfare.  Pay people $1 to dig ditches and fill them up again, and the whole economy gains $1.5. (emphasis mine)

So Cochrane:

1. Is against austerity during recessions, and

2. Is in favor of increased public investment during recessions.

But countercyclical deficits and countercyclical public investment do not, in his terminology, represent "stimulus"; that term is reserved for the Old Keynesian hole-filling sort of spending. And what does Cochrane think about that sort of stimulus?

Stimulus still an economically interesting proposition, and there is a great deal of uncertainty about whether, when, and how well it might work. There is a huge academic literature being produced right now... 

Here are the facts. Some economic models do predict a fiscal stimulus effect. Some don't...The facts are far from decisive...So, there is a lot of uncertainty and a lot we don't know about how the macroeconomy works.

And my response to this is:

!!! o_O !!!   <-- (this is an "emoticon" that indicates surprise)

If I told you that a famous economist thought that austerity is a bad idea in recessions, that recessions are a great time to boost debt-financed infrastructure investment, and that additional Keynesian stimulus spending was an "economically interesting proposition" about which the jury was still out, would you guess that the economist was John Cochrane? Before I read this post, I would not have. But hey, that's cool! ...

So why doesn't Cochrane stand up and loudly advocate a  massive debt-financed program of road and bridge repair? Is it because the public might get the wrong idea, and start believing in "stimulus" of the hole-filling variety? Is it because infrastructure investment must be politically sacrificed in order to "starve the beast" and fight against creeping socialism? Is it just because Paul Krugman and Brad DeLong are mean mean meanies?

For crying out loud!

I may be wrong, but it seems to me that politics and/or personal feuds have contaminated the public debate over fiscal policy.

SOTU: Obama Must Make the Case for His Economic Agenda

What should Obama say about his economic policies in the State of the Union address?:

SOTU: Obama must make case for his economic agenda

I like the longer version better, but there is also a shorter version here.

Update: Don't like some of the tweaks from an editor onthis one -- here's the unedited version:

SOTU: Obama Must Make the Case for His Economic Agenda: Since this is an election year, the annual State of the Union address provides Obama with the opportunity to convince voters that his economic policies have helped to bring about the recovery that is currently underway, and to highlight his plans for the economy from this point forward.

What does Obama need to do to defend his economic policies?

First, he needs to convince voters that his economic policies have been directed first and foremost at the problems the recession has caused for working class households. The perception is that saving the bankers came first, some see the financial bailout as little more than a way to make the already rich even richer, and with Wall Street recovering much faster than Main Street that sentiment is understandable. Why weren't job creation, mortgage relief, and other policies to help those struggling due to the recession higher priorities for the administration?

I think Obama can answer the question about why a financial bailout was necessary. The situation would have been much worse for the working class if the financial system had been allowed to meltdown entirely, and the financial bailout prevented that from happening. A harder question is why it was necessary to bailout the very people who caused the problems in the first place. Why weren't the high rollers in the financial sector asked to pay a higher price? Why couldn't we, for example, have nationalized troubled banks temporarily, kicked out the financial executives, repackaged the assets, and then resold them back to the private sector? That's what we do, in essence, when traditional banks go bad so why not do it here too?

Here again there's an answer, the administration did not feel it had the legal authority to do the bailout any other way -- the troubled institutions were non-traditional "shadow" banks and they did not have the necessary legal powers -- and not doing it at all would have been a disaster. There is disagreement about what they had the authority to do, but I think the administration is sincere in making this argument. In any case, Obama should take this opportunity to point out that the Dodd-Frank legislation fixes the problem of not having the legal authority to do anything but throw money at troubled too big to fail institutions, and that some of the key provisions of the Dodd-Frank legislation required time to implement and are just now coming online. But the main point to emphasize is that the recovery we are finally starting to see took a long time to get here, in part due to the political obstacles the administration faced, but it would have been even worse had the administration been less aggressive in its attempts to save and reregulate the financial sector.

But if the point was to help the middle class rather than bankers, what evidence is there that this has happened? This brings up the second thing Obama needs to do, explain how his stimulus package helped working class households -- the general perception is that it didn't do much at all -- and explain his plans to get people back to work as soon as possible. What does he plan to do between now and November?

The case for the stimulus package is a tough one, and it's partly the administration's own fault. The administration's initial projection for the severity of the recession was far, far too rosy, and this caused them to predict levels of unemployment that were much lower than they would actually be able to attain. When the actual economy turned out to be much worse than predicted, actual levels of employment fell short of projections making it appear that the stimulus did little or nothing. For example, suppose the prediction is that the unemployment rate will be 8 percent with no stimulus, and 6 percent if you put a stimulus in place. Thus, you tell everyone exactly that, the economy is likely to go to 8 percent unemployment if we do nothing, and 6 percent with the stimulus package. However, if the actual no-stimulus outcome is 10 percent rather than 8 percent, then even if the stimulus brings unemployment down to 8 percent it will look like it did nothing. You predicted 8 percent without the stimulus, and 8 percent was the outcome.

Thus, even though there is lots of evidence from both academic and business economists that the stimulus policies worked (e.g. 1, 2, 3), the president is in a tough spot making the case. I think the answer is to say exactly what happened, the original projections were far too optimistic and so on, and emphasize that things would have been much worse without the stimulus package.

But more important politically is what the president plans to do next, in particular between now and November, and the president must emphasize a strong commitment to job creation. The chances that a Republican Congress will go along with the president's proposals are very low, and he should not be shy about pointing to the political barriers that stand in the way of his policy initiatives. But he must make it clear that he won't stop trying to do whatever he can on behalf of the working class -- that he'll keep pounding Congress on this issue at every opportunity. The actual performance of the economy around election time is what will matter most, if things are improving that will make a big difference in November. But it's very unlikely our problems will be completely over by the time the election rolls around, and whatever Obama can do to make it clear that he is doing his best to help working class households despite the obstruction he faces will aid his election chances.

Summers and Stimulus: More or Less?

Jared Bernstein defends Larry Summers:

Summers and Stimulus, by Jared Bernstein: Ryan Lizza has a great piece out on President Obama’s decision making processes though many of the toughest issues he’s faced. ... He even links to one of key economic memos, and here, on one specific point, I’d like to offer a different, and I think more accurate, angle to Lizza’s take.

Throughout the article, Lizza supports the view that economic adviser Larry Summers was on the side of doing less in terms of stimulus against those of us who argued for doing more. Not so. ... Rather than discouraging the President from doing more, I recall his position as being much like he describes in the memo...:

“The rule that it is better to err on the side of doing too much rather than too little should apply forcefully to the overall set of economic proposals.”

I’m not saying we did enough, but I am saying Larry was among those who recognized the urgency of the Keynesian imperative. And not just in January of 2009, but for the duration of his tenure. ...

What about the charge that, as Krugman puts it:

[Summers et al believed that] if the stimulus is too big, we’ll have trouble scaling it back, but if it’s too small, we can always go back to Congress for more. That was deeply naive — and I said so in real time.

The reply is:

And yes, Larry was wrong, as was I and many others, that it would be easier to add than subtract. In fact, the evolution of that view is at the heart of the Lizza’s trenchant analysis, which at its core is an anatomy of the level of partisanship with which we are currently stuck. 

It’s fair to say that too few of us recognized that dynamic coming out of the gate. It’s also fair to say that such die-hard, mindless opposition by those whose primary goal is to defeat the President is…um…antithetical to good government, to put it nicely.

The fact that they'd face "die-hard, mindless opposition" from Republicans shouldn't have come as a surprise. Krugman and others warned about that as well.

Links for 2012-01-24

• Capital inflows, exchange-rate flexibility, and credit booms - Vox EU
• The State of Our Disunion - Robert Reich
• Economic uncertainty is no excuse for inaction - Larry Summers
• Journals Serving as Tombstones 学术期刊只是墓碑 - DannyQuah
• Racial Attitudes a Powerful Predictor of Obama Vote Preference - YouGov
• Getting up to Speed on the Financial Crisis - NBER - Gorton, Metrick
• The Safe-Asset Share - NBER - Gorton, Lewellen, and Metrick
• Capital controls are not beggar thy neighbour - Kevin P. Gallagher
• Romney Proposals Would Slash Nondefense Programs - CBPP
• Mispricing of sovereign risk and multiple equilibria - Vox EU
• How Fast, Recovery - Modeled Behavior

Surowiecki: Private Equity

Here's an explanation of how private equity works from James Surowiecki of the New Yorker:

Private Equity, by James Surowiecki: ...the people who run America’s private-equity funds must be ruing the day Mitt Romney decided to run for President. His fellow Republican candidates, of all people, have painted a vivid picture of private-equity firms ... as job-destroying vultures, who scavenge the meat from American companies and leave their carcasses by the side of the road. ...

But the real problem with leveraged-buyout firms isn’t their impact on jobs, which studies suggest isn’t that substantial one way or the other. ... The real reason that we should be concerned about private equity’s expanding power lies in the way these firms have become increasingly adept at ... deriving enormous wealth not from management or investing skills but, rather, from the way the U.S. tax system works. Indeed, for an industry that’s often held up as an exemplar of free-market capitalism, private equity is surprisingly dependent on government subsidies for its profits. ...

In the past decade,... Having already piled companies high with debt in order to buy them, many private-equity funds had their companies borrow even more, and then used that money to pay themselves huge “special dividends” ... to recoup their initial investment while keeping the same ownership stake. Before 2000, big special dividends were not that common. But between 2003 and 2007 private-equity funds took more than seventy billion dollars out of their companies. These dividends created no economic value—they just redistributed money from the company to the private-equity investors.

As a result, private-equity firms are increasingly able to profit even if the companies they run go under—an outcome made much likelier by all the extra borrowing—and many companies have been getting picked clean. ...

As if this weren’t galling enough, taxpayers are left on the hook. Interest payments on all that debt are tax-deductible; when pensions are dumped, a federal agency called the Pension Benefit Guaranty Corporation picks up the tab; and the money that the dealmakers earn is taxed at a much lower rate than normal income would be, thanks to the so-called “carried interest” loophole. ... It’s a very cozy arrangement.

If private-equity firms are as good at remaking companies as they claim, they don’t need tax loopholes to make money. ... Time to change them.

Paul Krugman adds:

Summers and Shleifer argued back in 1988 that buyouts are often aimed at “value redistribution” rather than “value creation”; specifically, a lot of the gains to the buyout specialists come from breaking implicit contracts with “workers, suppliers, and other corporate stakeholders.”

They make one especially keen point: if it were really about adding efficiency, why do the same people lead takeovers in many industries, instead of people with specific expertise in each industry doing the job? Their answer is that these specialists are specialists in deal-breaking, not value creation.

Is Newt a Bubble?

As I'm watching political scientists squirm in their chairs trying to answer the question of whether Newt is for real or a temporary blip in Romney's path, and answer why they didn't see the latest Newt bubble coming, it brings back memories.

So what do you think? Is Newt a bubble? Will his support collapse suddenly and spectacularly, or is he here for the long haul?

"The Food Stamp Speaker"

If you look into why food stamp enrollment has increased so much during the recession, it turns out that Newt Gingrich played a key role. This is from David Dayen at FDL:

The “Food Stamp Speaker” is Actually Newt Gingrich, by David Dayen: ...Gingrich never tires of calling Barack Obama a food stamp President, saying that the food stamp rolls increased by the highest amount in history under this Administration. As a technical matter, this is not true. George W. Bush actually put more people on food stamps than any President in American history... But that doesn’t totally get at who is responsible for the increase in food stamp benefits. ...

As Brooks Jackson points out, the economic downturn that began in December 2007 made 4.4 million Americans newly eligible for food stamp benefits. The Obama Adminstration included increased benefit levels in the 2009 stimulus... But there’s a reason that the food stamp program, or SNAP, became a vehicle for direct benefits to poor Americans. It can be traced back to a guy named Newt Gingrich.

In 1996, Gingrich succeeded as House Speaker in passing welfare “reform,” which decimated the welfare program, particularly its ability to respond during times of economic stress. ... The 1996 welfare reform made cuts to SNAP, most of which remain. But it’s still expandable during a downturn, unlike TANF. In 2010, 40% of single mothers received food stamps, while only 10% received TANF funds. And this is why SNAP costs increased by 102% during the Great Recession.

In other words, without the “end of welfare as we know it,” nobody would likely have become a food stamp President. ... I suppose the other option is to let the poor starve, which Gingrich must be advancing. But when he talks about “food stamp Presidents,” recognize that he’s responsible.

And he should be thrilled to take the credit! The US Department of Agriculture estimates that $1 spent on food stamps generates $1.79 for the economy, creating economic activity with one of the best multipliers of any federal program. Census data from 2011 shows that SNAP kept 5.1 million Americans out of poverty, including substantial numbers of women and children. It’s a great program... Almost all of the benefits get directly to people with a tiny administrative overhead.

This part is important:

Of course, whether or not SNAP is a good program has little to do with the racial overtones of Gingrich’s remarks. He and his allies can object all they want, but he clearly is painting a picture of a “food stamp king” as a mirror to Ronald Reagan’s “welfare queens.” This is ridiculous, primarily because the plurality of food stamp beneficiaries – 36% – are white. ...

I'm not sure what Newt is supposed to get credit for here. He squeezed the balloon at one end -- cutting welfare as we knew it -- and is disappointed that it inflated somewhere else. As he makes clear, he is not at all pleased that the people kicked off of welfare have been able to find a way to eat through food stamps. If he gets the chance, he'll fix that.

Finally, I have to add that it's pretty disappointing that the press will not go after Newt (or anyone else on the right) for the clear racial undertones of his remarks on this and other issues. Newt and his followers believe that most of our problems can be blamed on poor minorities and the government's attempt to help them -- if the poor only had Newt's morals (ahem) they wouldn't have these problems -- despite very clear evidence to the contrary. Admitting the truth about what caused our problems would mean placing blame on key powers within the conservative cabal, and it would require them to accept regulations and other restricitions on their ability to make unimaginably high profits. That is to be avoided at all costs.

Paul Krugman: Is Our Economy Healing?

The economy is looking a bit better, but that could change if policymakers make the wrong decisions:

Is Our Economy Healing?, by Paul Krugman, Commentary, NY Times: How goes the state of the union? Well, the state of the economy remains terrible. ... But there are reasons to think that we’re finally on the (slow) road to better times. And we wouldn’t be on that road if Mr. Obama had given in to Republican demands that he slash spending, or the Federal Reserve had given in to Republican demands that it tighten money.

Why am I letting a bit of optimism break through the clouds? Recent economic data have been a bit better... More important, there’s evidence that the two great problems at the root of our slump — the housing bust and excessive private debt — are finally easing. ...

There are, of course, still big risks — above all, the risk that trouble in Europe could derail our own incipient recovery. And thereby hangs a tale — a tale told by a recent report from the McKinsey Global Institute.

The report tracks progress on “deleveraging,” the process of bringing down excessive debt levels. It documents substantial progress in the United States, which it contrasts with failure to make progress in Europe. And while the report doesn’t say this explicitly, it’s pretty clear why Europe is doing worse than we are: it’s because European policy makers have been afraid of the wrong things.

In particular, the European Central Bank has been worrying about inflation ... rather than worrying about how to sustain economic recovery. And fiscal austerity ... has depressed the economy, making it impossible to achieve urgently needed reductions in private debt. The end result is that for all their moralizing about the evils of borrowing, the Europeans aren’t making any progress against excessive debt — whereas we are.

Back to the U.S. situation: my guarded optimism should not be taken as a statement that all is well. We have already suffered enormous, unnecessary damage because of an inadequate response to the slump. We have failed to provide significant mortgage relief, which could have moved us much more quickly to lower debt. And ... it will be years before we get to anything resembling full employment.

But things could have been worse; they would have been worse if we had followed the policies demanded by Mr. Obama’s opponents. For as I said at the beginning, Republicans have been demanding that the Fed stop trying to bring down interest rates and that federal spending be slashed immediately — which amounts to demanding that we emulate Europe’s failure.

And if this year’s election brings the wrong ideology to power, America’s nascent recovery might well be snuffed out.

Links for 2012-01-23

• Private Inequity - James Surowiecki
• Fed Set to Introduce Communications Policies - NYTimes.com
• Behavioral Eqs, Equilibrium Conditions, Identities... - Brad DeLong
• Process, Responsibility, and Myron’s Law - Paul M. Romer
• Are China and India converging? - Vox EU
• An iPod Has Global Value - Hal Varian
• Why did the ECB LTROs help? - Perry Mehrling
• Japans Lopsided Financial Balances - The Wilder View
• An Inconvenient Mankiw - Twenty-Cent Paradigms
• Immigrants as negative externalities - Modeled Behavior
• Wealth creation - Econbrowser

Who Should Pay for Deficit Reduction?

Richard Green makes an argument for progressive taxes:

The banal moderateness of Thomas Friedman, by Richard Green: In his paean to conventional wisdom this morning, the ever so serious Mr Friedman writes:

Second, I want to vote for a candidate who is committed to reforming taxes, and cutting spending, in a fair way. The rich must pay more, but everyone has to pay something. We are all in this together.

But how over the past decades have we all been in this together? In 2007, those in the bottom quintile had the same income they had in 1998, and a bump of little more than 11 percent since 1969; those in the top five percent have seen incomes rise by 74 percent since then.

Source: Alan De Smet plot of  US Census, Historical Income Tables - Families, Table F-1.

Sure, if everyone had benefitted from the policies of the past 40 years, then everyone should sacrifice now.

But for the time being, lets begin by asking for sacrifice from those with the means to do so.

When we measure who pays for bringing the long-run deficit under control, we should remember that deficit reduction is likely to include both cuts to spending and tax increases. We should also remember the complaint from the wealthy that most of the benefits of government spending go to lower income classes. According to this argument, the cost of reducing the budget deficit through cuts to government spending -- and Republicans will push for this option as much as they can -- will fall mainly on the less fortunate.

Do Republicans Want to Win the Presidential Election?

It's been puzzling so far, but I think I figured out the Republican strategy for the presidential election. Obama is already giving them everything they want in terms of policy, pretty much, and there's no reason to think he'll change after the election. Centrism is not an act for Obama, it's who he really is and when you compromise from the middle, and do so poorly -- i.e. give up most demands for one or two centrist bits in the final legislation -- the outcome leans heavily to the right. Given that, it's not at all clear that Republicans would be able to reach more of their goals if they controlled the presidency and faced united opposition from the left rather than the fractured opposition they face under a Democratic president.

And the right certainly has nothing to complain about when it comes to war mongering, domestic spying, and the like. Republicans are getting everything they want, more than they ever could have dreamed of with a Democrat in power, with little outcry from the leftists that usually make such a fuss over these types of activities.

Plus, the president is taking the blame for the lousy economy, and they are able to make headway in their long held goal of discrediting Keynesian economics. Having a president who only half-heartedly at best supports Keynesian policies -- witness the pivot to deficit reduction at the drop of a hat when it looked politically convenient -- means that the outcome of the policies will be as lackluster as Obama's commitment to them. So long as Republicans can block more effective policy, and so long as the president acquiesces and doesn't blame Republicans for obstructionism, etc., Republicans can win this war. That socialist, Keynesian (or is it Kenyan?) president tried it his way, and it failed!

If a Republican takes the presidency, that blame will fall on them. Sure, it's possible that the economy will take off over the next four years, but more realistically it's looking like more of the same sluggishness, a slow, agonizing, "are we there yet," recovery that won't be helped at all by the deficit reduction that lies ahead (thanks to one of those wonderful compromises by the administration). Who wants to preside over that? Instead, why not put up some weak candidates, very, very weak, and give the win to Obama? He's already done a lot of their work for them, why not let him take the lead in dismantling social welfare in the name of deficit reduction (e.g. Obama has often cited Social Security as a target).

I realize that Republicans really do want to win, they hate having Obama in power, but from their perspective would it really be so bad if they lost?